Sealy Corporation Q4 2007 Earnings Call Transcript

Sealy Corp. (ZZ)

Q4 2007 Earnings Call

January 31, 2008 5:00 pm ET

Executives

Kenneth Walker - SVP, General Counsel and Secretary.

Dave McIlquham - Chairman and CEO

Jeff Ackerman - CFO

Mark Boehmer - Treasurer

Analysts

Reza Vahabzadeh - Lehman Brothers

Keith Hughes - SunTrust

Matt Fischer - Deutsche Bank

Stanley Elliot - Stifel Nicolaus

Kevin Zietz - Goldman Sachs

Joel Hubbard - Hilliard Lyons

John Kernan - Morgan Keegan

Albert Kabili - Goldman Sachs

Presentation

Operator

Good afternoon ladies and gentlemen. Thank you so much for standing by. Welcome to the Sealy Corporation Fourth Quarter 2007 Results Conference Call. During today's presentation, all parties will be in a listen only mode. Following the presentation, the conference will be open for questions. (Operator Instructions). As a reminder this conference is being recorded today Thursday, the 31st of January, 2008.

Now we'll now turn the conference over to Mr. Kenneth Walker. Please go ahead sir.

Kenneth Walker

Good afternoon everyone. I want to thank you for joining us on Sealy's financial year-end 2007 investor conference call. Before we begin I would like to remind you that in accordance with the Safe Harbor Provision of the Private Securities Litigation Reform Act of 1995, company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements.

Such statements are subject to risk, uncertainties and other factors that may cause the actual performance of Sealy to be materially different from the performance indicated or implied by such statements. Such risk and factors are set forth in the company's annual report on form 10-K for the year ending December 2nd, 2007.

I'll now turn the call over to Dave McIlquham, Chairman and Chief Executive of Sealy Corporation.

Dave McIlquham

Good afternoon. Thank you, Ken. I want to also thank all of you for joining us on our year-end call to discuss Sealy's results. Joining me on this call is Jeff Ackerman our Chief Financial Officer and Mark Boehmer our Treasurer. Larry Rogers is at the Furniture Market in Las Vegas and will not be joining us today.

I will give you an update on our strategic operating initiatives and report on activities from this week at the market event. Jeff will provide a financial recap on our fourth quarter and full year results as well as the outlook for 2008, and then we will answer questions.

Overall, fiscal 2007 was a challenging year for Sealy and our financial results did not meet our expectation. However, we did execute well on key strategies, which we believe are going to be critical to our ongoing success.

We drove unit volume, increasing our domestic units 9% year-over-year, gained market share versus the industry increase of approximately 2% according to ISPA and protected the valuable real estate on our retailers floors.

Our strategy of securing that real estate with our retailers in 2007 has positioned us well to mix up slots and sales with our new product introduction, as we drive unit velocity with the slots maintained from last year.

While we have executed well against these strategies, we recognize that there are areas where we must improve. The underlying factors driving are weaker than expected performance in 2007, where number one: The need to update our premium innerspring product lines, in light of changing consumer preferences. Two, our retailer customer base that is changing and under pressure. Three, dynamic competition that has developed effective marketing and product strategies. And four, a challenging consumer spending environment.

Along with those factors, we also were pressured by higher than anticipated FR costs, innerspring products in the above $1000 price band, which haven't resonated with customers, and product launch costs that ran above, both our plans and historical norm.

While we expect challenging market conditions in 2008, our long term industry outlook remains favorable with solid growth drivers. In order to ensure that Sealy remains the dominant player, we know we must continue to invest, innovate and implement change to protect and strengthen our leadership in the industry.

Given the current situation, 2008 will be another critical step in the evolution of the company. I want to share with you the key strategic imperatives that will drive increased revenue and profitability in coming years.

We are taking action and making a number of investments in the first half of 2008, which we expect will foster improvement over the long term. We plan to drive AUSP growth, through one, mixing up our slots. Two, shifting consumers up in price point, through an enhanced product offering. And three, price increases which have already been implemented.

We have developed and introduced innovative new innerspring products focusing on the greater than $1000 price band, where we will have demonstrable points of differentiation, in order to recapture some of those high end sales. In fact, we just launched our totally new Sealy Posturepedic at the Las Vegas Furniture Market earlier this week, with very strong customer feedback and introduced seven new Stearns & Foster models that also incorporate some of our new design principles.

I would like to spend a brief moment talking about the philosophy and positioning behind this new Posturepedic line. We knew that in order to recapture high end mattress sales with Sealy Posturepedic, we had to develop an innovative product with a convincing consumer proposition. To accomplish this, we created an independent advisory board of leading orthopedists and sleep scientists and extensively surveyed consumers. We came away with the following key conclusion: Most people associated lack of sleep with one recurring problem, more than anything else, tossing and turning.

We learned from our Orthopedic Advisory Board that tossing and turning caused by your mattress, was related to two issues, pressure points and proper support. In order to reduce tossing and turning, we needed to develop a mattress that addressed both of these needs. Our new Posturepedic line is designed to increase support as you step up without compromising pressure relief.

As a result we can make the claim that the new Sealy Posturepedic mattresses are designed to eliminate tossing and turning created by pressure points. In consumer testing, we have confirmed that this message will resonate with consumers and we have already received very positive feedback from our retail customers as well.

In addition to the Orthopedic Advisory Board and consumers, we talked extensively to retailers and analyzed competitors' products as we develop this new line. This line has a very strong merchandising strategy, making it easy to step up with 21 new products in the critical greater than $1,000 price point band, 12 products in the $750 to $1,000 range, and seven SKUs below $750.

Based on planning discussions and commitments with our customers, we are very excited but about the prospects of this new line and believe it will help drive the AUSP, due to its strong step up story. In addition, the improved fields and performance should increase velocity of our slots, which is critical to gaining share in this environment.

