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Mattress Firm Holding Corp. (NASDAQ:MFRM)

Q4 2013 Earnings Conference Call

March 13, 2014 5:00 PM ET

Executives

Alex Weiss – Senior Vice President-Finance

R. Stephen Stagner – President & Chief Executive Officer

Jim R. Black – Executive Vice President, Chief Financial Officer

Analysts

Budd Bugatch – Raymond James & Associates, Inc.

Josh Borstein – Longbow Research LLC

Peter J. Keith – Piper Jaffray & Co.

Keith Brian Hughes – Suntrust Robinson Humphrey, Inc.

Operator

Greetings, and welcome to the Mattress Firm 2013 Fiscal Year End and Fourth Quarter Earnings Conference Call. (Operator Instructions) At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference to your host, Alex Weiss, Senior Vice President of Finance. Thank you, you may begin.

Alex Weiss

Thank you, operator. Good afternoon, everyone, and thank you for joining us today for Mattress Firm’s Fourth Quarter 2013 Fiscal Financial Results Conference Call. Let me remind you that certain comments made during the call today may constitute forward-looking statements made in and pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 as amended. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those risks and uncertainties are described in the press release and Mattress Firm’s latest filings with the Securities and Exchange Commission.

The forward-looking statements made today are as of the date of this call, and the company does not undertake any obligation to update these forward-looking statements. Also during the call today, the company may be discussing adjusted EBITDA or EBITDA, which are non-GAAP financial measures. Please see the company’s press release for a reconciliation to net income, the most comparable GAAP measure. If you do not have a copy of today's press release, you may obtain one by linking to the Investor Relations page of the company’s website at www.mattressfirm.com.

I would now like to introduce the management team at Mattress Firm. Steve Stagner, Chief Executive Officer; and Jim Black, Chief Financial Officer. Management will make some comments, and then we’ll be available for your questions.

With that, I will turn the call over to Mr. Steve Stagner. Steve?

R. Stephen Stagner

Thank you, Alex. Good afternoon, everybody. And thank you for joining us on our earnings call. Today, I will briefly highlight our fourth quarter and year end results, provide an update on our recent acquisition, and then provide perspective on the business as we move into fiscal 2014. Jim Black, our Chief Financial Officer will then provide a more detailed review of the past quarter and full year’s fiscal 2013 financial results and then Alex Weiss, Senior Vice President of Finance will discuss our outlook for fiscal 2014.

To begin, we would like to emphasize the continued success of our relative market share model, in driving sales and adjusted operating income during the challenging year for the bedding industry. Our growth in 2013 was highlighted by a net sales increase of 21% to over $1.2 billion, opening 154 stores which increased our company operated store base to over 1200 units and growing adjusted earnings per share by over a 11% to 166.

In response to the ongoing tough consumer environment during the fourth quarter, we continued our deliberate decision to capture additional units to grab, and drive market share growth at the expected cost of the near-term gross margin. This enabled us to grow net sales by 21% and comparable store sales by 6.5% during the fourth quarter. To reiterate, these initiatives include an enhanced emphasis on unit capture and market share gains through increased transactions. Taken a more aggressive approach on a handful of select price points, and broadening the availability of third-party consumer financing.

As planned, these initiatives had a negative effect on margins, causing a 210 basis points drop in adjusted operating margin during the fourth quarter as compared with the prior year. While it is taking a little longer than anticipated to built back in some margin benefit, we remain confident that we will realize margin improvement increasingly throughout the year. As we return to our more traditional selling approach and as new product are placed on to the floor.

Let me provide some additional color on our fiscal 2013 fourth quarter results. Our acquired stores continue to outpace the overall chain and demonstrated by their 16% same-store sales growth, contributing approximately 290 basis points to our comparable store growth in the fourth quarter. These markets where we have made acquisitions continue to be our fastest-growing markets.

