Hanesbrands Inc. (NYSE:HBI) Q1 2023 Earnings Call Transcript

Hanesbrands Inc. (NYSE:HBI) Q1 2023 Earnings Call Transcript May 3, 2023

Operator: Good day and thank you for standing by. Welcome to the Hanesbrands First Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the presentation, there will be a question-and-answer session. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your host today, TC. Robillard, Vice President of Investor Relations. Please go ahead.

TC Robillard: Good day everyone and welcome to the Hanesbrand’s quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress after the first quarter of 2023. Hopefully everyone has had a chance to review the news release we issued earlier today. The news release, updated FAQ document and the replay of this call can be found in the Investors section of our hanes.com website. On the call today, we may make forward-looking statements either in our prepared remarks or in the associated question-and-answer session. These statements are based on current expectations or beliefs and are subject to certain risks and uncertainties that may cause actual results to differ materially.

These risks include those related to current macroeconomic condition, consumer demand dynamics, the inflationary environment, cybersecurity and our previously disclosed ransomware incident and any on-going impact of the COVID-19 pandemic. These risks also include those detailed in our various filings with the SEC, which may be found on our website as well as in our news releases. The company does not undertake to update or revise any forward-looking statements, which speak only to the time at which they are made. Unless otherwise noted, today’s references to our consolidated financial results and guidance exclude all restructuring and other action-related charges and speak to continuing operations. Additional information, including a reconciliation of these and other non-GAAP performance measures to GAAP, can be found in today’s news release.

With me on the call today are Steve Bratspies, our Chief Executive Officer; and Scott Lewis, our Chief Accounting Officer and Interim Chief Financial Officer. For today’s call, Steve and Scott will provide some brief remarks, and then we’ll open it up to your questions. I’ll now turn the call over to Steve.

Steve Bratspies: Thank you TC. Good morning everyone and welcome. When we ended the year we spoke about our expectation that the global operating environment would remain challenging in 2023. And a result we would focus on balancing the execution of our long-term growth strategy with driving near term performance, including a return to high 30% gross margins as we exit the year, generating $500 million of operating cash flow and paying down debt. I’m pleased with how our team remains agile and focussed on controlling the things we can control, which show progress against both our near term and long-term goals. With respect to our near term performance and 2023 goals, for the quarter we delivered revenue, operating profit and earnings per share that were in line with our outlook.

We successfully refinanced our 2024 maturities, we reiterated our full year guidance, and we began seeing the benefits from our initiatives to unlock working capital. Specifically our inventory declined sequentially and we generated positive operating cash flow in the first quarter, which historically has been a quarter that uses cash. Turning to our long-term full potential growth strategy, during the quarter I had the privilege of spending time with our team in Australia as well as our associates in a world-class manufacturing facilities in Vietnam, Thailand, and Honduras. This gave me a chance to see first-hand how our full potential work is unfolding. In Australia, where we have a much higher mix of direct-to-consumer sales, I was able to walk a number of our bonds and Bras N Things stores.

Seeing the brands brought to life, the way we merchandise innovation and how the technology and automation investments in our distribution centers are generating increased efficiencies, gives me confidence that we’ll be able to support our growth in our D2C model. In walking through our manufacturing facilities, I’m always energized by the scale of our operations and the opportunities it presents. I was able to meet with many of our associates who are constantly finding new innovative ways to leverage our scale to improve efficiencies. I saw a number of these methods being used at our facilities, including the use of data analytics and machine learning to generate greater output on our selling lines. We’re achieving tangible results from the progress we’ve made to date in transforming our company, and our progress continues across a number of our full potential initiatives that should help us become a more consumer-centric, data-driven organization and make us more efficient and profitable.

I remain incredibly excited about our portfolio of brands and the innovation we’re delivering. In Hanes, we expanded our distribution of our Hanes Originals line, which is being supported by a national media and advertising campaign. Hanes Originals is a line of innovative products aimed at younger consumers, and we’re encouraged by the initial response from both our consumers and our retail partners. We also continued the extension of our global innovation platform of absorbency products. After a successful soft launch, we expanded distribution of our bond’s toddler training underwear across channels in Australia. With respect to our technology initiatives, we continue to improve our capabilities and user experience on our websites, including a more modern payment architecture and easier site navigation.

