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Hanesbrands Inc. (NYSE:HBI)

Q2 2011 Earnings Call

July 20, 2011 8:30 AM ET

Executives

Charlie Stack – Executive Director, IR

Rich Noll – Chairman and CEO

Dale Boyles – Interim Chief Financial Officer and CAO

Analysts

Eric Tracy – FBR Capital Markets

Bob Drbul – Barclays Capital

Jim Duffy – Stifel Nicolaus

Omar Saad – ISI Group

David Glick – Buckingham Research

Ken Stumphauzer – Sterne Agee

Andrew Burns – D.A. Davidson

Eric Beder – Brean Murray

Susan Anderson – Citi

Scott Krasik – BB&T Capital Markets

William Reuter – Bank of America-Merrill Lynch

Carla Casella – J.P. Morgan

Emily Shanks – Barclays Capital

Operator

Good morning. And my name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanesbrands’ Second Quarter 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

Thank you. I'll now turn the call over to Mr. Charlie Stack, Executive Director of Investor Relations. Please go ahead.

Charlie Stack

Good morning, everyone. And welcome to the Hanesbrands’ quarterly investor call and webcast. We are pleased to be here today to provide an update on our progress after the second quarter of 2011. 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 Investor section of our hanesbrands.com website.

I want to remind everyone that we may make forward-looking statements on the call today either in our prepared remarks or in the associated question-and-answer session. These statements are based on current expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially.

These results are detailed in our various filings with the SEC such as our most recent Forms 10-K and 10-Q, as well as our news releases and other communications. The company does not undertake to update or revise any forward-looking statements which speak only to the time at which they are made.

With me on the call today are Rich Noll, our Chairman and Chief Executive Officer; and Dale Boyles, our Interim Chief Financial Officer and Chief Accounting Officer.

Before I turn the call over to Rich, we want to reiterate that inflationary environment there are some aspect of our business that we intend to refrain from discussing in great detail for competitive reasons. Specifically, we will refrain from discussing details regarding cotton [pack] purchasing practices and forward-looking cost positions and we will not discuss specific timing or amounts of pricing actions.

I will now turn the call over to Rich.

Rich Noll

Thank you, Charlie. We continued our strong start to 2011, as Q2 was another great quarter. A combination of domestic and international performance drove both top and bottom line results. Sales grew 14%, marking our sixth consecutive quarter of accelerating sales growth and operating margins grew 70 basis points, highlighting the leverage generated from our supply chain and overhead.

Domestically we grew topline both organically and through our Gear For Sports acquisition. Our Champion brand grew double-digit as we experienced strong sales across our activewear channel. We continue to have strong support of our brand and strong media and we saw male underwear, panties and socks all have double-digit sales increases.

Gear For Sports had a good quarter and we remain optimistic about their future potential. They continue to expand outdoor account in the low single-digit and are aggressively rolling out concept shops to increase brand presence and drive space schemes. They are also now leveraging our supply chain for product and remain on track for the cost synergies that we have projected.

Now, let me make a comment or two about the general economic trends we're seeing in the U.S. Consumer spending continues to yield mixed results as evidenced by retailer comp store sales reports. Strong month follow lackluster months, repeating the trend we have witnessed since the recession. We don't expect changes in this pattern anytime soon.

Another trend we are seeing is that retailers more liberal with inventory dollars and units appear to be seeing stronger sales and comp results.

And lastly, consumers are migrating some of their purchases upscale, resulting in mid-tier specialty and department store retailers performing slightly better than the overall market.

Now turning to our international businesses, we are growing across the Americas and Asia. Asia provided the largest dollar growth with China and India both experiencing over 50% gains. We expect growth to continue as we expanded our offerings, placing hosiery, socks and women's panties across many accounts.

We also completed our acquisition of TNF, an Australia Champion licensee, which helps us further build our activewear base in Asia. And finally, Latin America was strong as well with Brazil and Mexico driving sales gains in the quarter. All of these actions further strengthen our potential for our future growth as we work towards our goal of $1 billion in international revenue by mid-decade.

Turning to pricing, we executed a price increase in late spring to offset higher cotton and other inflationary costs evidence by our innerwear segment profits that while down versus a year ago, did improve over the first quarter. In terms of elasticity, while still early preliminary results support our assumption that units fall off less than the rate of price increases.

Now looking ahead we have instituted another price increase in the U.S. retail business for the fourth quarter which should cover the increases needed as we head into 2012. We are also going after the additional space gains for next year to mitigate unit fall off from pricing elasticity and will provide more updates on 2012 space and program gains during the third quarter call in October.

So today, we are reconfirming our full year guidance with sales expected to increase over 13% to between $4.9 and $5 billion and EPS increasing more than 25% to a range of $2.70 to $2.90.

So to wrap up, we are steadily managing through this very volatile economic environment, leveraging our brands, our supply chain and our overhead to drive profitable growth.

I'll now turn it over to Dale for our financial highlights.

Dale Boyles

Thanks, Rich. Our second quarter performance was again strong as we continued to grow our topline and leverage our supply chain and overhead to drive EPS growth. Sales grew $149 million or 14% with the highest growth in the outerwear and international segments, up 26% and 24%, respectively.

Gear For Sports contributed $61 million or 23 points of the 26% growth in the outerwear segment. Our international segment saw strong growth in its key markets in the Americas and Asia, including the acquisition of TNF in Australia during the second quarter. Our innerwear segment sales increased 8% while hosiery grew 6% and DTC 4%.

Our operating profit grew more than $25 million or 21%, compared to a year ago, with operating margin increasing 70 basis points to 12.1% our highest ever, while operating margin for the first six months was 11.1% versus 10.4% last year. For the quarter, our operating margin was 15.3% for the innerwear segment, 10.8% for outerwear and 11.2% for international.

