HanesBrands - Q3 2022

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the HanesBrands' Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a Q&A session. To ask a question during the session, you'll need to press star one one on your telephone. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, T.C. Robillard, Investor Relations. Please go ahead.

T.C. Robillard (Chief Investor Relations Officer)

Good day, 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 third quarter of 2022. 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 investor 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 Q&A 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 the impact of COVID-19 pandemic and measures taken by governmental or regulatory authorities to combat the pandemic, as well as those related to the current macroeconomic conditions, consumer demand, the inflationary environment, and cybersecurity. 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.

Any references to 2019 reflect rebased 2019 results consistent with prior disclosures and can be found on our investor relations website. With me on the call today are Steve Bratspies, our Chief Executive Officer, and Michael Dastugue, our Chief Financial Officer. For today's call, Steve and Michael will provide some brief remarks, and then we'll open it up to your questions. I will now turn the call over to Steve.

Steve Bratspies (CEO)

Thank you, T.C. Good morning, everyone, and welcome. Over the last six months, there's been a dramatic change in the global operating environment. Conditions have become increasingly challenged, and this rapid change is weighing on our near-term performance. However, our operating philosophy of managing the things that are within our control positioned us to deliver operating income and earnings per share results that were in line with expectations for the quarter. Looking beyond the noise of the current environment, the long-term fundamentals of our categories, our brands, our business model, as well as the value creation opportunities of our Full Potential strategy remain intact. We're committed to improving HanesBrands. Our focus and our goals are unchanged. Remain agile so we can manage through near-term challenges while simultaneously balancing the long-term investments necessary to transform to a company that consistently generates higher growth and higher returns.

For today's call, I'll break my comments into two parts. First, I'll discuss the near-term environment and the additional actions we're taking to manage through it. Then I'll provide an update on the progress we've made implementing our long-term Full Potential strategy. Looking at the current environment, in just six months, we've seen the consumer and retail landscape flip from one with too much demand and not enough supply to one with too much supply and not enough demand. Inflation is hitting consumers' wallets and slowing demand. Retailers broadly are sitting on too much overall inventory, which is impacting orders in different ways across our business. In innerwear, our retail inventory is actually below last year's level. However, as retailers manage their overall inventory levels, it's negatively impacting near-term replenishment orders, as well as delaying the timing of certain events.

As you've heard from others, retailers across channels are seeing slowing consumer demand and have excess activewear inventory, which is resulting in order cancellations, including for Champion. The combination of these factors weighed on our sales performance in the third quarter, and we expect these headwinds to continue through the fourth quarter. Despite tougher than expected sales headwinds, our global team once again demonstrated their ability to adapt to challenges. With a relentless focus on controlling the things we can control, we are able to effectively manage expenses as well as realize cost savings from our strategic initiatives. This allowed us to deliver third-quarter earnings and operating profit that were in line with expectations. Given the current state of the demand environment, we've taken several additional actions to partially mitigate the profit and cash flow impact from the macro-related sales headwinds.

We continue to reduce our overall SKU count, even as we've launched new products and innovation. Since our peak, we've lowered our net SKU count by over 40%, and we have 22% fewer SKUs running through our supply chain. This progress has improved productivity metrics, lowered costs, improved the quality of our inventory, and created space for new product launches. We're moving quickly and with purpose to reduce inventory to be more aligned with demand and position us to end the year with inventory units below last year. We began taking time out in our manufacturing network and reduced inventory units 6% from second quarter's level. With the majority of our time out planned for the fourth quarter, we believe we're on track to achieve our year-end inventory goal.

Not only should this position us well operationally as we exit the year, but it also positions us to free up working capital in 2023. We're also building digital on-shelf analytics tools. We're sharing this data with our key retail partners to help them analyze inventory at a category level and identify replenishment opportunities to drive comp sales as well as value to the consumer. One of our retail partners leveraged this data, changed their replenishment approach, and realized significant immediate point-of-sale results. That success has led to replenishment orders in additional categories as they see the value of these digital tools and find additional growth opportunities while still managing inventory tightly. With respect to the balance sheet, given our leverage and the current outlook for the global operating environment, we took action to increase our near-term financial flexibility.

