As a reminder, today's conference may be recorded. It's now my pleasure to turn the floor over to Mark Rupe. Sir, the floor is yours.
Thanks, Huey. Thank you for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO, and Dale Williams, EVP and CFO. After our prepared remarks, we will open the call for Q&A. Forward-looking statements that we make during this call are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements, including the company's expectations regarding sales, adjusted EBITDA, earnings or adjusted net income, or the integration with Sealy, involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company's business. The factors that could cause actual results to differ materially from those identified include economic, regulatory, competitive, operating, and other factors discussed in the press release issued today.
These factors are also discussed in the company's SEC filings, including, but not limited to, annual reports on Form 10-K and the company's quarterly reports on Form 10-Q under the heading Special Note regarding forward-looking statements and our risk factors, as well as the company's press releases. The company undertakes no obligation to update any forward-looking statements. The press release, which contains reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures, is posted on the company's website at tempursealy.com and filed with the SEC. With that introduction, I will turn the call over to Mark Sarvary.
Thanks, Mark. Good evening, everyone, and thanks for joining us. Today, I will provide an overview of our performance in the fourth quarter and then discuss our key strategic growth initiatives in the context of our outlook for 2014. I'll then turn the call over to Dale, who will provide details on the fourth quarter and full-year financial results and 2014 guidance. Overall, our fourth quarter was in line with our expectations. We achieved solid overall growth in the quarter and are pleased in particular with the improvement in our Sealy and Tempur International businesses. Sealy's fourth quarter sales were above our expectations, driven by continued strong demand for Posturepedic innerspring and hybrid products, increased consolidated sales from our Comfort Revolution joint venture, and higher international sales in South America. Tempur International returned to positive growth in the fourth quarter, with sales increasing in Europe, Asia, and Latin America.
Our performance in Europe strengthened through the quarter, with most of our markets showing growth. However, sales did remain weak in Germany. Our Asia Pacific business also had another good quarter of growth, driven by strong results in Korea and Australia. Tempur North America fourth-quarter sales were down 1%. Sales in our retail channel, which account for 93% of segment sales, were up at 1%. Sales of products priced at $2,000 and above grew for the third consecutive quarter, and we saw solid growth in our adjustable base products, driven by higher attach rates and strong demand for our new Ergo Plus and TEMPUR-Up products. We had a good fourth quarter overall and have seen more stable performance in our business. However, demand continues to remain volatile week to week, with some softness in January due to sluggish traffic at retail in the U.S.
As Dale will explain, there is a certain degree of caution in our projections for 2014. Now, I'd like to discuss our strategic growth initiatives in the context of our outlook for 2014. As I said before, the foundation of our strategy is the commitment to investing in four key areas of our business. These areas are product innovation, marketing, new market expansion, and our supply chain, which we are striving to make easier to do business with. As previously communicated, we will fund these investments with a portion of the cost synergies realized from the Sealy acquisition and our annual cost productivity programs, as well as through overall growth in the business. The first strategic initiative is product innovation.
Our goal is to provide consumers the best bed and the best sleep of their life and to provide our retailers a complete and optimal offering across brands, products, and prices to drive their growth. To achieve this, we will increase our investment in R&D in 2014. We have an integrated global product development team that is focused on further leveraging the combined technologies of our comprehensive portfolio of products, as well as developing new-to-the-industry technologies. Our new Up adjustable bases for Stearns & Foster and Optimum are the first examples of our ability to leverage technologies across our brand portfolio. In January, we introduced a record number of new products in Las Vegas and Cologne, Germany.
Our new TEMPUR-Cloud and TEMPUR-Contour launches will be the largest in TEMPUR's history and consist of seven new beds featuring bold, new iconic designs, upgraded comfort feels, additional cooling features, and innovative new removable, washable top covers. We also introduced four new Stearns & Foster collections, including a new hybrid offering at the upper end of the range. The new Stearns & Foster lineup is integrated with Outlast material and air vents for improved climate performance and has a clear step-up story with features such as IntelliCoil encased springs, cashmere covers, and hand tufting. Our Tempur North America and Stearns & Foster introductions were very well received by our customers and in testing by consumers and RSAs. We are expecting both launches to be important drivers of our growth in 2014.
