Hanesbrands' Management Discusses Q4 2011 Earnings Results - Earnings Call Transcript

Feb.15.12 | About: Hanesbrands Inc. (HBI)

Hanesbrands, Inc. (NYSE:HBI)

Q4 2011 and Year End 2011 Earnings Call

February 15, 2011 4:30 pm ET

Executives

Charlie Stack – Chief Investor Relations Officer

Richard A. Noll – Chairman of the Board & Chief Executive Officer

Gerald W. Evans, Jr. – Co-Chief Operating Officer

Richard D. Moss – Chief Financial Officer & Principal Accounting Officer

Analysts

Robert Drbul – Barclays Capital

Susan Anderson – Citigroup

Eric B. Tracy – Janney Capital Markets

David Glick – The Buckingham Research Group

Jim Duffy – Stifel Nicolaus

Omar Saad – ISI Group

Ken Stumphauzer – Sterne Agee

Steve Marotta – CL King & Associates

Scott Krasik – BB&T Capital Markets

Eric Beder – Brean Murray Carret & Co.

Carla Casella – JP Morgan

[William Brunner] – Bank of America Merrill Lynch

Operator

At this time I would like to welcome everyone to the Hanesbrands’ fourth 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) Charlie Stack, Chief Investor Relations Officer you may begin your conference.

Charlie Stack

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 fourth 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 investors section of our www.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 10K and 10Q 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 Chief Executive Officer, Gerald Evans, one of our two Co-Chief Operating Officers, and Rick Moss, our Chief Financial Officer. For today’s call Rich will highlight a few big picture themes, Gerald will provide a sense of what’s happening in a few of our major businesses, and Rick will emphasis some of the financial aspects of our results. I will now turn the call over to Rich.

Richard A. Noll

The Q4 results and the 2012 guidance we release today are clearly below our expectations and the high standards we set for Hanesbrands, with the same challenges that face others in our industry are weighing on our results. Importantly, for 2012 excluding our issues in outerwear which I’ll discuss in a moment, the rest of our businesses should grow both sales and profits on top of 2011’s record levels. We should quickly get through our challenges and then you should see the true earnings power of the company in the back half.

I will start by highlighting a few key themes followed by Rick and Gerald giving you more details. Specifically, I will summarize why we missed expectations in Q4, the solid state of our core businesses, the challenges we face in the wholesale channel of our outerwear business, and then conclude with a few comments concerning our renewed focus on cash flow and debt reduction.

First, we clearly missed our Q4 guidance due to an unexpected sales short fall. Operating profits missed proportionately and while EPS didn’t miss quite as much we find that little consolation. What happened was relatively simple, into early November both our retail sell through rates and retailer order pace was tracking to our expectations. However, in December while our sell through rates remained in line with our expectations the order pace from retailers slowed substantially as they became rather nervous about mounting inventories throughout their apparel departments. As retailers began to markdown and clear out their cold weather apparel we expect the order pace to return to normal and equal our sell through rates.

The December short fall aside, we achieved much in 2011. We instituted multiple double digit price increases, managed unprecedented inflation, and completed the build out of our global supply chain. With all that, we recorded record sales, record operating margins, record EPS, and reduced long term debt to a record low $1.8 billion.

Notably, our core business worked quite well. We implemented three price increases and competitors have followed. Elasticity was within our expectations and price gaps are now closing to what we believe are appropriate long term levels. Both male underwear and socks increased sales and profit in 2011, a trend we expect to continue in 2012. I am very proud of the hard work and dedication of our teams to make 2011 a record year.

Now, let me comment on our single biggest challenge in 2012 which is in our outerwear segment. As a reminder, outerwear is comprised of both active wear and casual wear products that we sell to both retailers and wholesalers. A portion of the wholesale channel is where we’re having issues. For simplicity, we refer to this as image wear. It’s here where we are seeing the impact of a hyper competitive pricing environment.

While small, in 2011 image wear performed well growing sales to 8% of the company with double digit operating margins. However, things changed in the fourth quarter. The two largest suppliers began fighting for unit share especially in the most promotionally driven sectors of this channel. This fight led to rapid price declines just as the industry was facing the highest cotton costs in history unfortunately creating a perfect storm.

Our strategy is to maintain the premium and core sectors where pricing is reasonable for the go forward price of cotton but deemphasize the highly price sensitive promotional sector and let units and sales fall. For us, this is a business model decision because we are all about brands. As we make this transition, image sales will be smaller but we believe we’ll be more profitable and less volatile.

Despite the relative size of image wear sales, this perfect storm is substantially impacting our 2012 profit results leading to our EPS guidance of $2.50 to $2.60. The rest of the business will be dampened somewhat by inflation but for the full year it should grow both sales and profits. Both the image wear issue and inflation substantially impact our margins in Q1 causing a loss.

While we’re not thrilled with a loss in Q1, we anticipate that we’ll get through the majority of our issues very quickly. Operating margins therefore, should return to the mid to high single digits in Q2 and double digits in Q3. As the overhang of temporary inflation quickly passes, our back half profit run rate will show our true earnings power.

Lastly, we have a renewed focus on cash flow as inflation on [wines] and our heavy supply chain investments are now completed free cash flow should be very strong for the next number of years. In fact, in 2012 we anticipate generate free cash flow of our $400 to $500 million or over $4 per share.

