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Executives

Charlie Stack

Richard A. Noll - Chairman and Chief Executive Officer

William J. Nictakis - Co-Chief Operating Officer

Richard D. Moss - Chief Financial Officer

Analysts

Matthew McClintock - Barclays Capital, Research Division

Taposh Bari - Goldman Sachs Group Inc., Research Division

Susan K. Anderson - Citigroup Inc, Research Division

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

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

David J. Glick - The Buckingham Research Group Incorporated

Omar Saad - ISI Group Inc., Research Division

Kelly L. Halsor - BB&T Capital Markets, Research Division

Steven Louis Marotta - CL King & Associates, Inc., Research Division

Andrew Burns - D.A. Davidson & Co., Research Division

Eric M. Beder - Brean Capital LLC, Research Division

William M. Reuter - BofA Merrill Lynch, Research Division

Paul Simenauer

Hanesbrands (HBI) Q1 2013 Earnings Call April 23, 2013 4:30 PM ET

Operator

Good afternoon. My name is Laurel, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanesbrands First Quarter 2013 Earnings Call. [Operator Instructions] Thank you. I would now like to turn the call over to Mr. Charlie Stack, Chief Investor Relations Officer. Please go ahead, sir.

Charlie Stack

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 2013. Hopefully, everyone has had a chance to review the news release we issued earlier today. The news release and the audio replay of the webcast of this call can be found in the Investors section of our hanesbrands.com website.

I want to remind everyone that we may make forward-looking statements on the call today, either in our prepared remarks or in the associated question-and-answer session. These statements are based on current expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially. These risks are detailed in our various filings with the SEC, such as our most recent Forms 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 are made.

Please also note, in May 2012, Hanesbrands announced exiting certain international and domestic Imagewear categories that are now classified as discontinued operations. Unless otherwise noted, today's speakers will be discussing our performance from our continuing operations. Additional information, including reconciliation to GAAP performance measures, can be found in today's press release and in the Investors sections of our hanesbrands.com website.

With me on the call today are Rich Noll, our Chief Executive Officer; Bill Nictakis, one of our 2 Co-Chief Operating Officers; and Rick Moss, our Chief Financial Officer. Also with us today is T.C. Robillard, who will be assuming the Vice President of Investor Relations role beginning May 1.

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 will now turn the call over to Rich.

Richard A. Noll

Thank you, Charlie. At our recent Investor Day, we highlighted 3 aspects of our company that should allow us to drive superior shareholder returns for many years to come. All 3 of these aspects are evident in our first quarter results. Let me recap them for you.

First, we have a strong consumer franchise, a hallmark of any good CPG company and is reflected in the stability of our financial performance even in very volatile times. For us, short-term volatility within a quarter or 2 tends to revert to the mean, delivering the annual consistency more typical of a CPG company. In Q1, while sales were somewhat soft due to macro issues that we discussed at our recent Investor Meeting, due to the consistent replenishment nature of our categories, sell-through at retail has already rebounded and is back on track.

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 increase operating margins towards our 12% to 14% goal. In Q1, our margins expanded considerably, allowing us to deliver excellent profit results with an operating margin of 9% and record first quarter EPS of $0.51. And we are just beginning. Many of our current new products are just being rolled out nationally this quarter, and with our robust pipeline, we should enjoy the benefits for many years to come.

And third, our strong free cash flow. With a price to free cash flow ratio of approximately 10, our cash flow is substantial relative to our valuation. And that by itself creates many opportunities for materially increasing shareholder returns. This month's initiation of a regularly quarterly dividend is a great example. And as we said, we envision a dividend payout of around 20% to 25% of free cash flow. We're starting at the lower end of the range with the intent to increase our dividend over time. And we are not done. At some point, we plan to also employ bolt-on acquisitions and share repurchases as part of our strategy to maximize the value of our strong cash flows. As you can see from our first quarter results, our strategies are working, and they give us great confidence in our guidance for 2013.

So that's today's simple message, leveraging our enduring consumer franchise, driving our margin enhancing Innovate-to-Elevate strategy and being goods stewards of your cash, which should allow us to drive results for many years to come. And with that, I'll turn the call over to Bill.

William J. Nictakis

Thanks, Rich. As we've been doing for some time now, our organization executed really well in the first quarter, and we're pleased that our Innovate-to-Elevate strategy is working. This strategy is delivering improvement in our profitability while at the same time, driving performance at our retail partners.

But before I talk about the results, let me share our perspective on the macro environment since I know this is top of mind for many of you. For the quarter, there were 2 headwinds that impacted both our business, and from what we hear, the business of many retailers.