Michael will provide more detail in his section, but at a high level, with the help of all of our bank partners, we amended our credit agreement to provide us with additional flexibility. We believe the combination of all these actions allows us to lean into our Full Potential strategy in the face of the current macroeconomic headwinds and continue to make the necessary investments to transform the business for the long term. By doing the work that needs to be done, even in challenging times, we'll be in an even more advantaged position once the macro environment stabilizes. Turning to our Full Potential strategy, as we look forward, we believe our long-term business model, value creation opportunities, and our category fundamentals remain intact. Our Full Potential strategy is about transforming HanesBrands into a company that consistently generates higher growth and higher returns.

Full Potential is about becoming a more consumer-focused company, simplifying our business and our portfolio, making Champion a powerful global growth brand, and re-energizing and reigniting our innerwear business. During the quarter, we made additional progress on the implementation of our Full Potential growth strategy, particularly around innovation, talent, and supply chain optimization. With respect to product innovation, our innerwear pipeline is the most robust it's ever been. This quarter, we're taking a major step forward on our journey to get younger in innerwear. We're launching our Hanes Originals product line, which is a more modern fit and stylish core product aimed at younger consumers. I've been very pleased with the strength of the response by retailers, including expanded distribution in early 2023. Looking at activewear, Vanessa LeFebvre joined us in August as head of our global activewear business.

In her first 90 days, she's taken a deep dive into the global Champion business and is taking steps to build on our initial Full Potential work. She's brought on a new head designer in the U.S., identified additional opportunities for global collaboration, and has begun working with her team to unlock the next phase of Champion's Full Potential, with a focus on improving brand identity, product and channel segmentation, and global merchandising. We're also leveraging global talent as we continue our commitment to building our direct-to-consumer capabilities. Ryan Wilson, who was instrumental in driving Bonds' omnichannel success in Australia, is now leading our global e-commerce initiative. Turning to our supply chain, the Full Potential work we're doing on our global network is expected to put us in an even more advantaged position long term.

It'll make us consumer responsive and faster to market, provide us flexibility and speed so we can pivot to growth drivers in real time, lower operating costs and improve efficiencies to expand margins, and lower long-term CapEx to drive higher returns and cash flow. As part of Full Potential, we did an in-depth, end-to-end analysis of our entire global supply chain, including manufacturing and distribution. As a result, we learned where we're advantaged. We understand where we have opportunities, and we've begun to work to position our supply chain over time to match the revenue growth opportunities of our Full Potential plan. Last quarter, we highlighted the work we're doing on our distribution network. This includes consolidating to fewer, bigger DCs in the U.S., increasing the use of direct ship to large retail partners, the use of dedicated D2C facilities, as well as the increased use of automation.

With respect to our owned manufacturing operations, through this analysis, we reconfirmed our cost advantage. We know we can internally produce high-volume, cotton-based products quicker and at a lower cost than our sourcing partners, and we're continuing to build on this advantage by getting more efficient and taking opportunities to optimize our global footprint. One example is a recent decision to exit two facilities to further reduce overhead costs and better utilize our capacity. In terms of our existing large sourcing operations, we identified opportunities to lower costs and improve speed, and we're actively pursuing these improvements. Based on our understanding of where the consumer is going, we're building sourcing capabilities in areas such as synthetic fabrics and short-term fashion runs to position ourselves to capture that incremental growth.

As I take a step back, the global operating environment is certainly challenging, but the long-term fundamentals of our categories and the value creation opportunities of our Full Potential strategy remain firmly in place. As an organization, we're not standing still. We're leaning in and staying agile during these challenging times. We're managing the things that are within our control, we're taking fast additional actions to mitigate near-term challenges, and we're continuing to execute our Full Potential strategy to transform HanesBrands into a company that consistently generates higher growth and higher returns. With that, I'll turn the call over to Michael.

Michael Dastugue (CFO)

Thanks, Steve. I'm encouraged by the team's ability to adapt to the sales headwinds in the quarter and deliver operating profit and earnings per share that were in line with our expectations. I'm also encouraged by the continued progress we're making on implementing our Full Potential strategy. While we expect the current operating environment to continue to weigh on our near-term performance, our longer-term fundamentals and value creation opportunities remain intact. We're staying agile, and we're focused on controlling the things we can control. This allows us to manage through the near-term challenges, while at the same time make the investments and changes necessary to transform the business for the longer term. We're confident in our Full Potential strategy. We're making progress, and by leaning in during challenging times, we believe we'll be in a more advantaged position once the macro environment stabilizes.