Furthermore, we are encouraged that our legacy stores started to experience positive same-store growth during the fourth quarter, primarily due to additional unit capture as a result of our selling initiatives. This should be an additional driver of growth in 2014. The success of our sales initiatives drove a 6.5% increase in same-store sales growth, made up of a strong 9.1% same-store unit gain in the quarter, partially offset by a 2.3% AUP decrease. Despite our success in driving unit sales, our traffic trends remained challenged throughout the quarter. This was associated with an overall soft consumer environment and exacerbated by the added challenge of severe winter weather. In the fourth quarter, this included atypical inclement weather in many of our primary markets, resulting in approximately 2,100 store days where stores in these markets were partially or completely closed, and many other days where our sales were adversely affected, which we believe led to a sales drop of approximately $7 million to $9 million.

Now, let me give you updates on the acquisitions that we completed in the fourth quarter and our most recent acquisition activities that we announced this week. We have finished integrated the Mattress People and Perfect Mattress stores in our Nebraska and Wisconsin markets, and are excited about their prospects. While we saw some de-leverage from those acquisitions in Q4 and into Q1, we expect to gain some benefit now that we have implemented our selling model in these stores as we move further into 2014.

Now that we have fully integrated our previous acquisitions, we are excited to update you on the three recent acquisitions that we announced earlier in the week. We completed the acquisition of 37 Mattress Firm stores in Colorado, Kansas, and Virginia that were formally operated by two franchisees. One of the acquisitions was with our very first franchisee who opened in 1994, and we are pleased to welcome these teams to the broader Mattress Firm family.

At the same time, we are thrilled to announce the strategic agreement to acquire Sleep Experts, a 56-store chain with an exceptional sales per store average that was built over the past 11 years in Dallas and Austin. Additionally, this acquisition brings a high quality and experienced team that delivers remarkable customer service. We are excited about the potential to further enhance the operating performance of these markets at an accelerated pace, as we integrate these teams onto our efficient corporate operating platform. While we will experience some de-leverage in the first quarter from these acquired stores, they should provide us with a nice runway for growth during the balance of 2014 and beyond. Jim will provide additional details on the acquisitions. Looking forward, it appears that the pullback in the industry-level advertising directed towards the high-end consumer is improving, although not back to historic levels.

This supports the ongoing stabilization that we experienced in our specialty mattress our specialty mattress sales mix from the second to third and fourth quarters. We will continue to concentrate on the basic pillars of our business in the areas of selling intensity, merchandising assortment, real estate quality, and advertising effectiveness that are intended to maintain an excellent buying experience for our customers. We are confident that we can drive unit sales performance in 2014 because of the because of the following factors.

First, continued sales initiatives focused on unit capture, albeit at a reduced rate to allow us to build back in additional gross margin benefits. Secondly, exciting new product introductions and finally, anticipated ongoing spend by manufacturers focused on the higher end specialty category. Alex will provide additional detail on the full year expectations.

In closing, we achieved strong growth during 2013 from organic new store openings, continued strong performance from our previous acquisitions, and in comparable store growth. As a leader in our industry, we continue to believe in our relative market share model, we are optimistic for 2014, and look forward to integrating the announced acquisitions, and creating additional value for our shareholders.

I will now turn the call over to our CFO, Jim Black.

James R. Black

Thanks Steve, and good afternoon. I will focus my commentary on the fiscal fourth quarter that ended January 28. During the fourth quarter, we reported adjusted EPS of $0.30 which was unchanged from adjusted EPS of the prior-year quarter. Adjusted EPS for the current quarter excludes cost of our ongoing ERP implementation project, acquisition-related activities, and a non-cash impairment charge that are included in our GAAP results.

Diluted earnings per share on a GAAP basis including these costs were $0.25, based on weighted outstanding diluted shares of $34.2 million. Net sales in the fourth quarter were $312 million an increase of $33.9 million or 21% over the same period of the prior year. The increase in sales included comparable store sales growth of 6.5%, adding $16.6 million in sales during the quarter. Stores we opened and acquired added incremental net sales of $21.2 million, and stores we closed reduced net sales by $3.9 million during the quarter.

Comparable store sales growth of 6.5% was comprised of a 9.1% increase in unit sales, offset partially by a 2.3% decrease in AUP, which was related to the sales initiatives that Steve described. Furthermore the 6.5% total comparable store sales increase for the quarter included the combined effect of approximately 290 basis points from the former Mattress Giant stores acquired in May 2012, Mattress XPress stores acquired in October 2012, and Mattress Source stores acquired in December of 2012.