We also launched our Hanes loyalty program in March, which followed last November’s launch of our Club Champion global loyalty program. These programs are ramping nicely and should help us better optimize our marketing investments over time as consumers become more ingrained within our ecosystem. We also achieved another milestone on our journey to becoming a more data-driven organization with a successful conversion of our Champion North America business onto our new SAP platform. Our on-going migration to a common technology spine for the global organization will enable better business analytics and planning, which in turn should lower costs, improve efficiencies, and reduce working capital. On the supply chain front, we continue to drive increased efficiencies, faster speed to market, and cost savings across multiple initiatives.

We continue to optimize our manufacturing footprint, which is lowering fixed overhead. We’re improving speed and efficiencies within our DCs by implementing additional automation in our picking and sorting systems. We’ve significantly reduced our manufacturing lead times, particularly out of Asia, and we’re also realizing benefits from our Skip Flow initiative. By leveraging our global scale, we’re able to bypass our distribution centers and ship product from our factories directly to our large customers’ warehouses. This lowers costs for both us and our customers while also increasing delivery speed. And in terms of sustainability, we continue to build on our leadership position across our people, planet, and product pillars, including donating essential clothing to people in need, using renewable sources for nearly 50% of electricity needs, as well as reducing packaging weight and single-use plastics.

Not only are these initiatives good for the planet, but they’re good for shareholders as they lower costs and drive positive consumer connections to our brands. As you can see, we continue to make steady progress with the implementation of our full potential plan. We’re becoming more data-driven and consumer-centric, which should drive more consistent revenue growth over time, and we’re generating savings and efficiencies that positions us to exit the year at a high 30% gross margin level. So in closing, the year is unfolding as expected. We remain focused on driving near-term profitability, generating cash, and paying down debt. And we’ll continue to appropriately balance our near-term performance with the execution of our transformation growth strategy.

And with that, I’ll turn the call over to Scott.

Scott Lewis: Thanks, Steve. Overall, we accomplished a lot in the first quarter. We delivered results that were above the midpoint of our guidance for revenue, operating profit, operating margin, and earnings per share. We generated positive operating and free cash flow and based on the commodity and freight cost that are running through our supply chain today. We’re manufacturing products at gross margin levels that are in line with 2021 and early 2022. All of this gives us confidence that we are on track for the year to deliver meaningfully higher margin run rates as we exit the year generating thousands of million dollars of operating cash flow and paydown debt. For today’s call I’ll touch on the highlights from the quarter as well as provide some thoughts on our outlook for the remainder of the year.

For additional details on the quarter results and our guidance, I’ll point you to our news release and FAQ document. First quarter sales of $1.4 billion declined 12% versus prior year which includes the 200 basis point headwind from the impact of foreign exchange rates. On a constant currency basis, sales declined 10% as we left last year’s strong results. The year-over-year decline was primary due to the macro driven slowdown in consumer spending at the U.S. and Australia which more than offset cost of currency growth in Europe, Canada, Latin America and Japan. In the U.S. the decline was primarily driven by activewear for sales of our Champion brand and other activewear brand down 19% as compared to prior year. Our Champion’s performance was consistent with our outlook.

Sales in our other activewear brands declined more than expected in the quarter. The activewear decline was driven by the slowdown in consumer spending which resulted in lower point of sale and higher inventory levels at retail, as well as the strategic channel cleanup work we’re doing within the Champion in the U.S. On the positive side, we experienced another quarter of year-over-year growth in our collegiate business. Our U.S. innerwear business performed well above our expectations as we saw a balancing of shipments with point of sale. We also expanded distribution of our Hanes original bond which is aimed at attracting younger consumers as we’re seeing good initial results behind the national media launch. Shifting on to International Business, constant currency sales were down 3% compared to last year driven by declining innerwear sales in Australia and lower sell-in shipments of Champion in China.