For today's call, I'll touch on the highlights from the quarter, as well as provide some thoughts on our balance sheet and our outlook for the remainder of the year. For additional details on the quarter's results and our guidance, I'll point you to our news release and FAQ document. Looking at the specifics in the quarter, net sales declined 3% on a constant currency basis as compared to last year. Reflecting the 330 basis points headwind from foreign exchange rates, reported sales decreased approximately 7% to $1.67 billion. Although the macro headwinds are weighing on our near-term performance, year-to-date sales are 6% higher than pre-pandemic levels or 8% higher on a constant currency basis. With respect to our domestic segments, for the quarter, U.S. innerwear sales declined 11% compared to last year.

Relative to pre-pandemic, sales were 11% above 2019 levels. The decline versus last year was driven by the macroeconomic pressures weighing on consumer spending and inventory actions being taken by retailers. I'll note our innerwear inventory at retail is actually below last year. However, as retailers tightly manage inventory challenges in other categories, we are experiencing a spillover effect that is negatively impacting near-term replenishment orders and pushing out the timing of certain retail events. These headwinds more than offset the benefits from our first quarter price increase and retail space gains. Turning to U.S. activewear, third quarter sales were comparable to prior year and relative to pre-pandemic, sales were 3% above 2019 levels. As compared to last year, we experienced continued growth in the collegiate channels and strong growth in the printwear channel for both Champion and the Hanes brands.

This growth was essentially offset by declines in other channels, particularly for Champion. Similar to the headwinds in our innerwear segment, the macro pressures on consumer spending weighed on point of sale and higher activewear inventory at retail drove order cancellations in the quarter. In terms of our international segment, constant currency sales increased approximately 5% over last year, driven by Champion growth in Europe, innerwear growth in Australia, and the other Americas. This growth was more than offset by Champion declines in certain Asia markets. Turning to margins, adjusted gross margin declined 460 basis points over prior year to 34.5%. Inflation in commodity costs and ocean freight represented a headwind of more than 400 basis points to our gross margin in the quarter.

The timeout actions we're taking in our manufacturing facilities to reduce inventory represented an additional 100 basis points headwind in the quarter. These more than offset the year-over-year contributions from price increases, lower air freight usage, and the cost savings we're generating from our Full Potential initiatives. With more than 500 basis points of margin pressure in the quarter coming from these issues, we believe gross margins can return to or even exceed pre-pandemic levels over time as these headwinds ease. Our confidence is driven by the fact that we're already seeing lower commodity and freight costs moving through our manufacturing network, and we don't expect timeout costs to continue longer term once our inventory is aligned with demand. With respect to SG&A, on a percent of sales basis, our adjusted SG&A expense of 24.4% was comparable to prior year.

There is significant operating intensity across our organization as the global team managed expenses and realized efficiencies from our Full Potential initiatives. This allowed us to deliver operating profit in line with our expectations while also investing in our brand marketing and technology initiatives related to our Full Potential plan. Adjusted operating margin was 10% for the quarter, which came in near the high end of our forecast despite lower than expected sales. Turning to the balance sheet, we made progress on our inventory reduction initiative. Inventory units, while still up over prior year, were down 6% compared to the second quarter as we began to take time out in our manufacturing network. With the majority of our timeout planned for the fourth quarter, we're confident we can achieve our goal to end the year with inventory units below last year's level.

At the end of the quarter, our net total leverage ratio under our secured senior credit facility was 3.9 times on a net debt to adjusted EBITDA basis. Given our current leverage ratio and the near-term outlook for the global operating environment, we proactively worked with all of our banks to amend our credit agreement to provide us with greater near-term financial flexibility as we continue to implement our Full Potential strategy. As detailed in today's earnings release, the maximum allowable leverage ratio was increased for the next five quarters and will revert back to 4.5 times on a net debt to adjusted EBITDA basis for 2024 and beyond. While we will continue to implement our long-term investment strategy, and we're pleased to have the additional near-term financial flexibility given the operating environment, I wanna be clear that reducing leverage is a priority.

