漢佰 (HBI) 2012 Q3 法說會逐字稿

Good afternoon. My name is Nick. I will be your conference operator today. At this time, I would like to welcome everyone to the Hanesbrands' Third Quarter 2012 Earnings 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. Thank you.

Mr. Charlie stack, Chief Investor Relations Officer, you may begin your conference.

Good afternoon, everyone, and welcome to the Hanesbrands' quarterly investor conference call and webcast. We are pleased to be here to provide an update on our progress after the third quarter of 2012. Hopefully, everyone has had a chance to review the news release we issued earlier today. The news release and the audio replay of the webcast of this call can be found in the 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, and may be found on our website and in our news releases and other communications. The company does not undertake to update or revise any forward-looking statements, which speak only to the time in which they are made.

Please also note in May 2012, Hanesbrands announced exiting certain international and domestic Imagewear businesses that are now classified as discontinued operations. As noted in today's press release, additional information can be found in our 10-Qs and in the investor section of our Hanesbrands.com website. Unless otherwise noted, today's speakers will be discussing our performance from our continuing operations.

With me on the call are Rich Noll, our Chief Executive Officer; Bill Nictakis, one of our two Co-Chief Operating Officers; and Rick Moss, our Chief Financial Officer. For today's call, Rich will highlight a few big picture themes. Bill will provide a sense of what is happening in a few of our businesses. And Rick will emphasize some of the financial aspects of our results. I would now like to turn the call over to Rich.

Thank you, Charlie. We had a very good quarter with EPS of $1.11, operating margins of 12.8% and free cash flow of $287 million, with all three being at the highest levels in our history.

Sales grew 3% with notable strength in panties, which were up mid-single digits, male underwear, up nearly double digits, and Activewear up mid-teens. We also had a great back to school at [mass], although it was diluted somewhat by softness at mid-tier.

From an operating profit standpoint, Innerwear, direct-to-consumer and international all grew double-digits versus prior year. And Outerwear's profit performance improved sequentially as we cycled through the last of our very high cost cotton. Gross margins improved as expected, and we continued to see substantial SG&A cost-savings from efficiency initiatives in distribution.

Lastly, free cash flow was truly exceptional, and we have already completed our 2012 goal of paying down $300 million of debt.

We not only delivered a great third quarter, but I am also encouraged about the earnings momentum we carry into the fourth quarter and beyond. As we look to Q4, we expect sales growth to sequentially improve, operating margins to expand to another record of over 13%, EPS to exceed $1, and free cash flow of another $200 million plus.

It is great to finally have the cotton bubble behind us. Our margin momentum is strong, fueled in part by cotton becoming a tailwind, but also from the continued benefits of our optimization initiatives that are reducing both supply chain and SG&A costs.

Additionally, as Bill will further detail, our Innovate to Elevate strategy is beginning to help as new products such as ComfortBlend, SlimFit underwear and Smart Size bras are driving both higher sales and margins, as well as leading to shelf space gains for 2013.

Lastly, free cash flow should continue to build, and we expect to exit the year with substantial cash on our balance sheet positioning us well to pre-pay another $500 million of bonds in 2013.

So to wrap up, we are extremely pleased with our third quarter results. Our organization is executing well. Our brands are strong. Our new products are working. And I am excited about what I see in our innovation pipeline. While I am always watchful of the macroeconomic environment, our current momentum will certainly help us finalize specific plans to achieve 2013 EPS in the low $3 range.

With that, I will turn the call over to Bill.

Thanks, Rich. Our core categories continued to strengthen and performed well in the third quarter. We are a consumer-driven company and our consistent focus against the consumer is paying off. Our emphasis on delivering best in class product quality, developing meaningful, value-added innovations, and continuing to build our strong brands is working to meet consumer needs. This is evidenced not only by the share gains we are seeing in many of our core categories, but more importantly by the additional space gains our retailers are awarding us for 2013.

Before I talk about specific business performance, I want to talk about how we focus against the consumer, both with our leading brands and our approach to consumer innovation, specifically our ongoing Innovate to Elevate initiatives designed to drive value-added, higher priced and higher margin items for both us and our retail partners.

While the cotton inflation we experienced over the past 18 months posed some unique challenges, it enabled our core categories to burst through some of their mythical price barriers. Over this timeframe, our retailers came to learn what we knew; that consumers are willing to trade up and pay more for better brands and better products.