We have already started production on both and are building inventory in anticipation of a rollout starting in the first quarter. In addition, we are excited about our all-new Optimum collection of five new beds featuring more Outlast material, more gel memory foam from the top to the bottom of the mattress, and taller profiles that we believe will strengthen Optimum's competitive position within the $1,000-$2,000 price segment. These will be rolled out in the second quarter. Retailers also responded well to the fact that all the lines fit together with logical price points and step-up stories from top to bottom, both within and across the brands. New product introductions are occurring in our international markets as well.
At the recent Cologne Fair in Germany, we introduced six new Tempur mattresses featuring Breeze technology, with two models in each of the three mattress collections. As you know, we've been very pleased with demand for our Breeze beds in North America and are excited about the prospects for it internationally. Tempur International also introduced an innovative new EasyClean pillow. It features a washable material that allows for the whole pillow to be machine washed and tumble dried, as well as a new Breeze pillow and an integrated bedding system called Experience. Our second strategic initiative is marketing, and this includes advertising as well as in-store marketing and direct sales. In 2014, we will increase our investment in marketing. We're committed to advertising direct to the consumer to drive retail traffic and demand. Tempur will be advertised on TV continuously throughout the year with elevated levels around major holidays.
We will leverage our Ask Me campaign with new creative, and we will also support Stearns & Foster, Optimum, and Posturepedic with consumer advertising. We will also gain more impressions per dollar spent following our recently negotiated combined media buy. From an in-store perspective, we will support our new TEMPUR-Cloud and TEMPUR-Contour collections with new point-of-purchase materials, including new fixtures and signage, new headboards, and new top-of-bed merchandising. High-quality POP is also supporting the new Stearns & Foster and Optimum launches. Those of you who visited our showrooms last week in Las Vegas saw firsthand the visual appeal and functional benefits of the new POP, which we believe will not only differentiate our products on the floor, but also serve as a compelling tool for the RSA to increase conversion rates on sales of our products. The third strategic initiative is new market expansion.
As we laid out in our Investor Day presentation in September 2013, our international opportunity is significant. Over time, we expect to realize over $300 million in revenue synergies from international markets. We are advancing several initiatives across the world, and we will communicate them as they come to fruition. For example, last week, we signed an agreement whereby we regain Tempur-Pedic distribution rights in Mexico, previously held by a third-party distributor. This is the first deal since our combination with Sealy. While a relatively small business for Tempur today, Sealy has an established business in Mexico with deep and broad customer relationships. We are confident that the combination of the two businesses will enable us to drive our overall performance in Mexico. Also in January, we began integrating Sealy Canada and Tempur Canada. This is not a market expansion as both are already owned markets.
Sealy is the market leader, Tempur has a smaller but important presence. It is an important strategic initiative that we believe will improve our overall business in Canada and, importantly, make it easier for our customers to do business with us there. Our fourth strategic initiative is our commitment to building a world-class supply chain that is easier to do business with. We have several exciting initiatives underway that will improve customer service and lower costs within our transportation and distribution network, and we will update you on our progress later in the year. In addition, we're rolling out our Category Management Program, which is designed to help optimize floor plans to improve both our own and our retailers' sales and profitability. Our company accomplished a great deal in 2013, and we're excited about all of the initiatives we have in place for 2014.
Since completing the acquisition last year, we have integrated all the key functions, delivered greater cost synergies than initially projected, developed and launched compelling new products across our brands, and laid the groundwork for future revenue synergies both in the U.S. and across the world. An enormous amount of effort is behind each of these company-wide initiatives, and I am very proud of how the organization has come together as a single team. With that, I'll now hand the call over to Dale.
Thanks, Mark. I'll focus my commentary on the fourth quarter and full year 2013 financial results and then discuss our 2014 guidance. I will address the performance on a consolidated basis, then speak to the performance for each segment and provide commentary on the key areas or items where there's a notable variance from the prior year. As a reminder, the company completed its acquisition of Sealy in March 2013, and results for 2012 do not include the Sealy results of operations. Consolidated net sales for the fourth quarter were $678.1 million. Tempur North America net sales were down 0.7%, Tempur International net sales were up 4.5%. Sealy sales were $333.5 million. By product, bedding net sales for Tempur North America declined 0.7% to $205.7 million on flat units. Tempur International bedding net sales increased 4.5% to $88 million on a unit increase of 4%.