During the fourth quarter, sales of specialty mattress products comprise 43.8% of our net sales, compared with 40.9% during the prior-year quarter, while sales of conventional mattresses comprised 47.2% of our net sales, compared with 42.9% during the prior-year quarter. During the fourth quarter, the Company opened 33 stores acquired 46, while closing 9, bringing the total number of Company-operated stores to 1,225 at the end of the fourth quarter.

For the full fiscal year, the Company has opened 154 stores and acquired 46, while closing 32. Gross profit increased 16.8% to $114.5 million in the fourth quarter, compared to the same period in the prior year, as a percentage of sales, gross decrease of 125 basis points to 36.7% over the prior year on an adjusted basis excluding acquisition-related costs incurred in the prior year, the decrease was 150 basis points. This adjusted decrease has several significant components.

First, product gross margins decreased 215 basis points from a prior year. There was no significant change in the terms under which we purchased merchandise, and the decline was a result of the sales initiative described by Steve that successfully drove unit sales throughout the fourth quarter. Second, comparable store sales growth drove leverage over store occupancy and other constant recurring cost, resulting in gross margin expansion of 100 basis points during the fourth quarter.

The ongoing inclusion of the former Mattress Giant stores in the comparable store base, which commenced at the beginning of the second fiscal quarter of 2013, continues to drive year-over-year expense leverage, as we expected, and the 100 basis points increase in overall gross margin included 50 basis points of improvement attributable to the acquired stores. Third, our entrance into new markets, which results in lower average – lower leverage over store occupancy, warehousing, and other operating costs while we ramp up sales, resulted in 30-basis points of expense deleverage.

And finally, there was a combined net decrease in gross margin of 5 basis points across several smaller categories, due primarily to normal fluctuations. Sales and marketing expense was $75.4 million for the quarter, an increase of $13 million over the prior year. Sales and marketing expense as a percentage of net sales was 24.2% for the current quarter, which was unchanged compared to the prior year period.

The advertising expense component of sales and marketing increased $5.2 million to $26.5 million for the fourth quarter. Advertising as a percentage of net sales de-levered slightly by 25 basis points during the fourth quarter to 8.5%, as a result of lower than expected sales during the weeks affected by severe weather. The non-advertising components of sales and marketing expense, consisting mainly of salesman compensation, increased $7.9 million to $49.0 million for the quarter, primarily as a result of the increase in net sales. This expense, as a percentage of net sales, improved by 25 basis points over the prior year to 15.7%. General and administrative expense on a GAAP basis increased $5.9 million to $23.8 million for the fourth quarter as compared with the prior year period. This expense as a percentage of net sales de-levered by 80 basis points to 7.3% compared to the prior year period on a GAAP basis.

On an adjusted basis, general and administrative expense increased $4.9 million for the fourth quarter to $20.4 million, excluding $1.1 million of ERP implementation cost and $1.3 million of acquisition-related cost in the current year, and $1.9 million acquisition-related cost and $0.2 million debt amendment cost in the prior year. On an adjusted basis, general and administrative expense as a percentage of sales, de-levered 50 basis points to 6.5% compared to the prior year. The increase in expense in this category over the prior year reflects ongoing investment in our corporate infrastructure to support our growth initiatives and higher ongoing costs related to our new ERP system.

The company recorded a non-cash impairment charge of $0.4 million in the fourth quarter, as compared with a $2.3 million non-cash impairment charge in the prior year period. The current year non-cash charge reflects impairment of store level fixed assets for a number of – for a small number of stores. The prior year charge consisted primarily of a $2.1 million intangible asset impairment charge as a result of our plant to substantially discontinue the ease of the Mattress Discounters name acquired in 2010. These non-cash impairment charges are excluded from adjusted operating income, in both the current and prior year periods.

On a GAAP basis, operating margin was 5.4% in the fourth quarter. On an adjusted basis, operating margin declined 210 basis points compared to the prior year to 6.3%. In summary, the significant changes in adjusted operating margin are comprised of 150 basis point decline in gross margin, a 50 basis point decrease from selling and administrative expense to leverage and 10 basis point as combined operating margin declines in other areas.

Total other expense for the fourth quarter consisting mainly of interest expense, was $2.7 million, a decrease of $0.2 million from the prior year due primarily to the reduction in the amount of outstanding debt. The effective income tax rate was 38.4% for the fourth quarter which was slightly below the full year effective rate of 38.5%.