Importantly, our priorities for that cash are crystal to clear, to reduce debt. By December we want debt reduced to $1.5 billion and in 22 short months we could reduce our outstanding bonds to as low as $1 billion. This is a marked change from the recent past as we had to deal with inflation but rest assured it is our intent that debt will fall.

So to conclude, our brands, our retail partnerships, and our core businesses are strong. We’re working quickly to stabilize outerwear in the wholesale channel and we are focusing cleaning on debt reduction. As we believe this inflation overhang will soon pass, we should have good momentum later in 2012 and heading into 2013.

I’ll now turn the call over to Gerald Evans.

Gerald W. Evans, Jr.

With Rich’s high level overview of the business as a backdrop I would now like to talk about the performance of each of our key segments in 2011 as well as the primary drivers we see for each in 2012. This will provide some more detail on the individual areas of the business as there are factors that affect each differently.

First, I want to start with our core innerwear business. Our innerwear business, particularly our male underwear and socks businesses continue to perform well in 2011. Even with inflationary pressures, innerwear operating profit was up 5% for the full year.

Now, let me talk briefly about pricing in those core retail businesses. We implemented three price increases in 2011 and competitors have ultimately followed with overall pricing in the industry reaching levels for the average cost of cotton in 2012. We led the price increases with weaker competitors initially trying to gain an advantage by delaying by roughly a quarter. Their delay caused price gaps to widen but we generally anticipated their actions or corrected as needed. Elasticity was in our range of expectations.

Price gaps are now closing to what we believe are appropriate long term levels. As our visibility took the cost and pricing environment has improved, we solidified 2012 pricing with retailers to selectively adjust prices or increase pack sizes that optimize our competitive gap. All of which is built into our guidance.

All-in-all our retail partners have come to appreciate that price increases are driving their comp sales and profitability. In fact, even after three price increases in 2011 we continue to earn new shelf space at retail in 2012. Some of the largest gains are coming from Hanes Comfort Blend underwear and socks which will be supported with a new advertising campaign featuring Michael Jordan.

We are also encouraged by gains in intimate apparel driven by our Comfort Flex Fit platform and we are gaining space in hosiery as well. These gains alone could generate a couple of points of sales growth for innerwear in 2012.

Now, let me move to outerwear. Let me remind you that our outerwear business is comprised of four categories: image wear, which I will discuss first; as well as, Champion; casual wear; and gear for sports. Let me begin with our plans for image wear. As Rich discussed, we are experiencing somewhat of a perfect storm in that category.

The premium and core sectors appear to be appropriately priced for the longer term cost of cotton and should therefore return to historic levels of profitability as inflation quickly unwinds. However, the promotional sector which represents about a third of the overall market and roughly one quarter of our image wear sales is a different story. Here, competitors are fighting for unit volumes of promotional t-shirts where share could easily shift based on the lowest price of the day. To make it worse, the industry offers volume incentives to drive further unit volume in this sensitive segment.

While we have been less involved than our competitors in the promotional sector, it is clear that we need to deemphasize this portion of image wear. Our business model is about brands not the deal of the day. In response, we have removed growth incentives from products in the promotional sector and moved to dead net everyday pricing. While we expect promotional units and therefore sales to fall, we do not need to chase units at any costs.

We are making the necessary minor supply chain adjustments which represent between 2% to 3% of our capacity. Inherent in our guidance is an expectation that pricing in the promotional category could deteriorate a little further. Ultimately, as we resize this piece of the outerwear wholesale business, what remains should be smaller, less volatile and offer relatively consistent levels of profitability over time.

While we believe we have identified the proper path for image wear we will need to manage through a transition in 2012 which should result in the category losing money especially in Q1 and negatively impacting EPS by approximately $0.30.

Now shifting to Champion, that category continues to perform well at retail and gain market share in the desirable 18 to 34 year old market. With sales expect to grow led by new programs at major sporting goods retailers as well as expansion of the [C9 brand at Target. Casual wear will continue to reflect the loss of the fashion piece to the Just My Size business that is transitioning to private label but should begin to stabilize as newly added Hanes programs begin to set in late Q1 and into Q2.

Finally, we just completed our first full year with Gear For Sports and it continues to perform extremely well. 2011 was a record year in terms of both sales and profitability and Gear is on track to deliver an estimated $40 million of operating profit in 2012, up $10 million driven primarily by synergies.

Now, turning to our global supply chain with our manufacturing footprint now in place and heavy investments behind us, capital spending should drop to around $45 million around 2012 and $40 million per year for the next three to five years. In the near term, due to lower unit volumes from price elasticity and the previous mentioned changes, we are adjusting manufacturing capacity mainly by taking time out in our facilities as well as eliminating certain contractors. These proposed actions totaling approximately $20 million are built into our guidance and should take place primarily in the first quarter of 2012.

So in closing, while we continue to experience significant short term pressure from image wear, our core businesses remain strong and should grow both sales and profits in 2012. As we deliver value to our consumers and sales and profitability to our customers, we continue to gain shelf space at retail which is ultimately the best measure of the overall health of these businesses.

I will now turn the call over to Rick Moss, our CFO to discuss our financial performance.