Given how the industry and competition have changed, it is not enough to just have terrific product. Our second strategic initiative focuses on creating new advertising strategies, for retail and direct-to-consumer advertising for our Sealy Posturepedic brand. We have developed a simplified selling message and point-of-sale materials based on the no toss and turn positioning, which will help retailers close more transactions at higher prices. Our competitors have shown that effective marketing and advertising can improve communication with the end customer and ultimately drive sales results.

In the second stage of this new marketing program, during the back half of the year, after we have fully rolled out the new Posturepedic innerspring line and introduce new latex products, we planed to launch a new national advertising strategy that is currently being developed with our new advertising agency, Cramer-Krasselt based in Chicago.

We have also made significant changes to our roll out plans to accelerate the time it will take to bring the new product to market. New floor samples will begin shipping in March, but the real contribution from the new Posturepedic product line won't be felt until the third quarter, when the line is fully rolled out.

Additionally, we are taking steps to improve our gross margins. We made the first move with the previously announced price increase, which began to positively impact our margins this month. Our recently introduced new TrueForm line, which capitalizes on a lower cost supply chain and provides a great step-up story to higher margin products, is now more than 50% rolled out.

Similarly, we will take costs out of the supply chain for our latex product, as we realize the benefits of fully utilizing the capacity of the first production line and then add the second latex production line at our Mountain Top facility in the back half of this year. Our manufacturing plans continue to build on the efficiencies gained as part of our lean journey in areas such as scrap improvement and labor productivity.

Finally, the new Posturepedic line has been engineered to provide a higher quality, less complex production process and is designed to improve sales in the higher margin $1,000 plus price range. However, we are facing substantial cost input pressures in the near term and are focused on mitigating their impact. Specifically, we are seeing rising commodity prices in the first half of the year, especially in foam products and steel. We will have higher floor sampling expense in Q2, as we roll out the Posturepedic line and higher FR costs in the first half of the year, until we anniversary the July 1st, 2007 regulatory deadline date.

The company also intends to achieve cost reductions in fixed operating expenses, selling, logistics and infrastructure, as well as product launch costs. Our cost structure is simply too large and we cannot drive margin expansion, unless we lower our costs in all areas.

Adjusting our expense structure is an evolutionary process. For example, we recently announced changes to our sales organization and aligned the entire US sales force under a single executive Vice President of Sales, Louis Bachicha, a 24 year Sealy veteran. This change is consistent with the new leaner sales structure we implemented in the summer last year. We continually look for ways to improve costs and headcount productivity through attrition, lean manufacturing and process improvements, and we have reduced our hourly and salary headcount by over 300 positions domestically in the past 12 months.

In terms of product launch costs, we have been examining every process to determine how we can improve it. For example, we are changing the way we are merchandising our Posturepedic products by simplifying our top-of-bed marketing and implementing a print-on-demand approach to point-of-sale materials, which will limit productions to what actually will be used that the time of need.

We are also developing other initiatives in the SG&A area to improve the effectiveness of our co-op spending, with retailers, reduced logistics cost and the automate back office manual transactions processing activities.

We will of course continue our commitment to the specialty business. On the Visco side, we recently began shipping our new Sealy Posturepedic TrueForm. Visco products, this new line along with our focus on engineering, supply chain improvements and mix, should help improve the margins on our Memory Foam mattresses overtime.

Given the success and growth of latex, we believed it is going to be a major driver of our business over the long-term. In fact, demand for our latex products is so great, that it continues to outstrip our domestic supply, forcing as to look to our European facilities to source a portion of our good.

As we have announced, we are in the process of bringing on a second production line in the US and it will be at full capacity by the third quarter, which should help us better service customers and improve margins into the latter half of the year. Until that time, we will continue to import some of our latex cores from our French plant, which carry a $40 per unit distribution charges.

We had originally planned to intensify national advertising related to our latex products in the first half of this year. Given the demand for our products and capacity constrains, we have pushed the advertising plans to the second half of the year. Even without a major ad campaign, sale of our latex products were up nearly 50% in the fourth quarter, excluding the benefit of the extra week.

Finally, we plan to build on the momentum and strength in our international markets, as our long term objective remains to drive one-third of our growth from this sector.

In North America, we expect our operations in Canada to experience similar pressures as those in the US, but to continue outperforming our domestic business due to our stronger competitive positioning there and differences in the market place. We also expect strength in Mexico and Argentina to continue in 2008.

In South America, we are closing our manufacturing facility in Brazil and shifting to a distribution model, where we will import product from other Sealy plants. Profitability should increase with higher margins due to a shift to higher-priced products and a substantial reduction in operating costs, despite an expected sales decline.

In Europe, we expect from short-term pressures as we continue to work significant overtime to supply latex cores. We continue to see growth in lower margin OEM products, and feel softness in the Italian finished goods market.

These actions and plans are critical to profitable growth in the coming years and we are confident the right steps are being taken. Throughout this process, regardless of the market conditions, we will continue to deliver strong, consistent cash flow, as we did in 2007.

Despite the challenging year, we have invested in our business with new manufacturing plans, remerchandized product lines and developed new product innovations, such a latex and our new No Toss and Turn Posturepedic line.

In addition, we have returned value to shareholders through paying down more than $24 million in debts since our IPO and paying out more than $57 million through dividends and share buybacks. Our strategy continues to be focused on growing EBITDA and shareholder value over the long-term, and we hope to further our progress as we implement timely and new initiatives in 2008 and beyond.

I'll now turn the call over to Jeff.

Jeff Ackerman

Thanks Dave. I'd now like to walk you through the financial details. For the fourth quarter total sales were $441.3 million, an increase of $11.6%. This increase is the result of a 20% increase in units, partially offset by a 7% decline in average units selling price or AUSP.

