Hanesbrands' CEO Discusses Q3 2012 Results - Earnings Call Transcript

Oct.23.12 | About: Hanesbrands Inc. (HBI)

Hanesbrands Inc. (NYSE:HBI)

Q3 2012 Results Earnings Call

October 23, 2012 4:30 PM ET

Executives

Charlie Stack - Chief Investor Relations Officer

Rich Noll - Chief Executive Officer

Bill Nictakis - Co-Chief Operating Officer

Rick Moss - Chief Financial Officer

Analysts

Eric Tracy - Janney Capital Markets

Omar Saad - ISI Group

Susan Anderson - Citi

Jim Duffy - Stifel Nicolaus

David Glick - Buckingham Research

Joan Payson - Barclays

Scott Krasik - BB&T Capital Markets

Steve Marotta - C.L. King & Associates

Eric Beder - Brean Capital

Andrew Burns - D.A. Davidson

Operator

Good afternoon. May name is Nick, and 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. (Operator Instructions)

Thank you. Mr. Charlie Stack, Chief Investor Relations Officer. You may begin your conference.

Charlie Stack

Good afternoon, everyone. And welcome to the Hanesbrands quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress after the third quarter of 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 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, and may be found on our website and in our news releases and other communications. The company does not update -- undertake to update or revise any forward-looking statements which speak only to the time at 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 and as noted in today’s press release, additional information can be found in our 10-Q’s and in the Investors 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 today are Rich Noll, our Chief Executive Officer; Bill Nictakis, one of our two Co-Chief Operating Officer’s; 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 us some of the financial aspects of our results.

I’ll now like to turn the call over to Rich.

Rich Noll

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 profits standpoint, Innerwear, direct-to-consumer and International, all grew double digits versus prior year and Outerwear’s profit performance improve sequentially as we cycled through the last of a very high cost cotton.

Gross margins improved as expected and we continue to see substantial SG&A cost savings from efficiency initiatives and distribution.

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

We not only delivered a great third quarter but I’m 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 a dollar, and free cash flow of another $200 plus million. 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 cost.

And additionally, as Bill will further detail, our innovate to elevate strategy is beginning to help us new products, such as ComfortBlend, slim fit 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 flow in our balance sheet positioning us well to prepay 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’m excited about what I see in our innovation pipeline. I’m always watchful of the macro-economic environment. Our current momentum will certainly help us finalize specific plans to achieve 2013 EPS in the low $3 range.

And with that, I’ll turn the call over to Bill.

Bill Nictakis

Thanks, Rich. Our core categories continued to strengthen and performed well in the third quarter. We are 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 evidence not only by the share gains we’re 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 initiative, 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, post some unique challenges. It enabled our core categories to burst through some of the mythical price barriers. In all 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 mindset has enabled us to pursue enhancements that are superior to current offerings and that commend a higher price. And we found that we combine innovation with our strong brand equity, consumers really respond favorably and we’re 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’s driven share gain for our business and delivered significant growth for our retailers, even though 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. And we have more new products starting to enter the market, such as our 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’ll share more specifics around this strategy during our February Investor Day event.

Now I know another question you 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. Because one pattern we are noticing it’s the performance of brand. Those retailers that are focusing on national brand seem overall to be growing faster than those that are emphasizing their own brands.

Let me now shift the 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 raw sales were down in the quarter.

While our new products are performing well ahead of plan, gross overall performance was diluted by softness at J. C. Penney. In fact, Penney was responsible for the entire decline in bras and reduced total Innerwear segment growth by 2 points in the quarter.

Now I know many of you 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 a set for the balance of 2012 and 2013. And we are seeing the retail price gaps in our major categories revert to historical norms.

So that issue is behind us and we are now focus on working with our retailers to determine how to best leverage our innovation and brands to drive their categories, sales and profitability.

Looking at Innerwear profitability, we are pleased with the 10% increase in operating profit in the quarter. Gross margins continue to improve versus second quarter as lower cotton cost began 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 a combination of both external and internal factors. Clearly, there have been some macro issues in certain countries, overseeing economic growth slow substantially.

