Executives
Mark Boehmer – Vice President and Treasurer
Lawrence Rogers – President and Chief Executive Officer
Jeffrey Ackerman – Executive Vice President and Chief Financial Officer
Analysts
Analyst for Budd Bugatch – Raymond James
Keith Hughes - SunTrust Robinson Humphrey
Analyst for Brad Thomas – Keybanc Capital Markets
Mark Rupe – Longbow Research
John Baugh – Stifel Nicolaus
Reza Vahabzdeh – Barclay’s Capital
Grant Jordan – Wells Fargo
Karru Martinson - Deutsche Bank
Todd Harkrider – Goldman Sachs
Sealy Corporation (ZZ) F4Q09 Earnings Call January 13, 2010 5:00 PM ET
Operator
Welcome to the Sealy Corporation’s 2009 fiscal fourth quarter and full year earnings conference call. (Operator Instructions) At this time I would like to turn the conference call over to Mr. Mark Boehmer, Vice President and Treasurer of Sealy Corporation. Please go ahead, Sir.
Mark Boehmer
Good afternoon. Thank you for joining Sealy’s 2009 fiscal fourth quarter and full-year 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 risks and other factors are set forth in the company’s Annual Report on Form 10-K. A reconciliation of adjusted EBITDA and adjusted EBITDA margins can be found in our earnings release which is posted on our website at www.sealy.com.
I will now turn the call over to Lawrence Rogers, President and Chief Executive Officer of Sealy Corporation.
Lawrence Rogers
Good afternoon. Thank you Mark. I want to also thank all of you for joining us on this call to discuss Sealy’s 2009 fiscal fourth quarter and full year results. Joining me today are Jeff Ackerman, our Chief Financial Officer and Mark Boehmer, our Treasurer.
I am pleased to say that during our fiscal fourth quarter our operating and financial performance continued to improve in the context of moderating of still challenging market conditions. Total net sales were $332 million and represent our first year-over-year increase since Q4 2007. Gross profit was $131 million or 39.5% of net sales, a 331 basis point improvement from the prior year driven by a 371 basis point improvement in our US market.
Income from operations was $19.6 million, an improvement of $43.6 million from the same prior-year period and adjusted EBITDA was $37 million or 11.1% of sales, a 465 basis point improvement over Q4 2008. In addition, with our strong cash flow performance we drove down the leverage on our balance sheet. Our net debt to EBITDA ratio improved to 3.2 times from 3.76 times at the end of the third quarter of 2009. These results represent a continuing improvement in our business as we build momentum on these financial metrics both from a dollar amount and in terms of margin.
Let me now put our performance in the context of current industry conditions. We continue to see positive momentum building for bedding industry demand in the midst of a strengthening economic recovery. As we have stated previously, we are seeing a lot of consumer activity surrounding the traditional promotional sales periods but haven’t seen the sales follow through to the degree that we would like. What has been encouraging is that a number of the traditional industry demand drivers are beginning to have a more positive impact.
Credit conditions are stabilizing which has been pressuring the high end price points. Replacement demand, the most significant demand driver, has been inconsistent but is showing signs of rebounding. We believe that pent up replacement demand continues to build and we expect to see a strong recovery in demand as recessionary conditions diminish. To put this in context, over the last three recessions the industry has experienced cumulative growth of 20% on GDP growth of 8% in the two years following each recession. Many industry retailers while still under pressure have seen increased traffic flow and their subsequent profitability are critically dependent on the introduction of new products.
Looking at our fourth quarter we began to see positive comparisons on a year-over-year sales basis for the first time since Q4 2007. Our results today also reflect the excellent progress made against our previously stated set of strategic initiatives for 2009 including: Number one, growing profitable market share. As we have previously stated our successful product launches have helped consistently narrow revenue declines on a year-over-year basis for the prior three quarters. We were pleased to see these successful product launches lead to year-over-year revenue increases during the fourth quarter. We believe we have continued to gain domestic market share over the quarter based on publically available industry data and retailer feedback.