We'll continue to take actions to mitigate near-term challenges. We've positioned ourselves to return to more normal levels of cash flow next year by taking more aggressive actions this year to reduce inventory. We're realizing cost savings from our Full Potential initiatives, which should drive higher EBITDA as the inflation headwinds ease. Now turning to guidance. The sales headwinds we experienced in the third quarter are expected to increase in the fourth quarter. Specifically, this is the pressure on consumer spending in the U.S. and the spillover effect on near-term orders as retailers tightly manage their overall inventory levels. Relative to our prior outlook, our reduced fourth quarter profit outlook is driven predominantly by the increased sales headwinds. However, it also reflects incremental pressure from foreign exchange rates and higher interest expense, which are each impacting the guidance by a penny a share.

At the midpoint of our guidance range, we expect fourth quarter sales to decline approximately 19% as compared to last year. We expect gross margin to decline about 400 basis points versus prior year. Our outlook reflects an approximately 400 basis point headwind from commodity and freight inflation, as well as an approximate 200 basis point headwind from timeout costs related to our inventory reduction initiative. These headwinds will offset the positive contributions from price increases and cost savings we're generating from our Full Potential initiatives. Looking into next year, we would expect peak commodity and freight inflation to flow through our P&L in the first half of 2023. Recall as a manufacturer, our costs are capitalized on our balance sheet for approximately two to three quarters before rolling on to our P&L when the product is sold.

Given the current prices for commodities and freight as well as our current inventory turns, we would expect these lower costs to begin flowing through our P&L in the second half next year, particularly the fourth quarter. With respect to the adjusted operating margins, at the midpoint, we expect fourth quarter operating margin to decline approximately 660 basis points as compared to the prior year. Although SG&A dollars are expected to decline more than $40 million year-over-year, we will still delever due to the magnitude of the expected sales decline. Lastly, with respect to cash flow from operations, we expect full-year cash flow to be a loss of approximately $400 million. We expect to return to a more normal level of cash flow from operations in 2023, driven by improvements in working capital.

In closing, let me echo Steve's comments. The current operating environment is clearly challenging and is weighing on our near-term performance. However, we are taking actions, remaining agile, and staying focused on controlling the things that are within our control to manage through these challenges. Long term, the fundamentals of our categories and our business remain intact. We're confident in our Full Potential strategy. We're making the necessary investments and changes to transform the business for the long term. By leaning in during challenging times, we believe we will be in an even more advantaged position once the macro environment stabilizes. With that, I'll turn the call over to T.C.

T.C. Robillard (Chief Investor Relations Officer)

Thanks, Michael. 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 Q&A session. Operator?

Operator (participant)

If you'd like to ask a question at this time, please press star one one on your telephone. Please stand by while we compile the Q&A roster. Our first question comes from the line of Michael Binetti with Credit Suisse. Your line is now open.

Michael Binetti (Managing Director)

Hey, guys. I have a few here I'm just gonna throw at you. Can you? How is sell-in versus sell-through, and how empty are the shelves in retail now? Like, when does that flip? Said differently, you suggested the retailer destocking will continue through fourth quarter. Maybe if we look out a little further into early 2023, do you expect that to be continuing? If you wouldn't mind, you cut EBIT by about $75 million and cash flow from operations by $400 million. Can you just help us with the bridge there? That's a pretty big bridge. I'm curious if the amended credit agreement allows you to pay dividends.

Steve Bratspies (CEO)

Morning, Michael. Thank you for the, for the question. Yeah, as you mentioned, our inventory, particularly in the innerwear business, is actually down from last year. We definitely see opportunity to continue to build back with the retailers. Obviously, they have to manage their situation and how they're doing it and, you know, replenishment orders often get caught up in that basis. We've been working very closely with our retail partners, as I mentioned in the prepared remarks, you know, building new digital tools to shine a light and go a lot deeper into where, the inventory opportunities are at a geography level, at a store level, as we go forward. I do expect this to continue through Q4, which will be a headwind for us, and certainly anticipate it getting better throughout next year.

