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Hanesbrands Inc. (NYSE:HBI)

Q3 2011 Earnings Call

November 2, 2011 4:30 pm ET

Executives

Charlie Stack – Executive Director, Investor Relations

Richard A. Noll – Chairman and Chief Executive Officer

Richard D. Moss – Chief Financial Officer and Principal Accounting Officer

William J. Nictakis – Co-Chief Operating Officer

Analysts

Robert Drbul – Barclays Capital

Susan Anderson – Citigroup Inc.

David Glick – Buckingham Research

Omar Saad – ISI Group

Ken Stumphauzer – Sterne Agee

Steven L. Marotta – CL King & Associates, Inc.

Andrew Burns – D.A. Davidson & Co.

Eric Beder – Brean Murray Carret & Co.

Scott Krasik – BB&T Capital Markets

Paul Simenauer – JPMorgan

Emily Shanks – Barclays Capital

Jessy Hayem – TD Securities Inc.

Operator

Good afternoon, my name is Lisa, and I will be your conference operator today. At this time, I would like to welcome everyone to the Hanesbrands’ Third Quarter 2011 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)

I’d now like to turn the call over to Mr. Charlie Stack, Executive Director of Investor Relations. Please go ahead, sir.

Charlie Stack

Good afternoon, everyone, and welcome to the Hanesbrands’ quarterly investor 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 Investors 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 speaks only to the time at which they are made.

We want to reiterate that in this inflationary environment, there are some aspect 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 position or forward-looking specific timing or amounts 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 two new attendees. First is Rick Moss, our newly promoted Chief Financial Officer, many of you on the fixed income side have know Rick for years, Rick was [forward] to getting to know the equity side deeply 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 would join us on our fourth quarter call.

In terms of today’s agenda, Rich will highlight a couple of big picture theme. Bill will provide a sense of what is happening in the fields, 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 Hanesbrands.

I will now turn the call over to Rich.

Richard A. Noll

Thank you, Charlie. Let me address three topics that I’m sure are on top of mind. Profits being above our expectations, sales being below, and how has pricing impacted our results. 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 full year EPS of $2.16.

Profit increases were driven by Innerwear, up $24 million to 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 expansions, 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’re well on our way to having a record year.

Next, let me talk about pricing. Our approach, pricing to at least maintain operating margin is working, while units do in fact decline, they declined much less than price increases, and are driving good results for us, and our retail partners.

Let me highlight two categories that had some of our largest price increases, socks and male underwear. These categories grew 4% and 10% respectively in Q3. In fact it’s a great story, that further the retail sell through dollars are up nicely, and units are only down a few points. And actually price increase did dampen unit demand, in case it is mitigated by other tactical changes to measure up programs to drive sales and we’re 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 the elasticity is at or better than our expectations. It is also driving good dollar comp for our retail partners.

And finally, the best indicator of our pricing strategy is working is, our retailers continue to increase our shelf space as we expect net gain 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 and back-to-school coupled with retailers 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 loosing up, but we’re 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’ll now turn it over to Bill to discuss our results by business. Bill?

William J. Nictakis

Thanks, Rich. This quarter is a great example of how we’re managing through this inflationary environment. In a deflationary environment, it’s all about driving units at a faster rates and prices decrease. We step back and said, inflation here to [say] plus we’re focused on driving sales dollars, gross profit dollars and operating profit dollars.

We’re seeing that shift in our third quarter results, and there’s no better example of that and 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 combines more than offset margin inflation. We saw a good sales growth in our socks and underwear businesses, somewhat offset by lower sales in intimate apparel.

During the quarter, we effectively manage the escalating comp 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 see over 35 year old segments going back from apparel spending overall, and intimate apparel in particular especially in the last six to nine months. Also this category has been impacted by department store and mid tier retailers focusing on inventory management. While we expect this softness to continue into the fourth quarter, we’re now working with our key retail partners to formulate action plan, to turn these trends around in 2012.

Overall, retailers are feeling good about our Innerwear business, as in many cases, we’re 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 always secured the place you needed to deal with the highest commodity costs, but we’ve also secured net shelf place gains that could generate an additional two to three points of Innerwear growth.

