Executives
Kenneth Walker – Senior Vice President, General Counsel, Secretary
Lawrence Rogers – President and Chief Executive Officer
Jeffrey Ackerman – Executive Vice President and Chief Financial Officer
Mark Boehmer - Treasurer
Analysts
Budd Bugatch – Raymond James
Keith Hughes - SunTrust Robinson Humphrey
John Baugh – Stifel Nicolaus
Joel Havard – Hillard Lyons
Reza Vahabzdeh – Barclay’s Capital
Karru Martinson - Deutsche Bank
Grant Jordan - Wachovia
Sealy Corporation (ZZ) F4Q08 Earnings Call January 15, 2008 5:00 PM ET
Operator
Good day and welcome to the Sealy Corporation’s fourth quarter fiscal 2008 earnings conference call. (Operator Instructions) At this time I would like to turn the conference over to Mr. Kenneth Walker, Senior Vice President, General Counsel and Secretary of Sealy Corporation. Please go ahead sir.
Kenneth Walker
Good afternoon everyone. I want to thank you for joining us on Sealy’s financial fourth quarter 2008 investor conference call.
Before we begin let me remind you that in accordance with the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, the company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements.
Such statements are subject to risk, uncertainties and other factors that may cause the actual performance of Sealy to be materially different from the performance indicated or implied by such statements. Such risk factors are set forth in the company’s Annual Report on Form 10-K for the year ending November 30, 2008.
I’ll now turn the call over to Lawrence Rogers, President and Chief Executive Officer of Sealy Corporation.
Lawrence Rogers
Good afternoon. Thank you Ken. I want to also thank all of you for joining us on our call to discuss Sealy’s fourth quarter results. Joining me today are Jeff Ackerman, our Chief Financial Officer and Mark Boehmer, our Treasurer.
On this call I will provide an overview of the industry and our fourth quarter results as well as an update on the progress we are making on our strategic operating initiatives. Jeff will go into more detail on our fourth quarter financial results and some early thoughts on 2009. Then we will open up the line for your questions.
The fourth quarter was very challenging for the industry. In fact it was even more difficult than we anticipated and our results were below those of our third quarter as economic conditions in many of our global markets deteriorated even further. Despite this challenging environment we continued to focus on executing on our strategic initiatives and positively affecting the areas of our business that we can control.
In particular, during the fourth quarter we made measurable progress on a number of very important fronts including amending our credit agreement and completing the launch of our new Posturepedic line as well as responding to the current environment with a focused selection of new, value priced Posturepedic and Sealy branded products and providing our retail partners with the best possible set of tools and products for this environment as well as continuing to take actions to right size the company’s cost structure including taking out an additional $9.5 million in the fourth quarter of fiscal 2008.
Throughout the year Sealy continued to generate meaningful cash flow and in fiscal 2008 we paid down $22 million in debt. These results are indicative of our strength as a leader in the global bedding industry.
Let’s turn now to the current market conditions we are seeing in the industry. Bedding demand became increasingly weak over our fourth quarter and already weak consumer spending was exacerbated by tightening credit standards. Retail traffic was down and ISPA, the mattress industry association reported that the USA bedding industry revenues got progressively worse throughout our fourth quarter, down 11% in September, 22% in October and 29% in November. As we have said in the past ISPA is not a perfect barometer of actual industry results but it is directionally illustrative of the difficulty the industry has been experiencing. There also appears to be continued disproportionate pressure on higher end price points across the industry with inner spring mattresses below $1,000 seeming to perform relatively better.
From a retail perspective the channels that appear to be impacted most by these trends are independent furniture stores and small, independent retailers. Department stores and sleep shops seem to be performing slightly better which we believe is due in part with their ability to supply consumer credit along with their continued ability to advertise.
We expect this environment could lead to further consolidation in the retail community including store closings and downsizing in some channels. We would not anticipate this to have a negative implication for the mattress industry over the long term but it could result in continued near-term pressure.
In many of our international markets, particularly Europe, we have also continued to see macro economic conditions worsen and retail conditions become more challenging. From a cost perspective in the fourth quarter the industry faced a dual threat of continued commodity inflation and cost de-leveraging in a declining volume environment.
Most of the bedding industry’s raw material input prices were at all time highs during our fiscal fourth quarter and were significantly higher than prior periods on both a sequential and an annual basis. Over the last month or so material prices have eased. Given the timing of our supplier contracts we would expect to see sequential easing of our input prices provided these input prices remain at current levels.
However, we would not anticipate benefiting from year-over-year raw material cost reductions until the back half of 2009 when we begin to anniversary the steep material inflation the industry experienced in Q3 and Q4 of 2008. Having said this, some of the commodity suppliers have the ability to reduce capacity to mitigate falling prices which could offset some of the positive impact that the industry would see.
In terms of manufacturing costs the significant fall off in unit volume experienced by the industry has caused a de-leveraging of fixed expenses and placed a drag on margin. Consequently, manufacturers are looking for ways to offset under absorbed fixed costs by reducing shifts and closing plants.
