Sealy Corporation F3Q08 (Qtr End 08/31/08) Earnings Call Transcript

Oct. 7.08 | About: Tempur Sealy (TPX)

Sealy Corporation (ZZ) Q3 2008 Earnings Call October 7, 2008 5:00 PM ET

Executives

Kenneth Walker – Sr. VP, General Counsel, Secretary

Lawrence Rogers – President & CEO

Jeffrey Ackerman – EVP & CFO

Mark Boehmer - Treasurer

Analysts

Chad Boland - Raymond James

Albert Kabili – Goldman Sachs

Analyst

Karru Martinson - Deutsche Bank

Mark Rupe – Longbow Research

Joel Harvard – Hillard Lyons

Keith Hughes - SunTrust Robinson Humphrey

John Baugh – Stifel Nicolaus

Reza Vahabzdeh – Barclay’s Capital

Operator

Good day and welcome to the Sealy Corporation’s third quarter fiscal 2008 earnings conference call. (Operator Instructions) At this time I would like to turn the conference over to Mr. Kenneth Walker, Senior Vice President, General Counsel and Secretary of Sealy Corporation; please go ahead sir.

Kenneth Walker

Good afternoon everyone. I want to thank you for joining us on Sealy’s financial third quarter 2008 investor conference call.

Before we begin let me remind you that in accordance with the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, the company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements.

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

I’ll now turn the call over to Lawrence Rogers, President and Chief Executive Officer of Sealy Corporation.

Lawrence Rogers

Good afternoon and thank you, Kenneth. I want to also thank all of you for joining us on our call to discuss Sealy’s third quarter results. Joining me today are Jeffrey Ackerman, our Chief Financial Officer and Mark Boehmer, our Treasurer.

On this call I will give an overview of the industry and our third quarter results as well as an update on the progress we are making on our strategic operating initiatives. Jeffrey will go into more detail on our third quarter financial results and then we will open the lines for your questions.

Let me start by discussing the domestic bedding industry, retail mattress conditions continue to erode particularly at price points above $1,000. We do not believe industry’s trends have yet stabilized and US consumer sentiment continues to be weak which is taking a toll on the industry.

As evidence of this, one of the country’s larger mattress retailers filed for bankruptcy in September and some smaller players are exiting the market as well.

This not only illustrates the weak retail environment that many manufacturers are facing but also reinforces that we must monitor our retail relationships closely and look for ways to help them navigate through the current conditions.

Globally manufacturers continue to face heightened cost inflation, particularly in steel and foam due to higher commodity costs, and tight supplies on feed stocks. In this environment we are focused on controlling the areas of our business that we can impact, consistent with what we have discussed on our prior calls including the Posturepedic line rollout which is now complete, continued product innovation, cost controls and effective working capital management.

Now I’ll provide more detail on Sealy’s results, total sales for the quarter were $405 million, down 9.3%. Our domestic sales declined 11.6% as sales in the third quarter continued to be challenged. However we did achieve what we set out to do with the new Posturepedic inner spring line during the third quarter, significantly improving our sales results compared to the old line, driving gross margin and average unit selling price improvement through the mix shift to higher end price points, delivering a superior feel and improving overall manufacturability and quality.

Additionally our Sealy branded line performed relatively well during the third quarter. Consistent with broader industry trends we are still seeing weakness in some higher end price points however we did realize an increase in our Posturepedic sales at price points above $1,000 compared to our old line.

And we believe we are starting to regain share in this key price band. As we have discussed previously we are working diligently with a dedicated team of people to introduce a redesign of the Stearns & Foster product line.

While our domestic specialty business also faced some pressure our Smart Latex products outperformed and we believe continue to gain specialty market share in the third quarter. Internationally as we communicated on our second quarter conference call trends continue to soften as the economic headwinds we are seeing domestically are further impacting international economies.

Accordingly we experienced some deterioration in our international sales trends in the third quarter with Europe underperforming other markets. Our Canadian sales have slowed but remain healthy and we continue to experience strength in our operations in Mexico, South America and Asia joint venture during the third quarter.

We believe Sealy’s diversified geographic presence leaves us better positioned in the context of this environment to emerge with a stronger presence when the market turns.

A slight increase in our gross margin in the third quarter reflects the benefits of a number of initiatives in our domestic business. The price increases we implemented in December and July, the positive mix shift in our Posturepedic sales towards higher end price points, and the results of our lean manufacturing and value engineering efforts more then offset the effects of rising material costs and lower volumes.

This quarter also reflected the third consecutive quarter of significant SG&A reductions for the company as our previously discussed cost control initiatives continued to take hold and positively impact our earnings.

Turning to our strategic initiatives, we are making further progress in the key objectives we laid out at the beginning of the year. These include: (1) growing our average unit selling price; (2) implementing the new retail and direct to consumer advertising and marketing strategies; (3) improving our gross margins; (4) reducing our costs; (5) continuing our commitment to the specialty business; and (6) focusing on international.