This shift in mind-set has enabled us to pursue enhancements that are superior to current offerings and that command a higher price. And we found that when we combine innovation with our strong brand equity, consumers really respond favorably, and we are able to grow both our business and that of our retailers.

We have already seen multiple successes with our Innovate to Elevate strategy. Hanes ComfortBlend underwear has been a tremendous new product success that has driven share gains for our business and delivered significant growth for our retailers, even though it has a premium price.

Our Smart Size bra introductions on our Bali and Barely There brands have been widely acclaimed successes, as has our C9 by Champion premium yoga pant. Again -- because these products meet consumer needs in an innovative and elevated way. We have more new products starting to enter the market, such as the Champion No Show line of sports bras and our Hanes Slim Fit and Stretch t-shirts.

Our retailers recognize the power of this Innovate to Elevate strategy and are rewarding us with shelf space gains for 2013 across many of our core categories. We will share more specifics around this strategy during our February Investor Day event.

Now I know another question you all have is what we are seeing from a macro retail perspective. We really have not seen a significant trend change throughout this year, with good months and some not so good months. If there is one pattern we are noticing, it is the performance of brands. Those retailers that are focusing on national brands seem overall to be growing faster than those that are emphasizing their own brands.

Let me now shift to highlights from our third quarter, and let's start with Innerwear, where sales grew 3% --the third quarter of sequential improvement. Our male underwear and panties categories were strong, but bra sales were down in the quarter. While our new products are performing well ahead of plan, bras' overall performance was diluted by softness at JCPenney. In fact, JCPenney was responsible for the entire decline in bras and reduced total Innerwear segment growth by two points in the quarter.

Now I know many will have questions regarding pricing, given the declining cost of cotton. So let me address that now. Our wholesale pricing has been implemented, is already in the market and is set for the balance of 2012 and 2013. And we are seeing the retail price gaps in our major categories revert to historical norms. That issue is behind us, and we are now focused on working with our retailers to determine how to best leverage our innovation and brands to drive their category sales and profitability.

Looking at Innerwear profitability, we are pleased with a 10% increase in operating profit in the quarter. Gross margins continue to improve versus second quarter, as lower cotton costs begin to work through the supply chain. And this improvement should continue into Q4.

Let's now shift to international, the one area that is consistently performed below our expectations this year, due to combination of both external and internal factors. Clearly, there have been some macro issues in certain countries where we are seeing economic growth slow substantially. With that said, there are some executional issues we have identified and that we are now beginning to address. In the near term, we do expect to lag behind our goal for double-digit growth for international overall. But remain positive about the longer-term prospects for growth in our core international geography in the Americas and Asia.

Back to our domestic business and turning to Outerwear; sales were up 5%, driven by mid-teens growth in Activewear and high single digit growth from Gear for Sports. Champion continued to grow, with sports bras and other performance products leading the way. With regards to profit, the Outerwear segment suffered the most from the high cost of cotton. With cotton costs declining for the balance of the year and the positive strength of our order book, we anticipate improvement in Outerwear gross and operating margins in the fourth quarter versus last year.

Our final segment is direct-to-consumer. Sales grew 2% and operating profit was up 18% in the quarter. This group has done a nice job on focusing on profitable sales, with year-to-date profits improving 13%.

To wrap up, I am happy with our team's performance in the third quarter. We have accomplished a great deal in the midst of a very challenging environment, in large part, because we continue to focus on the consumer. Our brands remain the clear consumer favorites. We have a proven Innovate to Elevate process that is delivering strong results for both us and our retail partners. And we are on track to gain additional shelf space to support those innovations in 2013.

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

Thanks, Bill. As both Rich and Bill mentioned, our team executed extremely well in the third quarter, as we exhibited continued sequential improvement in sales, margin and EPS.

Sales in the third quarter were $1.22 billion, up 3% versus last year. Earnings per share were $1.11, up 31% from last year. The stronger US dollar negatively impacted our sales in the quarter by about $7 million or half a point of growth.

Gross margins for the quarter came in at 32.8%, slightly better than our expectations. Gross margins were down about 200 basis points or $14 million from last year's third quarter, primarily due to cotton costs that were 37% higher than prior year, from $0.97 last year to $1.33 per pound this year.

Supply chain savings for the quarter were $13 million, and stand at $31 million for the year and ahead of our plans.

SG&A continued to perform better than our expectations, driven not only by planned lower media spending, but also by lower distribution and other selling expenses. SG&A decreased $26 million from the prior year period and improved 270 basis points year-over-year to 20% of sales.