Richard D. Moss

First, I’d like to provide a few highlights from the fourth quarter and then review our guidance for 2012, as well as provide some perspective on the longer term prospects of the business as we look beyond the cotton headwinds currently working their way through our results.

Sales in 2012 were $4.6 billion up 7%, EPS came in at $2.69 up 25% and our operating margin for the year was 10.3%, all records for the company. EBITDA for the full year also increased 20% to $563 million. For the fourth quarter sales were $1.1 billion, flat with prior year and EPS came in at $0.41. Gross margins were 29.1% for the fourth quarter, down 120 basis points or $14 million compared to last year. Outerwear was the main contributor to the decrease in gross margins as sales in our Just My Size brand and profitability in image wear declined. Innerwear and hosiery delivered small gross profit gains versus prior year while international and direct-to-consumer were down slightly.

In the quarter, higher input costs net of total pricing represented an approximate $20 million head wind. Our Fourth quarter SG&A rate was 22.5% of sales versus 23.2% last year. SG&A dollars decreased by $9 million over the prior year primarily driven by lower distribution costs. Interest expense was $2 million lower than last year and income tax expense was negative in the quarter as we true upped to reflect a full year rate of 15.5% in 2011 versus 9.6% in 2010.

Looking at the balance sheet, inventory at the end of the year totaled $1.6 billion up $285 million versus previous year end with approximately $250 million related to inflation and $25 million from incremental units primarily supporting our international growth. Cash from operations for the year totaled $168 million including $28 million in contributions to our pension plans. We generated approximately $200 million in cash flow in the fourth quarter which we used to prepay $200 million of our floating rate notes.

Now, let’s turn to 2012 guidance. For the full year we expect sales growth of 2% to 4% compared to fiscal 2011. We expect EPS for the year to be $2.50 to $2.60 which includes a loss of approximately $0.30 per share in image wear. Let me take a moment to discuss the key drivers underlying this guidance and how our quarterly performance will be impacted.

From a sales perspective we are estimating first quarter sales around $1 billion. Excluding the impact of image wear we’re expecting sales trends in the first four to five months of 2012 fairly consistent with the back half of 2011 or roughly flat versus prior year. As our new shelf space gains begin to set and we anniversary the double digit price increases taken in late May 2011, we expect to see sales grow.

Turning to image wear’s impact on the P&L, we expect to loss approximately $0.30 per share primarily in the first half of the year and spread equally between the first two quarters. As cotton inflation unwinds and we start to pull back from the promotional sector, we should begin to see the premium and core sectors return to profitability. However, as we continue to evaluate the overall image wear category throughout the year, we will also need to revisit some of its associated intangibles from acquisitions during the 90s which may or may not result in a non-cash charge.

Back to the total business, we expect our first quarter gross profit margin percentage to be in the mid 20s range with about half of the decline from outwear driven by image wear and Just My Size, with the balance coming from inflation and cost associated with our supply chain adjustments. We expect relatively flat Q1 SG&A resulting in an estimated $0.35 per share loss for the quarter.

As the impact of cotton driven inflation wanes, second quarter gross margins should improve to the high 20s leading to operating margins in the mid to high single digits. The back half of the year could then see gross margins return to the low 30s with operating margins in the low double digits. For the year, interest expense should be approximately $15 million lower than 2011 and our tax rate should be in the low double digits for 2012.

Turning to free cash flow guidance, many of the headwinds we saw from working capital in 2011 should reverse and become significant sources of cash for us in 2012. Our free cash flow guidance of $400 to $500 million reflects the unwinding of inflation in working capital as well as reduced unit inventories. This free cash flow guidance includes pension contributions between $30 to $35 million and roughly $45 million in capital expenditures.

We paid down $200 million of our floating rate notes in December and long term debt at the end of 2011 totaled $1.8 billion. We currently plan to pay down the remaining $300 million of floating rate notes at the end of 2012 with a goal of prepaying our 8% notes when they become callable in late 2013. This would result in a substantial decline in interest expense versus historical levels and would bring our total outstanding bonds to $1 billion at the end of 2013.

Now I’d like to communicate a few of our thoughts related to the longer term prospects of the business. As we move past the early year challenges of inflation in image wear and the loss in Q1, inherent in our 2012 guidance is an average operating profit margin of approximately 11% for the second through fourth quarters.

While it’s too early to provide 2013 guidance, a 10% to 11% profit run rate could be a good assumption for modeling purposes. When coupled with expected lower interest expense, one could reasonably model 2013 EPS potential in the low $3 range. So while we don’t like the near term results due to the cotton bubble and the pricing issues in image wear as you can see we believe they will soon pass allowing the profitability and cash flow potential of our core businesses to reemerge.

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

Charlie Stack

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Drbul – Barclays Capital.

Robert Drbul – Barclays Capital

I guess the first question I have is can you talk a little as you look at the guidance you’ve given, the fourth quarter results, the visibility that you have as the year is laid out today with the call meaning that when you consider where you were 90 days ago or at the beginning of November you sort of had a $0.10 range in your fourth quarter estimate and now sort of we’re at the beginning of this year and your range appears pretty narrow as well, a $0.10 range, so can you just talk a little bit about your visibility around how you see the business? Especially, in the back half as cotton sort of does come down and through the supply chain the margin implications around that and your ability to achieve those numbers?

