Tempur Sealy International (TPX) Scott L. Thompson on Q4 2015 Results - Earnings Call Transcript

| About: Tempur Sealy (TPX)

Tempur Sealy International, Inc. (NYSE:TPX)

Q4 2015 Earnings Call

February 04, 2016 8:00 am ET

Executives

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Scott L. Thompson - Chairman, President & Chief Executive Officer

Analysts

John Baugh - Stifel, Nicolaus & Co., Inc.

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

Beryl Bugatch - Raymond James & Associates, Inc.

Mark Rupe - Longbow Research

Seth M. Basham - Wedbush Securities, Inc.

Jessica Schoen Mace - Nomura Securities International, Inc.

Keith Hughes - SunTrust Robinson Humphrey, Inc.

Peter Jacob Keith - Piper Jaffray & Co (Broker)

Curtis S. Nagle - Bank of America Merrill Lynch

Daniel H. Hofkin - William Blair & Co. LLC

Operator

Good day, ladies and gentlemen, and welcome to the Tempur Sealy Fourth Quarter 2015 Earnings Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer; instructions will follow at that time.

I would now like to introduce your host for today's conference, Mr. Barry Hyte (sic) [Hytinen]. Please go ahead.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Thanks, Catherine. Good morning, everyone, and thank you for participating in today's call. Joining me in our Lexington headquarters is Scott Thompson, Chairman, President and CEO. After prepared remarks, we will open the call for Q&A.

Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements, including the company's expectations regarding sales, earnings, adjusted EBITDA or net income and anticipated 2016 performance 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, regulatory, competitive, operating and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings, including but not limited to annual reports on Form 10-K and the company's quarterly reports on 10-Q under the headings Special Note Regarding Forward-looking Statements and/or Risk Factors, as well as the company's press releases. Any forward-looking statement speaks only as of the date on which it is made and the company undertakes no obligation to update any forward-looking statements.

This morning's commentary will include non-GAAP financial measures. The press release contains reconciliations of these non-GAAP financial measures to the most directly comparable GAAP measures as well as information regarding the methodology used for constant currency presentations. We have posted the press release on the company's website at tempursealy.com and have also filed it with the SEC. Our comments will supplement the detailed information provided in the press release.

And now with that introduction, it's my pleasure to turn the call over to Scott.

Scott L. Thompson - Chairman, President & Chief Executive Officer

Thank you, Barry. Clearly, we have a lot to talk about this morning. But the main news is, the company's quarter was very solid from an operating standpoint. We made very good progress towards our goals, January has started out well and the new product launches are on track.

Now for my report. Tempur Sealy leadership team is laser-focused on building the business for the long term. I'm frequently asked about how we're going to achieve this. The team has the entire organization focused on a handful of key initiatives to drive performance and build the business. These include the following: First, developing innovative bedding products and investing significant marketing dollars to communicate the health benefits of these products so that our consumers trade up to the best sleep products they can afford. The combination of great products and significant marketing will drive traffic to our retail partners and will help both us and our retail partners achieve higher average sales price.

Second, growing North American margin. By improving our Sealy assembly operations, improving supply chain and sourcing and taking opportunistic pricing actions. Third, growing market share outside of North America, in particular in Europe, with both the Sealy and the Tempur brands.

Lastly, consistently analyzing our distribution strategy to make sure our products are properly represented in all channels and that we've taken advantage of all market opportunities. In this area, I do have some comments regarding our thoughts on the bed-in-the-box concept that I'll share in just a minute.

Turning to some recent product news, we had some significant new product launches, both domestically and abroad that we believe were received very well. Additionally, we have announced certain price increases that have been very helpful to us and our retail partners.

First, a couple weeks ago at the Vegas Bedding Show, we launched our new Stearns & Foster product line which includes three collections, Estate, Lux Estate and a brand new Reserve collection. The trade received these products very well. Stearns & Foster's showroom was buzzing with traffic.

We expect solid distribution of the lineup. Retailers were very excited to learn that we'd be stepping up our Stearns & Foster marketing support, including investing in television advertising the first time in brand history. With this level of innovation included in the line, we also announced that we intend to keep the line in the market for three years versus the historical product life of two years. Major retailers have been supportive of this change as it saves them from having to replace floor models as frequently, and we hope others will follow.

Also, for many years, Tempur-Pedic has been the only brand that consistently achieved higher average sales price, which clearly benefits both us and our retail partners. Now, the team is excited to deliver a similar outcome with the powerful Stearns & Foster brand.

Because of all the innovation and features in the new Stearns & Foster line, we expect to drive higher average sales price, with the highest end (5:37) product price at $5,000 for the Reserve Queen, which is up from the former line's top product price of $3,300. Although volume is not expected to be significant at the high end, this product has the potential to help drive ASP for our retail partners and serve as a halo product for the brand.

On the Tempur-Pedic side of the business, we introduced the new TEMPUR-Breeze line, which delivers benefit of Tempur material, adaptive support, pressure point release and reduced motion transfer, while also leveraging proprietary technology that enables consumers to sleep cooler and wake up more refreshed.

