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Hanesbrands Inc (NYSE:HBI)

Q2 2012 Earnings Call

July 26, 2012 4:30 p.m. ET

Executives

Charlie Stack – Head-Investors Relations

Richard Noll – Chairman, Chief Executive Officer

Gerald Evans – Co-Chief Operating Officer

Richard Moss – Chief Financial Officer, Treasurer

Analysts

Omar Saad – ISI Group

Eric Tracy – Janney Capital Markets

Susan Anderson – Citigroup

David Glick – Buckingham Research

Joan Payson – Barclays

Scott Krasik – BB&T Capital

Steven Marotta – CL King & Associates

Eric Alexander – Stifel Nicolaus

Danielle McCoy – Brean, Murray

Andrew Burns – DA Davidson

Operator

Good afternoon. May name is Jay and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanesbrands’ Second Quarter 2012 Earning Conference Call and webinar.

All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Mr. Charlie Stack, Chief Investor Relations Officer, you may begin.

Charlie Stack

Good afternoon, everyone, and welcome to the Hanesbrands Quarterly Investor Conference Call and webcast. We are pleased to be here today to provide an update on our progress after the second quarter of 2012. Hopefully everyone has had a chance to review the news release we issued earlier today. The news release and the audio replay of the webcast of this call can be found in the Investors section of our Hanesbrands.com website.

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

Please also note, Hanesbrands recently announced exiting certain international and domestic imagewear businesses that are now classified as discontinued operations and as noted in today’s press release, additional information will be in our 10-Q and has been provided in the Investors section of our Hanesbrands.com website. Unless otherwise noted, today’s speakers will be discussing our performance from our continuing operations.

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 of our accomplishments through the first half of the year, Gerald will provide a sense of what is happening in a few of our businesses, and Rick will emphasize some of the financial aspects of our results.

I will now turn the call over to Rich.

Rich Noll

Thank you, Charlie. When we started the year we outlined two goals, to successfully manage through the cotton bubble and to derisk our business. When you look at this quarter’s solid results, you will see we’re making good progress towards both. We’ve accomplished much over the past six months and remain pleased with sales, profit and cash flow, all running at or better than our plans. And in fact from an EPS basis, we’re running a little over a dime ahead of where we thought would be at mid-year and I am sure somebody will ask me about that in the Q&A section.

So let’s start with an update on our efforts to derisk our business and then follow with how our core business is navigating the cotton bubble. First let me speak to the major actions we’ve undertaken to reduce risk and volatility in the imagewear category. In May, we announced our plans to sell the European imagewear operations and to exit private label and Outer Banks in the U.S. These moves allow us to devote our energy and resources to our branded businesses while removing volatility inherent in the sectors we exited.

The result of these actions is our newly named branded printwear, which should be a smaller, but more profitable and less volatile, where we remain committed to growing both the Hanes and Champion brands. We believe this is the right strategy for the category going forward and in hindsight only regret not taking these actions sooner.

Our other major derisking strategy is strengthening our balance sheet by focusing on cash generation and debt reduction. Through the first half of 2012, inventory is falling, free cash flow is strong, we continue to pay down debt, and we remain committed to further reducing bond debt to $1 billion by the end of 2013. These actions by themselves should not only significantly reduce volatility, but also power EPS growth, especially in 2014.

Turning to our core business, we have successfully managed through a significant cotton bubble. In 2011, cotton inflation impacted us by about $200 million and 2012 has seen a similar headwind through the first half. With that now behind us, we are pleased to see our margins returning to historical levels.

The best evidence of how we have navigated through the cotton bubble is innerwear. We saw at least mid-single-digit sales growth with our top three customers and our substantial profit turnaround as first-half operating margins were only 70 basis points below last year’s first half, when cotton was over 50% lower.

Importantly, our new program launches are off to a great start, and as we overlap last year’s price increases, we expect our positive momentum to continue. In the second quarter, outerwear was the only significant profit drag, but as cotton costs decline, outerwear results should improve dramatically in the back half.

So in closing, we are pleased with our performance and the accomplishments through the first half of 2012. We’re growing our brands, de-risking our business and our balance sheet continues to strengthen, all of which gives us confidence in the ability to deliver the year. Going forward, we should reap the benefits of being a totally branded company that can deliver consistent growth year-in and year-out.

With that, I’ll turn the call over to Gerald.

Gerald Evans

Thanks, Rich. Overall, we are building momentum throughout the company. We have navigated the cotton headwinds extremely well and we believe this experience positions our brands for future growth. The recent inflation had allowed our categories to break through historical price barriers and elevate the perceived value associated with our products. Our retail partners are now more open to higher priced trade up products, and we are well positioned to help them grow their basic apparel categories through our strong innovation pipeline.

As we have stated before, we are experiencing net shelf gains in 2012, especially in men’s underwear. We gained innerwear space at each of our top three accounts this year and are already gaining incremental space for our innovations in 2013.

