漢佰 (HBI) 2011 Q3 法說會逐字稿

Good afternoon. My name is Lisa and I will be your conference operator today. At this time, I would like to welcome everyone one to the Hanesbrands third quarter, 2011 earnings conference call. 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) I would now like to turn the call over to Mr. Charlie Stack, Executive Director of Investor Relations. Please go ahead sir.

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 third quarter of 2011. Hopefully everyone has had a chance to review the news release we issued earlier today. The news release and the audio replay of the webcast of this call, can be found in the Investor 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, as well as our news releases and other communications. The Company does not undertake to update or revise any forward-looking statements which speak only to the time at which they were made.

We want to reiterate that in this inflationary environment, there are some aspects of our business that we intend to refrain from discussing in great detail for competitive reasons. Specifically, we will refrain from disclosing details regarding cotton purchasing practices, forward-looking cost positions, or forward-looking specific timing or amount of pricing actions. As always, with me on the call today is Rich Noll, our Chief Executive Officer. But due to our recent executive announcements we have 2 new attendees. First is Rick Moss, our newly promoted Chief Financial Officer.

Many of you on the fixed income side have known Rick for years. Rick looks forward to getting to know the equity side equally as well. We also recently appointed Bill Nictakis and Gerald Evans as co-Chief Operating Officers. Going forward we intend to rotate them on calls, beginning with Bill today and Gerald will join us on our fourth quarter call. In terms of today's agenda, Rich will highlight a couple of big picture themes. Bill will provide a sense of what is happening in a few of our major businesses and Rick will emphasize some of the financial aspects of our results, as well as share his thoughts about how we can continue to maximize value at Hanesbrands. I will now turn the call over to Rich.

Thank you, Charlie. Let me address 3 topics that I'm sure are top of mind. Profits being above our expectations, sales being below and how pricing impacted our results. But the top line answer for pricing being, very well. Third quarter profit results were very strong. Our operating margin of 12.4% is at the highest level in our history. And our year-to-date EPS of $2.28 already exceeds 2010's full year EPS of $2.16. Profit increases were driven by innerwear, up $24 million for 44%. And Gear for Sports added an additional $13 million of profit. Profits also grew 10% in the rest of outerwear and 16% in our direct to consumer business. Price, mix and cost control fueled significant gross margin expansion and overcame higher commodity costs.

Gross margins increased 360 basis points leading to a 270 basis point increase in operating margin. With these results, we are well on our way to having a record year. Next let me talk about pricing. Our approach, pricing to at least maintain operating margins, is working. While units do in fact decline, they decline much less than price increases and are driving good results for us and our retail partners.

Let me highlight 2 categories that had some of the largest price increases, socks and male underwear. These categories grew 4% and 10% respectively in Q3. And socks is a great story. October's retail sell-through dollars are up nicely and units are only down a few points. While naturally price increases did dampen unit demand, in this case it is mitigated by other tactical changes that we made to our programs to drive sales. And we are extremely pleased with these results. Our male underwear business is also performing very well. While units have declined, sales dollars are still quite strong. And even with the third price increase that was effective in late September, sell-through data across our major accounts indicate elasticity is at or better than our expectations.

It is also driving good dollar comps for our retail partners. And finally, the best indicator of how our pricing strategy is working, is that retail has continued to increase our shelf space as we expect net gains 2012. Lastly, in terms of our overall sales results for the quarter, sales growth was lower than our expectation with a major reason, especially for innerwear, due to the consumer macro trends of back-to-school coupled with retailer's focus on their own inventories. Let me give you some context on both.

In August, retail traffic was down and overall retail sales were relatively soft. This softness in August, coupled with inflation, is causing retailers to focus on tightly managing their inventories. Fortunately, retail sales rebounded in September and October. So, we might see retailers loosen up, but we are not counting on it nor even expecting it. We will, however, stay appropriately alert to take advantage of any upside. So, to wrap up, we are appropriately managing price, controlling costs and effectively dealing with inflation. As evidenced by our third quarter results, we believe that we have the right approach to managing through this environment and we feel confident in our prospects to deliver a good Q4. I will now turn it over to Bill to discuss the results by business. Bill?

Thanks, Rich. This quarter is a great example of how we are managing through this inflationary environment. In a deflationary environment it's all about driving units at a faster rate than prices decrease. We stepped back and said inflation is here to stay. Thus we are focused on driving sales dollars, gross profit dollars and operating profit dollars. You are seeing that shift in our third quarter results and there is no better example of that than in our largest segment, innerwear. Profit growth for our innerwear segment was strong, up 44%, driven by a combination of price increases, lower operating costs and a very focused SG&A expense management, which combined more than offset commodity inflation. We saw good sales growth in our socks and underwear businesses, somewhat offset by lower sales in intimate apparel.

During the quarter, we effectively managed the escalating cotton inflation in our core underwear and socks categories and each business grew nicely. Our intimate apparel business was down, but not due to price. Remember, our broad business had only modest price increases back in February. Rather, we have seen the over 35 year old segment pulling back from apparel spending overall and intimate apparel in particular, especially in the last 6 to 9 months.