Number two, successfully launching our innovative new Stearns & Foster line. The rollout is now 100% complete and by all means is a resounding success with revenue more than triple that of last year’s fourth quarter. We not only completed the Stearns & Foster rollout but we introduced new Stearns & Foster Personality beds which retail at price points starting at $3,000 queen size. We have achieved strong market share gains in this category as evidenced through the continued excitement surrounding our new products in the marketplace.
Three, improving gross margin. Our gross margin was up 331 basis points for the quarter compared to Q4 2008 due to the lower material costs and production efficiency gains. Four, reducing our operating cost base. SG&A as a percentage of sales decreased by 163 basis points compared to Q4 2008 as we aggressively responded to the weaker revenue environment during 2009 by dramatically revamping our company’s cost structure. Our cost reduction initiatives continue to transform our company into a leaner and more productive organization and has become a hallmark of our corporate culture.
These cost reduction initiatives will provide us with increasing operating leverage as industry fundamentals continue to improve. Furthermore our adjusted EBITDA margin improved substantially on a year-over-year basis as we benefited from our all-encompassing approach to driving profitability.
Five and finally, maximizing our financial flexibility. In the third quarter we completed our comprehensive refinancing plan and during the fourth quarter we built additional flexibility by generating approximately $40 million in operating cash flow. As we move forward into 2010 we will continue to build on these initiatives with the following clear objectives:
One, grow profitable market share. We will continue to grow profitable market share focusing on account penetration, new distribution and product launch execution as well as discrete opportunities that present themselves in an ever changing competitive environment.
Two, develop strong innovative products. 2009 proved that great product wins in this industry and remains paramount to the success of our retailing partners. Our product development and product launch process built on extensive consumer testing has been codified allowing us to replicate our recent successes in the future as well as roll out products faster and more efficiently. In 2010 we look to see continued success with our new Specialty line which we are excited to be launching in Las Vegas early next month, our new Sealy promotional line and our Sealy Posturepedic 60th Anniversary products.
Three, managing the cost structure. We will continue to aggressively manage our cost structure to drive further improvement in operating income and adjusted EBITDA.
Four, de-lever our balance sheet. We will generate cash to de-lever our balance sheet as measured in the improvement in our net debt to EBITDA ratios.
We have a very seasoned management team that generated strong operational performance during a challenging period and successfully completed the refinancing of our capital structure. The team has not only weathered the macroeconomic headwinds in the 2008/2009 period but has now put the company in a strong competitive position to take advantage of its growing platform, leading product innovation position and the improving macroeconomic environment.
With that I would now like to turn the call over to Jeffrey Ackerman, our Chief Financial Officer. Jeff?
Jeffrey Ackerman
Thanks Larry. I would now like to provide some more detailed support for our financial performance during our fiscal fourth quarter. Our net sales were $332.1 million, an increase of 1.9% compared to the prior year period. Wholesale domestic net sales which exclude third-party sales from our component plants, grew 7.3% to $227.7 million compared to the fourth quarter of 2008. This increase was primarily due to a 7.9% increase in unit volume as we saw improving consumer demand for our products compared to Q4 2008 partially offset by a 0.6% decline in AUSP given the aggressive nature of the market.
International net sales were $99.1 million, a decrease of 6.6% or a decline of 8.8% on a constant currency basis. On a local currency basis our European sales were essentially flat to prior year while our Canadian sales were down 17.9% as a result of a challenging retail environment and reduced promotional activity. Our gross profit was $131.1 million and our gross profit margin was 39.5%, an improvement of 331 basis points compared to the fourth quarter of 2008.
US gross margin was 41.5%, an improvement of 371 basis points. International gross margin increased 191 basis points. In the US the increase in gross profit margin was driven primarily by lower material costs and continued improvements in manufacturing efficiencies. The gross margin improvement in our international businesses was primarily due to our European business which was favorably impacted by material cost reductions, cost reductions, cost improvement initiatives and pricing.