I’ll now turn to the balance sheet and statement of cash flows for a brief review. During the fourth quarter of 2013, we generated $33 million in operating cash flows, incurred $14.7 million in capital expenditures used $6.8 million in acquisitions and reduced outstanding debt $6.0 million. At the end of the fourth quarter, cash was $22.9 million, an increase of $7.6 million during the quarter, with approximately $77 million of availability under our revolving credit facility. Total debt was $221 million, with $21 million of outstanding revolver borrowings, and net debt leverage was approximately 1.40 times.

On February 27 of 2014, the company completed an amendment of a senior credit facility to provide additional financing flexibility. With the amendment, the maturity of the $100 million revolving facility was extended to one year to January of 2016. The allowable individual and cumulative transaction values under the permitted acquisition baskets were increased and the amount of incremental borrowing available under facility was increased from $50 million to $200 million.

Now I’ll provide more detail on acquisitions that occurred in the fourth quarter and our most recent acquisition activities that have occurred subsequent to our fiscal year end. As we have discussed on our third quarter call, the Company acquisitions during the fourth quarter. In November, the Company acquired a small mattress retailer operating five stores in Nebraska and Iowa for a total cash purchase price of $2 million. In December, the Company acquired the assets and operations of a former Mattress Firm franchisee operating in 39 stores, primarily in Wisconsin, for a total purchase price of $6.5 million, a portion of which was delivered in the form of a seller note that is payable in quarterly installments over one year.

The result of operations of the acquired businesses are included in the Company's results of operations during the fourth quarter from the respective closing dates of the acquisitions. In addition, I will provide a summary of recent acquisition activities that have occurred subsequent to our 2013 fiscal year-end, as previously communicated in our March 10 press release.

On March 3 of this year, the Company completed the acquisition of the operating assets of a former Mattress Firm franchisee, consisting of 34 stores and two warehouses, with 20 stores Denver, Colorado, seven stores in Colorado Springs, and seven stores in Wichita, Kansas, as well as three stores representing the Roanoke, Virginia operations of another Mattress Firm franchisee. The Colorado and Kansas operations were acquired for a cash purchase price of $15 million, subject to customary purchase price adjustments. The Virginia acquisition, which also includes the repurchase of the franchisee's rights to the remaining Virginia territory, was completed at a cash purchase price of approximately $450,000.

The sales per store of these acquired franchisee stores are slightly below the Mattress Firm chain average, although the markets in which they exist provide opportunities for further store penetration. Over time, we expect to drive our relative market share in these markets as we add stores and gain operating efficiencies and margin expansion. At March 7 of this year, the Company entered into an agreement to purchase the outstanding partnership interest of Sleep Experts Partners LP, which operates 56 specialty mattress retail stores in Texas under the name Sleep Experts, with 45 stores in the Dallas-Fort Worth market and 11 in the Austin market.

The total purchase price is $65 million, subject to customary purchase price adjustments. The $3.25 million of the purchase price will be paid with the delivery of Mattress Firm Holding Corp shares, having an equivalent aggregate value based in the weighted average share price during the 30 days prior to closing. The Sleep Experts chain is professionally operated, and its stores generate sales per store averages that are above the Mattress Firm chain average. The Dallas and Austin markets are highly penetrated, and we expect that the addition of the acquired stores will drive expense leverage and margin expansion in those markets as we integrate the operations throughout 2014. Alex will provide more information regarding the expected effects of these recent acquisitions on a result of operations in 2014.

The Company intends to increase incremental current senior credit facility by $80 million to $85 million to fund the cash requirements of these 2014 acquisitions. We expect that the incremental borrowings will contain pricing and maturity terms that are similar to the existing outstanding balance of our term debt.

I will now turn the call over to Alex Weiss for discussion of our fiscal 2014 guidance.

Alex Weiss

Thank you, Jim. I will address our updated financial guidance for fiscal 2014 which is comprised of the 53 weeks ending February 3, 2015. We currently expect full fiscal year sales in the range of $1.46 billion to $1.52 billion, an increase of approximately 20% to 25%, as compared with fiscal 2013. The sales estimate has been updated to include $80 million to $90 million of incremental sales in fiscal 2014 from the recently announced acquisitions that Jim previously discussed, with the assumption that we will complete the Sleep Experts acquisition by first fiscal quarter of 2014.