You'll recall our initial launch of Breeze in 2012 was a hit with consumers and retailers alike, driving average ASP and growing volume for Tempur. We believe the latest Breeze is a significant improvement on a product that is already very popular. I feel great about this product. It also happens to be the bed that I sleep on.

On the International front, which represents our fastest-growing segment, you'll be pleased to know that last month, at the bedding show in Cologne, Germany, we launched our International Tempur Hybrid, which is the international version of the Flex Collection we launched very successfully in the U.S. in 2015.

In addition, we also launched the Tempur and Sealy box spring offering, which are the new market segments for us in Europe. This show was very well attended and we feel very good about our international launches.

Onto the pricing front. You'll recall that last year that we increased retail price for select Tempur-Pedic products and these price increases were comfortably absorbed by the market. The price increase helped grow both our earnings and earnings of our retail partners in 2015. Building on this experience, we recently raised the price on a select range of Tempur-Pedic products.

In addition, we recently announced a round of price increases in our Sealy brand products, primarily focused on Posturepedic Hybrid as well as certain king-size offerings across the portfolio. As we've said before, we believe that strong product brands and products will lead to pricing opportunities.

Turning to our growing direct business, we strongly believe that it is important to grow our direct sales to consumers, as consumers are increasingly researching products online and are willing to purchase even large-ticket items directly from manufacturers. We believe we have a natural advantage in going direct. Many of you will recall that Tempur-Pedic actually started selling direct to consumers. As such, we have a great heritage and knowledge in the area. We believe that Tempur-Pedic can grow the direct sale model in a way that is highly complementary to the company's third-party retail business. In the coming months, you should expect to see a new, more sales-focused company website, approximately 20 new company-owned stores internationally and a couple of stores in North America. I should note that our direct-to-customer business in 2015 grew at almost twice the rate of our third-party retail business.

In addition, while we're not yet clear on how big the segment's online mattress sales will ultimately be, it is clear that channel at the low-end market is growing. In our view, the growth of this segment is primarily due to the appeal of a very simple and time-saving sales process as opposed to these products being of higher-quality or having features at the same price point as products sold in the traditional bedding channel. As a worldwide branded bedding manufacturer, we want to be wherever the consumer wants to shop.

So, we're very pleased to announce that during the first quarter of 2016, we will be introducing a Sealy-branded bed-in-a-box sold directly online. We'll also start to work with our third-party retailers to give them an opportunity to participate and realize incremental revenue. We've compared our product with the competition and we feel great about our competitive position. For now, that's all we're willing to say about this competitively sensitive upcoming new launch. Barry and I will not be taking questions on this topic.

Now turning to the fourth quarter results. The reported numbers have several one-time items that create a little noise in the numbers. Barry will walk us through the items in detail in just a minute. All of my comments are based on adjusted GAAP results for these one-time items because I think it's the best indication of the company's operating performance.

Overall, the company had a solid quarter with net sales up 2.9% on a reported basis and 6.7% in constant currency. You will note this is on top of a 10% net sales increase in the fourth quarter of 2014. As I'm sure you remember, last year's fourth quarter, we reported that we had some extensive buy-forwards in North America.

The increase in net sales, combined with a 170-basis-point increase in adjusted EBITDA margin to produce adjusted EBITDA of $133 million for the quarter, representing a $70 million increase or 14% increase versus prior year. This is after absorbing FX headwinds.

Major highlights for the quarter that I'd like to point out include: a solid growth throughout the world in constant currency. In North America, sales grew 5%, driven by TEMPUR-Flex and TEMPUR-Breeze products and our Posturepedic launch has achieved record distribution and considerable strength in Hybrid collections.

Internationally, we grew 12%, with solid growth in Asia-Pacific, Latin America, including particular strength in our Sealy business.

The next highlight is operating margin. Adjusted operating margin expanded 160 basis points to 14.5%. This was driven by improved operating efficiencies from global sourcing, lower commodity costs, supply chain and plant improvements and higher-priced products.

In addition, we leveraged our operating infrastructure while remaining committed to invest in brand, new products and innovation, as evidenced by R&D and advertising spend both being up for the quarter. We had great flow-through in cash as operating cash came in at $101 million in the fourth quarter, an increase of $57 million over the prior year.

While we are far from where we want to be, I'm pleased to report we saw improving trends in our Sealy assembly margins. As we discussed on the third quarter call, clearly this has been a big focus item for our North America team.

In the fourth quarter, we saw stable margins year-over-year, which has marked a significant trend change from the year-on-year declines we have been facing in recent quarters. This was more than just the impact of commodities. We experienced improvements in manufacturing productivity from a trend standpoint. We still have work to do, but it's refreshing to begin to see the results of our work in the reported numbers.

Turning to capital allocation, as we foreshadowed on the last earnings call, we've gone through a thorough evaluation of the company's capital allocation strategy. After looking at the business model in depth and the prospects across multiple economic scenarios, we've concluded that the appropriate leverage target should be about 3.5 times EBITDA.

The business has reasonably diverse geographic footprint, generates a lot of cash, has low maintenance CapEx, behaves reasonably well in recessionary stress testing due to the high variable cost structure and has no significant off-balance sheet debt.

So what should you expect? The target leverage is just that, a target. There will be times when we're above as we take advantage of opportunities and there will be times we might be below as we're viewing investment options.