We continued to make progress in right sizing our cost structure as our SG&A expenses as a percentage of net sales improved by 163 basis points to 34.3% from 35.9% in the fourth quarter of 2008. This represents a $3.1 million improvement in our SG&A expenses for the quarter. Volume driven variable expenses declined $4.1 million. Fixed operating costs exclusive of compensation expense decreased $10.5 million from the prior year period including a $4.8 million improvement in foreign exchange driven costs combined with reductions in discretionary and severance related costs.
Compensation expense increased by $11.5 million compared to the fourth quarter of fiscal 2008. This increase is due to $7.2 million of higher incentive and expected defined contribution plan payments coupled with $4.4 million of non-cash compensation expense related to equity grants.
Our income from operations was $19.6 million, an increase of $43.6 million from a loss in fiscal Q4 2008. Our prior year results included a non-cash charge of $27.5 million related to the impairment of goodwill in our European and Puerto Rican business units. Our interest expense for the fourth quarter of fiscal 2009 increased $7.2 million which includes $5.5 million of non-cash interest expense.
EPS were $0.02 per share compared to a loss of $0.45 per diluted share in the prior year quarter. Furthermore, the best metric for measuring our success total adjusted EBITDA grew by 75% to $37 million or 11.1% of net sales. These results represent an increase of 465 basis points over the prior year period.
Looking at our full year results for the fiscal year ended November 29, 2009, net sales were $1,290 billion a decrease of 13.9% or 11.3% on a constant currency basis. Gross margin was 40.1% compared to 38.9% in 2008. Income from operations increased to $111.1 million. Adjusted EBITDA increased slightly to $167.7 million. Adjusted EBITDA margin increased 186 basis points to 13.0%.
Now I will review our balance sheet categories. Compared to the fourth quarter 2008 day sales outstanding were flat. Days inventory on hand improved by approximately four days. Day’s payable decreased by three days as we took advantage of cash discounts for earlier payment.
Capital expenditures totaled $3.8 million during the quarter, down slightly from $3.9 million in the same prior-year period. We will continue to invest in our business and make strategic investments for the long-term. As Larry referenced, we refinanced all of our senior credit facilities during our fiscal third quarter which served to secure additional sources of liquidity, extend our aggregate debt maturities and reduce our cash pay interest ratios.
At November 29, 2009 the company’s debt net of cash was $716 million, an improvement of $40.8 million compared to November 30, 2008 and an improvement of $33.6 million compared to August 30, 2009. We took advantage of certain provisions in the company’s debt agreement to repurchase $5 million of its subordinated notes in the open market during the quarter. As of November 29, 2009 Sealy’s net debt leverage ratio excluding the convertible PIK notes improved by nearly a full turn to 3.2 times to 1 compared to 4.03 to 1 as of May 31, 2009. After only two quarters we have already achieved the 3.4 times leverage ratio hurdle that would allow us to force conversion of the convertible notes in June of 2012.
All of these actions combined with our strong operating performance led Moody’s to recently raise our ratings outlook to stable from negative and to concurrently upgrade our liquidity rating.
Now let me provide some additional detail on our 2010 initiatives. We will be highly focused on growing profitable market share in 2010. As a result of the continuing success of our Stearns & Foster line along with our upcoming product introductions we believe that our sales will grow above industry growth rates and thereby continue to gain profitable market share.
Next, we will diligently manage our cost structure, building on our long standing tradition of generating strong manufacturing productivity gains, ongoing aggressive cost management actions and leveraging our fixed cost structure over the expected growth in sales we expect a reduction in our SG&A and fixed manufacturing costs as a percent of sales.
We expect the combination of all these actions will generate a strong adjusted EBITDA growth of approximately 10%. In addition we will continue to manage our capital expenditures and expect to invest approximately $20 million in this area. This should result in significant free cash flow which we will utilize to de-leverage our balance sheet.