In Australia, inflation-related pressures are impacting consumer spending which drove lower traffic in our stores as well as a mixed shift towards wholesale. With respect to our Champion International business, constant currency sales declined 7% compared to prior year driven by lower sell-in shipments in China. We expect shipment growth to improve in China as point of sale or sell-through in the first quarter was up low double digits over last year. In addition to China’s reopening, we experienced constant currency growth in Europe, Australia, Japan, and the Americas in the quarter. So overall, our Champion international business remains healthy. Turning to margins, adjusted gross margin of 32.7% declined 440 basis points compared to prior year.

The decline was driven by infinite cost inflation which was in line with our expectation as well as lower sales volume and mix. These headwinds more than offset the partial quarter wrap of last year’s innerwear price increase, lower air freight expense, and cost savings benefits. Relative to our gross margin outlook, the difference was primarily driven by channel and product mix in the quarter. With respect to SG&A, as a percent of sales adjusted SG&A expense was 28.1%. SG&A expense delivered 215 basis points as compared to last year due to lower sales. However, this was 155 basis points better than our outlook driven by benefits from our cost savings initiatives particularly within distribution, discipline and expense management, as well as channel mix.

This result in an adjusted operating margin of 4.6% for the quarter, which is above the midpoint of our outlook. Interest and other expenses excluding the $7 million of cost associated with our refinancing were $66 million. This was in line with our guidance as the timing and pricing of our refinancing was as expected. And tax expense and EPS were both in line with our outlook. Turning to our balance sheet and cash flow, in the second half of 2022, we took actions to reduce our inventory units, which in turn positions us to unlock working capital in 2023. We began to see the benefits of these actions in the quarter as inventory declined 1% sequentially and we generated $45 million of operating cash flow in the quarter, which is notable because we historically used cash in the first quarter.

With respect to our debt, as expected, our leverage was elevated at 5.4 times on a net debt to adjusted EBITDA basis, which was below our first quarter covenant of 6.75 times. In the quarter, we successfully refinanced our 2024 maturities with a combination of a term loan deed and unsecured notes. The refinancing was the first step on our path to lowering our leverage. With positive cash flow generation in the quarter, we believe that we are on track to use all of our free cash flow to pay down debt this year. And now turning to guidance, we reiterated our outlook for the full year, including net sales of $6.05 billion to $6.2 billion, adjusted operating profit of $500 million to $550 million, adjusted earnings per share of $0.31 to $0.42, and operating cash flows of approximately $500 million.

Our outlook continues to reflect our immediate view of the consumer demand environment, given the macroeconomic uncertainty. We continue to expect margin pressure in the first half as we sell through our higher cost inventory. As we move through the second half, particularly the fourth quarter, we expect year-over-year margin improvement as we begin selling lower-cost inventory and we anniversary last year’s manufacturing timeout costs. As I highlighted earlier, based on the commodity and freight costs that are running through our supply chain today for manufacturing product at gross margin levels that are in line with 2021, and early 2022, this gives us visibility and the confidence that we’re on track to exit the year at meaningfully higher margin run rates.

With respect to our outlook for the second quarter, at the midpoint, we expect net sales to decline 3% on a constant currency basis, or approximately 5% on a reported basis. For adjusted operating profit, we are guiding to a range of $70 million to $90 million. We expect interest and other expense to be approximately $80 million. Tax expense of approximately $10 million, and adjusted EPS to range between break-even and a loss of $0.05. So in closing, we delivered first-quarter results in line with our outlook. We began the year generating positive operating cash flow as we started to unlock working capital, and we have visibility through our product margins as lower input costs are flowing through our facilities today. The year is unfolding as expected, and we believe we’re on track to deliver our 2023 goals, including a return to high 30% gross margin levels as we exit the year, generating $500 million of operating cash flow and paying down debt.

And with that, I’ll turn the call over to TC.

TC Robillard: Thanks, Scott. That concludes our prepared remarks. We’ll now begin taking your questions, and we’ll continue as time allows. I’ll turn the call back over to the operator to begin the answer-and-answer session. Operator?