Sealy has not been immune to these pressures and we have responded by controlling the areas we can impact including; taking measures to reduce our fixed operating expenses such as closing our Clarion, Pennsylvania facility in October. Two, ongoing value engineering of our mattresses to improve the cost and quality of our beds and three, effectively working capital management.
Despite these macro headwinds, Sealy continues to be the best positioned player in the mattress industry. We believe our greater financial flexibility, significant scale, vertical integration, international geographic presence and our broader selection of products and technologies across all price points gives us a distinct advantage particularly in the current environment.
Let me now turn to a discussion of our fourth quarter results.
Total sales for the quarter were $326 million, down 20.3% from fiscal 2007 on a comparable, 52-week basis. Our fiscal 2007 results included an extra week which added $33.2 million in sales and $4 million in EBITDA to our fourth quarter results last year. Our domestic sales declined 23% on a comparable 52-week basis due to continued challenging retail conditions.
From a product perspective we continue to be pleased with the headway our new Posturepedic line is making. Sales for the Posturepedic line continue to significantly out-perform versus the prior line. Our Sealy promotional and inflation-buster products are also performing relatively well which illustrates the competitive advantage of our diversified portfolio of technologies and price points.
At the higher end of the market we, as well as the industry, continue to experience weakness. However, we have seen a pick up in the $1,000 plus price point for our new Posturepedic line relative to our prior line and we believe we are well positioned to regain share in this key price band. While our specialty business also faced ongoing macro pressure, our Smart Latex products continue to gain specialty market share in the fourth quarter.
From an international perspective trends continued to weaken during the quarter as anticipated. Sales in our international segment were down 14.2% on a comparable 52-week basis or 6.8% in constant currency. The weakness stemmed primarily from economic challenge in Europe and to a lesser degree in Canada which continued to see a slow down. However, we continued to experience growth in our operations in Mexico, Argentina and our Asia joint venture although the rate of growth has slowed compared to prior quarters.
We continue to believe that Sealy’s broad geographic presence is a competitive advantage which allows us to diversify our macro economic risk across regions and countries.
As we expected our profit margins declined materially in the fourth quarter due primarily to further increases in material costs and de-leveraging on lower sales volumes. Even with the two price increases which we effectively implemented in 2008, Sealy absorbed a significant amount of rapid inflation over the past year and we are moving into 2009 focused on repairing gross margin rates.
To offset the margin declines we continue to make good progress on lowering our SG&A expenses and in the fourth quarter we took additional headcount reductions and closed our Clarion plant.
Turning to our strategic initiatives, we made significant progress through 2008 on many of our key objectives. As a reminder, these initiatives were: One, growing our average unit selling price. Two, implementing new retail and direct-to-consumer advertising and marketing strategies. Three, improving our gross margins. Four, reducing our expenses. Five, continuing our commitment to the specialty business. Six, strengthening our international business.
Regarding our initiative to drive average unit selling price growth our actions throughout fiscal 2008 included the roll out of Posturepedic, new product introductions and selective price increases which resulted in a 4.8% increase in domestic average unit selling price in the fourth quarter. As I mentioned, we have continued to see a positive mix shift in our Posturepedic line compared to the previous line which helped us make further progress in regaining inner-spring market share above $1,000.
Additionally, we have continued to experience strong average unit selling price growth in our specialty portfolio due to the more competitive an upscale merchandising initiatives we have taken. To build on this progress in 2009 we are working diligently on the launch of the new Stearns & Foster line with the same team that redesigned and delivered Posturepedic. We have had a number of our top strategic customers come in to review the new Stearns & Foster products and the feedback has been very positive.
We are preparing to debut the entire Stearns & Foster line during the spring Las Vegas market subsequent to which we will be rolling out the products to our retailers during the latter part of the second and third quarters of 2009.
Our second strategic initiative was to implement new advertising and marketing strategies to the Posturepedic brand. We were successful in executing on this initiative in 2008 with the launch and deployment of the Better Six national advertising campaign through which we delivered over one billion impressions across TV, print and internet from the June to November period. Our retailers have continued to magnify the impact of their coop dollars by leveraging the Better Six campaign and those of our customers who are using the messaging continue to perform better than those who are not.
Our third strategic initiative was to improve our gross margin. In the context of a challenging inflationary environment we made significant strides in offsetting some of the raw material inflation throughout fiscal 2008. We will continue these efforts in 2009. One of the primary focuses is around value engineering. This includes: One, the components we use. Two, the manufacturing process. Three, the design of our mattresses to improve the overall quality, performance and cost of our beds. We are working on making changes to our existing mattresses and manufacturing processes such as exploring different flame retardant materials and process as well as improving pressure point management which has been a key differentiator for our products.
Additionally, we expect to improve gross margin through the development of new products using innovative and purposeful designs which we are now applying to the new Stearns & Foster line just as we successfully did with Posturepedic.