We currently expect full-year adjusted EPS in the range of $1.88 to $2.00 representing an increase of approximately 13% to 20%, as compared with fiscal 2013. Our adjusted EPS estimate excludes incremental expenses directly related to our ERP system rollout of approximately $0.13 to $0.14 per share and acquisition-related costs from recently announced and completed acquisitions of approximately $0.08 to $0.09 per share. EPS on a GAAP basis, including these incremental expenses, is expected to be in the range of a $67 to a $76. The table in the press release provides detail of the estimated EPS effect of these adjustments, and I will provide further information on these adjustments in a moment.

The increase in sales includes the assumption of low single-digit comparable store sales growth for the full year and the expectation of 145 to 165 new organic stores and 93 acquired stores resulting from the recently announced acquisition. We expect that approximately 60% of new organic stores will be added in existing markets, in line with our relative market share growth strategy, with the balance in new markets to provide a base for future growth.

Net of closings, we expect a net increase in store units in the range of 205 to 220 and expect to a fiscal 2014 with approximately 1,430 to 1,455 Company-operated stores. We expect a disproportionate amount of our new store openings to occur during the first half of fiscal 2014. Given our use of sales initiatives focused on unit capture that Steve discussed previously albeit at a reduced rate to allow us to build back in additional gross margin benefits, we expect comparable store sales to start off stronger during the front part of the although negatively affected by the severe winter weather that has persisted into the first quarter, and then to moderate later in the year as we anniversary the sales initiatives put in place late in the third quarter of 2013. The Company has experienced a de-levered product margin decline since Q3 of fiscal 2013, as a result of our selling initiatives.

While we expect these effects to carry into fiscal 2014, we also expect to realize margin improvement increasingly throughout the year, as we return to our more traditional selling approach, and as new products are placed onto the floor. The acquisitions in Mattress People and Perfect Mattress that we completed during Q4 of fiscal 2013 are integrated into Mattress Firm, and while we have seen a drag on adjusted EPS in Q4 and into Q1 we expect that they will become slightly accretive for the remainder of 2014.

While not a major driver of comparable store sales, since the stores comprise over 4% of the total store base, we expect to gain a small overall comparable store sales benefit in Q4 of 2014, as those acquired stores enter the comparable store base. The anticipated addition of 93 stores in fiscal 2014 from the recently acquisition will further fortify our presence in Texas and provide us with footholds for strong growth opportunities in Colorado, Kansas, and Virginia. Our guidance has been updated to reflect our expectation that these acquisitions will have a drag of approximately $0.02 on an adjusted EPS basis in the first quarter, while we integrate the operations onto our platform, before becoming accretive and ultimately adding an expected $0.03 to $0.05 to adjusted EPS over the full year 2014.

Turning to adjusted operating margin, our guidance includes the expectations that overall adjusted margin will decline by 20 to 60 basis points during 2014, primarily due to initial deleverage from the late 2013 and recently announced acquisitions in 2014 and the effect of lower margin in early part of the year as we transition towards our more traditional selling strategies. From the perspective of line items in our results of operations, as compared with the prior year results, our 2014 guidance anticipates that gross profit margin will from flat to deleverage of 40 basis points, and likewise will be affected early in the year by the acquisitions and current sales initiatives, as well as initial deleverage in occupancy on the greater number of new store openings expected early in the year.

We expect that selling and marketing expenses will range from deleverage of 20 basis points, deleverage of 20 basis points, based on a lower advertising spend to sales rate in our base business as we infill existing markets offset by higher levels in advertising spend to sales as we enter new markets, continue penetrating development market and enter the recently acquired Denver market. We expect that general and administrative expense growth will result in 20 basis points in deleverage to 20 basis points in leverage as adjusted to exclude approximately $7 million to $8 million of direct cost related to the ERP system implementation and $4.5 million to $5.5 million associated with acquisition related cost.