With that said, there is some executional issues that we’ve identified and that we’re now beginning to address. In the near-term, we do expect a lag behind our goal for double-digit growth for International overall. But remain positive about the long-term prospects for growth in our core international geographies in the Americas and Asia.

Now 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 continues to grow with Sports Bras and other performance products leading the way.

With regards to profit, the Outerwear segments 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, where sales grew 2% and operating profit was up 18% in the quarter. This group has done a nice job of focusing on profitable sales with year-to-date profits improving 13%.

To wrap up, I’m happy with our team’s performance in the third quarter. We’ve 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’s 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’ll now turn the call over to Rick Moss to discuss our financial performance.

Rick Moss

Thanks, Bill. As both, Rich and Bill mentioned, our team executed extremely well in the third quarter, as we exhibited continue sequential improvement in sales, margin and EPS. Sales in the third quarter were $1.22 billion, up 3% versus last year and earnings per share were $1.11, up 31% from last year. Stronger U.S. dollar has negatively impacted our sales in the quarter by about $7 million or 0.5 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 in 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 both input costs and units. Free cash flow is 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’re expecting sales of $1.13 billion to $1.17 billion, and earnings per share of a $1 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 in EPS, $2.54 to $2.50 with the lower end of EPS, now $0.04 sends above our primary guidance.

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

Last week, we complete $300 remaining long-term debt repayment. We should end the year with substantially 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’m pleased with our results in the third quarter and year-to-date. We’ve successfully navigated the cotton bubble. Improved sales and margins throughout the year and are exceeding the free cash flow expectations we set. We’re executing well and look to continue this as we move into 2013 and beyond.

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

Charlie Stack

Thanks, Rick. That concludes the recap of our performance for the third quarter. Before we take your questions today, I’d like to follow up on Bill’s comment regarding your upcoming investor day.

We’re currently planning to host an Investor Day at our headquarters in late February and hope you would join us. Look for more information to come as we finalize the details over the next couple of months.

Now, we begin taking your questions and we will continue as time allows. Since there maybe 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 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?

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.

Eric Tracy - Janney Capital Markets

Hey guys, good afternoon. Congrats on a nice quarter.

Rich Noll

Thanks Eric.

Eric Tracy - Janney Capital Markets

So Rich, I guess, if we could may be talk a little bit about the macro and certainly some of the uncertainty out there as we head into holiday season. What you’re seeing from retailers, how they are thinking about their order books. How they planning from a pricing perspective, obviously, you guys have that locked in.

But just may be a little bit of color as we transition from what was a Decent 3Q. You expect sales to continue to accelerate in 4Q. May be just provide a little bit of a color on that backdrop?

Rich Moss

Yeah. So let me just do some of the overall macro consumer stuff and then turn it over to Bill for some of the specific 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 and but fortunately the overall trend has been slightly positive. No real change to that.

One thing we are seeing is mass is actually being little bit stronger, the mass here in department stores, that seems to be a trend change although I would necessarily says it’s a macro consumer trend change. You do have some issues with some mid tier accounts that are just faced with their own technical issues and that may just really be the things that’s driving that.

So overall, in this environment, we’re very watchful but we haven’t actually noted anything other than trends we’ve seen sort of business as usual. In terms of all portfolio, we do expect sequential improvement in sales growth for the fourth quarter. And Bill, do you want to talk about the promotion and pricing and how well set we are?

Bill Nictakis

Sure. For the holiday, we’re set. I mean the promotions are locked with all of our retailers and our innovations been working. It’s going to continue to work. Our promotional offers and consumer events are locked and we’re preparing to service them in a great fashion like we’ve been servicing them all year.

So I think we are poised for a strong holiday. The key is going to be traffic in terms of how people walk into the stores and I think we’ll all know more about that in a couple of months but they walk in the stores. I think they’re going to have a lot of innovation, a lot of great brands and some real good service, which has to borrow products.

