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Tempur-Pedic International (NYSE:TPX)

Q4 2012 Earnings Call

January 24, 2013 5:00 pm ET

Executives

Mark Rupe - Vice President

Mark A. Sarvary - Chief Executive Officer, President and Director

Dale E. Williams - Chief Financial Officer and Executive Vice President

Analysts

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Chad Bolen

David S. MacGregor - Longbow Research LLC

Reza Vahabzadeh - Barclays Capital, Research Division

Bonanza Chalaban - KeyBanc Capital Markets Inc., Research Division

Jon Andersen - William Blair & Company L.L.C., Research Division

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Jessica Schoen - Barclays Capital, Research Division

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Tempur-Pedic Fourth Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mark Rupe. Sir, you may begin.

Mark Rupe

Thanks, Sam, and thanks for everyone participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO; and Dale Williams, EVP and CFO. After our prepared remarks, we will open up the call for Q&A.

Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements, including the company's expectations regarding sales, earnings or the proposed transaction with Sealy, involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company's business. Factors that could cause actual results to differ materially from those identified include economic, regulatory, competitive, operating and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings, including, but not limited to, annual reports on Form 10-K, under the heading Special Note Regarding Forward-looking Statements and/or Risk factors. Any forward-looking statements speak only as of the date on which it is made. The company undertakes no obligation to update any forward-looking statements. The press release, which contains the reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures, is posted on the company's website at tempurpedic.com and filed with the SEC. With that introduction, I will turn the call over to Mark Sarvary.

Mark A. Sarvary

Thanks, Mark. Good evening, everyone, and thanks for joining us. Today, I'll provide a brief overview of our performance in the fourth quarter, an update on the progress of our recent initiatives, and then outline our strategic focus areas for 2013. Dale will then provide details on the fourth quarter and full-year financial results, and 2013 guidance.

Our fourth quarter results were in line with our projections, both in North America and internationally. Sales overall declined 7%, with North American sales down 9% and International sales down 4%. In North America, we continue to see signs of stabilization, driven by many of the initiatives we launched in the third quarter. Rollouts of our new TEMPUR-Breeze, Weightless and Cloud Select products are now essentially complete, and we've been pleased with consumer response to these new products. In particular, the response to the TEMPUR-Breeze mattresses has been quite positive. These mattresses feature phase-change material and our proprietary TEMPUR-Climate material, and they deliver a proven, cooler sleeping surface during the night. These mattresses are very different from other products on the sales floor, especially those that use gel memory foam. Those products are often advertised as being cooler. But in fact, the gel technology is ineffective in its claim that it will help consumers sleep cooler than they [indiscernible] has recommended that a competitor withdraw comparatives [indiscernible]. Our R&D efforts will continue to be focused on [indiscernible] and also are proprietary and consumer-valued and that allow retailers to attract new consumers and to improve their average retail selling prices.

In 2013, we will launch several new products that will continue to broaden the appeal of Tempur-Pedic, and some of those will be on display next week at the Las Vegas Bedding Show, including a new mattress collection, the TEMPUR-Choice collection.

TEMPUR-Choice will initially comprise 2 mattress models, priced at the higher end of our price range. The collection is designed to deliver the superior comfort and pressure relief of our proprietary TEMPUR material, while offering the added benefit of adjustable firmness and support across multiple zones on both sides of the bed. Initial retailer feedback has been very positive, and we expect that it will not only be incremental to our business, but also to theirs. I'll save the rest of the details on TEMPUR-Choice and the other planned product introductions for the show.

Switching now to our International business, as I said, our fourth quarter sales were down 4% consistent with recent projections. While we continued to perform well in some of our key European markets, such as Germany, weak economic fundamentals in Europe, as a whole, pressured our performance.

On the other hand, our Asia-Pacific business continued to perform well during the period, reflecting solid performance in the key markets of Japan and Korea. New products will also be a major focus for our International business in 2013. We have just begun shipping a new and entirely updated TEMPUR Original collection to our customers in Northern Europe and will roll it out to other regions during the year. Initial customer reaction has been quite positive and modest slot [ph] gains are expected. There will also be other new product introductions later in the year.

In addition to new products, we remain committed to our other 3 key strategic initiatives: Building awareness, increasing availability and investing in R&D to ensure we continue to deliver the best sleep. 2013, we will maintain significant advertising levels in both North America and internationally.

And as you may have seen, we are now working with a new ad agency here in North America, and we're working on new and enhanced advertising. Ask Me was an outstanding campaign for us for several years, however, we believe it is now appropriate to evolve our brand communication. Internationally, we will continue to invest in building awareness and driving conversion in our key European and Asia-Pacific markets.

We expect to gain incremental distribution throughout the world, partially from our new products within existing doors and partially from new customers. And finally, our R&D investment in 2013 will further increase and ensure that our pipeline of innovative new products remains robust.

Before turning the call over to Dale, I want to provide a brief update on our proposed acquisition of Sealy. We are excited about the potential for the combined companies. TEMPUR and Sealy will have a portfolio of highly complementary brands, products, technologies and geographic footprints that will provide a robust platform for growth. We have made substantial progress toward achieving the closing and we expect to close the deal during the first half of 2013.