Much of the growth in general and administrative expense in 2014 will reflect the impact of investments made in 2013 and early 2014 as a result of our growth, offset by the additional leverage we expect to achieve from our recently announced and completed acquisition. As we mentioned previously, the ERP system implementation can be characterized with a massive training effort with the objective of transitioning our sales and field organization from the old to new platforms on a sequential market-by-market basis.

The ERP training effort consists of specifically identifiable costs, including our core dedicated training team they travel during their project in temporary training facilities in our markets. The ERP implementation unit and related training is entirely independent of our normal training programs, which will continue as normal and the estimated cost included in our fiscal 2014 guidance as it’s not expected to repeat in the future period.

In fiscal 2013, we were very deliberate and methodical with our rollout and took the time to test and improve the ERP system as the year went along. As a result, the rollout occurred more slowly than we originally anticipated back in early 2013. We now feel very comfortable with our new ERP system, have converted over 400 stores to our platform and plan to convert the remaining stores by the end of fiscal 2014. We estimate that franchisees in 2014 will decline by about $1 million or 20 basis points over the full year as a result of our recent franchisee acquisition. The decline will be in place from the beginning of the year, as the expectation of some growth over the course of the year as our franchisees grow their sales as a – at a rate in line with our comparable stores sales growth rate.

We anticipate net interest expense for 2014 to be approximately $12 million under our current senior credit facility, and the remaining outstanding balance was carried out. Our forecast accounts for the additional interest expenses associated with the acquisitions, and assumes LIBOR rates will not move much from their current levels throughout 2014. We anticipate stock-based compensation expense will grow by approximately $1 million during the fiscal 2014, the full year expected income tax rate will be approximately 38.5% and we’re using diluted share count of about $34.5 million.

We anticipate capital expenditures will be approximately $65 million to $75 million in 2014, and debt is expected to increase by approximately $35 to $40 million, consisting of approximately $80 to $85 million of net borrowings during the front part of the year to fund the recently announced acquisitions and subsequent reductions of $40 million to $50 million over the course of the year from free cash flows.

This concludes our prepared remarks. And at this point, the operator will open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session (Operator Instructions) And one moment please, while we poll for questions. Our first question comes from the line of Budd Bugatch with Raymond James. Please proceed with your question.

Budd Bugatch – Raymond James & Associates, Inc.

Good afternoon Steve, Jim, and Alex, and congratulations on a very credible quarter and on the color that you gave for your guidance I appreciate that very much.

R. Stephen Stagner

Thank you Budd.

Budd Bugatch – Raymond James & Associates, Inc.

Just two questions that I have, because you answered most of them with the guidance. When you look at the split of sales, and specialty did gain some this year although loss as a percentage, can you – Steve, can you look at the at the conventional mattresses, and I believe hybrids are in there. Can you give us some color as to what portion of your hybrid sale – of your conventional might be hybrid which you might think about as specialty?

R. Stephen Stagner

Yes, Budd on the hybrid, we don’t break it out that detail but what I can tell you the hybrid SKUs accounted for two of the SKUs. So, it wasn’t a large mix of the sales really the non-innerspring sales growth came from Stearns & Foster lines and the other kind of high-end coil lines that were fresher and newer that really kind of drove the growth this year much less than, I would say, specifically Hybrids. I will say the Hybrids that we have on the floor are doing very well, but that wasn’t the real driver of the growth. So, I think that – hopefully that answers the question.

Budd Bugatch – Raymond James & Associates, Inc.

Okay. And just as we look at, I was in a couple of the stores looking for new product. I think it’s starting to get in there this week. What is the rollout, and when well the floors be refreshed?

R. Stephen Stagner

So we have quite a few models changing, as I think you know. We anticipate by Memorial Day to have all the new models on the floor.

Budd Bugatch – Raymond James & Associates, Inc.

Okay. I guess my last question is, and maybe you went over this, Alex, and if you did and if I missed it, I apologize. When you say low single-digit comp store sales growth, can you divine the range of that, so that we have a couple numbers?

Alex Weiss

We kind of think of that as [indiscernible] 1% to 3%.

Budd Bugatch – Raymond James & Associates, Inc.

Okay. That's it for me. Thank you very much. Congratulations and good luck on this year.

Alex Weiss

Thank you Bugatch.

Operator

Thank you. Our next question comes from the line of Josh Borstein with Longbow Research. Please proceed with your question.