Our fourth strategic initiative was to reduce our fixed cost structure. We made significant progress in taking cost out of our business in 2008 through workforce reduction and aggressive cost take-out initiatives which have resulted in lowering our cost structure by an annual run rate of approximately $30 million. In the fourth quarter we initiated actions to deliver incremental savings in 2009.
We are creating a culture whereby we are constantly seeking opportunities to make ourselves more efficient and we have proven our ability to take cost out of our business.
While many of the actions we have taken have been concentrated in the U.S., we are now in the process of taking similar actions in our international operations.
Our fifth strategic initiative was to continue our commitment to the specialty business. In 2008 we introduced our new PurEmbrace Smart Latex line at Macy’s and based on this positive experience we are now preparing for wider distribution in 2009. We also introduced new visco product during the year which have positively impacted AUSP’s. In 2009 we plan to continue to introduce innovative new products such as a new hybrid latex bed which we are currently developing and plan to launch later in the year. We have continued to gain specialty market share with our Smart Latex and remain confident in the long-term growth opportunities for this business.
Our final strategic initiative was to continue to strengthen our international business. We are seeing weakness in Europe and to a lesser extent Canada due to the economic challenges in these regions. This weakness has been somewhat offset by our diversity in geographies such as Mexico, South America and Asia. We also purchased half of our New Zealand licensee subsequent to the end of the quarter. While this is a relatively small business we think this is evidence of our financial strength which still allows us to take advantage of such opportunities with our licensees when they arise.
Furthermore, in 2009 revitalizing our challenged international markets will be a key focus and as such we are taking actions to right-size our international cost structure to align it with sales trends while working to identify new revenue opportunities.
Looking into 2009 I firmly believe there is no company in the industry that is better positioned than Sealy. We have greater financial flexibility under our amended credit agreements, a broad portfolio of products across different price points and technologies, wider distribution with strong retail relationships and a diversified geographic presence. Against a difficult and ever changing economic backdrop we will continue to adapt to the environment and focus on controlling what we can to further enhance our position as the leader in the bedding industry.
With that I would now like to turn this call over to Jeff Ackerman, our Chief Financial Officer.
Jeffrey Ackerman
Thanks Larry. I would now like to walk you through the financial details. For the fourth quarter total retail sales were $325.8 million, a decrease of $115.5 million or 26.2% compared to the prior year. The fiscal year ended November 30, 2008 with a 52-week year compared to a 53-week fiscal year ended December 2, 2007.
The 53rd week in 2007 contributed net sales of approximately $32.3 million. On a comparable 52-week period, total sales decreased 20.3%. The net loss for the quarter was $42 million or $0.40 per diluted share compared to net income of $17.1 million or $0.18 per diluted share in the same period of 2007.
Included in the results of the fourth quarter of 2008 were an impairment charge of $27.5 million or $0.30 per diluted share for the write off of the good will related to Sealy’s Europe and Puerto Rice reporting units and refinancing expenses of $0.03 per diluted share associated with the amendment of our credit agreement.
It is important to note that the impairment is a non-cash charge to earnings and did not affect the company’s liquidity, cash flow from operating activities or debt covenants. Additionally, the 53rd week in 2007 contributed approximately $1.5 million or $0.02 per diluted share to fiscal 2007 results.
I will now go into more detail on the components of our fourth quarter sales results.
Total domestic net sales were $219.6 million compared to $311.4 million in the fourth quarter of 2007. Excluding the extra week in fiscal 2007 which contributed $26.2 million of net sales, domestic net sales fell by 23% year-over-year.
Wholesale domestic net sales which excludes sales to third parties from our component plans were $212.2 million compared to $307.9 million in the fourth quarter of 2007. Excluding the extra week in fiscal 2007 which contributed $25.9 million, wholesale domestic net sales fell by 24.8% year-over-year.
Average unit selling price or AUSP increased by 4.8% offset by a unit volume decrease of 34.2% or 28.1% excluding the extra week. Unit volumes were impacted by a challenging domestic economy resulting in weak retail demand especially on products priced above $1,000 per set.
Fourth quarter 2008 AUSP’s were favorably impacted by the price increases we implemented in December 2007 and July 2008. In light of this economic environment, sales of the Sealy branded products and new Smart Latex and Posturepedic product lines out performed the rest of the U.S. portfolio.
While the industry has experienced weakness in higher end price points we have managed to drive an increase in our Posturepedic sales at price points above $1,000.
Branded specialty product sales were down approximately 28% in the U.S. with a 41% decline in units offset by a 23% increase in AUSP. Excluding the extra week sales were down approximately 21% and units by about 36%. Our Smart Latex products performed relatively well and we believe continue to gain specialty market share in the fourth quarter while our branded visco sales were more challenged.
Both lines delivered double-digit AUSP gains on the strength of the new products introduced this year. Internationally, sales decreased $23.8 million to $106.1 million, a decrease of 18.3% from the comparable year period or 14.2% excluding the benefit of the extra week which contributed $6.1 million. On a constant currency basis, adjusted for the extra week, revenues declined 6.8% in the quarter.