Also this category has been impacted by department store and mid-tier retailers focusing on inventory management. But we expect the softness to continue into the fourth quarter. We are now working with our key retail partners to formulate action plans to turn these trends around in 2012. Overall, retailers are feeling good about our innerwear business. As in many cases, we are driving the comp increases in their categories.

Our customers clearly value our market leading brands, and that makes us feel good about our potential in 2012. Not only have we already secured the pricing needed to deal with the highest commodity costs, but we have also secured net shelf space gains that could generate an additional 2 to 3 points of innerwear growth. Now shifting to the outerwear segment, we dedicated the same focus on managing through an extreme inflationary environment and growing our profits. Operating profits for outerwear were up 45% for the quarter, driven both by Gear for Sports and core business. In fact, yesterday was the 1 year anniversary of the acquisition of Gear for Sports.

And they continue to deliver great operating results. We couldn't be happier with Gear and feel really positive about their ability to deliver the synergy savings and profit growth, that we previously outlined. In fact, let me give you a couple of specifics about Gear. They are on track to deliver slightly over $30 million of operating profits this year and should benefit from synergy savings and growth to deliver an additional $10 million or so next year, just slightly over $40 million of operating profits. Now, that would yield an EBITDA of close to $45 million in 2012 against the purchase price of $225 million giving us the post synergy multiple of about 5 times.

And while we feel good about that, we are even more excited about their long term growth prospects and our ability to leverage their best in class graphics capabilities into our own core businesses. Turning to the rest of our outerwear business, Champion, retail casual wear and image wear, we delivered a 10% increase in operating profit as we effectively managed our net price and exerted strong cost controls in our imagewear and Champion businesses. Now, sales were down, with the majority of the decline driven by our Just My Size business at Walmart. Reductions in Just My Size represented a 7 point decrease in overall segment sales for the quarter and occurred as the account moved more of their plus size fashion business toward private label versus the core basics that we provide.

And turning to international, our sales continued to grow in the third quarter driven by continued strength of our Latin American businesses, rapid expansion of our Asian business and integration of our Australia acquisition. Of particular note, sales of our Hanes Basic business in China expanded by over 90% in the quarter, and our sales in Brazil grew by 36%. Now, we did experience slower sales in our Canadian and European businesses which had a negative impact on operating margins. In Canada where we hold the leading share in intimate apparel, sales were affected by declining intimates category purchase trends. Likely caused by one of our largest retailers pulling back from their high/low promotional strategy, to one of an EDLP approach. For our direct to consumer segment, profits were up 16% on tight cost controls. As we continue our focus on improving the profitability of this business. Hosiery operating profit was down 22%, driven primarily by an 8% sales decline for the quarter.

Turning to our global supply chain, we effectively eliminated service costs that we incurred last year and our supply chain generated savings of $11 million in the quarter. We remain on track to deliver approximately $40 million of savings for the full year. And, lastly, in the fourth quarter, we should begin to use lower cost cotton, which will benefit our P&L in the back half of 2012. So, in closing, we have effectively managed an extreme commodity inflation by taking strategic pricing. Our customers value our leading brands and category driving innovation, and we are on track to gain even more shelf space in 2012. I will now turn the call over to Rick, to discuss our financial performance.

Thanks, Bill. Our third quarter profit performance was strong as we saw profit improvements across most of our segments including innerwear, our Gear for Sports acquisition in addition to the rest of outerwear and direct to consumer. Let me walk you through a couple of P&L highlights that contributed to this profitability. Gross margins were 34.6%, up 360 basis points in the third quarter or $62 million. Innerwear was a major driver of the increase in gross margins and contributed nearly half of the dollar increase, as net price increases and supply chain savings, more than offset increased input costs including cotton. Gear for Sports performed extremely well and continues to add to our results contributing $27 million to gross profit in the outerwear segment. And the international segment increased gross profit nicely as well. As that segment benefited from price increases in most of its markets.

Our third quarter SG&A rate was 22.2% of sales versus 21.3% last year. SG&A dollars increased by $23 million over the prior year, driven by $15 million related to Gear for Sports, $9 million related to our growing international segment, with domestic SG&A excluding Gear, down slightly. Operating profit in total was up $39 million or 34%. Interest expense was $2 million higher than last year, and our third quarter tax rate was 20%. The resulting EPS for the quarter was $0.91 up 44% from last year.

Looking ahead to Q4, we expect sales to be in the range of $1.2 billion to $1.3 billion reflecting some cautiousness about continued retailer inventory management. This level of sales, along with higher prices and supply chain savings, should more than offset inflation and in turn should yield EPS for the quarter between $0.47 and $0.57 or $2.75 to $2.85 for the full year. A narrower range around the same midpoint of prior guidance. Now let me highlight a couple of points related to the balance sheet and cash flow. Inventory at the end of the third quarter was $1.7 billion up $350 million versus last year, mostly due to higher inflation. The higher inventory level consists of $260 million of higher inflationary costs, $40 million of incremental units and $50 million related to Gear for Sports. As we indicated last quarter, this should be the peak of our inventory dollars.