Sealy's bedding net sales were $305.3 million. By channel, Tempur North America retail net sales increased 1%, direct net sales declined 28%. Tempur International retail net sales increased 4.7%, direct sales increased 16.3%. Fourth quarter gross margin was 40.2% as compared to 50% in the fourth quarter last year. As we previously stated on conference calls, the inclusion of Sealy has altered the consolidated gross margin profile of the business. On a year-over-year basis, fourth quarter gross margin declined primarily due to the inclusion of Sealy and product mix. These impacts were partially offset by lower sourcing costs. On a sequential basis, gross margin decreased to 40.2% from 40.6%, primarily due to fixed cost deleverage in the Sealy segment and product mix. These were partially offset by favorable geographic mix.
Consolidated advertising spend, which includes both national and cooperative, was $71.4 million, or 10.5% of sales in the fourth quarter. Tempur North America advertising spend increased nearly 30% versus last year. D&A, as presented for the full year 2013, reflects a $6 million reclassification to selling and marketing expenses, with approximately $3 million occurring in both the second and third quarters of 2013. This reclassification does not impact previously reported operating income. Consolidated operating income was $74.1 million as compared to $51.3 million in the fourth quarter of 2012. Operating income in the fourth quarter of 2013 included $8.2 million of transaction and integration costs related to the Sealy acquisition. Operating income in the fourth quarter of 2012 included $7.6 million of transaction and integration costs related to the proposed Sealy acquisition, as well as $1.5 million of restructuring charges. Interest expense was $22.6 million.
The fourth quarter tax rate was 44% and reflects an adjustment to the repatriation tax based on final foreign earnings and profits for 2013. The normalized tax rate was 29.3%. In our fourth quarter income statement, we have a line item titled "Less Redeemable Noncontrolling Interest." This deduction to net income attributable to Tempur Sealy International Inc. and GAAP earnings per share is related to our joint venture with Comfort Revolution. Because we do not own 100% of Comfort Revolution, this amount has historically included the percentage of Comfort Revolution's net income that we do not own. As necessary, the amount will also include adjustments for changes in the redemption value attributable to our call option to purchase the remaining equity interest in the joint venture, which reduced net income attributable to Tempur Sealy. We will record non-cash adjustments in future periods as necessary.
These adjustments will not be reflected in our adjusted EBITDA or adjusted earnings per share. Fourth quarter GAAP earnings per share was $0.37 as compared to $0.39 per share in the fourth quarter of 2012. Adjusted earnings per share were $0.66 in the fourth quarter as compared to adjusted EPS of $0.60 in the prior year period. I will summarize the income statement for the full year 2013. As a reminder, 2013 results only include Sealy from March 18th, 2013. Sales increased 76% to $2.5 billion, with the increase due to the inclusion of $1.1 billion of Sealy net sales for the period subsequent to the March close. Tempur North America sales declined 6%, while Tempur International sales were flat relative to full year 2012 sales. Operating income was $244 million as compared to $248 million in 2012.
Operating income for full year 2013 included $44.6 million of transaction and integration costs related to the Sealy acquisition. In 2012, operating income for the full year included $11.1 million of transaction and integration costs related to the proposed Sealy acquisition and $1.5 million of restructuring charges. GAAP earnings per share for full year 2013 were $1.20 as compared to GAAP earnings per share for full year 2012, $1.70. Adjusted EPS in 2013 were $2.38 as compared to $2.61 in 2012. I'll turn to the balance sheet and cash flow for a brief review. As shown on the balance sheet, the primary changes are related to the acquisition and related accounting treatment. The company has consolidated funded debt plus qualified cash, $1.8 billion.
The ratio of consolidated funded debt less qualified cash to adjusted EBITDA was 4.4 times, calculated on a combined basis in accordance with the company's senior secured facility. A calculation of this ratio is included in the press release. During the quarter, operating cash flow was slightly negative due to a $40 million cash tax repatriation payment. We initially accrued for this tax provision in the third quarter of 2012, based on the timing of our decision to acquire Sealy. Capital expenditures were $11.6 million. I'd like to address our 2014 guidance. Today, the company issued financial guidance for 2014. The company currently expects net sales to be in a range of $2.8 billion-$2.9 billion. This reflects growth of 1%-5% compared to 2013, had we owned Sealy for all of 2013, and approximately 50 basis points of headwind from forecasted unfavorable foreign exchange.