The deteriorating retail environment in Europe and to a lesser degree in Canada were partially offset by gains in Mexico and Argentina. Excluding the extra week in the prior-year quarter our Canadian sales were down 18% or 7% on a local currency basis as a 1% increase in AUSP was more than offset by an 8% increase in unit volume. Our Canadian business has decelerated as Canada is facing a similar consumer slow down to what we have been experiencing in the U.S. market.
Turning to results in our European markets which are not impacted by the extra week, sales were down 13% in the quarter or 10% on a local currency basis. Our sales weakened given the slow down in the broader economic environment with sales of our finished goods products performing relatively better than our OEM products.
Our total gross profit was $118.4 million compared to $179.9 million in the prior year period. Our gross profit margin decreased to 36.3% of net sales compared to 40.8% in the fourth quarter of 2007. This decrease was primarily due to increases in raw material costs including inflation on steel and foam and de-leveraging of overhead expenses on lower volumes. These factors were partially offset by the price increases implemented since December 2007, continued improvements in manufacturing efficiencies and the improved gross margin of our new Posturepedic line compared to the prior line.
Additionally, within our Posturepedic line we have continued to experience a slight mix shift towards higher end products under the new line under relative success of sets priced above $1,000. Internationally, gross margins declined primarily due to higher raw material prices and de-leveraging of manufacturing expenses on lower volumes.
Consolidated SG&A expenses declined by $26.1 million from the same period a year ago to $117 million. This reduction in SG&A was driven by a $21.7 million decline in variable expenses and our ongoing efforts to aggressively reduce our cost structure which contributed to a $9.5 million reduction in fixed expenses. The actions we took to further streamline our cost structure included decreases in salaries and fringe benefit related costs and reduced spending on discretionary items.
These were partially offset by a $3.5 million impact from foreign currency fluctuations and $1.7 million of incremental severance costs.
We have made significant progress in reducing our SG&A expenses during 2008. However we experienced a de-leveraging of our SG&A expenses to 35.9% of net sales from 32.4% in last year’s fourth quarter. Of the 350 basis point increase, approximately 150 basis points were attributable to the impact of foreign currency fluctuations and severance costs. Despite the decline in sales we were able to generate positive income from operations excluding the goodwill impairment charge.
Adjusted EBITDA for the quarter which excludes goodwill impairment and refinancing charges incurred during the quarter declined to $21.1 million.
Let me now provide a brief overview of our full-year 2008 results. As I previously mentioned the fourth quarter of fiscal 2007 had an extra week compared to the same period in 2008. We estimated the extra week contributed $32.3 million in sales, $13.1 million in gross profit, $4 million in EBITDA and $1.5 million in net income.
For the full fiscal year, total net sales were $1.5 billion, a 12% decrease from the prior year. Domestic wholesale bedding sales declined 14.9% to $1.1 billion on a comparable 52-week basis. A 1.6% increase in AUSP was offset by a 16.2% decline in unit volume.
Internationally sales increased 3% to $442.3 million on a comparable 52-week basis or a 1.8% decrease in constant currency. Gross profit was $584 million or 39% of sales as compared with 40.9% of sales from the same period a year earlier on a comparable 52-week basis. Adjusted EBITDA for fiscal 2008 was $166.9 million.
Now onto our balance sheet. Looking first at accounts receivable. We continue to tightly manage our receivables during this difficult economic period. Our fourth quarter day sales outstanding were unchanged from the same period a year ago. Our domestic day sales outstanding remained essentially flat to Q3 but did increase approximately 2 days from the prior year levels.
Despite a 12% decline in our inventory levels, overall days inventory on hand increased two days driven by the results in the U.S. market.
Looking at accounts payable our day’s payable decreased seven days compared to last year as we took advantage of cash discounts available to us under our payment terms. Despite the challenges we faced during the year we generated $53.7 million in cash flow from operations in fiscal 2008. Capital expenditures totaled $25 million for the fiscal year ended November 30, 2008, down from $42.4 million in the prior year.
The company’s debt net of cash improved to $756.8 million, a reduction of $22.3 million as compared to the end of fiscal 2007. During the fourth quarter we successfully amended our credit agreement to increase the maximum leverage ratio under our financial covenants. The amendment increases the maximum permitted leverage ratio of total debt to EBITDA to 5.85 times through the third quarter of 2009. Then stepping down to 5.50 times through the second quarter of 2010 and stepping down again to 4.0 times thereafter.
The amendment also modified the definition of consolidated total debt removing the ability to reduce the amount of debt used in the calculation of the leverage ratio by the amount of cash on hand. As of November 30, 2008 Sealy’s leverage ratio of total debt to adjusted EBITDA as defined by our credit agreement was 4.69 to one.
Let me now provide some brief commentary regarding fiscal 2009. At this time we have limited visibility into retail trends and when a recovery will start to take hold. Therefore we are managing the business with the assumption this environment could continue for some time and we will maintain the approach we had in fiscal 2008. Control the elements we can to secure and grow our leadership in the industry and position ourselves for enhanced growth over the long-term.