We continue to project free cash flow between $100 million and $200 million, for the full year. EBITDA grew 31% to $174 million in the third quarter. And $467 million for the first 9 months, up 23%. We continue to expect net debt to EBITDA of 3 to 3.5 times at year end. I would also like to communicate a few of my thoughts regarding the opportunities we have at Hanesbrands and how I would like to contribute to our future success. Focusing first on debt and leverage, and then on driving high margin businesses. On debt and leverage, we built a strong capital structure that I believe will sustain us through whatever economic volatility may lie ahead. Having said that, a key focus of mine will be to continue to drive cash flow so that we can in turn continue to deleverage our balance sheet to a level even below that of the 3 times debt to EBITDA goal we've mentioned before, helping to ensure a solid foundation for future growth.

To achieve this goal, we will likely use our strong free cash flow to begin to repay our floating rate notes. Now, turning to high margin businesses, we have some great high operating margin businesses and we need to grow them. At the same time, we have some business lines that have significant margin improvement opportunities and we need to fix them. In those businesses, we will be concentrating on improving profitability, and then driving profitable growth there after. I am very excited to be taking on the CFO role of Hanes at this time in our history and look forward to the opportunities ahead. I also look forward to meeting many of you in the near future. I will now turn the call back over to Charlie.

Thanks, Rick. That concludes the recap of our performance for the third quarter. Now we will begin taking your questions and we will 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 1 question plus a follow-up, and then reenter the queue to ask any additional questions. Also, we understand we were facing technical difficulties earlier in the call. Therefore we will post our prepared remarks and the answer to the Q&A on our web site. I will now turn the call back over to the operator to begin the question and answer session. Operator?

(Operator Instructions) Your first question comes from the line of Robert Drbul with Barclay's Capital.

Rich, I guess I would like to start off on the top line a little bit. I'm trying to better understand the top line performance. And you talked about the units much less than price. When you look at the shortfall, were there surprises on competitor pricing responses? I'm just trying to get my handle around the price increases and exactly sort of, what led to the 5% which is a disappointing number for you guys and for us.

Absolutely. So, first of all, pricing had absolutely nothing to do with sales being softer during the quarter than our expectations. In fact, if anything, the whole pricing strategic is working better than our expectations, as I even talked about from an elasticity standpoint. The softnesses in the quarter versus our expectations was real simple, and it's driven mainly by our miss-estimate basically on retailer's sensitivity to inventories and managing them very tightly due to inflation and a little bit of the softness that we saw in the August back-to-school period, which I think heightened their sensitivity even more. You've heard me say over the last couple of quarters that -- actually I think a number of you asked, how are retailers going to handle this? And earlier in the year they were saying, yes, we are going to let retail inventories go up. We realize there is inflation coming, we'll let the dollars go up.

Clearly not 1 for 1 with price increases. We had a lot of retailers saying, but we will probably take less risk where we have mark down risk and let basics actually float up both in units as well as in dollars. While the reaction we are seeing is very different. A lot of them are managing inventories very tightly. Some even to keep them flat in dollars to last year. And it's impacting all categories, basics categories all the way through fashion. And I think that was the big miss versus our expectations.

Got it. Just sort of following that, when you look at where inventories are today at retail, any idea in terms of the levels of the retail inventories now versus last year and were there any major cancellations during the quarter? I'm just trying to get my hands around that a little bit more.

Yes, I think going into the fourth quarter holiday season in 2012. I think the retailers largely have the inventories in line. On their set programs they had to order those things 6 months, 9 months ago. They have already adjusted those orders based on inflation. And we look at our businesses, we have seen some tightening. A lot of that has already occurred for us. So, I think overall, we look at our point of sale trends, we look at the inventory, overall we feel pretty comfortable where we are going into Q4.

Thank you very much.

Your next question comes from the line of Susan Anderson.

Maybe if you could just break out the gross margin expansion a little bit between pricing Gear, supply chain savings et cetera, and then also if you can talk a little bit about what you expect to flow through in the fourth quarter?

Sure. First of all, if you think about the gross margin improvement, I would break it out this way. We got about $107 million of improvement from price mix, all of that net of the volume issues. We got $11 million of supply chain savings and those 2 together offset about $56 million of input cost increases, $24 million of which was cotton. As we think about how this impacts the guidance for Q4, I think about it this way, Susan, in terms of pluses and minuses. I think going into Q4 we have some positives. One is that we have additional price increases going into effect. We are going to continue to recognize supply chain optimization savings in the quarter and we are going to not recognize some excess service costs this year that we saw last year. Offsetting that of course will be higher cotton prices. There will be close to 2 times higher than they were last year and that is going to have an impact. And I think you have to put all of that then in the context of the environment that we've referred to around retailer inventory management, consumer spending and the uncertainties around that.

Okay, great. That is really helpful. And then just really quick if you guys can maybe touch a little bit more on the reduction in Just My Size. Was that a surprise to you guys and should we expect basically this amount of reduction going forward now?