The fiscal year ended December 2nd, 2007 was a 53-week year compare to a 52 week fiscal year in 2006. The 53rd week contributed net sales of $32.3 million. I will now go into more detail on the components of this growth.

Domestic net sales increased $26.8 million to $311.4 million, an increase of 9.4% year-over-year or 0.02% on a comparable 13 week quarter. The benefit of the extra week accounted for $26.2 million of the increase in domestic sales growth.

Unit volume increased 12.5% year-over-year or 3% excluding extra week. But this was partially offset by a 3% decline in AUSP.

Now I will discuss this performance in detail excluding the extra week. Our innerspring sales declined to 3.8%, the continued success of our new Sealy Posturepedic Reserve beds, which we began shipping in our second fiscal quarter, were offset by declines in our other innerspring products. In specialty bedding, we generated strong growth as sales increased approximately 29%. Unit volume was up 36%, slightly offset by a 5.5% decline in AUSP due largely to our pricing actions on Sealy Posturepedic TrueForm, which we took in the first quarter of 2007.

Our TrueForm business continued to exhibit solid growth as sales were up 13%. Even more significantly our branded laid tax business, which is camping up a larger base then this go product was up nearly 50%. The declined in averaging and selling price is primarily due to a combination of a shift in the mix of innerspring sales.

Specifically, lower sales of our Sealy Posturepedic products and the $1000 and above price range. And higher sales of our Posturepedic Reserve beds combined with the effect a strategic pricing actions taken in the fiscal first quarter of 2007 on selected products to drive volume.

Our favorable overall mix of higher price specialty sales partially offset these factors. Internationally, sales grew to $129.9 million and increased of 17% over the comparable year period, were 12% excluding the benefit of the extra week.

On the consequence basis revenues were 7.2% in the quarter, excluding the extra week our performance was as balanced. Total international operations posted a 30% increase in unit volume, partially offset by a declined in AUSP.

The Canadian business delivered another strong quarter and was that 18% or 5% local currency on a 6% increase in unit volume. Unit in sales growth was driven by strong performance in Sealy Posturepedic innerspring due primarily to promotional activities with large national accounts.

In our European markets sales were flat in the quarter were down 10% on a local currency basis. Unit growth was enable by the additional capacity they was brought on line last year to support the growing OEM customer demand for late expect course which carried of lower prices and margins.

Our total gross profit increase $2.4 million from the same period a year earlier to $179.9 million. As a percentage of sales, gross profit was 40.8%, which compares favorably to the 40.3% we saw in the third quarter. But unfavorably to the 44.9% we reported last year. The sequential improvement in gross margin from the third quarter was due to lower customer incentives and floor sample discounts on the revenue line partially offset by 1% increase in domestic per unit material costs.

Recall that the comparison to last year is more challenging because of $5.7 million benefit in Q4 2006 from an accounting change in the estimates related to workers compensation. Beyond that, the year-over-year gross margin contraction was primarily due to the addition of over $7 million of flame retardant materials to our products in the US, compared to the same quarter last year.

Gross margin was further impacted by the addition of value-added enhancements to our products, a shift in sales mix and pricing actions that I mentioned earlier. Partially offsetting these items were continued improvements in manufacturing efficiencies, including improved labor productivity and yields on raw materials. However, commodity costs including our petroleum and steel based input products continue to rise and exert pressure on margins.

SG&A expenses increased $17.4 million or 14% from the same period a year ago to $143.1 million. The extra week in the quarter accounts for nearly $10 million of the increase. As a percent of net sales, SG&A expense was 32.4% and 31.8% for the quarters ended December 2nd, 2007 and November 26th, 2006 respectively.

The increase in SG&A as a percent of sales was primarily due to an increase in bad debt expense and an increase in cooperative advertising expenses driven by a shift in customer mix. These increases were partially offset by favorable comparisons with write-offs of capitalized expenses incurred in the fourth quarter of 2006 and reductions in corporate and administrative expenses.

Net income for the company in the fourth quarter of 2007 was $0.18 per diluted share or $17.1 million compared to $0.22 per diluted share or $21.5 million in the same period in 2006. Fourth quarter 2007 diluted earnings per share includes an income tax benefit at $0.03 for the release evaluation allowances for a Mexican deferred tax assets, as the business has demonstrated the ability to generate sustained profitability. This was offset by $0.03 write-down charge related to customer bankruptcies.

As you're probably all aware, the weak environment has left many retail players in the industry in a tough spot, causing a few of our customers to file for bankruptcy. While we do not anticipate a significant impact to our sales from these bankruptcies on a go forward basis, we were forced to take write-downs related to these businesses in the quarter and continue to monitor this issue closely.

Despite these customer issues during the quarter, we managed to deliver a reduction in average domestic days sales outstanding from the prior quarter and year. We remain very focused on managing our receivables.

Let me now provide some insight into our full year 2007 results. As I previously mentioned, the fourth quarter of fiscal 2007 had an extra week compared to the same period in 2006. We estimate that that extra week contributed $32.3 million of sales, $13.1 million in gross profit and $1.5 million in net income.

For the full fiscal year, total net sales were a record $1.7 billion, a 7.5% increase from the same period a year earlier. Taking a look at how this performance breaks down domestically and internationally, domestic sales increase by $57.3 million or 4.7% driven by an 8.8% increase in unit volume partially offset by a 3.7% decline in AUSP.

Internationally sales were $61.9 million or 16.6% on a constant currency basis international sales increase 10.6%. Gross profit was $709.6 million or 41.7% of sales as compared with $707.9 million or 44.7% of sales for the same period a year earlier. Net income was $79.4 million versus $74 million in 2006.

Now moving on to our balance sheet, our working capital requirements remain a relatively low level. Looking first at accounts receivable our domestic day sales outstanding was 30 days which was four days better than the same period a year ago. International day sales outstanding were unchanged.