One example of our trade up innovations is our new Hanes ComfortBlend underwear line. This product features a softer, quick drying, durable fabric, that shrinks less, holds it shape, and commands a roughly 30% price premium in the market. We began shipping ComfortBlend to our major retail partners late in the first quarter and it is already performing above expectations generating incremental sales dollars for Hanes and for our retail partners. Next week, we will begin airing a new Michael Jordan television ad supporting ComfortBlend that we expect will drive performance even higher.

Already on air is new advertising for Hanes men’s Tagless underwear bottoms featuring Michael Jordan that addresses the number two consumer complaint with underwear bottoms, those annoying tags. Our new campaign showcases our offering of Tagless underwear bottoms to complement our line of T-shirts that went tagless more than 10 years ago.

Now turning to our second quarter results, let’s start with innerwear, where we had a strong quarter with sales increasing 2%. We had good performance once again across our men’s underwear, kid’s underwear and socks with all growing at least low single digits in the quarter. Our women’s panties delivered a second quarter of strong mid-single digit growth and bras achieved growth within the quarter as we are seeing the results from our work to upgrade our brand presentation and product offering at retail.

The results could have been even stronger with JCPenney’s recent strategic shift, we have experienced considerable declines in retail sell-through and shipments. When excluding the sales decline at JCPenney’s, innerwear sales were up 4.4% compared with 2.7% growth in the first quarter. But even with the Penney’s headwind, we expect sequential sales growth in innerwear as we overlap wider competitive price gaps experienced last year and continue to see the benefits of our space gains and new products.

Looking at innerwear profitability, we were pleased with the 18% increase in operating profit in the quarter. Gross margins, while still down in the face of higher cotton costs, improved over the first quarter. Positive performance of our bra and panty businesses helped to partially offset the impact of cotton costs on gross margins in the quarter and contributed nicely to profits.

It’s important to note we have now finalized all product pricing, shelf space and promotional plans with our major retail accounts for 2012, and we expect continued improvement from innerwear for the remainder of the year.

Our International segment, where sales are comprised of nearly three quarters innerwear faced the same cotton and pricing challenges but also showed improvement. The best measure of year-over-year performance is on a constant currency basis where we saw sales increase 5% after being relatively flat in the first quarter. Profit performance also improved increasing 10% versus prior year on a constant currency basis. We expect continued sales and profit improvement in the back half here as well as we overlap the cotton inflation.

So now let’s turn to outerwear, where we saw the majority of the profit declines in the quarter. Sales were up 1%, improving upon the 5% decline in the first quarter. Our retail Casualwear category performed well with sales increasing by over 50% as our new Hanes Beefy T program exceeded expectations and we put the Just My Size losses behind us.

Activewear again grew nicely, driven by Champion new performance products. And so much like Innerwear, we have good momentum here as well, and with the longer lead-time nature of outerwear, we have good visibility to the order book, pricing and cost, for our retail outerwear category for the balance of the year.

With our imagewear restructuring now complete, we are focused on driving profitable growth in branded printwear. We remain committed to our customers and can now devote our energies in this category to our Hanes and Champion branded products. As we reduce our focus on the promotional sector, these sales should continue to decline in the back half, but with recent pricing stability, we do expect to see better margin performance.

In regards to profit, outerwear has suffered the most from the high cost of cotton. With cotton costs declining for the balance of the year and the positive strength of our order book, we anticipate sequential improvement of outwear gross margins and operating profits in the third and fourth quarters.

So in summary, we are pleased with our performance through the first six months of the year. We have successfully navigated through the cotton headwinds. Our brands are strong. Our product innovations are working. And we are encouraged by the improving trends throughout the company.

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

Richard Moss

Thanks, Gerald. Let me begin by talking about how discontinued operations are handled in our reporting, and then I’ll discuss the second quarter performance and our guidance.

During the second quarter, we announced the sale of our European imagewear business and the exit from the private label and Outer Banks portions of our domestic imagewear category. As mandated by GAAP, these businesses are now being reported as discontinued operations. GAAP also requires us to report against revised prior-period financials in future 10-Ks and 10-Qs. Please refer to our 10-Q, press release and documents to be added to the Investors section of our Hanesbrands.com website for further details.

For first half of the year, discontinued operations contributed a loss per diluted share of $0.69, with $0.03 recognized in the first quarter and $0.66 of that loss occurring in the second quarter. The loss was virtually all non-cash and was primarily driven by the loss on the sale of the European business, the intangibles write-down and other related exit costs.

In February, when we initiated financial guidance for 2012, our expectations for what are now discontinued operations were sales of about $190 million, an operating loss of less than $1 million, and cash flow from operations of approximately $15 million.

My comments will now focus on continuing operations. Let’s turn our attention to our results for the quarter. As Rich and Gerald noted, our second quarter results came in slightly better than expected and we’re pleased with where we are halfway through the year.