Now, shifting to our Outerwear segments; we’ve 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 one-year anniversary of the acquisition of Gear for Sports, and they continue to deliver greater 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’ve previously outlined. In fact, let me give you a couple of specifics about Gear. They’re on track to deliver slightly over $30 million of operating profit this year, and should benefit from synergy savings and growth to deliver an additional $10 million or so next year to slightly over $40 million of operating profits. Now that would give you an EBITDA of close to $45 million in 2012, against the purchase price of $225 million, giving us a post-synergy multiple of about five times.

And while we feel good about that, we’re even more excited about their long-term growth prospects in our ability to leverage the best-in-class process capabilities into our own core businesses. Turning to the rest of our Outerwear business, Champion, the Retail Casualwear and Imagewear, 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.

Our sales was down with the majority of the client driven by our Just My Size business at Wal-Mart. Reductions in Just My Size represented a seven point decrease in overall segment sales for the quarter. And I’ve heard as the account moved more than plus five fashion business towards private-label versus the core basic that we provide.

And turning to international, our sales continue 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 margin. In Canada, where we hold the leading share in intimate apparel; sales were affected by declining intimates category purchase trends, the likely cause of 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%, and 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 the 2012.

So in closing, we’ve 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’ll now turn the call over to Rich, to discuss our financial performance.

Richard D. Moss

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 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 Outerwear segment. And the International segment increased gross profit margin as well as that segment benefitted 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 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 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, and the overall range around the same midpoint of prior guidance.

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, $30 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 nine months, up 23%. We continue to expect net debt-to-EBITDA of 3 to 3.5 times at year-end.

I’d also like to communicate a few of my thoughts regarding the opportunities we have at Hanesbrands, and how I’d 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 and I believe it 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 as the three times debt-to-EBITDA that 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 being 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 thereafter.

I’m very excited to be taking on the CFO role of Hanes, first time in our history, and look forward to the opportunities ahead. Also look forward to meeting many of you in the near future. I’ll now turn the call back over to Charlie.

Charlie Stack

Thanks, Rick. That concludes the recap of our performance for the third quarter. Now, we’ll begin taking your questions and 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 one question plus a follow up and then reenter the queue to ask any additional questions. Also we understand we were facing some technical difficulties earlier in the call, therefore we will post our prepared remarks and we enter to the Q&A on our website.

I’ll now turn the call back over to the operator to begin the question-and-answer session. Operator?

Question-and-Answer Session

Operator

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

Robert Drbul – Barclays Capital

Hi, good afternoon.

Richard A. Noll

How are you doing?

Robert Drbul – Barclays Capital

Rick, congratulations on your promotion.

Richard D. Moss

Thank you, Bob.

Robert Drbul – Barclays Capital

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

Richard A. Noll

Yeah, absolutely. So first of all, pricing had absolutely nothing to do with sales being softer in the quarter than our expectations, in fact if anything, the whole pricing strategy is working better than our expectations as I even talked about from elasticity standpoint. The softness in the quarter versus our expectations was real simple, and is driven mainly by our misestimate basically on retailer sensitivity to inventory, the management was 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 our sensitivity even more.

You’ve heard me say over the last couple of quarters that, actually I think a number of you’ve asked questions, how a retailer is going to handle this? And earlier in the year, they were saying, yeah, we’re going to let retail inventories go up or realize as inflation coming, we’ll let the dollars go up, clearly not one for one with price increases. We had a lot of retailers saying, but will probably take less risk or we've got mark down risk, and that basic has actually slowed up both in units as well as in dollars.

Well, 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 the 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.

Robert Drbul – Barclays Capital

Got it. And I’m 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 on product, just trying to get my hands around that, little bit more.

Richard A. Noll

Yeah, I think going into the fourth quarter, holiday season in 2012, I think the retailers largely have the inventories in line, I mean on their set programs they have to order those things six months, nine months ago, they’ve already adjusted those orders based on inflation. And we look at our businesses, we've seen some tightening, a lot of that’s 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.

Robert Drbul – Barclays Capital

Great. Thank you very much.

Operator

Your next question comes from the line of Susan Anderson.

Susan Anderson – Citigroup Inc.

Good quarter guys in a tough pricing environment.

Richard A. Noll

Thank you, Susan.

Susan Anderson – Citigroup Inc.

Maybe if you could just breakout 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 where you expect to flow through in the fourth quarter?

Richard A. Noll

Sure. First of all, if you think about the gross margin improvement, I’d break it out this way. We got about $107 million of improvement from price, mix, all that, net of the volume issues. We got $11 million of supply chain savings, and those two together offset about $56 million of input cost increases, $24 million of which was cotton.