That'll depend upon the consumer, and that'll depend upon how fast the retailers are able to clear out their inventory. We're ready to supply it, feel good about how our manufacturing systems are running. We're taking the appropriate timeout. That we need to prepare our inventory to continue to run the business at accelerated rates going forward. You know, we're working closely with them to hopefully build it back as quickly as we possibly can to make sure that we can continue to drive the consumer demand. In terms of the EBIT bridge, Michael, do you wanna talk a little bit about where we are on that?

Michael Dastugue (CFO)

Yeah. I think what I took was just trying to understand cash flow and then also understanding the amendment to the credit agreement. Let's start with cash flow. I think the first thing is just the sales outlook both was weaker in Q3, and as we dial down Q4. Sales, as you can appreciate, when we don't sell the product, we have more product and therefore it's more cash tied up. And then also income has come down. And so it's really just a function of the sales weakness and just lower profitability. But I think the challenge there. With regard to the amendment on the agreement, it does not preclude us from paying dividends. The old agreement had a $350 million annual basket.

To put in perspective, our dividends run around $210-$212 a year based on the current dividend rate. The amendment during this amendment period lowers that from $350 to $250. As you can see, it does not preclude us from paying our dividend.

Michael Binetti (Managing Director)

Could you comment on the cost of the credit agreement?

Michael Dastugue (CFO)

With regard to the amendment? Yeah, there was, you know, your normal fees as far as just. You know, you go for doing the amendment, but I, you know, appreciate what our bank group did. You know, we went to them a few weeks ago as we were looking at the, you know, the volatility in the macro environment. You know, we got this done, and they appreciated us proactively having the conversation, and a number of other companies sound like a similar conversation, so.

Michael Binetti (Managing Director)

Okay. Thanks, guys.

Operator (participant)

Our next question comes from the line of Tom Nikic with Wedbush. Your line is now open.

Tom Nikic (Senior Equity Research Analyst)

Hi, guys. Can you hear me?

Steve Bratspies (CEO)

Yes, we can.

Tom Nikic (Senior Equity Research Analyst)

All right. Sorry about that. Yeah, I apologize. I'm in the car with my daughter. You said, Steve, and Michael, I believe you said that your inventory in innerwear is down relative to this time last year. I was curious how it compares to pre-COVID levels. Then I was wondering if you know you could give any context for the Champion brand and you know where inventory stands in the channel, maybe you know, relative to last year or relative to pre-COVID levels.

Steve Bratspies (CEO)

Yeah. Thanks for the question, Tom. Just to be clear on our inventory levels, what I was talking about is at retail, so in retail stores, in their supply chain, our innerwear inventory levels are below last year, which is a really important distinction. Our inventory remains up, and that's why we're taking the time out in the fourth quarter. We took some in the third quarter, and we have more to take in the fourth quarter, to reduce our inventory levels. Our goal, as we stated in our last call, was to have our inventory units below last year at the end of the year. We think that will prepare us well to operate very efficiently and effectively going into next year. I think just really important to know that.

We think about our inventory, innerwear, activewear. We have inventory challenges on both, and we're working through that. You know, we're able to move the innerwear a little bit faster because it's more replenishment of inventory as we go forward. But in general, I feel good about the quality of our inventory because the vast majority of it is what we would consider and call basically a basic product that is either replenishable or constant ongoing product in the marketplace. We're taking the action on inventory. I feel good about being very proactive on that and getting us ahead of the curve as we go into next year, so we're well-positioned to continue to grow the business.

Tom Nikic (Senior Equity Research Analyst)

Understood. A quick follow-up. I know the inventory units are planned down. Could you tell us how much you expect to be the cost per unit to be up at the end of the year?

Steve Bratspies (CEO)

Yeah. We're not given that level of granularity. The inventory dollars are gonna be up. That's creating the cash flow pressure.

Tom Nikic (Senior Equity Research Analyst)

Understood. Thanks very much, and best of luck for the remainder of the year and into 2023.

Operator (participant)

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

Peter McGoldrick (Equity Research Associate)

Hi, this is Peter McGoldrick on for Jim. Thanks for taking our questions. Looking at the Champion business, could you provide more detail into the revenue makeup in the quarter and how the cancellations progressed? Is there any differential by channel, price point, or product classification that's influencing performance in this brand?