Our margins showed improvement in the second quarter and should continue to improve sequentially as we move through the third and fourth quarters. Sales in the second quarter were $1.18 billion, up 1% versus last year and earnings per share were $0.67, down 14% from last year. The stronger U.S. dollar negatively impacted our sales in the quarter by about $9 million or about one point of growth.

Gross margins for the quarter came in at 31.1%, down 400 basis points or $43 million from last year’s second quarter. These results varied widely by business segment with innerwear, international and direct-to-consumer all seeing gross margins down between 40 basis points and 130 basis points, while outerwear experienced a nearly 1,200 basis point drop as pricing challenges in the branded printwear category continued to exacerbate the impact of high cotton costs.

I should note that we planned about $8 million of costs in the second quarter, primarily associated with supply chain actions, which we now expect in the second half of the year. This shift benefited the second quarter by about $0.07 per share.

SG&A decreased $27 million from the prior year period driven by lower media spending, primarily in women’s intimate apparel, lower distribution costs and continued tight cost controls. On a rate basis, SG&A declined 260 basis points year-over-year to 20.9% of sales.

Operating profit in the quarter declined 12% or $16 million versus last year. Even with higher cotton costs, three of our segments experienced flat to improving operating profit results. Innerwear operating profit increased 18% as higher cotton costs, net of price increases, were more than offset by lower media and other SG&A spending.

Operating profit in our direct-to-consumer and international businesses were basically flat to last year and while operating profit declined in outerwear driven by the large drop in gross profit, we expect these margins to improve substantially in the back half of the year.

Interest expense for the quarter declined about $3 million and our tax rate was 18%.

One of the areas I’m most pleased with is our working capital management where we continue to see significant improvement in our inventory levels. Inventory was down $172 million from the end of last year and down $204 million from last year’s second quarter as we saw declines in both input costs and units. We expect inventory dollars and units to continue to decline through the back half of the year and generate substantial cash flow.

Let me now turn to our guidance for the year, which, going forward, we’ll speak to in terms of continuing operations. Our full year sales guidance is $4.52 billion to $4.57 billion or roughly 2% to 3% higher than last year with the biggest change versus previous expectations being the lower expected sales from JCPenney that Gerald discussed earlier. Sales are expected to improve sequentially through the back half of the year beginning in the third quarter as we expect continued increases from shelf space gains and more competitive price gaps than we experienced last year when we raised prices ahead of our competition.

Gross and operating margins for the balance of the year should also improve sequentially with the gross margin rates in the back half expected to average in the low to mid-30s while operating margins are expected to average approximately 12.5% to 13%. Recall last year’s cotton costs were increasing throughout the back half of the year while this year should see them receding.

Still included in this guidance are supply chain actions totaling about $20 million, of which approximately $16 million is associated with volume being exited due to imagewear restructuring. Of the $20 million of supply chain costs, about $14 million was incurred in the first half while – with approximately $6 million still to come in the back half.

We expect SG&A spending to continue to be lower than last year’s level. As Gerald mentioned, product pricing, shelf space, and promotional plans for 2012 have been finalized with our major retailers and we have visibility to virtually all commodity costs for the remainder of the year. Full-year interest expense is now expected to be approximately $17 million lower than last year. So we see favorable trends in our operating profit and interest expense outlook for the year.

Unfortunately not all of this benefit will be recognized on the bottom line as our full-year tax rate is now expected to be in the mid-teens, an increase from previous guidance of a low double-digit rate. We expect the tax rate to fluctuate by quarter with the third quarter’s rate expected to be slightly less than 10% and the fourth quarter rate expected to be in the mid to high teens. When all this is netted out, we expect full-year earnings per share from continuing operations of $2.50 to $2.60. While similar to our previous guidance, the quality of our earnings is better in our latest outlook.

We continue to expect $400 million to $500 million of free cash flow for the full year, reflecting lower inventory than last year in both dollars and units. Included in our free cash flow guidance are pension contributions of approximately $25 million and roughly $45 million in capital expenditures.

On July 12th, we paid down the first $150 million of our planned $300 million long-term debt prepayment for 2012 and we remain committed to paying down the balance of the floating rate notes by the end of the year. For 2013, we remain committed to prepaying the $500 million of 8% fixed rate notes and we continue to see 2013 EPS potentially in the low $3 range.

So, with the first half of 2012 running a bit ahead of our plans, the de-risking of our product portfolio and balance sheet well underway and cash flow accelerating, we remain confident we can deliver our guidance for the full year and carry that momentum into 2013 and beyond.

And with that, I’ll now turn the call back to Charlie.

Charlie Stack

Thanks, Rick. That concludes the recap of our performance for the second quarter. Now we begin taking your questions and we’ll continue as time allows. Since there may be a number of you who would like to ask a question, I’ll ask that you limit your questions to one question plus a follow-up and then re-enter the queue to ask any additional questions.