Operating profit in the quarter increased 8% or $12 million versus last year, with double-digit increases in three of our four reporting segments. Our operating margin of 12.8% is the highest in our company's history. Outerwear which was impacted the most by higher cotton costs, swung from an operating loss in the second quarter to an operating profit of $46 million and an operating margin of 11% in the third quarter.

As expected, interest expense for the quarter declined about $5 million, and our tax rate was 8%.

Moving to the balance sheet; our focus on working capital improvement and cash generation was evident in the quarter, with inventory down $267 million from the end of last year as we saw declines in input costs and units. Free cash flow was very strong at $287 million for the quarter, and we expect a strong fourth quarter of cash generation as well.

Turning to our guidance for the fourth quarter, we are expecting sales of $1.13 billion to $1.17 billion and earnings per share of $1.00 to $1.06. Gross margin should be in the mid 30s, with operating margins slightly above 13%. Interest expense should be about $33 million, and we expect the tax rate to be in the mid-teens.

This should result in full year sales of approximately $4.52 billion and EPS of $2.54 to $2.60, with the lower end of EPS now $0.04 above our previous guidance.

We now expect free cash flow of approximately $500 million for the year, with about 80% of that generated in the US. This guidance is at the upper end of our previous range and includes pension contributions of approximately $30 million and roughly $45 million of capital expenditures.

Last week, we completed the $300 million long- term debt pre-payment for 2012. We should end the year with substantial cash on the balance sheet and have a nice head start on the $500 million needed to pre-pay the 8% fixed rate notes in 2013.

As Rich mentioned, we continue to see 2013 EPS potentially in the low $3 range.

All in all, I am pleased with our results in the third quarter and year-to-date. We have successfully navigated the cotton bubble, improved sales and margins throughout the year, and are exceeding the free cash flow expectations we set. We are executing well and look to continue this as we move into 2013 and beyond.

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

Thanks, Rick. That concludes the recap of our performance for the third quarter. Before we take your questions today, I would like to follow-up on Bill's comment regarding our upcoming Investor Day. We are currently planning to host an Investor Day at our headquarters in late February and hope you will join us. Look for more information to come as we finalize the details over the next couple months.

Now we'll begin taking your questions. We will continue as time allows. Since there may be a number of you who would like to ask a question, I will ask that you limit your questions to one question plus a follow-up, and then re-enter the queue to ask any additional questions.

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

(Operator Instructions). Your first question comes from the line of Eric Tracy from Janney Capital Markets. Your line is now open.

Hi, Good afternoon and congrats on a nice quarter.

Thanks, Eric.

Rich, if we can maybe talk about the macro -- and certainly some of the uncertainty out there as we head into the holiday season? What you are seeing from retailers, how they are thinking about their order books, how they are planning from a pricing perspective? Obviously, you have that locked in. But maybe a little color as we transition from what was a decent 3Q. You expect sales to continue to accelerate into 4Q. Maybe just provide a little color on that backdrop.

Yes, so let me just do some of the overall macro consumer stuff and then turn it over to Bill for some of the specifics about our holiday. In terms of the overall environment, we haven't seen a major trend change since the recession. There are some good months followed by some bad months when you look at the overall retailer sell-through data. But fortunately, the overall trend has been slightly positive. No real change to that.

One thing we are seeing is mass is actually being a little bit stronger than mid-tier and department store. That seems to be a trend change, although I wouldn't say it is a macro consumer trend change. You do have some issues with some mid-tier accounts that are faced with their own tactical issues. And that may be the thing that is driving that.

So overall in this environment we are very watchful, but we haven't noticed anything other than the trends we have seen. It is business as usual.

In terms of our own portfolio, we do expect sequential improvement in sales growth for the fourth quarter. Bill, do you want to talk about promotion and pricing and how well set we are?

Sure. For the holiday, we are set. The promotions are locked with all of our retailers, and our innovation has been working and will continue to work. Our promotional offers and consumer events are locked. And we are preparing to service them in a great fashion like we have been servicing them all year.

We are poised for a strong holiday. The key will be traffic, in terms of how people walk into the stores. I think we will all know more about that in a couple months. If they walk in the stores, I think they will have a lot of innovation, a lot of great brands and some real good service to have the chance to buy our products.