Starting off with our initiative to drive average unit selling price growth we increased our domestic wholesale average unit selling price by 3.3% in the third quarter due to a number of factors. First, the new Posturepedic line and the positive mix up we are experiencing is starting to translate into average unit selling price growth.

We have been encouraged to see our retail customers who have rolled out the new Posturepedic line continue to produce improved sales compared to the pre-rollout period.

While the overall market about the $1,000 price point is still soft, we are seeing improvement in our new Posturepedic line in this price band. Additionally the strength of this line below $1,000 allowed us to successfully implement a price increase in July on our mattresses at these price points.

Our second strategic initiative is to build brand awareness through new advertising and marketing strategies. As we discussed last quarter we launched our first national advertising campaign “get a better six” which has been very well received by our retailers.

The “get a better six” campaign was designed not only to deliver a strong direct to consumer message but also to serve as a platform for our retailers to better leverage their cooperative advertising dollars.

We have seen a significant and growing number of customers adopt the better six messaging in their co op advertisements and in fact, the retailers who have done so are seeing a lift in their sales compared to retailers who are using other messaging.

We are tracking well above where we expect to be in delivering impressions at this point in time, which puts us well on our way to exceed our total objective of one billion impressions across TV, print and the internet.

Our third strategic initiative is to improve our gross margins. We saw our gross margins stabilize in the third quarter as a result of our price increases, the mix up with our Posturepedic line and our lean manufacturing efforts.

However material costs in the quarter increased approximately 12% over the prior year. Despite some recent abatement in commodity cost increases, we expect to receive additional price increases in the fourth quarter as the pricing mechanism in our supply contracts reset.

To help mitigate this pressure on our margins, we continue to evaluate and improve the design of our products. Our goal is to reduce exposure to our highest cost materials and remove non-value added production costs while still enhancing product quality, and feel.

We have also made progress with our Smart Latex integration as our second latex line is now fully operational which should help offset increases in our chemical costs. Our fourth strategic initiative is a continued focus on our fixed operating expenses, selling, logistics, and infrastructure as well as our product launch costs.

We have proven our ability to take costs out of almost every aspect of our business through our cost reduction initiatives which produced another quarter of significant improvement in SG&A expenses.

We have identified additional opportunities to lower our expense structure that we are initiating in the fourth quarter. Our fifth strategic initiative is an ongoing commitment to the specialty business where we’ll be expanding distribution of our Smart Latex products in 2009 and we remain confident in the long-term growth opportunity for Smart Latex as we believe we continue to gain share.

In terms of production, now that we have two lines at our Mountaintop, Pennsylvania plant fully operational we have stopped importing from Europe and have shifted our focus towards optimizing the efficiency of both these lines and developing innovative new formulations.

Our final key strategic initiative is to continue to focus on our international business where we continue to expect to achieve one-third of our growth over the long-term. As I mentioned earlier, we are seeing weakness in some of our international markets related primarily to economic challenges abroad, particularly in Europe.

Given this we are taking similar cost reduction initiatives as at our US business and applying them to Europe and Canada to reduce expenses where possible. In Mexico, we recently launched specialty products into this market for the first time and the initial results have been encouraging.

We are determined to operate our business in a more effective manner. We recognize the difficult environment and we are methodically analyzing all aspects of our business both internally and with customer input.

If something isn’t working we are going to acknowledge this and fix it in order to make our organization stronger. One example of this is our recent decision to discontinue our active link sales program and return to our previous more personal service to all of our customers.

In summary, while our Posturepedic line continues to perform well, the overall retail environment remains very challenging, both in the US and internationally and consumer confidence is still fragile. We will also be facing additional hikes in commodity costs as we head into the industry’s seasonally weakest quarter.

Given these headwinds we continue to focus on the areas of our business where we can positively impact as we have shown over the past few quarters. We are confident our actions will enhance Sealy’s future with our progress in fixed cost reductions, our improved product portfolio and a solid leadership team in place, we are positioning Sealy as a leaner, more effective organization who will have an even stronger earnings profile when the industry emerges from this difficult period.

I will now turn over this call to Jeffrey Ackerman, our Chief Financial Officer.

Jeffrey Ackerman

Thanks Lawrence, I’d now like to walk you through the financial details. For the third quarter, total net sales were $405 million, a decrease of 9.3% compared to the prior year. Net income was $10.9 million or $0.12 per diluted share, compared to $21.5 million or $0.22 per diluted share in the same period of 2007.

Keep in mind that our third quarter 2007 net income included a $7 million or $0.07 per diluted share benefit from the reversal of certain tax reserves. I’ll now go into more detail on the components of our third quarter sales results.