Adjusted EBITDA to be in a range of $415 million-$435 million, including a forecasted unfavorable foreign exchange impact of approximately $9 million. Adjusted earnings per share to be in the range of $2.60-$2.85. This includes $0.19 per share of depreciation and amortization related to the Sealy purchase price allocation, or PPA, and unfavorable foreign exchange of $0.10 per share. We're also providing the following additional full-year 2014 guidance assumptions. Depreciation and amortization of approximately $93 million, which includes the PPA depreciation and amortization of $17 million. Interest expense of approximately $89 million. The annual tax rate of approximately 31%. Average share count, 62.1 million shares, and capital expenditures of approximately $65 million. It is important to note that our 2014 adjusted EBITDA and adjusted EPS guidance excludes the impact of ongoing integration costs related to the acquisition of Sealy.
From an earnings perspective, our guidance reflects margin expansion resulting from cost synergies and leverage, offset partially by investments in new products, marketing, and R&D, as well as forecasted unfavorable foreign exchange as compared to 2013, related primarily to Canada. Based on these assumptions, we expect our operating margin to be in a range of 11.7%-12% for the full year 2014. We are planning for first quarter 2014 sales to be flat to slightly up as compared to fourth quarter 2013 sales of $678.1 million. As Mark indicated, order trends have been somewhat soft in January due to sluggish traffic at retail in the U.S. Our first quarter sales outlook also assumes a slight transitory impact as customers wind down inventory on existing models in advance of flooring our new Tempur-Pedic and Stearns & Foster products.
We expect our operating margin to be approximately 10% in the first quarter of 2014. In the first quarter, we will ship a record number of floor models as we launch the new TEMPUR-Cloud and Contour offerings, as well as the new Stearns & Foster collections. In addition, we expect floor model shipments to remain elevated in the second quarter as we complete these rollouts and begin shipping our new Optimum beds. We expect floor model shipments to be much lower in the second half of the year. Through January, we are tracking to these expectations. In considering our guidance, it is possible that our actual performance will vary depending on the success of our new initiatives, macroeconomic conditions, and competitive activities, or the consequences of other risk factors we've identified in our press release and SEC filings.
As noted in our press release, our guidance and these expectations are based on information available at the time of the release and are subject to changing conditions, many of which are outside the company's control. With that, operator, please open the line for questions.
Yes, sir. Ladies and gentlemen on the phone lines, to queue up for a phone question, please press star then one on your touch-tone phone. If your question has been answered or wish to remove yourself from the phone queue, you may press the pound key. Again, if you would like to ask a question at this time, please press star then one on your touch-tone phone. One moment for questioners to queue. It looks like our first phone question will come from Joshua Borstein with Longbow Research. Please go ahead. Your line is now open.
Hi, Mark, Dale, and Mark. Thank you for taking my questions here. Just on the guidance, is it possible to talk about what the guidance implies for each of the three segments on the top line?
Sure. For the full year, we actually expect all three segments to grow mid-single digits. For the first quarter, as I mentioned, we expect Sealy to be flat to slightly up. We expect Tempur International to be flat. We expect Tempur North America to be down mid-single digits. Again, that's a function of the transition of essentially the core of our product line.
Thank you for that. That's very helpful. The deal that you said you inked in Mexico, can you talk a little bit about maybe a little more detail, what exactly that is and what the potential revenue upside might be from that deal?
For Tempur North America or for Tempur, it's a relatively small business, mid-single digit millions. For Sealy, it's really quite a large business, almost 10 times the size. I think it's one of the examples of where we can leverage one infrastructure I.E., in this case, Sealy, to gain greater distribution of our other product line, in this case, Tempur. The way that it's done, though, has been very consistent with the way around the world we have acquired what we call third party, Tempur third parties. We've done this all across the world, in Australia, in Austria, in Poland, in Korea. This has been our traditional method of seeding a country and then growing it when it gets to an established state.
Josh, the cost is fairly minimal. It's about $1 million.
Okay, great. If I could just sneak one more in. With respect to the rollouts, it seems like, I think you mentioned this will be the greatest rollout in terms of SKUs going out for Tempur. How does this compare to the previous rollout last year in terms of the gross margin impact that it might have?