I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

Question-and-Answer Session

Operator

(Operator Instructions) The first question will come from the line of Omar Saad with ISI Group. Your line is open.

Omar Saad – ISI Group

Thank you. Good afternoon, guys.

Rich Noll

Hi, Omar. How are you doing?

Omar Saad – ISI Group

Very good. Thanks, Rich. So, I wanted to just kind of follow-up on – get an update from you guys on your views on the gross margin, the input costs issue, the cotton flow through into the second half and next year, how pricing has kind of played in that equation, the sustainability of some of the price increases? I know a lot of this was set up – set in advance, but just would like – it would be good to hear kind of you guys kind of reconfirm the gross margin outlook for this year, and just kind of longer term, assuming the input costs in cotton stays relatively stable.

Rich Noll

Gerald, do you want to talk to 2012 and I’ll pick up the longer term?

Gerald Evans

Yeah, Omar, this is Gerald. Let me just start with the pricing. As I said in my comments, we have locked in our pricing for the balance of the year along with our promotions. We feel really good about where it’s set. I think our retailers feel good as well. We have preserved sort of the increase in the pricing in the market, which gives us good headwind – good tailwind going through the balance of this year and into next year.

Rich Noll

From a longer-term perspective, we feel really good about our overall margin trends are returning back to historical levels you can see in the back half. We are talking about 12.5% to 13% operating margins, which are pretty strong for us. We feel really good about continuing to invest in our brands and keep that momentum going forward in the long term.

In terms of 2013 specifically, you know we’ve talked about – you know there is no reason that we shouldn’t have a goal to have EPS in the low threes. All the exact puts and takes of that in terms of sales growth and margin growth, and so on and so forth, we will wait to give that when we get closer to the beginning of the year. We feel really good about our ability to keep driving our brands, expand our margins over time at a faster rate than sales, use our cash flow and drive pretty strong EPS growth, so all of that is still intact.

Omar Saad – ISI Group

Thanks, that’s helpful and then as you think about this plan and your ability to drive these businesses and the brands, one of the equations historically that’s kind of moved around and been a little bit of a moving target and outside of your control in addition to commodity pricing, has been retailers’ focus or lack of focus at various points of time on inventory levels, and whether they are stocking or restocking the business or destocking the business. Where do you – where do you think you are in that cycle, if you had to guess in terms of where retailers’ focus has been on their inventory levels? Do they feel they still need to take inventory levels down? Has that kind of settled out at this point?

Rich Noll

And, so let me talk about that first for the long-term and then sort of on a shorter term perspective. There is actually some great stuff we were looking at not too long ago that actually shows total retailer turns or days sales of inventory and it took a dramatic improvement, step down, if you will. There was a focus on increasing their turns since the recession and all that’s held. So it’s sort of like before the recession, they had a certain level of inventory turns that they felt acceptable, since the recession, they’ve worked really hard to improve that across the board and that sort of stayed and I think it’s going to stay there forever. So I don’t think we are going to go back to them having sort of the levels of inventory that they had prior to the recession. So from a long-term perspective, it’s corrected itself, it’s sort of in our numbers and the industry’s numbers and I don’t expect it to change dramatically.

From a short-term perspective, in our categories, we do see them take up or take down our inventories by a week here or a week there because they can – as they are moving things around, they can take it out of us because we’ll make more easily than others because they don’t pre-book a lot of our orders on innerwear, they order every single week. And so that fluctuation happens if they take out a week of inventory for a full year, it can impact our shipments 2%, but in a quarter, it actually has a big impact.

The important thing to remember while we face those kind of volatile fluctuations quarter-to-quarter, it has virtually no impact on sell-through and the long-term health of our business. And so that’s just a little bit of volatility that we have to deal with in the short-term but it really doesn’t matter from a long-term growth perspective.

Omar Saad – ISI Group

Thanks, Rich, really helpful.

Operator

The next question on the line comes from Eric Tracy with Janney Capital Markets. Your line is open.

Rich Noll

Hi, Eric.

Eric Tracy – Janney Capital Markets

Hey, guys good afternoon. Congrats on nice profitability.

Rich Noll

Thanks.

Eric Tracy – Janney Capital Markets

So Rich, I guess just kind of bigger picture since the last time we talked, at least the perception of the macro environment potentially deteriorating here, yet seems like you guys have a pretty decent visibility from a top line perspective on pricing, maybe just talk to again the environment, conversations with retailers within the mass channels and the visibility you guys have as you’re going into the back half.

Rich Noll

Yeah, let me actually talk about that on two levels just from the overall sales perspective and then sort of how it impacts our outlook for the rest of the year.