Now let me give you some details around the operating profit improvement for the quarter. Gross margins were up 10 basis points in the second quarter or $52 million. Gear For Sports added $22 million and we benefited from a net $18 million of sales growth and price increases offset by higher cotton and commodity costs. In addition, we realized $12 million of our supply chain savings in the quarter.

Turning to SG&A, our second quarter SG&A rate was 22.8% of sales versus 23.4% last year, which continued to reflect good leverage. Our SG&A dollars increased by $27 million over the prior year, driven by $13 million related to Gear For Sports, higher net distribution costs of $6 million and $5 million of higher media. The higher net distribution costs were due to $8 million of higher sales volume and incremental costs to implement our price increases, partially offset by elimination of $2 million of our excess service costs we incurred last year.

Interest expense was $3 million higher than last year due to higher working capital needs. Our second quarter tax rate was 20%. The resulting EPS for the quarter was $0.87, the same as the year ago when EPS benefited by $0.20 from a lower income tax rate.

Turning to the balance sheet, inventory at the end of the second quarter was $1.64 billion, up $345 million versus last year mostly due to higher inflation. The higher inventory level consists of $205 million of higher inflationary costs, $90 million of incremental units and $50 million relate to Gear For Sports. Between now and the end of the year while we will see higher inflation in inventory we will have overlapped the Gear For Sports inventory increase and our expectation is that units will be down.

Free cash flow, while normally negative in the second quarter was positive and was higher versus last year. EBITDA grew 21% to a $170 million in the second quarter. For the full year, we continue to project free cash flow between $100 and $200 million. We expect our year ending net debt level to decrease by the amount of free cash flow and expect net debt to EBITDA at 3 to 3.5 times at year end.

In summary, we had a very strong quarter. Our leverage was again evidenced in our results and we remain confident in the remainder of the year. We're implementing our price increases, realizing our supply chain savings and eliminating the excess service costs from last year. As a result, we are reconfirming our full year guidance of sales between $4.9 billion and $5 billion and EPS in the range of $2.70 to $2.90.

I'll now turn the call back over to Charlie.

Charlie Stack

Thanks, Dale. That concludes the recap of our performance for the second quarter. Now we will begin taking your questions and we’ll continue as time allows. Since there maybe a number of you who would like to ask a question, I’ll ask that you limit your initial questions to two or three and then re-enter the queue to ask additional questions.

I’ll 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 Eric Tracy from FBR Capital Markets. Your line is now open.

Eric Tracy – FBR Capital Markets

Hey, guys. Good morning. Congrats on the nice quarter.

Rich Noll

Hey Eric. Thank you.

Dale Boyles

Thanks.

Eric Tracy – FBR Capital Markets

And Dale, welcome.

Dale Boyles

Thank you.

Eric Tracy – FBR Capital Markets

So, Rich, if we could, I know you want to be a little bit higher level on this but from an elasticity perspective, if you could talk about the back half assumptions, the cadence, how we should think about it. Just maybe a little bit more color on that, if product turns out to be more in-elastic, it could be at the high end of the range versus more elastic at the low end. Just a little bit more color around that would be helpful.

Rich Noll

Great. You know, we’ve got what we think are pretty good assumptions built into our guidance on negative price elasticity. That’s really broke into a couple of categories. One would be overall consumer reaction. The other is retailers just managing their inventories and dealing with inflation sort of cutting back on unit inventory levels, as well as also price gap issues that we expect to be there for some period of time.

Since we’re the number one brand we tend to lead on price and by definition therefore everybody else follows and so you might have some gaps that goes for short period of time eventually all those gaps have to close because everybody’s facing exactly the same kind of inflationary pressures. So we’ve got all that built into our guidance.

You’re probably really not going to see in our guidance assumes it, it’s really late third quarter or fourth quarter where those things can actually have a meaningful impact on unit volumes. So from a 2011 perspective the affect is somewhat muted because it’s obviously not for a very long period of time.

We did say that we’ve seen units fall off less than the rate of price increases so that means dollars obviously overall will be up. And we feel good about our strong brands being able to support the prices that we need out there in the marketplace.

Eric Tracy – FBR Capital Markets

Okay. And then, I guess, I know you, again, on the cotton issues, I know you don’t want to get too detailed, but as we think about FY ’12, I know previously you had kind of you’re being pretty conservative from a, where cotton could be, obviously has moderated pretty significantly here, potentially sets up, I’d imagine at least for the back half of next year, very, very nicely. If you can just as we get through the year in the cotton perspective would be helpful if you could give your thoughts Rich.

Rich Noll

Yeah. Well, the first thing I know about cotton is it’s highly volatile and we’re probably going to have to deal with that situation for a long time to come. I mean it’s dropped about $0.25 just in the last 2.5 weeks, yet it was up limit yesterday. So where it’s all going to settle out for 2012 is sort of anybody’s guess.

But you’ve got it right, the 2011 cotton is working it’s way through the supply chain now and the industry in essence bought that between $1.70 and $2 and that’s going to work its way through retail starting in the fourth quarter and into 2012, possibly as long as up to midyear.

When you look at the future’s curve right now 2012 cotton, so delivery for sometime in ’12 is actually lower and you can see -- it is actually as low as a buck, if it remains that low we need to wait and see. However, obviously, I think there will be things that we’ll have to take into consideration for the back half of the year.

In fact we’re already starting to talk to retailers about how to make sure that lower cotton prices don’t adversely affect them from a negative comp perspective and us as well and we’re already developing programs to make sure we handle this volatility in a successful manner for both of us.

So we’ve got a lot of runway between now and then to figure it out. We’re actively working on it and I think that’s the advantage we have with our supply chain and our strong brands as we can handle that kind of volatility and which I believe is going to be here to stay.