Well, kind of as a model, the way to think about this is in the second quarter of last year, we had more floor models, combination of Tempur and Sealy, had more floor models than ever before. I think we said a number of around 70,000 floor models. This year, in the first quarter, we will have a number comparable to that. That's a much bigger number than has ever been done in the first quarter. Traditionally, these big rollouts are done in the second quarter. This year, we're going to have that number in the first quarter. Then in the second quarter, we're going to have an elevated level, roughly comparable to what we had in the prior year. It's going to have an impact on gross margin and-
Yeah. From a margin implication standpoint, for the year, we are expecting a gross margin for the business to be about 41%. In the first half, we would expect that to be roughly 100 basis points lower, as there'll be significant floor model expenses in both the first and second quarters. Then, in the second half, obviously, better as we get past the big rollouts.
To put that in context, that 41% is about 100 basis points better than the last three quarters of this year, if you average that. That's a function of the cost synergies that we've been able to get offset by the investments we've made in these new products, as well as FX, which as Dale said, has been a hurt this time.
Okay. 70 million SKUs rolling out this quarter and-
70,000.
Sorry.
$70 million. That would be great.
That would be a big number. An additional $70,000 in 2Q as well then, right?
Yeah, I'm not giving exact numbers. I'm just using that. That's a good basis because that was the number we quoted last year. That is roughly right for both quarters.
Okay, terrific. I appreciate the help. Thank you, and good luck.
Thank you.
Thanks.
Thank you, sir. Our next phone question will come from Brad Thomas with KeyBanc Capital. Please go ahead. Your line is open.
Hey, thanks, guys. Just to follow up around some of the financial outlook for the first half of the year. I know you're not giving specific quarterly earnings guidance. Dale, could you give us maybe a little bit better sense of what range you think this first quarter might come in, given that it's such an unusual kind of stub period that we're up against?
Well, from a total business standpoint, we're looking at sales at the top line of -1% to -2% on a year-over-year basis. What that means, to give you a gauge, since you don't know what the first quarter last year was, except for because that was essentially Tempur only, that's why we gave you the gauge against the sequential of the fourth quarter. First quarter, we expect to be slightly up from the fourth quarter. Also in the first quarter of this year, we're expecting EBIT margin to be around 10%, impacted by the floor models. As we said in the prepared remarks, January sales were a little bit softer than we would've liked. Actually, from an overall standpoint, most of the country was fine.
There were a couple segments of the country, basically the Northeast and the Midwest, that were a little bit soft. Anyone's guess as to what could have caused that here over the last month. I think that gives you a pretty good indication of how to gauge Q1.
That's very helpful. From a synergy perspective, I know as time goes on, it'll get more and more difficult to quantify it, you did say you're finding more opportunities and realizing them faster than you had expected. Where do you think synergies have come in since the deal closed, what are you modeling for 2014?
Well, I would say we're not inconsistent from what we said at the Investor Day in September in New York. When we decided to purchase Sealy, we had an estimate of $40 million of synergies being recognized over the first three years. In year one, to the best of our ability to track it, we believe we ended up right about the $18 million number that we talked about on the third quarter earnings call. For this year, just as we talked about in September, we believe that we will see about $40 million of synergies. Also consistent with what we said in September is that some of these excess synergies that were Getting, we're reinvesting in the business. We're reinvesting in the product, we're reinvesting in R&D, we're reinvesting in marketing. That's what consistent with what you're seeing in our plan for 2014.
Great. Thanks so much.
Thank you.
Thank you, sir. Our next question in queue will come from Budd Bugatch with Raymond James. Please go ahead. Your line is open.
Good morning. I didn't know who he was talking about. Good morning, Dale. Good morning, Mark.
Good morning.
Good afternoon, Mark. Evening. Sorry about that. Couple of questions, if I could. One on the pro forma, Dale, for the year, if we were to take it, because you say the year is going to be up 1%-5%, is that about $2.78 billion or $2.77 billion? How do we think about that?
I'd say round to $2.8 billion to $2.9 billion.
That's what your-
Last year-
Your guidance assumes, and you said that's up 1%-5%.
Yes
versus the pro forma last year, if I read that right.