Our domestic days inventory on hand improved by one day to 27 days from the prior year. Internationally days on hand was one day better than the same period of last year. Domestic day's payable increased two days as compared to the same period a year ago to 71 days. International day's payable was 84 days which represents a decrease of one day.

Turning now to sources and uses of cash, for the fiscal year 2007 cash flow from operations improved $36.2 million over the prior year to $94.4 million. Our 2006 results included a $32.1 million cash impact from the IPO and related debt extinguishment.

Capital expenditures total $42.4 million for the fiscal year ended December 2, 2007 including $8.1 million related to new domestic facilities. The company's debt net of cash was $779 million at December 2nd, 2007 compared to net debt of $787 million at the beginning of the year.

During the fourth quarter we purchased $40.1 million of public debt at par on the open market and incurred a charge of $1 million as a write-off of deferred financing fees to retire portion of our highest cost debt. Net debt was impacted by the $42.4 million of capital investments we made in our manufacturing facilities and other areas to support our growth as well as $27.4 million in cash dividend and the use of $16.3 million to repurchase our common stock.

Our leverage ration for net debt to adjusted EBITDA as defined in our credit agreement stands at 3.59 times, as the end of our fiscal year.

Well within our maximum leverage permitted in the credit agreement of 4.5 times. On January 3rd, 2007 we announced that our board of directors declared a cash dividend for the fourth quarter in the amount of $7.5 per common share. During the quarter we have repurchased 628,200 shares of our common stock for $9.2 million. We maintained that our use of cash flow reflects power commitment to return a portion of excess cash to our share holders while working toward our targeted net debt levels in preserving flexibility to fund our continued growth plans.

Now in light of all of the initiatives and challenges that Dave laid out today I want to provide some assistance on how we are thinking about our business in 2008. However we do not anticipate providing similar quarterly updates. For the full year we expect sales to be flat to up in the low single digits. Gross margins to be down slightly. SG&A expense to be flat to down as a percent of revenue and EPS to be flat to slightly down. We expect capital expenditures to be in the range of $35 million to $45 million.

In the first half of the year, we are facing difficult comps and a deteriorating consumer environment, as we make significant investments to launch our largest product line. However, we expect to begin to benefit from some of these investments in the second half of the year. We expect units to be down in the first quarter, and first half of the year prior to rolling out our new Posturepedic line, and our AUSPs to begin improving as a result of the pricing actions we recently announced in the fourth quarter. Note, that we do not expect to see any significant impact to AUSP from the new Posturepedic line until the third quarter.

Our outlook also seems gross margins will continue to be under pressure and down versus the first half of 2007. We faced difficult comps, as we expect to see an incremental $14 million to $16 million of FR costs in the first half of the year and significant increases and commodity prices. Specifically, we've seen sharp increases recently in foam and steel prices. We have a significant amount of effort being exerted on how to steadily mitigate these cost impacts.

Additionally, due to strong demand for our latex products, we are currently importing product from our European facilities and incurring the related shipping cost of $40 per bed, until the second manufacturing line in our US facility is fully operational. We also will have significantly higher floor sample cost in the second quarter related to our Posturepedic rollout.

Now moving on to SG&A. We are in the process of implementing cost improvement initiatives, including controlling our product launch costs and lowering our fixed operating expenses; selling costs, logistics and infrastructure costs. However, our Posturepedic rollout will drive higher product launch costs impacting SG&A primarily in the second quarter, as we make significant investments to launch our largest product line.

Taking all of this into account, we expect EPS to being negative for the first half of 2008. As we move into the second half of the year, we expect US units to be flat, as we focus on premium price points with our specialty products throughout the year and see improved sales of our Posturepedic line at prices above $1,000.

We anticipate a modest increase in AUSP to be achieved through the previously discussed pricing actions, a mix shift towards $1,000 plus price points as we roll our new Sealy Posturepedic beds and shift the slots we fought to protect in 2007 to Posturepedic. We also plan to continue to help sell our specialty products and introduce new latex product later in the year.

In the back half of 2008, we expect margins to improve as we'll have the benefit of the new Posturepedic, improved mix of TrueForm products and the benefits of the additional capacity at f our Mountain Top facility for our latex products. We will also see reduced floor sample discounts. SG&A in the second half of the year will have significantly lower product launch costs and we are targeting a net reduction on a full year basis.

As we start to realize the benefits associated with implementing our cost improvement initiatives, we should be able to invest more heavily in advertising after fully rolling out the new Posturepedic. While we achieve a reduction in SG&A expenses as a percent of sales in the second half. Taking all of this into account we expect EPS growth in the second half of the year to improve as we see improvements in both gross profit margin and expense leverage.

We are running the business for the long term and expect that 2008 will mark a critical step in the evolution of this company to propel us towards our long term goals of driving revenue growth, improving profitability and continuing to deliver strong cash flows.

This concludes our prepared remarks. We'd now like to open the line for your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen at this time, we'll begin the question-and-answer session. (Operator Instructions). Our first question is coming from Reza Vahabzadeh with Lehman Brother. Please go ahead.

Reza Vahabzadeh - Lehman Brothers

Good afternoon.

Dave McIlquham

Hello Reza.

Reza Vahabzadeh - Lehman Brothers

As far as the extra week, Jeff, by the way, thanks for all the information in the press release and the call so far, but so the net impact of extra week on EBIT was how much?

Jeff Ackerman

Well, our net income was $1.5 million.

Reza Vahabzadeh - Lehman Brothers

Okay. So maybe a little less than $5 billion on the EBIT?

Jeff Ackerman

Well, our cash rate for the year was about, you probably ought to just use about a 38% tax rate.

Reza Vahabzadeh - Lehman Brothers

Okay. That's fine. Thank you. And then as far as the new product spending, you talked about the higher FR cost, how much higher spending will you have on new product launch costs in the second quarter?