Eric Tracy – FBR Capital Markets

Okay. And then maybe just last, if I could, from some of the topline opportunities that are out there, pretty vast be it through acquisition, international, but maybe the graphic tees, I know there’s been stuff in the press here lately. I know it’s been an initiative you guys are focused on but maybe provide a little bit more color there on the opportunity and how we should think about that business evolving?

Rich Noll

Yeah. What we said a couple of years ago that our outerwear segment, we wanted to focus and shift towards more branded and defendable segments and de-emphasize more commodity like segments to the market and graphic tees was a major part of that. We started our own initiative, which is Hanes Inc., we’ve also made the Gear For Sports acquisition.

When you add those things together, approaching 25% of our sales now in the outerwear segment is all graphic or attributed apparel. It has better overall operating margins than those commodity segments and we also believe there’s a lot more long-term growth potential.

So which one of the things that’s helping that segment start to margin up and continue its strong growth. So we feel really good about that long-term and we’ve got a very small share of a very large market so we can expect some good growth for a long-time to come.

Operator

Your next question comes from the line of Bob Drbul from Barclays Capital. Your line is open.

Bob Drbul – Barclays Capital

Hi. Good morning.

Rich Noll

Hi, Bob.

Dale Boyles

Good morning.

Bob Drbul – Barclays Capital

I guess the first question I have is when you look at the guidance in reaffirming the full year guidance for this year. Can you, in terms of a range, the $0.20 range that's still out there, how much of that uncertainty is from -- the uncertainty around the tax rate versus the uncertainty to price elasticity on the increases for the remainder of the year?

Rich Noll

No. I mean, the bulk of the range is really there not ever having anything to do with the tax rate or even cost at this point, which are very well known. It really has to do with the overall consumer spending level and the negative impacts due to elasticity. And so we have our baseline assumptions if they're a little bit better than those baseline assumptions gets us into the high-end of the range and vice versa and so really that's what's driving it.

Bob Drbul – Barclays Capital

Okay. And then on the gross margin for the remainder of the year, how much of the -- when we look at sort of service cost or airfreight from the third and fourth quarter? How much of that would you expect not to have to anniversary? Can you quantify sort of those numbers remind us what they were for last year?

Dale Boyles

Yeah. We incurred about $30 to $35 million of excess service costs last year, mostly in the third and fourth quarter. We did eliminate a few million this quarter but looking at the full year we're $30 to $35 million.

Rich Noll

And I think, Dale, wasn't it $5 million in this quarter – what was --last year -- what was it last year in this quarter?

Dale Boyles

About $5.

Rich Noll

I'm sorry, the third quarter.

Dale Boyles

I'm sorry, it’s about $10…

Rich Noll

Yeah. And then the remainder in the fourth quarter.

Bob Drbul – Barclays Capital

Okay. And then my last question is on the (inaudible) space gains sort of account and programs, you're talking about some new programs coming online in ’11 and in '12. Can you talk about the cadence when we should expect some of those and sort of exactly what they are especially as you look into the remainder of this year?

Rich Noll

I can't go into detail on exactly what they are because we don't really lock them in until late summer early fall, but I can talk about the cadence a little bit. And I think 2010 the great model for space gains, we came out of the recession pretty strongly, a lot of retail resets in that February to April timeframe, so you lock the programs in usually by fall because you obviously need time to make the product and then you have to fix your fills in that first or early second quarter and then you get those gains and wrap around all year.

There's a second set of space changes that happen later in the year sort of tied right after back-to-school going into holiday. We have received some space gains there but on a full year impact since it happened so late it really drive a lot of benefits. In 2010 they were a lot of programs across lots of retailers in all of our categories.

We're attacking this in a very similar manner. This isn't about going to get one big new program. It's continuing to drive the strength of our brands with new programs, new product offerings throughout a whole host of accounts, so the lot of small wins and a lot of different places.

Operator

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

Jim Duffy – Stifel Nicolaus

Thanks. Good morning, everyone. Nice job on the quarter.

Rich Noll

Thanks, Jim.

Jim Duffy – Stifel Nicolaus

I have a few questions around the flow of business for the remainder of the year. Can you speak to the inventory levels in the channel and how retailers have postured their inventory positions, particularly in light of the price increases?

Rich Noll

Yeah. Retail inventories are a mixed bag on balance. They're approximately about where they were last year at this time but you have very different results by retailer. So we've got some retailers that actually, I think they're very focused on driving results and their units are actually up versus last year even at higher prices. You've got other retailers that actually both the units and dollars are down below last year.

So you've got retailers that have very predispositions and focuses on working capital versus driving sales results and gains. The ones that we've seen so far that have been more liberal with inventory dollars are actually doing better than those that are actually pulling way back.

At the end of the day it got – it hinges on what you believe about consumer elasticity and we actually think from a long-term perspective that's not going to be a big impact. They may have some short-term sticker shock but at the end of the day promoted prices this year back-to-school for example, are just getting back to where they were in 2005 and we don't think it's going to in the near-term have a big impact on consumer elasticity and that's why retailers with broader or deeper inventory seem to be winning in the marketplace.

Jim Duffy – Stifel Nicolaus

See, Rich, it sounds like you feel based in the context of your expectation for elasticity that some of retailers may even be a little bit under inventory?

Rich Noll

Yeah. Clearly from – in our categories I absolutely think that's the case. They are tending to manage their inventories at a very aggregate gross level and the place that they can make some of them that are very focused on that. The place they can make the biggest impact is in high turn categories which tends to move more correlated to our categories.

Overall, retail inventories look good, but there are some accounts that are probably being overly conservative in managing their plans. I think as they see they start to lag somewhat overall share or comp store sales perspective, obviously they'll change their approach to that.