Richard A. Noll

Overall, I feel really good about our ability to achieve the guidance we talked about for 2012. Let me first hit on and reiterate what happened in Q4, give you a little bit more color around that and then how that relates into sort of what our overall sales assumptions are and the guidance for 2012. As I said, sell through rates were running fine right to our expectations, orders from retailers were running fine.

December came though and retailers always bring their inventories down before their year end, normally it’s in January, this time it was in December and in fact, the only other time I’ve seen that in 20 years of being in these types of businesses was in December of 2008. That inventory pull down equaled that level. It didn’t have to do as much with our categories as really retailers were worried about their overall apparel levels of inventory because they were dealing with inflation, cold weather gear was starting to mount up.

A lot of them came out after Christmas and actually called their earnings down because they know they’re going to have to take markdowns to clear it out and we just got all caught up in that. As we’ve now said we’re going into 2012 let’s make sure that we’re not trying to build in anything that we aren’t already seeing in our expectations and so our sales run rate projections inherent in this guidance are pretty clear. It’s relatively flat sales excluding the issue we’ve got in image wear until we start to shift those space gains and we actually start to overlap the double digit price increases in late May where our competitive gap started to widen.

I feel really good about the foundation upon which we’ve built this plan. In terms of the overall range, at the end of the day there’s no question we missed Q4. I don’t like to miss, it irritates me by no small stretch of the imagination. But, I think it’s appropriate when we look at our overall business to have a tight range. I think our $0.20 range last year was relatively wide, it was almost 10%, and it was because of the uncertainty that we had to deal with pricing and we don’t see that kind of uncertainty in 2012, hence the narrower range.

Robert Drbul – Barclays Capital

I guess as you talk about it, can you elaborate a little more given the reduction in the Just My Size and the negotiations on the new programs, can you talk a little bit more about the shelf space gains you are expecting? Is there an updated number in terms of is it 2% of your top line in shelf space gains when you look at different buckets for the top line guidance?

Gerald W. Evans, Jr.

Let me just give you a little color on the Just My Size situation first. We have one more quarter to really wrap the impact of the loss of the fashion segment of that and that will be the first quarter and that will be in the range of $25 to $30 million. As we go into the second quarter we begin to offset that with the placement of some new Hanes programs that will go into effect and we’ll begin to see casual wear grow going forward. We feel like we’ve got one more quarter and then that’s behind us.

From the standpoint of additional space gains, we’re really gaining across the board. As I referenced in my remarks, we’re seeing great gains, we’re actually gaining space from both private label and other brands in our underwear, socks, intimate apparel as well as hosiery so we feel like we’ve got real good strong momentum on all fronts.

Richard A. Noll

Champion as well, you mentioned we’ve got good space gains going there so when you exclude image wear we actually feel really good about the health of our overall business.

Operator

Your next question comes from Susan Anderson – Citigroup.

Susan Anderson – Citigroup

I guess I just wanted to drill down on the guidance really quick again. I guess the way I look at it, if you add back the $0.30 impact from screen print and then you think about where the supply change savings and the cost synergies from Gear take you, it almost seems like you’re expecting the core business ex the screen print to be down year-over-year? Maybe if you could just provide a little bit more color on how you expect those businesses to pan out in terms of top line and margins?

Gerald W. Evans, Jr.

The screen print business or the image wear business as we call it, as we said will contribute about a $0.30 a share loss this year. It will be about half in the first quarter and half in the second.

Richard A. Noll

When you look at the rest of the business, when you subtract that out, actually operating profit should be up in the 5% range.

Susan Anderson – Citigroup

Then you’re also expecting top line to be up for the rest of the business too?

Richard A. Noll

Yes. Inherent in our guidance is 2% to 4% total growth. Image wear will actually be a little bit down so that’s actually mitigating that somewhat. So yes, overall sales the rest of the business will be up.

Susan Anderson – Citigroup

I may have missed it, did you just give a percent in terms of the space gains that you guys had? I think last quarter maybe you said 2% or 3% for this year?

Richard A. Noll

We do think that the space gains are in line with that sort of increase, yes.

Susan Anderson – Citigroup

Then just one more question on the image wear business, maybe if you could talk about what changed from last quarter that changed your guidance so significantly? If you could just talk about pricing, kind of where yours has gone versus the competition, and is it all priced in now? Then also as we enter the second half of ’12 do you think the lower cotton cost will help your image wear business? Should we somewhat of a rebound there in terms of margins?

Richard A. Noll

Overall, our sales in the wholesale channel which we call image wear, the business is about 8% of our sales. Last year it had double digit operating margins. However, in the fourth quarter there was some share shifts going on late in the year and the two largest suppliers started to go after and fight for unit share and that let to them fighting on price after the most pricing sensitive segments of the market which led to a rapid decline in overall pricing which we really started to see just in the fourth quarter, just in the last few months.

That’s just sort of changed that landscape and when you couple that with the high cotton cost coming through, like I said it creates that perfect storm really weighing our results in the near term and you’re seeing that from other people that have announced their results that operate in this segment. In terms of why we’re pulling back from some of these segments, at the end of the day it’s really a business model issue.

