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Executives

Mark Sarvary - President & Chief Executive Officer

Dale Williams - Chief Financial Officer

Barry Hytinen - Vice President of Investor Relations

Analysts

Mark Rupe - Longbow Research

Brad Thomas - Keybanc Capital Markets

Keith Hughes - SunTrust

Budd Bugatch - Raymond James

John Baugh - Stifel Nicolaus

Matt McClintock - Barclays Capital

Henry Kerpellen - Oppenheimer

Tony Gikas - Piper Jaffray

Joel Havard - Hilliard Lyons

Tempur-Pedic International Inc. (TPX) Q3 2009 Earnings Call October 15, 2009 5:00 PM ET

Operator

Good day, ladies and gentlemen and welcome to today’s Tempur-Pedic third quarter 2009 earnings call. This call is being recorded. Now for opening remarks and introductions I’d like to turn the conference over to Barry Hytinen. Please go ahead.

Barry Hytinen

Thanks Anthony and thank you for participating in today’s call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO and Dale Williams, CFO. After prepared remarks, we will open the call for Q-and-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 and earnings, involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company’s business. The factors that could cause actual results to differ materially from those identified include economic, competitive, operating and other factors discussed in the press release issued today.

These factors are also discussed in the company’s SEC filings including the company’s Annual Report on Form 10-K under the headings Special Note regarding forward-looking statements and Risk Factors. Any forward-looking statements speak only as of the date on which it is made. The company undertakes no obligations to update any forward-looking statements.

The press release, which contains a reconciliation of non-GAAP financial measures to the most directly comparable GAAP measures is posted on the company’s website at www.tempurpedic.com and filed with the SEC. I would also like to remind investors that we will be hosting an investor presentation next Thursday, October 22 beginning at 10.30 am Eastern Time. A live webcast of the event will be available on our website.

Now with that introduction, it is my pleasure to turn the call over to Mark.

Mark Sarvary

Thanks Barry and good evening everybody and thanks for joining us today. Today I’ll provide a brief overview of our performance in the third quarter and then will give you an update on our progress on our key strategic initiatives. Dale will then provide a detailed review of the quarterly results and our updated guidance.

During the third quarter we continued our focus on maximizing sales, improving margins, and generating cash flow and uncertain environment. While sales are still down a 11% from last year, again this quarter they improved sequentially, they were up 21% in the third quarter compared to the second quarter.

Throughout the economic downturn, we have not seen normal industry seasonality, but in the third quarter we do attribute some of our improvement to a seasonal lift in all trends. Our productive projects help to increase gross margins by 590 basis points to 47.6%. Lower commodity cost and pricing also a big factors in the improvement.

Operating margin at 19% was also up and improvement of 200 basis points last year and 330 basis points the last quarter. Finally our focus on cash continued to drive exceptional result. We lower that $54 million during the quarter, a year-to-date debt reduction, $104 million, which exceed the high end of our full year target.

A funded debt to EBIT ratio stands below two times for the first times, since the first half of 2007. Dale will provide more detail on the financials in a moment, so I’ll focus the rest of my commentary on progress with our 2009 strategic initiatives.

The first initiative throughout the year has been to improve gross margin and as mentioned earlier we made great progress here. Improved productivity and utilization rates throughout our operations are having a big impact. Sourcing initiatives continue to drive lower material costs and pricing actions taken earlier in the year, continue to be a benefit. I’d like to take a moment right now to thank the many employees throughout our organization, who have been responsible for driving our strong result in this area.

Our second initiative, driving improved retail effectiveness and here to we’re making good progress. We’re continuing the promotional events that we’ve described in previous call. In the fourth quarter, we’re executing several retail promotions including one focused on our Ergo adjustable base and anther one on pillows.

Clearly, one of the most important ways we improved effectiveness with our retailers is to drive consumers to their stores and this quarter we launched our new advertising campaign, Ask Me and so far we’ve been very happy with the response, but it is gone in. The Ask Me campaign, leverages power of our passionate user applicant and the extremely positive word of mouth, that’s always been a differentiator for our brand.

The campaign encourages people to use social media through more about Tempur-Pedic. We’re also working with retailers to help them leverage the Ask Me campaign into their own marketing efforts. This quarter, we increased our investment in market spending and we intent to continue to grow our investments in the months and years ahead.

Our third initiative is to broadening the range of products that we offer. This quarter the Las Vegas Bedding Show, we launched the TEMPUR-Cloud line of beds, one of the most exciting launches in our history. For some consumers, our exciting mattress offerings just feel to from.