Total domestic net sales fell by 11.6% year-over-year to $296.1 million. Wholesale domestic net sales which excludes sales to third parties from our component plants were down 12.7% to $289 million as a 3.3% increase in average unit selling price, or AUSP, was offset by a 15.5% drop in unit volume.

Third quarter 2008 AUSPs were favorably impacted by the price increases we implemented in December, 2007 and July, 2008. The positive mix up we have been experiencing with our new Posturepedic line and lower floor sample discounts related to the acceleration of our Posturepedic rollout into the second quarter.

As Lawrence mentioned, industry demand has been deteriorating driven by continued pressures on consumer spending which has reduced traffic on retailers’ floors and contributed to the decline in our wholesale domestic unit volume.

Despite challenges in the domestic mattress industry our new Posturepedic line is performing well, most notably above $1,000. Branded specialty bedding sales were down approximately 10% in the US as a 24% decline in units was offset by a 19% increase in AUSP.

By product category, sales of our Smart Latex products were essentially flat in the third quarter while our branded visco sales declined approximately 17%. Internationally net sales were $108.9 million, a decline of 2.2% or 8.3% on a constant currency basis.

A deteriorating retail environment in Canada and Europe were partially offset by sales gains in Mexico and Argentina.

Our Canadian sales were down 3.1% or 6.6% on a local currency basis as a 0.2% increase in AUSP was more than offset by a 6.8% decrease in unit volume. While our Canadian business decelerated we were facing difficult comparisons this quarter as August, 2007 was the strongest month in Sealy Canada’s history and we also experienced some temporary business disruption and additional costs related to the relocation of our new manufacturing plant in Toronto during the quarter.

In our European markets sales were down 11.4% in the quarter or 22.5% on a local currency basis. Our sales weakened given the slowdown in the broader economic environment and were also impacted by our largest OEM customer as they drew down inventory in preparation for the launch of their new line.

Our total gross profit fell by $15.8 million to $164.1 million. However our gross profit margin increased slightly to 40.5% of net sales in the third quarter of 2008 compared to 40.3% in the third quarter of 2007.

Domestic gross profit was $126.9 million or 42.9% of domestic net sales as compared to 41.5% in the third quarter of last year, an increase of 140 basis points.

The improvement in our gross profit margin was due to a number of initiatives including price increases implemented in December, 2007 and July, 2008, a positive mix shift in the sales of our new Posturepedic line, continued improvements in manufacturing efficiencies, and lower floor sample discounts related to accelerating the Posturepedic rollout into the second quarter.

It is also important to note that we have now completed anniversaried the impact of incremental FR costs. These factors were partially offset by higher material costs, particularly in steel, foam and latex, as well as a deleveraging of overhead expense on lower volumes.

Additionally we incurred a $1.4 million charge related to air bed inventory as we have made the decision to exit this business. After testing this product with our retailers we concluded that we can invest in other opportunities with a better return profile.

International gross profit was $37.2 million or 34.2% of international net sales as compared to 36.8% in the third quarter of last year. The decline in our overall international gross margins was driven primarily by a deleveraging of manufacturing expenses on lower volumes.

Consolidated SG&A expenses declined by $7.2 million or 5.1% from the same period a year ago to $132.9 million. This reduction in SG&A was driven by a $6.3 million decline in variable expenses and our ongoing efforts to aggressively reduce our cost structure which contributed to a $5.3 million reduction in fixed expenses.

The actions we took to further streamline our cost structure include better management of product launch expenses, strategic workforce reductions and reduced spending on professional services and other discretionary items.

These improvements were partially offset by investments in our better six national advertising campaign which as Lawrence mentioned, has been widely adopted and well received by our retailers, as well as a $2 million increase in bad debt expense.

The increase in bad debt expense relates primarily to the September bankruptcy of one of our large retailers with whom we had discontinued selling earlier in the year. As the retail environment remains challenging we are monitoring our retailer relationships closely and working with our retail partners to proactively mitigate any potential risk.

Despite our significant decline in SG&A dollars, we experienced a deleveraging of our SG&A expenses to 32.8% of net sales from 31.4% in last year’s third quarter as a result of our lower sales levels and the investments we made in our national advertising campaign.

We also recorded a $2.4 million restructuring charge related to the closure of select administrative offices in one of our manufacturing facilities. Adjusted EBITDA which excludes this restructuring charge declined only 12.6% to $46.8 million from $53.5 million in the third quarter of 2007.

Now on to our balance sheet, we managed our working capital requirements aggressively during the quarter. Looking first at accounts receivable while we continued to tightly manage our receivables during this difficult economic period, our third quarter day’s sales outstanding increased two days from the same period a year ago.

Our domestic day’s sales outstanding remained essentially flat to Q2 of this year and Q3 of the prior year. Overall day’s inventory on hand increased five days driven by our domestic days on hand which increased by approximately six days to 25 days from the prior year.