Q&A Session

Operator: Our first question comes from Jay Sole with UBS.

Jay Sole: Hello, can you hear me?

Steve Bratspies: Yes, go ahead, Jay.

Jay Sole: Oh, great. Thank you. So maybe just thanks for the detail on the prepared remarks. Just thinking about the guidance for fiscal 2023, talking about sales being down 2%, is it possible to talk about what you’re expecting by segment, maybe innerwear, and then maybe talk about activewear? That’d be helpful. Thank you.

Steve Bratspies: Sure, Jay. Good morning, and thanks for the question. So, as Scott mentioned in his remarks, as I did, we reiterated our full-year guide. We don’t guide by segment directly, but let me give you just a few kind of directional point’s maybe that can help you. As we look at the company innerwear, think low single digits down for the year. We’re starting to see, that’s POS-driven, softer consumer spending. We are past the destocking phase that we’ve been talking about for a while in the last couple quarters, and we expect a pretty good balance between POS and shipments in the innerwear space as we go forward. So that business will move along with the consumer, and we’ll get a good sign as we go through back-to-school to see what the replenishment volume looks like there.

On the international side, think down low single digits on a reported basis, be up low single digits on a constant currency basis. We’re seeing growth in Asia. We’re expecting kind of good, stable performance in Europe, but we do expect some headwinds in Australia as we go forward, because that economy — think of Australia as trailing the U.S. by a quarter or two in terms of impact on inflation and interest rates is how we’re seeing it play out. And then on the activewear side, probably down mid-to-high single digits, kind of facing the same headwinds that we’re seeing in Q1. We’re going through strategic cleanup, particularly in the U.S. We are seeing slowing down in consumer spending and, POS trends, and there’s still a lingering inventory challenge.

So directionally, that’s where I think you should think about the guide for Q2 and basically for the rest of the year, kind of innerwear, flattish, activewear down mid-single digits again with continued headwinds.

Jay Sole: Got it. That’s very helpful. Steve, if I could follow up just on the activewear inventory. I mean, when do you feel like that inventory situation is going to be where you want it to be?

Steve Bratspies: Yes, I mean, there’s clearly still challenges in the channels. It has not cleared up. As we think about our balancing our business, right, we’ve got innerwear, we’ve got activewear. Innerwear is certainly balanced out faster than activewear has, and there’s a lot of reasons for that. I mean, it’s a different business, different channels, different competitors. So we’re seeing it start to balance out, Jay, but I think it’s going to take a little bit of time for us to work through that. And that’s going to really drive by the consumer and how much they start to kind of reengage with the category. It has not gotten super promotional in our space, but I think it’s going to take some time for that to balance out as we go forward.

And we’re watching it closely. I mean, you can see in our results we had a little bit of higher E&O expense in the activewear space in this quarter than we had initially planned. So we’re watching it closely. If you think back to the actions that we took at the end of Q4 last year, we’re going to be very disciplined on inventory. And that’s something we’re, I think doing a much better job of today than we’ve done in the past. Sequentially, Q1 inventory is down 1%, which I’m very good — feel good about, and how the team is managing that. We continue to reduce SKUs. So we’re going to manage it at the macro level as a company, and then we’re going to manage it at the micro level too, category by category, business by business.

Jay Sole: Got it. Okay. Thank you so much.

Steve Bratspies: Thanks, Jay.

Operator: Our next question comes from Ike Boruchow with Wells Fargo.

Ike Boruchow: I wanted to talk, the first question is I wanted to talk about the margins in the first quarter. So just really good job controlling the SG&A. But when you kind of adjust that out, it looks like the gross margins actually came in maybe 100 to 150 basis points below what you had planned in the first quarter. Can you just talk to what exactly happened in Q1 that would have driven, a slightly worse gross margin versus plan?