To address this, we conducted extensive consumer research and product testing, which led to the creation of a totally new formula TEMPUR-ES. This soft formula is used on the top of our TEMPUR-Cloud mattress line. This line of beds features a support and longevity of a traditional Tempur-Pedic bed with the cloud like softness of pillow top bed. The first inline, the TEMPUR-Cloud Supreme is now shipping. The entry level product, the TEMPUR-Cloud will start shipping in the first quarter and a higher end model is planned for late 2010.

At the same time, we outlined our new product segmentation. We grouped that product range into three collections. The TEMPUR collection, The TEMPUR-HD collection and the new TEMPUR-Cloud collection, each collection has multiple models with a range of price points differentiated by their functionality and specification. We believe this new segmentation makes the difference between our products easy-to-understand for consumers and that’s make the selling process easier for retailer.

Our fourth initiative is to stabilize and ultimately grow our direct channel. This quarter we are quite pleased with our results. For the second quarter in a row sales were up sequentially and for the first-time in a very long time, our direct business was up year-on-year.

Our US Direct channel was up 16% in the quarter. As I mentioned last year, we’ve seen a significant improvement and Internet generated leads and ecommerce sales. We’re pleased with the conversion and we planned to build on this program. Our website is in the process of being completely revamped and we’re implementing a series of initiatives across our direct business.

System lastly, is our focus on improving household penetration in our international market. Our new mattress line, the sensation was launched earlier this year and has been very well received. The sensation features a dynamic support base, which provides both unique feel and functionality. Building on the success of the first sensation, we’re now in the process of rolling out the second in that line at an entry level premium price point.

We’ve had a good quarter and will continue to be a challenging economic period. Well, we’re not prepared to call a recovery in the economy. Our third quarter results reflect a degree of stability in the market. When the economy does recover and more consumers open their volumes and process again. I believe the steps we’ve taken during 2009, will position the company well to capitalize on its substantial growth potential.

With that, I’ll now handover to Dale.

Dale Williams

Thanks Mark. I’ll focus my commentary on the financials are updated 2009 guidance. As we look at sales, let’s begin with an overview. In total, net sales were $224 million, a decline of 11% over the same period last year.

Foreign exchange rates continued to be unfavorable during the quarter. On a constant currency basis, net sales declined 10%. However, the negative effect of currency on revenue has eased substantially from what we experienced in the first half of the year and we expected to neutral to slightly positive in the fourth quarter.

Our revenue improved sequentially 21%, following a 5% sequential improvement in the second quarter. We believe our US business dropped in the first quarter of this year and the international business dropped in the second quarter. As we look forward, we anticipate the fourth quarter will be down slightly on a sequentially basis reflecting normal seasonality. However, we expect sales will be up on a year-over-year basis.

Now, let’s turn to the details of our third quarter performance. Domestic sales were down 12%, while international sales were down 10%. On a constant currency basis, our international sales declined 7%. By channel and domestic retail, net sales were $130 million, a decline of 12%, yet up 23% on a sequent basis.

As Mark mentioned, our domestic direct channel was up 16%. Internationally, retail sales were down 10% to $61.0 million. On a constant currency basis, international retail sales were down 7%.

On a product basis, mattresses were down 14%, driven by a 15% decline in units. Domestic mattress sales declined 15% on an 18% decline in units. We are pleased with our improved average selling price especially since our new entry priced Advance bed has been performing well.

In the international segment, mattress sales declined 13% on a 9% unit decline. The sales decline reflects the negative impact of foreign exchange rates. On a constant currency basis, international mattress sales declined 9%.

In total, pillows were down 10%, driven by an 11% decline in units. Domestic pillows sales declined 9% on a 10% unit decline. International pillows sales were down 10% on a 16% decline in volume. Gross margin from the quarter was 47.6%, up 590 basis points year-on-year and 100 basis points sequentially.

On a year-over-year basis the gross margin improved principally related to three factors. First, our focus on driving manufacturing productivity has having a positive impact. Next, commodity cost continued to down versus last year. Although they did rise from the levels we are experiencing in the first half.

Lastly, pricing actions taken early in the year continue to benefit. These factors were partially offset by fixed costs deleverages, production volumes were down versus last year. We increased our commitment to drive branding awareness with $19 million spent on advertising, including 9% of sales spent in the domestic segment.

Our G&A expenses was up compared to last year and last quarter. In the third quarter we incurred extra expense to catch up our bonus pull for the first nine month as a result of better than expected performance in outlook. In addition legal expenses were slightly higher. In the fourth quarter we expect G&A expenses to be down sequentially.