Eric Tracy - Janney Capital Markets

Okay. I guess, the follow-up to that, sales seem to be holding a decent visibility there. You’ve now turned the corner on cotton and some really nice tailwind cyclically and I think structurally on margin, consumer gross margin perspective. Rich, I mean, how do you think about investing from a G&A perspective behind marketing dollars to support continued sales based gains in gaining more traction with your retail partners. Both from a 4Q perspective and then as we sort of go into next year?

Rich Noll

Yeah. Clearly, I’ve talked about that before that we did cut media back, for example, this year to navigate some of the issues we had with the cotton inflation and our intent is to restore that in 2013 in terms of tens of millions of dollars. And I’ve also talked about if we’ve got some upside this year, we’ll actually begin that process this year.

In fact, I think our total media spent for the euro be up a couple million more than what we originally plan going into the year. And 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’ll do that but we’ll clearly be doing it in 2013 and that’s already built into what Rick was talking about as our potential earnings per share for 2013.

Eric Tracy - Janney Capital Markets

Okay, guys. Hey guys, I appreciate it. Best of luck.

Rich Noll

Thanks.

Operator

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

Rich Noll

Hello, Omar.

Omar Saad - ISI Group

Yeah. Can you hear me?

Rich Noll

Yeah, now.

Omar Saad - ISI Group

Great. Thanks. Good afternoon. How are you?

Rich Noll

Great.

Omar Saad - ISI Group

Wanted to follow-up on Bill’s discussion of the retail price gaps, can you talk about reverting the more historical normalization there. Can you talk about where you’ve seen those price gaps at the largest, were they coming for the business and what exactly, how bigger these price gaps that are narrowing?

Bill Nictakis

Let me tackle the subject of pricing and let me put it into context. Our number one priority is to ensure that we’re investing against their consumer. I mean, that’s really the life color of our business. Our first and foremost priority is to make sure that we’re making a proper investments against our great brands, ensure we have terrific product quality and that we continue to prime innovation pump.

And we have to ensure that we have the proper pricing in place to do that and to make sure we’re delivering the proper value to the consumer. We have that pricing right now. I think into our businesses I said the prices are in place and set for the balance of this year and next year. And our customers, I think overall are pleased with how we’re managing the business. We’re growing our sales, growing our profitability, growing the productivity of the space and the best evidence of that is the fact they’re rewarding us with some more space gains for next year.

The gaps seem to be moving back towards historical levels. I can speak to what your competitors are doing or not doing but the retailer has set the prices and our focus is working with them to drive the consumer into the stores, drive the AUR and that’s going up.

Rich Noll

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

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

To be frank, when they are below that 5% level, the retailers actually start to work towards, saying wait a minute we didn’t get more for Hanes or if competitors are actually below that. They have a tendency and we’ve seen this and did this in past, where they raise those retails to maintain at 5% to 10% GAAP and that’s ideal.

Omar Saad - ISI Group

Great. Thanks and then on the factory side, as you guys took some down time this year, can you just give us an update on where you’re standing in terms of the capacity and overhead absorption? Are you running at full capacity? Do you see any need? You know as you look at, given your outlook for the business and 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 down time. Thanks?

Rich Noll

Yeah. So in terms of overall capacity and down time, if we 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 businesses, private label pieces and so on. So we had to restructure that. We also wanted to take some short time to make sure we’re beginning to bleed off inventories, both of those things we accomplish when we feel real good about where we are.

In Q4, there is a lot of seasonal down time, Christmas holidays and other things as well as regularly scheduled down time, it will take but that’s all built into our guidance. When we entered the year, Rick, I think we’re talking about $20 million.

Rick Moss

$20 million for all those actions.

Rich Noll

…and how much we spent.

Rick Moss

We spent through the third quarter about $19 million.

Omar Saad - ISI Group

Got it. And then quick comment, we saw the news of this target C9 store. It’s a test location obviously targeted to a great retailer. What is the store, how is it positioned to the consumer and are there any expansion plans?

Rich Noll

Yeah. What, I think you’ll have to ask the target teams in terms of their expansion plans on that. I mean clearly, we love the fact that they are showcasing our C9 by Champion brand, and we are continuing to help them drive that category, is performing very well for them. And we hope that they add more of those stores.