Having said that, it is clear that based on where we are today and our expected near-term cash flow that we have some excess capital in the system. After reviewing several options, we currently think the best way to deploy some of the excess capital is to give it back to shareholders in the form of share repurchase activity. We are pleased to announce that the Board of Directors unanimously have authorized $200 million in share repurchase. We expect this to be the first authorization in what will be a series of authorizations. We'll be working on a debt agreement to align them with our new average target and long-term strategy to return capital to shareholders.

We've also been working on guidance policy. The company, the team really, the team is focused on the near-term aspirational plan, which is based on 2017 EBITDA. For 2016, we're working hard to get on a glide path for success in 2017. Also as we've talked about, we're leaning towards margin versus revenue.

So where we are, is we're going to give annual EBITDA guidance in a range and some commentary on revenue and other items. As I mentioned, 2016 has started off in a solid fashion. Our guidance for 2016 EBITDA is $500 million to $550 million, growth of 10% to 20%. Barry will give you some more color on this in a minute.

Before I hand over the call, I would like to briefly comment on two other matters, the Danish tax matter and the recently announced streamlining of the Board of Directors. First, the Danish tax matter. While Barry will discuss it in detail, as the new guy on the team, I want to share my perspective.

This is an international transfer price dispute. It is about who gets the taxes, Denmark or the United States, in double-taxation under Subpart F of the Tax Code. The company did everything it was supposed to do, including relying on numerous independent firms, to determine what was the appropriate royalty rate. After a lot of review, we have determined we should increase our reserves. This is an issue that's been worked on by the company for over 10 years. I want to put it behind us, eliminate the uncertainty and move forward.

Turning to refreshment and streamlining of the Board of Directors, as I'm sure you saw from our press release on Tuesday, at my request, the Board of Directors worked on a plan to refresh and streamline. The results are outlined in earlier release.

I want to take just a minute and truly thank the five Board Members, who have chosen not to stand for reelection, for their many years of service and demonstrated leadership. During their tenure as directors, the company grew significantly, established the Tempur brand worldwide, successfully acquired the Sealy brand and established the company as the largest bedding manufacturer in the world. They leave a legacy of accomplishments. The 40% reduction in Board size is consistent with the overall organization's focus to drive to become more productive.

Now, Barry will walk you through the quarter and the year results.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Thanks, Scott. As Scott mentioned, consolidated net sales for the fourth quarter were $767.3 million, up 2.9% versus the fourth quarter last year, and on a constant currency basis, were up 6.7%. Adjusted gross margin improved 80 basis points to 41.1% and adjusted operating margin improved 160 basis points to 14.5%.

Recognizing we have several adjustments to our results, which I will address later, I wanted to start by going through our fourth quarter P&L on an adjusted basis. Selling and marketing expenses were approximately $144 million, a decrease of 4% year-on-year, with no reduction in advertising spend. We are committed to investing in products and marketing, while maintaining our focus on leveraging our infrastructure.

G&A expenses were approximately $68 million, an increase of 11%. Now this includes approximately $4 million in discrete legal and professional fees, $2 million in bad debt expense for a specific customer, and an incremental $1 million of stock-based compensation expense associated with our long-term performance-based incentive programs.

Total operating expenses were approximately $212 million, an increase of 1%. Other income was approximately $1 million as compared to approximately $2 million of other expense in 2014. The adjusted income tax rate was approximately 30%. Income attributable to non-controlling interest, net of tax, was approximately $200,000, a decrease of 67%.

There were no adjustments to equity and earnings of unconsolidated affiliates, royalty income or interest expense. Adjusted net income was $62.7 million, an increase of 18%. Adjusted EPS was $0.99, an increase of 15%. On a constant currency basis, adjusted EPS increased 25.6% as foreign exchange rates negatively impacted adjusted EPS by $0.09. Adjusted EBITDA increased 14.4% to $133 million in the fourth quarter, and on a constant currency basis increased to 21% as foreign exchange negatively impacted adjusted EBITDA by $8 million.

Now, since we had a number of adjustments to the reported GAAP numbers this quarter, let me take a minute to walk through them. This is outlined on Page 10 of the press release. There were approximately $74 million of after-tax adjustments. They included: first, $61 million for the Danish tax matter which I'm going to address in a moment. Second, as we discussed on our last call, we completed actions this quarter around corporate head count reductions as well as certain international store closures, which resulted in a $7.7 million charge. We should get a full payback in less than a year. Third, integration costs of $3 million related to the transitioning of manufacturing facilities and other costs related to the continued alignment of the North American business segment related to the Sealy acquisition. We are nearing completion of our integration efforts and currently expect about $3 million in 2016. Fourth, executive management transition and retention compensation of $2.4 million. And lastly, we incurred $900,000 in non-cash expense associated with the de-risking strategy for our defined benefit pension plan. I do expect that going forward the adjustments will decrease in both number and amount.

Now, I would like to take a moment to address the Danish tax issue. First, let me provide some background information and context. As we have been disclosing since 2008, we have pending income tax assessments from the Danish tax authority related to a dispute over the royalty rate that the Tempur United States Company pays our Danish subsidiary in connection with the use of intellectual property to produce our Tempur material.