Interest expense was $4 million, down $2.0 million year-on-year, reflecting lower debt levels. Our third quarter tax rate was 32.7%, consistent with our guidance on early cost. Net income was $25.7 million, up from last year. Given our improved profitability EPS was up $0.02 from last to $0.34.

Turning to the balance sheet, we continued to improve our financial flexibility. Our accounts receivable balance was up sequentially with higher sales and we lowered DSOs by two days from the second quarter. Accounts receivable continue to be in very good shape despite the economic environment.

Inventories were down $3 million sequentially, we feel our inventories are too low at the end of the quarter given that demand levels we have been experiencing couple with the new product launch as Mark discuss.

We have modestly increased our production plans to increase supply and improved delivery to our customers. We generated $55 million of operating cash flow; capital expenditures were $4.2 million. We reduced debt $54 million to $315 million, we’ve reduce that $104 million this year and $204 million over the past 12 months.

Our funded debt to EBITDA ratio was 1.96 times, down slightly from last quarter and well below our debt covenant of 3 times. Now I would like to address our guidance for full year 2009. I would like to start by echoing a point Mark made earlier. While we have experienced improvement in our sales trends, sales visibility as to low and we certainly did not evidence to call in economic recovery.

We continue to use the methodology for guidance that we have using since the downturn begins. We’ll believe use our recent sales volumes and extrapolate based on those results. Based on that methodology the company has increasing it sales and EPS guidance for full year 2009. The currently expect net sales to range from $790 million to $805 million, which is outlook we are forecasting the normal seasonal pattern, traditionally the fourth quarter slightly lower than the third quarter.

We currently expect EPS to range from $1 to $1.05 per diluted share. We anticipate interest expense for the full year to be $17.5 million and we are now using a share count of $77 million for the fourth quarter and $76.1 million for the full year. The increase is principally related to more stock options being in the money given the higher stock price.

Regarding our tax rate, based on our current expectations, we anticipate the full year tax rate to be approximately below 34.0%. 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.

This concludes our prepared remarks and at this point operator we’d like to open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Rupe - Longbow Research

Mark Rupe - Longbow Research

On the gross margin, Dale could you provide any more color on kind of any of the compositions that the three major buckets for the improvement? Was it one-third, one-third, one-third?

Dale Williams

No, basically what we’ve seen as the years gone on is a little bit more shift towards productivity. I think last quarter I said, we thought that the composition was about 40:40:20, productivity chemicals and the price increase we took earlier in the year, at this stage we would tend gauge it more like 45% related to productivity, 40% related to chemicals and 15% to related pricing.

Mark Rupe - Longbow Research

Then as we look forward, the puts and takes kind of obviously some of these will continue to play a role going forward. I would assume, chemicals maybe not have the same kind of benefit, but then also with the inventory production coming backup, I mean is it similar kind of composition going forward do you think?

Dale Williams

No, it will probably shift a little bit going into this quarter, last year in the fourth quarter was when we started to see chemicals coming down, actually they kind of peaked mid-quarter and then they’ve started dropping and that we’re dropping fairly dramatically once they turned.

So, as we look at the next into the end of the year through the fourth quarter, we expect productivity, they continue to be a prime driver, pricing that we took in the first quarter of this year, we’ll continue to help, our commodities will be a little bit less of the help, not dramatically plus, but we do expect and have received notifications of some further price increasing commodities.

The other thing to taken into consideration for the fourth quarter is that we do expect to get a little bit of volume leverage on a year-over-year basis. At the same time, we are going shifting a lot of floor models on the Cloud Supreme, which we shipped at a pretty good discount. So, that will put some pressure on gross margins in the fourth quarter.

Mark Rupe - Longbow Research

Then on the sales performance, obviously came in better than people expected. In your commentary you’d said some of that was due to seasonality. Where there anything else that was going on, I mean, obviously I know you work the retailers pretty hard, but was pretty much digit of it?

Dale Williams

Yes, I mean we did traditionally the third quarter is the best quarter in the year and we did see that. The seasonality didn’t look exactly like normal seasonality in terms of I came through the quarter, but I mean we continued our promotions to what we’ve doing for the first two quarters of the year. There’s nothing substantive change other than that.

Mark Rupe - Longbow Research

Then just lastly on the pillow business, obviously the fourth quarter always historically had been kind of a stronger business in last year obviously is weaker. You mentioned also that either some fourth quarter retail promotion. Are you doing anything different strategically in the pillow business as we head into the fourth quarter?

Dale Williams

The promotion is a new thing. We will be putting a focus of it throughout all our channels and the pillows is a very important business for us and we will continue to put a strategic focus on. There’s nothing fundamental that you don’t know, that’s going to be announced in the next three months.