As we think about how this impacts our 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 increasing going into effect, we are going to continue to recognize supply chain optimization savings in the quarter, and we’re going to not recognize some excess service costs this year that we saw last year.

Offsetting that of course would be higher cotton prices. That will plus two times higher than they were last year, and that’s going to have an impact. And I think to put all of that in the context of the environment that we’ve referred to around our retail and inventory management, consumer spending and the uncertainties around that.

Susan Anderson – Citigroup Inc.

Okay. Great, that’s 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?

Richard D. Moss

Yeah, so let me give you a perspective on Just My Size, we ended that about two years ago that agreement with Wal-Mart, 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.

Just started succeeding then Wal-Mart has become more interested in that, they started putting some of their own people against that, and their focus to shift it a little bit more towards their own brand, 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 headwind for us in the fourth quarter until the first part of 2012 on Just My Size. Now, mitigating that is, hey we’re continuing to work with Wal-Mart and other accounts in terms of how they can leverage our Hanes brand and jersey programs, and we are picking up significant incremental programs, they’ll help us offset Just My Size.

Susan Anderson – Citigroup Inc.

Okay. Great, thanks a lot, guys.

Richard D. Moss

Thanks.

Operator

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

David Glick – Buckingham Research

Thank you. Two main questions, Rich, what I’ve noticed being in the stores and looking at the competitive pricing environment, it looks like, I mean 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 elasticity standpoint. So I’m just wondering to the extent you can comment on it, the pricing gap and whether that’s likely to persist, and then secondly just given the sales in Q3 and the wide range in Q4, I mean typically you guys have a pretty formulaic approach, if I’m not mistaken like mid-to-high single digit 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?

Richard A. Noll

Okay. So three questions, let me hit the first one, top line on price elasticity, I’ll turn it over to Bill. So let him talk about price gap and sustainability, and so on and so forth. And then, we’ll cycle back and Rick or myself will talk a little about price packs for 2012.

And first of all, I’m thrilled how our whole pricing strategy is working, and is impacting our results. It’s all extremely positive. I’ve 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’ve had a couple of major retailers even talk exclusively about what their comps are in socks and underwear, and we’re driving their comp store increases. Elasticity is less than we expected, even with the third price increase. So that’s all extremely positive, pricing has nothing to do with what our sales results are.

Overall, weighing on it actually is, in lot of the intimate apparel categories, where you’re seeing department stores and a broad set of mid tier retailers begin getting pulling back on inventory which is weighing on the results, we’re seeing some of the club channels being a little bit more sensitive to working down inventories and so on. So I think that’s more of a transitional thing, but quite frankly we misestimated 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?

William J. Nictakis

Yeah. When you’re coming to price gaps, I think first comment is, you can’t generalize because it varies by category, it 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, it will remain a moving target.

I think, what I see 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 customers, consumers don’t have as much confidence in. We are unable to take pricing as quickly or as much.

Gaps have increased over this last few months as Rich said. 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, may be in a little different manner than norm, but they’re pleased with the results.

And I think that shows up, in terms to have more set up to gain space next year. So I think that’s 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. 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 it historically had.

Richard A. Noll

And David, I’ll will even echo what Bill, he actually said that to me a little bit more strongly. He said, look $1, $1.25 is the new $0.50, our brands was strong enough, they mean 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, and our retail partners are actually thrilled with the categories that have had the largest price increase. If you look at the categories that are down, it’s intimate apparel, we ultimately had a 5%, it has nothing to do with the pricing.

In terms of 2012, I’m going to actually answer that instead of Rick since we’re 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 a pound.

While we said, we would get price to solve this problem, we’d only put one price increase in the previous decade, we've now since gotten three prices in the last nine months, and it’s working, working better than we expected, and it’s driving our retailers’ results. And so we've got all the price we need to even deal with the high watermark on prices.

So I look at 2012 saying, hey we’re 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 who got to work through their inventory issues. But all of those are sort of minor things. When you look at what’s happening to our margin structure throughout 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 our categories. So you’ve got the opportunity for really strong back half, but that’s not to say that the front half is going to be, necessarily bad, I think you’ll see some ebbs and flows. But I think we’re set up well for 2012.