This was due primarily to an increase in in-transit inventory from suppliers and slowing demand. International days on hand increased one day from the same period last year.

Looking at accounts payable our day’s payable increased 18 days compared to last year as we worked to continue the progress we made last year in more effectively managing our working capital. These efforts have delivered $64.8 million in cash flow from operations year-to-date; an $11 million improvement from the comparable period last year.

Capital expenditures totaled $21.1 million for the nine months ended August 31, 2008, down from $33.5 million in the prior year. The company’s debt net of cash improved to $748.9 million, a reduction of $42.7 million as compared to the third quarter of last year.

As of August 31, 2008 Sealy’s leverage ratio of net debt to adjusted EBITDA as defined by our credit agreement was 3.78 to one, and below the maximize ratio of 4.25 to one. The maximize leverage allowable in our credit agreement steps down to 4.0 to one in the fourth quarter.

We are looking at all the options available to us to maximize our financial flexibility and continue to have an active dialogue with our banks. We also continue to take actions to reduce our cost structure and are closely managing our working capital and capital expenditures.

Let me now provide some brief commentary regarding the fourth quarter. We have seen the mattress retail environment continue to deteriorate. Consumer confidence remains at depressed levels and has resulted in reduced traffic at retailers which we are seeing continue into the fourth quarter.

Additionally as we mentioned earlier our international business continues to slow, particularly in Europe. Beyond the industry trends there are a few things to keep in mind regarding our fourth quarter.

First, historically our fourth quarter sales have been our seasonally weakest. Additionally we had a 53rd week in fiscal 2007 which added $32.3 million to our fourth quarter results last year and will not repeat this year.

From a margin standpoint we anticipate seeing some deterioration. We expect to receive additional price increases in the fourth quarter when the quarterly pricing mechanisms in many of our supply agreements reset.

On our last call we projected that by year end our material costs would be up approximately 10% to 12% compared to the levels we experienced at the end of the second quarter. We now expect our material costs to increase approximately 14% to 15% over the same timeframe.

This combination of lower sales and higher input costs in the fourth quarter will result in significantly lower EPS then what we achieved in Q3.

While we do expect market weakness and cost pressures to intensify in the near-term, we will retain a tight focus on managing those areas of our business that we can control. We expect to make further progress on our strategic operating initiatives. This includes expanding distribution of our Smart Latex products, creating innovative new products including the redesign of our Stearns & Foster line, and implementing additional cost savings initiatives such as the actions we initiated this past week to further streamline our organizational structure as we continue to aggressively manage our costs and working capital.

Let me be clear, we are confident that when the market improves, the actions we are taking to make ourselves a leaner organization with a substantially improved product portfolio will not only strengthen our position as the world’s leading mattress manufacturer, but also lead to an improved long-term growth prospect.

This concludes our prepared remarks and we are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Chad Boland - Raymond James

Chad Boland - Raymond James

Regarding gross margin, extraordinary impressive job even with a modest increase given the declines in volumes that we’re seeing right here, as we look out into the fourth quarter so just to summarize I guess we should expect a better benefit from the price increases as those have had more time to flow through, lower volume sequentially but at the same time more difficult raw material cost environment, so we should expect gross margin to be down sequentially in Q4, is that right?

Jeffrey Ackerman

First off in the fourth quarter we do expect gross profit margin to decline, and that’s consistent with our historical trends. However there are some additional factors impacting the fourth quarter. Based on the increases we saw in the cost of feeds stocks during the third quarter we will see increased raw material prices when the pricing mechanisms that I referenced, when those reset in the fourth quarter.

Also wanted to just bring you back to another comment, on those material costs, at the end of the second quarter when we spoke last time about 90 days ago, we had expected an increase in material costs of 10% to 12% to occur by the end of this fiscal year. So sequentially a 10% to 12% increase in costs. That now looks to be about 14% to 15% based on those feed stock costs and indices that we saw during the third quarter.

We’re going to work to try and mitigate the impact of these cost increases. We’re working with our suppliers to reduce costs and then we’re also developing more cost effective designs and wherever possible we’re trying to substitute some lower cost materials while improving the feel and quality of our products.

The change in these costs have actually opened up some other opportunities for us that were not, up to this point, were not possible.

Chad Boland - Raymond James

Given the pullback that we have seen at least in the spot prices of oil and scrap steel for instance, if we assume those prices stick around, maybe give or take 5% or 10% of the levels that they’re at right now, at what point given the contracts and price mechanisms that you have built in, at what point will we expect to see some moderation in those costs?

Jeffrey Ackerman

Well as I said, for us we have supply agreements that in many cases set on a quarterly basis and so those prices are based on indices averaging through the prior quarter. I also want to make people understand that this volatility that we’re seeing in for example oil, as you mentioned, that doesn’t always necessarily translate directly into a reduction in our costs.