As Scott said, it's an international transfer pricing dispute on whether more profit should be in Denmark or the U.S. It is not the result of Tempur avoiding the payment of its fair share of taxes. Fundamentally, it is about who gets the taxes, Denmark or the U.S.

Absent an agreement between Denmark and the U.S. in which both countries agree on the transfer price for the use of the intellectual property, the company will incur a level of double taxation. In addition, the flow of the royalties from the U.S. to Denmark creates an additional taxable income in the U.S. under Subpart F of the Internal Revenue Code, which also creates an additional layer of tax in the U.S.

Despite the fact that the governments have a well-established process to resolve disputes between the two countries, they were unable to agree on this issue and ended talks in 2013. It is highly unusual that international tax authorities are unable to come to some agreement, but in the current environment in which governments look for additional taxes from global companies, occasionally the governments cannot come to a mutually agreeable solution. This is what happened in our case.

Second, it is important to point out that the company established the transfer price for this item in a manner that is prescribed under internationally recognized transfer pricing standards, including relying on an independent study completed in 2001 that set what the independent firm concluded was an appropriate royalty rate.

Further, we've evaluated our position thoroughly through the years, and in fact we continue to evaluate our position as part of our normal quarterly and year-end financial statement preparation process. The company has maintained and continues to maintain that its historical position is more appropriate than that asserted by the Danish tax authority and has examined all reasonable avenues to resolve this matter in a fair and equitable manner.

Third, as disclosed in our SEC filings, the numbers for the government's assessments are large and they continue to grow. We strongly disagree with the government's calculation methodology, which forms the basis of their assessment, and believe we have solid technical merits in our position.

Fourth, because of the inability of the IRS and the Danish tax authority to reach an agreement on mutually acceptable transfer pricing, Tempur is left with the option of litigating the case in Danish administrative proceedings and then in the Danish court system, or seeking to negotiate a compromise solution, reestablishing negotiations with the Danish tax authority and the IRS. We have been advised that there is very little history of transfer pricing litigation in the Danish courts.

In Denmark, there are no courts that focus on tax matters, unlike the U.S. This adds to the unpredictability of pursuing a resolution through litigation. So at this point, the company would prefer a negotiated resolution on acceptable terms and the company has begun the process of discussing this with the Danish tax authority and the IRS. While discussions are in the early stages, the company believes that the possibility of avoiding litigation is promising.

Fifth, during 2015, management and the Board, reacting to the increasingly challenging European tax environment, as evidenced in the financial press almost daily, engaged an independent party to review the various positions and to develop an approach to attempt to resolve the matter.

In December, the independent third-party provided the company with its recommendation which the company has independently analyzed and believes it represents a very fair and equitable outcome for all parties.

In connection with the preparation of the audited financial statements for 2015, the company has considered all facts and circumstances including items that occurred in 2015 that could materially impact the amount of potential exposure the company faces for all years through 2015.

We concluded that it is prudent and appropriate at this time to increase our recorded exposure for this item. As such, the company recorded a charge in the fourth quarter of approximately $61 million. We believe that the company's tax reserve should provide the basis for negotiated settlement with both the Danish tax authorities and the IRS. Such a settlement would result in avoiding uncertainties of the Danish courts in the current tax litigation environment.

However, there are no assurances that we will be successful, in which case we will pursue the matter in the Danish administrative process and then the Danish courts, which would likely take several years to resolve. We have considered this matter in our go-forward effective tax rate and expect 2016 to be approximately 30.5%.

Now turning back to our segment results. North America net sales increased 3.8% and were up 5.3% in constant currency. Solid growth of 4.8% in the U.S. was driven by mid-single-digit growth for both the Tempur-Pedic brand and the Sealy brands. This comparison was particularly impressive given the difficult compare. As disclosed last year, we experienced heavy year-end purchases from a few customers who elected to stretch to higher rebate tiers in the fourth quarter of 2014. At that time, we estimated $15 million to $20 million of incremental net sales from that activity. We have changed our trade programs, and as a result, we do not have that type of year-end activity in 2015.

Therefore, excluding the $15 million to $20 million from last year, our North American net sales would have increased about 7%. We've recorded a strong performance in Canada in the fourth quarter, with sales increasing 10.7% on a constant currency basis. However, unfavorable foreign exchange translated sales into a reported decline of 5.8%.

Bedding product sales increased 4.3% on improved pricing and a slight unit increase. Our new TEMPUR-Flex and Sealy Posturepedic products, together with TEMPUR-Breeze products, were drivers of growth. Our other products are slightly down, driven by a slight decline in pillow sales.

North America adjusted gross margin improved 230 basis points to 38.9%. The gross margin improvement was driven principally by Tempur-Pedic U.S. gross margin, which was strong in the quarter and continued to benefit from improved efficiency in our operations, which includes lower sourcing, commodity costs, supply chain and plant improvement, as well as pricing.

Sealy U.S. gross margins were stable year-on-year. Though our current Sealy margin performance is below our long-term expectations, we are encouraged by the progress from our operational initiatives. We expect further good news in this area over the next year.

North America adjusted operating margin improved 320 basis points to 16.8%, driven by the adjusted gross margin as well as an improvement in our selling and marketing leverage.

