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Hanesbrands Inc. (HBI)

April 04, 2013 6:00 pm ET

Executives

Charlie Stack

Richard A. Noll - Chairman and Chief Executive Officer

Richard D. Moss - Chief Financial Officer

Gerald W. Evans - Co-Chief Operating Officer

Analysts

Matthew McClintock - Barclays Capital, Research Division

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

Susan K. Anderson - Citigroup Inc, Research Division

Eric M. Beder - Brean Capital LLC, Research Division

Omar Saad - ISI Group Inc., Research Division

Tom Roller

Eric A. Alexander - Stifel, Nicolaus & Co., Inc., Research Division

Charlie Stack

Good afternoon, everyone, and welcome to the investor meeting here in Las Vegas. My name is Charlie Stack, and I'm the Chief Investor Relations Officer here at Hanesbrands. Yesterday, we held our annual shareholder meeting and we welcome those of you that are here today, as well as those listening in on the webcast.

We did issue a news release earlier today, and the release, along with the audio replay of the webcast of this call, can be found in the Investors section of our hanesbrands.com website.

I want to remind everyone that we may make forward-looking statements 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 and may be found on our website and in 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 were made.

Please also note in May 2012, Hanesbrands announced exiting certain international and domestic inventory categories that are now classified as discontinued operations. Unless otherwise noted, today's speakers will be discussing our performance from our continuing operations. Information on discontinued operations and financial results for prior period continuing operation is available on the Investors section of our hanesbrands.com website.

Also, references in this presentation to earnings per share, EBITDA, gross margin, SG&A and operating margin represent continuing operations, excluding charges primarily related to items such as bond prepayment expenses in 2012, and for 2007 to 2009, gains related to pension and post-retirement benefits, restructuring and related expenses and other debt prepayment expenses.

Free cash flow, as well as EBITDA and EPS excluding actions are considered non-GAAP performance measures. For reconciliation to GAAP, please see our press releases dated January 28, 2009, January 27, 2010, February 5, 2013, which are also available in the Investor section of our website.

With us here today are several members of our management team, including our Chief Executive Officer, Rich Noll and our Chief Financial Officer, Rick Moss. For today's agenda, we have a short presentation that Rich will go through, and then we'll open it up to Q&A, with which myself, Rich and Rick will handle. And with that, I'll turn it over to Rich.

Richard A. Noll

Thank you, Charlie. Before I start today, I'd like to talk a little bit about the IR transition that we've alluded to over the last couple of months, specifically about Charlie Stack. As you know, this -- we've talked to Charlie about leaving the Head of IR and going back into the business, and that's going to be effective on May 1. His new role is going to be the VP, General Manager of Canada Innerwear. So we want to thank Charlie for all his great contributions he's made in his previous role, and we think it's about time that he get back to the business and start helping us drive results instead of just talking about it. So please, everybody, make sure you congratulate Charlie. And he's done a great job, and we know he's going to do a great job in the future.

Also, I'm going to talk about who is going to take over his spot also starting on May 1. He joined us April 1. His name is T.C. Robillard. He's joining us from Cbeyond, where he was the head of IR. He's also got 15 years of both buy and sell side experience, and T.C.'s also in the audience. So those of you that are here today will get a chance to meet him. He and Charlie will overlap over the next 30 days, and so he'll make sure that -- Charlie will make sure that you get a chance to meet T.C. and we expect a very smooth transition.

So with that, please welcome both of -- welcome T.C, and I'll start my prepared remarks. What I'd like to do is actually do a recap, a short recap, of a number of the themes that we talked about just a little over a month ago at our Investor Day in Winston-Salem. From that, I'll segue into detailing a little bit of the announcements that we put out this morning or a few hours ago this afternoon, and then we'll open it up for Q&A.

So let me highlight the 3 key themes that we went through on that Investor Day and that are driving -- that we focus on to execute our strategy to drive our results. And it's first, we have a strong consumer franchise, a hallmark of any good CPG company as reflected in the stability of our financial performance in very volatile times. Second, our Innovate-to-Elevate strategy allows us to leverage our most precious assets, our strong brands, our approach to consumer-driven innovation and our great global supply chain, all of which combined to allow us to organically grow sales and increase operating margins towards our 12% to 14% goal. And third, our strong free cash flows with a price -- free cash flow ratio of about 10, our cash flow is substantial relative to our valuation, as that by itself creates many opportunities for substantially increasing shareholder returns.

Let me detail a couple of these themes from -- and using a couple of the slides that we showed you back on that day. And the first, which is part of our Innovate-to-Elevate strategy, is our big strong brands. Hanes, in fact, is the third largest apparel brand in the United States in terms of dollars and #1 brand in units. We have 4 brands with $400 million or more of annual retail sales, and we hold the #1 or #2 share in every category in which we compete. Importantly, our brands resonate with consumers, young and old, rich and poor, and they span from aging baby boomers to new second wave millennials.

Over the past 6 years, we have spent over $0.75 billion in advertising, R&D and quality improvement, and the result is that our leading brands have never been stronger.

The second piece of our Innovate-to-Elevate strategy is the innovation platform. We use a disciplined process just like any good CPG company. We call it the big idea process. It starts with needs that we understand that consumers are looking for in our products. We make sure they're in big categories. We make sure we're developing great products that work and fulfill those needs. Advertise them, make sure it's big at retail, and we do all of those things that greatly increases the probability of success of those new product launches.

We are driving 3 major platforms going forward. One is the TAGLESS platform, the second is our ComfortBlend platform and the third is our Smart Sizes platform. And we talked about all those platforms in detail at our Investor Day. And for those of you that came to Winston-Salem, we gave you the opportunity to touch and feel a lot of the products.

And those 3 -- those things are delivering results. And in fact, it's one of the things that's helping drive such great results in the first quarter from a margin perspective.