Scott Lewis: Yes, sure. Good morning, Ike. I appreciate your question and joining the call today. So compared to our Q1 outlook, really two things drove the lower gross profit rate. And each are roughly equal in size. The first is lower mix of DTC sales, more than we expected. And that impacted gross margins, but actually was a driver of the better than expected performance in SG&A. And the other half is product and channel mix in U.S. innerwear and activewear. And we also had some higher promotional activity in our stores in Australia as traffic has slowed. So that, again, performance overall by the time you get to operating margin, we were pleased. As you think about, I know you asked about Q1, but as I think about gross margins, I just want to expand on that a little bit about what we see for the rest of the year.

And we feel really good about our ability return to the high 30% gross margin rate as we exit the year. We have this visibility, as we can see, lower costs running through our supply chain today. Input costs have come down significantly. For example, cotton costs, they’re down nearly 25%. They’re continuing to decline. Freight costs are down 40% year-over-year. And actually you can see that on the balance sheet with raw materials and work in process inventory levels down 15% from last year. So considering all of this, I see Q2 actually as an inflection point. As you would see, our gross margin rates improve over the course of the year. Looking at the second half, again, you’re going to see improvement, again, as inflation eases off over the course of the year.

Q3 rates, gross margin rates will be flat up slightly. And then you’re going to see a meaningful improvement in Q4, the gross margin rates. And then as you think about the back half of the year, you have to keep in mind we’re anniversary-ing and lapping the timeout cost that we did, that Steve was referencing last year, about 100 basis points impact in Q3 and about 200 basis points in the Q4.

Ike Boruchow: Got it. Super helpful. And then just to stick with the gross margin, can you talk about pricing? Maybe let’s just stick with innerwear, just pricing in the first quarter and then expectations on price for the rest of the year.

Steve Bratspies: Yes, so we are now kind of just lapping the innerwear pricing from last year. As you heard me talk about, we take pricing on a long-term basis and really a strategic view. Like I say, we put the consumer at the center of every decision that we make. And our plan over time is to grow space, grow our share. And we need to be diligent about those price gaps. So we’re going to balance that as we go forward, and we’ll manage short-term variations. But net, all the pricing that we took last year has held. And as you know, we didn’t price the peak inflation, but it’s all held, and we feel good about it. But we don’t see pricing in the future certainly in the near term.

Ike Boruchow: Thanks guys.

Operator: Our next question comes from Paul Kearney with Barclays.

Paul Kearney: Hi, everybody. Thanks for taking my question. Just first on activewear. So we’re lapping — hello, can you hear me?

Steve Bratspies: Yes, go ahead.

Paul Kearney: Thanks for taking my question. So first on activewear, how should we think about lapping the ransomware from last year and balancing that against kind of the weak consumer backdrop in North America?

Steve Bratspies: Yes, in terms of that cyber event, there’s no on-going operational impact for any products that we’re doing. It’s built into our guide and our expectations for the quarter. But you should think of that as behind us, no on-going impact on the operations of the business.

Paul Kearney: Okay. And secondly, just on the inventory, how much of the reduction was kind of a like-for-like product reduction versus the SKU reductions that you’ve taken? Thanks.

Steve Bratspies: I think it’s both. So certainly the SKU reduction work that we’re doing is making a big difference, and it’s something that I’m very passionate about, and it’s something that we’re going to continue to drive as we go forward. SKUs are down 45% from the peak, and it seems to be really benefiting the business. That said, we’re also really working on making sure that we have the right inventory and the SKUs that are driving our growth. So if you looked at our inventory right now, the 16% of products that account for nearly 55% of our sales, they represent 46% of our finished goods inventory right now. So we are leaning into the SKUs that matter most, and we’re going to make sure that the ones that should never be out are never out and balancing our inventory appropriately.

So I’d say it’s a balance of both as you go forward, because both are incredibly important to managing inventory for a company this size and for as diverse and as global as we are.

Paul Kearney: Thanks. Pass it on.

Operator: Our next question comes from the line of Paul Lejuez with Citi.

Unidentified Analyst: Hey, everyone. This is Brandon on for Paul. Can you hear me?

Steve Bratspies: Yes. Go ahead, Brandon. Got you.

Unidentified Analyst: Okay. Thanks. Thanks for taking our question. So I was wondering, could you talk about POS trends for innerwear throughout the quarter? How did that exit, and how are you looking at that going forward?