First, the delay in the timing of federal income tax refunds, which had a measurable impact in the 3 to 4 weeks from late January until mid-February. And second, the unseasonably cool March, which overlapped last year's unseasonably early warm weather.

When we look at our point-of-sale trends, we estimate the delayed tax refunds dampened sales by about $20 million, while the cooler weather in March impacted sales by another $5 million to $10 million. When we look at our point-of-sale trends over the past 4 weeks including Easter, we see that business is rebounding and is now running ahead of last year. So we believe the short-term impact of the first quarter are now behind us. Remember that consumers tend to purchase the same numbers of pairs of basic apparel over the course of any given year. So eventually, we expect to see the sales come back. When you couple that fact with the shelf space we're gaining this quarter, our increase in media and current retailer inventory positions that are at or below last year's levels, we feel good about delivering our sales guidance for the full year.

Now let me turn to our specific results for Q1, and let's start with Innerwear where we've been executing against our Innovate-to-Elevate strategy for some time. This strategy helped drive significant margin improvement during the quarter as our Innerwear operating profit increased 69%. While Innerwear sales were down 2% for the quarter, men's underwear, socks and bras all grew as hosiery and panties declined. We're seeing great results in our 3 large innovation platforms, TAGLESS, ComfortBlend and Smart Sizes. During Q2, we'll be setting significant incremental space for our ComfortBlend products as this platform continues to exceed both our plans and the productivity goals of our retailers.

We increased our media in Q1, and many of you probably saw our ComfortBlend and TAGLESS ads featuring Michael Jordan that ran during the NCAA basketball tournament. And as a reminder, we still plan to spend an incremental $30 million to $40 million on media this year. And that should only enhance the performance of these platforms.

Our sock category also posted strong results with sales up mid-single digits. As with underwear, the ComfortBlend platform continues to exceed expectations. And our overall Hanes sock innovation strategy that focuses on comfort and color is performing very well. We're using this same approach innovation on our C9 by Champion portfolio of socks, which delivered strong double-digit sales growth during the first quarter.

The bra category was also up mid-single digits, logging the second consecutive quarter of growth. The Smart Size platform continues to resonate with consumers, with sales of Smart Size bras across all of our brands up over 30%. Another highlight was our Bali brand, which posted double-digit growth in the quarter.

Overall, we are pleased with our Innerwear profit results and how our Innovate-to-Elevate strategy is working to deliver products that delight consumers, grow our retailers categories and improve our margins.

Let me now move to our next segment, Activewear. As a reminder, effective March 1, we renamed our Outerwear segment to Activewear to better reflect how consumers use these products. This segment posted a strong improvement in operating profits in Q1, delivering an 8% operating margin as we recovered from last year's cotton inflation. While sales were down 2% in the quarter, when you exclude the branded printwear decline, the core business was up 4%. In fact, retail sales of Hanes, Champion and Just My Size posted a combined 6% increase in the quarter, led by strong growth in core Champion and Hanes branded products.

Finally, International sales declined 5% but were up 1% on a constant-currency basis. We continued to execute against our regionalization strategy while we're aligning our International businesses into 4 key regions to leverage both our regional expertise and global supply chain. The results are unfolding as we expected.

To wrap up, I'm happy with our profit performance in the first quarter, and we're on track to deliver our sales and profit guidance for the full year. The margin results indicate that our Innovate-to-Elevate strategy is working as we combine our market-leading brands, consumer-driven innovation and low-cost global supply chain to deliver strong results for both us and our retailers. I'll now turn the call over to Rick Moss to discuss our financial performance.

Richard D. Moss

Thank you, Bill. Before I discuss our first quarter results, I'd like to comment on how pleased we are to return cash to shareholders with the recent initiation of a regular quarterly dividend. The $0.20 per share dividend represents an annualized dividend yield of just under 2% and about 20% of our normalized annual free cash flow of $400 million, a great start.

Now let me talk about our first quarter results. Sales were $945 million, down about 3% versus prior year but roughly flat when you adjust for the planned decline in branded printwear of $15 million and the currency headwind of $7 million. Sales were still below our expectations, however, due to the macro factors Bill mentioned.

Our gross profit margin for the quarter was 34.6%, slightly ahead of our expectations. This 840-basis-point improvement was mainly due to a more stable cotton cost and product pricing environment, and we also benefited from our ongoing Innovate-to-Elevate strategy, which is designed to increase price per unit and lower cost per unit, particularly on new products.

SG&A was down about $2 million in the quarter versus last year. Media was up approximately $3 million or 50% higher than last year as we continue to restore spending to support our product innovations. Our plan is to spend an additional $30 million to $40 million on media this year, with more than 2/3 of the increase coming in the back half of the year. I also want to note that about $6 million of the SG&A spending, primarily marketing and selling related, that we had planned for the first quarter will likely now occur in the second quarter. So I encourage you to adjust your models accordingly.