From a margin standpoint we are focused on recovering some of what we gave up in fiscal 2008. In the second half of 2008 we saw a sequential increase in our material costs of approximately 15%. We expect that at current commodity levels as the quarterly pricing mechanisms in many of our supply agreements reset the majority of this increase will unwind by the end of the second quarter of 2009.
Consequently, we don’t expect to see year-over-year improvement until the second half of the year. However, this improvement would be significant if current trends continue. Additionally, given our lack of visibility into the timing of an economic recovery we will operate under the notion that sales will continue below prior year levels. Since this will have an ongoing de-leveraging effect on our fixed costs we will continue to evaluate our infrastructure in relation to the environment.
As Larry mentioned we will also continue our focus on value engineering to positively impact gross margin in the areas we can control including evaluating the components we use, improving our manufacturing processes and being innovative with the design of our mattresses to improve the quality and manufacturability.
SG&A expense management will also continue to be a key area of focus for us. We are developing and implementing plans to further streamline our domestic and international cost structure and reduce delivery expenses. Additionally, we would expect to realize a reduction in our product launch and advertising costs in 2009 given that we will be anniversarying the roll out of our Posturepedic line and the development costs of our Better Six advertising campaign.
However, we will continue investing strategically for the long-term and make the necessary capital expenditures to do so. This will allow us to reduce our spending in 2009 to levels below our historic 2% of net sales.
Overall we expect the near term to remain challenging but we will continue to make progress in managing the areas of our business that we can control in order to generate positive cash flow. We believe that the long-term industry fundamentals remain intact. In the last three recessions we have seen industry growth return at above average levels when economic conditions rebounded. Sealy is the largest and strongest manufacturer in the bedding industry and we believe this puts us in the best position to capture the opportunity when the market turns.
This concludes our prepared remarks. Operator would you please open the line for questions.
Question-and-Answer Session
Operator
(Operator Instructions) The first question comes from the line of Budd Bugatch – Raymond James.
Budd Bugatch – Raymond James
You gave us a little bit of color on the raw material and the sequential increase over the second half of 15%. I wonder if you could provide any more color maybe in dollars and how the third quarter looked or how it looked year-over-year fourth quarter.
Jeffrey Ackerman
Let me try and give you a little bit of color. As I said, we saw the costs on our raw materials increased 15%. I just want to clarify that was sequentially from the beginning of the third quarter and they ramped up continuously through the quarter and by the end of the quarter we were at levels about 15% higher than we began the first half of the year. As we look forward we have fairly decent visibility into our performance around cost for materials in the first half of the year so about six months out.
What we anticipate is that we would see most of that price increase unwind so by the time we get to the end of the second quarter that has been fully unwound.
Budd Bugatch – Raymond James
So at the end of the second quarter you will be at the same place you were at the end of the second quarter or third quarter of 2008?
Jeffrey Ackerman
We should be, again assuming commodity trends don’t change, we should be right to where we ended Q2 2008.
Lawrence Rogers
The only rider we would place on that is in some of the larger upstream commodity suppliers in the chemical field for instance, have the ability to restrict capacity and they try and control pricing relative to available capacity. So that would be the only watch out we would have to prepare for.
Budd Bugatch – Raymond James
Would you want to hazard a dollar number on the increase you had in raw material costs in the fourth quarter over a year ago?
Jeffrey Ackerman
I’ll share that our raw material costs as a percent of our cost of goods sold is roughly 2/3.
Budd Bugatch – Raymond James
When you look at your SG&A can you give us a feeling of what advertising, I know we will see that in the K and I’m not sure when you are planning to file that, what advertising and promotional expenses look like this year?
Jeffrey Ackerman
The K will be filed this evening and so you will be able to see that. For the year we were at total advertising cost of about $155 million.
Budd Bugatch – Raymond James
My last question has to do with your accounts payable. We noticed the significant draw down of $55.7 million in the fourth quarter of your accounts payable and you said you had taken advantage of some discounts. What is a normal run rate going forward for payables?
Jeffrey Ackerman
We did pay down our payables at the end of the year and took advantage of some cash discounts. We are going to just manage that as we need to throughout the year.
Budd Bugatch – Raymond James
A lot of days different this year versus last. Is this just an unusual end of year timing issue?
Jeffrey Ackerman
We had greater flexibility with our amended credit agreement and there were some cash discounts out there so we chose to just go take advantage of that.
Budd Bugatch – Raymond James
Do you care to hazard an idea of third quarter is when we will see gross margin improvement year-over-year and up margin improvement?
Jeffrey Ackerman
As I was saying, I think that it is incredibly difficult at this point to see what the retail environment is going to do. If you look at what is going to drive our margins it is two things; first, the material prices we talked about. So in the back half of the year if nothing changed from the trend we are on right now we can see some significant improvement. The second factor is I talked about what impacted the fourth quarter was really the de-leveraging of our fixed cost base. Those are the two things that will impact us. As we look forward in 2009, Larry, I and the management team are very much focused on making sure our fixed cost structure is right sized for the revenues that we have and we are going to continue to do the things we have always done around value engineering and lean manufacturing and we are going to be continuing just to apply those principles.