David Glick – Buckingham Research

In terms of things that you do now, I mean it sounds like shelf space gains you mentioned Innerwear was 2% to 3%, I don’t know but Outerwear, you’re going to get some growth there, International should be accretive to your sales growth as well, obviously the question is price versus units and…

Richard A. Noll

Right, 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, I’m glad that it’s only one quarter. But when we look at the elasticity, it’s running, I think I’ve always said, well it’s going to be above zero, and below one. In some of these categories, and a good way to think about it is, we’re seeing it, maybe in the realm of somewhere in the middle of that.

David Glick – Buckingham Research

So having said all that is, mid-to-high single digits is still a reasonable bookings for?

Richard A. Noll

And that’s where we’ll say, we haven’t put our plans together yet and really to talk about 2012, although I feel like we’re on a lot more strong ground today than we were a year ago, when we had so many unknowns.

Operator

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

Unidentified Analyst

Hello, everyone. Good afternoon, and thanks everyone. Someone in for Jim this afternoon, just had a question regarding your shelf space gain, just a follow-on. You noted that was Innerwear, was it Champion brands or are you seeing it more on the Hanes branded products on the Innerwear side of things?

Richard A. Noll

Yeah, we’re seeing space gains across multiple brands, multiple classes of trades. So we have Innerwear gains in socks, in underwear, bras on depending on which accounts you have gains come in for Champion, you have C9 and Target, etcetera. So right now, we are still finalizing, but we are seeing positive response across categories and across channels.

Unidentified Analyst

Okay. So could I imply from that you are seeing uptick at a say sporting goods vis-à-vis department stores, vis-à-vis mass things like that, should I imply that it’s across those retail type partners or...

Richard A. Noll

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

Unidentified Analyst

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 poetical increasing, vis-à-vis price declines, have you guys seen any sort of movements that you would be open to talking about at this time?

Richard A. Noll

Yeah. 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’ll continue to be testing those kinds of tactics, and depending on the customer, the category implementing some potentially in the back end of the year.

Operator

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

Richard A. Noll

Hi, Omar.

Omar Saad – ISI Group

Thanks. Good afternoon. Rich, so if I do some of the math back up the Gear for Sports, it looks like your sales dollars might have down a little bit in the quarter. You talked about the retailer sensitivity, the inventories, given inflation is flowing through, how you kind of underestimate that a little bit? Is it possible that retailers, and especially look at kind of the first half numbers when maybe your price increase came through at the end of the second quarter, and then in the beginning of the third quarter, or at the 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 pricing really ramps up? That will be impacting the inventory situation with the retailer?

Richard D. Moss

Yeah. Omar, that’s no. The answer for it is, they clearly do not do it there, they’re focused on managing their inventory that we thought maybe they would because there were significant price increases, there was none of that. Their number one party seems to be controlling inventory period.

Richard A. Noll

This is Rich, let me also make sure we get this clear. This sensitivity was about inventory, isn’t about our categories, it’s their total inventories in their company. So there is at least department store count that their total women’s business is relatively soft, but men’s is actually pretty strong. They are cutting inventories in women’s 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’re shifting those dollars over to drive men’s.

That’s just one example, this isn’t so much about our categories, this is about, they're seeing double-digit increases in inventory dollar values at their corporate level, and are saying we've 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’ll do it thoughtfully, we’ll do, we’ll let basics be a little bit higher than something else, while you get into the middle of it. Now they are facing the dollar increases, and they're doing it with a more of a hatchet than with a (inaudible)

Omar Saad – ISI Group

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

William J. Nictakis

I think, overall everybody has – almost everybody has a heightened sensitivity to inventory, not everybody, but almost everybody is concerned in 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.

Richard A. Noll

There is 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’ve got 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 for them to sort of cut back in the near term, because they have already made commitments on some of their ready to wear businesses.

Omar Saad – ISI Group

Thanks, could you also quickly just address, the International business is still strong, but may be not quite as strong it has been, was there any change there, any specific region you’d call out?

Richard A. Noll

No. 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, again it was back to promotional strategy being changed, and a significant reduction in orders based on that, their sell through was off, managing inventory and then they cut back, but if you look our emerging markets are…

Richard D. Moss

And Europe was a little soft.

Richard A. Noll

And Europe was soft, absolutely right.

Richard D. Moss

So those two places we’re really a [Audio Gap]

Operator

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

Richard A. Noll

Hi, Ken.