As a result of the improved gross profit margin and lower SG&A spending, operating profit increased by nearly $75 million versus last year, with improvement in 3 of our 4 operating segments. This resulted in an operating profit margin of 9%, a 790-basis-point improvement over last year's first quarter.

Interest expense for the quarter declined $11 million versus prior year. And our tax rate was 13%, including a onetime favorable impact of tax law changes signed into law on January 2 of this year.

EPS for the first quarter came in at $0.51. Even adjusting for about $0.05 of SG&A expense timing, our results were still about $0.05 to $0.06 ahead of our expectations for the quarter, a great result especially in a difficult macro environment.

Moving to the balance sheet. We remain focused on working capital improvement and generating strong cash flow as we move through the rest of the year. Our inventories are in line with our expectations as we begin to build for our key selling periods later this year.

Now let me talk about the progress we're making towards achieving our guidance for 2013. Our sales guidance for the full year is approximately $4.6 billion. We remain confident that our strong consumer franchise and the replenishment nature of our categories will enable us to achieve our guidance. The recent POS data that Bill shared with you seems to bear this out.

We're off to a very good start in reaching our operating profit guidance for the year of $500 million to $550 million. Our strong gross profit margin in the quarter and our continued commitment to cost management put us ahead of plan coming out of the first quarter. And pricing is largely in place, and our input costs are basically set for the balance of the year. As we continue to drive our Innovate-to-Elevate strategy, we expect operating margin expansion to move us closer to our 12% to 14% long-term goal.

Interest and other related expense is expected to be $120 million. This includes approximately $15 million in prepayment expense anticipated in the fourth quarter to retire the remaining $250 million of 8% senior notes.

The full year tax rate is expected to be in the teens, with the second and fourth quarter rate at the higher end of the range and the third and fourth quarter rate at the lower end of the range due to the timing of anticipated discrete tax items.

EPS for the full year is expected to range from $3.25 to $3.40, with more pronounced earnings growth from the first half of the year as we overlap cotton inflation from 2012.

Free cash flow is expected to be $350 million to $450 million, including expected pension contributions of approximately $38 million and net capital expenditures of approximately $50 million.

In closing, I'm pleased with our performance in the first quarter. Instituting a regular dividend represents another major milestone for us and highlights our commitment to increasing shareholder returns. The combination of our margin enhancing strategy, our execution and our performance in the first quarter gives us confidence in achieving the full year guidance we laid out for you at the beginning of the year. And with that I'll turn the call back over to Charlie.

Charlie Stack

Thanks, Rick. That concludes the recap of our performance for the first quarter. Now we'll begin taking can your questions and we'll continue as time allows. [Operator Instructions] I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Matt McClintock with Barclays.

Matthew McClintock - Barclays Capital, Research Division

I have a couple of questions. First, Bill, you mentioned that the current retailer inventory positions are at or below last year, and I was wondering if you could give more color on that. Is that on a dollar basis or a unit basis? And how should we think about replenishment building as we proceed throughout the year?

William J. Nictakis

Yes. I think as we look at our weeks of supply across our categories, across our customer base, we feel really good. We're either parity or actually below where we were last year in terms of average weeks of supply. So we get into the second quarter and again towards back-to-school. We feel really good that inventories are clean and there's not going to be any impediment to the normal shipping flow.

Matthew McClintock - Barclays Capital, Research Division

Okay. And then Rick, you talked about gross margin, and I'm sorry if I actually missed this, but I was wondering if you could break out the gross margin improvement this quarter into the 2 buckets that were provided in terms of how much was that cotton driven and how much of that was driven by the Innovate-to-Elevate strategy.

Richard D. Moss

The Innovate-to-Elevate was about 100 basis points, and the rest was cotton.

Matthew McClintock - Barclays Capital, Research Division

Okay. And then lastly, if I could shift gears to International real fast, I see the constant currency sales were down about roughly 1%. I was wondering if perhaps there were anything that you guys could share with us or opportunities that might drive near-term improvement in that business. And perhaps Canada, if you could focus on Canada and the opportunities that you see in that market in the short and near term.

Richard A. Noll

Yes. Short term, the Canada business is real simple. It's Zellers coming out and Target not yet being in there. They just opened their 24th door 3 weeks ago. So that's a big drain. Long term, it bodes real well for us. We have a great business relationship in the U.S. with Target and are already on track to have that same type of relationship on basics, as well as C9 by Champion up in Canada. So long term, it's a real positive for us there. But certainly, it has a big impact in the first quarter, and through the second quarter, that will be a pretty hefty drain.