Operator
The next question comes from Keith Hughes - SunTrust Robinson Humphrey.
Keith Hughes - SunTrust Robinson Humphrey
On the raw materials you said 2/3 of cost of goods sold for raw materials. Is that correct?
Jeffrey Ackerman
Yes.
Keith Hughes - SunTrust Robinson Humphrey
If you look at that based on the price you are seeing are you seeing a bigger decline in petrochemicals, raw steel, springs? Where is it coming from?
Jeffrey Ackerman
What we saw during the year was the largest increases were in steel.
Keith Hughes - SunTrust Robinson Humphrey
I’m talking about since the increases. What has been coming down?
Jeffrey Ackerman
What has been coming down faster is the steel but it had a lot farther to come down as they say.
Keith Hughes - SunTrust Robinson Humphrey
Is this the raw steel you are buying that you are turning into springs or is this the finished items you are buying?
Jeffrey Ackerman
What we do because we are vertically integrated is we are just buying drawn wire.
Keith Hughes - SunTrust Robinson Humphrey
Can you give us the break down of gross margin domestic versus international?
Jeffrey Ackerman
Gross margin, and you are just talking about the quarter I assume, for the quarter we had for domestic was gross profit margin of 37.8% and for the quarter total international gross profit margin was 33.3%.
Keith Hughes - SunTrust Robinson Humphrey
You mentioned earlier the new Posturepedic line that was introduced last year out performing the lines that it replaced. How is that possible given how much business is down right now just in general?
Jeffrey Ackerman
Let me talk to you just about how we think about that. What we did was we were measuring pre and post launch and we looked at the trend we were seeing on the old line and compared those to the trends we were seeing on the new line after the roll out. We are looking at that on a customer-by-customer basis.
Keith Hughes - SunTrust Robinson Humphrey
Business in December and early parts of January. Is it worse than the numbers you have reported here in the United States?
Lawrence Rogers
I would say that December continued to be difficult. In January we are seeing a little bit of moderation to that trend. Of course January for us is only about 60% over so I base that comment on our point in time. Conditions out there are being drive by very tight consumer credit and the consumer sentiment you are seeing reported every day coupled with the job market does not make an easy market.
Jeffrey Ackerman
Let me just add on to that it is really volatile still and so at this point I think it is really hard to draw any conclusions from what we are seeing. As Larry said we are still early on and we are just looking at this business going forward assuming the pressures we saw in the fourth quarter that those could continue for some time.
Operator
The next question comes from John Baugh – Stifel Nicolaus.
John Baugh – Stifel Nicolaus
I think you mentioned the expectation of consolidation at retail. Are you guessing or are you talking about what you have already seen? If it is the latter could you put some color on what you are seeing and how that may impact you? Then I’m also curious on the credit front of your mattresses that you sell in the United States how many do you think are bought on credit by the ultimate consumer and what are you hearing from your retail customers about the percentage of rejection if you will on credit versus a year ago?
Lawrence Rogers
Let’s start with your first question about consolidation. There is risk in this environment there is no question. That is a high level of focus for us. We are monitoring our retail relationships very closely and we are in regular communication with our customers so we are just watching closely. I don’t think one has to be too much of a clairvoyant to consider this is the toughest time that anyone has seen in recent memory and that will have an impact on some retailers. As I said in my script we are seeing tougher times for independent retailers than we are for some of the larger ones so we are anticipating there could be some consolidation.
On the credit front, clearly when someone goes into a mattress store part of the sale may or may not include largely being predicated on available credit and this is a pretty aspirational category. So many people may go in shopping for that $999 advertised product but with good salesmanship in normal times they could be sold up or traded up to a $1,399 or $1,499 product. We believe that there is less of that happening today because of the tighter control of credit. We think that is going to impact.
But let’s really go onto what we can do. We are continuing to make our retailers as successful as possible. We are providing them with great new products as we have done with the Posturepedic and PurEmbrace Smart Latex and we are value pricing some of our inner-spring product lines. Clearly the inflation busters we offered this past year are performing rather well and the work we are doing on the new Stearns & Foster product and some of the hybrid latex lines you will be seeing in 2009. So we are going to continue to provide them with great product with innovative features and strong advertising so they can leverage their coop advertising dollars.
John Baugh – Stifel Nicolaus
Do you have any feel or any guess, again how much of Sealy mattresses are sold in the U.S. by retailers on credit?
Lawrence Rogers
It depends on the channel. Some channels that have access to greater amounts of credit like some of the larger department store chains clearly some of them have their own credit cards, long established relationships with the credit facility and indeed some of the larger sleep shop chains because of their size and their leverage have very strong relationships with the credit facility.