Operator

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

Susan Anderson - Citi

Good evening, everyone. Congrats on a great quarter.

Rich Noll

Thanks, Susan.

Susan Anderson - Citi

I guess I wanted to drill down little bit on the guidance and maybe the different moving parts, I guess starting with topline first. Like why the lower topline, 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 coming in a little bit lower?

Rich Noll

Now, let me give you sort of big picture on it and then I will turn it over to Rick for some more of the specifics. Overall, we are forecasting, if you look at your sales growth for the fourth quarter, the midpoint is about 4% to 5% growth, the top end of the sales ranges about 6%.

And we’ve got a wide range there because you never know, how retailers are going to act -- react in terms of pulling down their inventory, whether it’s going to be in that December timeframe, which we saw last year or normally as they do in January, which would be in 2013.

So we widened the range a little bit. When we came into the year, we were forecasting sales growth of 2% to 4%, but however as sort of the year played out, pennies was actually a big drive on that topline and we’ve already talk about International underperforming a little bit. When you add those two things up, we sort of flow through the lower end of our sales range rather than the high end.

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

Rick Moss

Yeah. If you look at, as Rich said, if you look at the quarter from a top-down, we -- as a result of J. C. Penney and the fact that our International business isn’t delivering the growth that we had originally expected, we’ve adjusted our sales guidance accordingly.

I would say this and we’ve been cautious all year along, and I think in an uncertain environment that it continues to be that way. But when we kind of, maybe contrast Q4 and Q3 for you a little bit, Susan, they may give you a little bit of 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 and that’s normal, that’s normal seasonality of our business. So you have higher margins and a little bit lower sales versus Q3.

At the same time, our tax rate will go to the mid-teens versus 8% in Q3. So those dynamics would drive us to an EPS number of about a $1 to $1.06. Again, for our cash flow, we do expect to be at the top end of the range at about $500 million.

Susan Anderson - Citi

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

Bill Nictakis

Yeah. I think, reaching our inventory levels seem to be in line overall. They are not over inventoried, they are not under inventoried. And as Rich said, they ultimately will adjust to inventory levels coming out of the holidays whether they do it in December or do they do it in January.

Last year was a dramatic reduction in our inventories in December, that was the second biggest we’ve seen in two decades. So the guidance that Rick talked about, as soon as they are gong to be some of the normal reduction in retail inventories, does not assume it go to the huge levels we saw last year. But we expect them to pull down a little bit, because that’s typically what they do.

Rich Noll

Yeah. And actually that’s a good point because that’s probably a little bit of a change from when we were originally talking that we assume that there wouldn’t be any destocking in the fourth quarter, we actually do have a little bit built into that guidance. Not a major change but it is a small change, and I don’t want to miss that point.

Susan Anderson - Citi

Okay. 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, where price is still up year-over-year and then units down or how should I think about that?

Rich Noll

Yeah. I think when we went into this big double-digit price increase, we wanted to start 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 give that specific.

We are now overlapping the price increases as we go into the fourth quarter. We have most of them fully in place last year. And so while there was some price in the third quarter, by the time it gets to the fourth quarter, there’s going to be very little price in those numbers.

Susan Anderson - Citi

Yeah. Okay. Great. Thank you, guys.

Operator

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

Jim Duffy - Stifel Nicolaus

Thanks a lot, guys.

Rich Noll

Hi, Jim.

Jim Duffy - Stifel Nicolaus

So 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 is the risk to that?

Rich Noll

So, I’ll just start. It’s a little early to talk about sizes and scope for 2013 with all these new products. We do have a great innovation pipeline. The ComfortBlend underwear, for example, we can see them back in 2010. We actually ship this year. However, with all of the pricing and changes in all of that stuff, plus and our retailers were focused on getting through the cotton bubble. You are going to see a lot more of this innovation start to launch going in 2013.

We will give more specifics around that on our fourth quarter call in terms of the dollars and sense of it. And it’s our intent on the February Investor Day to profile a lot of these new products and actually talk about how they’re doing. You will actually be able to 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?