Richard D. Moss

And Matt, can I just make one correction? On a constant-currency basis, our International sales were actually up 1%.

Operator

And your next question comes from the line of Taposh Bari with Goldman Sachs.

Taposh Bari - Goldman Sachs Group Inc., Research Division

I had a question on just the macro color. Last quarter, you had mentioned that retailers -- or you were seeing a more cautious position out of retailers for the first time in quite some time, the first quarter a little bit weaker than you would hope. Has that changed? Are retailers being a little bit more aggressive now with sell-throughs kind of snapping back into place? Or what are you seeing in terms of the way retailers are acting?

Richard A. Noll

Yes, I think -- this is Rich. Let me sort of put it in sort of a broad perspective. So when retailers were starting to see some of these tactical issues in the first quarter in terms of the declines because of the income tax delays and then weather, to be honest, nobody really overreacted. I think everybody understood that there is these tactical issues out there that will correct themselves. I mean, when you look at the weather, it was crystal clear throughout the country. You could see where there was big swath of bad weather and snowstorms especially on weekends. Comp there was really, really down. In other places where there wasn't bad weather, comp sales were fine. So I don't think anybody really overreacted. It was more like, look, we're having these set of issues. This, too, shall pass. Every single spring eventually comes and it gets warm. So I don't think there was a real overreaction, and therefore, nobody is really saying, "Okay, great, things are better. Let's go ahead and change our tactics." I really think that it sort of was as expected.

Taposh Bari - Goldman Sachs Group Inc., Research Division

That's helpful. And then going back to the original comment of sell-throughs returning, I guess 2 parts to that. Did that happen at a point in time in April? And did it happen on a national level? So are you seeing the Northeast revert back to -- the Northeast and the Midwest revert back to more normal sell-through patterns?

William J. Nictakis

Yes. The answer is it really is a switch being flipped. In terms of the income tax refund, you could see exactly when that started. You could see the cooler weather in March. And as the weather is warmed up, you can see a real clear delineation. All of a sudden, the trend line's moving up. So it is night and day. And yes, we see that Midwest and North doing better, snowstorm now. It will have a couple of soft days probably by the -- clearly, it's very clear to see what's going on with that.

Taposh Bari - Goldman Sachs Group Inc., Research Division

And then last question I have is the Innerwear business adjusted for the $15 million branded printwear shift. 4% is pretty good, especially considering that, that category or that part of your business is probably more weather sensitive than Innerwear. So can you just talk about that business, the health of that business perhaps in some more color? And have you seen evidence of that category improve as well over the past 4 weeks?

Richard D. Moss

Yes. The answer is yes, we're seeing the exact same weather-related trends happening. Our Innerwear business has spiked over the last 4 weeks and our Activewear business has spiked in the exact same manner. So it is a macro phenomena there. And I think if you look at the solid branded results in the first quarter on Activewear, it's back to our brands resonate. I mean, the Hanes programs are working well, the combination of brand and innovation. And Champion has -- continues to do well across all classes and trade for us.

Operator

And your next question comes from the line of Susan Anderson with Citi.

Susan K. Anderson - Citigroup Inc, Research Division

I thought the intimate sales were pretty good. I was wondering if maybe you could give us some color on what's driving that. Is it the Smart Sizes? And do you expect that to continue throughout the rest of the year? Because it seems like other players are kind of struggling in that category. And also maybe if you could just touch on the inventory at the retailers and then to intimate's specifically because I thought I heard that it was starting to build up a little bit.

Richard A. Noll

Yes. If you look at our intimate business, as we said, the bra business is growing nicely. I think that really is innovation driven. Smart Sizes across Hanes, Barely There and Bali is doing exceptionally well for us and really lifting our whole portfolio there. So innovation is working on that. Our panty business was down. That's a lot of promotional overlap more than anything because we didn't overlap some of last year's promotions. We've been growing that business. We feel good about our panty business and innovation we have coming in place that will start showing up Q2 and Q3. And our hosiery business lagged, and it's been lagging as the category declines and we sure are following suit with the overall category softness there. Your second question in terms of inventory levels, it really is going to vary by account when you look at intimates. Overall, again, we're at or below when you look at it on a macro basis. We're in good shape. And of course, some retailers may be heavy some others lighter. But overall, we're in good position.

Susan K. Anderson - Citigroup Inc, Research Division

Okay, good. And then one more question on the Hanes Outerwear. It seemed like that performed really well also in the quarter. Was that driven by space gains? Or are those coming later in the year?

Richard A. Noll

The majority of the growth on Hanes Activewear businesses were just productivity -- new programs that were outperforming prior year's programs. So it really wasn't big space gains in the first quarter. It was just productivity.