John Baugh – Stifel Nicolaus
Could you maybe comment, Bud was trying to get at working capital for 2009? Could you sort of talk in the context of the 5.85? If you divide that by your current debt you’d need EBITDA of $130 million I think and G&A is around 30 or so. I think there are a few other items. So it implies EBIT needs to be 90. You didn’t run at that rate in the fourth quarter but I’m curious as to, I’m not asking you to make an earnings estimate or when you will trip covenants…that is not the question. The question is do you need to reduce debt as rapidly as you can and not pay cash discount and manage the working capital to reduce debt? Is that going to be a strategy or do you still have the flexibility to do investments or other things that come up?
Jeffrey Ackerman
This is how we are thinking about it, as you mentioned we are going to make some investments and we are going to be adapting to the market so we have got specific actions we are going after. Let me just kind of walk down P&L how I think about this. There are clear actions we are going after to drive the top line. Just like we were successful in launching the Posturepedic line we are going to apply a lot of the lessons learned there to successfully launch the Stearns & Foster line. We also have the Latex products coming. So we are focused on that. We are looking forward to seeing how material costs are going to trend and in the back half of the year that would give us some significant opportunity again if current prices hold. Then to further improve our gross profit margins we are going to be looking at value engineering and ongoing lean manufacturing initiatives. Then on the SG&A side our opportunity is a couple of easy ones. One is we are anniversarying the launch of the Posturepedic line. We are also anniversarying the cost of producing the Better Six campaign. Then we have the full year effect of the actions we took during 2008 so we will get some benefit from those. We are focused on additional items during 2009 both domestically and now with greater emphasis on our international opportunities.
So we are going to, as I think we have done in the past, we are going to aggressively manage our costs and aggressively manage our working capital and opEx as dictated by the market.
Operator
The next question comes from Joel Havard – Hillard Lyons.
Joel Havard – Hillard Lyons
Jeff I think you said something to the effect of closely monitoring, and I wrote capacity but I don’t think you said that, but the point you were getting to was where you might consider further capacity reductions. Could you elaborate on that theme? I guess to put that in the context of I believe it cost you $2.5-3.5 million earlier this year to close Pennsylvania. Would you be looking at similar sized issues or at some point would you pull the trigger on something more substantive?
Jeffrey Ackerman
I don’t believe I mentioned anything about capacity reductions.
Joel Havard – Hillard Lyons
Not specifically. That was my interpretation. That is where I was trying to drag you.
Jeffrey Ackerman
Larry and I are absolutely committed to doing whatever it takes in this environment to adjust our cost structure to align it with the pace of the current retail environment. So there are a variety of levers we could pull. We are going to do what is necessary.
Joel Havard – Hillard Lyons
I’ll take that as a broad enough statement. Just one follow-up of a housekeeping nature. Was the 91-ish million shares average at year end or is that ending?
Jeffrey Ackerman
That was weighted average.
Joel Havard – Hillard Lyons
Are we actually then closer to the high or mid 80’s?
Jeffrey Ackerman
If you are looking at the quarter?
Joel Havard – Hillard Lyons
Just squeezing the dilution out?
Jeffrey Ackerman
Our diluted and basic share count is the same.
Joel Havard – Hillard Lyons
Ending is still in the low 90’s then?
Jeffrey Ackerman
Right.
Operator
The next question comes from Reza Vahabzdeh – Barclay’s Capital.
Reza Vahabzdeh – Barclay’s Capital
On the gross margin line what were the major contributors to the gross margin decline? Is there any way you can break it down? I am assuming raw materials and the operating leverage were the major drivers. I’m not sure it is 50/50 or how you would attribute the gross margin decline.
Jeffrey Ackerman
I guess just kind of in rough numbers on approximation I would say it is roughly 2/3 materials and 1/3 de-leveraging of the fixed cost base.
Reza Vahabzdeh – Barclay’s Capital
To your comments are there tangible actions you think you can take to meaningfully offset these downward pressures on your gross margin over the next couple of quarters or will it take longer?
Jeffrey Ackerman
There are a couple of things we can do. Obviously one is we are going to continue to leverage our scale in negotiation with our suppliers but as long as the trend continues as I mentioned earlier on the raw material cost we should see improvement there. I would say that is probably the most meaningful thing initially. Was there something more specific?
Reza Vahabzdeh – Barclay’s Capital
I don’t know if you talk about value engineering so I don’t know if that is going to be significant. I don’t know if there is much you can do with plants and manufacturing or headcount to help the gross margin?
Jeffrey Ackerman
Let me just first clarify again for some others on the phone. The value engineering, when we think about that it is everything from the component used to the manufacturing processes we have to the designs of our mattresses that we employ. So those are things we have a very strong team of engineers to help us out with that and there is no reason the benefit we would see in 2009 would be any different than what we have seen historically. So a couple of areas, as an example of what we would work on in that area, is flame retardant materials. We are on probably our third generation of our solution and so we are looking at ways to reduce the cost associated with that by 10%.
We are also looking at ways to improve pressure point management of our products which has really been a key differentiator with our new Sealy Posturepedic line. So we are going to apply those learning’s to the new Stearns & Foster line and thereby with that line also have an opportunity to improve margins.