I hope that the price on oil and some of these commodities stays down. Its been extremely volatile but a big driver for us is the chemical costs and unfortunately we have not seen the chemical costs really abate at all and they are now still at all time highs and these are really [polyall] and [TDI] a couple of costs that we use in foam, and then similarly on steel prices, we’ve seen scrap steel prices decline quite a bit in the market.

However what is probably more relevant for us is wire rod and the prices on wire rod have not really abated significantly. The wire rod our suppliers buy and change that into drawn wire. So these things like oil and natural gas and some of these commodities, they are absolutely a positive sign but trying to predict where we’re going to end the fourth quarter and what impact that will have going forward would just be speculative on my part.

Chad Boland - Raymond James

How much left should we expect in Q4 for restructuring at least tied to the previously announced plant closure and would there be any called out expense or items related to the consolidation of the sales organization that you announced earlier this week?

Lawrence Rogers

We’re obviously going to continue to focus on all the cost reductions. The organization has now adopted a point of view that all expenditures regardless of where they are actually have to have a return on investment so we’re not going to get specific on this call, but we’ll stand on our record the last three quarters and believe me we’re serious about taking out any and all costs that’s not value added.

So you should expect to see more progress as we report on our fourth quarter.

Jeffrey Ackerman

You’ll see in our Q that related to the Clarion plant closure, the company is expecting an additional $500,000 to $700,000 of expense related to that restructuring.

Operator

Your next question comes from the line of Albert Kabili – Goldman Sachs

Albert Kabili – Goldman Sachs

On the earlier comments on the margin declines, when you’re talking about a decline in the fourth quarter are you referring to a sequential decline or a year-over-year decline?

Jeffrey Ackerman

I was referring to a sequential decline.

Albert Kabili – Goldman Sachs

Any thoughts on year-over-year or maybe you can frame what kind of magnitude of sequential increase are we talking about in raw material costs?

Jeffrey Ackerman

The sequential increase that we’re looking at for material costs?

Albert Kabili – Goldman Sachs

Correct.

Jeffrey Ackerman

As I mentioned we were expecting, from where we exited Q2 to see about a 10% to 12% increase by the end of the year. We were able to opportunistically make some buys in the third quarter that offset some of those material cost increases. So the material cost increases, that 14% to 15% that we’re now expecting by the end of the year versus where we exited Q2, that will be backend loaded into the fourth quarter.

Albert Kabili – Goldman Sachs

And when you mean 14% to 15% you’re talking about a full year so that at the end of the year you’re talking about raw material costs for the full year being 14% to 15% higher or is that just a run rate in the fourth quarter?

Jeffrey Ackerman

That’s a sequential number so if you use the end of May, for example, as an index of 100 steel components that we’re purchasing or foam components, we’re saying that by the end of the year we would expect that index to be at 114 or 115.

Albert Kabili – Goldman Sachs

I know you’re still in negotiations, on the debt covenants any color in terms of, is this something that given the difficult state of the credit markets something you want to, I would imagine not wait to the last minute on, any color as to what options you’re looking at? Is equity on the table at this point?

Jeffrey Ackerman

Our focus really here at Sealy is to make sure that we’re maintaining maximum financial flexibility for the company and as I mentioned we’re in an ongoing dialogue with our banks so we feel like we’re executing well on the new product line that we just implemented with Posturepedic so we’re going to stay focused on executing well on that and other launches to drive revenue.

We’re going to stay focused on reducing our costs as we’ve done now in Q2 as well as Q3 and then the actions we’ve talked about for Q4. We’re going to just keep working against working capital and CapEx and all those things have put us in a position where we generated $65 million so far this year in operating cash flow.

And it leaves us with a leverage ratio of 3.78. We’ve got plenty of smart people working on this and we I think have, because of where we are currently with our leverage ratio and the progress we’ve made I think we’ve got more options then maybe some others might have. But I can tell you when we’ve got a definitive course of action all laid out for that, that’s in the best interest of all our stakeholders, we’ll let you know what it is.

Albert Kabili – Goldman Sachs

Is this something based on the trends you’re seeing in September do you feel you can make it through the fourth quarter and maintain that four to one leverage ratio?

Jeffrey Ackerman

Yes, I’m not going to comment just on where we are with the fourth quarter since as you know its not our policy to give specific guidance but I will tell you that Lawrence and I and the rest of the management team are extremely focused on maximizing the performance of the company and in parallel we’re having ongoing conversations with our banks and some other advisors.

Albert Kabili – Goldman Sachs

On the receivables I know you mentioned that we’ve seen the days go up a bit, how are you thinking about managing the risk given the bankruptcies and potentially more that are out there in terms of retailers? How much left do you have to squeeze on the payables side and the length of your payables as well?