Turning to International, net sales declined slightly, yet on a constant currency basis, were up 12.1%, with growth in Asia-Pacific and Latin America. Bedding product sales decreased 1.8%, though on a constant currency basis were up 11.1%.

Units increased 18.2%, reflecting significant growth from our Sealy brand business in Latin America and a special promotional event in our Asia-Pacific market. As a result, our International average selling price was down, but this was entirely due to foreign exchange and a higher mix of Sealy products, which have a lower average selling price relative to Tempur products.

Other channel sales were up 16.5% on a constant currency basis, driven by strong Tempur direct sales. International adjusted gross margin declined 410 basis points to 49.8% compared to prior year of 53.9%, which drove a 400-basis-point decline in adjusted operating margin to 20%.

Our gross margin decline was driven by product and country mix from the increase in distribution of our Sealy-branded products. As we've pointed out, we are going to be mixing down internationally as we rolled out Sealy, but this should be EBITDA-accretive.

Now, I'll summarize the income statement for the full year 2015. Sales increased 5.4% to $3.15 billion as compared to $2.9 billion in 2014. North America sales increased 7.2% and International sales decreased 1.9%. On a constant currency basis, sales increased 9.4% with an 8.5% increase in North America and a 13.2% increase in International.

From a channel perspective and on a constant currency basis, our Third-Party Retail business grew high-single-digits in both segments and our Direct business was particularly strong, growing double-digits in both segments. Adjusted operating income increased to $374 million as compared to $320 million in 2014. Adjusted earnings per share in 2015 increased 20.4% to $3.19 as compared to adjusted EPS of $2.65 in 2014. Now on a constant currency basis, adjusted EPS increased 32%.

Now moving onto the key balance sheet and cash flow items. At the end of the fourth quarter, net debt was $1.4 billion, an improvement from year-end 2014 of $214 million or 14%. Our leverage ratio, based on the ratio of consolidated funded debt, less qualified cash to adjusted EBITDA, as reported in the earnings release was three times as of the end of the fourth quarter. And this ratio has improved significantly over the past year due to both debt pay-down and to an increase in EBITDA.

Operating cash flow in the fourth quarter was $101 million, up from $44 million last year. Operating cash flow, less capital expenditures in the fourth quarter, increased to $86 million from $27 million last year. Our fourth quarter performance demonstrates the business's ability to generate strong cash flow.

Let me highlight a few points about the business's cash generation. We are focused on improving cash cycle through inventory and supplier management and believe there is considerable opportunity for further improvement. As to capital expenditures, we expect to be returning to maintenance levels in the near future, and as a reminder, depreciation and amortization is running ahead of capital expenditures, which we expect to continue for many years. So, the business's cash earnings potential is quite substantial.

Turning to our financial guidance for 2016, as Scott mentioned, the company currently expects adjusted EBITDA to be in a range of $500 million to $550 million including approximately $20 million of commodity tailwinds, partially offset by $10 million of expected foreign currency headwinds in 2016.

At the midpoint, this adjusted EBITDA guidance represents a 15% growth rate on a reported basis or a 17% growth on a constant currency basis.

We are also providing the following additional full-year 2016 guidance assumptions: Sales growth of mid-single-digits on a reported basis and capital expenditures of approximately $75 million. Our 2016 CapEx is slightly elevated due to our continued productivity initiatives. Once we complete these initiatives, we anticipate approximate $60 million to $65 million in annual capital expenditures. We anticipate depreciation and amortization to be approximately $95 million to $100 million in 2016. Our guidance is based on adjusted figures and dependent on the factors that I discussed at the beginning of the call.

From an adjusted EBITDA perspective, our guidance reflects margin expansion resulting from improvements in North America, offset partially by unfavorable merchandising mix internationally as we continue to launch our Sealy Europe operations as well as expand our distribution in Latin America and Asia.

We expect to ship a significant number of floor models as we launch the new Stearns & Foster collections and the TEMPUR-Breeze offerings. So the demand for floor models has been strong, which is a great long-term sign, but will put pressure on our reported numbers in the first half of the year as we expect product launch costs to be ahead of prior year in the first quarter and second quarter.

Please carefully note our 2016 earnings seasonality should be similar to what we saw in 2015, with about 40% of EBITDA coming in the first half of the year and 60% in the back half of the year. And with the launches we discussed, we expect the second quarter to be stronger than the first quarter.

With that, I'll turn the call back over to Scott.

Scott L. Thompson - Chairman, President & Chief Executive Officer

Thank you, Barry. Great job. One last topic I'd like to address, since we talked last, there's been a significant transaction in our industry. I would like to congratulate Mattress Firm, its Board of Directors, Steve Stagner and his team on the pending acquisition of Sleepy's. It's an exciting opportunity for Mattress Firm.

I also see as an exciting opportunity for the company to have our portfolio of brands sold in the first ever national specialty mattress retailer and one who shares the importance of advertising and driving higher ASP.

We're pleased to announce that we've reached an agreement to extend our long-term supply agreement with Mattress Firm and strengthen our relationship by offering the limited assortment of exclusive Tempur-Pedic and Stearns & Foster products. These products are designed to drive higher ASP and margins, while creating broader array of products for our customers to choose from.