The year, it still is unfolding, it’s relatively mixed. You see some good selling periods followed by some weak selling periods. You’ve got some retailers that are doing pretty well. You’ve got other retailers that are struggling. And so, it’s sort of a little bit of a choppy environment. While things are still in the uptrend, it’s no question about it, there is some volatility around consumer spending. And when you look around at the headlines, you can’t help but wonder about with all of the bad news that’s constantly bombarding everybody; are they going to start to get a little bit nervous later in the year and pull back. And so that’s just something we all need to be mindful of. I don’t think we’re seeing – we’re certainly not seeing any trends our businesses are picking up yet, but we’ve always got to be watchful for it.

In terms of how it relates to us, and let me just actually talk a little bit about how it relates to our guidance. We feel really good about where we are. As I said, we’re about a dime ahead of where we thought we’d be by mid-year. But we have only earned $0.43 year-to-date. We’ve still got over $2.10 of earnings per share yet to go. And just given that macro environment, that makes us a little bit more cautious. We’re happy to be ahead, but it’s a little too early to declare victory and say that that dime is going to absolutely fall through to the bottom line.

And that brings me to a second part of what we might do if we actually find ourselves – if our trends continue as strong as they have been, and that is what we might want to do with those extra funds. And as Gerald talked about, we’ve got great innovation going. It’s working. We have pulled back on media a little bit and a great place to invest may be putting – restoring some of that media this year and continuing to drive upside for 2013, so we feel real good about our overall guidance. We realize the macro environment is a little choppy out there, but we feel real good about our ability to deliver this year.

Eric Tracy – Janney Capital Markets

And yeah, just the follow-up to that, I mean would be because the low $3 EPS next year, I think that does suggest that there’s going to be a level of investment made behind the brand and with retailers, again maybe just speak to that, what you’re seeing from a competitive standpoint, others, some of the bigger players from a promotional cadence, just sort of how you defend that position as we go into next year because it seems like the margin lift just on the cotton unwind is obviously pretty massive?

Rich Noll

Yeah and I think one of the things that we’re already starting to see is some of the large – larger bigger brands in lot of our categories are taking the opportunity to invest further in consumer and drive innovation, advertising. You will see some of our larger competitors have actually ramped up their advertising because I think what we’ve all learned through this entire change with inflation is that cutting price doesn’t further drive consumption in our categories.

What drives consumption is drawer-changing events and when I – something like that I mean is when we took the tags off T-shirts, people started to wear them. They said, “You know what? I am throwing all my old T-shirts away and I am buying all new.” We are now doing that with bottoms. Our ComfortBlend products that are out there are starting to show that some people for them it’s a drawer-changing event and so that’s where we want to invest our funds to drive true incremental demand for both us and our retailers, and I think that’s how lot of the competitive environments are going to play out over the next year or so.

Eric Tracy – Janney Capital Markets

Okay guys. Appreciate it very much.

Rich Noll

All right, thanks.

Operator

The next question on the line is from Susan Anderson with Citigroup. Your line is open.

Rich Noll

Hi, Susan.

Susan Anderson – Citigroup

Hi, guys. Congrats on a great quarter.

Rich Noll

Thanks.

Susan Anderson – Citigroup

Maybe if you – you mentioned the space gains and you are already seeing space gains next year, maybe if you could give some numbers around what you got this year, maybe just an update there, because I think you have given some previously and then what you are looking at next year?

And then also, I don’t know if you could comment, but just on Jockey’s entrance into the mass market and where do you see that they are going to compete with you? It seems like some of their product is very performance based?

Rich Noll

Let me answer the space gains first. As we said in our first call this year, we estimated we had a 2% space gain and we certainly see that going in place. Most of that went into place at the end of the first quarter and is now placed with the innovations driving sales. We feel that it’s early to know what the full gain will be for 2013, but we’re pleased to see that our innovations both on the innerwear side as well as the outerwear side are being appreciated and understood and we’re already getting some of those commitments. So we’re pleased that we have got positive momentum going into 2013 from that standpoint as well.

From the Jockey standpoint, what I do want to clarify there is the Jockey space did not come from us. In fact, our net underwear space at Target is up. There are other pluses and minuses in the department that were changed around with the true space coming out of private label to make room for the Jockey program. Our underwear sales at Target are very strong and we expect to add additional space in the second half of the year to drive our innovations.

We think we’re well positioned to compete with the Jockey brand. We compete with them in the mid-tier channel very effectively where we have over twice the share that they do and our products stack up very well. Our brand tends to appeal to a broader spectrum of both young and old while their brand appeals to an older consumer.

Jockey has also been in the mass channel for a number of years within Walmart and we have competed very well there, and are continuing to gain share along the way. So we feel well positioned with our underwear business for continued growth.

Susan Anderson – Citigroup

Great, thanks. Yeah, I was out in the stores last week and it definitely – you could tell they didn’t take space from you. And then just another question on the gross margin breakdown, I don’t know if you could give a little bit more color around it, it seems like you guys did a lot better than expected, so just some colors around the driver in terms of like cotton costs or supply chain savings or whatever it was.