And the follow-up to that, sales seem to be holding -- you've got decent visibility there. You have now turned the corner on cotton and some nice tailwinds cyclically and structurally on margin -- on a gross margin perspective. Rich, how do you think about investing from a G&A perspective behind marketing dollars to support continued shelf space gains and gaining more traction with your retail partners, both from a 4Q perspective and then as we go into next year?

Yes, clearly I have talked about that before, that we did cut media back for example this year to navigate some of the issues we had with cotton inflation. And our intent is to restore that in 2013, in terms of tens of millions of dollars. I have also talked about if we have some upside this year, we will actually begin that process this year. In fact, I think our total media spend for the year will be up a couple million more than what we originally planned going into the year.

As the fourth quarter unfolds if we see opportunities where we've got some strength to continue to invest behind driving results into 2013, we will do that. But we will clearly be doing it into 2013, and that is built into what Rick was talking about as our potential earnings per share for 2013.

Great. Appreciate it. Best of luck.

Thanks.

Your next question comes from the line of Omar Saad from ISI Group. Your line is now open.

Hello? Omar?

Yes, can you hear me?

Yes, now.

Great, thanks. Good afternoon, how are you?

Great.

Wanted to follow-up on Bill's discussion of the retail price gaps. Can you talk about -- reverting to more historical normalization there -- can you talk about where you have seen those price caps at the largest? What that could mean for the business? How big are these price gaps that are narrowing?

Let me tackle the subject of pricing and let me put it into context. Our number one priority is to ensure that we are investing against the consumer. That's really the lifeblood of our business. And our first and foremost priority is to make sure we are making the proper investments against our great brands, ensuring that we have terrific product quality, and that we continue to prime the innovation pump.

And we have to ensure that we have the proper pricing in place to do that and to make sure we are delivering the proper value to the consumer. We have that pricing right now. Our Innerwear business, as I said, the prices are in place and set for the balance of this year and next year.

Our customers overall are pleased with how we are managing the business. We are growing the sales, growing their profitability, growing the productivity of their space. The best evidence of that is the fact that they are rewarding us with some more space gains for next year.

The gaps seem to be moving back towards historical levels. I can't speak to what competitors are doing or not doing, but the retailers set the prices. Our focus is working with them to drive the consumer into the stores, drive the AUR and [basket rings] up.

I think you see, historically, our gaps have been between 5% and 10% versus the number two brand in underwear category or socks. We are in that range now. Last year at Christmas, those gaps had widened substantially, if you remember that we were -- being the number one brand, we lead the price increases. And you saw gaps of 20%, 25% that we had at retail.

Now they are back to that normal historical 5% to 10%. You can see things change day in and day out as different promotions go in and out. That's where they seem to have settled out.

To be frank, when they are below the 5% level, the retailers actually start to work towards saying, wait a minute, we can get more for Hanes. Where if competitors are below that, they have a tendency, and we have seen them do this in the past, where they raise those retails to maintain the 5% to 10% gap. And that's ideal.

Great. Thanks. And then on the factory side, as you took some downtime this year, can you give us an update on where you stand, in terms of the capacity and overhead absorption? Are you running at full capacity? Do you see any need given your outlook for the business and the revenue side of it, to enact some of those measures in the future? What did you learn from that whole experience, in terms of having to take downtime? Thanks.

So in terms of overall capacity and downtime, if you remember, when we entered this year we had two challenges. One, we had to restructure overall supply chain to deal with exiting the discontinued ops -- the Imagewear business, private label pieces and so on. We had to restructure that. We also wanted to take some short time to make sure we were beginning to bleed off inventories. Both of those things we accomplished and we feel good about where we are.

In Q4 there is a lot of seasonal downtime, Christmas holidays and other things, as well as regularly scheduled downtime that we'll take, but that is all built into our guidance. When we entered the year, Rick, I think we were talking about, what -- $20 million?

$20 million for all of those actions.

How much have we spent?

We've spent -- through the third quarter, about $19 million.

Got you. And any quick comment, we saw the news of this Target C9 store, it is a test location and Target is a great retailer, but what is this store? How does it position to the consumer? Are there any expansion plans?

You would have to ask the Target team in terms of their expansion plans on that. Clearly, we love the fact that they are showcasing our C9 by Champion brand. We are continuing to help them drive that category. It is performing very well for them. We hope that they add more of those stores.

Your next question comes from Susan Anderson from Citi. Your line is open.

Good evening, everyone. Congrats on a great quarter.

Thanks, Susan.