Operator

Your next question comes from Eric Tracy with Janney Capital Markets.

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

So I guess, Rich, for you, just first in terms of the top line, again, you went through sort of the macro issues. I know we've got some programs that are coming up, starting here in May and June and selling in terms of Macy's, as well as the men's underwear at Wal-Mart. Can you just maybe remind us again sort of the timing, magnitude of those? And then are there any other sort of -- you're obviously having success with these innovation platforms. Any other type of program wins or shelf space gains that we can be thinking about in the back half?

Richard A. Noll

Yes. Eric, in terms of the program and the space gains, most of those are going to come Q2 as we speak. And the biggest gains are going to be on our basics businesses. So ComfortBlend has delivered extremely strong results across all customers. We're being rewarded and recognized by a significant incremental space on that. That will start setting next month, and it should continue to drive our business. We're seeing the same kind of opportunity on socks. That ComfortBlend socks has done very well. Some of our just basic color innovations have done well, and we're being recognized with incremental space there. Macy's sets in June, and that -- we're just very proud that Macy's wants to put the Hanes brand in their shops, have America's leading brand being -- the opportunity to buy that at Macy's now.

Richard D. Moss

Yes. And Eric, in terms of the additional space gains that we may get later in the year, the fall -- there's the opportunity for a little bit, but really, that's not the big reset time. It's usually in the January through May timeframe, especially a lot of retailers have been moving those later and later. So the opportunity for additional space gains that we don't already have line of sight to, which we do for some of the rest of the year, really comes to 2014. And as these new programs continue to work, Bill, wouldn't you agree that, that opens up more opportunities for further expansions?

William J. Nictakis

Yes. We deliver the kind of productivity we deliver. We get recognized and rewarded with more space, and they make more money with our products.

Richard D. Moss

Absolutely.

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

Okay. And then, Rick, maybe switching gears, I know there was a big move on the Activewear business to continue to enhance and drive profitability there. Maybe give us an update in the quarter. And then maybe the timing of another -- the intention to internalize some of the source product, maybe just the timing and how we should think about the cadence of that improving profitability?

Richard D. Moss

Sure. I'll speak to that and Bill can add in as well. But we're very pleased with the progress that, that group has made. Their goal is to increase their operating profit, margin, double digits. And I think the margin in the first quarter of 8% is a good step in that -- in the right direction there. So it's significantly better than it was last year. I think it's -- owes to 2 things: number one, the switch -- the decline of the -- the shrinking of the branded printwear business; and the fact that, that group is very focused on improving profitability.

William J. Nictakis

And in terms of internalization, I'd say that is a continuous process. It's not an event or an episodic activity here. We are always looking at opportunities to internalize things. And frankly, what we do is we tend to take things and test them. And once they become big and scalable, then we put them into our supply chain and leverage our low cost, leverage our scale.

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

Okay. And then if I could, just one more. Rich, for you, kind of strategic question on uses of cash. You've obviously initiated dividend, laid out the potential for acquisitions and a potential buyback. How does the International piece work into that? And I mean, specifically really Asia and leveraging the supply chain that's set up there and being able to sell into the region. I know it's a longer-term sort of -- but maybe just kind of give us an update on thoughts there, what level of investment needs to be made relative to the opportunity? Because it certainly does seem sizable and could be sort of that next layer of organic growth.

Richard A. Noll

Yes. In terms of acquisition strategy -- I think let me start by just putting once again the entire usage of cash strategy in a framework. Obviously, debt paydown is done this year. Dividend is clearly a priority. We started at the lower end of our range. Over time, you will see that increase into the higher end of our range, of that 20% to 25% of free cash flow. After that, share repurchases and bolt-on acquisitions. There's no one priority. It's really going to be more opportunistic on exactly what's available at any particular time. Both domestic and international acquisitions within the Americas and Asia would be part of that strategy. And we clearly have had a demonstrated track record where we could make an acquisition to get us -- build a little bit of critical mass internationally and build upon that platform over time. And that strategy has worked in the past. It can work in the future. Great example of that is we're #1 in men's underwear in Brazil. We made a small acquisition there about a decade or so ago, and we've been able to grow the brand that we acquired with that company and also use them as a way to leverage the Hanesbrands into Brazil. Making the acquisition in intimate apparel space in some more countries or further expanding like we've done recently in Australia are all part of that strategy. In terms of priority of international versus domestic, we don't really prioritize one over the other. We look at -- we are actually keeping abreast of everything that's going on in those marketplaces, and we'll take advantage of any new opportunity that comes our way when the time is right.

Operator

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

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Rick, a question for you with respect to gross margins. We should see some further improvement when cotton costs fall into the P&L. Higher-volume quarters are still ahead. Looking forward, is the gross margin better than 35% achievable this year?