Let me give you a perspective on Just My Size. We entered that about 2 years ago, that agreement with Walmart, really as an attempt to revitalize their plus size business. Put a team together and we did that, actually and we started turning around and building that momentum with their team. As we started succeeding, then Walmart has become more interested in that. They started putting some of their own people against that and their focus has shifted a little bit, more towards their own brands, more towards some of the fashion basic stuff versus the core basics that we typically have provided them. So, it remains to be seen how that whole strategy is going to work out. I think there is going to clearly be head wind for us in the fourth quarter and into the first part of 2012 on Just My Size. Now, mitigating that is, hey we are continuing to work with Walmart and other accounts in terms of how they can leverage our Hanes brand and Jersey programs and we are picking up significant incremental programs that will help us offset Just My Size.

Thanks a lot, you guys.

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

Two main questions, Rich. What I've noticed being in the stores and looking at the competitive pricing environment, it looks like clearly you guys have a premium brand relative to your competitors in the mass channel. But the pricing spread seems to have widened. And my first reaction looking at the sales increase was maybe the consumer is responding. I'm not hearing that on any elasticity standpoint. So, I'm just wondering to the extent you can comment on it, the pricing gap and whether that is likely to persist. And then secondly just given the sales in Q3 and the wide range in Q4, typically you guys have a pretty formulaic approach if I'm not mistaken, like mid to high single digits kind of long term sales growth goal. And I was wondering if you could put Q3 and Q4 in that context and help us understand how to think about shelf space gains and growth in the segment and how we can think about 2012 in that regard?

Okay. So three questions. Let me hit the first one top line on pricing elasticity. I'll turn it over to Bill to let him talk about price gap and sustainability and so on and so forth and then we will cycle back and Rick or myself will talk a little bit about prospects for 2012. And first of all, I am thrilled, how our whole pricing strategy is working and is impacting our results. It's all extremely positive. I talked about socks and underwear being up 4% and 10% respectively in the quarter. When you look at overall sell through, dollars are up. Our dollars are up and driving most of our retail partners comp store increases in those categories and I know we have had a couple of major retailers even talk explicitly about what their comps are in socks and underwear, and we are driving their comp store increases. Elasticity is less than we expected even with the third price increase. So, that is all extremely positive.

Pricing has nothing to do with what our sales results are. Overall, what is weighing on it actually is in a lot of the intimate apparel categories where you are seeing department stores and a broad set of mid-tier retailers begin getting -- pulling back on inventory which is weighing on the results. We are seeing some of the club channels being a little bit more sensitive to working down inventories, and so on. So, I think that is more of a transitional thing. But quite frankly we miss-estimated coming into the year their sensitivity to their own working capital needs. And so, I don't see it as having anything at all doing with pricing. In fact, you are right, our sales were a little bit below our expectations, but pricing is actually delivering higher margins than we expected and we expect that kind of thing to continue. With that, Bill, do you want to talk a little bit about sustainability and price gaps?

Yes. When it comes to price gaps, I think first comment is, you can't generalize because it varies by category, varies by class of trade and parts of the world that we operate in. And clearly in this environment it has been a moving target and it will remain a moving target. I think what I would say is, everybody is seeing higher costs flow through their P&Ls. I think you are seeing higher retail prices manifest themselves on a broad, broad basis. I think the key difference is the timing that people took pricing and the amount of pricing and I think that all comes back to the power of your brands and people with strong brands took pricing sooner. People with lesser brands didn't have as much confidence or who customer's consumers don't have as much confidence in, weren't able to take pricing as quickly or as much. Our gaps have increased over these last few months.

As Rich said, though, that elasticity is at or even less than we had anticipated as those gaps have widened. Our customer feedback is positive. Overall we are helping our customers grow their category, maybe in a little different manner than norm, but they're pleased with the results. And I think that shows up in terms of, we are set up to gain space next year. I think that is working fairly well for us. And I think, we are comfortable that in some categories our gaps will be wider than they've historically been. And it seems to be working for our customers, working for us and as long as we invest in our brands, the product innovation, the quality, I think our brands can support a little higher price gap than they've historically had.

And David, I will even echo what Bill says. He actually says it to me a little bit more strongly, he said, look $1.00, $1.25 is the new $0.50. Our brands are strong enough, they need to have wider gaps than they did historically. That's what we've learned from this thing. We've got great brands, we've got great products. Our customers like them. Our retail partners are actually thrilled with the categories that have had the largest price increase. You look at the categories that are down, it's intimate apparel. Bras only had a 5% increase, it has nothing to do with the pricing. In terms of 2012, I'm going to actually answer that instead of Rick since we are right now in the planning process. So, it's way too early to try and give guidance but let me just sort of frame the situation from where it was a year ago.

A year ago, cotton was going up and we had no idea how far up. And I don't think any of us, all of you included thought that it was going to over $2.00 a pound. While we said we would get price to solve this problem, we had only put 1 price increase in, in the previous decade. We have now since gotten 3 prices in the last 9 months and it's working, working better than we expected and it's driving our retailer's results and, so, we have got all the price we need to even deal with the high water mark on prices.