By executing on this strategy over the last number of years, it has absolutely been driving results. From 2009 to 2012, we grew sales $800 million; operating profits, over $100 million; EPS, over $1; and all while reducing leverage 2 full turns. And we are not done. In 2013, using the midpoint of our guidance, we intend to grow sales another $100 million; operating profits, $85 million; EPS, $0.70; and all while reducing the leverage close to another full turn. And given that these results happened in spite of cotton inflation, it demonstrates that we have pricing power, that we can successfully manage volatile times and that we strive to do what we say.

Now turn your attention to this slide to the red boxes and look at the relationship of compound annual growth rates for sales, operating profits and EPS. Each growth rate increases substantially as you walk down the P&L from 5% compound annual growth rate for sales, increasing to 12% for operating profit and increasing again to 21% for earnings per share. That's a relationship for which we continually strive, magnifying those growth rates through down the P&L, and it's the essence of our financial model.

Those are the things that Innovate-to-Elevate strategy with a strong consumer franchise have been driving the results of our P&L that I just showed you. And the third plank is our free cash flows. We've been using those free cash flows to delever over the past couple of years, and it's been the right thing to do. But now, we need to talk about what the potential uses of those free cash flows are going forward.

The first is dividends. I'm happy to announce, as we announced today, that we've instituted a regularly quarterly dividend. We had our board meeting yesterday, we met. And as we looked at our track record of delivering results against executing the strategy over the last couple of years and our near and long-term optimism about our future potential, the board felt it was the right time to institute a regularly quarterly dividend. So we announced today that we're initiating a $0.20 per share per quarter dividend with this quarter's dividend being payable on June 3.

Obviously, we'll do it again next quarter, payable in September, and the third quarter or the last quarter of the year would be payable in December. It annualizes out to about $0.80 a share. Obviously, this year since we initiated a little bit end of the year, it will be $0.60.

On Investor Day, I talked about our long-term philosophy about dividends and sort of what the guard rails may be, at it being 20% to 25% of free cash flow to go to dividends, normalized free cash flow, which we discussed being around $400 million right now. So the 20% level gives you around $80 million or about that $0.80 a share -- per share per year level, growing to 25% over time. And then clearly, as time goes on and our normalized free cash flows grows, obviously, if you keep the same ratio, so would the dividend. So we feel very good about implementing this leg of our usage of free cash flow.

But we won't be done with just that. We've also got the potential for bolt-on acquisitions, as well as share repurchases. We've got very strict criteria for bolt-on acquisitions, as you can see here, being in our core categories; financially justifiable based on cost synergies; provide complementary revenue growth opportunities; and outside of transaction cost and such -- things such as that, be accretive in the first year. And we feel very good about our potential to grow organically, but we also see that we can also create value as we've done with Gear For Sports acquisition that we did in 2010 to create value by leveraging this great supply chain and Innovate-to-Elevate infrastructure that we've created here over the last couple of years.

So with that, I'll turn to the other piece of the announcement that we made today, which was we wanted to preannounce the quarterly earnings. It is very early in our quarterly close with the quarter just ended on Saturday. So while we have preliminary top-level results, we do not have all of the details by any stretch of the imagination, by segment, or at the level of detail, such as gross margin and things like that. So we are not going to be discussing that level of detail today. That will need to wait until our normal call on April 23. However, let me top line the results and give you a couple of drivers before we open it up to Q&A.

First is our sales are expected to be approximately $945 million. As we talked about on Investor Day, we were seeing sales being impacted negatively by the income tax delay that was quite dramatic, actually, over about a 3 to 4-week period in late January and early February. And that accounted for about $20 million of impact in the quarter.

We're also seeing -- in March, we started to see some softness. Later in March, it started to normalize. But then later in March, as snowy and cold weather was happening through a lot of the United States. In fact, we just heard that it's snowing in Winston-Salem today, so that cold snowy weather still isn't over. Compared to last year's, very early spring, and that probably is going to impact sales, I think about $5 million to $10 million. So those are the 2 major drivers that ended up having sales to be a little bit below our overall expectation of what we were thinking about for the quarter.

In terms of earnings, operating profits are expected to be between $82 million and $85 million, and EPS is expected to be $0.48 to $0.51. That expectation is versus our base plan of $0.40 for the quarter. So while we're a little bit ahead of it, it's -- part of that we think is going to be about timing and probably about at least $0.05 of it though should be a good solid beat for the quarter. So we feel really good about the earnings that we're going to -- that we're seeing for Q1.

Over the next couple of weeks, we'll do all of the bridges. And when we do our normally quarterly call, Rick will be able to talk you through all that to help you better model it. So with that, I'd like to reconfirm our full year guidance. It's really great to have good earnings in Q1 to be able to reconfirm guidance, and that is full year guidance of sales of $4.6 billion, operating profits of $500 million to $550 million, EPS of $3.25 to $3.40, and we still expect to pay down the last $250 million of our 8% notes in the fourth quarter, I think when they're due in December.

And with that, that ended my prepared remarks. And I will ask Rick to come up, and we'll open it up for Q&A. And there are some microphones, so that we -- and Derek will bring it over to you so we can -- Matt's got the first question, and then after that, Eric?

Question-and-Answer Session

Matthew McClintock - Barclays Capital, Research Division

Yes, Matt McClintock, Barclays. So, Rich, you said you were going to double EPS and you're -- you've pretty much done it. You said you were going to delever, and you've done it. And you hinted at doing a dividend, and now you've done that, too. How confident should we be or should we increase our confidence in your ability to do bolt-on acquisitions that are accretive in the first year, and how's that looking?