Jim Duffy - Stifel Nicolaus

Are the pricing into 2013 or any of the risk factors set? I’m surprised that you can, I guess have that locked in for the full year at this juncture, maybe just a little?

Rich Noll

Yeah. Well, certainly they are lot more stable than they were over the last 18 months, that’s for sure. Go ahead.

Rick Moss

I think when you look at the Innerwear business and I will talk about Outerwear. Innerwear is done. The prices are in the marketplace. Today, those were the prices that we expect to continue into ‘13, throughout ‘13. And then again the conversation with our customers has been 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. So they are pleased with it, and I think that they are just pleased. On the Outerwear side, we had the first half for the year lock down and again, Outerwear tends to be program-by-program, season-by-season.

So we have great visibility for the first half of the year. All those programs are locked prices. 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 to be, just to be finalized and everything. But that’s sort of where we are and we feel good about it and feel real good about how our innovations work there.

Jim Duffy - Stifel Nicolaus

That’s great to hear. Thank you, guys.

Rick Moss

Thanks.

Operator

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

David Glick - Buckingham Research

Thank you. Good afternoon. Rich, just -- it sounds to me like there is a bit of a change in tone, on the part of the management team toward topline opportunities and you’re coming off a 12 to 18-month period before you had to be a little more defensive in terms of point back marketing, raising prices, managing elasticity, kind of 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 those 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 it, maybe a change in mindset going into next year?

Rich Noll

Yeah. And I think I will preface it just a little bit 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 and but you are right, we had to take a pause as we have to deal with the cotton bubble, where all of our attention started to focus on raising prices and it ended up raising prices three times in 12 months, unheard of in our industry prior to that.

And so, but now we are back to that. So, I do think as a total change but we had it there before, we are now going to reemphasis 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 do think the price, changing prices so much proved to both us and our retailers that those artificial price barriers that people had in mind like in some accounts would be $10 and another 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 if everybody started to understand, the consumers willing to pay for it.

And I do think there is sort of an inflection point change there, and so it allows us to bring a lot more innovations to the marketplace than we would’ve even conceived before. And we are going to unveil a lot of that stuff I think you will see it helping us driving into ‘13, but actually even importantly into ‘14 and ‘15 as well.

David Glick - Buckingham Research

Great. Thanks. And if I can just ask about the intimates business, I mean we just anniversary a major destocking in that category a year ago and it was a tough business again. It sounds like really more so, on the product side of the business.

If you pull out that what’s going on at J. C. Penney, which I assume is all of your mid-tier commentary. Are you starting to see the business turn in your other accounts and is that obfuscating, maybe a turn in the business?

Rich Noll

Yeah. Look, J. C. Penney was four points of growth in our bra business for the quarter. So it clearly had a significant impact on it. Overall, what we are seeing is our innovation across the whole, smart sizing launch that we’ve done in Bali there in Bali. And Haynes is working exceptionally well, while we are struggling to keep up with demand on that.

So we are seeing that work. We are seeing our panty business, especially in maths performed pretty well for us and consumers responding to renovations. So we are marching on the right path on those, on that business right now.

David Glick - Buckingham Research

Okay. Great. Last question for Rick on cash, is the $250 million exiting the year reasonable, the head start you are talking about towards prepaying that $500 million and are you precluded from paying off that $500 million before December?

Rick Moss

Well, keep in mind we said about $500 million we paid off $300 million of the debt, so that would leave about the richer for two, slightly more than $200 million in the fourth quarter. And that’s probably, which you’ll see on the balance sheet more or less. In terms of -- but still nice substantial down payment on that number. The call date on those bonds is December 15th of 2013.

Operator

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

Joan Payson - Barclays

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

Rich Noll

We don’t normally give gross profit by division. We think for competitive reasons that’s by segment, we soon do that. But I can talk a little bit about where we think gross margins going and some of the dynamics there. I think I would think gross margin really in both short-term and long-term.