I wanted to drill down a little bit on the guidance and maybe the different moving parts -- starting with top line first. Why the lower top line, particularly since it seems like the third quarter was in line and then sequentially better in the fourth quarter? And then for earnings, raising it to the top end was great, but why not raise it further? And also particularly since it seems like the tax rate is coming in a little lower.

Well let me give you the big picture on it and then I will turn it over to Rick for more of the specifics. Overall, we are forecasting, if you look at our sales growth for the fourth quarter, the mid-point is about 4 to 5% growth. The top end of the sales range is about 6%.

We have a wide range there because you never know how retailers will react in terms of pulling down their inventories, whether it will be in the December time frame which we saw last year, or normally as they do in January, which would be in 2013. We widen the range a little bit.

When we came into the year, we were forecasting sales growth of 2% to 4%. But however as the year played out, JCPenney was a big drag on the top line and we talked about international under performing. When you add those two up, we are closer to the lower end of the sales range rather than the higher end.

In terms of filling in the specifics, Rick, I will turn it over to you.

Yes, if you look at the -- as Rich said, if you look at the quarter from the top down, we -- as a result of JCPenney and the fact that our international business isn't delivering the growth that we originally expected, we have adjusted our sales guidance accordingly. I would say this; we have been cautious all year long, and I think in an uncertain environment, it behooves us to continue to be that way.

Let me contrast Q4 and Q3 for you a little bit, Susan, to give you a little insight into the guidance. Our operating margins are going to be higher in Q4 than in Q3 -- is our expectation. But sales will be lower from Q3 to Q4. Now that's normal. That's a normal seasonality of our business.

So you will have higher margins on a little lower sales versus Q3. At the same time, our tax rate will go to the mid-teens versus 8% in Q3. So those dynamics are what drive us to an EPS number of about $1 to $1.06.

And again, our cash flow, we do expect to be at the top end of the range at about $500 million.

Great, That's helpful. And then a follow on that, from your perspective, how is inventory at retail right now, from what you could tell? Like you said last year, we had the destocking in December. Is there anything right now that you think would cause that to happen again at this point in the fourth quarter?

I think retailer inventory levels seem to be in line, overall. They are not over inventoried. They are not under inventoried. As Rich said, they ultimately will adjust their inventory levels coming out of the holiday, whether it is in December or do they do it in January. Last year was a dramatic reduction in their inventories in December. That was the second biggest we have seen in two decades.

So the guidance that Rick talked about assumes there is going to be some of the normal reduction in retailer inventories, does not assume it goes to the huge levels we saw last year. We expect them to pull down a little bit because that's typically what they do.

That's a good point. That's a little change from when we were originally talking, that we assumed there wouldn't be any destocking in the fourth quarter. We actually have a little bit built into that guidance. It is not a major change, but it is a small change. I don't want to miss that point.

Got it. And then one last question on the pricing and units in the quarter, maybe if you are able to give some color on that, in terms of the driver of the total sales growth? For instance, were prices still up year-over-year and then units down? Or how should I think about that?

When we went into the big double-digit price increase we wanted to get away from talking about exactly how units were going to go relative to prices and so on. So I don't want to get that specific. We are now overlapping the price increases as we go into the fourth quarter. We had most of them fully in place last year. While there was some price in the third quarter, by the time you get to the fourth quarter, there will be very little price in those numbers.

Great, thanks, you guys.

Your next question comes from Jim Duffy from Stifel Nicolaus. Your line is open.

Thanks, hello, guys.

Hi, Jim.

So a question on some comments during the call. You alluded to new programs for 2013. Are you prepared to talk about those in size and scope?

And then you also talked about pricing being secured for 2013. What if anything do you see as the risk to that?

So I will just start -- it is a little early to talk about size and scope for 2013 with all of these new products. We do have a great innovation pipeline, ComfortBlend underwear for example. We conceived them in 2010. They actually shipped this year. However, with all of the pricing and the changes and all of that stuff, us and our retailers were focused on getting through the cotton bubble, you will see a lot more of the innovation start to launch going into 2013. We will give more specifics around that on our fourth quarter call, in terms of the dollars and cents of it.

And it is our intent on that February Investor Day to profile a lot of these new products and actually talk about how they are doing. You can see them at retail and so on. So that will need to wait for February.

In terms of the other -- what was the other part of your question, Jim?

The pricing into 2013. Any potential risk factors to that? I am surprised that you can have that locked in for the full year at this juncture.