If you go back five, six, seven years ago we’ve actually had a few hundred million of private label business in our retail accounts and so on and so forth and we decided we needed to be a branded company and try and reduce the volatility that you see in private label and very price sensitive segments of the market. We’ve done all of that, the last place we need to do it is in this wholesale channel and I think this is the right strategy to make sure that what we sell in the image wear channel fits the rest of our business model, focusing on where people worry about product quality and brands matter.

Susan Anderson – Citigroup

Then in terms of pricing did you guys bring your pricing down to match the competitors or are you just kind of losing the sales as you go and like you said just kind of exiting out of that part of the business?

Richard A. Noll

No, by any stretch of the imagination in this market overall you need to be competitive. We’re very competitive, the only thing we’ve changed is on the most price sensitive segment of the market. We’ve eliminated any volume incentives because we don’t have any desire to grow that category. So we’re relatively competitive, we believe that this is a business that we want to be in and we’ll be in for the long term in that premium and core segment and it will return to its historical levels of profitability as we get through the inflation issues that we have in the first couple of quarters.

Operator

Your next question comes from Eric B. Tracy – Janney Capital Markets.

Eric B. Tracy – Janney Capital Markets

Rich, if you could talk beyond the image wear business, broadly within innerwear, maybe speak to the cadence of the top line guidance relative to some of the cautious inventory positioning and maybe the pricing strategy, particularly in the back half of the year as we start to normalize some of this cyclical cost inflation sort of what your view is from an industry broad prospective and sort of how you guys play into that?

Richard A. Noll

Let me start with that really broad industry view how not just people in our under wear situation or space were reacting but how the enter apparel industry has reacted. Overall, as everybody has been faced with inflation you hear time and time again that there’s a tendency to price for the average price of cotton for 2012. You’re hearing that from people that sell to department stores, we hear it from major suppliers from Asia, we hear it from people that are predominately in the retail business and they expect a little bit of margin compression in the first couple of quarters and actually to make up for it a little bit in 2012.

You’ll hear that refrain over, and over again, and we’re no different. I think that’s how pricing ended up playing overall in our innerwear segment. So for us overall, cotton other than in image wear, cotton is not a profit issue it’s more of a timing issue for us because those categories should end up with operating profits up for the year.

In terms of how we’ve gone through it, we’ve been working with our retailers very closely on all of these pricing dynamics over the last 18 months and today is no different. They have line of site where cotton’s going, we basically already talked to them and have pricing locked in for 2012, having all that baked in and it’s in our guidance so we feel really good about our pricing situation and we’re feeling really good about how retailers responded to our leadership in this category demonstrated by the space gains that we’re getting.

Eric B. Tracy – Janney Capital Markets

Just a follow up to that then, and it sounds like you got really good visibility to the pricing, is there a chance that some competitors that try to enter the branded apparel space get much more aggressive from a pricing perspective? Kind of what’s your thought there?

Richard A. Noll

In the retail channel everybody had to take price and did take price with all the inflation that’s here. In fact, one of our major competitors took three price increases as we did and they took it up to that average cost of cotton going forward for 2012. So let me make it crystal clear everybody in the retail arena had to take price so don’t extrapolate anything that’s going on in the wholesale image wear channel as to what may happen in the retail arena.

In terms of other big competitors that have been trying to come into this arena and talking about it I’ve been getting the question about [Gilda] and entering into our space time and time again for many, many years about how they’re going to come into the retail space. So it felt like it was forever so I actually ask somebody, when did they first start to announce they were going to enter into the retail business? We went back, we looked at their transcript and it was their fourth quarter call in 2003.

So they’ve been at this for nine solid years. In the last three years alone we’ve grown our underwear and sock business 20%. We’ve expanded space, we’ve continued to expand space, we take share from major competitors, private label including them and so we feel really good about how our brands resonate for consumers, work for our retailers, and our ability to continue to grow our sales and profits in those key categories.

Eric B. Tracy – Janney Capital Markets

Then maybe switching gears if I could a bit, really nice to see sort of the reemphasis on debt pay down using the aggressive free cash to delever here over the next couple of years. Is there a shift sort of in the thinking or just sort of walk through the thought process there, why get more aggressive? Is there a thinking of an optimized cap structure now at two times?

Richard A. Noll

What’s the change in our thinking overall about the capital structure? Let me give you sort of the big picture theme and then turn it over to Rick to talk about some of the more specifics. I really think there’s an overriding theme here about risk. I hear in the investment community people talking about risk on versus risk off. There’s clearly a lower appetite for risk in the investment community and we share that. So we’re looking through our business and saying, “How do we reduce the risk of our business model?”

The thing we’re talking about and pulling back in the image wear and that price sensitive area, it’s all about managing risk. Those types are things are always going to be more volatile than branded oriented business. And, our capital structure with our leverage introduces risk into our business model. As you have some smaller shocks they get magnified a little bit more on your bottom line.

We’re in a mode where we want our business model and our financial results to be less volatile and we think that will pay dividends ultimately in our stock price being less volatile. Rick, do you want to talk about the specifics on capital structure and debt pay down?