Rick Moss

Yeah, Susan, I would attribute the gross margin improvement to a couple of things, one, was the strength of the innerwear business. That’s historically been our most profitable segment and it did very, very well and that helped, essentially with the mix, if you will, that drove some gross profit. So we did have higher cotton costs in the quarter, but we were able to mitigate a good chunk of that with pricing and then we had about $9 million of cost savings from our supply-chain programs in the quarter.

Susan Anderson – Citigroup

Okay. Great. Thanks a lot you guys.

Rick Moss

Thanks.

Operator

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

David Glick – Buckingham Research

Yes, thank you. A clarification and a question, Rick, if you could walk us through kind of the EPS puts and takes? I mean obviously, you’ve restated numbers, you have expenses shifting, you have a higher tax rate, and you guys said your $0.10 – running $0.10 ahead of your plan and have some either flow through or have some strategies to invest it for more sales growth. But to the best of your ability, can you kind of break down the pluses and minuses, because on the surface it looks like a great Q2 and that you took it out of the second half, but certainly, as we listen to the call it doesn’t sound like that, but if you could give us – if you could simplify that as best you can.

And then I just want to get a little more color on the intimates business. Because I know you’re about to lap some destocking there and it sounds like you’re beginning to get some traction. I wanted to get a little more color on the outlook there?

Rick Moss

Okay. I realize that our guidance for continuing operations happens to be similar to what we – our previous guidance was, but I really do think, David, that the quality of the earnings that we’re talking about are much better. As you got, I hope you picked up in the script, the profitability from the exited businesses was expected to be – have a minimal impact on this year. So, what you ended up with were – which you will end up with are higher margins, a higher operating profit number from continuing operations that, as we said, will be offset somewhat by a higher tax rate. So, as we look at the various puts and takes, it – the exited businesses really didn’t have that much of an impact on profitability.

Rich Noll

And David, if I can, I would just want to – before we get into the intimates piece, one comment you said that how great was the quarter or whatever and we – that was $0.67 and clearly Rick talked about there was about $0.07 of that is clearly a move to the back half of the year in terms of expenses just because of timing of supply chain or whatever. Still, that’s a $0.60 number that was clearly above our plans. I feel real good about that performance in this quarter.

David Glick – Buckingham Research

Okay and Gerald, want to talk about the intimates?

Gerald Evans

Yeah, sure, I’d be happy to talk about the intimates. We are pleased with the performance in the quarter and I’ll break it down in two pieces – the bra and the panty pieces of the business. We really started our work first on the panties business roughly 12 months ago or so, just upgrading, doing – going back to basics; upgrading our brand and product presentations, contemporizing our packaging, getting some of our silhouettes correct and so forth, a lot of good support out of our retailers and you’ve seen now two strong quarters in a row out of that business.

And really, we’ve followed a similar path with bras now, a little behind in our start, but again working on the breadth and depth of offerings both in our core brands and then teaming that up with what we believe is the most important thing if you’re going to innovate is for it to be meaningful innovation within the intimates business which we’ve done with our ComfortFlex Fit platform that really does simplify Fit, which is a real challenge in the category and does it in a comfortable fashion. That is actually generating incremental purchases in the category, which we believe is a big breakthrough in that category when there’s limited purchases by a customer in a year.

The one headwind we do have as we look forward is that the story has been very different within JCPenney where we are – sales have actually been lower. The sales trends have been lower than we anticipated as their traffic has fallen in general more than they anticipated with their shift in strategy. So, we are projecting that we will continue to have weakness in that account for the balance of the year and we’ll be approximately 40% down in the year relative to what we had planned. So we planned for it to be roughly 2% of our business and now it’ll be well below 1.5%, closer to 1% of our business for the year.

David Glick – Buckingham Research

Thank you, and one quick follow-up. Are you past the point where you think you have to continue to kind of add more value for the pricing that you have out there in terms of more value packs, or do you feel like you’ve kind of reached an equilibrium and now you can focus more on driving customer demand with more marketing?

Gerald Evans

We do. Our value packs are flowing into market now, and as we come out of back to school, they will clearly be in place and we are now, as you heard in my comments, actually speaking about the advertising behind both our tagless bottoms and our ComfortBlend is our next step to really drive sales.

David Glick – Buckingham Research

Okay, great. Thank you very much. Good luck.

Rich Noll

Thanks.

Operator

The next question comes from the line of Bob Drbul with Barclays. Your line is open, sir.

Joan Payson – Barclays

Hi, it’s Joan Payson on for Bob today.

Rich Noll

Hi, Joan.

Joan Payson – Barclays

How’s it going? So I guess one question I have in terms of the inventory decrease this quarter down 12.5%. Maybe if you could just quantify how much of that was related to costs and how much was the shelf space?