Richard A. Noll

Really, I'll go back to that slide where I showed our history over the last 5 or 6 years. We have been constantly executing against these strategies year in and year out when recessions came, when inflation came. And it is paying results and it is evident in those financial results. We feel really good about their track record, the strategies are right and it makes us feel real confident about our near-term and long-term future. We've built, I think, just a great thing with this Innovate-to-Elevate strategy in this global supply chain, and a great way to create value is to put bolt-on acquisitions into it and be able to derive more units and more volume through it and create a lot of value for shareholders. And we've demonstrated that with our acquisition of Gear For Sports. And clearly, it is part -- one of the 3 planks of our uses of cash flows, bolt-on acquisitions. First was dividends, we've now done that. And you'll see bolt-on acquisitions at some point in the future, there's no question.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

Eric Tracy with Janney Capital Markets. First, congrats on execution, the issuing of the dividend is great to see. I guess, if I could focus on top line, it sounds like about $30 million in the quarter coming from some transitory issues, be it the tax refund and/or weather. How should we think about top line for the balance of the year? The expectation certainly implies a reacceleration against more difficult compares, so be it from a unit basis or pricing basis and, obviously, just speak to the program that you have in place that helps support the reacceleration.

Richard A. Noll

Yes. So we didn't put it in the presentation, but I'll remind you about a slide that we actually showed. I think it's one of the most important slides to think about when thinking about our business overall because of that stability on an annual basis, where we tend to see some quarterly volatility. And that is, in our Innerwear business, the payers purchase per person per year. And there was a slide that I think Howard showed that said in men's underwear, it's been 7.7 or 7.9 in 2000 and 2009 and 2012. And actually, they brought it up for me. You can see some of the numbers here. And so when you look at -- that's just men's underwear. Bras are similar, panties are similar, so there's a lot of consistency in what people buy in our categories on an annual basis. In any one quarter, in any 3-week period, you can see volatility, but, and excuse the pun, it all tends to come out in the wash throughout the year and you start to see sales tend to normalize. And when it comes to weather and it comes to the tax refund checks, clearly, there was less traffic in those couple of weeks and there's less traffic this year than there was last year from -- because of the weather issues. But that will all sort of work itself out, and the stability of our categories will ultimately win out and you'll start to see it tend to normalize. In some cases, like with the tax refunds, you may start to see it come back in Q2. In other cases, you'll see it start to come back throughout -- slowly throughout the year. But there's a lot of stability in the purchases. On the activewear side, it's a little bit more simple, and I think it is a little bit more weather-driven. Right now, you've got a lot of retailers and us included with these kind of products. We've got tank tops out there, we've got shorts and there's not a lot of people buying those things yet. But one thing I am certain of, it will get warm. And as it gets warm, people will start to buy those products. So we don't see this as a major impact on our overall sales, that's why we’re sticking to our full year guidance of $4.6 billion. It's only about $30 million, as you said. That can easily sort of smooth out through the next couple of quarters.

Eric B. Tracy - Janney Montgomery Scott LLC, Research Division

And then maybe just speak to the new programs you're making for men's underwear in [indiscernible] Wal-Mart [indiscernible]?

Richard A. Noll

Yes, so -- and there's actually 2 things. So we've got a couple of good things that are sort of working in our favor from a sales momentum perspective. One is all of the new programs that we set last year that are continuing to build such as the ComfortBlend underwear that you're talking about. And we've got a lot of good positive wraparound yet to come from those. The second piece is we have a lot of space expansions happening in Q2. Over time, a lot of those space expansions would tend to happen late Q1. Over time, a lot of the retailers have shifted that to be a little bit later, and so we've got a lot of space expansions going out in Q2 as planned, and that actually starts to help us build momentum through a little bit later in the year. So we're feeling really good about our ability to maintain our sales guidance through the year. Susan?

Susan K. Anderson - Citigroup Inc, Research Division

I have a question on the guidance. So obviously, the upside's coming from the margins. Maybe if you can just give a little bit more color on what's driving that. Is it all innovation in cotton? And what percent is devoted to each? And then also, on just the timing shift that you mentioned for the first quarter, that will be a positive impact. Will that then be a negative impact on the second quarter?

Richard A. Noll

Rick?

Richard D. Moss

Yes, let me address the -- what I can, at least so far about the margins. Obviously, the margin is positively impacted by lower cotton prices last year. In the first quarter, cotton was $1.88. This year, we still haven't seen the final number on that yet, probably $1, slightly less than $1 this year, so a significant drop there. That does account for a lot of the margin expansion. Along with, though, our continued implementation of the Innovate-to-Elevate strategy driving things like our ComfortBlend product with higher margin. So we are seeing good results from that. So as you look at roughly dime [ph] that we beat our expectations, as Rich said, as we go through the -- our initial path through the numbers looks like maybe about half of that is timing, probably a shift from Q1 to Q2 for the most part. I won't say it exactly looks good, but for the most part that's where it is. So still -- it was very good for the rest of the year.

Susan K. Anderson - Citigroup Inc, Research Division

And then just one follow-up. If you look at the NPD data, the units, particularly in men's underwear, have been down pretty significantly over the past couple of years. So do you guys think this is kind of like a new norm, like a new base, or do you think that people have been buying less and eventually they'll get back to what they were buying before?

Richard A. Noll

Yes. So the units have been down -- we'll stick on men's underwear as your specific question because as prices went up, elasticity was less than 1, but units clearly have dropped through the entire industry and that's actually driven our units down as well. Now that we're going into this year and one of our major strategies, especially in men's underwear, was to negate some of the -- that last price increase that was designed to go to the -- by, I think, $1.50 or so cotton, $1.40, $1.50 cotton by increasing pack size, which is actually now going to start to allow units to start to trend up. You asked the right question in terms of, okay, it's sort of like gasoline. When gasoline first broke $2.50 or $3, everybody pulled way back. After a while, people get used to it and they start going back to their old consumption patterns. I think you'll tend to see that in our categories over time, but not necessarily the next quarter or even next year. But I think, remember that stability of pairs purchased per person per year, it tends to be relatively stable and there's no reason to say that it's going to magically go down because prices went up. But I think it will take a little while for it to work itself through. Eric?