Well, things are a lot more stable than they were over the last 18 months, that's for sure. Bill, go ahead.

You look at the Innerwear business and I will talk about Outerwear. Innerwear is done. The prices are in the marketplace today. Those are the prices that we expect to continue into 2013 -- throughout 2013. The conversation with our customers has been that our strategy of innovation, brand building, quality and price is working really well for them. They are having strong sales growth, strong profit growth, strong productivity growth. They are pleased with it. They are just pleased.

On the Outerwear side, we have the first half of the year locked down. And Outerwear tends to be program by program, season by season. So we have great visibility for the first half of the year. All of those programs are locked, prices set.

For the second half of the year, about 50% of that business is committed and locked. And then the other part of that is still just to be finalized and everything. But that's sort of where we are. We feel good about it. We feel real good about how our innovations work there.

That's great to hear. Thank you guys.

Thanks.

Your next question comes from David Glick from Buckingham Research. Your line is open.

Good afternoon. Rich, it sounds to me there is a bit of a change in tone on the part of the management team toward top line opportunities. You are coming off a 12 to 18 month period where you had to be more defensive in terms of pulling back marketing, raising prices, managing elasticity and finding the right retails to satisfy demand.

And it sounds like as you go into 2013, you have an opportunity given -- breaking through some of the price barriers you talked about, where you can perhaps be more on the offensive in terms of investing in marketing, perhaps more aggressive with trade and advertising allowances, and move more on the offensive and perhaps continue this trend of improving sales. That should carry into 2013. Is that the right way to think about maybe a change in mind set going into next year?

Yes, and I think I would preface it a little differently. If you remember, we came out of the recession heading into 2010 with 5% growth from shelf space gains, a lot of which was driven by innovation.

But you are right. We to take a pause as we had to deal with the cotton bubble. All of our attention started to focus on raising prices and ended up raising prices three times in 12 months --unheard of in our industry prior to that. But now we are back to that. I do think -- I don't think it's a total change, but we had it there before. We are now going to reemphasize and focus on it a lot more going forward.

I do think there is one change in it, though. Not that it's the first time we are doing innovation. But I think changing prices so much proved to both us and our retailers that those artificial price barriers people had in mind, like in some accounts it is $10 and other accounts it was $20. As we had to blow through those because of cotton inflation, it created the license and the opportunity for us to invest even more in better innovation because everybody started to understand that consumers are willing to pay for it.

I do think there is an inflection point change there. It allows us to bring a lot more innovation to the marketplace than we would have even conceived before. And we are going to unveil a lot of that stuff. You will see it helping us drive into 2013, but actually even more importantly into 2014 and 2015, as well.

Thanks. And if I can just ask about the intimates business? We just anniversaried a major destocking in that category a year ago, and it was a tough business again. It sounds like really more so on the bra side of the business. If you pull out that what is going on at JCPenney, which I assume is your -- all of your mid-tier commentary, are you starting to see the business turn in your other accounts? Is that maybe a turn in the business?

JCPenney was four points of growth in our bra business for the quarter. It clearly had a significant impact on it.

Overall what we are seeing is our innovation on bras. The whole smart sizing launch that we have done on Barely There and Bali and Hanes is working exceptionally well. We are struggling to keep up with demand on that. We are seeing our panty business, especially in mass perform well for us and consumers responding to our innovations. We are marching on the right path on that business right now.

Great. Last question for Rick on cash. Is $250 million exiting the year reasonable -- the head start you are talking about towards pre-paying that $500 million? And are you precluded from paying off that $500 million before December?

Well, keep in mind, we said about $500 million. We've paid off $300 million of the debt. That would leave, as Rich referred to, slightly more than $200 million in the fourth quarter. That's probably what you will see on the balance sheet, more or less. In terms of -- but still a nice substantial down payment on that number. The call date on those bonds is December 15th of 2013.

Your next question comes from Joan Payson from Barclays. Your line is now open.

Good afternoon. Just in terms of -- first off, the gross margin drivers -- in the last quarter you talked a little about how that was differentiated by business segment. Maybe if you can just give some color on where the Outerwear business came in versus Innerwear in each segment?

We don't normally give gross product by division for competitive reasons. We don't do that. I can talk a little about where we think gross margin is going and some of the dynamics there.

I would think of gross margin in both the short-term and long-term. The short-term, the issue with gross margin are going to be primarily around cotton. So this quarter, cotton prices were 37% higher than last quarter. This is the last quarter where that dynamic comes into play.