Richard D. Moss

Well, Jim, I really don't want to give guidance per se on gross profit margin. I will say that you are right, that we should continue to see improvement in cotton costs year-over-year as the year progresses, though that gap, year-over-year gap, will narrow as the year goes on. And it will become less of an issue as we get into the back half of the year.

Jim Duffy - Stifel, Nicolaus & Co., Inc., Research Division

Okay, great. And then the Innerwear operating margin was certainly a standout in the first quarter. Looking forward, maybe on a full year rate, as you work towards that corporate objective for 12% to 14%, how would we think about the blend of margin by segment?

Richard D. Moss

I think from a longer-term perspective, the Activewear group probably has, relatively speaking, the most opportunity for operating profit margin growth because they have historically been below double digits and can get -- I would believe, can get into double digits. It doesn't mean that the Innerwear group doesn't have opportunities for margin growth as well. It's just a little more pronounced in the Activewear group.

Richard A. Noll

Yes. At the end of the day, when you look -- as you just said Jim, when you look at the operating margins for Innerwear, they're already pretty sizable. Our goal there is to grow units and grow the top line, not trying to further expand margins, make sure we are investing in our brands so that we have a healthy business not only today but next year, the year after and many years to come.

Operator

Your next question comes from the line of David Glick with Buckingham Group.

David J. Glick - The Buckingham Research Group Incorporated

Just a follow-up, Rick, on the P&L just so that given that you have quarterly guidance that directionally we're modeling it correctly, those helpful comment on gross margin, it sounds like -- you had said the first half earnings would be up, obviously higher than the second half. Are the second half earnings -- can they be flattish? Or are you assuming they're going to be down? And then as far as sales growth, given the shelf space gains in Q2, should that be the highest growth rate quarter of the year so that we're thinking about the model correctly as the year unfolds?

Richard D. Moss

I just really don't want to get into quarterly guidance like that. I think -- like I said, it's first half of the year, we'll see much greater improvement in terms of year-over-year comparisons than in the back half of the year.

David J. Glick - The Buckingham Research Group Incorporated

Okay. And as far as one of your larger customers was -- Penney's was 100-basis-point headwind or so for you on the top line, they're certainly making noises about focusing on basics, which I'd like to think while may not be material overall, there certainly could be another small tailwind. Is it your sense that you're going to see them more aggressively pursue brands like yours without tending to be more inventory and size intensive and more basic oriented? And are you feeling more optimistic on that front?

Richard A. Noll

So clearly, there's been a big change at Penney's. If you remember, it used to be 2% of our business. It's now a little bit over 1.25% is about -- is what it is. There's no question that as they've now overlapped their promotional changes of last year, we started to see their sell-through go up and down, looking more in line with what the rest of the retail world does. So it's been improving. They've -- since the change at the top, they really haven't communicated exactly what changes in direction that they're going to undertake as a company. The good thing is there's a lot of stability of management, believe it or not, in terms of the head merchant. We know a number of those people, one of the women that runs it. She was a strong player when Mr. Ullman was there before, under there, same thing. She was there under Mr. Johnson and will be going forward as far as we know. So I think there is going to be a lot of stability. They're focusing on national brands. Basics will probably be a part of it. So there could be some upside. Yet at this point, they've got a lot to figure out. We need to wait to hear from them before we make our own conclusions about how it will impact our business.

Operator

Our next question comes from the line of Omar Saad with ISI Group.

Omar Saad - ISI Group Inc., Research Division

Rich, you talked a little bit at the beginning about kind of capital allocation, dividend, M&A, repurchase. And it seemed to me -- and please correct me if I'm wrong, it seemed to me you're emphasizing probably dividend growth from the lower part of that 20 to 25, maybe up towards the higher end over time, then M&A, then share repurchases. Is that the right order of priority? Or am I misinterpreting?

Richard A. Noll

Yes, you're misinterpreting a little bit. I would say there's probably a slight preference on the dividend payout, getting it towards the higher end of the range. Yet from a dollars perspective, that's a relatively small dollar amount. So you don't really need to think of it as eating up a lot of overall free cash flow. In terms of M&A and share repurchases, you shouldn't think about it as a priority, one as a priority over the other. I really think about it as over time, you're going to see us use a mixture of dividends, share repurchases and bolt-on acquisitions to maximize value. In any given year, you may favor one over the other just because of the tactical timing of what's going on. But when you look at it over a number of years, you're going to see a mixture of all 3 of those things. So we don't necessarily think of it as it's in this order, A, B and C, rather than as they're all things that we'll employ to create value.