Eric M. Beder - Brean Capital LLC, Research Division

Eric Beder, Brean Capital. Could you talk a little bit about the elasticity you're seeing in terms of raising prices with the newer products? And is the value message from it that it's worth this extra money coming through as loud and clear in doing it? And I know you can just start to aggressively advertise that product, too. How has the response been to those?

Richard A. Noll

Yes, all of our new products that we've had out there now for quite a long period of time are working extremely well. They're delivering on the goals or exceeding the goals that we have. The ComfortBlend product that you're talking about has a 30% price premium to the basic product, and it is hitting or exceeding all of our plans and our retailers' plans. And so -- now, you can't just do that, as you said, by putting the product out there. You have to advertise it and tell the consumer that these new products are out there. And so clearly, we feel very comfortable in how it's working. These are, and pun intended and I'm actually going to steal Howard's joke from Investor Day, the ComfortBlend T-shirt is what we call a drawer-changing event. And that was his joke, not mine. So if you don't think it's funny, please blame Howard Upchurch for that, the President of Innerwear. And what that means is people buy this product. They try it. They like it so much better than their current product. They go out and buy a bunch more and throw out all their old underwear T-shirts. We saw that phenomena happen when we introduced TAGLESS, the first time in underwear T-shirts and we're seeing it again with ComfortBlend. And so what that does is it really helps increase the category and the units in the category for a good long period of time, and it tells you the effect, how well they're working, if the innovation is working. So we feel real good about our products. And one other, same thing with the Smart Sizes bras, the other platform that we talked about. Those products are working extremely well. Some of them after launch have become the number -- top 5 I think of products in the department store and mid-tier retailers they've been in. And remember, that strategy is to go from, I think it's 32 cup-and-band sizes down to about 8 -- 5 or 6 small, medium, large, extra large sizes. So not only does it provide great fit and is easier to shop for a woman looking for a bra, it also substantially reduces our SKUs and our retailer's SKUs, which lowers our costs and increases overall inventory turns. So you can also have a win-win with innovation. Better for the consumer, better for the retailer and better for us.

Eric M. Beder - Brean Capital LLC, Research Division

Great. And in terms of you've talked historically about how the supply chain continues to offer like 50 to 100 basis points of annual gross margin gains. Are those -- are we still in that cycle that the supply chain can do that?

Richard A. Noll

So we've talked historically about the supply chain being able to generate $30 million to $40 million a year of incremental cost savings. I don't think we focus it on a basis-point improvement. We've talked about it in terms of dollars. I think the important thing, though, to think about the way we're improving margins going forward, it's not independent things where we're doing cost savings on supply chain or we're doing innovation to increase some certain prices, we're also building our brands. You really got to think about that integrated Innovate-to-Elevate strategy, where it's a strong brand that we talked to with the consumer that gives us the ability of premium price coupled with innovation, coupled with leveraging that supply chain. All 3 of those things work together to allow us to increase our overall operating margins to that 12% to 14% goal that we have.

Eric M. Beder - Brean Capital LLC, Research Division

Last one for me. Just last one on Macy's. When is the Macy's rollout going, and how are you feeling about that?

Richard A. Noll

It ships in May, so it will hit stores probably by June, you'll start to see it. Yes, Father's Day. And so we'll be able to give you a read on that, probably not really a good read until the quarter -- October call. Omar?

Omar Saad - ISI Group Inc., Research Division

Can you and Rick maybe address a little bit, now that you've instituted the dividend, talk about capital structure, strategically how you're thinking about it? First of all, a little bit of a backdrop behind why the dividend over the share buyback. I know it's something you had mentioned previously at the Analyst Day, and especially if you think about how your view on the stock is being pretty undervalued by the market, why is share buybacks not a better use of cash? And then secondly, now that you've instituted a dividend, is the priority to grow the dividend or buy back stock in the absence of bolt-on acquisitions?

Richard A. Noll

So in terms of the overall capital structure, we've talked about a leveraged long-term debt-to-EBITDA ratio between 1.5 and 2.5. We ended last year at 2.5. We should end this year somewhere about 1.5. So that's sort of our overall leverage. It's pretty well done and taken care of. We did talk about dividend being a priority, because when you think of a business model such as ours, with a strong consumer franchise, pretty darn stable through volatile times, hyperinflation, ability to derive margin potential that generates a lot of strong free cash flow, it makes sense for a company such as this for the financial model to mirror that business model and therefore pay a dividend. Good strong companies with good cash flow and growth prospects pay dividends. We're an anomaly by not. We hear constantly from a lot of investors or potential investors, the fact that we don't pay a dividend relegates this to sort of segment of the market that we really don't want to be in because it's not our -- it's not a good reflection of our business model. So it's an absolute must. The board felt really good about our track record historically, feels very good about our near and long-term prospects, and that's why the dividend now. In terms of acquisitions versus share buybacks, as we said, both of them will be part of the mix over time. You're right, given our strong free cash flow and earnings potential, you're the one that says that our stock tends to be overvalued. I think that we need to formulate what our right share buyback strategy is. But first, we wanted to delever, institute a dividend and over time, we'll go through bolt-on acquisitions and think about share buybacks.

Omar Saad - ISI Group Inc., Research Division

Is the -- in the absence of acquisitions, though, would the priority be to grow the dividend or to do share buybacks? Or have you not determined that?

Richard A. Noll

Talking about hypotheticals at this point just doesn't make sense. We've laid out what our strategies are. We laid out how we think about it. Now what we need to do is just to continue to execute against our business model. And when things happen like today, that we just -- or yesterday we instituted a dividend, we'll announce it. It'd be the same thing with those other things.