Short-term, the issues of gross margin are going to be primarily around cotton. So this quarter, we -- cotton prices were 37% higher than the last. This is the last quarter where that dynamic comes into play. Beginning next quarter our cotton prices will be flowing through the P&L would be lower than 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 in the $1.80 range. And so we will see substantially lower cotton cost flowing through really the -- between now even from the fourth quarter on through likely through the all of next year, that’s kind of 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 it was prudent we can do both of those things and sometimes very challenges circumstances.

Joan Payson - Barclays

Okay. Thanks. And then in terms of the International business, I guess what do you still see as sort of the greatest challenges of the regions, where you are seeing the most pressure and what are your priorities in terms of investing internationally?

Rick Moss

Yeah. Let me talk a little bit about International, Bill mentioned in his remarks. First of all I want to put it in perspective. Its about 11% of our overall sales and while its critical component of our long-term growth prospects. In the near-term, our results are going to be driven by how we do in the U.S. 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’ve felt the issues that International business was feeling and the same thing that U.S. business was in the first part of the year. We expected that to start to return the double-digit sales growth by now, it hasn’t.

So, it have -- its forced us to sort of step back take stock and figure out why it hasn’t. And really there is -- as well as a little bit of macro issues we really haven’t done as well tactically in terms of leveraging our great innovation, we’ve got in the U.S. and fully leveraging that U.S. supply chain. So, we are looking at some things to address that. Our intent is to get it back on the growth track that we have laid out, but it may take us few more quarters until we do that.

Operator

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

Scott Krasik - BB&T Capital Markets

Yeah. Hi, everybody. Good quarter.

Rich Noll

Thanks, Scott.

Scott Krasik - BB&T Capital Markets

Just talking the people in the industry, it seems like there is wall after back-to-school there’s a lot of inventory. There is sort of disorganization, shelves aren’t cleared out and that’s a driving a lot of it, lack of replenishment or slowdown in replenishment. I mean is that the case, is that something you can control and improve going forward. So, you don’t get this massive slowdown in replenishment right after back-to-school.

Rich Noll

So, we’re not necessarily seeing a massive slowdown in the replenishment. So, I am not sure exactly, where you are getting that.

Scott Krasik - BB&T Capital Markets

I guess just seasonally, not massive replenishment suddenly. I guess just sort of seasonally you get this wall after back-to-school?

Rich Noll

Yeah. I mean that just the normal cadence, right where -- the beginning of the year during the winter sales going to be slower. They built towards back-to-school period and then there is that sort of in between, between back-to-school and holiday especially in October and all of retail tends to slowdown.

I don’t see that as a problem. We just always need to understand it, make sure that we are flowing inventory accordingly. And I don’t think this year Bill anything slowing differently than we’ve seen on average for many years in a row, is that correct?

Bill Nictakis

Absolutely.

Scott Krasik - BB&T Capital Markets

Colder weather happens, it tends to help a little bit.

Rich Noll

Help a little bit, pick up a little bit earlier but the good thing about winters, it always eventually gets cold.

Scott Krasik - BB&T Capital Markets

Okay. I think so for last, but let’s…

Rich Noll

Yeah. Yeah. Lastly…

Scott Krasik - BB&T Capital Markets

Right. Then just a couple of others, in addition so you’re going to reinstate the media spending next year, you’ve talked about getting distribution savings as well, will that portion return or is that permanent savings?

Rich Noll

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

Operator

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

Steve Marotta - C.L. King & Associates

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

Bill Nictakis

No. I don’t think we say it’s flat.

Rich Noll

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

Steve Marotta - C.L. King & Associates

Okay. And excuse me, lastly as it relates to the $26 million or so decrease in SG&A cost you mentioned that major part of that was the decrease in marketing, is it possible that these are the components of that decline on a year-over-year basis?

Bill Nictakis

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

Operator

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

Eric Beder - Brean Capital

Good afternoon. Congrats on a solid quarter.

Rich Noll

Thank you.

Eric Beder - Brean Capital

No, we can’t talk J. C. Penney at depth. I’d like to throw in something else here. Do you have an anniversary as an event in J. C. Penney in Q4. I am curious what you are seeing for 2013 in terms of potential shop-in-shop, but where you are going to go J. C. Penney.