With that operator, we open the call up for questions please.

Question-and-Answer Session

Operator

Thank you, ladies and gentlemen. Our first question comes from John Baugh with Stifel. Your line is open.

John Baugh - Stifel, Nicolaus & Co., Inc.

Thank you and congratulations on a strong fourth quarter. I was wondering if you could touch on Sealy International. I think you made the comment, Barry, that you expect it to be EBITDA-accretive. Obviously, there was some drag on overall margins, but could you give us a sense of where that rollout is? What the impact may be on revenue over the next couple of years and sort of what your expectation on profit is there?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Hi, this is Scott. I can give you a little bit of that. I don't do a lot a multi-year forecasting. As I said in my part, we're rolling out some newer products. We think that it will be kind of back-loaded from an international standpoint. Barry mentioned we're going to be mixing down, but we see EBITDA growth overall from an international standpoint, if you let me take out the FX, which I have no idea which way it's going to go.

John Baugh - Stifel, Nicolaus & Co., Inc.

Okay. And then quickly, Barry, on cash flow, just quickly, how would you expect working capital to play out in 2016 based on your mid-single-digit revenue forecast?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

You know, John, working capital tends to move around. What I would say is over the long term, we're very focused on improving cash cycle. As I mentioned in the prepared remarks, we think that there's a significant continued opportunity in payables and we're working on inventory days. And so, I would say that that's our focus over the long term.

John Baugh - Stifel, Nicolaus & Co., Inc.

Great. I'll defer to others. Thank you.

Operator

Thank you. Our next question comes from Brad Thomas with KeyBanc. Your line is open.

Bradley B. Thomas - KeyBanc Capital Markets, Inc.

Thank you. Good morning, Scott and Barry. Wanted to ask about trends that you're seeing in North America, really domestically more specifically. I think on the Tempur side, you said that if we back out some of the one-time purchases that happened in the fourth quarter last year, you would have been up about 7%. I think last quarter, you'd been running at about 9.6% growth. Could you just give us a little bit more of a sense of what you've been seeing in the domestic market and how you're thinking about the outlook for the Tempur brand in particular in 2016?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Sure, let me talk a little bit about just North America and I'll let Barry talk about particular brand. I mean, when we look at the world, we split the world up between North America and Europe, primarily because those are the biggest drivers of our business. The other markets we're in are significant from a growth standpoint for the long term.

When we look at North America, I mean you look at it, consumers have a cleaner balance sheet. We've got an improving housing cycle with housing starts forecasted to be up. House prices are forecasted to be up. GDP, call it 2.1%, not great, but certainly not bad. Consumer confidence looks good at 96.5%, again, not great, but not bad. Unemployment rate going from 5.3% this year to 4.8% or so maybe next year, looks pretty good. Wage growth, not great, but again, not bad. Maybe there is a wealth effect from the recent market activity. Certainly, we're feeling some pressure from the oil markets. Texas is doing fine, but I'd say Houston is a little bit weak, but we're benefiting in other markets. So when I put North America together from a macro standpoint, I would call it good, and we expect solid growth in North America.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Brad, what I would add to that is, when I mentioned the kind of 7% if you had adjusted for the buy-ups last year, that was all of North America. So that's Tempur Sealy and Canada, so if you – most of that activity, you're right and what you alluded to was on the Tempur-Pedic brand. And as we said on – as I said in my prepared remarks, Tempur-Pedic brand was up mid-single-digits. So if you added the $15 million to $20 million of the buy-up last year and kind of adjusted for that, you'd get a much higher growth rate, kind of mid-teens, which would be similar to where we've been running through the last few quarters.

Operator

Thank you. And our next question comes from Budd Bugatch from Raymond James. Your line is open.

Beryl Bugatch - Raymond James & Associates, Inc.

Thank you and thank you for all the color this morning. I wonder if I could coax maybe a little bit more color and assumptions on how you see going from the sales line through to the adjusted EBITDA line for 2016, in terms of cost of goods sold, operating expenses and maybe, Barry, through a little bit on the tax rate expectation for the year?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Well, Budd, I would say we don't want to get that granular, but as we alluded to on the prepared remarks we expect a continued improvement on gross margin. I mentioned that we'll have some commodity benefit; we'll have some pricing benefit. Floor models obviously in the launch, just because of the magnitude and the scale of the launch and the price points that we're talking about, will be up. And then as Scott mentioned, we're going to increase our advertising. And so – but beyond that, getting too granular, that's kind of how we think about it.

Beryl Bugatch - Raymond James & Associates, Inc.

And tax rate for the year, how should we plan...?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Yeah, we're using 30.5%, as I mentioned in the prepared remarks.

Beryl Bugatch - Raymond James & Associates, Inc.

Okay. Thank you very much.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

You're welcome.

Operator

Our next question comes through Mark Rupe with Longbow Research. Your line is open.

Mark Rupe - Longbow Research

Good morning, guys. How are you?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Great. How are you doing?

Mark Rupe - Longbow Research

Doing good.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Good.