Ken Stumphauzer – Sterne Agee

I just want to follow-up on 4Q sale and trying to understand the fall process behind it, at least optically, it looks if you guys are coming up against the much more difficult comparison, and your guidance, and you no longer have the benefit coming from Gear for Sports at least for the entire quarter. So I’m just trying to get a sense of why you expect organic sales to accelerate no matter in what you are speaking to?

William J. Nictakis

Well, I think, it’s really simple. Let’s just zero in on Innerwear for the third quarter, it was basically flat for the third quarter, that’s not the type of – that’s not the trends or the sell through that we’ve been running. So some of that’s 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’ve got a lot of puts and takes, but at the end of the day, we got a little bit more conservative on the fourth quarter. It’s a trend where – yeah, sales weren’t quite as strong as we had predicated in the third quarter, but margins are a lot better, and we think that some that’s going to spill in to the fourth quarter.

Ken Stumphauzer – Sterne Agee

And then just a follow-up on sales in 4Q. In 3Q, you alluded to kind of inventory de-stocking to a certain degree by the retailers, and I think historically, you guys would take that as may be one week of supply, is that an accurate assumption on my part?

Richard A. Noll

Yeah, that’s usually a good guess. Sometimes it’s in the – I will remind you, sometimes it comes late in the fourth quarter, sometimes in happens in January. So it’s one of those 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 form one year to the next.

Ken Stumphauzer – Sterne Agee

So before...

Richard A. Noll

By that time, year ends though.

Ken Stumphauzer – Sterne Agee

Okay. Got you. So between – perhaps like the inventory draw down on retailers, then secondly, the Just My Size business that in and of itself was a 600 to 800 basis point top line head wind in 3Q?

Richard A. Noll

Yeah. A great way of think of it, just put this back in a 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 would have been 9% or something line that. So those two issues right there, zero in and sort of frame the entire problem.

Operator

Your next question comes from the line of Steven Marotta with CL King.

Steven L. Marotta – CL King & Associates, Inc.

Good afternoon, everybody, very quickly you’ve mentioned obliviously the destocking, particularly occurring in the August and September timeframe. Can you speak a little bit more or quantify more of the point of sale, sell throughs that you are currently experiencing either, again from a percentage standpoint and how that’s compared or maybe market share?

Richard A. Noll

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 couple of retailers who 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’s one of the things where we've been talking about. Sell through in Champion is overall are pretty good. And so, I think things are, I think basically they are overall fine, they're trending relatively close to our expectations with the couple of exceptions that I have noticed. We have a question about our great gross margins for the quarter?

Steven L. Marotta – CL King & Associates, Inc.

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

William J. Nictakis

I just want somebody to ask and say, hey wow, somebody, you guys have got gross margins going up, operating margins going up, there is not that many companies doing that in this inflationary environment, but anyhow I will let you ask your question, go ahead.

Steven L. Marotta – CL King & Associates, Inc.

Hey guys, you guys had some gross margin, operating margin going up in this inflationary environment, most of companies aren’t doing that, how are you doing that?

Richard A. Noll

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 in, and I think you said 4Q of ’12, but did you mean something sooner than that?

William J. Nictakis

I’d say, we’re going to start using it in the fourth quarter of ’12?

Steven L. Marotta – CL King & Associates, Inc.

No.

William J. Nictakis

Which means that, we’ll start using in fourth quarter of this year, we just had this show up in the P&L mid-year next year, really in the second quarter, third quarter of ’12.

Steven L. Marotta – CL King & Associates, Inc.

Okay, that’s what you referred to, and actually I think you said 4Q ’12 in the prepared remarks, nevertheless I appreciate that, and now Rich, feel free to answer that question.

Richard A. Noll

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

Richard D. Moss

Thank you.

William J. Nictakis

Thank you.

Operator

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

Andrew Burns – D.A. Davidson & Co.

Good afternoon. I was hoping if you’d spend a little bit more time on the intimate apparel category notwithstanding the inventory fluctuations of the quarter, for the whole year, that’s been a promotional category, and I was wondering about your strategy to may be reinvigorate sales for those brands in terms of maybe as marketing dollars, new products, new pricing strategy, anything there to reinvigorate that category, thank you.