Steve Bratspies (CEO)

Sure. Let me talk a little bit about Champion kind of high level, and then we can drill down. You know, like every brand, Champion's not immune to the current market challenges that everyone's facing. We certainly saw that in Q3, and we think those pressures are gonna continue through Q4, and that's what we put into our guide. You know, beyond the near term, I feel really good about what we can do with Champion, and we continue to find new opportunities as we go forward. As you look at the business today, we're seeing strength in the college channel and our European business. Both did well. Also in our print wear channel, we're seeing good strength in that business and are encouraged about the performance that they've had.

We are seeing challenges in our particular domestic wholesale business, and we're working, you know, hard to address that. I think the new leadership team that we have is doing just a fantastic job jumping in, looking for new opportunities. The supply chain capabilities that we're building in Champion are gonna allow us to react to the market quicker and move faster to find those consumer opportunities. You're gonna see a more disciplined product segmentation and channel segmentation work from us. We have new design capabilities and leadership. We're really leaning in to the Champion brand. We understand where our opportunities are, and we're doing the work. Now, it takes time to do this work, but we're gonna do it right, and we're doing it right for the long-term benefit of the brand.

I'm not satisfied with where we are today, I'll tell you that, but we're gonna continue to improve this business. I think the most important thing is we're taking action. You know, we're leaning in right now, and we have the opportunity to build this brand into, something really special. It can take some time and it takes some work, but we're doing that right now.

Peter McGoldrick (Equity Research Associate)

Okay. Thanks. Just following up on the discussion of segmentation within domestic Champion. Could you discuss your footprint? Is your vision for space and door penetration the same, or are there any adjustments to that in line with your segmentation strategy?

Steve Bratspies (CEO)

Yeah. We are gonna make changes, but I'm not gonna go into the details of exactly what that is and how that looks. We are building a very detailed, very disciplined plan, and we're gonna stick to that plan as we go forward. You'll see more to come on that, but I'm not gonna get into the details of it right now.

Peter McGoldrick (Equity Research Associate)

Okay. Thank you.

Operator (participant)

Our next question comes from the line of Will Gaertner with Wells Fargo. Your line is now open.

Will Gaertner (Analyst)

Hey, guys. Thanks for taking our question. So just to go back to the capital structure. You know, you have about $1.5 billion plus of debt coming due over the next, call it, you know, 12-18 months. Can you just talk a little bit about, you know, timing of refinancing and how you're thinking about that that's gonna come due over the next 18 months?

Michael Dastugue (CFO)

Yeah. Will, it's Michael. Yeah. Yes, we have about $1.4 billion that matures in the second quarter of 2024. I think, you know, as we look out, we're gonna be opportunistic and, you know, we're looking at all of the different markets, whether it's the, you know, U.S. or Euro market, right? Because the debt we're talking about is both issued in the United States and in Europe. We also can have the opportunity to look at the bank market. You know, also as we think about, you know, as we get back to a more normalized cash flow outlook, looking at the cash that we'll generate over the next, say, 18-20 months. We'll be looking at a number of different things to refinance that debt.

Will Gaertner (Analyst)

Gotcha. Thank you. Just sort of changing topics. You know, you're talking about clearing out inventory. I guess, does that imply that you guys are gonna be a lot more promotional with product and encouraging retailers to be more promotional with product, as we look into fourth Q and into the first half of next year?

Steve Bratspies (CEO)

Yeah. As we look at this fourth quarter, we definitely are looking to clear inventory. You know, we're taking the actions that we control to do that, through the timeout that we're taking, and I think we'll end the year in a really good situation. We're not driving promotional activity in the market. Our plan is to produce less, so we do kinda take care of our end of the inventory plan. I do expect that the market in the fourth quarter will probably be a little more promotional, maybe than it's been in the past. You know, retailers drive the promotional cadence and make those decisions as they go forward. We're being very aggressive on our end to make sure that we prepare ourselves with an inventory position of high quality inventory to close the year to prepare ourselves for next year.