Rick Moss

Sure. The inventories are down $172 million from the end of the year. That’s – about $138 million of that is from costs, from input cost reductions and balance is from unit declines.

Joan Payson – Barclays

Okay, thanks. And then I guess touching on pricing again, maybe if you could provide an update in terms of where AURs stand right now versus competition and where are you on the price gaps. I think in the past you’ve said you’re targeting a 5% to 10% gap going forward.

Rick Moss

The competitive gaps have closed going into back-to-school. We’ve got very competitive offers on the floor now, so we do believe as we come out of back-to-school, we’re right where we want to be with the competitive gaps closed.

Joan Payson – Barclays

Okay, great. Thank you.

Rich Noll

Next?

Operator

The next question on the line is from Scott Krasik with BB&T Capital. Your line is open.

Scott Krasik – BB&T Capital

Hi, thanks for taking my question. Any early reads on the success of the promotional packs and for back-to-school? And what I am getting at is as you presumably increase the promotion next year to give more value back, could you see a meaningful pickup in units now?

Rick Moss

Scott, from the standpoint of back-to-school, it’s pretty early, the events are really just getting on the floor as I said a minute ago. We think we’re really well positioned from the standpoint of what we’ve got on the floor and what our competitive position is. We, in many cases, have more ads than we had the prior year. So we think we’re well prepared for that.

From the standpoint of the bonus packs going forward, historically we’ve seen as we add a pair to a package we do get incremental unit sales and we would expect that over time we will drive incremental unit sales with those multipacks.

Scott Krasik – BB&T Capital

Good. And maybe update on your outlook, I may have missed it, on outerwear now that we’re past the Just My Size issue and we’ve right-sized the imagewear business, maybe talk about the growth potential for the outerwear programs in the back half of the year and what – is that sensitive to weather or what are you seeing there?

Gerald Evans

Really in terms of standpoint of the outerwear business is – the retail businesses have strong growth potential in the second half. We can see the order book well, the Hanes Beefy T program performed very well, we’ve wrapped the Just My Size losses and Champion continues to perform well. So we’ve got good visibility and we feel like we have good momentum there.

Rich Noll

On the branded printwear side, Gerald?

Gerald Evans

And on the branded printwear side, it’s early in the transition of our intent to reduce our emphasis on the promotion piece and focus on the branded core and premium pieces. What we are seeing early is that our units are actually up in the premium segment, which indicates that our strategy is working. But certainly from the standpoint of, we are still winding down sales for this year as we exit those segments that we’re exiting and it will ultimately be around $180 million this year and level out, we believe, around $150 million next year.

Rich Noll

Yeah, just as a point of clarification, so there’s no confusion, most of the exits in the U.S. inventory went down into discontinued ops. We did pull back, if you remember on promotional parts of the Hanes business. That is actually still in continuing ops and that’s the $180 million to $190 million that branded printwear will be this year and it will shrink down to $150 million next year as we continue to pull back from there. I just wanted to make sure everybody was clear about that.

Scott Krasik – BB&T Capital

Thanks, Rich. And just one last one if I may, international sales, I think you’ve guided them pretty well so far, but when do we see the inflection back to positive growth and what will drive that?

Rick Moss

The international business is really a snapshot of our innerwear business, particularly with the exit of the imagewear piece in Europe; it’s about three quarters innerwear. And so it went through the same set of challenges that our business hit here, higher cotton costs that rose through the year and we actually pass that as we get to the second half of the year and then price increases generally went up into the third quarter. So we see that the trends will pick up, you saw the trend pick up from the first quarter to the second quarter from the first quarter on a comp sales basis. We think we will see similar trends as we go forward and increasing in growth as we get into the fourth quarter and we lap all those challenges.

Scott Krasik – BB&T Capital

Okay. Well, I think we are going to see better days ahead. Congratulations for getting through this unbelievable period.

Rich Noll

Thank you very much.

Operator

The next question comes from Steve Marotta with CL King & Associates. Your line is open.

Steven Marotta – CL King & Associates

Good evening, everybody. Amplifying on the previous question, could you be specific about Asia? There is certainly lots of talk about Asia slowing and how that particular geography performed in the second quarter as well as your expectations for the balance of the year?

Rick Moss

Yeah. Asia still relatively small part of our total international mix, I think Japan is the biggest market for us. We did have some slowness in the second quarter as we sort of wrapped some incremental volume we gained the year before after the earthquake. We are bullish there on it and how we will do in the second half as we get past some of the same challenges and we think that the trends will be certainly favorable as we ramp up into the second half of the year.

Steven Marotta – CL King & Associates

Okay. And related to supply chain savings that you’ve spoken about in prior years, $40 million savings last year, this year and next year. I believe you said there was $9 million savings in the quarter, are you relatively still on track for those projections and if not if there is a delta there at all.