Richard A. Noll

If you look at intimate apparel, it’s clearly our biggest challenge, a couple of macros and then we got to execute better and differently too. And macro over 35 consumer, which is our core business, I mean we’re really strong in the full figure over 35, but she is the one who are shopping less, both overall apparel and certainly in intimate apparel. So our bull’s eye target market for our Bali, Playtex businesses, she’s just not shopping as often, and we’re seeing in terms of, that category is really suffering overall, and we’re the leader in that.

Second, clearly the mid-tier department store accounts are focused on inventory, they’re cutting net back, planning simple and that impacted our business. Third, is hey we have to continue to invent, derive and bring products that the consumers want and are willing to pay for both on full figure and on average figure. And we have demonstrated our ability to do that, 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, tactical we’ve just got 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, are doing right now. It was not an issue of pulling back on promotions, that’s macros and then hey, just make sure we are brining out the right kind of news and supporting it the right way.

Andrew Burns – D.A. Davidson & Co.

Okay. Thanks. And then lastly, I know you answered a question with Just My Size program, could you sort of speak to how that program has evolved over the last two years and growing in sort of what Wal-Mart’s commitment is to that program, I know their strategy in apparel have been evolving over that time period? Thank you.

Richard A. Noll

Yeah, I think when it started, I think what we’re focused on the plus size consumers. So they said, hey, we’ll just let you deal with it. We did a really a good job, it has become important to them. Now that one 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’s sort of the long and short of what’s happened with that business. I think we will continue to work them on our products and focus on the areas that we’re really good at, and work to help them grow their category, we’ve shown we can do it in the past, we’ll I’m sure we’ll do it again with them.

William J. Nictakis

Yes, Rich, I like to think of, if any of you ever heard of those sports illustrated jinx, you might remember there was actually an article in The Wall Street Journal talking about Wal-Mart Just My Size, and how well it’s doing in grabbing their plus sized category, I guess we should have know then that, oops, it 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 for their consumer, we’ve got more opportunity to help them drive growth, but we are going to get through what we got right now. Next?

Operator

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

Eric Beder – Brean Murray Carret & Co.

Hi, sounds great. How are you today?

William J. Nictakis

Good.

Eric Beder – Brean Murray Carret & Co.

I have two questions here, how much of your business, in your replenishment, and when you look at kind of the there’s always the kind of business, replenishment?

William J. Nictakis

Yeah, it’s almost all of the Innerwear business probably a third to 40% of the Outerwear business and the bulk of the international business in DTC.

Eric Beder – Brean Murray Carret & Co.

Okay. And if I look back the final cost issues, always that’s going through?

Richard A. Noll

I am sorry, I missed that?

Eric Beder – Brean Murray Carret & Co.

Hold on. Hold on a sec.

Richard A. Noll

Cotton cost did you say?

Eric Beder – Brean Murray Carret & Co.

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

Richard A. Noll

You mean in terms of inflation we are seeing from China or from the benefits we are getting from Nanjing and Vietnam selling?

Eric Beder – Brean Murray Carret & Co.

But wasn’t that for ’12 or into, we've heard people talk about China labor prices increased, how are you offsetting that and how is that your China operation are helping you in terms of driving cost?

Richard A. Noll

And I think it’s real clear that, a lot of the inflation that we and other apparel companies are seeing is not just cotton based, obviously that’s the lion share of it. But we are seeing double-digit wage increase, but not just in China. It started in China and it preceded everybody else by about two to three months.

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’s 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 and in fact of what are the $275 million to $300 million of cost increases we’ll experience this year. Only about 50% to 60% of its cotton based, the rest of it’s all those other costs, am I correct, Rich?

Richard D. Moss

That’s correct.

Richard A. Noll

That’s all here, most of that’s here to stay and that’s why as cotton starts to mitigate. In the back half of next year, you’re still going to see inflation from these other areas work through everybody’s supply chain, which is going to dampen some of the benefits that you’re going to get from cotton, not all of it, but good thing is we’ve got the pricing, but we need to navigate even the high watermark of cotton.

Operator

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

Scott Krasik – BB&T Capital Markets

Hi, everybody. Thanks for taking my question. A question on the sales, really the visibility to sales and then a follow up, Rich if we think back July 20, is when you gave the guidance, did you have any indication based on the sell throughs 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?