Will Gaertner (Analyst)

Understood. Thank you. I'll pass it on.

Operator (participant)

Our next question comes from the line of Jay Sole with UBS. Your line is now open.

Jay Sole (Managing Director)

Great. Thank you so much. Steve, can you just give us a little bit of a breakdown of how the men's business versus the women's business performed within the innerwear segment? Maybe on the print wear, give us an idea of how big that business is today and, you know, what kind of print wear you're doing well with. Maybe lastly, on cash flow, you know, you mentioned normalized cash flow should be something that we see in 2023. Can you give us an idea of what you think normalized cash flow looks like?

Steve Bratspies (CEO)

Sure, Jay. Thanks for the questions. Let me take the first two, and then I'll let Michael talk about cash flow. Not a significant difference between men's and women's in the innerwear business right now. That could change. You know, when you look back historically, you know, we would spend a lot of time looking back at the 2008, 2009 time, trying to get a feel for where the business could go. Now, we're a very different business than we were then in terms of our mix. We have much bigger international business. I think we're a much stronger business. Historically, the men's business holds up much better in a recessionary time than the women's business. We'll see if that happens. We have not necessarily seen that playing out at this point.

It varies by, you know, product category and, quite frankly, by retailer and channel at this point. But at a macro level, we have not seen a significant difference or change or inflection point between the two businesses as we go forward. In terms of our Printwear business, we don't get into the exact size of that business, but what I would tell you is, the business has held up pretty well, particularly the Champion brand in that business. We continue to find new opportunities to not only build that business, through the Champion brand and also the Hanes brand, as we go forward. You know, we've also had the opportunity to take pricing in that channel, and we have done that, where appropriate, and that has paid dividends for us as we go forward.

In terms of the cash flow, Michael.

Michael Dastugue (CFO)

Yeah, Jay. I think, well, clearly we're not gonna be giving guidance. I think when you do look at, you know, the last couple of years prior to this year, which is a very unusual year, those are probably, you know, good numbers to be thinking about. You know, I think that the inventory levels are, you know, gonna come down as we've talked about, and so therefore, working capital is gonna be the big driver of it.

Jay Sole (Managing Director)

Got it. Okay. Thank you so much.

Operator (participant)

Our next question comes from the line of Paul Lejuez with Citi. Your line is now open.

Brandon Cheatham (VP of Equity Research)

Hey, guys. This is Brandon Cheatham on for Paul. I just wanna follow up on the inventory question. You know, when you look at your inventory units, target by year-end and you remove the SKUs that you've exited, are you still projecting that to be down year-over-year?

Steve Bratspies (CEO)

Yes. At the end of this year, we're projecting that our absolute units in inventory will be down versus prior year. As you think about how you match all this together, we're being very aggressive on SKU reduction, and it's one of the things that I'm very passionate about and I think is an unlock inside of our business, and it is proving to be there. You know, 40% reduction so far, 22% fewer SKUs actually running through our supply chain right now is an unlock for us. What that does is it also changes your mix, right? It allows you to be in stock and, the terms we use, never-outs, of our inventory mix.

While total inventory units come down, the quality and the mix of that inventory gets better as you lean into your faster sellers. What you do is you create room to have more inventory on your better product and to launch innovation at the same time, all while reducing your absolute inventory units going forward.

Brandon Cheatham (VP of Equity Research)

Got it. Can you talk about, you know, your manufacturing capacity? You did provide some color on, you know, some downtime. You know, how are you able to manage that with third party versus your own manufacturing facilities? Can you talk a little bit about margin pressure when you have to idle your own facility versus, you know, if you can take a third party offline, and what are kinda some of the puts and takes there?

Steve Bratspies (CEO)

Sure. When you think about downtime in our network, the majority of that is coming from our own facilities. That's what we can control. That's what we can move the fastest on. So that's what we're being very proactive on, and moving to, you know, with speed to make a difference. It's one of the benefits of having your own network is you can actually make things happen in a very short period of time. There's a cost that comes with that, and I'll let Michael talk a little bit about what that cost is. You're able to move very quickly, take action, rectify the situation, and end up operating much leaner and much better going forward. The majority of that's inside of our network.