Reza Vahabzdeh – Barclay’s Capital
On the cash flow front, is there anything you can do minor asset sales just to generate some cash flow here and there so debt levels do not increase as EBITDA is under pressure? I don’t know if there are any actions you can talk about.
Jeffrey Ackerman
I would just again say that the levers we can pull are the same ones we were using last year. So what we did was again focus on good execution of any kind of product launches, so we had Posturepedic, we had the roll out of some new products in the fourth quarter, we are going to roll out a new Stearns & Foster line, we are going to aggressively manage our costs, we are going to aggressively manage our CapEx and if we need to we believe there are things we can do around working capital.
I just again want to remind folks we have generated $53.7 million of cash flow from operations during a very challenging year so there are levers we can pull.
Reza Vahabzdeh – Barclay’s Capital
On new product introductory costs which you just touched on would we assume that is going to be materially less than the prior year in the first half?
Jeffrey Ackerman
Yes and for really two reasons. One we will have a little bit of productivity around some of the learning’s from the Posturepedic launch. The other thing is that the Stearns & Foster line is just a much smaller line than the Posturepedic line so there are fewer slots but the cost of each slot is more. So again on a net basis there would be a material reduction in product launch costs.
Operator
The next question comes from Karru Martinson - Deutsche Bank.
Karru Martinson - Deutsche Bank
In terms of the broader industry some of the trade publications, Furniture Today for example, are saying 2009 you should see units down about 9.3, dollars down 8.5. When you look out in terms of the magnitude of the industry is that kind of how you are approaching the year?
Lawrence Rogers
We think the year is pretty difficult to really forecast. We admire the stab the trade press took at really cobbling those numbers together but it is very, very unpredictable at the moment. I think it is just too early to call. We have limited visibility into retail trends, it is hard to tell when that is going to actually start to happen.
We think the most prudent thing we can do is just planning that this economic situation is going to continue with us and we should right-size our organization and prepare for the worst and if something better happens then we are going to come out of this thing very sharply in terms of enhanced profitability with much lower cost basis.
Karru Martinson - Deutsche Bank
Given your relative strength to the other 300 bedding manufacturers in the country…
Lawrence Rogers
Actually it is 650.
Karru Martinson - Deutsche Bank
I was figuring by now it might be 300, that leads to the question what are the other players here on that and where are you feeling you are picking up share as both the industry consolidates and the retailers consolidate?
Lawrence Rogers
Clearly I think my script kind of referenced there is more pressure on the smaller retailers. Typically those are ones that aren’t national in nature. Our broad distribution and our plant network certainly allows us to service a large change whether it be sleep shops or department stores and in fact if small retailers disappear that end consumer is going to end up at those larger chains which we currently service. We think there is opportunity there in the likely consolidation amongst the smaller retailers in the country.
Karru Martinson - Deutsche Bank
In the past we have talked to suppliers and some of the bedding guys here it has been protracting the bedding versus the consumer confidence has always been singled out as if the consumer feels good they will shop. When you look out at the landscape do you feel that is the case or is consumer credit really going to be a bigger issue here as we go forward?
Lawrence Rogers
I think both have an effect on the market but clearly consumer credit is going to be a constraint and I think we need to see it get a little better. I think as the TARP money hopefully starts to find its way down it should be helpful. We look at the history the history somewhat is a bit of a window to the future. The past four recessions we have seen in this industry as we come out of it we have had strong single digit and in many cases double digit bounces and I don’t see why we should expect any different reaction this time. We need to get our cost structure right, lower than when we went into this recession so when the top line does bounce we can really regain profitability in a very quick fashion.
Operator
The next question comes from Grant Jordan – Wachovia.
Grant Jordan - Wachovia
First, you talked about you expect revenue and units to be under pressure obviously. How do you think the AUSP is going to react?
Jeffrey Ackerman
I think the AUSP that we are currently seeing have really been pressure tested, certainly the last six months of this year. We also believe that if Posturepedic continues on the track it is on we have a pretty good opportunity there and indeed the re-launching of Stearns & Foster I think we have been pretty open and honest we were unhappy with the current line of Stearns & Foster and with the launching of this into the higher price segment with it being new, fresh and with some innovative features we think we have the opportunity to move ahead with one of our initiatives being average unit selling.
Grant Jordan - Wachovia
As one of your large competitors’ deals with some financial issues have you seen any sort of benefit to you as you are dealing with retailers?
Lawrence Rogers
We have just stayed real focused on our game plan. We think it behooves us because you really never know how those things are going to turn out. We are just going to stay on our plan. We are going to focus on all the initiatives I talked about in my script and Jeff and I are just dedicated to get this company right sized and we are going to deal with the economy whether they be opportunities or challenges as they come along.
Operator
That concludes our question-and-answer session. At this time I would like to turn the call back over to Larry Rogers for closing remarks.
Lawrence Rogers
Thank you very much for joining us on our fourth quarter and annual call. We appreciate everyone in attendance and look forward to a call at the end of our first quarter.
Operator
That does conclude today’s conference. You may now disconnect.
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