So, I look at 2012 saying we are going into that year with a lot more certainty and a lot more momentum than we actually entered 2011. So, I feel good about our prospects. It's not to say there won't be some retailers that have to work through their inventory issues. But all of those are sort of minor things. When you look at what is happening to our margin structure, through all this, I feel really good about our ability to head into 2012. That said, obviously you are going to have cotton prices coming down in the back half of 2012, retailers are already talking about how they don't want to see a lot of deflation in a lot of our categories. So, you have the opportunity for a really strong back half. But that is not to say that the front half is going to be necessarily bad. I think you will see some ebbs and flows. But I think we're set up well for 2012.

In terms of things that you do know, sounds like shelf space gains, you mentioned innerwear was 2% to 3%. I don't know about outerwear. You are going to get some growth there. International should be accretive to your sales growth as well. Obviously the question is price versus units.

And you still have wrap around on price increase and if you want some estimate on price versus units, I think a good way to look at it, is remember, look at socks and male underwear for the quarter. Socks were up 4% in dollars, male underwear was up 10% in dollars. And, granted, it's only 1 quarter but when we look at the elasticity, it's running, I think I have always said well, it's going to be above 0 and below 1 in some of these categories, and a good way to think about it, as we are seeing it maybe in the realm of somewhere in the middle of that.

Right. So, having said all that, is mid to high single digits still a reasonable book ends for --?

That's where we will say we haven't put our plans together yet. And it's too early to talk about 2012 although I feel like we are on a lot more strong ground today than we were a year ago when we had so many unknowns facing us.

Great.

Your next question comes from the line of Eric Alexander from Stifel Nicolaus.

I'm subbing in for Jim this afternoon. Just had a question regarding your shelf space gains, just to follow on. Are you -- you noted that it was innerwear. Was it Champion brands or were you seeing it more on the Hanes branded products on the innerwear side of things?

Yes, we're seeing space gains across multiple brands, multiple classes of trade. So we have innerwear gains in socks, in underwear, bras, depending on which account. You have gains coming for Champion, C9 at Target et cetera. So, right now we are still finalizing but we are seeing positive response across categories and across channels.

Okay, so, could I imply from that, you are seeing an uptick at a sporting goods vis-a-vis department stores vis-a-vis mass, things like that? Should I imply that it's across those retail type partners or --?

Yes, I think -- the support for our brands is widespread. And that's what's nice about it. We are seeing support of our strategies and investment in our brands and our quality and innovation across the different categories and across customers. You know, we have shown that we are helping them grow their category. And as long as we can do that, we tend to continue to win.

Okay, thank you for that. And then, I know you don't want to get too far into '12 but just kind of thinking about this. How are the discussion with retailers going on in terms of let's say pack size potentially increasing vis-a-vis price declines? Have you guys seen any sort of movement that you would be open to talking about at this time?

We are always talking and testing with our retailers. In terms of ways to drive their categories. Historically pack size increases have been a way to drive consumption and drive their business. So, we have tests out there today in terms of pack size increases with our customers. And we will continue to be testing those kinds of tactics and depending on the customer and the category, implementing some potentially in the back end of the year.

Your next question comes from the line of Omar Saad, with ISI Group.

Rich, so if I do some of the math and back out the Gear for Sports, it looks like your sales dollars might have been down a little bit in the quarter. And you talked about the retailer sensitivity to inventories given the inflation that's flowing through, and how you kind of underestimated that a little bit. Is it possible that retailers, and especially looking at kind of the first half numbers when you made your price increases came through at the end of the second quarter and then in the beginning of the third quarter -- or end of the third quarter rather. Is it possible that retailers were kind of building inventories ahead of that and getting some of the goods in their hands before the prices really ramped up and that might be impacting the inventory situation with the retailers?

Omar no, the answer is they clearly did not do it. They are so focused on managing their inventories that we thought maybe they would because they were significant price increases, there was none of that. Their number one priority seems to be controlling inventory. Period.

This is Rich. Let me also make sure we get this clear. This sensitivity about inventory isn't about our categories. It's their total inventories in their company. So, there is at least one department store account that their total women's business is relatively soft but men's is actually pretty strong. They are cutting inventories in womens pretty dramatically. They can't cut ready to wear because as much as they can replenishment businesses because they want to make sure that they are shifting those dollars over to drive men's. That is just one example. This isn't so much about our categories.

This is about -- they are seeing double digit increases in inventory dollar values at their corporate level and they're saying we have got to manage this down, start to take it down across the board. Originally going into the year, and I even talked about this, a lot of them were talking about, well, we will do it thoughtfully. We will let basics be a little bit higher than something else. Well, you get into the middle of it and they're facing the dollar increases and they are doing it with a, more of a hatchet than with a scalpel.

And so, I guess -- is it more the mass customers that you have or more kind of the mid-tier department store customers you have, or is it everybody?