Omar Saad - ISI Group Inc., Research Division

Got you. That's very helpful. And then you talked a lot about the timing of tax refunds and some of the impacts you saw there. Have you been able to discern from some of the trends and the sell-throughs and switching your replenishment business -- replenishment businesses and there's obviously been -- at the beginning of the year, there was a lot talk about the tax increases that the American consumer was going to be facing for the first time in a long time. Have you seen that at all have an impact or discussions with retailers? Or has it really been more weather and timing of tax refunds?

Richard A. Noll

It's really more of the timing of tax refunds than the weather. The data is crystal clear when we look at it. The tax refunds, when they were delayed a couple of weeks, the sell-through implications on those couple of weeks, I think, Bill, wasn't it down almost double digits for like 2 weeks? And then as soon as the tax refunds started to flow again and matched last year's numbers, you see that, that's correct. And then on weather, you could see it area by area across the country. Whether or not there's a broader macro issue on the payroll tax increase and those things, that data isn't quite that clear yet.

Omar Saad - ISI Group Inc., Research Division

Got you. And then, Rich, I wanted to circle back again to one of your initial comments. You talked about CPG companies and the consistency of those businesses. I think what jumps out probably most substantially in terms of -- and I agree there's a lot of similarities, but maybe some of the differentials there between Hanesbrands at least from a cursory review versus some of the CPG guys, one might be -- the global exposure, and I know that's an area you're focused on, but another is probably the margin level. You look at some of these CPG companies, they've been able to sustain pretty robust margins over very long periods of time. I know your margins are moving in the right direction and keep expanding.

Richard A. Noll

Yes. In terms of the global footprint, clearly, in the Americas and Asia, that's one of our priorities for growth long term. I think from a margin perspective though, if I focus on operating margin, not growth versus SG&A because that's business model dependent. But when you look at operating margins and you look at the operating margins of Innerwear, I think that they -- you could stack those up to virtually any CPG company and feel good about that. Clearly, we've got a little bit of corporate unallocated. That's always going to reduce that a little bit. And Activewear is one of the areas where we've got margin opportunity. So when you look at the categories that are most like CPG companies, measure on an operating margin basis, I think you see even a lot of similarities there.

Operator

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

Kelly L. Halsor - BB&T Capital Markets, Research Division

This is Kelly for Scott. Just following up on Jim's question about gross margins, when you look back on a historical basis, gross margins tend to be higher in Q2 than Q1, barring any significant changes in cotton costs. Is there anything that I'm not considering that would make it -- this pattern not being the same in this year?

Richard D. Moss

I think what we've seen historically is that while that's -- what you're saying is true more often than not. It also -- there's also a lot of years where it isn't. Last year, for example, granted there were a lot of cotton movements. Actually 2 years ago, the highest margin of the year was in our first quarter. So it's not universally true. But that's the case.

Kelly L. Halsor - BB&T Capital Markets, Research Division

Okay. But there's nothing that I'm missing here that would be a major impact in how I'm doing that on a sequential basis?

Richard D. Moss

Our history is our history. So no, you're not missing anything.

Kelly L. Halsor - BB&T Capital Markets, Research Division

Okay. And just my second question is just with general corporate expenses. How should we be viewing that? I know that your media spend is obviously growing, but in terms of any major buckets there that we should be modeling out that I'm not considering?

Richard D. Moss

Well, obviously, from an SG&A standpoint, the biggest mover this year is the increase in media spending, the $30 million to $40 million increase in media spending which will come primarily in the back half of the year, I think some 2/3 of it in the back half of the year.

Operator

Your next question comes from the line of Steven Marotta with KL (sic) [CL] King and Associates.

Steven Louis Marotta - CL King & Associates, Inc., Research Division

Can you speak to the proportion of revenue dedicated to pre-books versus replenishment in the first quarter and the second quarter?

Richard D. Moss

Well, we're -- I could tell you broad we're not going to get into it on a quarterly basis. But if you look at our Innerwear business, it is replenishment other than a promotional order, which we booked -- we have back-to-school and holiday. The rest of that is just replenishment, and about 70% of our Activewear business is pre-book.

Steven Louis Marotta - CL King & Associates, Inc., Research Division

Okay, that's very helpful. And as it relates -- just more or less a reiteration. As it relates to the $15 million prepayment, can we think of interest expense as within that $25 million to $27 million in each quarter? Or was that incremental $15 million in the fourth quarter bucket?

Richard D. Moss

The incremental $15 million is in the fourth quarter bucket. The rest of it should be fairly even through the year.

Steven Louis Marotta - CL King & Associates, Inc., Research Division

And that equates to roughly $0.12 a share, which is included in your current EPS guidance range, correct?

Richard D. Moss

That is correct, Steve.