With respect to the HSR antitrust review, Tempur-Pedic and Sealy are continuing to cooperate with the Federal Trade Commission in its review of the proposed acquisition. On January 22, 2013, both the company and Sealy, certified [ph] to substantial compliance with the FTC's second request of documents and information concerning the acquisition. By agreement, the FTC will have 45 days, following substantial compliance, to review the additional materials and information submitted by the parties.

As Dale will discuss in more detail, in December we entered into a new senior credit facility and closed on a senior note offering, so we are also well-positioned from a financing perspective. In addition, with respect to the purported class actions challenging the merger, as described in more detail in the 8-K filed today, Tempur-Pedic and Sealy have entered into a Memorandum of Understanding with the plaintiff's lawyers to resolve this litigation in order to avoid the expense and uncertainty associated with litigation. This MOU is no admission of wrongdoing and no change to the deal terms. There will be an updated disclosure in Sealy's information statement to be circulated to its stockholders. This removes the litigation as a potential impediment to closing.

And finally, we continue to work with Larry Rogers and the Sealy team to prepare for a very successfully integration once the required regulatory approval is received, and we're making very good progress.

I'm sure you understand our constraints in discussing additional details regarding the transaction. We will be sure to provide an update when appropriate.

With that, I'll now hand the call over to Dale.

Dale E. Williams

Thanks, Mark. I'll focus my commentary on the fourth quarter and full year 2012 financial results, and our 2013 guidance. I will also review the highlights of our recent financing transactions that support our planned acquisition of Sealy. Let's begin with an overview.

In total, fourth quarter net sales were $341.1 million, a decrease of 7% over the same period last year. North American net sales were down 9% and International net sales decreased 4%. Now by channel, North American retail, net sales were $207.8 million, a decrease of 8%. International and retail sales were down 7% to $87.9 million. On a direct basis, our North American direct channel sales decreased by 17% to $17.5 million, while our direct sales internationally increased 64% to $12.3 million.

By product, overall mattress sales were down 5% on a unit decline of 2%. North American mattress sales decreased 5% on a 2% increase in units. In the International segment, mattress sales decreased 7% on a unit decrease of 8%. Total pillow net sales decreased by 8% on a 10% decrease in units. North American pillow sales decreased 26% on a unit decrease of 21%. International pillow sales were up 11% on a 5% increase in units.

Sales of our other products, which include items that are normally sold along with the mattress, were down 11% in total and down 13% in North America and down 8% internationally.

Gross margin for the quarter was 50%, down 200 basis points year-on-year and up 80 basis points sequentially. On a year-over-year basis, fourth quarter gross margin declined primarily due to the following: product mix and higher new product cost, and floor models associated with rolling out the new products. These impacts were partially offset by improved efficiencies in manufacturing and distribution.

On a sequential basis, gross margin increased 80 basis points as a result of favorable commodity costs, decreased promotions and discounts and geographic mix. These benefits were partially offset by product mix and increased manufacturing and distribution costs. Advertising spend in the fourth quarter decreased 14% to [ph] $33 million from last year's fourth quarter. As a percentage of sales, advertising spend was 9.8% in the fourth quarter compared with 10.6% in the fourth quarter last year.

Despite the slight reduction in advertising, we've continued to see positive trends in our brand awareness and purchase consideration due to a more effective advertising spend.

Excluding transaction and integration costs related to the Sealy transaction, and restructuring costs, we maintained G&A expenses relatively comparable to last year's level in the fourth quarter. We increased R&D expense in the fourth quarter by 69% year-over-year by [ph] $4.5 million.

Operating income was $51.3 million, or 15% of sales, as compared to $85.8 million, or 23.4% of sales in the fourth quarter of 2011. Operating income in the fourth quarter of 2012 included $7.6 million of transaction and integration costs related to the proposed Sealy acquisition, as well as $1.5 million of restructuring charges.

Interest expense was $5.8 million and included approximately $900,000 related to the closing of our recent high-yield bond offering. The tax rate was 48%. The tax rate reflects the provisions for taxes recorded with respect to the anticipated repatriation of foreign earnings which, in total, was $6 million in the fourth quarter. Without this tax impact, the normalized tax rate for the quarter would have been approximately 32.5%. We recorded earnings per share of $0.39 on a GAAP basis for the fourth quarter of 2012. Adjusted earnings per share were $0.60 in the fourth quarter.

Now I will summarize the income statement for the full year 2012.

Sales were down 1% in total, North American sales down 4% and International sales were up 6%. Operating margins declined to 18% in 2012 from 24% in the prior year. As a reminder, operating income for the full year 2012 included $11.1 million of transaction and integration-related costs and $1.5 million of restructuring charges.

GAAP EPS for the full year 2012 was $1.70. Adjusted EPS was $2.61, down 18% as compared to GAAP EPS of $3.18 for the full year 2011.

Next, I'll turn to the balance sheet and cash flow for a brief review. Our accounts receivable balance was essentially flat at 34 days. Inventories were up $2 million year-on-year or 2%. Inventory days increased 2 days to 49 versus the prior year. Payables were up 9 days, primarily due to timing.

During the quarter, we generated $36 million of operating cash flow and capital expenditures were $12 million.