Steve Bratspies: Sure. When you look at the quarter, the quarter actually started a little stronger than it ended from a POS perspective, which kind of marries up to, I think, a broader consumer environment that you’re seeing out there. So it’s challenging right now. The good news is that inventory is balancing with that POS, so we’re getting back to the way the business, I think, should be managed over time. But the retailers are certainly being on the conservative side as they try to match with POS going forward. So I think we’re going to learn a lot over the second quarter as to where the consumer is, and it’s kind of in line with our expectations in the quarter. And then starting through the month of April, it’s kind of following the Q1 trends, and that’s what we built into our guide.

Unidentified Analyst: So are your mass merchants, have they turned back on the replenishment business? Because I know that back in 4Q, it sounded like they shut that off.

Steve Bratspies: Yes. We’ve never shut off on a replenishment basis. It’s always about how you find balance. So what was happening is, and it’s across multiple channels, so this is a broad statement when I say this. Replenishment was flowing a little bit below the POS, so there was an inventory reduction that was happening over time. Those two lines, if you think about lines on a graph, between the rate of POS and the rate of shipments has merged, and we’re basically running at the right balance. So this idea of a destocking of inventory, that’s all behind us, and now it’s about managing the business closely. We work very closely with our retail partners, always finding opportunities in certain pockets, whether it’s certain stores, certain categories, to rebalance inventory, and they’re great partners, and we’re using a lot of different data and analytics tools which are new to this company to find those opportunities, which should help us drive sales as we go forward.

Unidentified Analyst: Got you. And in the release, you called out the printwear business as being particularly weak for the activewear. So I was wondering if you could expand on that. Do you expect that to rebound, and if there’s any particular reason that printwear would have been so weak? And how big of a business is that for you in activewear?

Steve Bratspies: Printwear certainly was a challenge in the quarter, and it’s a bit of a consumer-driven. Are there big events, corporate events, all those kinds of things, which can sometimes get caught up in the broader economy and companies making reductions as we go forward. The POS, the pull-out from our wholesale partners has just slowed down dramatically, so they’re balancing inventory as we go forward. I don’t necessarily expect a significant rebound in that business in the near term, but it will depend upon the broader macroeconomic environment. In general, it’s a relatively small business for us, but I think it’s a business that’s going to be challenged and a channel that’s going to be challenged in the near term while the consumer environment remains muted.

Unidentified Analyst: So that’s also experiencing the destocking. Sales are trending below POS, is that what you were saying? Just so I have that clear.

Steve Bratspies: No, no, it’s not really a destocking. It’s a POS is down. So that business is down, so the inventory flow that we would more normally expect is just lower.

Unidentified Analyst: Got you. Appreciate it. Thank you. Good luck.

Steve Bratspies: Thank you.

Operator: Our next question comes from Tom Nikic with Wedbush Securities.

Tom Nikic: Hey, good morning, guys. Thanks for taking my question. I just wanted to follow up on activewear. I know there’s been a lot of promotional activity in the space, and there’s a couple of big brands out there, big competitors that had a lot of apparel inventory that they were trying to work through. Could you just comment on what you’re seeing from a competitive dynamic? Are you seeing the competitors still being sort of heavy-handed with discounts? Has that eased up at all? Any comments on the competitive environment for Champion would be helpful. Thanks.

Steve Bratspies: Yes, sure. Let me talk about the environment, and then I’ll take a minute to talk about Champion overall. The POS in the channels has been soft, and that tracks with inventory in general, and that’s really just driven by the broader consumer environment. So it’s a very competitive space. As you said, there are a lot of big players. When you get an inventory backup of the scale that we have, people try to move it and try to move it aggressively. But it’s really not unexpected when you get into this kind of situation, so I wouldn’t say there’s anything necessarily abnormally playing out based on the current situation of a slow consumer with a lot of inventory. So we have to manage through that. What I would tell you for our business specifically, I’m really excited about the long-term of the Champion business and the opportunities that it presents for us.