I think overall everybody -- almost everybody has a heightened sensitivity to inventory.

Not everybody, but almost everybody is concerned and placing certainly much more focus this year than they did last year in terms of inventory. And they are more willing to run the risk of an out of stock and sacrifice the sale, in order to control their inventory.

There are even some accounts, there is at least one where there is a new leader in place that's got a new strategy. They are putting things in place to take effect with their new fiscal year and they are making sure they are managing their inventories appropriately before their new fiscal year starts. You have a whole lot of tactical things going on that end up not just affecting our businesses but a broad set of businesses. Unfortunately replenishment businesses are the easier place to sort of cut back in the near term, because they have already made commitments on some of their ready to wear businesses.

Thanks. Could you also quickly just address the international business was still strong but maybe not quite as strong as it has been. Was there any change there, any specific reason you would call out?

Our international business overall performed about on expectations in terms of the sales growth. I think the biggest challenge we had on top line was in our Canadian business. And again, it was back to promotional strategy being changed and significant reduction in orders based on that. Their sell through was off. Managing inventory and then they cut back. But, you know, if you look, our emerging markets --.

Europe was a little soft.

And Europe was soft. Absolutely right.

So, those 2 places were really it.

Your next question comes from the line of Ken Stumphauzer with Sterne, Agee.

I just want to follow-up on 4Q sales and kind of understand the thought process behind it. At least optically it looks like you guys are coming up against a much more difficult comparison and you are guiding -- and you no longer have the benefit coming from Gear for Sports at least for the entire quarter. I am just trying to get a sense of why you expect organic sales to accelerate in the manner in which you are speaking to?

I think it's real simple. Let's just zero in on innerwear for the third quarter. Innerwear is basically flat for the third quarter. That's not the type of -- that's not the trends or their sell through that we have been running. So some of that is a little bit depressed, and I think you are going to see that segment tend to get back to a little bit more reasonable growth than we would have expected. And so you have a lot of puts and takes. But at the end of the day, we got a little more conservative on the fourth quarter. It's that trend where yes, sales weren't quite as strong as we had predicted in the third quarter but margins are a lot better and we think that some of that is going to spill into the fourth quarter.

And then just to follow-up on sales in 4Q, in 3Q you alluded to kind of inventory destocking to a certain degree by the retailers. And I think historically you guys have pegged that as maybe 1 week of supplies. Is that an accurate assumption on my part?

Yes, that's usually a good guess. Sometimes it's in the -- and I will remind you sometimes it comes late in the fourth quarter, sometimes it happens in January. So, it's one of the reasons that it's hard to predict our business exactly quarter-to-quarter because you can easily get those swings as retailers arbitrarily make those decisions differently from one year to the next. -- by the time their year end ends though.

I got you. So between perhaps like the inventory draw down to retailers and then secondly to Just My Size business, that in and of itself was a 600 basis point - 800 basis point top line headwind in 3Q.

Yes, a great way to think of it, and I'll just put this back into perspective. If intimate apparel was flat and the Just My Size was flat, our total top line growth would have been just under 10%. I think it would have been 9%, or something like that. So those 2 issues right there zero in and sort of frame the entire problem.

Your next question comes from the line of Steve Maroda with CL King.

Very quickly you've mentioned obviously the destocking particularly occurring in the August and September time frame. Can you speak a little bit more or quantify more, the point of sale sell throughs that are -- you are currently experiencing either from a percentage standpoint and how that's compared or maybe market share?

You know, I think overall we are feeling pretty good on some of the cotton intensive categories on sell through relative to our elasticity assumptions. And if you want any numbers, there has been a couple of retailers that have talked about some of those categories and what their comps were. And, so we feel good about that. Actually our sell through right now in the bra business is a little soft. And that is one of the things that we're -- we have been talking about. Sell through in Champions overall pretty good. And so, you know what, I think things are -- basically they are over all fine, they're trending relatively close to our expectations with a couple of exceptions that I've noticed.

Okay.

Does somebody have a question about our great gross margins for the quarter?

Actually that wasn't part of what my Q&A is. I just have 1 more question then you can answer that one if you want. Bill mentioned something in the prepared remarks --.

I just want somebody to ask and say, hey wow, you guys have gross margin going up, operating margins going up. There's not that many companies doing that in this inflationary environment. But anyhow, I'll let you ask your question. Go ahead.

Hey guys you guys have gross margin and operating margin going up in this inflationary environment. Most companies aren't doing that, how are you doing that?

Thank you, what a great question.

Actually you can't answer that. But I do have one other quick one. Bill, you mentioned during the prepared remarks that lower cotton will benefit, I think you said in 4Q of '12. But did you mean something sooner than that?

We are going to start using it in the fourth quarter of '12 --

No, '11.

'11, which means we'll start using it fourth quarter this year, we should start seeing it show up in the P&L midyear next year. Really, end of second quarter, third quarter of '12.

I thought that's what you referred to and actually I think you had said 4Q '12 in the prepared remarks. Never the less, I appreciate that. And now, Rich, feel free to answer that question.