Yeah. You're saying for 2013. Yeah. On a pro forma basis, 2013 would be about $2.77.
Okay. All right. When you talk about you said 50 basis points of foreign exchange drag, is that against the $2.77 billion?
Well, that's included in the $2.8-$2.9.
Okay. The $9 million of foreign exchange drag on the earnings line, that looks like that's got to be pre-tax. Is that right?
Correct.
Okay. All right. When you looked at the operating margin by segment in the fourth quarter, I know we're going to get that with the K.
Yes.
Can you kind of give us an early look at what the operating margins by segment were?
Sure. Because in the K, you're going to see GAAP, I'll give you GAAP. On a consolidated basis, operating margins were 10.8% in the quarter. The Sealy operating margin was at 6.4% for the quarter. I'm going to come back and give you a little color here.
Please.
Tempur International, 23.8%, and Tempur North America, 10.3%. A couple things to point out there. Number one, on Tempur North America. Tempur North America bears the cost of corporate. All the corporate costs get borne in that Tempur North America number. In addition, a significant percentage of the transaction, all the transaction costs, but a significant percentage of the integration costs are borne in the Tempur North American number. Sealy in the fourth quarter was a little bit lower than what it had been running. Sealy in the fourth quarter, that's a softer quarter traditionally for Sealy. Certainly Sealy's fourth quarter business is much less than the third quarter business, particularly on a new calendar basis that they're on. You get some fixed cost deleverage within Sealy. Also, as Comfort Revolution is growing, and that's becoming a little bit bigger piece of the Sealy segment.
Comfort Revolution being a startup is not very profitable yet, that also drags the Sealy margin.
Okay. At the end of 2014, where do you think you will be with your debt leverage ratio? Where do you project you'll be?
At the midpoint of our guidance, that would imply a debt to EBIT of about 3.8.
Okay. How does that compare to where you thought you would be by now? I know that we can go back and think about where you were when you originally planned the acquisition and came to us.
Well, for the end of 2014, we would've thought we would've been probably in the 3.5 range. Certainly our business in 2013 was not as strong as we would've liked and as strong as we thought it might be at that time, particularly on the Tempur side. Tempur North America did not perform as we expected it to at the start of the year. Tempur International did not perform as we expected it to at the start of the year. Sealy actually performed slightly better than we expected it at the start of the year. Overall it's basically the Tempur business in 2013 was a little softer than we would've liked. That translates on a compound basis to just slightly higher on the debt to EBITDA than what we would've expected a year ago.
Okay. Do you think you catch that up, or how does that stand then?
But I would say that, again, going back to September in the Investor Day and the three-year plan we talked about, the guidance we just gave for 2014 is absolutely consistent with that plan. We said we wanted as a combined business to have a 6% or more compounded growth rate. We also said we expected to be a little bit lower than that at the beginning and for that growth rate to grow over that three-year period as we got further into the integration, as we got further into the benefits of the integration and being able to share more on the technology side and on the customer side. I think that we are right in line with the plan we outlined last September.
My last question just is on the FX. Is that pretty much all EUR, or how should we think about the-
Actually, a significant piece of that is Canada, the Canadian dollar. The Canadian dollar is a significant piece of the FX problem. Actually, the EUR is doing pretty well right now. But in Canada, we have a very sizable business in Canada on a combined Tempur Sealy basis. Just if you look at last year, 2013, the average exchange rate was $0.97. Our planning for this year was to have the exchange rate be about $0.92. Today, well, I didn't see today, but I assume it's not that different. But right now the spot rate is right around $0.90. The Canadian dollar has significantly weakened. The reason why that creates a little bit more earnings pressure than what you might expect is a significant portion of the COGS of the Canadian business, both for Tempur and Sealy, is U.S. dollar denominated.
Their COGS goes up while the revenue's going down.
Got you.
Internationally, we've got a mixed bag on Tempur International side. There is some FX pressure there as well. The euro, as I said, and the European community in total, it roughly is okay. Most of the FX pressure that we're seeing is in Asia.
Got you. Okay. Mark, I'm sorry, one thing for you, the acquisition in Canada and the combination in Canada and combination in Mexico, you thinking that's strategically something you're gonna do in most other parts of the world now? You're gonna combine Sealy and Tempur that way? Is that a model for outside the U.S.?