Operator

Your next question comes from Brad Thomas - Keybanc Capital Markets.

Brad Thomas - Keybanc Capital Markets

Taking a look at your guidance and my math is terms of the sales outlook for the fourth quarter that you’re looking for 8% to 15% increase in sales. Could you just talk a little bit about the drivers of that and maybe what kind of a benefit we could see from the Cloud rollout, and what you’re expecting from the different channels and just anymore color behind, what drives that forecast?

Dale Williams

From 3Q to 4Q traditionally in the U.S., you’ll see a drop off in mattress business and that’s historically been the seasonal nature of this business. We haven’t seen normal seasonality for little while, but since we feel like we saw some of the current normal seasonality in third quarter, we would have currently expecting that we will see a little bit of drop in mattress business in the U.S., in the fourth quarter.

Pillows should be a little bit better based on historical patterns. The Cloud is starting to ship. However, most of what we’re going to be shipping our expectation at this stage in this quarter is floor models. Floor models are generally, pretty deeply discounted. So they’re not going to be a big drive of top line.

International, the thing historically has provided some counterbalance from our business is seasonality versus the U.S. industry seasonality is. The fourth quarter has traditionally been seasonally the strongest quarter internationally. Again at this stage, we’re not really counting on much seasonality out of the international business this quarter, that the international markets.

They kind of have been a little bit out of phase with the U.S. market in terms of the downturn when they felt the impact. We’ve seen now couple of quarters of sequential growth domestically, the international business looks like. It may have turned a little bit, that’s not enough that we would expect to see normal seasonality.

Brad Thomas - Keybanc Capital Markets

Then I was wondering, if you could just talk a little bit more about the composition of your sales. You’ve really seen some great results, some great improvement in that direct business, what’s driving that improvement and then as we think about the gross margin impact from that? How much of a tailwind was that on your gross profit this quarter?

Mark Sarvary

The composition of the sales, as I said this the first quarter in a long while that our actual sales is direct have increased year-on-year, but still the proportion that increased didn’t have a material effect on its own, that was not enough to make a difference to the gross margin and talking specifically though about why we’re seeing a growth in DR.

We have said all this year that’s been a focus for us, because we really believe that is potential there and one of the things that we done is put particular emphasis on growing leads by the way that we structure and invest in our advertising the way that we use the web to generate leads. Interesting one other things about that we learned about leads is that for every lead that turns into a sales three or four of them go through our retailer.

So, interestingly we increasingly view our marketing as being one whole things, we try to think of them altogether, because almost all consumers who buy a retail have checked online and so it is a heck up there is a great deal of integration of those of the channels. So, that hasn’t really had a big effect on our gross margins.

The thing that’s driving our gross margin again one other thing our gross margin is that, we’re pleased that our average selling price is slightly up this year, even though we put a big emphasis on Advantage bed. So, we are seeing what we seen throughout the entire downturn that while absolute levels of sale are down. The proportion of sales at each level and each price point is roughly the same. Where we’ve been able to see the improvement is to some extent commodities, but also significant improvement and productivity.

Operator

Your next question comes from Keith Hughes - SunTrust.

Keith Hughes - SunTrust

Just building on your comment, Dale on the raw material price hikes will you be looking at retail prices and potentially rising again in the fourth quarter early 2010?

Dale Williams

Keith, retail pricing is something that we look at on a routine basis, but did not talk about that our comment on that prior to a making a decision or be communicating that decision to retailers and so at this stage certainly at something that we look at the do from time-to-time on certain parts of our line, but not something that we would plan are talk about right now.

Keith Hughes - SunTrust

With adjust EBITDA under two times is that a number that you’d like to stay at longer term?

Dale Williams

Under two?

Keith Hughes - SunTrust

Yes, is that a number your comfortable at longer term or will you continue to pay down debt?

Dale Williams

We said for this year, that we would continue to pay down debt. Sound to this year and that’s what we’re going to do and from a long term standpoint, ye we wanted to under two. I think that most people in today’s world versus two, three ago world, we’ll try to operate on a little bit more conservative capital structure. I think that we will generally try to operate a little bit more conservative capital structure, but we haven’t changed our strategic intent at this stage around, where cash flow goes, so it’s going to go to head on that.

Operator

Your next question comes from Budd Bugatch - Raymond James.

Budd Bugatch - Raymond James

Just kind of a strategic question asking you to put on kind of your crystal ball, if you would think about it and look into your crystal ball, not put it on. I was impressed with the segmentation of product between the ES and HD and Tempur we saw in Vega and I command on that, can you quantity or maybe talk some color as to the size of each of those markets and how do you think that will play out over time relative to one another and how they’ll grow?