Jim Duffy – Stifel Nicolaus

Okay. And then, a couple more questions around the guidance and the split between 3Q and 4Q. Can you help us with the seasonality of Gear For Sports and how that balances between the two quarters?

And then, lastly, looking to the third quarter, it looks like the year-to-year impact from cotton should be within the same ballpark as it was in Q2. You've got more price which you've taken into the third quarter, I guess, I'm just scratching my head why both the revenue growth and year-to-year margin profile wouldn't be more favorable in the third quarter?

Rich Noll

Yeah. Let me talk to Gear For Sports and then I'll let Dale talk about the overall cadence of the inflation and the answer there is I think we'll see more in the third quarter than you might expect. But overall with Gear, their business is more weighed towards Q3 and a little bit really in Q4. But it's actually more front-loaded than our overall business.

So I think our overall business between first and second half is probably $48.52. They’re probably closer to $45.55 and with a lot of it in the third quarter, but also still pretty strong in October through about half of November. December really, really starts to slowdown. So they'll start to deliver even more benefit to us in the next two quarters. And in terms of the overall cadence of cost and the guidance, Dale?

Dale Boyles

Yeah. If you look at the back half of our year, that's when our inflation starts to hit our P&L's especially cotton in the third and fourth quarter. So you'll see the high dollar cotton roll out pretty dramatically over the second half of this year.

Rich Noll

Yeah. The high cotton costs really start to show up beginning in July.

Jim Duffy – Stifel Nicolaus

Okay. And then, thinking about what you said about seasonality for Gear and the price increases, which have been in effect. Is it reasonable to expect that year-to-year growth in the third quarter will be stronger than the fourth quarter, certainly, as you anniversary some of the revenue from Gear that was already in the P&L last year, right?

Rich Noll

Yeah. No. Actually we're talking, I think, we gave guidance on both sales quarters will be up somewhere between the low and mid teens. There might be little difference from a percentage or two. But I think of the more equally than they are one being up dramatically up than another. I wouldn't say their exactly equal but I think of that more as appropriate than one being up more than another.

Jim Duffy – Stifel Nicolaus

Okay. That's helpful. Thank you very much.

Operator

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

Omar Saad – ISI Group

Thanks. Good morning.

Rich Noll

Hi, Omar.

Omar Saad – ISI Group

Few questions. Thank you. Richard, would you mind talking about your inflation outlook little bit more, it sounds like maybe you expect it, with cotton kind of coming down as much as it has, it seems like you've shifted a little bit more from kind of a structural kind of steady inflation to maybe it's going to be a little bit more volatile over the next year or two. Has something changed there?

Rich Noll

Well, I think, well, clearly the futures curve has changed. I think when I was giving you that cotton was in that dollar -- the 2012 cotton was in that $1.25 to $1.35 range. I’ll be honest, I’m -- I was surprised that it hit down, went as low as a $1.00. To tell you the truth if it stays at this level, corn and other crops are going to be much more desirable for farmer’s to plant and you’re going to see the shift back. Cotton needs to be at least above $1.25 or so for it to maintain acreage relative to other crops. So we might be seeing a little bit of a dip down that may actually not last.

But in this world we’ve got to be prepared for anything and so we’re clearly open to the possibility cotton could stay this low for the foreseeable future in 2012 and we’ll need to put programs in place to deal with it. At the end of the day, I can’t predict it so we’ve got to figure out how to manage through a much more volatile environment and I think we’re prepared to do it.

Omar Saad – ISI Group

And with that, is that -- so in this scenario where it stays low, do we start thinking about price decreases or how should we think about that?

Rich Noll

No. That’s where we’re already talking to our retailers, at the end of the day, they want their average price per pack to not go down because then they’ve got to deal with negative comps. And retailers are already talking about how do we make sure we prevent that, if in fact cotton stays low at these levels in the back half of 2012.

So we’re working on different ways for them to work together to make sure we can prevent that. I don’t want to talk more specifically about it but at this point we want to work with retailers to develop the programs and I don’t want to actually tip my hand to our competitors, but I think there are some clear ways that we can help get through that kind of environment pretty successfully with our retail partners.

Omar Saad – ISI Group

Okay. And then on the shelf space side, I’m sorry, on the demand elasticity side have you seen a difference? I know it’s still early but the -- for the big price increase, but have you seen a difference across channels? You’ve made a couple comments about people trading up, the higher end doing a little better than the lower end retailers. Are you noticing any difference in consumer demand elasticity across your channels from an income demographic standpoint?

Rich Noll

You know, no, at this point, it’s a little too early to tell, to be honest, because we only have a few weeks of data. You’ve got different retailers having different levels of inventory and so on and so forth. So it’s a little too soon to try and discern if there’s difference across channels.

Omar Saad – ISI Group

Okay. And then on the shelf space gain side is it market share coming from private label or other brands that you think where your best opportunities are?

Rich Noll

You know, I think it’s the same as 2010. It’s all of the above. I think in a high price environment, weak brands, those third, fourth and fifth level brands that really don’t have a reason for being are very, very vulnerable and because they can’t support higher prices and they don’t have the media spend to make their brand strong. We see opportunities there.

And private label, in some of our categories like for example men's underwear, private label has lost share each and every year for the last four years and that trend is probably going to continue as well.

Omar Saad – ISI Group

All right. Last question, M&A environment, how do you balance -- what is it like and how do you balance that? It sounds like Gear For Sports has gone pretty well for you guys. How do you balance that with debt reduction in terms of uses of cash over the next couple of years?

Rich Noll

Well, clearly, we want to make sure that our leverage continues to improve. The best way to do that is by driving EBITDA up and then that gives us a lot of flexibility on what we want to do with our cash flow. While this year we're calling for $100 to $200 million of cash flow because of the working capital needs to inflation. Next year it should return to at least a normal level of cash flow or even slightly positive if we start to see some of these inflation in fact begin to moderate. So over the next 18 months we should have a lot of cash that we can use to drive value.