Richard D. Moss

I think just to add to what Rich said first, by continuing to deleverage the balance sheet we’re going to be able to significantly improve our financial flexibility. It’s going to enable us to return cash to shareholders in the forms of dividends and/or stock buy backs, it increases our capacity for potential acquisitions, and really when you think about it what we’re trying to do is really a timing issue. Let’s get the debt down to a level that’s appropriate for our business and then we have a lot of opportunities, a lot of options open to us at that point.

Operator

Your next question comes from David Glick – The Buckingham Research Group.

David Glick – The Buckingham Research Group

I was just wondering if you could help us kind of breakdown your outlook by your reporting segments, just generally relative to your 2% to 4% range clearly the image wear business is a drag but if you can kind of quickly walk us through the segments and how that growth would compare to the total? And in particular, the international business a little bit softer than I expected and previously you guys had talked about double digit growth there, I’m wondering if we can expect to see that? Finally, is there some kind of restocking embedded in your sales outlook? Clearly, it sounds like sell through exceeded the ship in and at what point do you expect to see the benefit and is that incorporated into your assumptions in innerwear and intimates?

Richard A. Noll

Let me do a quick answer to the [inaudible] and then the big one and then I’ll turn it over to Gerald for international. We have no inherent restocking built into our guidance. So we’re saying inventories will stay at these levels. In terms of more specific guidance by segment, at the end of the day we don’t really want to go through segment-by-segment and talk about sales and operating profit increases at that level of detail.

Suffice it to say we feel good about all of the rest of our business with the exception of the image wear and that wholesale channel. Internationally specifically though we have talked about and let me have Gerald give you a couple of highlights there and some of the expectations.

Gerald W. Evans, Jr.

International had a strong year for 2011. We were up 14% sales growth for the year. We did slow down a bit in the fourth quarter in international in a couple of countries. It was not immune from some of the same challenges we felt in the US business, particularly our largest business Canada felt a slowdown in both the intimate apparel category as well as a slowdown in order pace as we moved towards the holiday period and there was some general softness in Europe related to the economy.

But as we look to 2012 we expect another strong year. Our Latin America businesses, particularly our Brazil businesses and our Asian businesses, and particularly our China businesses, are all growing very strongly and we expect to be on a double digit pace once again.

Operator

Your next question comes from Jim Duffy – Stifel Nicolaus.

Jim Duffy – Stifel Nicolaus

A big picture question for you Rich, the plan for the business had been low to mid single digit revenue growth with operating margin expansion. Is that now out the window? Do you still see this as a growth business? I hear about cap ex plan below D&A, emphasis on cash flow, it seems as if there’s a change in operating philosophy as we look forward?

Richard A. Noll

Let me start by reminding you, we grew our gross margin 50 basis points in 2011 and got 50 basis points of SG&A leverage so we feel really good about our ability to continue our margin expansion. The cap ex really has to do with the fact that our footprint is now in place and we don’t need any more spending for big moves.

We still have ample capacity to grow within that footprint. In fact, one of our largest facilities Nanjing is only half full so the ability to continue to expand and support 3%, to 4%, to 5% top line growth on a consistent basis is within that footprint and within that type of capital spending that we’re talking about.

So we didn’t build it to be tight in a box and not support growth. What we don’t need to do is pick up factories and move them around the world anymore and that’s why the capital expenditures are coming down. We still think that our businesses have a lot of room for growth. International, we’ve still got that growth out there by mid decade to have it reach a billion dollars.

I think the focus on cash flow though, as Rick said, is more of a timing issue. We need to take some risk out of the business by delivering. We’ve got strong cash flow coming now as inflation unwinds. It’s a good time to reduce that risk, reduce the volatility, and then we’ll have a lot more flexibility to drive value with that cash flow either through returning cash to shareholders or doing like we did for Gear For Sports and doing opportunistic acquisitions.

The business model really hasn’t changed and so I feel good about our prospects. By growing the top line, continuing to expand margins, and using that cash to drive an ever great growth of EPS.

Jim Duffy – Stifel Nicolaus

Just a follow up on that related to the operating margins, the guidance for the second half of the year implies I guess double digit operating margins yet you’re talking about 11% operating margins into 2013. What do you see as a sustainable operating margin run rate for this business given your current portfolio and where you expect to take it? Maybe what’s near term sustainable and longer term achievable?

Gerald W. Evans, Jr.

Well I think based on what we said today if you look again back from Q2 to Q4 you see that 11% operating profit margin is above historically what we’ve been able to do. Then we said we think that’s sustainable to 10% to 11% level through ’13. Beyond that I would just say, reiterating what Rick said a little earlier, we think they’re going to continue to be opportunities for us to improve our profitability over time and we’re going to be diligent about making sure that over time we do consistently provide greater return on our sales.

Richard A. Noll

Don’t over focus on what Rick was trying to help you do from a modeling perspective to think about next year. I think one of the major things we’re trying to communicate is to say we don’t view the numbers that we’re talking about for 2012 for a new low base from which we modestly grow. And, I think what we’re trying to communicate is that we would expect things to snap back in 2013 and I think that’s the message you want to take away from it.

Operator

Your next question comes from Omar Saad – ISI Group.

Omar Saad – ISI Group

I wanted to actually follow up on the price increases and help me understand how much of that are you guys going to be able to keep through pack sizes, are you going to have to give back later in the year as lower cost cotton flows through? In the retail business not the screen print, and how we should think about how that’s impacting your sales growth guidance for the year too?