Josh Borstein – Longbow Research LLC

Hello Steve, Jim, and Alex. Thank you for taking my questions here. The first one, the levers you pulled back in 3Q to encourage RSAs to improve unit capture, maybe they've overshot the market a little bit in 4Q. What have you changed with RSA incentives to better align unit growth and margin preservation?

R. Stephen Stagner

Josh, that's a great question. Basically as I started out in the last quarter talking about that we were lowering the prices on specifically four to five different models, we are also using part of the levers inside our compensation plan to put more to focus on unit cash flow. Since last quarter ended and as we go forward, most of those levers are still in place as we continue to experience a choppy environment. We have pulled back some of those levers more on a compensation side. The price points are still the same, and since we had a lot of new models coming on the floor in the coming weeks and months, we will use that as the strategic structural way to pull back on those, in particular, levers. But as we continue through the choppy environment, I wanted to keep the focus on grabbing positive comps.

Josh Borstein – Longbow Research LLC

Okay. And does the focus on unit capture come at the expense of mattresses at higher price points, or are those two things mutually exclusive?

R. Stephen Stagner

I think you can look at our overall mix. We've seen a little bit of degradation over the past couple of quarters in higher-end mattresses in some regards, but it’s been because of this focus. That is primarily attributed to just an overall less level of advertising and then on the level from the advertising from the manufactures. The unit capture that we are talking about has been primarily in the promotional end.

Josh Borstein – Longbow Research LLC

Okay, great. Thank you for that. And then last one from me. With the new product, and given all the weather headwinds that you see in January, February, have there been any issues in selling off old inventory in order to make way for the new, whether that's mattresses or accessories like adjustable foundations? Just trying to get a sense of if rollout has proceeded in line with your internal plans or not.

R. Stephen Stagner

Yes, the rollout is in line with our plans. The weather has not directly impacted the overall span on the rollouts. It has directly impacted sales in stores on given days, but we're still on track for our rollout for Memorial Day.

Josh Borstein – Longbow Research LLC

Great. Thank you very much, and good luck in 2014.

R. Stephen Stagner

Yes thanks Josh.

Operator

Thank you. [Operator Instructions] And thank you. Our next question comes from the line of Peter Keith, Piper Jaffray. Please proceed with your questions.

Peter J. Keith – Piper Jaffray & Co

Hi, good afternoon, everyone. Steve, as we're just rolling into 2014 here, I know there's some choppiness with the weather trends. But I was hoping you might be able to provide your big picture perspective on the health of the industry when you look at product innovation, and the cadence of advertising, and general consumer demand trends?

R. Stephen Stagner

Yes Peter we are pretty optimistic about the year from the perspective of the new products although we’re not characterize them as revolutionary. I do think that we were overdue for some freshening up on the lines. If you think about it, Peter, all our specialty product lines, Tempur-Pedic, iComfort, and Optimum were over two years old. So those lines of the productive we’re getting a little bit tired on the floor which I think also drove a lot of the premium business shows in the past couple of quarters. So, these new products certainly have some strong aesthetics. They have better curb appeal and some nice clean stories that should translate to value to the consumers.

We're pretty excited about that part. We're also excited about the advertising the manufacturers, in particular the ones that focus on high-end specialty mattresses seem to be more consistent and honoring their word, although we're not back to historic levels. We seem to see some more consistency going in the macro on the advertising, which I think will bode well for the summer. And we are seeing those who advertise getting the results in sales on their lines. Finally, I was encouraged to see consumer confidence in the macro level starting to claim up, breaking over 80, which I think is fantastic. If we can, hopefully get a little tailwind with the consumer, then this should be a pretty good year for us.

Peter J. Keith – Piper Jaffray & Co

Okay. That's a helpful summary, appreciate it. When we look at the guidance, and I agree with Budd, you guys did a nice job detailing everything. But on the cadence of comps for the year, within that 1% to 3% full-year comp range, should we expect all quarters to be positive, particularly looking in the back half of the year?