There’s just a tremendous amount of growth potential out there, and obviously we have our full potential growth plan, but we’ve got a new team in place, and the work that they’re doing really builds the foundation of this business, both on top line and on margin, well beyond what we’re trying to do in the full potential. So we’re doing a lot of work on a global basis to coordinate our offering, simplify the business, create a lot more speed, enter and grow different categories globally like footwear. So while the business overall and the categories overall are struggling, we’re moving forward very aggressively, and I’m very confident that we have a clear path to long-term growth for this business. There’s certainly disruption short term, particularly in the U.S. and we have a lot of work to do in the U.S., but I remain confident in this brand.

International business is doing well, and we run those businesses historically a little bit differently. We’re more disciplined in terms of channel and product segmentation around the globe than we’ve been domestically. So I feel good about where we’re headed in this business. We do need to work through the near term inventory issues and the near term promotional environment to get back to a more steady base with the consumer. But I think we’re going to be really well-positioned on the other side of this to come out really strong as the market settles.

Tom Nikic: Got it. Thanks very much and best of luck the rest of the year.

Steve Bratspies: Thank you.

Operator: Our next question comes from Jim Duffy with Stifel.

Jim Duffy: Good morning. Thanks for taking my question. Good execution, guys. It feels like you’re seeing the ball and there’s some good clarity on margins. I wanted to focus on revenue visibility and recent indications of consumer behavior. Can you maybe speak directionally the differences in POS trends between mass channel and other wholesale accounts? And if you could speak to the retailer mindset as they plan to back-to-school and holiday that would be helpful.

Steve Bratspies: Sure. Thanks for the question, Jim. In terms of channel variation, POS is not strong across the board. There’s always a little bit of variation, but I wouldn’t say at this point, you can say, Oh, this channel is really strong. And this channel is not doing — is doing markedly worse. I think it’s across the board, a broad-based consumer challenge that we’re facing right now. And that’s across most of the businesses, which is really playing out as we expected and — which — that’s why we were kind of in the guide range in Q1, and we put all that into our guide for Q2. When you think about back-to-school, obviously, it’s a big time for apparel, big time for our categories. I think overall, the industry is better year-over-year, but still below, I would say, pre-pandemic levels for the big lift and the big burst of energy and activity for consumer base that used to come with back-to-school.

As I said, it’s getting better, getting back to that level, but we’re not there. When I look at our position for back-to-school, I think we’re really well positioned. And I’m excited for the season. We’ve increased our share of off-shelf placements, taking some space from some key competitive brands. I feel good about our price points and our mix. So I think we’re in good shape for back-to-school. I think the load-in will be good. I think it’s going to come down to what the replenishment behavior is from the consumer to see how strong the season is. But I think we’re well positioned to win the season.

Jim Duffy: Okay. Great. And then a question on just inventory and inventory levels. Can you speak to the cost per unit — in your view on cost per unit into year-end? How much of the cost of inventory contributed to the inventory relief that you’re expecting?

Steve Bratspies: Well, we’re definitely going to see deflationary pressure on the inventory that we’re carrying. So as Scott was talking about earlier, the costs that are running through our factories today are markedly lower than they’ve been. So the cost of production right now is reduced. And as we think about ending the year and gross margin flowing through the P&L, we expect to see a significant improvement and get to that high 30. That should also play into the cost of inventory that we have. So obviously, we’re not going to sell every piece that we make. But as that inventory rolls off our balance sheet and into our P&L, we’ll get the benefit. And the inventory that builds and sits on our balance sheet, we’ll be at those lower costs as well. So we get the benefit going forward on the P&L and the balance sheet.

Jim Duffy: I understand that. Can you put some shape around the magnitude of that relief as it contributes to the cost per unit of inventory?

Steve Bratspies: Yes. I mean I don’t want to get into specific cost per unit, but as Scott talked about earlier, significant reduction in cost and significant reduction in freight. So we are making product at a much better cost base than we are today, and that will flow through in our margin.

Jim Duffy: Understood. Thank you.

Steve Bratspies: Thank you.

Operator: Our next question comes from Hale Holden with Barclays.