Gerald W. Evans, Jr.

As we went out and led the price increases we certainly had gaps widen for a while but we have seen the competitors follow and we think the industry is generally priced to the average cost of cotton in the market. As Rich noted, in certain cases we’ve now gone out, we’ve seen what’s going in the market, we’ve worked with our retailers to make some adjustments whether it be in price or in pack size. Those are making their way to market now and we’ve effectively locked down our prices with our retailers for the balance of the year.

Richard A. Noll

If I could just put it in context with the history of I think the question you’re asking. We did with our three price increases price for a higher level of cotton with our third price increase than what we’re all seeing for the average of 2012. I think by the time some of our other competitors put in their three price increases was about a quarter later and they didn’t go quite that high and that’s necessitating some of this adjustment that we’re talking about.

But, all of our retailers know exactly where they’re going to end up. It’s built into our guidance and it’s clearly locked in, even through our promotion through back-to-school. So we feel really good about our situation.

Omar Saad – ISI Group

Help me out, if you don’t mind, on the guidance for the gross margin for the first quarter it seems like you guys are looking for I guess 900 basis points pressure and a lot of it is coming from the screen print business, if I’m not mistaken. Help me through the math how a business that represents 8% of the mix is having that big of an impact on the gross margin. Are there other pieces to it as well?

Richard D. Moss

Let me walk you through some of the math on that and break that down for you. Before I do that let me again, just reiterate a couple of points. As you put Q1 kind of in the context of the full year it’s important to remember that image wear is a profit issue but when you look at the rest of the business cotton related inflation [inaudible] is a timing issue, a short term timing issue at that. Remember that really all of the cotton related inflation that we’re going to experience in the first half was actually on the balance sheet at the end of the year and it will flow through the P&L in the first half of the year impacting margins in the first quarter a little more than they will in the second quarter.

Let me be a little more specific. When you think about the first quarter loss, it really is a gross margin issue. We see gross margin again in the mid 20s, we’re looking at about 800 or so margin drop in 2011. About half of that is going to be from the outwear business, mostly from image wear but also remember we’ve got the Just My Size sales decline of $25 to $30 million in sales that will impact profitability in that quarter as well.

We’ll have about 150 basis points of that margin decline will be from supply chain costs that Gerald referred to, cost associated with adjusting the supply chain and the balance will be the cotton inflation. Again, because the first quarter tends to be a little bit smaller quarter, actually 15% to 20% smaller than the other quarters, it’s going to have a bigger impact than it will in the other quarters, the second quarter.

Operator

Your next question comes from Ken Stumphauzer – Sterne Agee.

Ken Stumphauzer – Sterne Agee

I just had a couple of ones, first as far as a clarification, the down time you guys are taking in 1Q is that included in the $0.30 number you quoted for the image wear division?

Richard D. Moss

No, it’s not.

Ken Stumphauzer – Sterne Agee

Then secondly, regarding the guidance I actually have a hard time getting to the numbers unless I assume that SG&A is down pretty considerably the last three quarters of the year. Is that a reasonable assumption or is there something else that I could perhaps be missing?

Richard D. Moss

I would think of SG&A basically as being flat for the year, flat to down slightly.

Ken Stumphauzer – Sterne Agee

Then just one last thing regarding the image wear and the hit you guys are taking in that division, can you explain the mechanics of that? You guys are not writing down inventory, correct? You’re just selling the product at prices which would essentially involve a loss? Is that correct and is that why it’s being dragged out over two quarters?

Richard D. Moss

No, it’s the pricing environment relative to the cost of the goods that are being sold is an issue but it’s not resulting in a NRV, net realizable value, issue from an accounting standpoint. Remember, they have operating expenses that they have to cover as well.

Operator

Your next question comes from Steve Marotta – CL King & Associates.

Steve Marotta – CL King & Associates

Rich, you mentioned earlier in the call that you hadn’t seen the kind of destocking at retail in innerwear since December 2008. Can you talk a little bit about magnitude of the comparable December 2011 and also how long it took for retailers to realize restocking?

Richard A. Noll

Yes, I think the 2008 versus this December, like I said retailers always adjust inventories in January. They rarely do it, I used to say never do it, in December now it’s rarely do it in December. Actually, the pull down in inventory that we saw in December of ’11 was actually a little bit greater than the pull down in December ’08 just to sort of give you the order of magnitude. Gerald, do you want to comment on more recent sell through and order pace trends?

Gerald W. Evans, Jr.

What I would add from a standpoint of while the orders were pulled back drastically in December, our point of sale continued to meet expectations from the standpoint of how it’s performing through the register. As we exited that period and came into January, actually retail inventories were in pretty good shape from the standpoint of weeks of supply. As we’ve now come through January towards the beginning of retailers new fiscal years we’re seeing the order rate normalize as it should be.

Steve Marotta – CL King & Associates

Looking back to 2009, how long did it take for retailers to restock from the December 2008 destocking?

Richard A. Noll

That’s not going to give you any indication of what’s going on here because remember that was in the depths of the recession. The stock market in January ’09 was heading to 6,500 and their sell through rates across the board and their traffic was declining so I don’t think it’s actually a good model to try and project what’s going on here. This is much more of a short term anomaly, their dealing with their inflation numbers. At the end of the day they all said they would let their dollar inventory go up a little bit because of inflation and at the end of the day their CFO said, “No, don’t let it go up.”