As it relates to our debt position, we were very pleased to have recently announced the closing and signing of several financing transactions necessary to finance the acquisition of Sealy and to pay related fees and expenses. With these, we are now positioned to fund the acquisition. In mid-December, we completed a $375 million offering of 6 7/8 senior notes due in 2020. We also entered into $1.77 billion senior secured credit facilities, comprised of a revolving credit facility of $350 million, a Term A facility of $550 million and a Term B facility of $870 million. Total proceeds from the sale of the senior notes have been placed in escrow pending release upon receipt of regulatory approvals and the satisfaction of other conditions to the completion of the Sealy acquisition. And similarly, the credit facilities are expected to close and fund in connection with acquisition of Sealy.

As a result of these financing activities, we felt it was important to note that we will be incurring certain interest expenses. On the senior notes, we have already pre-funded into escrow $20 million of interest expense. We will accrue it as defined under the terms of the notes. We will also be paying ticking and certain other financing-related fees on the $1.77 billion senior secured facilities until the transaction closes. Further, there will be transaction-related costs incurred at closing, as well as deal-related financing and transaction closing fees amortized over several years thereafter. We plan to recognize these transaction-related expense items and adjust for them accordingly in our non-GAAP performance results. As detailed in the press release, our total indebtedness increased to $1.025 billion due to the $375 million bond transaction. Our funded debt of $651 million at the end of the fourth quarter was relatively comparable to the third quarter level. The cash balance increased by $28 million to $179 million, primarily driven by our international operations.

Now I'd like to address guidance. The full year 2013 guidance we provided today is stand-alone for Tempur-Pedic. It does not factor in anticipated net sales or earnings from Sealy in 2013. The company plans to issue updated guidance after the closing of the transaction for the combined entity. With that background, we currently expect 2013 net sales to be approximately $1.425 billion, an increase of approximately 2% versus our 2012 total sales. And we currently expect 2013 adjusted EPS to be approximately $2.55. The first quarter is a challenging comparison. We are expecting mid to high-single-digit growth thereafter.

It's important to note that our 2013 adjusted EPS guidance does not factor in transaction and integration costs related to the proposed acquisition of Sealy, interest expense costs on the financing transactions just described, or the future tax provisions to be provided in connection with the anticipated repatriation of foreign earnings together with the transaction. We project our gross margin to be slightly down for the full year as compared to the 50.9% recorded in 2012. We believe that any anticipated benefits from our productivity programs and the slight fixed cost leverage, will be offset by product mix and anticipated slight commodity cost increases. We project our operating margin, adjusted to exclude Sealy transaction and integration costs, to be approximately 17.5% to 18%. We'll be accruing for our equity incentive programs at a more normal level in 2013 as compared to 2012, which benefited from an adjustment of $10 million. We anticipate interest expense for the full year to be approximately $20 million under our current debt facilities.

We anticipate capital expenditures will be approximately $35 million. We anticipate the full year tax rate, excluding APB 23, to be approximately 32.5%. We are using a share count of 61.5 million shares for the full year. We do not expect to repurchase any shares due to the pending acquisition of Sealy.

Let me give you a little context for our guidance. The $1.425 billion sales guidance for the full year is consistent with the methodology that we've used for the past couple of quarters, specifically projecting that current trends will continue. Our fourth quarter sales of $341 million annualized with industry seasonality would be approximately $1.425 billion. We believe that it remains prudent to plan the year this way. That said, our first quarter is the toughest comparison of the year. We're planning for sales to be flat to slightly down as compared to the fourth quarter 2012 sales of $341 million. We expect our adjusted operating margin to be approximately 17% in the first quarter. Through the first 3 weeks of January, we are tracking to these projections. In considering our guidance, it is possible that our actual performance will vary depending on the success of our new initiatives, macroeconomic conditions and competitive activities, or the consequence of other risk factors we've identified in our press release and SEC filings. As noted in our press release, our guidance and these expectations are based on information available at the time of the release and are subject to changing conditions, many of which are outside the company's control.

With that, operator, please open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from John Baugh of Stifel, Nicolaus.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

I wondered if you could just go into the International piece, and particularly as it relates to guidance. Maybe give a little more detail about specifically where the pockets in Europe are weak and what the assumptions are going forward in that region of the country? And then walk around the globe, you mentioned Asia-Pacific, strong, what the outlook there is?

Mark A. Sarvary

Let me give you some commentary, and then maybe I'll ask Dale if he could just give a little bit of the numeric detail. But from a -- we've been reading, obviously, a lot about Europe and the weakness in Europe. And we have, as we've said in previous calls, seen weakness in pockets of Europe. We've never seen the systemic weakness across the whole of Northern Europe. We've seen pockets of weakness. But we've seen, like I said in the prepared comments, some strength for our business, for example, in Germany, despite the fact that we know that the industry in Germany is actually quite struggling. So we are seeing pockets of strength and occasional pockets of weakness in Europe. But as of yet, we still haven't seen a systemic weakness in Europe, but we have been cautious about it and we continue to keep our eye on that.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

And Mark, what specifically are you going to be doing in Europe in terms of advertising new products or, if you will, things outside of the macro that may drive the business in '13 versus '12? Or will it be very similar in terms of what you were trying to do last year?