Jeffrey Ackerman

About receivables and I just want to clarify, our receivables balance and the day’s sales outstanding that we had at the end of the quarter domestically was essentially flat to Q2 and to prior year so we haven’t really seen any deterioration in receivables. And we will continue to aggressively manage that. We have a great collections group and that group is working hand in hand with the sales organization so that we can really have an early warning and then work with our retail partners to make them successful and that’s our first and foremost focus is making sure that they’re successful.

On the payable side, we have a great relationship with our suppliers and we’re just going to continue the progress that we made in the second quarter and continue it in the third quarter.

Operator

Your next question comes from the line of Analyst

Analyst

Wanted to just talk about the overall environment a little bit, obviously its weak but when you’re talking to your retailers how much, do you get a sense of how much this is driven by the demand side of the equation versus consumers who are unable to perhaps get credit as freely as they used to be?

Lawrence Rogers

I would say that clearly our retailers are certainly feeling the effects of the headwinds in consumer spending although on the plus side, the ones that are advertising; specifically the ones that are getting behind the better six messaging are performing somewhat better then those that are not.

We’re pretty focused on making sure that our retailers are as successful as possible and we’re attempting to provide them with strong new innovative product as we’ve done with Posturepedic and the PurEmbrace Smart Latex lines.

We’re also investing in advertising support to help drive the customer into their stores. So is the business climate difficult? Yes. Are there some things you can do to assist? Yes, and we’re doing everything we can.

Analyst

But you’re not hearing that some of the larger retailers are not being able to offer credit terms to their customers.

Lawrence Rogers

There’s been some tightening of credit clearly but the ones that are large, they’ll have access to credit and are still performing.

Analyst

In terms of the market share that you talked about that you’re starting to regain above $1,000, was that in the quarter or as the quarter progressed--?

Lawrence Rogers

The market share that we are addressing is relative to Posturepedic and its been successful across all price points but as we mentioned the success below $1,000 was helped by our price increase and the fact it took hold around the 21st of July, while the success above $1,000 is really where we’re showing some gain as compared to the previous line and that’s starting to move the market share needle for us in the above $1,000 price band.

Analyst

It sounds like Stearns & Foster is still maybe the weak link.

Lawrence Rogers

Yes, we have people focused on Stearns & Foster, it has had an impact on our business but we feel good about where we’re going and some of the early things that we have seen from the development team tells us it’s going to be an opportunity going forward, so we’re excited about that.

Analyst

Is it too early to ask about a re-launch next year and how that might sequence?

Lawrence Rogers

You’ll hear more about it but typically we re-launch products every two years so that would put it on target for a spring launch of 2009.

Analyst

If you could comment about the specialty business, how the Macy’s program is going and if given that you’ve decided to give up air beds if you’re still committed to visco.

Lawrence Rogers

Certainly the PurEmbrace at Macy’s the latex line is really only been out there a few months. We saw a significant uptick in the line with the Labor Day advertising so we feel good about that. In fact, we are starting the further rollout of the line in the latter part or early part of 2009 to some of our other retailers.

So we feel good about PurEmbrace latex, the air bed category, that was a business that we looked at and we felt that it was important based on the requests from our retailers that we get into the business. We designed the air bed, albeit we didn’t manufacture it. We had it manufactured by a third party so we had little or no capital investment on our part.

And after testing the product for what we felt was a reasonable period of time, we’ve concluded that there’s a better return on our investment in other areas so we’re getting in behind the latex line and we’re going to continue to pick up your third question, we will continue to actively support and promote visco products as well.

Analyst

I also saw something about a new heating and cooling product that you’ve aligned with, is that a 2009 initiative or just sort of on the radar for longer term?

Lawrence Rogers

That’s part of our innovation; we’re pretty focused on bringing exciting new innovations to our retail community not unlike what we’ve done with our no tossing and turning pressure relief Posturepedic program. So we’re going to continue to work hard on bringing innovative sought-after products to the retailer and to their customers. So that is something that you will likely hear more about on future calls.

Analyst

In the last quarter there were some warranty changes to your warranty program or estimates that benefited, would those have been material in this quarter?

Jeffrey Ackerman

No, there were no adjustments really to warranty reserves or accommodation reserves. It was just a change in methodology.

Analyst

The contracts that you have, would you say that those are in terms of when they reset, are they fairly standard or did you have an advantage versus your competitors on costs during the quarter?

Jeffrey Ackerman

We absolutely leverage our purchasing power and just our scale with our suppliers so we are definitely getting the best prices available on the products that we’re buying.

Analyst

More from a timing aspect, do you think that you would have had an advantage versus competitors?

Jeffrey Ackerman

I think if the 90 day or kind of one quarter lag and it varies really by commodity but I’ll use that as an example, in a period of increasing costs, we clearly have an advantage because we’ll have a delayed impact from those, however the flip side of that is in an environment where costs are declining we’ll see a delayed benefit.