Omar Saad - ISI Group Inc., Research Division

All right. That's helpful. Just a quick clarification question on the timing issue, is that timing of SG&A first quarter, second quarter or some other margin drivers?

Richard A. Noll

I'll answer that on April 23. We're still, as always, still kind of working through a couple of things. I'd rather answer that later.

Omar Saad - ISI Group Inc., Research Division

Fair enough. But clearly, gross margin was a driver, given the year-for-year kind of decrease in cotton cost?

Richard A. Noll

Yes.

Omar Saad - ISI Group Inc., Research Division

And then on -- any updated on -- any updates on your JCPenney business? I know there's been some kind of top-to-top industry meetings. It's been a drag for a lot of vendors who sell into that channel. Any insight into when you might be able to recapture some of that business?

Richard A. Noll

So Penney's used to be about 2% of our sales. Last year, it dropped to about 1.25% so we did start to see their appeal less start to normalize as we started to overlap last year's elimination of promotions and everything. And I actually don't have all those figures on the top of my mind. However, I do remember the one comment that we started to say is, when we were looking at -- was the income tax refunds and looking at some of the weather impacts, JCPenney was starting to look much more like a lot of the other accounts, than how it had been over the last year or so, which was a big outlier, I don't remember the specific numbers but I remember we were making that comment. We'll get a much better read on some of those types of things because when we announce earnings on April 23, because we'll get the next 3 weeks of POS, which includes Easter, which is going to be critical for us to really have a good understanding of now that the weather is behind us and the tax refund stuff is behind us, sort of what the run rate looks like for Penney's and other accounts as well.

Omar Saad - ISI Group Inc., Research Division

One last quick question, sorry. On...

Richard A. Noll

Sure. We've got plenty of time. Don't worry about it.

Omar Saad - ISI Group Inc., Research Division

You mentioned on the Smart Sizes kind of the 3 big ideas you put up there, your ComfortBlend tag was really easy to kind of get your arms around as investors. Yes, Smart Sizes, sounds like it's off to a good start. Can you help frame how big a business this is? Is it still -- are we still in the infancy stages? Obviously, the kind of wholesale intimate apparel, women's bra business, if you will, is a big business, a big industry. And are we really talking about something that transforms the industry? Just kind of help us frame it.

Richard A. Noll

So one of the things that I always like to talk about when we talk about innovation isn't new products for new products' sake, what some people call newness or even niche products. For us, it's really about innovating the core. And one of the examples I'd like to use is from using Tide with P&G. So Tide has been the #1 detergent brand for 60 or 70 years. But the Tide that you would buy in 1960 is very different from the Tide you would buy today. They constantly innovate it by doing line extensions, but really innovating the core and improving the base product. We use the same kind of philosophy. So our goal is to always make sure that we are zeroing in on the big consumer needs, which ultimately end up being in core products. TAGLESS is a great example of that. You innovate the core, and that's what really drives incremental units in a big way. Now you can't always innovate the core. Sometimes like ComfortBlend, you launch your product, it's going to probably be 10% or 15% of the market sometime soon. Over time, you'll probably see that grow to being 40% or 50% of the overall market and become the core. Smart Sizes probably has that same kind of ability over time, because it's a lot easier to shop that fits almost as good, or is as good, if not better, across most size ranges. It's easier to shop, easier for the retailer, easier for us. And so I think over time, you're going to see that kind of product gain share throughout the entire marketplace and those that are there first and then own that proposition are going to do the best, and I think that's the best way for me to frame it. Matt [ph]?

Unknown Attendee

Yes, I just have a follow-up question to Eric's question earlier and your answer. You said that you still get the $30 million to $40 million in annual cost savings; that we need to think about that now more holistically within the Innovate -- the broader Innovate-to-Elevate strategy, by the end of this year, we could be bumping up on the lower end of your 12% to 14% longer-term operating margin goal. And what I want to ask is, when we start to get within that 12% to 14% range, does that mean that you'll start to perhaps maybe reinvest the $30 million to $40 million into the product itself and perhaps not let it flow to the bottom line like you have before in the past?

Richard A. Noll

Well, in fact, some of that is already happening. That's why we've talked about how we don't want to commit to a $40 million cost savings goal that's going to drop through the bottom line each and every year. That's why you need to think about this as a sort of an overall integrated approach. Some of the products that we're launching actually cost more to -- and have lower productivity levels than -- that's one of the reasons we are able to get higher prices where we need to get higher prices for them. So you have to think of it more as an integrated approach. You're right, the high-end of our guidance is actually I think an operating margin of 12%. And so clearly, we're starting to get right into that level. I feel real good about the overall trajectory and it will be sustainable. Not only do we want to continue to drive this innovation, we want to continue to talk to the consumer, continue to increase advertising so that we're talking to consumer in the right way, continue to change the mix of that advertising about 20% -- I think it's about 20% today is Internet-driven media, social media and those things. You're going to see that tend to grow over time. So we're going to work on all those things to make sure the health of our brands is better than everybody else in the marketplace.

Unknown Attendee

And if I can get one more, please, sorry.

Richard A. Noll

Sure.

Unknown Attendee

So Maidenform has come out and mentioned that they're going to enter the full figure bra market by the end of this year, and I just wanted to see if you had your thoughts -- any thoughts on that at all in terms of potential competitive threat?