With that let me turn the call back to Larry.
Lawrence Rogers
Thanks Jeff. Let me conclude by saying that our confidence in the long-term viability of the mattress industry has not wavered. Our industry has historically experienced strong growth coming out of recessionary periods. Furthermore, we are increasingly optimistic about our prospects for the 2010 fiscal year given our recent operating performance and more examples of stabilization in demand.
Our improved outlook is further supported by the reestablishment of our year-over-year revenue growth and our adjusted EBITDA performance. We believe our company has never been in a stronger strategic position to gain profitable market share and drive increasing value for our shareholders.
Thank you. Operator would you please open up the line for questions?
Question and Answer Session
Operator
(Operator Instructions) The first question comes from the line of Analyst for Budd Bugatch – Raymond James.
Analyst for Budd Bugatch – Raymond James
You mentioned in your comments about 2010 you expect to grow above industry growth rates. I know there are a couple of different very prominent forecasts out there for 2010. Would you care to hazard a guess at what you think the industry will do or what is incorporated in that statement?
Lawrence Rogers
I will start out with it and Jeff may be welcomed of course to step in with any additional comments. There are a couple of numbers floating around out there. I believe the ISPA organization has floated a 7.9% or let’s call it an 8% growth number and a recent straw poll taken by Furniture Today a week or so ago kind of places the industry number around 3%. So I guess those are the two goalposts. 3% and 8%. We still believe regardless of what number is correct that given our performance we will outperform the marketplace and continue to gain profitable market share.
Analyst for Budd Bugatch – Raymond James
You talked about unfavorable pricing trends and maybe aggressive marketing conditions. I would imagine with Stearns & Foster tripling year-over-year mix was at least neutral if not favorable. Could you elaborate a little bit on the pricing commentary and how do you think that plays out over the next few quarters?
Lawrence Rogers
First of all to build a base for this answer, like all retailers during the holidays bedding retailers felt that discounting was necessary to drive traffic into the stores if they were to compete for the consumer dollar. Economic conditions while they are moderating, pricing pressures won’t necessarily vacate this market. They will lessen but I am not so sure they will vacate.
We really believe that based on the evidence we experienced in 2009 that introduction of new products is probably the most significant way for retailers to offset this pricing dynamic and so we are pretty focused on continuing to create and produce a good line of introductions in 2010 starting with our Specialty products which we are going to reintroduce in the Vegas market in a couple of weeks and of course the Personality Beds that extend the Stearns & Foster pricing not to mention the Posturepedic 60th Anniversary products that are also in the wings ready to roll out.
Analyst for Budd Bugatch – Raymond James
SG&A did increase about $3 million sequentially despite the lower sales. Was compensation expense the major driver of that and if so how do we model that SG&A run rate going forward?
Jeffrey Ackerman
The way to think about that, we did have a little bit of an increase there but the compensation expense was the biggest driver on that. As you think about that going forward really the part to keep in mind is on a year-over-year basis the increase related to stock based compensation which is non-cash. That was about $5 million.
Operator
The next question comes from the line of Keith Hughes - SunTrust Robinson Humphrey.
Keith Hughes - SunTrust Robinson Humphrey
Raw materials, could you give us an update on where you stand currently in terms of any increases you are seeing and in the market?
Jeffrey Ackerman
As you will probably recall our raw materials prices we get those locked in pretty much on a quarterly basis so any increase in commodity prices will impact us on a bit of a delay basis. I assume you are asking the question because of the more recent increase in the price of oil?
Keith Hughes - SunTrust Robinson Humphrey
That and steel too. That is a little more near-term. Whatever you are seeing on those two issues.
Jeffrey Ackerman
As I said any changes there we would see on a lag basis. Oil, for others on the call we don’t buy oil. That gets used in chemicals made for making foam. We are a couple of steps away from that. It has to kind of cascade down through the supply chain before it impacts us. I think more importantly as we think about materials costs we are looking at probably in the back half of the year some of those oil related raw materials really increasing in the back half of the year.