Dale Williams

I mean I think that is the crystal ball question, but I will say that I think that the advantage of the segmentation and the importance of the segmentation for us is that it makes it easier to explain quickly to a consumer what difference between the beds are. That’s useful for the consumer and also useful for the person selling.

At the same time as dividing it into these three groups. Obviously, we introduced the new Cloud bed and the Cloud bed has a softer initial feel. There are a significant proportion of the population, there’s something else in the order of 40-plus percent would prefer a softer feeling bed. One could say that the target marketed for the soft bed is 40%. Now, the truth is that the HD bed appeals to some proportion of the soft bed users too.

Just standing here right now, I think that as good a guess as any is a third, a third, a third in terms of where we’ll ultimately be for those three collections. So what I would also say is that we see them as, within each collection, we see opportunities for both adding products, but also evolving some of the product line that we have within the collection. So what we have now is by no means what we would ultimately have.

Budd Bugatch - Raymond James

Just as a couple of other questions, the inventory in day’s cost of sales outstanding really did drop dramatically and Dale said you aren’t happy with the service levels and I’ll suspect your customers and retailers probably are not all that happy with it either as it gets down that level. What’s is your goal for year end inventory level, either in kind of day’s cost of sales outstanding or dollars? What do you see that to be?

Mark Sarvary

I’ll ask Dale to answer the specific event, but I think a point that you’re making about inventory being below where we want it to be is right and frankly in this last quarter we did have some glitches, we serviced to our customers, which we’re very, very happy about it and it’s a big area of a focus.

To some extent, it’s a function of the fact that, it is incredibly hard to predict volumes in this environment. I mean everybody knows that it’s just very hard, but that’s not an excuse and it something we’re addressing and so we’re pleased that our inventories low and we believe in the long run we’ll be able to get inventories in that low, but right now our systems are not good enough for that and we’re going to need some increase in inventory going forward. I don’t know the exact plan is for the end of the year though.

Dale Williams

At the end of the second quarter, you may recall when asked some other question or made the similar statement that our inventories are getting little low and I thought in a third quarter we might increase inventories in the mid to high single digits. Demand exceeded our expectations at that time, which is a good thing, but that did lead to some service issues during the quarter.

So I would say again at this stage, that our expectation for this quarter is that combination of trying to beef up supply as well as beef generating sufficient amount of stock on the new products, that we’ve launched the Cloud Supreme, specifically that is starting to ship now. We will look for inventories to be up in the order of elaborate $10 million or so $1 million.

Budd Bugatch - Raymond James

So somewhere in the area of about $58 million, because last year inventory were ended for about $60 million or about 51 days cost of sales, right?

Dale Williams

Sale of last year is right about $60 million, correct.

Budd Bugatch - Raymond James

51 days cost of sale, so we can do those number. You would also said in terms of gross margin that there were some fixed costs deleverage and when you gave your percentages, I think the mark, you went 45 for a 40 year. When I think to get to understand, what was the size of the fixed costs deleverage to gross margin?

Dale Williams

I don’t have that in front of me, but volumes were down about 15% on a year-over-year basis with and that’s unit volumes on mattress with fixed cost in our COGS being in the neighborhood of 20% that would indicate your booking at the neighborhood you can run the math on that, but what we’ve talked about in terms of the percentages was, these were the good guys and I gave you 100%, but it actually adds up to each of these pieces individually add to more than 100%, because you do have the deleveraging still occurring.

Budd Bugatch - Raymond James

Do you think you’ll still have deleverage in the fourth quarter, if you’re attempting to build the inventory?

Dale Williams

No, I believe that in the fourth quarter we will actually begin to see some leverage in the factories, because we expect revenues to be up in the fourth quarter on a year-over-year basis and we expect the buildings some extra inventory where last year revenues that were down and we were dropping inventory.

Budd Bugatch - Raymond James

Two other quick questions are, in relation to what Keith asked you about, is your adjusted or debt-to-adjusted EBITDA goes down. I just tested that the EBITDA goes down. Are there any priorities for cash that are changing and as you look getting mark on that crystal ball going forward? What kind of priorities for cash might you have next year?

Dale Williams

It is a crystal ball and again check priorities will change, when we started this year, our big priority was to make sure that we were safe with our covenants and we have remained so and we’re going to end this year obviously comfortably below two and we will, I am sure revisit what our objectives are, we’ll talk about that probably in the first quarter call, but for right for the rest of this year, we are planning to continue. It will just plan to use cash flow to pay down debt, what we’ll do next year we’ll talk about in January.