Mark A. Sarvary

It's similar -- similar, but it's continuation. So for example as, again, I've said in some of the countries, like Germany and other of the major European countries, advertising is quite effective. And we find that it has really quite good ROI, and we will continue to invest in those countries, in doing that and building awareness. And remember that our awareness levels in Europe are still way, way lower than they are in the U.S. And secondly, we'll continue to introduce new products. I talked about the new TEMPUR Original, which is essentially a new version of our original line and it's improved in a variety of ways. But what it is, is a continuation of the intention of broadening the offering in each of the retailers, so that they will carry some representation of all 3 of our collections, the Original, the Sensation and the Cloud, and because we know that having that range of offerings is what really -- it makes sales really take off in a given store. So those are both continuation, but there's a lot of road left in there.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

And, I guess, my last question is, but beyond advertising, both U.S. as well as outside of U.S. Could you tell us -- I don't think you gave us what it was as a percentage of revenue for the year just ended, and then what -- rough guidance for those 2 regions for '13?

Dale E. Williams

Okay. For the year -- John, I don't know if you're still on, for the year ended -- for the full year or...

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Full year, full year '12.

Dale E. Williams

For the full year '12, North America, obviously, was down 4% in '12. Our International business was up 6% for the full year '12. Our Asian business actually was -- Asia-Pacific business actually was up more than that 4%. Our Asia-Pacific business for the year was up double digit. Our European business was up, kind of, probably, broadly, and I don't have it exactly in front of me, but the European business probably was up in the low-single digits, but some countries performed very well. Certainly, Southern Europe was especially weak, as you might expect. And there were some pockets of weakness in other parts of Europe that, as we experienced through the year, in general, the overall European market got softer. As we're looking at 2013, we are expecting, as I said earlier, from a North American standpoint, first quarter continues to be a very difficult comp. But for the balance of the year, we expect North America to be up mid- to high-single digits. On the international side of the business, we are expecting our International business to be up for the year in the low- to mid-single digits.

Operator

Our next question comes from Budd Bugatch of Raymond James.

Chad Bolen

This is actually Chad filling in for Budd. A couple of questions. I was surprised to hear you say that domestic mattress units were up 2% year-over-year, if I heard that correctly. Can you give us a little bit of color on where you saw that growth and kind of what drove that?

Mark A. Sarvary

Well, the first thing I want to say is that, it's a little bit colored by the fact that we had floor models. So if take out new floor models, it would probably be down 1% or so. But it's still fine as the stabilization that we've been talking about. And it's consistent with what we had expected. Obviously, there is a greater proportion in the fourth quarter of products, of the -- well, there is Simplicity included in the fourth quarter, which wasn't in the fourth quarter of last year, and obviously those retailed at a lower price. So that affects the sales, the sales not the units. But the units are relatively flat year-on-year.

Chad Bolen

Okay. And so if I do the math in domestic mattress, AUSP would have been down roughly 7-ish percent and, of course, that's affected by the floor models, that's affected by Simplicity as well. Any other major drivers of that or does that really sum it up?

Mark A. Sarvary

No, that sums it up.

Chad Bolen

Okay. And just a housekeeping, Dale, would you repeat what you had said about what your expectation is for Q1 operating margin?

Dale E. Williams

Yes. That's 17% on an adjusted basis, excluding transaction and the things related to Sealy.

Chad Bolen

Got you. And talking a little bit about some of the other product categories. It looks like domestic other sales lagged mattresses. Can you talk a little bit about what's going on there? I would have thought that maybe around the holidays that would be a better category. Has there been any kind of a change in the adjustable attachment rates or any color you can give us there?

Mark A. Sarvary

The bottom line is, you're right. The adjustables is the key component of that, and the adjustable attach rate hasn't changed materially in retail at all. There was a promotion in the prior year, in the fourth quarter and last -- 2012, we had it in the third quarter. So that caused some change of it. And also, it's like the attach rate on Simplicity, which is our biggest seller on direct, is slightly lower. But there's no fundamental change to the attach rates, overall.

Dale E. Williams

And the floor models impacted that as well.

Mark A. Sarvary

Yes, of course.

Dale E. Williams

You don't have Ergos on floor models.

Chad Bolen

Okay. So technically, year-over-year, it was down because of the promotion in the prior year, the floor samples and the Simplicity mix issue. But structurally, you don't think there's any major change there. Is that the right interpretation?

Mark A. Sarvary

That's exactly right. That's exactly right, yes.

Chad Bolen

Okay. And Mark, I was very much intrigued by your comments about TEMPUR-Choice and an adjustable firmness product. Can you give us any more hints about it? Are we talking about an adjustable air bed? Any other teasers that you could provide?

Mark A. Sarvary

We are quite excited about it. But, as I said, it is first and foremost, a Tempur-Pedic bed. And it has TEMPUR material and it is -- provides the support and the comfort of TEMPUR, it feels like TEMPUR. But it does have the ability to adjust, and I'm not going to go into great details, but it does use air as a component of its overall structure.

Operator

Our next question comes from David MacGregor of Longbow Research.