Jeff Ackerman

The product launch costs are primarily focused on our floor sample discounts and then also the supporting materials and meetings that we'll have for that. It will be up similar to the increases that we saw this year.

Reza Vahabzadeh - Lehman Brothers

And this will be mostly but in the second quarter?

Jeff Ackerman

Yes. That's a biggest piece of the launch costs will show up in the second quarter. So that's where we'll see unfavorable comparison to the prior year.

Reza Vahabzadeh - Lehman Brothers

Okay. And then as far as domestic sales, did you experience any material softness towards the latter part of your fourth quarter or so far in the first quarter or have sales trends been relatively even in the U.S. business.

Jeffrey Ackerman

No. Reza We actually did see some deterioration as we progressed through the quarter.

Reza Vahabzadeh - Lehman Brothers

Okay. And your strategy as far as any kind of a slowdown in consumer spending, Dave or Jeff is to focus on the new products or to offer the reserve beds?

David McIlquham

No. Reza we are totally focused on getting the new Posturepedic line launched. We'll start our first four sample shipments a bit in early March. We took a price increase, which started phasing in the middle of December. And we don’t anticipate any significant closure pricing or anything like that on the existing line. Given we just raised prices and given the response which was tremendously positive from our customers to the new line. We're totally focused on getting the new Posturepedic line rolled-out as quickly as possible.

Reza Vahabzadeh - Lehman Brothers

And then how effective has that pricing increase been so far. And is it a full offset to your cost increase? And that's it for me. Thank you.

David McIlquham

I will answer the first part of that question. I'll let, Jeff answer the second one. The price increase is stuck largely because our competitors are raising prices generally as well given the input cost pressure we're all feeling.

In fact there were some other price increases announced at market and we are fortunate in that were we merchandising our Posturepedic line, which I think give us some further opportunities down the road. So the price increases have stuck we've started to see the impact of that in January as they got fully rolled out in our average unit selling price.

And Jeff, I will let you turn it over to you.

Jeffrey Ackerman

Rashid, I think we have talked about this before but the amount of price increases that we have seen on raw materials combined with the incremental costs on FR those are more than the price increase.

Reza Vahabzadeh - Lehman Brothers

Thank you.

Operator

Thank you. Ladies and gentlemen we ask you to please limit yourself to one question and one follow-up in the interest of time and then re-queue for any additional questions. Our next question is coming from the line of Keith Hughes with SunTrust. Please go ahead.

Keith Hughes - SunTrust

Thank you. Jeff, can you break out the gross margin of U.S. versus international in the fourth quarter?

Jeffrey Ackerman

Yeah, gross margin for the U.S. versus international just a second.

Keith Hughes - SunTrust

And while you are looking for that, you had mentioned 13% growth in the quarter for TrueForm and 50% growth in the quarter for latex is that dollars or units?

David McIlquham

That was dollars, and now is on a like-for-like basis in terms of the number of weeks.

Keith Hughes - SunTrust

Excluding the extra week. Correct.

David McIlquham

That is correct.

Jeffrey Ackerman

Our gross profit margin domestically in the quarter was 42.3% and internationally the gross profit margin was 37.1%.

Keith Hughes - SunTrust

That is sequential improvement from the third to the fourth, but there wasn’t much price, much of the price increase involved in that, was there?

Jeffrey Ackerman

No, there was no pricing action. If you remember our, we announced the pricing increase in the fourth quarter but it did not go into effect until December and we really didn’t see any impact in December from the price increase.

Keith Hughes - SunTrust

If the Posturepedic launch is what you think its going to be in the second half of '08 would we get back towards some of the historic cause on gross margins in the United States? Does is it have that kind of potential or is that too aggressive?

David McIlquham

Yeah, I think Keith that'd be definitely too aggressive. We expect as we said before, we expect to see margin improvement in the second half of the year.

Keith Hughes - SunTrust

Okay, thank you.

Operator

Thank you and our next question is coming from the line of Albert Kabili with Goldman Sachs. Please go ahead.

Albert Kabili - Goldman Sachs

Good afternoon guys.

David McIlquham

Hi, Al.

Albert Kabili - Goldman Sachs

I guess a quick question first on the specialty business. If you could just break out what the dollar size was in the fourth quarter and the split between latex and visco?

Jeffrey Ackerman

Yeah, we haven't for competitive reasons we haven’t done that historically and we're not in a position to be able to do that now.

Albert Kabili - Goldman Sachs

Okay, got it. And then on the international business it looks like Europe was a bit weak ex-currency. Could you just talk to us a little bit about what's going on in Europe and the outlook?

David McIlquham

Yeah Al, its Dave, the Italian market is very soft and the business was down there. The French market last year was generally strong throughout the whole year and that continued through the fourth quarter for finished goods. Obviously our OEM shipments were up but largely because of IKEA and we saw some OEM shipment weakness in other parts of the world. As we think about '06 we think OEM will continue to be strong in Europe largely driven by IKEA. We just come out of the Paris furniture show and we had good reaction there and the French market seems to be holding up. But we continue to be concerned about Italy.

We continue to be concerned about the input cost inflationary pressures in Europe which are similar to the U.S. And we're given the demand and the priority we're placing on IKEA and the U.S. business with our latex production over there. We think our international OEM sales could be a little soft as well in '08.

Albert Kabili - Goldman Sachs

Okay. And then a question on Specialty as well on the gross margins I know the margins are a little bit lower than the overall business. With the new initiatives that you're talking about opening up the second line in Pennsylvania, do you get your margins back up to the overall corporate average for Specialty in the back half of '08 or how should we will be thinking about that?

Jeffrey Ackerman

Yes. The way to think that we're going to with this TrueForm line let me talk about it first, okay, because as we introduced that we feel like we now have a differentiated products and we've adjusted the supply chain team that does a couple of things. One is it takes out some of the working capital investment. The second thing it does is it also gives us greater leverage because our scale then to consolidate all of that with one supplier domestically.