Rich Noll

Yeah. I just said, the good news about Penney strategy is to focus on Blends placed our wheelhouse right. I mean we have the leading brand of underwear. Bali and Playtex are among the absolute leading brands in that apparel.

So, over the long haul, what Penney is doing placed our strength. We are dealing with the short-term challenges and in terms of shops right now they are send or go to they are not going to have a branded underwear shop, so that sort of off the table. We’re going to do well in our share of underwear they went dust sales, but they are not putting a Hanes concept shops for instance.

And the Bali and Playtex sort of remains to be seen how they are going to handle that, that piece of it. But key challenge for us is just -- as they get the traffic back in the stores we will hopefully benefit with that.

Bill Nictakis

Yeah. In terms of the overlap, we didn’t really start seeing the major declines until their Q1, which started February, March, April and when they started to really implement this strategy. So we don’t actually start to overlap this for quite a while. And I think it remains to be seen how the consumers respond to their new strategy next year, it may that they have got a new base from which they can now grow as they institute these shops and things like that.

It maybe that the consumers have started to find other places to shop and they are traffic continues to decline. I have no idea nor well I speculate on what happen, but I do think we want to be cautious and wait until we start to see it happen, before we start to decide which direction Penney is going to go.

Eric Beder - Brean Capital

Great. If I look about free cash flow, you are going to use $500 million of free cash next year to pay down the debt, I would assume, based upon what you are talking about here, we’re pretty much ahead of the schedule little bit, when you enter the year, give us our returns on million dollar in cash now. What is your thoughts on after that debt is paid down, what to do the excess cash, as I think we know the debt after that really is to make sense to pay down?

Rick Moss

Yeah. At that point is as we pay down that $500 million of debt, we still anticipate good strong cash flow into 2014 and so on. And there are three things that we can do with are obviously acquisition, share buybacks or dividends. And we’ve talked about bolt-on acquisitions can make sense for us. We’ve talked about the fact that a zero dividend pretty doing 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 we will return value to shareholder is by primarily being a dividend stock. And -- but I think of all three of those could actually be on the table. We don’t need to make any decisions yet, we still have another $500 million of debt to pay down.

But once, we do and we start to formulate what our plans were, about year from now, we’ll start making sure that we are communicating that to the investment community.

Operator

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

Andrew Burns - D.A. Davidson

Hi, guys. Congrats on solid quarter.

Rich Noll

Thank you.

Andrew Burns - D.A. Davidson

Getting in the stores for last few months, it appears that you’re 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 in the competitive advantage in terms of driving sell-through?

Rich Noll

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

Andrew Burns - D.A. Davidson

Thanks. And you talked about this innovate to elevate initiative and it sounds like, we’ll hear more about it and see some more of that in 2013? Can you talk about what you’re seeing in the market that gives you confidence that this is sort of up market higher price point product is the direction to go and now you are talking about potentially moving up market and existing accounts or even new distribution points? Thank you.

Rich Noll

Yeah. Well, primarily focused on existing accounts and I will give you an example of ComfortBlend underwear that, I talked about and Rich mentioned. We have been testing and planning with this idea for couple years, we know, we would be good, but its doing about 60% better than we had planned it to do this year. And our customers are recognizing that because they are given us more space next year, additional space to support that.

This is what, we looking at ComfortBlend is being sort of a home run idea, that really can change consumer behavior, when we saw this a decade ago, we launched Hanes TAGLESS T-shirts, it was a drawers changing event. It was such a benefit to consumers that basically, consumers were replacing their current drawers of T-shirts with Hanes TAGLESS T’s and w had a couple really, really good years, because of that.

We are starting to hear antidote to the same kind of thing with ComfortBlend, it’s such a superior product, that people say, hey, this is great, I am going to change out my drawers and replace it with, ComfortBlend. So, we are seeing a big success there. We are seeing it with our Smart Size and Comfort revolution, Bali bra, so just trading up our existing accounts, is really what we are focused on.

Operator

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

Charlie Stack

Thanks. We’d like to thank everyone for attending our quarterly calls today. And look forward to speaking with many of you soon.

Operator

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

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