When you couple that with the warm weather and cold weather gear starting to mount up I think they started to get nervous and hit the button pretty quickly. This is a very different situation than what you saw in 2009 because the fundamental sell through rates were starting to decline. This was going towards our expectations, there was an adjustment that was bigger than we expected and clearly not at the time we expected. But this too shall quickly pass.

Operator

Your next question comes from Scott Krasik – BB&T Capital Markets.

Scott Krasik – BB&T Capital Markets

Just a couple things, explain to me this $20 million in manufacturing charges that is not in the $0.30? Is that though strictly related to the down time around the inventory withdraw?

Gerald W. Evans, Jr.

No, actually it’s a combination of several things. Coming out of last year and the destocking and the elasticity effects of price increases, we had the need to realign our inventories and so we’re taking time out as well as we’ve made some small adjustments in our supply chain related to pulling back on the promotional segment of the innerwear predominately taking out one of our own sewing facilities and exiting some contract facilities. Generally, we have the contractors in place to flex and so forth. It got a little costlier this time than typical because we do have this time out that we’re taking to readjust inventory and that’s why it’s in the first quarter.

Scott Krasik – BB&T Capital Markets

It’s almost the reverse of the rush in costs from a year and a half ago? There’s some cost in terms of aligning demand with the inventory?

Richard A. Noll

I think that’s a fair statement although on an ongoing basis, just to give you an example, if we were trying to simply make a 2%, 3%, or 4% adjustment in our overall inventory levels, that’s one or two weeks of time out which would be $4 or $5 million at most probably per week if you took the entire system down. I think this one is a little bit compounded because you’ve got the effects of elasticity that we need to take, our inventories are a little higher than we’d like and we specifically want to drop those and improve our working capital productivity and generate cash. To tell you the truth, some of this time out and this restructuring is one of the major reasons we can generate $400 to $500 million of free cash flow this year and we think it’s a good trade off.

Operator

Your next question comes from Eric Beder – Brean Murray Carret & Co.

Eric Beder – Brean Murray Carret & Co.

Could you talk about inventory levels? How should we think about inventory levels after you go through the expense of cotton throughout the year? How should that start to flow?

Gerald W. Evans, Jr.

We have about $285 million of additional higher inventory at the end of 2011. $250 of that is inflation related, that’s going to flow through the first half of the year and then we do have a goal to continue to drive units down as we believe with the supply chain footprint in place that we can optimize our inventory that way as well.

Richard D. Moss

We need to definitely increase our overall working capital turns and the primary driver is going to be improving inventory turns and we figured this was a great time to do it and generate the cash.

Eric Beder – Brean Murray Carret & Co.

Can you talk a little bit about Gear? How is that going? You talked about synergies to taking out contracts and other things, are those synergies still flowing? And how should we think about that business going forward in terms of kind of organic growth and the opportunities there?

Richard A. Noll

We’re thrilled with the Gear acquisition. We said in our first full year it would make about $30 million. It did in 2011. We said that would grow to about $40 million primarily driven by synergies in year two which is 2012. We are right on track. They’re growing their top line, it’s integrated well into our overall supply chain and I couldn’t be more pleased with how the whole thing is going.

Operator

Your next question comes from Carla Casella – JP Morgan.

Carla Casella – JP Morgan

I’m just wondering if you could discuss a bit your thoughts on JC Penney’s new pricing strategy and how that might affect your business?

Gerald W. Evans, Jr.

Certainly an exciting strategy by JC Penney the vision of modernizing their identity is really exciting. Certainly their focus on national brands is consistent with our philosophy on national brands and as we do with all of our customers we’re working closely with them to build plans but it’s early days for us. We want them to be successful. When our customers are successful we’re successful.

We’re in the early days of planning and transitions sometimes can be challenging so as we look to this year we have anticipated there would be some impact on our intimates business in particular as they adjust their inventories and we’ve built that into our guidance. Not so much on the underwear and socks business where we’re still in expansion mode.

Operator

Your next question comes from [William Brunner] – Bank of America Merrill Lynch.

[William Brunner] – Bank of America Merrill Lynch

I’m curious all of the focus on debt reduction whether this signifies that you’re less focused on acquisitions this point, whether there are less on kind of the for sale out there available to you, or how I should be thinking about that?

Richard A. Noll

I’ve always said that we want to use cash flow to maximize shareholder value and we will compare returning cash to shareholders, opportunistic acquisitions that can leverage our infrastructure and global supply chain, and paying down debt. We want to do all of those. I think in this environment we want to reduce the volatility of our business model and so it’s a timing issue. We think we should funnel our cash flow to reduce debt, reduce some of our risk and volatility and then there’s in 22 short months we can radically change our entire profile.

There is ample opportunity to still look at opportunities to return cash to shareholders and do opportunistic acquisitions. So don’t think of this as a change in strategy in how we’ve talked about using cash flow to maximize value, simply a timing shift.

Operator

There are no further questions as this time. I’ll turn the call back over to Mr. Stack.

Charlie Stack

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

Operator

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

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