Beginning next quarter, our cotton prices will be flowing through the P&L and will be lower than the prior year. So last year in the fourth quarter, our cotton prices were $1.74. In the first quarter of this year and the second quarter they were in the $1.80 range.

So we will see substantially lower cotton costs flowing through, really between now -- from the fourth quarter and on likely through the -- all of next year. That's the short-term dynamic.

I think longer term, we think we can continue to drive gross margin expansion by having a well-executed pricing strategy and by continuing to deliver consistent cost savings over time. I think we have proven we can do both of those things in sometimes very challenging circumstances.

Thanks. And then in terms of the international business, what do you still see as the greatest challenges or the regions where you are seeing the most pressure? And what are your priorities in terms of investing internationally?

Let me talk a little about international. Bill mentioned it in his remarks. First of all, I want to put it in perspective. It is about 11% of our overall sales. And while it is a critical component of our long-term growth prospects, in the near term, our results will be driven by how we do in the US. And we are doing very well in the U.S.

That said, we still want to get ourselves back with international to double-digit sales growth. As we have felt the issues that international business was feeling and it was the same the US business was in the first part of the year. We expected that to start to return to double-digit sales growth by now. It hasn't.

It has forced us to step back and take stock and figure out why it hasn't. And really there is -- well, there is a little bit of macro issues. We haven't done as well tactically, in terms of leveraging our great innovation that we have in the US and fully leveraging the US supply chain.

So we are looking at some things to address that, but our intent is to get it back on the growth track that we have laid out. But it may take us a few more quarters until we do that.

Your next question comes from Scott Krasik from BB&T Capital Markets. Your line is now open.

Hi, everybody. Good quarter.

Thanks, Scott.

Just talking to people in the industry, it seems like there is this lull after back to school. There is a lot of inventory and there is this disorganization, shelves aren't cleared out, and that is driving a lot of this lack of replenishment or slow down in replenishment. Is that the case? Is that something you can control and improve going forward, so you don't get this massive slow down in replenishment after back to school?

So we are not necessarily seeing a massive slow down in replenishment, so I am not sure exactly where you are getting that.

Just seasonally, not massive replenishment specifically. Just sort of seasonally, you get a lull after back to school.

Yes, That's just the normal cadence, where the beginning of the year -- during the winter, sales tend to be slower. They build towards the back to school period, and then there is that in between period between back to school and the holiday, especially in October. And all of retail tends to slow down. I don't see that as a problem. We just always need to understand it and make sure that we are flowing inventory accordingly. I don't think this year anything, Bill, is slowing differently than what we have seen on average for many years in a row. Is that correct?

As colder weather happens, it tends to help.

Help a little bit, pick up a little bit earlier. The good thing about winter is it always eventually gets cold.

Except for last year.

Yes, let's leave that aside.

And then just a couple others; in addition, so you will reinstate the media spending next year? You've talked about giving distribution savings as well. Will that portion return? Or is that permanent savings?

We have always talked about being able to optimize our supply chain, which includes distribution, and try and ring out $30 million to $40 million of savings a year. We have been talking about that for a number of years. We also said on average you will see about two-thirds of that benefit show up in gross margin and about one-third of it on SG&A. Some of the SG&A savings that we are seeing with distribution this year is all a part of that. We feel really good about how much progress that group is making, and we continue to expect further progress next year.

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

Good evening, everyone. Bill, I want to go back to a question somebody asked a couple questions ago regarding pricing next year. You mentioned Innerwear is complete. Outerwear, the first half is locked. The intimation there is that pricing is flat on a year-over-year basis for the next 15 months or so, is that accurate?

No, I don't think we would say it is flat.

I don't think we were trying to -- let me go ahead and answer that. We were not trying -- we are trying to say that it is finalized. We weren't trying to imply any sort of direction, nor would we want to. We will talk about those types of specifics when we give the specific 2013 guidance on our Q4 call.

And lastly, as it relates to the $26 million or so decrease in SG&A costs, you mentioned that a major part of that was a decrease in marketing. Is it possible to tease out the components of that decline on a year-over-year basis?

We don't give it that detailed for competitive reasons. But as Rich pointed out, we are seeing it really across all of the categories of SG&A. Distribution costs are down, other selling expenses are down, as well as overhead expenses as the organization has been intensely focused on reducing SG&A as a percentage of sales.

Your next question comes from Eric Beder from Brean Capital. Your line is now open.