Keith Hughes - SunTrust Robinson Humphrey
From your current comments it sounds like raising price on existing lines is probably not an option. Is that fair to say?
Lawrence Rogers
We are obviously not going to talk about what we are going to do from a pricing standpoint in this environment.
Keith Hughes - SunTrust Robinson Humphrey
Moving onto Stearns & Foster you had a lot of positive comments there. The up 300% number, when you think when you look at the Stearns & Foster business was the year-ago period really the bottom or are there a lot more easier comps coming in the business there?
Lawrence Rogers
I would say that a year ago in the fourth quarter if it wasn’t the bottom it was getting close to it. So if that gives you any kind of an opportunity to model that. Clearly the result we have seen from Stearns & Foster has surpassed our and our retailers’ expectations. The enthusiasm is still very, very fresh and still very high relative to the product launch and we think there might be another wave, if you will, with the Stearns & Foster Personality Beds that we are in the process of rolling out in the next few months.
Keith Hughes - SunTrust Robinson Humphrey
You talked about 10% EBITDA growth. Is that what you are looking for?
Jeffrey Ackerman
Yes.
Keith Hughes - SunTrust Robinson Humphrey
Would that be off this $168 million adjusted number for 2009?
Jeffrey Ackerman
Correct.
Keith Hughes - SunTrust Robinson Humphrey
The non-cash compensation in the quarter which was slightly over $5 million is that going to be a recurring number at that level? It was under $1 million in the prior-year period. Any sort of help there.
Jeffrey Ackerman
It relates to equity grants that were made at the time of the refinancing. So yes it will continue on going forward at that level.
Operator
The next question comes from the line of Analyst for Brad Thomas – Keybanc Capital Markets.
Analyst for Brad Thomas – Keybanc Capital Markets
To expand on Keith’s question, with lower material costs looking at gross margin opportunity in 2010 what do you see here for different input drivers, headwinds, tailwinds, things of that nature?
Jeffrey Ackerman
As we look at it what we will continue to do is we will look to really leverage our Stearns & Foster line. Also the introduction of the new Specialty line and then really try and drive some productivity. Historically we have been able to drive productivity gains in the mid to high single digits in our plans. So we will look to continue that. The other thing we will do is look to just leverage our fixed cost base there.
Lawrence Rogers
The other thing I would add there is Q4 from a seasonal point of view is typically a lower gross margin period than certainly Q3. So you might be looking at a number that is at the lower part of the seasonality.
Analyst for Brad Thomas – Keybanc Capital Markets
Concerning the re-launch of the specialty category do you have any idea of what the expected cost savings would be here relative to the Stearns & Foster re-launch? Would it be more or less? How do you sort of look at that?
Lawrence Rogers
I think some of that will certainly be driven by volume. While we would like to predict the success of the line and we feel very confident based on the consumer research I think it is a little early for us to be predicting any hard number relative to the Specialty.
Jeffrey Ackerman
You are looking at the product launch costs? Is that what you are referring to when you say the cost savings? I wasn’t quite sure I understood the question.
Analyst for Brad Thomas – Keybanc Capital Markets
Sort of in relation to the cost savings you saw with Stearns & Foster but yes the launch costs essentially.
Jeffrey Ackerman
Just as far as launch costs I don’t know I would expect a big change year-over-year and the reason being we launched Stearns & Foster in 2009. This year we will be doing the specialty line but as Larry mentioned we have a couple of other initiatives around the Sealy brand in line as well as the 60th Anniversary of Posturepedic beds which is not a full line launch but there is clearly quite a few slots associated with that.
Operator
The next question comes from the line of Mark Rupe – Longbow Research.
Mark Rupe – Longbow Research
On the gross margin for the fourth quarter relative to the third quarter I know there is a seasonality aspect but is there anything else that happened in this first quarter versus the third quarter kind of puts and takes beyond volume?