Steven Louis Marotta - CL King & Associates, Inc., Research Division

Though it is a onetime item?

Richard D. Moss

It is a onetime item that we are including in our guidance.

Operator

Your next question comes from the line of Andrew Burns with D.A. Davidson.

Andrew Burns - D.A. Davidson & Co., Research Division

I wanted to follow-up on the C9 program. It was low single digits in the quarter likely impacted by external factors. Could you talk about the growth opportunity going forward? And is it primarily a function of improving sell-through at this point? Or are there some categories you see for that C9 program that it could extend into to accelerate the growth?

Richard A. Noll

Yes. I think there is 3 ways we're going to continue partner with Target to grow C9. You have their Internet opportunity where we're working with them. You have Canada. And then you have continuing to drive within North America stores. And as we look at North America, there's opportunities both to improve productivity of the existing programs, and then we'll work with as other categories that are brand right for C9 and where their own brands maybe aren't delivering the kind of productivity that they'd expect to have or would like to see. So there's a lot of opportunity for us across multiple geographies, channels and categories still with C9.

Andrew Burns - D.A. Davidson & Co., Research Division

Great. And at the Analyst Day, we heard about the X-TEMP product getting into stores, getting to Kohl's. it seems to really have grabbed some great shelf space. Can you talk about the success of that product and really the climate control product category, ability to expand that beyond Kohl's?

Richard A. Noll

Yes. We've been in at Kohl's for a couple of months. They are very pleased with the results. We're pleased with the results. They're ahead of plan. We haven't set the product in any other account yet. It will start getting set in another 6 to 8 weeks. We did a promotion with one account. So it's way too early to make a call, but all signs are positive for X-TEMP. And we think it's just another example of us being able to Innovate-to-Elevate in terms of it's a higher ring for our customers, they make more money and we do as well.

Operator

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

Eric M. Beder - Brean Capital LLC, Research Division

When you look at this innovation, this very aggressive rollout of innovation product, what kind of is the shelf life of these products in terms of how long you before you have to, I guess, come up with the next innovation? I know [indiscernible] pretty much throughout the entire chain. You've got the offerings eventually. But kind of how do you look at the rollout and the shelf life of these products?

Richard A. Noll

You really need to step back and think about our categories as really what we're really doing is driving innovation in the core. And while some of these products will start out relatively small, our goal is to actually build them into a substantial portion of the overall market. I think of TAGLESS as an innovation, right? That wasn't some niche product that had a short shelf life that then had to be replaced. Basically, it's over the last 10 years we've been able to drive that from T-shirts to bottoms to panties to a whole host of product categories. And it's become the new innovative core. ComfortBlend may be another product that becomes -- that's similar. I think over the next 5 or 10 years, you're going to see that kind of performance-oriented fabric be in a much larger portion of the core market. So you shouldn't think about these as niche products that have to come in and out. It's really about driving innovation with consumers for the products that they want to solve their needs that are going to have a lot of staying power.

Operator

And our next question comes from the line of William Reuter with Bank of America.

William M. Reuter - BofA Merrill Lynch, Research Division

I apologize if I missed this, but in terms of the decrease in inventory, did you break out what was price versus units?

Richard D. Moss

No, we didn't do that, but I can give it to you now. The -- versus first quarter and last year, inventory is down $272 million. $81 million is due to lower units, $121 million due to lower input cost and $70 million is the discontinued operations.

William M. Reuter - BofA Merrill Lynch, Research Division

Okay. And then only other one for me. You mentioned bolt-on acquisitions. Last quarter, you guys had said you were targeting leverage of 1.5 to 2.5. I mean, are there any companies that will be larger that would be on a kind of wish list basis that if you guys -- if they became up for sale, that you wouldn't be interested in that are much larger than bolt-ons?

William J. Nictakis

We've talked about what our acquisition criteria is. What we're really trying to communicate is we have strong free cash flows and we want to deploy those free cash flows to maximize value. So when you think of acquisitions, think of it in the context of how to maximize the value you get out of free cash flow. Don't think of it as an acquisition strategy by itself.

Operator

And your last question comes from the line of Carla Casella with JPMorgan.

Paul Simenauer

This is Paul Simenauer on for Carla Casella. Just one quick question. Did you guys say what percent of your sales growth target is from space gains?

Richard A. Noll

Can you repeat the question? You cut out.

Paul Simenauer

Did you guys say what percent of your sales growth target is from space gains? I may have missed that.

Richard D. Moss

No, we don't actually break that level of detail out.

Operator

And with no further questions, I'll turn the call back over to Mr. Stack.

Charlie Stack

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

Operator

And this concludes today's conference call. You may now disconnect.

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