As that cash gets generated, we'll then make the determination whether it's in the best shareholders interest to use it for further debt pay down or bolt-on acquisitions like Gear For Sports. If another Gear For Sports is out there and our debt-to-EBITDA ratio's pretty low or below 3, I think obviously we'd have the opportunity to take advantage of it. But we don't need to speculate at this point, we'll just wait until we have the cash and then decide then.

Omar Saad – ISI Group

Thanks. Nice job, guys.

Rich Noll

Thanks a lot, Omar.

Operator

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

David Glick – Buckingham Research

Good morning, guys. My congratulations on the quarter.

Rich Noll

Thanks.

David Glick – Buckingham Research

Rich, I just wanted to confirm what you said, I believe you said that you have secured all the additional Q4 price increases to cover that cotton in the $1.75 to $2 range that should carry you into 2012. I just want to make sure that I heard you correctly on that?

Rich Noll

Yeah. For all practical purposes we're in that situation, yeah.

David Glick – Buckingham Research

Okay.

Rich Noll

Then…

David Glick – Buckingham Research

I'm sorry, go ahead.

Rich Noll

Have been presented and accepted at retail, right now we're talking about the innerwear categories, the same is true for the outerwear category which is actually done on a seasonal basis and had actually been done quite a while ago.

David Glick – Buckingham Research

Okay. And then the, the soonest that this lower cost cotton could flow to your income statement is probably what mid-to late Q3 or is it really a Q4 opportunity?

Rich Noll

The high-cost cotton through our P&L in 2012, probably mid-year.

David Glick – Buckingham Research

And so the high-cost lasts till midyear and then lower cost potentially starts to hit in Q3?

Rich Noll

Yeah. No. And no -- I want to remind everybody, cotton has come down a lot in the last couple of weeks. It’s not clear exactly where it’s going to end for 2012 and we have got other inflation impacts such as double-digit wage increases in the entire developing world, in the DR and Central America and Vietnam and China and that’s all going to start working its way through the P&L probably showing up in about mid-2012.

So that’s going to mitigate some of the declines due to cotton prices. Now cotton obviously is going to be a big driver for the cotton in terms of categories, but that will start to work its way through. But it will all show up about mid-year.

David Glick – Buckingham Research

And then last question, just in terms of retailer pricing behavior, I know a lot of retailers own a lot of their lower cost inventory and it seems like the pricing at least that I have seen at some of your big -- big customers particularly in the mass channel hasn’t necessarily gone up from, you know, beyond the spring price increase. Is it your expectation that the more dramatic move up will be kind of mid-to-late back-to-school or maybe I am just missing some of the pricing behavior? But those are my observations and I am curious what you think is going to happen in how prices are going to go up as the year unfolds?

Rich Noll

We’re clearly seeing our prices go up. You do have some retailers as we implemented this price increase and they’re coming up on back-to-school on promoted prices. Some of them did choose to maybe not take the full increase and then turn around four or five weeks later and actually implement a price decrease due to back-to-school. Those are more tactical things rather than sort of an industry trend. I think its all retailers’ intent to fully price for the cost that they’re absorbing.

David Glick – Buckingham Research

That’s great. Thanks very much and good luck.

Rich Noll

Thanks.

Operator

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

Ken Stumphauzer – Sterne Agee

Good morning, guys. Thank you for taking my questions. First, I actually just want to follow up on 3Q and make sure that I am not missing something. You guys had alluded to higher cotton costs rolling through in the back half of the year, but when you are still disclosing what the cotton costs should be, it was actually a pretty moderate year-over-year increase at least in terms of sense. So did many things flow through differently than you had previously anticipated or is there some kind of costs associated with the price increase that flows through in the quarter? Or is there anything else than can explain why the year-over-year growth, at least in percentage terms, shouldn’t be more substantial?

Rich Noll

Two things and I think there is a couple of things from a overall cost perspective going on and then we’ll also -- I just want to highlight some of those service costs issues in terms of Q3.

So, first of all when we were still giving that guidance I’m not sure we had fully locked in Q3. When we came into the year, we had a certain level of expectations for cotton which would flow through our P&L for late Q3 and Q4, which we didn’t have locked in at all. We ended up the cotton market ended up being much higher and our average price was a little bit higher. That may explain some of it.

The other thing is in the first half of this year our sales were a little bit better than we overall expected especially in Q1. That’s why we took our guidance up a dime and that means we got into higher cost cotton a little bit sooner. And that also actually weighted average upped Q3 probably from what we would have given a while ago. So those two effects probably are explained the difference you are thinking about.

The other thing is I will remind you, last year the service cost laid out as Dale just talked about was about $10 million in Q3, but about $20 million in Q4 and I think people from a modeling perspective might have been thinking about that more evenly.

Ken Stumphauzer – Sterne Agee

Okay. And then I wanted to touch on SG&A. It’s been at least in dollar terms year-over-year. it's been very volatile over the past three quarters and was a little bit higher than what I anticipated heading into today. So I am curious to know what precisely is -- is it the acquisitions that’s causing the unusual amount of volatility? And then how should that look the next couple of quarters in dollar terms?

Dale Boyles

Well, you know, we are real pleased with the leverage that we are seeing this year and it continues to improve again in this quarter. I think what you have to keep in mind is you have to look at us really over the year. Our course can be volatile because of the media spend, that’s a big spend and at $90 million to a $100 million range for the year. So any one quarter can rise or fall dramatically just depending on the timing of those ads.

So, if you look at it from a full-year perspective, you know, look at you are adding about $50 million to last year and then the rest of the dollars floating up, but not nearly as the sales growth rate. So, think of it that way. It’s really volatile from quarter-to-quarter.