Jeffrey Ackerman
Third quarter versus fourth quarter? No, the biggest item was really on the volume because as far as materials go there was not a big shift. I would like to remind folks that the fourth quarter we were comping the price increase that we took late in the third quarter of 2008. So in the third quarter of 2009 we obviously weren’t comping the full effects of the price increase.
Mark Rupe – Longbow Research
On the specialty launch coming up here as far as the margin structure on that are you anticipating that to be kind of structured in a way that it would be higher than the current run rate? Or is it going to be somewhat comparable?
Lawrence Rogers
I would say it will be priced according to the market needs and clearly we think we have great product and we would be certainly planning to hold margin and planning to of course it be accretive because of the volumes we expect to meet.
Mark Rupe – Longbow Research
On Canada obviously it looks like it came in a little bit weaker than everybody was expecting.
Lawrence Rogers
There was a glitch from a promotional calendar point of view. It is not anything I would read as being a permanent issue. In fact I will tell you at the latter part of the quarter things were repaired.
Operator
The next question comes from the line of John Baugh – Stifel Nicolaus.
John Baugh – Stifel Nicolaus
How do you get $0.02 on $2.5 million with 278 million shares? Is there something on the accounting there?
Jeffrey Ackerman
One of the things you have to remember when calculating the EPS was the PIK interest associated with the convertible notes is excluded. So on a full-year basis we were at $13.5 million of net income and you add back PIK interest of 5.3 and then divide that by the diluted share count. That is how you got to the $0.10 and the $0.02 works similarly. We had PIK interest in the fourth quarter of about $3.5 million so you would add that back.
John Baugh – Stifel Nicolaus
Did the share count jump mid-year by about 8 million shares? Is that correct?
Jeffrey Ackerman
The fully diluted share count increased as a result of the issuance of the PIK notes.
John Baugh – Stifel Nicolaus
Going forward in terms of modeling for 2010. Do we jump that about 8 million?
Jeffrey Ackerman
Every six months starting with the January 15th you should bump it by 4%.
John Baugh – Stifel Nicolaus
That expires assuming you can convert in June?
Jeffrey Ackerman
June 2012.
John Baugh – Stifel Nicolaus
I am curious whether you think the gains you have experienced are due to maybe some better slot positions on the floor with some of your competitors going through challenges or just strictly Stearns & Foster and new product launches?
Lawrence Rogers
Our read it really is never one thing. It is always a combination of many. The improvement would be driven largely by Stearns & Foster and some of the other product tweaks we have made in the marketplace. As you and I have talked one-on-one many times you can never understate the importance of great products in this industry because that is what drives sales. That is what drives customers into the stores and that is what drives our retail sales associates to sell product.
John Baugh – Stifel Nicolaus
You did not make a comment, I know you are rolling out or doing something with Specialty at Vegas and this will be an emphasis but can you sort of comment on what happened in 2009 with Specialty? How it went? Was there any improvement in the fourth quarter? Full year launch? Is everybody just sort of waiting?
Lawrence Rogers
Clearly the above $1,000 or luxury category has been the area that has probably been impacted the most through the entire 2009 year. Our line as far as Specialty goes, while it is at the end of its tenure we need to refresh it and that is what we have planned to do and have started to work on it the latter part of our second quarter and it is now ready for market. I think the proof will be in the reception it receives. From the general trade, we have already exposed it, if you will, to our larger customers and we are pretty confident in what we are going to find.
John Baugh – Stifel Nicolaus
Could you put any color on Stearns & Foster? You mentioned triple. Any reference in size or does it bubble in 2010 versus 2009?
Lawrence Rogers
Here is the way I would think about it. We really didn’t get Stearns & Foster launched until the third and fourth quarter so we still haven’t anniversaried, if you will, on an annual basis the first and second quarter. There should be some upside for us going into 2010.