And then the way we've merchandised that is to set that so that instead of having price points to cap out $1,699 we now have price points that run up over $4,000 which gives us an opportunity to trade people out. So we expect to see significant margin improvement on TrueForm. On the latex side the impact is really about $40 per unit on every unit that we receive from Europe.

And so we will see some improvement on that as Dave mentioned we plan introducing new product and that will actually be one of the opportunities to improve margins there and that will more significant than the supply chain changes.

David McIlquham

Al I would just add, I think this is the way you should think about Specialty margins. As Jeff said our margins will improve given all the actions that we have taken, but our ability to ultimately drive our specialty margins to the levels that historically are high than innerspring margins have been. I think we will be dependent on our success in launching the right go to market consumer, advertising and marketing for Specialty because in that category we are up against two very, very strong competitors who have lots of consumer marketing investment. And so we going have to build consumer demand in Specialty for our products, which is the plan if we ultimately want to drive our margins to the levels you talked about.

Albert Kabili - Goldman Sachs

Okay then a follow up to that Dave on the rollout costs and national advertising strategy. I took it from Jeff’s comments that rollout -- product rollout costs, you feel will be flat or even slightly down despite the Posturepedic launch and a national advertising strategy. So just wanted to clarify if I got that right and then two is that just coming from more efficient rollout costs or are you thinking that includes may be pulling back on some of co-op spending that you’ve been doing and plowing that into international advertising?

Jeffrey Ackerman

Al this is Jeffrey. Let me just clarify a couple of things. Well, we expect as a slight decrease on for the full year on product launch products. Okay, that does not include the advertising costs. What we are going to do is, we will look at our advertising strategy with our new ad agency and we will base our levels of spend on the type of return that we think, we can get on that. The actions we are taking that Dave talked about were looking to reduce costs and get more efficient either through trade spending or through automation and delivery cost and just all the infrastructure costs. We are going to try to use those to fund some of that advertising.

David McIlquham

And then I’ll just finish that up. Coming back to the large question though -- the larger questions about co-op, I think consistently said, we’ve got to find a way to make our co-op advertising spending more effective and we believe that, it's a long-term journey but we are committed to it. That doesn’t necessarily mean cutting co-op spending with customers.

There could be more effective use of the money. It could be a shift in terms of the content that we give them and they spend it on based on maybe revisions to our co-op policy. We are very cognizant of the commercial relationships that we have with customers and we are committed to being partners with them. But we have to make our co-op much more effective than it has been and we have got lots of customers I think that are willing to help us do that. So we're looking at a variety of initiatives in that area not necessarily just cutting spending.

Operator

Your next question is coming from John Kernan with Morgan Keegan, please go ahead.

John Kernan - Morgan Keegan

Hi guys, its John Kernan calling in for Laura Champine.

David McIlquham

Good, John, how are you?

John Kernan - Morgan Keegan

Good. Can you give us -- I mean you gave us some color on the commodity inflation on a per unit basis drawing forward in '08, are you going to expect to see comparable increases like you did in '07?

David McIlquham

No. John we expect to see higher material inflation in '08 than what we saw in '07. And let me just give you a little bit of background on what some of the commodity prices are that are out there. In the fourth quarter if you look at some of the quarter prices on heavy metal scraps are really a kind of an indicator of steel prices, the forth quarter was up 28% over the prior year and we're also seeing now that scrap prices have ran up further in the first quarter of this year and looking to be up also another 27%, sort of initially. And then on the phone side really as I have mentioned before those is another area where we expect to see increases.

The fourth quarter TDI prices were up 13% and it looks like the prices are going to be up another 12% on top of that in the first quarter. Now so those -- so we are experiencing some pretty significant increases on raw materials and these are now, as far as, when those translate into products that we purchase now they are quite a bit smaller number. For example kind steel wood we get about 20% of that we see about 20% of that actually come through in our steel costs.

John Kernan - Morgan Keegan

Okay.

David McIlquham

And on the TDI prices, it's kind of is about 50% of that would come through in our foam finished costs.

John Kernan - Morgan Keegan

Okay. Could you quantify that all like on a per unit basis?

David McIlquham

Yes. Well, here's how I am looking at it I guess, think about it at this way. Our material costs we're expecting to be up in the range of 4% to 6% in the year.

John Kernan - Morgan Keegan

Okay. That's right.

David McIlquham

All material costs.

John Kernan - Morgan Keegan

Thank you.

David McIlquham

Sure.

Operator

Well, thank you. Our next questions come from Joel Hubbard with Hilliard Lyons. Please go ahead.

Joel Hubbard - Hilliard Lyons

Thank you. Guys going back to the comments, Jeff it was in your irregular forecasting per check the guidance there too by the way. But thinking about the year's sales picture, did I hear you right that you're looking for a softening of units as well in the near-term that such a discrepancy from -- you all been sort of ahead of the curve here lately. Can you talk a little bit more about that and Dave your comments would be appreciated too?

David McIlquham

Sure. Joel as we said the environments gotten more challenging -- was more challenged because we moved through the fourth quarter. So we do not expect to see unit growth but I just wanted to go back to our strategy during 2007, was really to drive units in order to secure the slots that we had on retailer's floors and that allows us then to come back with our new Posturepedic line and provide all the distribution points that we want to get there.

Joel Hubbard - Hilliard Lyons

I will make sure I understand this, so is this a function you pushed to get slots but now you're kind of flushing out product at the dealer level in front of the introductions?

David McIlquham

Well, I would say rather than push to get slots we took pricing actions on the innerspring side -- product actions on the innerspring side in '07 to protect those innersprings slots. Particularly given the fact that, those innerspring products in some cases weren't performing as we had expected. The incremental slots that we gained last year were generally all in the Specialty area.