R. Stephen Stagner

In the back half of the year, I would expect comps to moderate to kind of flattish to maybe slightly positive, it kind of the overall cadence as we mentioned we’ll start higher just as we are considering with some of our selling initiatives and going up again the period in the last year where we had really strong gross margins and then obviously once we ramp these selling initiatives of 2013, we will moderate more to that flattish level. The one thing two kind of to note to you is that we have still seen some weather into Q1 as on the retailers have as well. So you should take that into account that when we say starting out higher and going to lower number that is there is a weather impact you have to factor in, as well.

Peter J. Keith – Piper Jaffray & Co

Okay, that's helpful. Also within the comp, the acquired stores continue to provide a nice comp lift, 290 basis points I think you said in the fourth quarter. How should we think about that rolling into 2014? I'm sure it's going to decelerate, but how quickly well it decelerate?

R. Stephen Stagner

Yes, that's going to decelerate pretty quickly and just because we’re coming up against after the stores have ramped up pretty significantly. And so there are going to be roughly in line, maybe slightly above our standard stores, but they're pretty close to our average store.

Peter J. Keith – Piper Jaffray & Co

Okay. That's great. Thank you very much, everyone.

R. Stephen Stagner

Thank you.

Operator

Thank you, our next question, our last question comes from the line of Keith Hughes of SunTrust Robinson Humphrey. Please proceed with your question.

Keith Brian Hughes – Suntrust Robinson Humphrey, Inc.

Thank you. I got disconnected a couple times, so I'm not sure if this has been asked. But the acquisition in Texas, on a per store base, that's one of the more expensive we've seen you do. I know you talked about some good same – sales per store metric. Can you give any more details there of why they're doing – what they're doing and why they're doing so well?

R. Stephen Stagner

Yes, Keith. The stores in Texas, certainly it’s hard to give a lot of details on the call because we have enclosed yet. But what I can tell you is they are a very high performing chain with very strong store averages backed up with very great people, great execution with a lot of focus on the consumer and it’s really strong brand, we see there is a very important strategic and accretive opportunity because this chain is tucked right inside two of our important markets and we should be able to access the synergies in a very quick fashion in this market.

Keith Brian Hughes – Suntrust Robinson Humphrey, Inc.

Okay. And with the number of stores, net stores, you are looking to add, you're going to be well in excess of 1,400 stores by the end of this fiscal year. Can you just kind of back up with us and give us your views on how many stores, what’s the max you can reach before you have to move into geographies you’re not currently in?

R. Stephen Stagner

So what we have consistently talked about is that, we think that we could reach around 2500 locations and, I think that – gives us a little bit of runway a significant runway actually beyond almost doubling the chain again from this point.

Keith Brian Hughes – Suntrust Robinson Humphrey, Inc.

That would include California, Northeast, and things like that. If you x those out, what’s the – you seem to be raising your penetration number that you’re comfortable going to. Is that fair to say?

R. Stephen Stagner

Well we think that the country on a conservative basis if you go border-to-border, coast-to-coast, can hold at a minimum of 1 store per 100,000 people. There is 313 rough million people in the U.S. so that would impute to a little over 13,000 locations.

James R. Black

In our core market if you look at Houston and other markets we, we’re down to way below that 1 per 100,000 number. So, to your point earlier, we haven’t changed our official 2,500 target for the country, but I think we feel more comfortable with it. We’re pretty – we were comfortable before and now that we’ve seen in our strongest most penetrated markets continuing to add stores we gain extra comfort by the day.

Keith Brian Hughes – Suntrust Robinson Humphrey, Inc.

Okay. Final question. Now that the weather has improved really somewhat in the Sun Belt states, are you seeing some sales snapback from the winter impacted results?

R. Stephen Stagner

Yes, Keith I think as you see the weather improved in there as the mercury rises we’re starting to see definitely more consistent trends to what we will expect than normal environment. So, clearly and we were even seeing pretty decent results but then we had to close stores as we just lost the volume so.

Keith Brian Hughes – Suntrust Robinson Humphrey, Inc.

Right. Okay, thanks very much.

R. Stephen Stagner

Thanks Keith.

Operator

Thank you. I’d now like to turn the call back over to management for closing comments.

R. Stephen Stagner

Okay, well. Thank you all for joining us on the call tonight and the time that you had spent to discuss our Q4 results. And we look forward to speaking to you again very soon. Have a great evening.

Operator

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time, and thank you for your participation.

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