Michael Dastugue (CFO)

Yeah, as you heard us call out, right, in Q3, we had approximately 100 basis points of impact from the timeout, and about 200 basis points in Q4 is what we're guiding to. You know, that cost is essentially things like, you know, all the overhead that goes, you know, depreciation and rent, et cetera, that goes with these facilities, the management team that doesn't get charged to any particular inventory. You know, depending on the market, we may be paying our associates for a week or two to not work because we've had to pull back. That's what this cost reflects.

Brandon Cheatham (VP of Equity Research)

Got it. I guess why wouldn't you prioritize third-party facilities? Is it because you're contracted? Then, you know, when could those be renegotiated, so maybe you could bring your own facilities back up to speed and, you know?

Michael Dastugue (CFO)

One thing to keep in mind is we, you know, we don't make all the same product in every facility, right?

Brandon Cheatham (VP of Equity Research)

Right.

Michael Dastugue (CFO)

There are certain products that we work with third parties because of different, maybe it's a shorter, smaller run, it's more synthetics, et cetera. It's not like everyone makes the same products that we're making.

Steve Bratspies (CEO)

Right.

Michael Dastugue (CFO)

If that makes sense.

Steve Bratspies (CEO)

Let me just add to that. Also, you know, we're very focused on long-term relationships with our sourcing partners. One of the things that we're doing, which is driving big results in our sourcing business overall, is what I call supplier matrix, which is finding the right suppliers, the right strategic partners over time, and we're working on building those relationships and maintaining those relationships. We have to be careful about how we do that. The other probably most salient point to it is, you know, we make and sell more innerwear than we do activewear in the Champion business. We make more of the innerwear business, and we source more of the activewear business.

For us to make an inventory change and an action in a short period of time because it's more innerwear than activewear, we have to address that inside of our network.

Brandon Cheatham (VP of Equity Research)

Got it. Okay. That makes sense. Anything that you can comment on how the spring order book is looking? Any details there?

Steve Bratspies (CEO)

Yeah. We're not gonna comment on 2023 at this point. The only thing I would tell you is the consumer headwinds that, you know, we're experiencing now, we have guided into Q4, and we would expect challenging consumer environment as we go forward for a while.

Brandon Cheatham (VP of Equity Research)

Got it. Appreciate it, guys. Thank you.

Steve Bratspies (CEO)

Thank you.

Michael Dastugue (CFO)

Thanks.

Operator (participant)

As a reminder, if you'd like to ask a question at this time, please press star one one. Our next question comes from the line of Paul Kearney with Barclays. Your line is now open.

Paul Kearney (VP of Equity Research)

Hey, guys. Thanks for taking my question. Most of the questions have been asked already, but maybe just two quick ones. On gross margin, can you quantify how much of the pressure was from commodity, ocean freight, and manufacturing downtime? Then two, on SG&A, how should we think about your planned investments behind the brands? Are you taking reductions? Should we think about reductions into next year on maybe some of your marketing investments behind the brands? Thanks.

Michael Dastugue (CFO)

We've been running about 400 basis points of pressure as it relates to commodities, ocean freight, et cetera. I think we called out that we've been. In addition, we had about 100 basis points in Q3 that related to the timeout that we're taking. In Q4, the 400 basis points of inflation continues, and the timeout is approximately 200 basis points because there's more timeout being taken in Q4. There are offsets to those as it relates to the pricing actions we take and plus some of the cost reduction programs that we've got.

Steve Bratspies (CEO)

In terms of SG&A, you know, again, we're not guiding into 2023. Let me just talk a little bit about, philosophically, about spending and investing. You know, we laid out in our Full Potential plan that, you know, we're gonna invest in technology, we're gonna invest in our brands. I fully believe that the plan we have is the right plan. We're gonna remain agile, and we're gonna adapt in the times that we're operating in. I think you should think about us as being very confident in the plan that we have, the strategy that we have going forward. We're gonna continue to execute against it. We're gonna continue to lean in and remain agile.

We're gonna be thoughtful about the economic times that we're in right now, you know, for many of us, is unprecedented in how we're doing this. We'll adapt, and we'll be thoughtful about the investments that we're making, but we're very confident in the strategy that we have, and we're gonna continue to execute that as we go forward.