And so as we think about '08 to Jeff's point, and we have had lots of these discussions with customers in the last month as we introduced the new Posturepedic line. We are not looking for slot increases in '08. We believe that our goal, particularly given the environment we are in has to be to drive higher end slots and velocity and that will come with the new Posturepedic line, which is why we talked about the first half, second half split as we did.

And just to add color to that, as Jeff said, we did see a slowdown in the fourth quarter. Clearly everything that you have read about retail and about the softness that's out there, we are seeing that in the home furnishings industry. And we heard a lot about it from retailers over the last 10 days, as they came here to view the new line and as we talked to them at market.

So, we do see a tough environment for the next -- certainly for the next three to four months. And that's exacerbated a little bit, Joe because there is always a bit of disruption when you are changing lines and starting early March we are going to be starting the conversion to our entire Posturepedic line because we have introduced a totally new line and we will replace every model.

And that is why we see the second half, really independent of what happens to the macro-environment. We see the second half being very different than the first half. We will mix up slots with the new Posturepedic line. We think we will improve velocity, obviously that means we will improve AUSP, and given the pricing actions that we have taken and the cost engineering and the design of the new product, that should more positively impact the margins in the second half as well.

Joel Hubbard - Hilliard Lyons

I see. Thank you for the additional commentary guys.

David McIlquham

You are welcome.

Operator

Thank you. Our next question is from the line of Kevin Zietz with Goldman Sachs. Please go ahead.

Kevin Zietz - Goldman Sachs

Hey guys. Question on the price increase and whether you saw your volumes drop-off after that went in place?

David McIlquham

Yeah, we definitely have seen more softness, and I think that is consistent with Jeff’s comment about deteriorating trends in the fourth quarter. But to Jeff’s point we didn’t have any pricing action in the fourth quarter. We really didn’t have much of pricing impact in December.

So I have got no way of quantifying it, Kevin, but given that our competitors took up prices as well, and the fact that for the consumer that's walking into the store, and purchasing a mattress and hasn’t been in the market in seven to 10 years, they are still seeing all the same price points.

So increasing prices I don’t think has much impact on consumer demand, because the consumer is just not aware of what the values are. Increasing prices as long as the rest of the market moves really shouldn't impact on individual company too much because of the competitive balance doesn’t change. So as we access it we think most of the trend is a macro-economic driven, not a function of us or anybody else having taken a price increase in the last 60 days.

Kevin Zietz - Goldman Sachs

Right, Well I guess notwithstanding the pressures that are out there, when do, you go out to your retailers for co-op, to change the co-op spend and is there are risk that they are concerned about taking the product on without the international advertising kind of coming at the same time?

David McIlquham

Oh I would, first of all we don’t have any timeline for when we would ever go talk to a customer about reducing co-op that, was your question. As I said earlier that isn't necessarily where the focus of all our initiatives are in terms of more effective co-op and I think your thinking about right at the end of the day. It’s a comprehensive go to market strategy and it has to involve commitments on our part to invest in the brand and in the products.

It has to involve content on our part to ensure that we've got effective advertising, if we're going to convince retailers to use some of their co-op dollars differently. And I think in some cases that will be very easy. We've got retailers that are very, very aggressive and committed to advertising Sealy Posturepedic. And they do a great job of it. We've got other retailers that I think, we’ve got -- who spend a lot of money.

But I think we could make the content of that advertising better and more effective for Sealy. And we’ve got some retailers that we -- I think we've got to find new solutions for and it’s a long-term initiative because we want to be partners with our customers and we’ve got to make sure it’s win-win. It starts with product, but it obviously can't end there. And I think as we look at the second half of '08, we believe we will have a very strong Sealy Posturepedic innerspring line.

We'll have our new TrueForm line out. Obviously, our current latex products are performing well. We will introduce some new latex products that fit the new Posturepedic positioning. So, that’s why we hired the new agency and it's literally only been in the last three to four weeks where, we've converged around the platform and the positioning that you saw the Las Vegas market and so. This is a long-term initiative that we feel good about but that will take thoughtfully and carefully.

Kevin Zietz - Goldman Sachs

And one follow-up. Could you speak to the flexibility in the plan given all the headwinds in the markets and obviously the costs going out with the launch in terms of -- and if covenants step down in the second quarter, I just want to understand how comfortably you're with that and whether there's flexibility in the plan?

Jeffrey Ackerman

Kevin so you are asking on our flexibility around the guidance?

Kevin Zietz - Goldman Sachs

Just flexibility around the covenant and where you may have leverage to whether be -- if you think its price increase -- further price increases or what not if things end up being a little bit more bumpy than you are expecting?

Jeffrey Ackerman

Right so Kevin we are not at all concerned with any our debt covenants. l mean we are comfortably under all of those. I think that’s your primary question. As I mentioned in my prepared comments, our leverage ratio is at 3.59 and covenants requires to, be at -- under 4.5. So we got a basically a full turn there.

Kevin Zietz - Goldman Sachs

Okay and isn’t there a step down at the second quarter?

Jeffrey Ackerman

In the second quarter?

Kevin Zietz - Goldman Sachs

May be I misread the credit agreement.

Jeffrey Ackerman

You know what I have got. I will let Mark go ahead and take that.

Mark Boehmer

Hi Kevin.

Kevin Zietz - Goldman Sachs

Hi Mark.

Mark Boehmer

We are right now its just that we are a little under 3.6. That’s lower than the lowest level the credit agreement ever goes.

Kevin Zietz - Goldman Sachs

Okay.

Mark Boehmer

We are in pretty good shape.

Kevin Zietz - Goldman Sachs

Like that's what you are saying if you don’t think even with all these pressures that you will go much higher than where you are right now.

Mark Boehmer

We are comfortable as that and we are going stay with the clients to a degree.