I think we already answered it. I'll wait for the next real question.

Thank you.

Your next question comes from the line of Andrew Burns with Davidson.

I was hoping we could spend a little bit more time on the intimate apparel category notwithstanding the inventory fluctuations of the quarter for the whole year that has been a promotional category. And I was wondering about your strategy to maybe reinvigorate sales for those brands in terms of maybe it's marketing dollars, new products, new pricing strategy, anything there to reinvigorate that category? Thank you.

If you look at intimate apparel is clearly our biggest challenge. A couple macros and then we have to execute better and definitely too. A macro over 35 consumer, which is our core business, I mean we are really strong in the full figure over 35, but she is the one who is shopping less both overall apparel and certainly in intimate apparel. So our bullseye target market for our Bali, Playtex businesses, she's just not shopping as often. And we're seeing that in terms of that category is really suffering overall, and we are the leader in that. Second, clearly, the mid-tier department store accounts are focused on inventory. They are cutting that back plain and simple and that impacted our business.

Third is, hey, we have to continue to innovate and bring products that the consumers want and are willing to pay for both on full figure and on average figure. And we've demonstrated our ability to do that. Our Barely There business is growing double digits on top of double digits, and that's an average figure focused, younger focused brand and it's having extremely strong results. And frankly, tactically, we just have to take some of the same strategies that are working to drive Barely There, apply them to Playtex, apply them to Bali. And that's what our teams are in process of doing right now. It's not an issue of pulling back on promotions, it's macros and then hey, just make sure we are bringing out the right kind of news and supporting it the right way.

Okay. Thanks. And then lastly, could you -- I know you answered a question on the Just My Size program but could you sort of speak to how that program has evolved over the last 2 years and grown and sort of what Walmart's commitment is to that program? I know their strategy in apparel has been evolving over that time period. Thank you.

When it started they weren't real focused on the plus size consumer so they said hey, we will just let you deal with it. We did a really good job. It has become important to them. Now they want to exert a little more influence and control over that and take it in a modified, not a different direction, but a modified direction. So, I think that is sort of the long and short of what's happened with that business. And hey, we will continue to work with them on our products and focus on the areas that we are really good at and work to help them grow their categories. We have shown we can do it in the past. I'm sure we will do it again with them.

This is Rich. I like to think of, if any of you have heard of the Sports Illustrated jinks. You might remember there was actually an article in The Wall Street Journal talking about Walmart Just My Size and how well it's doing and driving their plus sized category. I guess we should have known then that, oops, looks like, that might be the top for a little while. I do think they will reengage and start to realize that Just My Size resonates with their consumer. We have more opportunity to help them drive growth but we have to get through what we have right now. Next?

Your next question comes from the line of Eric Beder with Brean Murray.

I have 2 questions here. How much of your business right now is replenishment and when you look at kind of the -- how much of your business is replenishment?

It's almost all of the innerwear business, probably a third to 40% of the outerwear and the bulk of the international business and DTC.

And if I look at the China costing issues, how is that flowing through?

I'm sorry, I missed that.

Hold on one second.

Cotton costs did you say?

In terms of China, China costing issues, how is that working through?

Oh, you mean in terms of inflation we are seeing from China or from the benefits we are getting from Nanjing and Vietnam sewing?

I think that's what we're pointing to, we have heard people talk about China labor prices increase. How are you offsetting that and how is it your China operations are helping you in terms of driving costs?

I think it's real clear that a lot of the inflation that we and other apparel companies is seeing is not just cotton based. Obviously that is the lion's share of it, but we are seeing double digit wage increases, but not just in China. It started in China and it preceded everybody else by about 2 to 3 months but we are seeing those double digit wage increases sort of cascade throughout the entire developing world, it's in Vietnam, it's in Bangladesh, it's in Honduras, it's in El Salvador, it's in the Dominican Republic. So, it's broadly throughout the developing world. A lot of it is driven by the fact that they are experiencing food and energy inflation which is a much higher portion of people's discretionary spending there. And that's just part of the inflation that we are dealing with. In fact, you know, what is it? $275 million to $300 million of cost increases we will experience this year, only about 50% to 60% of it is cotton based. The rest it is all those other costs, am I correct Rick?

That's correct.

So, that's all here. Most of that is here to stay. And that's why as cotton starts to mitigate, in the back half of next year you are still going to see inflation from these other areas work through everybody's supply chain which is going to dampen any -- some of the benefit that you are going to get from cotton. Not all of it but the good thing is, we have the pricing that we need to navigate even the high water mark of cotton.

Your next question comes from the line of Scott Krasik from BB& T Capital Markets.

Question on the sales or really the visibility to sales and then a follow-up. Rich, if we think back July 20, when you gave the guidance, did you have any indication based on the sale through at that time that the replenishment business would stop or was it really a function of August which was weaker than expected? I just want to understand how good, or how high of a visibility you have to the rest of the quarter's replenishment business?