Ken Stumphauzer – Sterne Agee

So, I guess, you know to follow up on that and then it was plus $30 million in 4Q plus 10 in 1Q and then plus 20 in 3Q? Is it somewhere between those three numbers?

Dale Boyles

Somewhere. Again just thinking about broad for the whole year. Again, you look at this quarter, you know, our SG&A was up almost half of it up was Gear and again higher sales volume from distribution costs. So, that was another increase and then the media was another $5 million.

Rich Noll

And I want to be careful, Ken. I don’t to get into trying to give guidance by each of the components of the P&L for part of the year or whatever. I am really pleased with our overall leverage of our SG&A in this quarter. The increase was due to Gear. Six million of it was due to the higher volumes that we actually had to ship to our distribution center and $5 million was Higher Media.

In essence, the rest of our SG&A was dead flat and that’s pretty darn good. And so, I feel good about our overall leverage that we are seeing both in the quarter and overall. I think from a mixed perspective between gross margin and SG&A, that’s going to fluctuate from quarter to quarter. I wouldn’t get too concerned about it.

Ken Stumphauzer – Sterne Agee

Okay. And then just one last question for you, Rich, you kind of alluded to this but as cotton prices come down in the back half of the year, I am just curious for your historical perspective on how deflation has played out. Has in the past when you have had inflation, followed by subsequent pretty severe deflation, has it proven to be a structural benefit to margins, i.e. does not all the price go back to the retailers and the consumer?

Rich Noll

You know it’s a pretty competitive market out there and operating margins from my perspective can only range so much and I think that one of the things we’ve talked about is my driving our topline mid-to-high single digits, we can magnify that advantages through our supply chain and our overhead and drive mid-teens EPS growth obviously that implies our operating margins, should be closer to our competitors’ level of that 12% to 18%. We think that’s achievable long-term. It’s because we are structurally able to take advantage of our cost advantages with our supply chain and we fully expect to be able to keep those things in an environment of inflation or deflation.

Operator

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

Andrew Burns – D.A. Davidson

Good morning. Nice quarter everyone.

Rich Noll

Hi, Andrew.

Andrew Burns – D.A. Davidson

Two -- questions. Just on Gear For Sports, I heard you mentioned you are now leveraging the supply chain. I was hoping you could -- since update us in terms of the amount of volume that’s on your own supply chain versus still being sourced, I thought that transition continued into 2012. I was just looking for an update there, thanks.

Rich Noll

Yeah. Let me just talk about it, it’s going extremely well. We are now just starting to take advantage of that. It took about six month to sort of get everything in place, so we are now beginning to reap those benefits. However, just because those benefits go into inventory they don’t really start showing up until 2012. So we feel like we are right on track for the $0.20 this year and the additional $0.10 going into $0.30 next year. So we feel real good about Gear.

The great thing is we are leveraging the supply chain, but they’ve also got upside revenue opportunities because we’ve been able to give them a little extra capital and that really means another $1 million or $2 million. They are able to expand their overall operations and go for growth. I talked about them rolling out concept shops where they actually use that to emphasize the brands and some of the bookstores. It allows them to gain space, helps their customer drive sales and us to drive sales.

They weren’t able really to do that and I did think they did four of those over four years even though they knew they worked, but they didn’t have the capital to do it. We freed the capital up and they are going to 12 of them over the next 12 months. So that gives you an idea of where there is also long-term revenue synergies. So we feel really good about this deal.

Andrew Burns – D.A. Davidson

Excellent. And the second question, it seems to me the Intimate apparel category has been fairly promotional so far in 2011. Could you speak to the competitive dynamics for that space and the opportunities longer term for growth in that category for Hanes’ brands?

Rich Noll

You know overall in that category has a lot of good growth characteristics in it and we have got a very strong share. One of our -- our main -- we really think of the share in terms of full figure where we’ve got a really good share with Playtex and Bali and so on and then the average figure, think of that more in that sort of Victoria’s Secret segment where they actually have strong shares. What’s interesting is the overall markets growing, however, full figures held up a little bit better during the recession and it showed in our sales.

It’s actually sort of been a little bit softer over the last 12 months and average figures been doing much better both in the marketplace and our overall sales. So there are some puts and takes. I don’t think it’s necessarily been a lot more promotional. Prices did actually increase there in February and those prices stuck throughout all retail. And I think the category is good but I think we are seeing some dynamics in the short-term where average figures are actually doing a little bit better than full figure. But I think that will probably be turning around in the next couple of quarters.

Operator

Your next question comes from the line of Eric Beder with [Brean Murphy] (sic) [Brean Murray]. Your line is open.

Eric Beder – Brean Murray

Hi. Good morning. I’m going to apologize if I ask a question that was said already, my phone has problems today. When you look at the space gains you picked up with Dollar General and some of the other ones here, how are those working out and how do you look upon them as growth drivers going forward?

Rich Noll

I won’t talk to any one particular account, but overall the space gains that we got in 2010 which also wrapped around into 2011 have performed very well. And it’s actually allowed us to continue discussions with a lot of retailers on how to further capitalize on its growth and help them continue to drive their business.

Eric Beder – Brean Murray

But currently in the hosiery category rose after five quarters of being down, is there something going on there or is that just finally, people wearing hose or how do you look at that?

Rich Noll

Well, there are a couple of things going on. First of all, it was pretty strong in the quarter due to placing a new program with one or two major retail accounts and so you can see what the margins in that category, that’s a really good thing. The hosiery is starting to decline right starting to moderate a little bit. We still think the business is long-term decline, but it is starting to show signs of life with across a whole range of product categories and innovation. However, at this point we are still managing the business appropriately given its long-term decline trends.