Jeffrey Ackerman
I just want to make sure I clarify when you were asking about the share count and the impact with the PIK notes, that 4% accretion obviously when you think about our share count is only that portion of it related to the PIK notes. So that is more like 180 million. So that portion would increase by 4%, not obviously the entire share count.
Operator
The next question comes from the line of Reza Vahabzdeh – Barclay’s Capital.
Reza Vahabzdeh – Barclay’s Capital
You talked about the S&F line being up 300%. Where does that leave you with the rest of your lines in the US? Was the rest of your product line also up in sales and volume?
Lawrence Rogers
No. As we have talked about on previous calls there has been a little bit of cannibalization of Posturepedic above $1,000 which we had expected and planned to see. Clearly I think we have already dealt with the question on Specialty and what we saw in the fourth quarter relative to it being at the end of its product cycle and us reintroducing in a couple of weeks. Clearly Stearns & Foster and I would say promotional were the strongest part of our portfolio. One of the strengths, however, that I would like to point out is that because Sealy has a number of different portfolios and a number of different technologies it allows us to focus and move our business in a positive way as we address those various portfolios.
Reza Vahabzdeh – Barclay’s Capital
The increase in sales for S&F, was that partly driven by just increased slots per store or was that expanded distribution?
Lawrence Rogers
When you think about it, our strategy going forward as we talked last year was to limit the distribution from previous Stearns & Foster rollouts. We actually have cut back the number of dealers in a neighborhood of 40%. Clearly dealers have expanded the amount of Stearns they have on their floor compared to the previous slotting they have provided us. So fewer dealers. More slots. Better results.
Reza Vahabzdeh – Barclay’s Capital
On the input cost front, you mentioned that you think costs might rise in the second half of 2010. Do you have any basic expectations for what input costs could do for you in 2010?
Jeffrey Ackerman
What we have is it will peg pretty closely to the costs of barrel per oil and steel. Those are the two biggest drivers. If you think about foam and steel it makes up over 50% of our raw materials. It should track somewhat to that. Again, as I said really on a lagged basis so that is why just kind of projecting out what we think oil and some of the related petrochemicals will do that is where we are projecting an increase in the back half of the year.
Reza Vahabzdeh – Barclay’s Capital
What is the increase you are looking at or expecting at this point?
Jeffrey Ackerman
We haven’t really given that. We are still comping higher numbers in the first half of the year and we would expect that to reverse in the back half of the year. So our material costs at this time last year were still a bit higher and so we would expect to see some favorable overlap on materials in the beginning of the year but then that to reverse in the back half of the year.
Reza Vahabzdeh – Barclay’s Capital
Have you seen any increase already over the last month or two?
Jeffrey Ackerman
No. Again we don’t see things really in an immediate impact. It is a bit more delayed for us.
Lawrence Rogers
The other thing I would like to add is we have a number of value engineering projects each year. They are focused on creating value without taking material costs out but just doing things better and differently so there is a bit of an offset that we plan through our value engineering.
Reza Vahabzdeh – Barclay’s Capital
Was [inaudible] sales down 17.9% or 7.9%?
Jeffrey Ackerman
17.
Reza Vahabzdeh – Barclay’s Capital
Europe was down how much, X currency? Flat?
Jeffrey Ackerman
Essentially flat. It was down a fraction of a percent.
Operator
The next question comes from the line of Grant Jordan – Wells Fargo.
Grant Jordan – Wells Fargo
As you think about ways to continue to reduce debt you have a 10% call option on the [inaudible] notes, and then you also continue to buy stock back on the open market, have you made any decisions about which way you will go with that?
Lawrence Rogers
I will let Mark also chime in but what we will look at is kind of what the pricing is on the sub-notes and right now given the price of the sub-notes in the market it is pretty close to a push between the sub-notes and senior secured.
Mark Boehmer
As Jeff said you kind of look at current economics of the two. Obviously in the fourth quarter we took advantage of where the sub was trading to do some open market purchases. We will continue to make that evaluation going forward.