Budd Bugatch - Raymond James

Are you being talking about maybe guidance for 2009 at Analyst Day or now if you like?

Dale Williams

2010 you mean?

Budd Bugatch - Raymond James

2010, pardon me, yes.

Dale Williams

No, we’re not going to talk about guidance at the Analyst Meeting, next week.

Mark Sarvary

So from a framing standpoint, if you look at what we have tried to do from a guidance standpoint, we are not giving 2000 guidance now, with a few month to frame 2010 based on the convention or the methodology that we’ve been using and take either expectations through the fourth quarter or more reasonably take expectations for the second half and roll that forward for the next year, given our current guidance $790 million to $805 million that would have implies the second half of $428 million or $443 million. If your roll that forward into the next year, that would give you a ballpark in the neighborhood of 8% to 10% kind of top line increase, just using the current methodology.

Budd Bugatch - Raymond James

Okay and that methodology you’re comfortable to use going forward?

Mark Sarvary

That was comfortable with it based on what we have seen so far and it has worked very well so far and obviously we did a little bitter in a third quarter than that methodology indicated. However, until more time goes by and we see some more market data, we’ll continue to tweak, but that’s the methodology that we’ve been trying to use.

Operator

Your next question comes from John Baugh - Stifel Nicolaus.

John Baugh - Stifel Nicolaus

Can discuss the international, I’m not as close to that side of the business. Is sensations driving there, are you doing promotions over there? Did you increase advertising? Just give us some color on the international side, it turned quicker than I thought it would.

Mark Sarvary

The international of this, first of all, as you well know, international is hardly homogeneous. There’s much difference in parts of the countries in Europe. For example, Spain, which I’m sure you’re reading about the 20% unemployment there, which is performing differently than other countries.

So you have to careful of it, but the truth is as Dale said. He went into the downturn, a little later than the U.S. did and it seems to be not coming out stabilizing a little slower, but having said that, the activities in international have included all the things that we talked about in U.S., there have been promotions, which have been quite successful. They celebrated the 15 year of Tempur-Pedic and had a promotion in many countries associated with us, which worked quite nicely.

The sensation bed has been a very successful launch, it’s further more successful launches in history of the company, but certainly be international business as it’s been currently configured and then there has been investment in advertising and suddenly in some of the countries in Europe has been quite effective.

So the same things that we’ve been doing in the U.S. have been done in international. The only thing you have to bear in mind though is that we don’t get down to this granular level, but the impact and some of the European countries are quite different. Other European counties and Asia is quite different to Europe.

There are pockets of growth or pockets of better performance, I should say pockets of earlier signs of stability both in Asia and in Europe, but there are still weak places.

John Baugh – Stifel Nicolaus

Then I think you slipped in there marketing spending was going up in the US and the months or quarter ahead. Did I hear that right and because it put a little more color behind that?

Mark Sarvary

Yes, you did hear right and we are going to continue to throughout the downturn we continue to invest in advertising we will continue to do so, but this new advertising campaign that we just launch that is been very tested, very well received we intend to invest behind it and we feel like this is the time when the echo, justified to do so and now is the right time to start to kind of build the ground work assuming that we are starting to stabilize.

John Baugh – Stifel Nicolaus

So Mark, that means your ad spending of percentage of revenue both domestic and international be up I will recall you were pulling it back a little early part of this year?

Mark Sarvary

We said their that will give you the specific, we said in more than once quite frequentaly what we say is we should for around 9% in the total target and we have been little bit below that we intend to approximately at that going forward, that’s the number that we feel is appropriate for us and it will obviously grow it. It will goes up or down with sales, but we have been little cautious on it earlier in the year. we feel like in this fourth quarter is the time to we shift we are planning right now to be standing at our normal run rate.

Dale Williams

I would just add John in one of my comments was the we judge and in the US at 9% in the third quarter so that was up from a spend rate in the first half of the year we were spending in the low 8s, so we did take it up and international continue to since its little bit behind the US its still a little bit behind the US in terms of spending as percent of revenue, but as we get into the next year, we will see ad rates, our media spend as a percent of revenue tweak back-up towards the 9% level that we have been expecting and we made spend little bit more than that US hear in the next couple quarter given the new Ask Me campaign and the planned advertising around the Cloud product line that we plan to do in the first quarter.

John Baugh – Stifel Nicolaus

Then lastly I heard a comment on APU was that up sequentially, up year-over-year and would that be up without a year including the pricing increase.

Mark Sarvary

It roughly the same at the pricing increase.