David S. MacGregor - Longbow Research LLC

Just to build on the International question, I know historically your European gross margins have been somewhat greater than your North American gross margins. So as you put together your guidance for 2013, what are you assuming in terms of change with that relationship?

Dale E. Williams

Actually, David, we do expect the International gross margins to continue to be higher. Now as we've talked frequently, there are 2 components to that. One is the fact that the North American business pays a royalty to our Danish business, where the technology was developed. So it's one pocket to another, but it does affect comparatives, gross margins. And then we have the benefit internationally of just slightly higher pricing with thinner mattresses, so there's a little bit less cost in them. But from a go-forward standpoint, we would not expect that to change dramatically. Actually, over time, those royalty rates are reducing, so that will squeeze the difference a little bit, but not dramatically in the short-term, like a year.

David S. MacGregor - Longbow Research LLC

With respect to the quarter just completed, can you just talk a little bit about variance and unit volumes within the price points in North America?

Dale E. Williams

Yes. No, we don't break our business down by price point for obvious competitive reasons.

David S. MacGregor - Longbow Research LLC

Sure. I just wondered if you could talk qualitatively in sort of bigger scale mix.

Dale E. Williams

Well, the only thing I would say is we had some new products, the Breeze products that performed very well. Those are higher-priced. So the higher-priced segment was benefited by the strong uptake on the Breeze. The other new products that we introduced, Weightless did well, but the Breeze was the one that was more of the shining star right out of the gates.

David S. MacGregor - Longbow Research LLC

Okay. Great. Final question, just again back to the guidance, could you to talk about your net sales growth for next year, 1.5%, 2%. What are you assuming in terms of net sales growth for North America versus net sales growth for International?

Dale E. Williams

As I said earlier, for the balance of the year -- for the whole year numbers, what we are looking at is International business being low- to mid-single digits and U.S. business, actually for the balance of the year, being similarly in a low- to mid-single digits. We look at them as potentially having roughly the same growth rate, but over the course of the year now it won't come out that way. So that's why I gave a little bit of a range on each, but we do expect both segments to show growth next year.

David S. MacGregor - Longbow Research LLC

Okay. And one more if I could just quickly. You talked last quarter about number of manufacturing issues you were facing with the Breeze and the Weightless. I'm just wondering if those have been cleared up or whether those conditions would continue to the extent that they might impact shipments around some of the new products you're going to roll out next week.

Mark A. Sarvary

Well, the Breeze -- the issues with the Breeze and the Weightless have been resolved. And there would -- the issue, as we said on the call last time, we had underestimated the demand. And so it was a function not so much that we weren't manufacturing, it's just that we didn't realize how many we were going to need. So that has been addressed. And on the new products, we're going to do as we do with any product, we're going to make sure we have the amount of inventory and so on that we need. But again, there's always a degree of risk when you're projecting what things are going to be. So I think we've made the right preparations and I think -- but I can't say until we're further down in the path. But we've made the same preparations as we normally do.

Operator

[Operator Instructions] Our next question comes from Reza Vahabzadeh of Barclays.

Reza Vahabzadeh - Barclays Capital, Research Division

Dale, on the gross margin guidance, can you just maybe outline some of the key puts and takes that goes into your thinking, whether it's input costs, sales leverage, mix, anything of that sort?

Dale E. Williams

Yes, for this -- for 2013, as I said earlier, from a gross margin standpoint, we're expecting very slight decrease in gross margin on a year-over-year basis, flat to slightly down. And that's really a function of a couple of things. One, we are expecting some slight increases in commodity costs; number two, the big negative driver there is product mix, as the Breeze is doing well, Weightless is doing well, I think one of the things David may have been hinting at earlier but didn't specifically say is, with any new product, you can have some startup costs but then also these are brand-new technologies that are a little bit more expensive technologies and any time you have a completely new technology, you've got a tremendous learning curve to go through to improve the cost. So the mix of those. And then we've got other new products that we're going to be introducing this year, along with Choice and others. So those are the key negative factors that are affecting gross margin this year, but we do expect -- our productivity program is back and fully invigorated. So we're looking for good productivity improvements and ideally, a lot of those will come on some of the new technologies to improve those margins over the course of the year.

Reza Vahabzadeh - Barclays Capital, Research Division

Got it. And maybe, Mark, if you can just outline some of your assumptions and your comfort around North America sales being up mid-single digits starting in the second quarter. What goes into that thought process?

Mark A. Sarvary

Well, it's a function of the comparison. I mean obviously, we've got a tough, I don't know if you can call it a good compare, but a horrible compare, whatever, from year-to-year. But the other thing though is that, obviously, the steps that we took in the third quarter, which created the stabilization that we started to see, is going to have the effect going forward. And that's one component of it. And the effectiveness of our promotion and promotions and so on is one component of it. And then the other component is that we're going to have a full year of Breeze, which is Breeze and Weightless, which are both doing quite well. So whereas that was something that didn't exist in the first half of last -- in the second and third quarter of last year, it does this time. And also, we have the new products that we will be launching at Vegas, and then, again, we expect that there will be more again in the August Vegas.

Reza Vahabzadeh - Barclays Capital, Research Division

Right. So the full impact of the new products to be launched in Vegas, you expect them to be realized and impact your sales, I suppose, in the second quarter?