Operator

Your next question comes from the line of Karru Martinson - Deutsche Bank

Karru Martinson - Deutsche Bank

With the 53rd week of sales the EBITDA impact that we’re looking at is $3 to $4 million, is that kind of how I should be looking at that?

Jeffrey Ackerman

Yes, the high end of that.

Karru Martinson - Deutsche Bank

In terms of the covenants, is your mindset here as you said, to do this sooner rather then later, regardless of whether or not you think you’re going to hit the numbers this quarter but looking forward you’re now going to continue at a four times, this is the prudent thing for you to do?

Jeffrey Ackerman

We’re going to continue to stay focused on just maintaining that flexibility so as I said we’re focused on driving the things we can with the team that we have here and we’re in ongoing discussions with our banks.

Operator

Your next question comes from the line of Mark Rupe – Longbow Research

Mark Rupe – Longbow Research

As it relates to how you ended up the quarter in early September have you seen any differences in the volume change in whether it be from a price segmentation or a product type segmentation relative to the beginning of the quarter?

Lawrence Rogers

Certainly as you would expect with all the news that we’ve recently seen with the banks and the credit markets it’s had an effect on the consumer. Consumer is very fragile right now so we have seen a slowdown since the Labor Day holiday advertising so yes, as you anticipated with your question; we saw September slowdown with all the news on Wall Street.

Mark Rupe – Longbow Research

Was that considered across the board or is that more high end and more specialty versus inner spring or is that just across the board?

Lawrence Rogers

I would say that the upper end has probably been more impacted then has the lower end but there has been a general decrease in retailer foot traffic.

Operator

Your next question comes from the line of Joel Harvard – Hillard Lyons

Joel Harvard – Hillard Lyons

Are you getting much by way of request or such from your retail partners on banking them a little more aggressively then you have in the past and particularly beyond the scope of your usual historical level of co op? You had talked about rationalizing and refining the advertising co op disciplines, where are you on that track?

Lawrence Rogers

We believe what’s best for our customer and best for us right now is to continue to provide them with great product and we’ve done that with Posturepedic and we’re doing that with PurEmbrace Smart Latex and we’re going to continue to support them. We have laid down this national advertising program on Posturepedic and no toss and turn pressure relief. They have found that if they hitchhike on that message, they’re current cooperative spend is working harder for them.

So we have by taking those kinds of ideas and making those kinds of investments in the market, found that that’s the answer that they’re looking for. Indeed when you look out there today, there’s not a lot of national advertising running in our segment. So that’s been welcomed by them and it seems to be a terrific opportunity that they’ve jumped on.

Joel Harvard – Hillard Lyons

Was over the past few quarters, you talked about taking a more disciplined approach with your retailers, in other words, they need to play ball with Sealy or there will be consequences. Are you implementing some of that? Did the message get across without really having to wrap knuckles?

Lawrence Rogers

No we haven’t taken any kind of retaliatory action towards anyone. In fact we have terrific relationships with our retailers and so there’s been no reduction in the levels of cooperative support that we offer our people and in fact if you looked at it in a way, we’ve made increased investments albeit in national brand advertising to improve the relevance of our Posturepedic message and so our relationship is one of a partner with our customers.

Jeffrey Ackerman

The real benefit there in the way we get the biggest bang for our co op dollars is we need to provide them with great products and then secondarily providing a national advertising campaign that they can leverage gives them also a bigger bang for their spend on advertising so that’s what we’re doing to really improve the effectiveness of our co op spending.

Operator

Your next question comes from the line of Keith Hughes - SunTrust Robinson Humphrey

Keith Hughes - SunTrust Robinson Humphrey

How much national advertising are you budgeted to do in the new fiscal year and you mentioned a reduction in co op spending across the board, is there any way you can quantify that?

Lawrence Rogers

Certainly we don’t disclose for competitive reasons the amount of advertising spend in that area but in the more recent national advertising program we have budgeted and purchased what would amount to one billion consumer impressions across TV, print and internet and so that is a substantial amount of national advertising.

Jeffrey Ackerman

I want to make sure that everybody understands, co op is a variable expense so in the past we’ve talked about reductions in co op, but that’s been driven by the fact that we’ve had lower volumes so really on a rate basis we’re not really seeing a difference in our co op spend.

Keith Hughes - SunTrust Robinson Humphrey

On Stearns & Foster I’m going to assume that the business at Stearns & Foster, the percentage decline is greater then what I’ve seen from the corporate average, is that correct?

Lawrence Rogers

Well certainly the Stearns & Foster, we don’t break out the performance of Stearns & Foster separately but we have seen, we’ve been unhappy with the performance of Stearns & Foster. We’ve been honest and forthright about that on all of our calls and for that reason we have a very talented team working almost around the clock redesigning this product and we will have it ready for the spring market in Las Vegas and so it’s not unlike the Posturepedic program that we just recently launched.