Dale Williams

It little slightly higher than the price increase, the price increase equated to a little over 3% across the business never ASP was up about 3.9% so you got a little bit price increase plus a little bit of mix, which actually spices little bit because, one of the products that’s doing very well is the advantage, which is our lowest priced bed. It is new to the portfolio this year and has performed very well, but we are seeing some addition to ASP beyond just the pure price increase.

John Baugh - Stifel Nicolaus

That’s year-over-year, right Dale?

Dale Williams

Yes.

Operator

Your next question comes from Matt McClintock - Barclays Capital.

Matt McClintock - Barclays Capital

Dale, just one quick question, I think you’ve done a really good job of outlining all of the tailwinds for gross margin for your coming quarters, but I just wanted to know get your thoughts on the inventory and the inventory levels and should we be looking for any headwinds associated with for ramping up productions such as, I don’t know speeding up raw material deliveries or anything like that similar to the inventory shortages you had back in 2006-2007.

Dale Williams

No, because we started ramping things in the third quarter as the business performance was going, we were trying to ramp production and we feel like what we had a few spotty issues, it wasn’t big across the board issues like we had in 2007 it was more spotty. We feel like by the end of quarter are certainly by now here early in the fourth quarter, we’ve got that a little bit better in terms of the customer service levels etc.

At this stage, we do expect increased inventories in the neighborhood of $10 million quarter-to-quarter and which we like we need to do that with business improving a little bit as well as just putting stocking in our own warehouses for the Cloud, so we can support the retailers with it. So we will see predict production continuing to ramp some and we feel like we’re in pretty good shape with our suppliers right now.

Operator

Your next question comes from Henry Kerpellen - Oppenheimer

Henry Kerpellen - Oppenheimer

The first question I have I guess is about the top line guidance for the year, as someone mentioned earlier it employs 8% to 16% growth in the fourth quarter. Wanted to know, if that was indicative of any improvement in the sales by quarter in third quarter, is that sort of a new kind of run rate that you’re seeing? Are you seeing an improvement there?

Mark Sarvary

Primarily it’s turning positive because from a comparison standpoint, we’re now comping against our financial crisis, that occurred at this time last year like September, after the couple of key bankruptcies at this time last year, everyone’s thought that the entire global financial system was melting down, it almost did, but so your business took a dramatic downturn, not just for us, but for any consumer products company at this time last year.

So we have much easier comps and essentially what we are doing from the guidance, they’ve must taking what we saw from a volume standpoint in the third quarter that just ended, carrying that forward into the fourth quarter and then seasonally adjusting it. That’s the approach that we’re taking.

Henry Kerpellen - Oppenheimer

I guess the other question was about, if you could just talk about utilization rates at your facilities and where they were in the third quarter and where do you see them going in the fourth quarter maybe in beyond considering then you’re thinking about ramping up inventories. I wanted to get the sense of how much kind of leverage that we might be able to expect.

Dale Williams

Our factories have been running at about one third, that’s the utilization. It’s not going to be materially different in the fourth quarter, even though we’re adding some inventory.

Henry Kerpellen - Oppenheimer

Then just I guess the last question is wanted to ask you about kind of the market share for not only Tempur-Pedic, but other competitors in the specialty channel. I wanted to see if you’re still gaining share and if the differential is still growing and maybe what percentage there?

Mark Sarvary

We have a very small share of the total market and it’s one of the reason that we believe, we have good potential for growth, but in the specialty market, we think over this year we probably gain share just we don’t the data to validate that we think though and what we looked at from the year as the whole going forward through the year effectively quarter-by-quarter.

We believe our share has increased sequentially, but remember what Dale just said, which was in the fourth quarter of last year, that was a real downturn in the business and particularly of the specialty and premium products once that we complete with it. So we think it’s been getting better all year, but it started from a low point.

Operator

Your next question comes from Tony Gikas - Piper Jaffray.

Tony Gikas - Piper Jaffray

A couple of questions, can you talk a little bit about the SKU plan by the three new segments maybe for the next year and maybe the impacted price due to mix? Second question, maybe just a quick update on retail door count and expectations; third question, do you guys have a better feel for the correlation with the housing market, however limited that is, have you learned anything in the last six to 12 months in that regard?

Mark Sarvary

Well, I’ll take a crack at the SKUs and Dale will do the doors and then on housing we’ll both tick away. On the SKUs I think the way to think about this is first of all, what we’ve done with these new groups, these new collections, essentially grouped the first two groups, the Tempur and TEMPUR-HD were a grouping of existing products.

The Cloud products with the addition of three new products, two that what we showed in Vegas and one that we said it’s going to come next year as a new collection. What we see happening is, overtime is that we will have a range of prices and functionalities within all three of those range. Right now, we have approximately 12 SKUs, depending on how you count and what I think is that we’ll possibly end up with 12 to 15 of that sort of number.