Mark A. Sarvary

Second half, starting in the second quarter.

Dale E. Williams

We'll start rolling out the new products from the January Vegas, the show next week. We will start rolling those out in the second quarter.

Reza Vahabzadeh - Barclays Capital, Research Division

And then did you outline your new product introduction cost and the inefficiencies that go along with that for 2013?

Dale E. Williams

Reza, we actually have never really broken that out. It's something that is an ongoing component of the business. Probably for 3 quarters of any given year, we have new products rolling out. The floor model cost associated with that is partly a function of the price of the products and also a function of how broadly distributed it becomes.

Operator

Our next question comes from Keith Hughes of SunTrust.

And we'll go ahead and move on to the next question. Our next question comes from Brad Thomas of KeyBanc Capital Markets.

Bonanza Chalaban - KeyBanc Capital Markets Inc., Research Division

This is Bonanza Chalaban in place of Brad. So just going back to the fourth quarter. You had a good improvement sequentially in top line trends from the third. Could you maybe just talk a little bit about the trends and how they played out intra-quarter? We would just be interested because one, it seems like consumer spending was a little bit choppy during the quarter from a macro perspective; and two, you had a lot of initiatives going on and it sounds like those are gaining traction.

Mark A. Sarvary

Yes. I mean, the fourth quarter was relatively consistent through the quarter. There was obviously the hit of...

Dale E. Williams

Sandy.

Mark A. Sarvary

Sandy, which did have an impact. But within the bounds of normal volatility that one gets because of when Christmas falls and so forth, it was relatively consistent through the quarter. Except for Sandy, which wasn't consistent.

Dale E. Williams

Sandy impacted a couple of weeks there pretty severely.

Bonanza Chalaban - KeyBanc Capital Markets Inc., Research Division

Okay. And then you just launched the Breeze and Weightless in August of last year. It appears that you're going to be launching a couple of more in the coming weeks and months of this year. How many models do you think is the right number to be launching each year? And do you think something like 2 is the right number or are the company resources being a little stretched?

Mark A. Sarvary

I think that's a good question, and it's an important question. The critical way to think about this is that we need to be sure that the product range viewed as a whole is A, is optimized from, obviously, from our point of view but very importantly, from a retailer point of view. We want to make sure that the range of offerings we have, in totality, provide a very broad range of -- satisfy the needs of a broad range of consumers at premium price points in a differentiated manner that are effective together for the retailer. Some part of that is -- some component of that is adding new products as we find ways to meet the needs of consumers that we, until then, had not been able to meet the needs of and sometimes, it's going to be improving products that exist already. And overall, it's going to be viewing it from a category management point of view of how do we optimize the collective offering. And that is something that will be of increasing importance to us in this year and going forward. Over the last years, we've grown from having a relatively smaller group of offerings to quite a larger -- to having a large group and it's important but they -- and we always think about this, how they fit together. So it's not so much as saying we can have 1 or 2 new products a year as it is we are constantly working to optimize the collective -- the range as a whole.

Operator

Our next question comes from Jon Andersen of William Blair.

Jon Andersen - William Blair & Company L.L.C., Research Division

I wanted to start with -- gross margin improved sequentially, I think you said 80 basis points. You talked about that -- one of the reasons for the improvement, I guess, was less promotion, less discounting. Can you talk a little bit about what you're seeing from that standpoint at, I guess, the retail and wholesale level? Do you think we've hit a point where the worst of that is behind us?

Mark A. Sarvary

Well, what it is I would say is more of an efficiency gain than -- as I said when we started to modify our approach in light of the competitive environment, that we were going to be working at ways to improve our effectiveness in promotions with retailers and that some of the things that would work well and some would work less well but that we would learn and we would apply what we learned. And we are doing just that. And I think we're getting a bit smarter and a bit more efficient. But on the other hand, I think it's an ongoing process of learning, and we will continue to learn and continue to develop. So it's not like we now know the answer and we're going to apply it. But on the other hand, I think we're a lot -- we're smarter than we were and we will continue to get smarter.

Jon Andersen - William Blair & Company L.L.C., Research Division

That's helpful. A point of clarification on your sales guidance for the first quarter. You had commented earlier that you expected sales to be flat to slightly down year-over-year. Was that accurate or flat to slightly down sequentially?

Dale E. Williams

Sequentially.

Jon Andersen - William Blair & Company L.L.C., Research Division

Okay. Given that, it looks like that kind of implies a double-digit decline on a year-over-year basis, which would be the -- that would be the, I guess, the highest decline over the past year, which is just a little surprising to me given the commentary around some improvement or bottoming in North America. Just any color there would be helpful.

Dale E. Williams

Yes. Well, I think, from a color standpoint, as we said, we did have benefit in the first quarter this year of -- I'm sorry, in the fourth quarter. So from a sequential basis, the Breeze, the Weightless were still -- and we just started shipping those in September, the bulk of the rollout occurred in the fourth quarter. They're basically substantially complete and from the rollout of those products by the end of the year. So that did have a benefit to the fourth quarter that is not going to be there in the first quarter. Plus on a year-over-year compare, we did have the Simplicity starting to roll out at the end of the first quarter last year that we're not expecting today, to start shipping the new products we'll introduce next week, until the second quarter. And then from an International standpoint, which is also a key component, we are not expecting internationals to turnaround on a dime. The International business is hanging in there. Asia Pacific continues to do fairly well. Europe has been a little disappointing with the economic environment but we don't expect that suddenly -- substantially get better.