Mark Rupe - Longbow Research

Could you share any color, maybe on pricing benefit in 2016 versus 2015?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Mark, the way I would think about this is we've raised prices as Scott mentioned on both Tempur-Pedic and a small range of Sealy brand products. And those were mattresses, so when you think about our pricing, obviously people should focus on what we specifically raised. So that's the mattress portion of our business, and only a select range. So, I'd be thinking about a low single-digit percent increase.

Mark Rupe - Longbow Research

All right. Perfect. Thanks.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

But for mattress.

Mark Rupe - Longbow Research

Great.

Operator

Thank you. Our next question comes from Seth Basham with Wedbush Securities. Your line is open.

Seth M. Basham - Wedbush Securities, Inc.

Good morning, it's Seth Basham. Thanks for taking my question. I'd like to get a little bit more color around the trends on unit growth in the fourth quarter in North America specifically? I think, Barry you mentioned they're up slightly. Does that statement still stand excluding adjustable foundations?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Hi, Seth, good morning. Without getting too granular, I can tell you that our mattresses as a component of the bedding were positive and we also had a kind of a steady attach rate on adjustables on our Tempur-Pedic brand. We do see adjustables over the long-term as something that from an attach rate perspective has room, particularly on our Sealy brand side where as you mix up within the brands and we have a sort of innovation that we've had with Stearns & Foster and our Posturepedic Hybrid, we think that there's an opportunity there for additional adjustable sales and attach rates. And as you may remember from the Las Vegas Bedding Show, we just recently introduced a new adjustable, the Ease (43:12) by Sealy, which I think has really nice features and functionality at a sharp price point. So we expect improving performance from adjustables over time.

Seth M. Basham - Wedbush Securities, Inc.

Just a follow-up if I may, as you look at 2016 would you expect to see positive unit growth for Tempur-Pedic in North America?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Yeah.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Yeah.

Seth M. Basham - Wedbush Securities, Inc.

And that's on mattresses as well as adjustables?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Yeah. When we're thinking about what we've got going in, Seth, for 2016, the Breeze collection and what we're doing and as well as building on the very positive launch we've had from Flex, we certainly would expect unit growth from our Tempur-Pedic brand business and the attach rate even if it was just flat you'd see growth as a result, so.

Seth M. Basham - Wedbush Securities, Inc.

Great, thank you.

Operator

Thank you. And our next question comes from Jessica Mace with Nomura Securities. Your line is open.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Hello? Operator, maybe we can go to the next one...

Jessica Schoen Mace - Nomura Securities International, Inc.

Hi, good morning.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Hey, Jessica. How are you?

Jessica Schoen Mace - Nomura Securities International, Inc.

I'm good. Understanding you don't want to talk about any product launches in particular, I was wondering if you could comment on the general consumer behavior around bedding purchases that you've seen in the recent quarters.

Scott L. Thompson - Chairman, President & Chief Executive Officer

Recent quarters being third quarter and fourth quarter?

Jessica Schoen Mace - Nomura Securities International, Inc.

Yes, just on that.

Scott L. Thompson - Chairman, President & Chief Executive Officer

Fourth quarter and January, yeah.

Jessica Schoen Mace - Nomura Securities International, Inc.

Yes, and high-end or different categories and how that's really informed your decision about your product strategy in the year ahead?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Yeah, look I would tell you that we feel like – we're talking North America right now specifically, we can talk about the other markets if you want to, but right now we're talking about North America. I'd tell you demand feels good. I mean as I said in the prepared remarks, January started out in a very solid fashion and from our viewpoint it looks like North American consumer is in very good shape.

Operator

Thank you. Our next question comes from Keith Hughes with SunTrust. Your line is open.

Keith Hughes - SunTrust Robinson Humphrey, Inc.

Thank you. As you look at the 2016 guidance you've given, at least directionally can you talk about Sealy gross margins and which way they would be moving in your view and any other detail you can give on initiatives you have around Sealy for the next sort of year or two?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Sure. I mean, directionally it's pretty easy. We expect it to go up. Okay? As we talked about pretty clearly I think on the third quarter call, my recollection is Sealy margin had declined 100 basis points since third quarter year-over-year. In the fourth quarter what we're saying is that that deterioration stopped and it became stable. So we'll call that improvement, but we certainly wouldn't call that success.

So our clear indication is we would expect to have more good news about the Sealy margin initiatives that we put in place throughout the year. And it will take several quarters to get where we probably want to get to. But we certainly expect the Sealy margin to improve some during 2016.

We don't really have time on the call to go through the initiatives, but I can tell you that the entire North America team is focused on Sealy margins. And like I said, we're beginning to see real progress as the numbers come in. So if you give me one more quarter and ask me that question on the first quarter, I think I can probably go into more detail, but I appreciate the thought.

Operator

Thank you. Our next question comes from Peter Keith with Piper Jaffray. Your line is open.

Peter Jacob Keith - Piper Jaffray & Co (Broker)

Thanks. Good morning, everyone. On the advertising increase that's planned for this year across a number of different brands, I don't know if you would be able to quantify the percent increase in dollar spend, that would be helpful. But one question we'll be getting is how you think about that from a cost takeout perspective? Do you want to match cost takeouts with advertising increase and drive overall SG&A savings or should we just anticipate some pressure on the SG&A line?

