Hanesbrands Inc. ( HBI - Analyst Report ) reported second quarter 2012 earnings per share of 67 cents, down 14.1% from the prior-year quarter. Sharp increase in cotton prices during the quarter affected the margins, eventually bringing the earnings down. However, earnings outpaced the Zacks Consensus Estimate of 49 cents per share.

Revenues and Operating Profits

The quarterly revenues inched up 1.0% to $1.2 billion, driven by sales growth in both Innerwear and Outerwear segments. This was almost in line with the Zacks Consensus Estimate of $1.24 billion.

Hanesbrands’ gross profit margin and operating profit margin both contracted owing to higher cotton and commodity costs.

Gross profit went down 10.5% year over year to $366.9 million and gross profit margin shrank 400 basis points to 31.1% during the second quarter. The decline in profit resulted from inflation in cotton prices. The quarter’s operating profit contracted to $119.9 million, 11.7% lower than the year-ago level. Operating profit margin contracted 80 basis points 10.2%.

Segment Details

Net revenue at the Innerwear segment increased 2.2% year on year to $664.9 million in the reported quarter. The increase came on the back of decent performance of men’s underwear, women’s panties and socks. Operating profit in the segment went up 17.9% year on year to $121.2 million, driven by profitable bra and panty business that offset high cotton cost.

Outerwear segment sales climbed 1.2% from the year-ago period to $295.4 million. Strong sales of Champion activewear sales and new Hanes casualwear were partially offset by lower sales in branded printwear. Outerwear segment reported operating loss of $977.0 million in the quarter.

Net sales at International segment slipped 1.8% to $125.7 million in the quarter. Operating profit went down 0.3% to $11.6 million in this segment. The reason for decline in revenue was foreign exchange headwinds.

Direct to Consumer segment sales went down 3% to $94.6 million and operating profit slipped marginally by 0.3% to $11.7 million in the quarter.

Other Financial Updates

The company exited the second quarter of 2012 with cash and cash equivalents of $29.7 million compared with $34.6 million in the previous quarter and long-term debt of $1.7 billion compared with $1.8 billion in the first quarter of 2012. Operating activities used $12.7 million of cash compared with $94.1 million in the previous quarter.

Guidance

The company maintained its fiscal 2012 diluted EPS guidance to be in the range of $2.50 - $2.60 on net sales of $4.52 billion - 4.57 billion. Gross and operating margin percentage is expected to improve sequentially for the third and fourth quarter.

For 2012, the company expects free cash flow to be in the range of $400 million to $500 million. The company’s near-term priority for the usage of free cash flow is to reduce long-term debt and de-leverage its balance sheet. The company expects to further reduce bond debt to $1 billion by the end of 2013. The company expects to reduce interest expense from prior year to $17 million on the back of debt reduction.

Our Recommendation

Hanesbrands is a leading player in the innerwear, casual wear and active wear markets in the U.S. It is well established in the industry and competitors include the likes of Limited Brands Inc. ( LTD - Analyst Report ) and Maidenform Brands Inc. ( MFB - Snapshot Report ) .

However, Hanesbrands’ debt-ridden balance sheet and unfavorable foreign translations may weigh upon both the top and bottom lines. Its soft guidance also hurts investors’ confidence.

Hanesbrands currently holds a short-term Zacks #3 Rank (Hold). On a long-term basis, we maintain a ‘Neutral’ rating.