Jon Andersen - William Blair & Company L.L.C., Research Division

Okay. That's fair. I guess you can could see why I would raise the question because the compare actually -- the Q1 compare year-on-year is easier than the compare you had in Q2, 3 and 4 of '12. And it seems like things are getting better on the margin in North America. It just feels like maybe there's some conservatism in that, maybe that's what I'm trying to get a sense for.

Dale E. Williams

I think as Mark has said before, from your mouth to God's ears. Yes, we'd love for that to be the case.

Operator

Our next question comes from Joe Altobello of Oppenheimer.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

I just wanted to follow-up on Jon's question. I mean, obviously, I understand the commentary you gave regarding the timing of new product introductions, et cetera. But if you look back historically, seasonally, I think, it's been probably 4 years since the financial crisis where you haven't seen a sequential improvement from 4Q to 1Q. I mean, is it all due to timing? Were there certain promotions that might have happened late in the quarter that might have pulled some demand forward?

Dale E. Williams

Yes. No, Joe, we understand that from the North American standpoint, seasonally, there's usually a little bit of an uptick in the first quarter. However, internationally, seasonally, there's a downtick in the first quarter from the fourth quarter performance. Our view is -- the way that we're that we're trying to look at this is we had benefit in the fourth quarter not from a promotional thing but from the rollout of the floor models and we don't really have floor models in the first quarter. We have new products that we're going to be introducing next week that we think people are going to be very excited about. The retailers that have seen them are excited about them but they're not going to start shipping until the second quarter. So we think that there's just some -- we haven't totally turned the corner here yet and ideally, we're just thinking that there's a little bit of pressure there. And so it's going to be between possibly a little bit of benefit in the U.S., the International seasonality is lower there. And so we're just trying to balance, and from an outlook standpoint, thinking the current trends are what we should continue to guide.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Okay. And in terms of the Choice line, is that going to replace an existing SKU or collection or is that going to be completely incremental?

Mark A. Sarvary

That's a new line.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Okay, so it's completely incremental. And then just lastly, just in terms of the advertising, I think you said in the fourth quarter of this year was 9.8% of sales, and I guess full year was 11.8%. What do you think that looks like in '13 and how much of that is going to go toward the Choice line? Is that going to be disproportionate behind Choice or is it to be spread out amongst your different new offerings?

Mark A. Sarvary

The amount -- the plan is to spend something a little bit less than we spent last year. But still, a very healthy amount, in excess of 10.5%. And also in last year, we spent disproportionately in the first half and not so much in the second half. This year, we'll spread it more evenly across the year. And as far as how we're going to focus it, in general, we use advertising that applies to -- the bulk of our advertising will advertise the whole line and then we'll use some of it to introduce new products. But in general, we'll tie them together. So it's -- we're always going to be -- we'll communicate, obviously, we'll advertise the Choice line but it will certainly not be the only thing we advertise. The bulk of our advertising is about the brand Tempur-Pedic.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Okay. So the spread amongst the advertising dollars will be relatively normal, as we've seen in past years?

Mark A. Sarvary

Exactly.

Dale E. Williams

Exactly.

Operator

Our next question comes from Jessica Schoen of Barclays.

Jessica Schoen - Barclays Capital, Research Division

You talked a little bit about new product introductions at the higher end of your pricing range and investing in R&D to drive innovation and potentially, ASP. I was wondering how your assumptions about ASP fit into your guidance for the top line in 2013?

Dale E. Williams

Well, Jessica, we would expect to -- ideally, it would be nice to see some ASP benefit. Certainly in 2012, we saw some ASP reduction, but we are shifting the focus a little bit more to the higher end of the line. Simplicity was an ASP drag in 2012. The change in economics was a bit of a nasty drag in 2012. Those economics will continue, but items like Breeze and some of the other new products that we will have, that will be focused a little bit more to the higher end of the line. Ideally, we'll start to reverse that trend.

Jessica Schoen - Barclays Capital, Research Division

Okay. And then going back to the comment about the initiatives you've rolled out over the last year and continuing to learn about the impact of different initiatives, as well as the commentary about decreased promotions and discounts in the quarter. What -- is there anything baked into the guidance for gross margin in 2013 that we should be thinking about, about any potential further evolution of those initiatives?

Dale E. Williams

No, what I said about gross margin is we expect gross margins to be down slightly in 2013 and it really is not a function of changing economics or anything, it's a function of product mix. As I said earlier, some of the newer products, particularly with the brand-new technologies, start out at a little bit lower margin than fleet average gross margin. And ideally, as we build volume and build learning, we learn to make them less expensively, and we're able to improve the margins on those products through lower cost. So that's really the expectation that we're looking at there. In our outlook on gross margins, we are not thinking that there's going to be additional or a radical change in economics.

Operator

[Operator Instructions] Our next question comes from Peter Keith of Piper Jaffray.