Eric Beder – Brean Murray

Okay. Most of my questions have been answered. Thank you and congratulations on the quarter.

Rich Noll

All right. Thanks a lot.

Operator

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

Susan Anderson – Citi

Hi. Good morning, everyone.

Dale Boyles

Good morning.

Rich Noll

Good morning. Hi, Susan.

Susan Anderson – Citi

Hi. I guess, really quick on the outerwear segment, it looks like yours is pretty much on track but as you back out those sales it looks like maybe they were a little bit weaker than last quarter, can you maybe talk a little bit about the other categories in that segment and kind of what’s driving that?

Rich Noll

Yeah. Gear obviously accounted for the lion’s share of the increase, I think it was only up 3% excluding that. Obviously with that kind of business you’ve got to be careful quarter-to-quarter, you are going to have some volatility. I think long term, you add a couple of quarters, the business is still pretty strong and healthy and we feel good about it.

Importantly to note, is the operating margins in that segment to continue to improve, not only with Gear weighting averaging it up but the core segment itself has actually increased. So while sales aren’t up as much, profit actually is doing fairly well and that’s all driven by our strategy of branded more defendable, things like graphics and things like that as well as I think the overall core business being a little bit better.

Susan Anderson – Citi

Okay. Great. And then in the innerwear segment I think you already talked about the kind of the category some of the performance there. Can you maybe talk about how much of the increase, it seems like it did much better versus the first quarter was price increases and how much was just better performance maybe driven by the increase ad spend?

Rich Noll

Yeah. So the innerwear segment is clearly one where you saw the profits down actually Q4 last year Q1 this year and still they were down versus prior year in Q2, although just a little bit and that’s because it was starting to feel the effects of inflation we actually hadn’t been able to yet to pass on fully implement the price increases that we needed and that’s going to start now turning around and as we had implemented the June price increase and then the fourth quarter price increase to offset the further inflation that’s it going to see.

In terms of sales it was up about 8%. Units were up and actually I mentioned that we have -- saw double-digit gains in a couple of a key categories and so clearly units were up there as well. As we go into the higher price increases, I want to emphasize that we do expect negative elasticity impacts and that units will actually decline, but dollar revenues will still be up in those cotton intensive categories in innerwear.

Susan Anderson – Citi

Okay. Great. That’s very helpful. And then just maybe really could touch on the higher profits at retail, what drove that in that segment?

Rich Noll

I am sorry, I missed that. Just higher what at retail?

Susan Anderson – Citi

Profits, say in the direct segment?

Rich Noll

Oh. I think that was just good management by that organization. You know, sales were up, I think the comp store sales were pretty good. Tight inventory -- tight management on cost led to their profit increase.

Susan Anderson – Citi

Okay. And then really quick on just the price increases, I believe the more significant increases began in June. And I know you guys said that dollars are still up even though units may be declining, but have you seen a change since, say, the beginning of the year when there was only single-digit price increases, or is it kind of too early to tell in terms of the, you know, the consumer’s buying behavior?

Rich Noll

Yeah. We didn’t expect a lot of negative impacts of price elasticity to -- for the first price increase in February. At 5%, it’s never been our experience that that has a negative impact on units. We are seeing obviously an impact on units with this -- the June price increase that would be in the teens’ level, probably mid-to-high teens in the cotton intensive categories.

It's a little too early to tell exactly the types of things that are driving that and if it’s just short-term sticker shock, if it’s short-term dislocation because of those price gaps that I talked about, long term, when you look at pairs purchased per year in a lot of our basic categories, those numbers have been extremely stable over the last decade or more. And whether prices were coming down or prices were going up, long term, prices purchased per person per year is pretty darn rock solid. And that’s why we don’t think there’s going to be major long-term impacts to the consumer or negative elasticity.

Operator

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

Scott Krasik – BB&T Capital Markets

Hi, Rich, Dale. Thanks for taking my call.

Rich Noll

Sure.

Scott Krasik – BB&T Capital Markets

So just a couple left here. Is there anything structural about your approach to media spend that would make it higher in the third quarter versus the fourth quarter?

Rich Noll

Media does absolutely go -- bounce around a lot by quarter. Overall we’re increasing media up to just under a $100 million in total this year. I think it’s just a couple of million below that. I am not exactly sure how it skews by quarter, but it doesn’t go up equally in all quarters.

Scott Krasik – BB&T Capital Markets

Okay.

Rich Noll

And it depends on the exact timing of our flights that we are running, the exact timing of different holidays, when they show up, for example, Easter shifts can actually be a big part of the movement between quarters and so on.

Scott Krasik – BB&T Capital Markets

Okay. And then in terms of the price increase, you sort of alluded to it, but just to confirm, you are set with another round of price increases in both innerwear and outerwear that will cover the first half of 2012, is that correct?

Rich Noll

That’s correct.

Scott Krasik – BB&T Capital Markets

Okay. Great. And are you changing your approach, I know you try to be pretty consistent, but to buying cotton with the futures as low as they have been in the last month or so?

Rich Noll

You know one of the things that this volatility has taught us is that we should -- our strategy to not bet and/or speculate on cotton is a good one. So we’ll continue to dollar-cost-average and therefore, we are going to end up having the same costs as the overall marketplace and be able to price accordingly.

Scott Krasik – BB&T Capital Markets

Right. Okay. And then have you taken the opportunity to test the higher prices first in your Direct-to-Consumer segment? Has that --

Rich Noll

You know, whenever we’ve run test there in isolation since -- if you try and take prices up there, but the rest of the market’s not going up, you don’t necessarily get a good read because people actually can see that the prices are higher than other places. So, while we’ll play around with that, it’s not necessarily a good way to actually test the overall elasticity. You actually need to see prices go up in the general marketplace to really get a good read.