Rick Moss

Yeah. It’s – we are at about $18 million year-to-date. So we’ve said $30 million to $40 million this year. So I feel like we are right on track to hit our expectations and don’t see any reason why we can’t do that.

Steven Marotta – CL King & Associates

Great. Lastly and very quickly, you mentioned the price gaps narrowing in the third quarter. Do you anticipate a similar level for the fourth quarter or are there any anticipations for again the last quarter of the year as it relates to price gaps?

Rich Noll

We think that the price gaps have closed and as our packs roll out in certain instances, it is well positioned to finish the year.

Steven Marotta – CL King & Associates

Terrific. Thank you.

Operator

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

Eric Alexander – Stifel Nicolaus

Hi, this is Eric Alexander in for Jim. Thanks for taking my question. I do appreciate it.

Rich Noll

Sure.

Eric Alexander – Stifel Nicolaus

A follow-up to earlier commentary on advertising spending, what are you guys planning? If you could quantify your 2012 marketing investments that are planned right now?

Rick Moss

Yeah. We’ve decided for competitive reasons not to give the absolute figures. We did pull back this year somewhat as we needed to sort of get through these cotton inflation issues, although in the quarter most of where our pullback was, as Rick said, I think was, the lion’s share of it actually was in the women’s intimates area where actually we’re making that decision irrespective of cotton because as you had seen our performance before, we’ve tried to remix that business a little bit, the media wasn’t really working, and we decided to make those investments in other places. Going forward, I think with all the innovation in the pipeline that we’ve got coming, we do want to get our media levels back to those historical levels.

Eric Alexander – Stifel Nicolaus

Okay, and then as a follow-up to that, would you guys obviously achieving your gross margin back to historic levels in second half, it’s sounds like, which is obviously good work, kudos on that, any reason that 10% or 11% operating margin that you guys were looking for in next year at least in prior quarters that you had called out, do you think you can higher than that or are you still kind of thinking in that ballpark from an operating margin standpoint?

Rich Noll

When you do some modeling to get into the low threes, you’re going to see you’re going to need relatively good operating margins to get into there. I don’t want give specific guidance about 2013. I will also remind you one of the impacts of stripping out with discontinued ops, which takes those businesses from sales all the way out through the P&L, the net effect is it does actually mask, because there is not a lot of profit associated with it, to take almost $200 million of sales out, our operating margin is up, Rick, how much.

Rick Moss

About 40 or 50 basis points.

Rich Noll

Basis points, you have to sort of recalibrate our operating margins for that 40 or so basis points as well.

Eric Alexander – Stifel Nicolaus

Okay, very helpful. Thank you.

Operator

The next question on the line is from Danielle McCoy with Brean, Murray. Your line is open.

Danielle McCoy – Brean, Murray

Hey guys.

Rich Noll

Hey.

Danielle McCoy – Brean, Murray

Thank you for taking my question. Just a quick question on shapewear. How do you guys see that category going forward? Do you think it is a growth category and what do you guys plan on doing like going forward?

Rich Noll

I think that we do view shapewear as an important part of our Intimate Apparel business, I think it’s one that we are doing some repositioning of our own products on, we are not fully where we are yet, but there is a lot of work in the pipeline, I think you will see more from us later is what I would tell you at this point in time.

Danielle McCoy – Brean, Murray

All right, great. Thank you so much.

Rich Noll

Certainly.

Operator

And the next question on the line comes from Andrew Burns with DA Davidson. Your line is open.

Andrew Burns – DA Davidson

Thanks, and good afternoon.

Rich Noll

Hi, Andrew.

Andrew Burns – DA Davidson

Hi, I have a question on market share. All in when you look at the shelf space gains you have had in key categories, exiting of some non-core programs and businesses, what would you point to as sort of the biggest opportunities to gain market share or grow the business going forward whether it’s a particular category or channel or continued share gains versus private label? Any color there would be helpful.

Rich Noll

I really think that our biggest share gain opportunities come from continuing to drive innovation and create value in the core categories with which – that we are in and it comes through reinforcing that with branded messages. And so we view all of our categories as areas where we have potential to expand our share.

Andrew Burns – DA Davidson

Thanks. And within JCPenney, that merchandise strategy has continued to evolve with even some changes in recent weeks. At this point, is there any opportunities within some of those more recent changes or direction that retailer is going in terms of maybe adding back some programs or offsetting any of that weakness? Thanks.

Rich Noll

Well, I think there is strategy still evolving, I think they are very focused on trying to get the traffic to pick up in there and they are looking at some good things. So sure there is always opportunities to restart that traffic and rebuild some of that inventory over time and we are optimistic they’ll find a way to get that done.

Andrew Burns – DA Davidson

Thanks. And good luck in the back half.

Charlie Stack

Thanks, Andrew.

Operator

And there are no further questions.

Charlie Stack

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

Operator

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

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