Just to be clear, the license in Mexico was an acquisition, the Canadian one was not. That's just a merger of two companies that were already owned by us. What I think is the model that we will replicate wherever we can is where we have a strong infrastructure of one company and a weaker one. If we have both legacy Tempur and legacy Sealy in geographies, we're looking for places where the infrastructure of one can help the sales of the other. As I said in my prepared notes, there are several things that we're working on. Obviously, I can't talk about them until they come to fruition. That's the model that we're looking at.
Okay. Thank you very much. Good luck on the rest of the year.
Thanks.
Thanks, Bud.
Thank you, sir. Then as a reminder, ladies and gentlemen on the phone, to queue up for a phone question, you may press star then one on your touchtone phone. Again, star one to queue up for a question. Now our next phone question will come from John Baugh with Stifel. Please go ahead. Your line is open.
Thank you. Good evening. A couple things. First, could you just comment on what drove the Tempur direct business in the quarter negative year-over-year?
I mean, the fact is it hasn't been good. It wasn't good for much of last year. There are several macro reasons for this. One is that there is a growth by retailers to have direct businesses, which effectively provides another way for people to get Tempur products online. That kind of puts a form of competition in place. Not to mention that there are other, obviously, competing visco elastics. It also is affected by the fact that it's very sensitive to advertising. As you know, we didn't advertise continuously throughout last year, and we are doing that now. Also, it's very susceptible to promotion. Having said all of that, we have a big focus this first part of the year on direct.
We put our first focus last year on retail, because at 93% of our business, that was where we had to put our focus. We have now put a degree of focus on that direct business. We know it's an important part of our business, and we do intend to stabilize it and use it effectively. We're not pleased with the results. Now, having said that, direct includes what we traditionally think of as direct, which is telephone sales and internet sales and catalogs and so on. It is both in North America and Internationally, and it also includes retail stores. If we look at our direct business Internationally, that is growing quite well. The retail stores are growing quite well Internationally, but so is our direct internet business.
In North America, as you know, we have our flagship stores, the three flagship stores, and they too, are performing quite well. We are now turning our attention to that area.
Great. Mark, could you maybe give us an outlook Internationally, not just for Tempur, but Sealy as well in the key markets both brands address?
In a very broad brush, if you look at Europe, Tempur is very established in Europe, all the large countries. Literally, obviously, all the large countries. We have a strong business there, and we're well established and a good infrastructure. Sealy has a licensed business in that part of the world, clearly over time, there could be an opportunity there. In Asia, it's a bit broad to call it Asia, because Asia's so different. If you look at it, Sealy and now Tempur Sealy has a joint venture in much of Asia, which is a strong and growing joint venture. Tempur has business across Asia, China, Japan, Korea, and so on. There are opportunities there across the board for a combined, not necessarily combined, but there are opportunities in different places in different ways. It'll be different.
We have the joint venture is one that is planned through 2020. We have opportunities for sharing and leveraging each other's infrastructures in different parts of Asia. In South America, I talked about Mexico, then in South America, both Sealy and Tempur have businesses, but Sealy has a more established infrastructure, particularly in Argentina, than does Tempur. Both groups are growing well in Brazil. There are opportunities there for combination.
Great. Lastly, maybe for Dale. There's so many moving parts. You mentioned the segment or Tempur North America, EBIT at, I think, 10.3, but it's got all the corporate. I know in the first half we're going to have a bunch of noise with product launch. Is there any way to think about where Tempur North American EBIT margin is settling out on an annual basis, X corporate cost and X transaction cost and product intro noise, et cetera? Thank you.
Tempur North America, as we look at it, is from a 2013 standpoint, stripping out all the integration, all the transaction costs, all the corporate costs, Tempur North America on a standalone basis actually had pretty decent results, had a pretty good year. From an overall EBIT standpoint, Tempur North America is more in the high teens.
Great.
For next year, we would actually expect Tempur North America to improve its profitability. We believe that Tempur North America in 2014 will see some gross margin expansion. While we are investing some more in marketing, we'll see leverage in R&D and in some other selling aspects that as we get benefits in the business because of the improvement in the synergies year over year. There's $22 million additional synergies in 2014. We do expect to see some improvement in the bottom line of Tempur North America as a standalone entity. One of the complications is over time, Tempur North America is becoming less and less of a standalone entity. Tempur North America and Sealy are, as the integration goes further and further, are becoming more of one entity.