Operator

Your next question comes from the line of William Reuter from Bank of America-Merrill Lynch. Your line is now open.

William Reuter – Bank of America-Merrill Lynch

Good morning.

Rich Noll

Hi. Good morning.

William Reuter – Bank of America-Merrill Lynch

With regard to an earlier question about acquisitions, you guys talked about Gear For Sports, it sounds like kind of a template for these. In terms of -- how about larger more transformative acquisitions? I am wondering if you would have any appetite for such an acquisition and whether if these targets -- you know if there are certain targets that became available whether they would make sense?

Rich Noll

Our acquisition criteria, we’ve laid it out, it’s pretty clear. We want acquisitions that are only in our core basic apparel categories. They need to be justified based on leveraging our supply chain or overhead and cost synergies alone should justify any premium that you might need to pay, but they also need to have complementary long-term revenue synergies, obviously Gear fits that.

We also stated that we’d like to do it out of free cash flow, not really necessarily to lever up to do some big transformative transaction. So that gives us, I think, a wide range of opportunities to look at, you know, Gear was a start and it has performed extremely well. You can imagine using that type of strategy to help forward our international growth through the Americas and Asia to get some critical mass in certain categories that we may not have.

For example in Brazil, we are number one in men’s underwear, we don’t have any business to speak of in women’s intimate apparel. So getting from some critical mass in a place like that could make a long term and short-term sense. And sort of that’s what our criteria is, we feel really good about it and we can be successful with that acquisitions, but if those kind of acquisitions present themselves we’ll take advantage of them because that can actually help drive our results as well.

Operator

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

Carla Casella – J.P. Morgan

Hi. A couple of liquidity type questions. On the -- the inventory and working capital, the peak to trough has changed given the cost and unit, et cetera, can you just say and you gave us some guidance for the full year, for the third quarter do you -- are you giving guidance for the magnitude, the working capital increase you could see for those seasonal peak in the third quarter?

Dale Boyles

Well if you look at our normal unit volumes, they were up in the first half and then the units will decline from here to the rest of the year. But what we are seeing is a higher inflation from a dollar perspective is growing. So we could see a peak in the third quarter. But, you will see that to go down as we wrap the Gear For Sports increase. That will go down to zero. And again, the units will be down the rest of the year and slightly below last year by the time we get there.

Carla Casella – J.P. Morgan

Okay. And then the Accounts Receivable facility, are you still using that? Where do you stand on the availability and how much has been used for the quarter?

Dale Boyles

I mean we feel real good about the receivables facility and I think we used about $215 millionish of that facility at the end of the quarter.

Carla Casella – J.P. Morgan

Okay. And then one more business related question, on the China facility, can you just talk about the capacity at that facility? And if you still have opportunity to leverage the overhead costs there?

Rich Noll

Right now it’s right on track. We are doing extremely well. It’s at around 75% of our current plans which it should reach right on plan by the end of 2011. What’s important to know, though, is we built that building to only be slightly over half full. And so our current plans are only to get machinery and equipment through end of 2011 and we still got a lot of -- for the path of it, we’ve got a lot of expansion opportunity and the whole idea was to make sure we built that Asian cluster with textiles in Nanjing and sewing in Vietnam and Thailand to not only support growth for the U.S. but actually these are ways that we can provide low-cost product to build our business in Asia.

And those products are starting to flow through that supply chain now. It allows us to get really competitive on costs and that’s going to continue to expand overtime. So we have got a lot of opportunity to continue to leverage that entire cluster and lower it’s -- continue to lower its cost throughout the years.

Operator

And our last question comes from the line of Emily Shanks from Barclays Capital. Your line is open.

Emily Shanks – Barclays Capital

Good morning. I just have two very quick questions. Around the acquisitions that a lot of people have been asking on, can you comment on what the status is of the pipeline i.e., are you seeing any compelling assets that are in play out there now both domestically and internationally, if you could comment please?

Rich Noll

I think as the credit market has loosened up you clearly have a lot of people that are willing to look for opportunities or sell their businesses. And so, I think, there has been an actual increase in people trying to present their companies for sale. A lot of things that get presented to us don’t fit our criteria and therefore we don’t want to look at them. I don’t think the market for the type of things that we are looking at has changed dramatically, to tell you the truth, over time.

So there is businesses out there that are up for sale some of which we are not that interested in. Other than which it could be right but really from a long-term perspective we want to make sure that we can get our cost energies from it. So, I think it’s sort of a -- the market is picking up a little bit. It gives us more opportunity to look, but right now we are focused on getting through, driving our brands, driving our supply chain and managing through 2011 and into 2012.

Emily Shanks – Barclays Capital

Terrific. And then my last question is just housekeeping. In your guidance for free cash flow, what’s the embedded CapEx expense for fiscal year ’11? I just wanted to refresh that, please.

Dale Boyles

Yeah. For the full year we expect to spend about $100 million net.

Emily Shanks – Barclays Capital

Okay. And will that change dramatically as we look into ’12? Can you comment on that yet?

Rich Noll

You know we like to tell people to think about capital expending at around that level from a long-term perspective. Any given year, it could be lumpy as you saw as we are investing heavily in the supply chain. Earlier it was above that number. I think we might have hit a high watermark of about $125 million or so over -- at some point in the last couple of years. If anything in 2012, it might be below that number, but I wouldn’t necessarily at this point we haven’t put together plans for ’12 so that’s more conjecture than it is a fact.

Emily Shanks – Barclays Capital

Thanks. Great quarter.

Rich Noll

All right. Thanks a lot.

Operator

There are no further questions at this time. I’ll turn it back to Mr. Stack for closing remarks.

Charlie Stack

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

Operator

Ladies and gentlemen, this concludes today’s conference call. You may now disconnect.

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