Kevin Zietz - Goldman Sachs

Okay great. Thank you.

Operator

Thank you. Our next question is coming from the line of Stanley Elliot with Stifel Nicolaus.

Stanley Elliot - Stifel Nicolaus

Good afternoon. This is Stanley in for John Baugh. Quick question for you guys. We have been picking up from some retailers in the field that there is a fairly high return rate by customers as in the latex products was wondering if you could comment on that.

Jeffrey Ackerman

Stanley this is Jeff. I am not sure where you are getting the information but I can tell you that returns on latex, are in line with our company average.

Stanley Elliot - Stifel Nicolaus

Okay, very good. Thank you.

Jeffrey Ackerman

Sure.

Operator

Thank you. [Matt Fischer] from Deutsche Bank. Please go on with your questions.

Matt Fischer - Deutsche Bank

Hi, in terms of you are consumer kind of mix, it seems to be that with the product that you are doing in $2,000 price throughout plus price point that consumers is holding in. Is that, the right perception to take away with from this and how are the other price points holding in?

David McIlquham

I want to make sure I understood your question, Matt really was, are we seeing that the consumer buying beds above a $1,000 that’s remaining relatively robust. Was that ..

Matt Fischer - Deutsche Bank

Yes. That customer is still shopping since especially since seeing that kind of a focus of your new rollout it's that 10,000 plus price points. Or are you seeing weakness in that category?

Jeffrey Ackerman

Look I think as we have talked about on our prior calls are above a $1000 is really the weakness spend in the innerspring and so, we are addressing that with this new Posturepedic line. And we feel like there is still in enough customers out there. They will be very interested in own your line.

David McIlquham

Yeah, I would. I think that’s the way we have to think about it. I mean clearly the macro-environment I think has affected traffic across all retailers but at the end of the day. Our issues our competitive product issues, in terms of feeling, performing and, I think we fixed that with the new design and we’ve got it. In this environment we are going to have better products and better marketing because we are going to have to build share and I think others improve if they got the right products and the right marketing that even in a tough environment they can build shares. So, we are not prepared to use the economy as an excuse. So, we’ve got our better products and we got execute better.

Matt Fischer - Deutsche Bank

In terms of that share in this type of environment do you see the bigger players taking share from the smaller guys and how where do you see that share coming from?

David McIlquham

In think in this environment it’s a function of the retailers -- strong retailers take a share from weaker retailers and obviously we've seen some bankruptcies in the last few months and we're likely to see another one or two in the coming months. So I think retailers share will shift and I think manufacturer share will shift. I think it's clearly over the last few years the stronger and the largest mattress companies have all picked up share at the expense of the weaker ones and I think those trends will continue.

Jeffrey Ackerman

And I will just that we're seeing that the larger retailers now there is as we've talked about before, we've got leadership positions with the larger retailers and they are ones that our best position moving forward so is our position as well too.

Matt Fischer - Deutsche Bank

Just on the housekeeping side I mean if I heard you correctly domestic innerspring units ex the extra weak were down 3.8% from the quarter, correct?

David McIlquham

That was correct.

Matt Fischer - Deutsche Bank

Okay then the latex plant expansion this second line. Is that in the CapEx guidance that you gave us correct?

Jeffrey Ackerman

Yes. That’s in process now as we speak.

David McIlquham

That line actually comes on stream in the next 60 days. It will take us another 90 days or so to ramp it up but we're well on the way in terms of installation of that second line now.

Matt Fischer - Deutsche Bank

I wanted to just be clear on the innerspring sales they said it was a decline of 3.8%, the sales worth. So I want to make sure I got?

David McIlquham

Okay. Sales not units

Matt Fischer - Deutsche Bank

The sales, correct.

David McIlquham

[Nothing].

Matt Fischer - Deutsche Bank

Okay. And then just lastly in terms of the FR cost I mean what's keeping those input costs higher as we've gone past kind of that rush to get everybody compliant, what’s the outlook there on those costs going forward?

Jeffrey Ackerman

Well, we're comping the first half of the year. We're comping lower FR costs because our full line was not FR compliant, and so that was completed in the third -- our fiscal third quarter by July 1st. So that's into our third quarter, and consequently this first half of the year, we are still seeing, we're comparing a fully converted line to a partially converted line. So that's really the different type we are speaking too. It’s not that it's increasing as we go through the year.

Matt Fischer - Deutsche Bank

Okay. Thank you very much.

David McIlquham

Sure.

Operator

Thank you. And our final question is a follow-up from Keith Hughes. Please go ahead.

Keith Hughes - SunTrust

Yes, just real quick here on the national advertising. Do you have a date were that's slated to launch?

David McIlquham

I don't -- we don't have one yet Keith, we haven't even had our first presentation from the agency yet in terms of creative.

Keith Hughes - SunTrust

And finally, just to review, Jeff, excluding the actual week domestically what were the units again?

Jeffrey Ackerman

I didn’t say Keith but if you hang on just for a second I can tell join you. They were domestic units excluding the week -- excluding the extra week in the fourth quarter, total units were up 2.9%.

Keith Hughes - SunTrust

2.9%. And AUSP was what?

Jeffrey Ackerman

Our AUSP was domestically was of about 3%.

Keith Hughes - SunTrust

Thanks.

Jeffrey Ackerman

Okay. I did wanted to just make one other comment before, we wrap up, I am not sure we have any other questions. But I did want to -- it was brought to my attention that I had mentioned in my prepared comments that first half '08 EPS would be negative that of course is negative versus the prior year. Not negative in the absolute terms.

Operator

Okay. And ladies and gentlemen this does conclude the Sealy Corporation fiscal fourth quarter 2007, Earnings Call. We do thank you very much for your participation. You may now disconnect. Thanks for using ACT conferencing. Have a very pleasant day.

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