Richard A. Noll

So let me help everybody understand the bra market. So we look at it in terms of -- segment it 2 ways: age and size. So under 35 versus over 35, average figure versus full figure. So think of that 2 by 2 matrix. The 2 biggest categories are under 35 average figure and equal in size is over 35 full figure. So what intimate apparel brand would you think of if I say under 35 average figure? They have a lot of stores and it's a secret, right? So Victoria's Secret is really, really strong shares at that under 35 average figure and I think they're about 4x the next largest competitor in that segment. We have in that similar size market over 35 full figure, a similar type of share advantage. It's about 4x the next largest competitor. So that's where we've really focused our Playtex brands and our Bali brands, and so we feel really good about the strength of that position. It's hard for somebody such as Maidenform, who probably tends to be a little bit more an average figure, but across the full spectrum of age range, to try and then morph that brand equity into that at over 35 full figure, because it's just not going to translate or resonate with that consumer. I've seen these types of things tried before, and Maidenform is a great average figure brand. There's no question about it. Going into full figure may prove problematic and we welcome any competition. But we feel really good about our competitive situation in that category.

Unknown Attendee

I got a couple of follow-ups here. First is, really, it's the free cash. You've essentially said $400 million sort of annualized level. Beyond operationally, is there anything from a CapEx perspective we should be thinking about? I get most of the infrastructure in terms of international manufacturing has been established, if anything, is stepping down over the next year or 2. But anything from a CapEx incremental investment that needs to be made over the next 2 to 3 years that could somewhat mute the free cash flow outlook?

Richard A. Noll

No. We've been $40 million to $50 million in the last year or so and I would expect us to be in kind of in that range for at least the next 2 or 3 years.

Unknown Attendee

All right. And then the second one, Rich, this may come as a surprise that I'm asking this, given I've sort of pressed you for the last couple of years on deleveraging as much as possible. But now that the business has stabilized, you've gotten rid of some of the volatility. Why the 1.5 to 2.5x? You're essentially a vertically integrated manufacturer. What are the thoughts on the longer-term sustainability of having a cash structure with a greater leverage profile, and how do we think about that?

Richard A. Noll

What have you done for me lately? First, mention the news from S&P.

Richard D. Moss

Yes, some of you may not have seen this. S&P today upgraded our debt rating to BB. So now both the agencies are -- or have recognized the improvement with ratings upgrades. I would say in terms of the capital structure going forward, I'd love to get to 1.5 first by the end of the year before we do that. I think what we've said historically is that range, of 1.5 to -- give us enormous financial flexibility. The ability to do what we need to do when we need to do it. Our access to the debt capital markets is very, very strong. It was when we were levered a lot more, and it will be -- it's even more so now in a broader range of economic environment. Again, it gives us tremendous flexibility. We love that. Look, I'm the guy who put most of the debt in place. I miss it sometimes. Now and again, I miss it. But I'll tell you, I feel much more comfortable with that as a platform for building our company in the future with a capital structure like that.

Richard A. Noll

And I know -- we've talked about this over time and I know that you're raising the question for a number of reasons. There is absolutely no question we've talked about is that the fact that we had a lot -- very high leverage and did -- never had a demonstrated track record of paying it off is the thing that -- was the anchor around the -- we talked about it as the anchor around the neck of our PE multiple. As that anchor is being cut, you're starting to see our PE multiple just float up, it's happening in the marketplace. With -- many investors have said that they predicted that, that was going to happen and I think it's a great thing. So no reason to go for us above that 2.5, but right now, we're tracking towards 1.5 by the end of the year.

Unknown Analyst

Okay, 2 follow-ups here, one on advertising. So I know historically, you've cut -- had to cut back, brought it forward and now -- I think it kind of pained you to cut back on the advertising if I remember the periods you had to do it. Going forward, what should we expect in terms of the rate of advertising increase? Can you talk about how it's going to shift. How should we think about that kind of shift?

Richard A. Noll

Well, so in terms of this year, we've talked about reinstituting media on a level of $30 million to $40 million. We did cut it back somewhat last year for 2 separate reasons. One, as we were redoing and revamping some of the bra business, that media that we were spending in that category was not working and so we wanted to pull back, drive the Smart Sizes platform, use other vehicles to get that news out there that is paying good dividends. It's working really well. This year and next year, we'll reassess the role of TV advertising in that category. The second reason was we did cut a little bit back on some of the other stuff just because of the inflation that we're dealing with, yet still fully supported all of the innovation that we had. This year, we have even more innovation. Therefore, we needed to ramp it back up $30 million to $40 million. I think going forward from here, it will clearly grow at a faster rate than sales, because of the level of innovation that we have and our margin structure can support it. I don't want to be very specific about it for competitive reasons, but clearly, for us, media works. We can see it, you can see it in our brand equity measures and so we'll keep using it as a strategy as long as we have great innovations to talk about.

Unknown Attendee

Okay. About the innovations, I guess, there's 2 -- I have 2 kind of thoughts I want to kind of broach here. One is, that the innovation, some of them have less cotton. Does that -- is this -- there's a little bit less cotton...

Richard A. Noll

Yes.

Unknown Attendee

Do they reduce your dependence on cotton as they become bigger and make the numbers less variable as we've seen with the cotton, up and down?

Richard A. Noll

At the end of the day, the bulk of the products being sold in the United States are cotton-based. And you see that from some of the performance-oriented activewear brands. Realizing if they really want to tend to grow and continue growing in a big way, they need to be in cotton-heavy types of product. And so cotton is here to stay. It's a big part of what we sell. Things like the performance fabrics do on the margin, reduce that but not substantially so.

Unknown Attendee

Okay, and the other thing is that you mentioned that you had to raise pricing at the same time because it's -- I guess, it's in the beginning stages and it's not fully ramped, so about the margins -- even though you've raised the prices higher -- or maybe I'm reading this wrong. How do we look -- how should we think about these margins on these innovative products, raising pricing on a relative basis higher? Where does the margin go? Does this get you even further along in '12 to '14, if these products go from I don't know, 10% to 50% on your type of profit [ph]?