Grant Jordan – Wells Fargo
Any target in terms of debt reduction for the year?
Jeffrey Ackerman
Not that we have provided.
Operator
The next question comes from the line of Karru Martinson - Deutsche Bank.
Karru Martinson - Deutsche Bank
To ask Grant’s question a little bit differently now that you have brought down leverage so dramatically is there a new target leverage rate you want to guide the business to?
Jeffrey Ackerman
I don’t know there is a new target. I think we have talked about in the past a total leverage ratio below three. We are not there yet. We are actually just north of four on a total leverage ratio but our objective would be to get down below three on total net debt leverage ratio.
Karru Martinson - Deutsche Bank
So looking at that 4.2 number right now and bring that number down below three is the goal?
Jeffrey Ackerman
Yes.
Karru Martinson - Deutsche Bank
In terms of the competitive landscape, you mentioned you had market share gains from Stearns & Foster. What is the health of your competitors? Are you seeing smaller competitors consolidating or is it still kind of gaining share from the bigger players?
Lawrence Rogers
Well it is a bit of a mixed bag to be frank with you. Some of the smaller players certainly have had a difficult time through 2008 and 2009 and then there is the added complication or industry disruption, if you will, with the Aeries Capital acquisition of Simmons and taking it through bankruptcy. So it is a combination of a couple of things providing opportunity. We have been taking advantage of that opportunity. Clearly we were very aggressive with our Stearns & Foster product and because it is a pocketed coil unit and we had never really actively participated for pocket coil business in the past and in doing so we believe we have unleashed and uncovered an opportunity.
Karru Martinson - Deutsche Bank
On the retailer front, do you feel the worst is behind the industry in terms of bankruptcy and how do you feel about your exposure on that front?
Lawrence Rogers
I think Jeff mentioned we are kind of flat in our day sales outstanding so we haven’t seen any creep in terms of a negative direction from a day’s outstanding point of view. We haven’t identified anybody at the moment and the head of our sales for the US business meets with the head of accounts receivable every Friday and they are required to report to Jeff and I if there is any red flags on the horizon.
The other thing I think we have done a pretty good job of is moving into help retailers that appear to be having a problem just kind of navigating some of the challenges that are out there. We have sent teams of our finance people in on a couple of locations to help a retailer work through a strategy and just better run their business. That has worked pretty well for us also. So short answer, nobody on the horizon right now we are concerned about. We have been running a pretty tight ship from a day sales outstanding.
Operator
The next question comes from the line of Todd Harkrider – Goldman Sachs.
Todd Harkrider – Goldman Sachs
Early last month there was a news article that mentioned your intent to sell some of your European assets. Is that still on the table or would you consider selling any of your international assets if you got the right multiple?
Lawrence Rogers
I am not familiar of talks we are in so if we are in talks someone better tell me.
Todd Harkrider – Goldman Sachs
So the [inaudible].
Lawrence Rogers
That comes as a bit of a surprise to me. But we are in an industry that is always fraught with a little bit of color and a little bit of rumor. To be frank with you, any acquisitions targets would probably come from our licensees and there are three or four of them I would consider acquiring and would be very accretive to Sealy going forward. As far as selling assets right now I am not in any active mode or in any discussions relative to that.
Todd Harkrider – Goldman Sachs
Do you think you would be in a position to acquire any of those this year or would it maybe be a 2011 event?
Lawrence Rogers
We are in a pretty good cash position. As Jeff said earlier we will continue to invest in the business where it makes sense. Clearly our balance sheet is strong so I guess that is how I would answer that.
Operator
That concludes our question and answer session. I will now turn the call back to Larry Rogers.
Lawrence Rogers
Thank you everyone for your participation today and for your interest and continued support of our company. We would like to wish you a good evening and we look forward to talking to you at the end of the first quarter 2010.
Operator
This concludes today’s conference call. You may now disconnect.
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