We felt we had a distance to go in Posturepedic. We did a lot of consumer research. We identified the issues. We fixed them. We built in some terrific innovation and we’re going to do the same thing with Stearns & Foster.

Keith Hughes - SunTrust Robinson Humphrey

So July, 2009 Vegas show.

Lawrence Rogers

No, it’s going to be spring in Las Vegas so it’s around the corner.

Operator

Your next question comes from the line of John Baugh – Stifel Nicolaus

John Baugh – Stifel Nicolaus

On Europe is that decline due to the loss of position or an account or is that just general weakness that you’re seeing in Europe and then I want to make sure I’ve got the sales comparison right for the Q4 effectively to take out $32 million from the year ago to get a comparative. So if you were down say 105 from that, give or take you’d be down about $370 million sales area, is that correct?

Lawrence Rogers

Relative to Europe, the European situation is really got a lot to do with the weakening economic conditions particularly as you have reported recently in the paper the, our sales were impacted in Europe primarily by one of our largest OEM customers that drew down their inventory in order to prepare for the launch of their new product which we are very heavy suppliers of.

So it was kind of in the hand off at that moment. Given this, I would also tell you we’re focusing on implementing similar cost reduction initiatives as we’ve done in our US business to ensure that we have all of our businesses better aligned from an expense to current sales trend.

Europe is a focus. We’re working on it, it’s very top of mind and you’ll hear more about it when we report the fourth quarter.

Jeffrey Ackerman

In the fourth quarter of last year, we had an incremental $32.3 million due to the extra week in our fiscal year and I’m not going to comment on projections or specific guidance for the fourth quarter.

John Baugh – Stifel Nicolaus

Do the covenants change beyond the end of this fiscal year or do they stay at 4.0 going forward?

Jeffrey Ackerman

They stay at 4.0.

Operator

Your final question comes from the line of Reza Vahabzdeh – Barclay’s Capital

Reza Vahabzdeh – Barclay’s Capital

I wanted to follow-up on September trends, volume trends domestically were somewhat similar in the second quarter and third quarter, while AUSP improved somewhat, I think you mentioned that September was somewhat weaker. Should we take that to mean down 20% volume, still up low single-digit AUSP?

Jeffrey Ackerman

We don’t give specific guidance on that. I’ll just reiterate what we’ve said is that we saw the consumer environment continue to deteriorate.

Reza Vahabzdeh – Barclay’s Capital

Could you maybe say if it was mix or volume and mix?

Jeffrey Ackerman

I think Lawrence already talked to, what’s happening from the mix. It’s a general weakness across all price points with all the events taking place on Wall Street and just all the news of the economic and environments, credit environments getting, we’ve just seen a slowdown in traffic and the high end has been particularly hard hit.

Reza Vahabzdeh – Barclay’s Capital

You mentioned one larger customer’s bankruptcy filing, how do you feel about your other say top 20 accounts?

Lawrence Rogers

Certainly it’s been a tough environment out there. But we’re working very actively with all our customers. We have a very close relationship with them. The customer that was referred to earlier was one that we had made a decision to discontinue doing business with early this year. I think that that’s a testament to the fact that we’re watching our customer base very carefully.

We have the courage to step up to these things if we think there’s uncertainly relative to risk and reward. So we’re going to continue to guide ourselves with that kind of a practice and our senior sales people by ritual, sit down every Friday and go through every account with our senior people in receivables so we have a very active watch list if you will, and we’re staying on top of our business.

Jeffrey Ackerman

As I said before the best guarantee on all that is to make our customers successful so whether it’s making sure that the products that we have that they’re getting out there, that we’re having effective training, that we have good promotions, we’re working with them to make them a success to avoid those problems.

Reza Vahabzdeh – Barclay’s Capital

Have you had to terminate any other relationships in that same way?

Lawrence Rogers

Not any one of that size. There’s been a number of smaller people and to be candid with you, if they reach their credit limit, we just go on a do not ship.

Reza Vahabzdeh – Barclay’s Capital

In terms of your bank covenants, the way you calculate EBITDA, is that 198 or--?

Jeffrey Ackerman

The LTM period is 198.4.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Lawrence Rogers

Thank you, in closing I’d like to tell everyone we really appreciate the continued interest you have and that you are showing in Sealy. While the short-term will be challenging, Jeffrey and I and the team, we’re confident that our actions will enhance Sealy’s future. With our progress in fixed cost reductions, our improved product portfolio, and the solid leadership the team’s providing, we believe that the company will have an even stronger earnings profile when the industry emerges from what we’re finding to be a difficult period. So thank you for your time and we look forward to updating you on our progress during the next call. Thank you.

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