Richard A. Noll

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, it was already there. August, I think did change people’s mind beyond the stock market declines in September, further reinforcing everybody’s mind maybe it’s a time to be more cautious rather than less. And so I think Bill, when you say, I’d start to build at that point? No question, and I actually, I remembered right around shortly after that Jamie Diamond actually on his call, he used the quote saying “in this environment it’s hard not to be cautious”, and that’s echos through the entire retail community, and a lot of other companies.

Scott Krasik – BB&T Capital Markets

That’s fair. So then just looking at the fourth quarter, the round of price increases ahead 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?

William J. Nictakis

Actually most of the comments that we gave is all about the sell through versus in the elasticity since the third price increase and a lot of that is October data. So it’s very extrapolatable going forward.

Operator

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

Paul Simenauer – JPMorgan

Hi, 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 seven points, which we calculate to be around $27 million, correct me if I am wrong, would this be a good quarterly run rate or is it just a seasonally strong quarter for Just My Size?

Richard D. Moss

You hit the number that’s about right about $25 million, $26 million of head cost. And we will have over the next few quarters, we are going to continue to have some headwind there. We’re not going to tell you exactly how much, but it’s probably going to be a negative for us. Again, we’re going to start offset now with some other jersey programs and everything but in the first quarter of ’12, four quarter its weight around us plain and simple.

Paul Simenauer – JPMorgan

Great, next can you give us a range of price increases you have taken now through all three price increases?

Richard D. Moss

Sure, and again it depends on the category, (inaudible) took 5% in February that’s it. We took 5% this year.

Paul Simenauer – JPMorgan

And cotton and some of the Outerwear category fleece we took 10% or so. So it really varies and some of the core Underwear socks and depends which category, which class of trade and everything. We took north of 20% in some items, significantly higher than that, but I mean the core cotton underwear and sock businesses were well north of 20% cumulatively.

Operator

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

Emily Shanks – Barclays Capital

Good afternoon. Thank you for taking the question. I had a follow-up question on some of your comments Rick around targeted leverage levels, specially, I want to clarify that I heard you say over time, you look to delever below the three times levels and I was curious if you could give us color in terms of is investment grade trading is a goal of yours longer term? And then secondarily, with 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?

Richard A. Noll

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 as I was growing up in the treasury profession. And that’s going to be a key focus of mine in this organization. This is a great organization to be a cash flow guy in. We historically had very strong cash flow, we’ve deployed that cash flow in a lot of different ways over the years, since the spin-off depending on what the – where we felt it would add the most value. And I think we are going to continue to generate a lot of cash flow.

As we do that, we are going to assess what the most beneficial use of that cash flow is going to be. I think as to the question on acquisitions, the Gear acquisition was a great deal for us, it 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 three times has really put us in a position to give us a foundation for really strong growth going forward.

Emily Shanks – Barclays Capital

Okay, thank you. And just as a quick followup you didn’t talk about so ratings, category necessarily is that fair to say than that investment grade isn’t necessarily on your list of goals at the moment?

Richard D. Moss

No, it isn’t I think it’s far enough down the road that we’ll cross that, that bridge is two or three bridges down the road, when we get there.

Emily Shanks – Barclays Capital

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

Richard D. Moss

Thanks.

Operator

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

Jessy Hayem – TD Securities Inc.

Thank you, could you just please tell us what the cost of cotton that flow through your results on a per pound basis this quarter?

Richard D. Moss

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

Jessy Hayem – TD Securities Inc.

And the $0.90 something compares to about $0.60, it sounds if I remember correctly last year.

Richard D. Moss

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

Jessy Hayem – TD Securities Inc.

Okay, great and then, I’m sorry if you’ve mentioned that already, but can you just give me idea of what the timeline, I know you don’t want to give exact I guess cotton cost going forward, but the timeline of when you anticipate hitting your peak cotton costs would be?

Richard D. Moss

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

Jessy Hayem – TD Securities Inc.

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

Richard D. Moss

Yeah, it will fall pretty evenly through those three quarters.

Richard A. Noll

And just to follow-up as we’ve said we’re now beginning to use lower cost cotton now, in this quarter it flows through about mid year of 2012 and based on everything we’ve heard from virtually every other apparel company that’s been talking, they are talking about similar timeframes on when you’ll start to see those benefits show up in People’s P&L. There is something I’m talking about in the fall of ’12 which is sort of summer shipments and things like that. So it’s fairly typical.

Jessy Hayem – TD Securities Inc.

Okay. Great, thank you.

Operator

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

Charlie Stack

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

Operator

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

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