Jonathan N. Berg - Piper Jaffray Companies, Research Division

The is actually Jon Berg on for Peter tonight. Dale, just a couple of housekeeping questions left from us. And the first one is, could you give us an update on your domestic and international door counts?

Dale E. Williams

Sure. Let me pull that out here. Door counts, on the international side, the door count is right about 5,700. Last quarter was 5,600. So about 100 doors added there. On the domestic side, looks like door count is up about 50, so it's right about 8,700. Now that's the total North America. So a number that you would more readily recognize, that includes Canada. So 8,300 for U.S., that's the number we generally talk about.

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Okay, great. And then secondly, if you look at your International sales, what were they on a constant-currency basis?

Dale E. Williams

Yes, constant-currency impacted International. It didn't affect the total business just because of the size, relative sizes of the business. Constant currency though did affect the International negatively, about 2 points in the fourth quarter. So currency was less of an impact than it's been all year, but that was principally because the dollar strengthened late in 2011. And so the comparison there, and then it weakened a little bit here in the fourth quarter of 2012. So the year-over-year compare was much closer in the fourth quarter.

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Okay, great. And then one last one if I could sneak it in. On the -- and I apologize, I might have missed some of this, but I think you said you were going to be switching away maybe, from the Ask Me campaign. I was just curious on -- did you mention any timing around that, when that might occur this year?

Mark A. Sarvary

We are -- our new campaign, the one that we -- our new campaign that we would anticipate going with for an extended period will launch in the second quarter of this year.

Operator

Our next question comes from Keith Hughes of SunTrust.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Most of the questions have been asked but just on pillows and domestic pillows, could you give us sort of a feel of what's happened there, what you're going to be going in the future? I know it was down substantially year-over-year?

Mark A. Sarvary

Yes. The pillows is a bit lumpy to begin with, and there are -- and it does get affected by, some retailers buy in substantial quantities in one quarter or another, so it can make it move quite a lot. But the overall -- pillows is something that we are not pleased with and it's something that we will continue to focus on.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And we have several questions on the first quarter. When did Simplicity kind of hit its peak in terms of sales in 2012, so we can consider that comp?

Mark A. Sarvary

Second quarter, but it was substantial throughout the year. It's not like it's gone away. It's still a substantial contributor today.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

But it hit run rate in the second quarter?

Mark A. Sarvary

That's what I believe. Yes, that's what I believe. But it would be second or third. But the point is, it's not right, you wouldn't be right to project it like a spike. It rolled out during the second quarter primarily. And its sales, therefore, would have been augmented by the floor models. And while its sales have slowed, it is still -- I just -- forgive me, I don't have the exact numbers off the top, but don't treat it as a spike. It is throughout the year.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And I guess, finally on Tempur-Pedic Choice, we'll see more about it next week. But in terms of support for retailers, the adjustable business has always been one that the independent retailers, at least when Select Comfort was an independent retailer, they always struggled with the whole sales process a little bit, it was a little bit different. Is that something you're going to address with your support for retailers or is there different plan? Any sort of details on that would be helpful.

Mark A. Sarvary

Listen, seriously, that is a -- clearly, we've given good consideration to that and we -- but I think it would be much better, and I'd like to address that question when we're standing in front of the collection in Vegas next week.

Operator

Our last question comes from Joan Storms of Wedbush.

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

I just had a quick question on just list [ph] of retailers and relationships and things there. We know, because Mattress Firm is a public company, that they had specialty beds, had increased in their stores from around the 10 count to sort of the low 20s, and it seems to be sort of staying there. Can you comment on still there might be opportunities out there with other retailers that are up-and-coming or other large ones that may be playing catch up in the specialty field or how are you feeling about their addressing the specialty business?

Mark A. Sarvary

I think it's fair to say that across-the-board, specialty is growing. And I think that what people are recognizing is that it's important, as the -- the retailers are, across-the-board, I think, recognizing that it's important to make sure that as they grow the specialty business, which is one that not only is growing in aggregate, but also is one that has very good consumer response, is that they want to make sure that they're maintaining their ASPs. I know that a lot of the retailers are making sure that they put a focus not just on specialty per se, but on making sure that they're focused on premium specialty. And I -- so that's something obviously that we encourage, because we are committed to providing products that are innovative and that can justify a premium price and meet the needs -- and make -- deliver a happy consumer who doesn't return the bed. So I think that's where retailers are increasingly focusing across-the-board.

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Okay. And then just briefly, we have seen a couple of articles and trades -- in the trades, I guess, regarding iComfort not being able to compare some of their advertising product to yours. Do you foresee any benefit from that if that is the case?

Mark A. Sarvary

We take very seriously the importance in all of our commercials in making sure that things are -- can be validated and are justified. And obviously, we're very proud of the fact that Tempur-Pedic mattresses are -- sleep, frankly, cooler than any of the competitive ones, and with our new Breeze products, sleep materially cooler than regular mattresses. So we just want to make sure that the right messages are getting out to the consumer.

Operator

I would now like to turn the call back over to Mark Sarvary for closing remarks.

Mark A. Sarvary

Thank you very much. We look forward to talking with you all again in April when we will host the first quarter earnings conference call. And I hope I'll see many of you in Vegas next week. So thanks a lot, everybody.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.

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