Richard A. Noll

All right. Now I understand. When you say raising price, I started thinking about it as raising price on a product, taking it from -- like we did when we were raising price due to cotton, from $10 at retail to $11. What you really mean is sort of introducing products, value-added product to get higher prices per unit and then you get a mix shift that raises your overall average price. So yes, innovation does help from that perspective, but I want to remind you, we make great margins on all of our products and some of our core products are our most profitable products in our line. And the reason is we can max scale of production of making the same thing over and over and over again, and that allows us to really improve the productivity of those products and drive down those costs. So while some of them are going to be margin-accretive, there's no question about it, they really do drive the price per unit, which is always a good thing, but our core makes a lot of good margin as well. It's an integrated strategy where you need to slowly shift the mix over time, make sure your business stays healthy, it allows you to continue to grow, keep being recognized as one of top brands, being the innovative [ph] brand, and therefore, it's more likely to be a brand that people identify as for someone like me and delivers great innovative products and is worth the price. And if you can hit on those 3 brand equity measures, which we track, you're going to have very strong shares, and we excel in all of those.

Unknown Attendee

If I take those measures and [indiscernible], I don't know, from 10% above sales synergies [ph], is that going to cost you some margins, or is the cost to make those make them a negative now?

Richard A. Noll

Yes, so the question is -- because they didn't hear it on the webcast. The question is exactly how does all this work through your mix and impact the margins and so on. And I don't want you to think about it from that tactical of a basis because you really want to think about driving innovation from a long-term perspective and it's what allows us to build a sustainable business to get in those 12% to 14% operating margin ranges.

Tom Roller

Tom Roller with Janus Capital. Can you address kind of where you stand right now in inventory turnover metrics? And it seems like you're a little bit below kind of where you were maybe a few years ago. And what are the opportunities to kind of drive that inventory turnover higher now that your margins have stabilized to a nice level?

Richard D. Moss

Well, one of the key drivers of our free cash flow in the last while has been our ability to drive down inventory. During the time that we were shifting the geography of our supply chain offshore and then -- between the Eastern and Western hemispheres, we did build some inventory. Obviously, when cotton prices got high, the inventory built again and we're seeing the benefit both of the footprint now being in place as they will optimize that footprint and the cotton coming out of inventory. I think that bodes well for our future in terms of our ability to drive our turns. We're very focused on getting our turns up to about 3x, inventory turns up to about 3x, which is a substantial improvement over where we've been. That will continue to drive free cash flow generation for the next couple of years, and help us to be actual -- to have working capital either be positive or no worse than neutral for us.

Tom Roller

You think you can kind of fund future sales growth with the actual maybe inventory flat or reductions?

Richard D. Moss

Yes, I think as our marketing and supply chain teams work together, we'll -- we are very focused on improving the efficiency of the inventory.

Richard A. Noll

Susan?

Susan K. Anderson - Citigroup Inc, Research Division

So we've talked a lot about underwear but haven't really brought up the Champion brand. So I thought maybe if you could remind us of the space gains there this year and where do you see the white space left to grow that brand both from a distribution and then product expansion standpoint? So is the right growth rate kind of like a mid-single digit growth rate for that brand?

Richard A. Noll

Well, we won't get into the specific growth rates of the brand. We don't get into that level of detail. But we've got great space gains in both, what we would call, the mother Champion brand as well as continued driving of the C9 by Champion at Target. We've seen a lot of space expansion across the board, especially in sporting goods arenas, and -- but we also see distribution, as I said, at Target. So we expect that brand to continue on a good growth trajectory.

Unknown Attendee

Can you talk about international a little bit and step back this year, maybe some of the challenges you're facing near term, as well as the opportunities for the next 2 or 3 years?

Richard A. Noll

Let me have -- Derek, would you give the microphone to Gerald Evans, our -- one of our co-op -- co-Chief Operating Officers and -- to detail some of the international highlights, not from the quarter, but at least talking about the longer term last year and some of the pressures you're seeing or you expect to see this year.

Gerald W. Evans

Sure, what -- and we've covered a great deal of this in the Investor Day, but from my standpoint, we really had 2 headwinds we're trying to overcome this year. We have currencies that were running about 5 points or so of headwind for us and another couple of points coming on the sales line from the retail transition in Canada where Target had bought out Zellers stores. It's one of our largest customers in the market. Canada is one of our largest international markets. Closed all the stores, now they will gradually open them up through the year, through 2013. So that has a headwind against us that we have to overcome. But what we spoke about was, fine, those are the things we can't control, but there's a lot of things we can control and they're really about doing a better job and executing, taking these great things you're hearing people talk about, these innovations and driving them faster across the international markets, not just in the U.S. market. Doing a better job of driving our regional scale. We've got some very nicely established businesses in the various regions and doing a better job of taking their management and their supply chains and driving it. So what we really have focus -- we have 4 regions, we've got our North America region, which is the Mexico and Canada businesses that we're working to more clearly integrate into our U.S. business through those adjacencies. We're driving our Asia business out of our very well established and long -- very long but least successful Japanese business, which would also then manage the Chinese business and some of the others in the region. South America, we've got 2 very successful businesses in Brazil and Argentina, where we hold leading positions. We're levering the management strength in the supply chain scale across the region there as well to really drive the businesses forward. And the last area is Australia that we entered 2 years ago with a small acquisition, doing very well and we're going to continue to drive out that acquisition and we think that, that represents a lot of positive growth. So as we look forward to 2014, we think you'll see it get back into sort of the single digit growth and double digits as you get beyond that towards the mid-decade.

Richard A. Noll

Any other questions? One over here.

Eric A. Alexander - Stifel, Nicolaus & Co., Inc., Research Division

Eric Alexander, Stifel. Just a quick question, trying to wrap around the model here a little bit. So I know this is a little bit for Rick here, the first quarter looks tremendous on the operating -- looks like I'm knocking [ph] out to somewhere 35-plus gross margin, some deleverage on SG&A. And then to fit to the top end of your guidance, I have to dial back my gross margin. Can you help me understand why you guys have good visibility in your pricing for the rest of the year, promos and such, I know Bill might be able to provide some detail on that as well. But just trying to -- try and help me out, thinking about long-term or at least over the next 3 quarters on gross margin.