We don’t have a fixed numbers, but we’re not going to end up with 25 or 30, we can end up with some number perhaps a little more than this, but not much, much more. What we will see is, the way that we’ll there though is going to be both by the addition of some new items by the replacement of some and by the evolution of others. So it will be a gradual migration, what we don’t see happening is a massive increase overall in SKUs, so that’s the first question.

You’re asking that pricing on SKUs. As we said, we are very focused and we had said this for sometime now and we continue to be on the part of the market as we call the entry level premium part of the market, which is the $1,000 to $2,000 mattresses, where we believe there is, or we know there is a very big market and we believe there is very significant growth for us as a potential.

The advantage of it, which we have put big emphasis on this year, is focused there. The TEMPUR-Cloud bed is also focused there. So we will continuously see and we will continue to see a big focus of growth there, but we also see that our higher-priced beds are growing too and that’s why we are able to see an average price actually modestly growing this year and we don’t see that’s going to change going forward and that’s not in our time, that’s what we anticipate happening. Dale, why don’t you give the doors?

Dale Williams

Yes, you asked about doors, on the domestic side we actually say a slight increase in doors this quarter. We went from about 6400 doors to by about 6450 just a very modest increase in doors this quarter. Internationally we saw slight decline in doors. We went from about 5,000 doors to 4900 doors throughout this economic downturn.

We had up to this point seen a slight decline in there on a quarterly basis, but now things are seem to stabilized on the bankruptcy side and we’ve actually seen some customers who went bankrupt, coming back into business generally in a different form with different ownership or they were bought out by a larger retailer who open those doors backup. So we are now seeing slight increase in doors domestically, still a little bit of a decline internationally.

Final part of your question, I believe it was around housing. If you look at the historical date of the industry that they tied us most significant from a statistical standpoint correlation to the mattress industry is GDP. Housing, there’s not for say a direct correlation, but there’s sort of an insularly correlations of the industry. So it’s not one of the leading indicators though for say of the industry that you can really tie statically through the business.

Certainly the housing slump has been an issue that’s weighted on significant portions of consumer products. Certainly most consumer durable, there’s a modest tie there, not a direct correlation of it. I think another thing to do phrase ancillary. Obviously, unemployment is one, but rate is changed about employment is something that’s very focus and both of them drive consumer confidence. They’re all the big things, but housing by itself is not a good predictor. It’s many together and it’s all the ones that you thing.

The one thing that I think is some of the discussion is about, what is the long term potential has the demand? Has America changed as a result of this crisis in terms of what people proclivity to buy premium products are and whether that is the case or not, I don’t know, but what I do believe and what I think where we fit in with it. Our product that is something that is perceived in good for you and healthy, and frankly, good investment and in the end, I think that will services well as this economy recovers.

Operator

Your final question comes from Joel Havard - Hilliard Lyons

Joel Havard - Hilliard Lyons

One question on the dealer front guys I don’t who wants take it, but I wondering if you are seeing in this new and revise mix of customers and improvement in the consumer credit availability in terms and that’s of thing?

Mark Sarvary

It’s getting a little better than it was, but it is no back to where it was I think months ago.

Joel Havard - Hilliard Lyons

What kind of presuming it won’t go back to where it was 18 months ago any timeframe that matter Mark with maybe your point slight improvement from the dark days of a quarter or to back and kind put any kind of number on it to quantify, where scores are, or things about nature.

Mark Sarvary

Of course we are still up and in terms of score requirements versus what they used to be Joel, I think the biggest thing as you go back couple of two or three quarter ago and our fourth quarter of ‘08 most of the first quarter of ‘09. Consumer credit almost didn’t exist, that exist now, that is helpful that consumer credit exist, because we have a expense of product and people, some consumers need credit have be able to purchase it and some other retailers use credit as they selling tools.

Joel Havard - Hilliard Lyons

Dale one follow up the last follow up I promise to that is have you seen anything with your dealer base, trying some of the let’s refer to it as more traditional financing methods is lay away coming back anything like that making difference for your guys.

Dale Williams

I haven’t seen it in part of that in this industry.

Operator

This does conclude the Q-and-A segment. I’d now like to turn the call back to company for closing comments.

Mark Sarvary

Okay, thanks everybody we look forward to talking with all of you again next week when we host our Investor Day in New York and thanks for joining us this evening.

Operator

Once again this does conclude today’s conference call. We thank you for your participation.

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Source: Tempur-Pedic International Inc. Q3 2009 Earnings Call Transcript
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