Scott L. Thompson - Chairman, President & Chief Executive Officer

I mean, I guess I don't tie the two together and I'll let Barry take a crack at this after me. We are committed to advertising for the long-term and I don't see a trade-off between one pot of cost and advertising. Advertising drives this business. We were founded on it and so we will advertise whatever we think the right number is regardless of what's going on in other cost initiatives. Having said that, do we have cost initiatives in place? Sure, we are working on other cost areas, but I really don't tie the two together. Barry, do you have any other color there?

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

I think you hit the high points. We're going to increase our advertising spend, Peter and that will go up a little bit on a rate basis and that's all embedded in the guidance.

Operator

Thank you. Our next question comes from Curtis Nagle with Bank of America Merrill Lynch. Your line is open.

Curtis S. Nagle - Bank of America Merrill Lynch

Good morning, thanks for taking the question. Just a quick question I guess on the buybacks. Just, I guess given the leverage targets you guys have laid out, anything more you could say in terms of the timing given that $200 would – not saying it's a mismatch, but leverage should imply something maybe little bit bigger, so again just initial step or how should we think about that?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Yeah, your math is right. I mean, if you go through the leverage target and you look at the expected operating cash flow, the current authorization, the buyback looks relatively small compared to what the potential could be. What I was trying to say in my prepared remarks is we've got authorization for $200 million. We see this as the start of a long-term process and we expect future authorizations. We have some debt agreements that we have to work through and Barry can walk you through that in a minute. But, no, I would see this is as the initial share buyback.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

Hey Curtis, we have the credit facility which we are going to be working on and then we have the 2020 high-yield bonds, those both would – the first step would be to, as Scott alluded to, work through the credit facility which is something we've got under way and then the bonds would be a factor. Those are callable in December, so that's another thought to think through and I would be happy to talk to folks about that in detail since it's all disclosed already on additional calls.

Operator

Thank you. Our next question comes from Daniel Hofkin with William Blair. Your line is open.

Daniel H. Hofkin - William Blair & Co. LLC

Good morning, gentlemen. Just a question regarding kind of the overall innovation level of cadence of it this year versus same time last year. Just curious kind of how you are feeling, let's say the two bigger – the TEMPUR brand as well as Stearns & Foster where you have had the most innovation recently this time versus last year. What you think is kind of the incremental newness and the impact of it and then over time if you can comment on it, where you think there are opportunities for further additions to the product pipeline or added features?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Okay. I'm going to have to be a little bit careful with your question because obviously there's competitive information that you're kind of fishing around, which I'm probably not going to get anywhere close to on an open call. I think what I would say is, the first thing I did when I got here was to look at the pipeline because I do think that's a critical part for the company's continuing success, and the pipeline as I've said before is robust. As I mentioned in my prepared remarks, our spending in R&D is up which goes to our commitment and I would tell you that there is a well developed plan for products over a multi-year period that we feel very good about. And I don't know if you want to add anything Barry to that.

Barry A. Hytinen - Chief Financial Officer & Executive Vice President

I think I would just add that as our customers and a lot of investors saw at Las Vegas in the bedding show and we feel like we brought a tremendous amount of innovation this year to the Stearns & Foster collection as well as the TEMPUR brand. Stearns, we have the new Nano coils. We've got the Precision Edge all the way around. We totally reinvented our proprietary IntelliCoil.

In the Reserve Collection, we've just created I think a tremendous ultra-premium halo collection there which will help mix up pricing. So the Stearns & Foster collection Dan is well improved. And that's an area, as we said on the last call, was a focus area because our product margins and our merchandising mix, really specifically merchandising mix, has been a challenge. And that's at the high end on our Sealy brand portfolio.

And then on the TEMPUR side, the new Breeze as Scott mentioned in detail in his prepared remarks, it is a significant advancement in cooling. We estimate it's twice as cooling as the prior collection and the aesthetics are great. We've increased the profiles and importantly we've introduced a Breeze for the Flex Collection, our Hybrid, which has been so successful this year. So we think we brought a tremendous amount of innovation this year. We can't wait to get it out onto showroom floors.

Operator

Thank you. And our next question comes from Mark Rupe with Longbow Research. Your line is open.

Mark Rupe - Longbow Research

Well, can you share any details on the exclusivity arrangement on the products with the new mattresses firm deal?

Scott L. Thompson - Chairman, President & Chief Executive Officer

Not really anymore than I already have which they are designed to drive higher ASP and be margin accretive.

Mark Rupe - Longbow Research

Okay. You think it's a portion of the line, like a small piece of the line or is it more of an entire line?

Scott L. Thompson - Chairman, President & Chief Executive Officer

I would say, like I said in the prepared remarks, we are offering a limited assortment of exclusives.

Mark Rupe - Longbow Research

Perfect. Thank you.

Operator

That is all the time we have for today's questions. I would now like to turn the call back to the company for any closing remarks.

Scott L. Thompson - Chairman, President & Chief Executive Officer

Thank you, operator. To the 7000 employees worldwide, thank you for what you do every day to make the company successful. To our retail partners, thank you for your outstanding representation of our brands. To our shareholders and lenders, thank you for your confidence in Tempur Sealy's leadership team and the board of directors.

Operator

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

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