Richard D. Moss

I can't answer that right now, because we're 3 days into closing. So I'd really like to stay away from talking about gross margin exactly where it is because we're still working through that. But suffice it to say that we feel very good about our guidance for the full year, and we feel like we've got a little bit of a momentum going through the first quarter. We're ahead of where we thought we'd be, so it gives us greater confidence in our guidance for the year and -- but I really would defer any discussion. I'll answer that question better for you on April 23.

Eric A. Alexander - Stifel, Nicolaus & Co., Inc., Research Division

I can appreciate that. I know you guys are really -- just wanted to just give it a shot.

Richard D. Moss

Michael hasn't bridged [ph] it for me yet, so I can't really bridge [ph] it for you.

Eric A. Alexander - Stifel, Nicolaus & Co., Inc., Research Division

And then one, this is more -- some of our recent checks out of the Denver area. We've noted at our -- going into a local Wal-Mart, some of the inventories were maybe down a little bit at the end of the quarter for HanesBrands versus say, Fruit of the Loom or some of the other brands out there. Are you guys seeing any tightening up from your retailers on inventories? Anything different than recent quarters?

Richard D. Moss

No. Actually, right now, inventories -- retail inventories seem to be in line relative to where they were last year, especially given the overall weeks of supply. So as I've said, as the sell-through drops early in February and then again because the March, retailers adjusted their inventories pretty darn quickly, so most of it showed up in the quarter, but they're right in line with where they should be and sort of where they were for -- they were at this time last year going into Easter.

Richard A. Noll

Yes, Susan? There and then over here.

Susan K. Anderson - Citigroup Inc, Research Division

So I guess, just looking out over the rest of the year and then the longer term, maybe if you can talk about, like you said those businesses are pretty stable business. To me, it seemed like the macro was the biggest risk and even with weak sales in the first quarter, you guys beat numbers. So maybe if you can talk a little bit about what you see as the longer-term risk to the business? Should we -- you got of the screen-print so that gets rid of a lot of the volatility, but is this going to be a pretty stable business going forward?

Richard A. Noll

When you think about our Innerwear category and the stability of the Paris purchase per year, when you think about the activewear category for us, which is still in a lot of the basic apparel categories, such as tees, basic tees, but also performance tees and graphic tees, as well as fleece products, they tend to be purchased on a regular basis. That adds a lot of stability to our overall business because of the category. The second thing is we think of our consumer franchise. As we sell to hundreds of millions of consumers, not a dozen big retailers, those consumers demand our brand and that adds the stability to our overall business. So those things provide that backdrop of, on a year-in and year-out basis, we've had a lot of stability because of our business model. It can be volatile quarterly a little bit as retailers will move their inventories up and down and things like that, but it all tends to come out in the wash and be pretty stable annually. We also then took big pains to make some tactical changes to even further improve our business model stability by, as you say, exiting the private label business in printwear, getting out of the printwear business in Europe, as well as deleveraging our overall balance sheet. So those, coupled with the fact of our inherent business model, the mix shifts that we've had, you should see a lot more stability in this business going forward than you did even over the last 5 years. So remember, when you look at our results over the last 5 years, even before we made those business model changes, with recession and with hyperinflation in cotton, we still delivered pretty darn consistent results over that time frame. And I think it's a hallmark of being -- having great brands and great categories and it allows us to have that model where we can have 2% to 4% or my goal, 3% or 4% organic top line growth, use our Innovate-to-Elevate strategy, a combination of ours brands, innovation and supply chain productivity improvements to drive that into a higher level of operating profit growth and using that strong free cash flow to magnify that into a greater rate of EPS growth and we're going to do that for a number of years going forward. So we really feel good about our long-term opportunity.

Unknown Attendee

I'll try a follow-up, gross margin question here. Obviously...

Richard A. Noll

Good luck. I wish you the best of luck.

Richard D. Moss

All right. I wish you the best of luck.

Unknown Attendee

Obviously, SG&A can bounce around depending on investments and marketing spend and such. But is there any movement that we should think about on the gross margin side or any seasonality to think about on gross margins?

Richard D. Moss

Let me talk just generally about the pattern of gross margins. We talked in our Investor Day about how you would -- then in the course of the year, those margins can be pretty volatile from quarter-to-quarter. A lot depends on the volume for the quarter and the shifts of volume from one quarter to the next and the like. So that's always inherent in our business, and I realize can make some of the quarterlies a little tough. But for us to -- but, as Rich has pointed out, over the course of the full year, very, very stable. We've said pretty consistently that we expect to come out of the cotton inflation experience with better margins. We've said that the Innovate-to-Elevate strategies are going to continue to, over time, help us improve our margins both gross and in operating. So long term, we feel very good about the direction of our margins.

Richard A. Noll

But I don't comment about the quarterlies anymore [ph].

Richard D. Moss

[indiscernible] Not yet specific, not yet.

Richard A. Noll

All right. Any other questions? Well, thank you, all, for attending. We really appreciate it, and hope you appreciate the good news we had. We love the fact that we feel good about our situation and we instituted our regular quarterly dividend. It's a huge milestone for us. And one of the parts of that milestone or a contributor to that is our long-term relationship with Michael Jordan. We are entering our 25th year of our relationship with Michael Jordan, and that's why we're here to celebrate with his -- by supporting his Michael Jordan celebrity -- he's got a number of charities that he supports, and we're here to celebrate that relationship with him and expect to continue that for many years to come as we continue to deliver great results over time. So thank you for coming.

Richard D. Moss

Goodbye. Thank you.

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