Good afternoon. Congrats on a solid quarter.

Thank you.

We've kind of talked JCPenney to death, but I would like to throw in something else here. So your anniversary a significant decline in JCPenney in Q4, I am curious what you are seeing for 2013, in terms of potential shop-in-shop or where you will go with JCPenney?

As I said, the good news about JCPenney's strategy is the focus on brands plays to our wheelhouse. We have the leading brand of underwear, Bali and Playtex are among the absolute leading brands in intimate apparel. Over the long haul, what JCPenney is doing placed our strength. We are all dealing with the short-term challenges.

In terms of shops, right now they are saying they are not going to have a branded underwear shop. So that is off the table. We will do well in our share of underwear there when the dust settles, but they are not putting in a Hanes concept shop, for instance. And the Bali and Playtex remains to be seen how they will handle that piece of it. But the key challenge for us is as they get the traffic back in the stores, we will hopefully benefit with that.

And in terms of the overlap, we didn't see the major declines until their Q1 which started February, March, April, when they started to implement this strategy. We don't overlap this for quite awhile.

It remains to be seen how the consumers respond to their new strategies next year. It may be that they have a new low base from which they can now grow as they institute these shops and things like that. It may be that the consumers start to find other places to shop, and their traffic continues to decline. I have no idea nor will I speculate on what will happen. We should be cautious and wait until we start to see it happen before we decide what direction JCPenney will go.

Great. And if I think about free cash flow, you will use $500 million of free cash flow next year to pay down the debt. I would assume, based on what you are talking about here, you will be ahead of the schedule a little bit when you enter the year, given that you have $200 some million in cash now. What are your thoughts on after that debt is paid down, what to do with that excess cash? I think we know that debt after that doesn't make sense to pay down.

At that point, as we pay down that $500 million of debt, we still anticipate good, strong cash flow into 2014 and so on. There are three things we can do with it, obviously; acquisitions, share buy backs or dividends. We have talked about how bolt-on acquisitions can make sense for us.

We have talked about the fact that a zero dividend is pretty darn low. And having some level of dividend could make sense. Although I don't think you should ever look to us as being the major vehicle that will return value to shareholders is -- by primarily being a dividend stock.

But I think all three of those could be on the table. We don't need to make any decisions yet. We have another $500 million of debt to pay down. Once we do and we start to formulate what our plans are a year from now, we will start making sure that we are communicating that to the investment community.

Your last question comes from Andrew Burns from D.A. Davidson. Your line is now open.

Hi, guys, congratulations on a solid quarter.

Thank you.

Getting into stores the last few months, it appears that you are doing a much better job of highlighting the transition for extra units per pack, particularly in undershirts compared to your key competitors. Have you found this to be the case and competitive advantage in terms of driving sell-through?

Well, I appreciate you noticing that we are working on that and making some progress. This is one of the ways we said, hey, we are going to go and make sure we are delivering value to the consumer. We did do the bonus pack, six for the price of five kind of thing. And it has been a good tactic to help our customers protect their AURs and basket rings while delivering value to the consumer.

Thanks. And you talked about this Innovate to Elevate initiative, and it sounds like we will hear more about it and see more of it in 2013. Can you talk about what you are seeing in the market that gives you confidence that this upmarket, higher price point product is the direction to go? And are you talking about potentially moving up market at existing accounts or even new distribution points? Thank you.

Yes, primarily we are focused on existing accounts. I will give you an example with ComfortBlend underwear, that I talked about and Rich mentioned. We have been testing and playing with this idea for a couple of years. We knew it would be good. But it is doing about 60% better than we had planned it to do this year. Our customers are recognizing that because they are giving us more space next year, additional space, to support that. This is what -- we look at ComfortBlend as being a home-run idea that can change consumer behavior. We saw this a decade ago. We launched Hanes tagless t-shirts. It was a drawer changing event. It was such a benefit to consumers that basically consumers were replacing their currents drawers of t-shirts with Hanes Tagless tees. We had a couple of really, really good years because of that. We are starting to hear anecdotes of the same kind of thing with ComfortBlend. It is such a superior product that people are saying, this is great. I am going to change out my drawers and replace it with ComfortBlend. We are seeing a big success there. We are seeing it with our Smart Size and Comfort Revolution, Bali bras. It is trading up our existing accounts, is what we are focused on.

This concludes the question-and-answer session. I now turn the call over to Mr. Charlie Stack for closing remarks.

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

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