Unidentified Analyst: Good morning. I just have one question, which is it sounds like at least the U.S. consumer trends have softened through to the end of the quarter, and Australia remains relatively soft. So I was wondering how much conservatism you think there is in the full year revenue guide if things get — continue to get weaker? Or how you built forward for where we seem to be going on the consumer?

Steve Bratspies: Yes. I mean, overall, as you said, consumer demand environmental — sorry, the environment of global remains challenging, inflation, macroeconomic headwinds, consumer confidence, all those things that you know about. We’ve taken a muted view for the consumer for the full year. We saw that play out in Q1 as we expected. We expect those Q2 trends to continue off of the base where we are in Q1, which is in line with our guide. And we reiterated our full year outlook. So we feel like we understand where the consumer is, where they’re going. If there’s a dramatic shift one way or the other from where we are, obviously, we’d have to deal with that. But we think we’re well prepared to operate in this environment.

As we’ve talked about, inflation is easing. We’re managing inventory really well. Costs are coming down throughout the business. We’re going to deliver the cash flow that we’ve been talking about at historical levels. But when you think about this business, we’re doing a lot of things to make a difference right now. We continue to build core capabilities, which is fundamentally important. So we’re not standing still during this time. We’re moving the business forward. We’ve proven we can manage SG&A really well. I think our supply chain is a real key asset to have right now and have visibility to cost so we can prepare ahead of time. And we’re in a basics business, which is a good place to be during this time. So we think we can manage the consumer environment well.

We’ve included it in our guide, and we’re ready to adapt as necessary.

Unidentified Analyst: Thanks. Thanks so much. I appreciate it.

Steve Bratspies: Thank you.

Operator: Our next question comes from Carla Casella with JPMorgan.

Carla Casella: Hi, it’s Carla from JPMorgan. A question on gross margin. So you mentioned in the first quarter that you have 310 basis points of freight. It sounds like that’s starting to go away, but how should we think of the second quarter relative to first? Are you still seeing a similar headwind or is it less headwind? Or have we cutely reversed as of early second quarter? Or is it really the back half?

Scott Lewis: Yes. Thanks for your question and joining the call today again, Carla. So for gross margins, you’re exactly right. And I mentioned a little bit of this earlier, as we think about the cadence of our gross margin rate through the year. But specifically for the second quarter, we’re expecting that our gross margin rate will be up versus the first quarter, but it’s still going to be down around a little over 400 basis points compared to last year. And the inflation pressures will ease. So we had again about 310-basis point impact in Q1. We’re seeing headwinds of around 270 basis points in Q2. And to your point, as you go into the back half, it’s going to ease more, especially in the fourth quarter. It’s going to be meaningfully less headwinds in the fourth quarter.

Carla Casella: Okay. Great. And then you — I think an earlier call, I was kind of asking about this as well. But on the cash flow, you’re looking for $500 million of operating cash flow for the year. Have you said how much of that you expect to come from working capital release?

Scott Lewis: Yes. Thanks, Carla. I’m glad you asked the cash flow question. I was looking forward to that one. So we started off the year really, really strong. We have $45 million of operating cash flows in the first quarter and $20 million of free cash flow. And just a little bit of context around that. I think that, as you look at the first quarter — historically, we used cash in the first quarter. So I think that’s a really important point. And I think that reinforces our ability to generate strong cash flow. And the $500 million that we have for the full year operating cash flow, I’d say half or a little over half of that is going to be working capital-driven. With the inventory reductions that Steve mentioned earlier, that’s going to allow us to generate that $500 million.

And gives me confidence we’re going to return back to the historical levels of operating cash flow. And then just a final point, and we mentioned this on the last call, is on the cash flow once you get to the free cash flow, we’re going to be using all that cash, free cash flow to pay down debt, and that’s what we’re focused on this year.

Operator: That concludes today’s question-and-answer session. I’d like to turn the call back to TC Robillard for closing remarks.

TC Robillard: We’d like to thank everyone for attending our call today, and we look forward to speaking with you soon. Have a great day.

Operator: This concludes today’s conference call. Thank you for participating. You may now disconnect.