Well, obviously if we had the visibility back then, we wouldn't have guided to where we did. I will say that when we look at it, there was no question, the sensitivity for retailers about inventory was already there. August I think did change people's mind. To be honest the stock market declines in September further reinforced in everybody's mind maybe it's a time to be more cautious rather than less. And so I think Bill, wouldn't you say it started to build at that point?

Absolutely.

No question. You know, actually I remembered right around, shortly after that, Jamie Diamond on his call he used the quote saying in this environment, it's hard not to be cautious. You know I think that's -- that echoes through the entire retail community and a lot of other companies.

That's fair. So, then, just looking at the fourth quarter, the round of price increases that hit at the end of the third quarter, is there any visibility that the pricing or the elasticity commentary that you made is similar or better and then as we get into the back holiday period, do you have an approach to mitigate your pricing if you aren't seeing the elasticity favorable?

Actually, most of the comments that we gave you is all about the sell through and elasticity since the third price increase. And a lot of that is October data. So, it's very extrapolateable going forward.

Your next question comes from the line of Carla Casella with JPMorgan.

This is Paul Simenauer for Carla Casella. Just a couple of questions. First, how much was the Just My Size sales impact? I think you said 7 points which we calculate to be around $27 million, quote me if I'm wrong. Would this be a good quarterly run rate or is it just a seasonally strong quarter for Just My Size?

That is -- you hit the number, that's about right, about $25 million, $26 million of a hit to us. And what we will have over the next few quarters, we are going to continue to have some headwind there. We are not going to tell you exactly how much, but it is probably going to be a negative for us. Again, we are going to start off setting out with some other Jersey programs and everything.

First quarter of '12.

First quarter of '12. Fourth quarter it's a weight around us plain and simple.

Great. Next, can you give us a range of price increases you have taken now through all 3 price increases?

Sure. And again, it depends on the categories. So, bras we took 5% in February. That's it. We took 5% this year. In cotton and some of the outerwear categories, fleece we took 10%. So, it really varies. In some of the core underwear socks and depends which category, which class of trade and everything, You know we took 20%, north of 20% and some items significantly higher than that. But I mean the core cotton underwear sock businesses were well north of 20% cumulatively.

Your next question comes from the line of Emily Shanks from Barclays Capital.

I had a follow-up question on some of your comments, Rick, around targeted leverage levels. Specifically I want to clarify that I heard you say over time you look to de-lever below the 3 times level and I was curious if you could give us color in terms of is investment grade ratings a goal of yours longer term and then secondarily would the goal of just getting leverage down to 3 to 3.5 times preclude you from making an acquisition that potentially could be immediately leveraging?

That's a good question, Emily. You know me, I'm a cash flow guy. I believe in cash flow. It's in my blood from growing up in the treasury profession and that is going to be a key focus of mine in this organization. This is a great organization to be a cash flow guy in. We do -- we have historically had very strong cash flow, we've deployed that cash flow a lot of different ways over the years since the spinoff depending on where we felt it would add the most value. I think we are going to continue to generate a lot of cash flow. As we do that, we are going to assess the most beneficial use of that cash flow's going to be. I think as to the question on acquisitions, the Gear acquisition was a great deal for us, continues to be and will be into the future as it continues to add value. I think if something comes along that meets, the acquisition criteria that we've set, we certainly are going to take a look at it. But absent that we are going to drive our debt down. Because I think getting to a level below 3 times will really put us in a position to -- give us the foundation for really strong growth going forward.

Okay, thank you. And just as a quick follow-up, you didn't talk about the ratings category necessarily, is it fair to say, then, that investment grade isn't necessarily on your list of goals at the moment?

No, it isn't. I think it's far enough down the road that we will cross that bridge, which is 2 or 3 bridges down the road when we get there.

Great. I appreciate the color. And congrats again on the new seat. Thanks.

Your next question comes from the line of Jessy Hayem with TD Securities.

Could you please tell us what was the cost of cotton that flowed through your results on a per pound basis this quarter?

Yes, it was $0.97 for the quarter. Year-to-date it's averaged about $0.88.

Okay and then the $0.90 something compares to about $0.60 if I remember correctly last year?

No, actually it was $0.72 in the third quarter of last year.

Okay. Great. And then I'm sorry if you mentioned that already but can you just give me an idea of what the timeline -- I know you don't want to give exact on cotton costs going forward, but the timeline of when you anticipate hitting your peak cotton costs would be?

The peak cotton costs are going to be in Q4 of this year. Q1 and Q2 of next year and then will fall off after that.

Sorry, the peak will be in Q4, Q1 and Q2?

Yes, it will flow pretty evenly through those 3 quarters.

And just to follow-up, as we've said, we are now beginning to use lower cost cotton now in this quarter. It flows through about midyear of 2012 and based on everything we have heard from virtually every other apparel company that has been talking, they are talking about similar timeframes on when you will start to see those benefits show up in people's P&L. You will hear some of them talk about it in the fall of '12, which is sort of summer shipments and things like that. So it's fairly typical.

Okay, great. Thank you.

We have reached our allotted time for questions. Are there any closing remarks?

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

This concludes today's conference. You may now disconnect.