Great. Those numbers were helpful. Just lastly, if I could, it sounds like weather's impacted January to degree. Are you able to look at the other areas of the country? Is there any perceptible change from, I don't know, I guess December was tough too with weather and the holiday, maybe going back to the October-November comparative period?
Dale, I don't have October-November in front of me, certainly in January, the bulk of the country, we saw good performance. We did see specific weakness in the Northeast and the Midwest. I'll let you draw the conclusion as to what drove that with a few weekend storms. This business is heavily reliant on weekends, and when weekends are impacted, it can affect the business.
Great. Thank you. Good luck.
Thank you, sir. Our next phone question will come from Denise Chai with Bank of America. Please go ahead. Your line is now open.
Okay. Thank you. Wanted to ask first about gross margin, if you could break that out for us roughly by the three divisions.
Sure. What time period?
For the fourth quarter, please.
Gross margins. Again, this is on a GAAP basis. Tempur North America was 43.6%. Tempur International, 60.1%. Sealy is 30.9%. Consolidated is 40.2%.
Okay, great. Thank you. Was there any kind of forex hit in 2013?
Fairly minimal. Normally, when we have much movement in foreign exchange, particularly on our international business, we talk about, here's the actual performance, here's what it would be on a constant currency basis. If you noticed, we didn't talk about that on this release. All year, really, the impact of FX has been fairly nominal. There was some impact particularly in the Sealy business in the second half of the year as the Canadian dollar was starting to weaken. The primary impact and the significant weakening occurred late in the year, and that's why we're projecting a big impact in 2014.
Okay, got it. Thanks. Just going back to Tempur North America, was the performance in line with your expectations of kind of flat to up low single digits if you take out the Northeast and the Midwest?
Well, the Northeast and Midwest we're talking about is January.
Okay.
Tempur North America was close. It was down 0.7%. We thought it would be flat or slightly up, it was a little bit below our expectations.
Got it. Just last one. Can you tell us what level of guidance, sorry, if advertising is embedded in your guidance?
For the next year from a percent of revenue standpoint, we're looking for something in that ballpark, 10.5%-11% of sales, kind of consistent with what we have normally run.
Great. Thank you so much.
Importantly, one thing on advertising is that we will be running continuously throughout this year. That's more important. Although the rate, the way of doing it is going to be special, we want to ensure we're on air all the time.
Understood. Thank you.
Thank you, ma'am. Our next question will come from the line of Joe Altobello with Oppenheimer. Please go ahead. Your line is open.
Thanks. Good afternoon, guys. Just wanted to start, I guess, with the advertising. You mentioned, Dale, just now, to a previous question, ten and a half to 11% in 2014. Just for comparative purposes, what was that ratio in 2013?
That's a complicated one, Joe. It was right around 11%. The reason why that's complicated is we don't really have the results at Sealy for most of the first quarter.
True. Okay.
It was ballparked right around 11%.
Okay. Gotcha. In terms of the first quarter guide, you mentioned obviously weather impacting you in January. If you can just look at those markets that are not weather-impacted, what are you seeing in terms of year-over-year increase? What will Tempur North America be up in the first quarter ex-weather, I guess, is the best way to ask that.
Well, I'm not going to parse it that way, Joe. Weather has some impact on January. All that business could come back in February if the weather calms down. Certainly, it could come back in March. If a consumer doesn't buy this weekend, they might buy next weekend, or they may buy two weekends from now when they don't have something planned. While it may affect one month, it could come back in the quarter. We are factoring that in a little bit. One of the big things is we've got this humongous transition occurring, as retailers are taking product off the floor, they got to sell that. As they are putting the new product on the floor, they got to sell the old product off the floor.
While retailers don't have a lot of inventory, there's a little bit of inventory they got to clear out. There's some inventory we got to clear out. The transition, particularly when you're talking about changing seven models from a Tempur standpoint, from a Sealy standpoint, all the Stearns & Foster product is changing. That's quite a few models as well. That's where we're just trying to say, particularly for Tempur, we've never seen this level of transition before. We believe that there's some transitory impact that will affect the performance over the quarter.
Okay. That'll probably continue into Q2, it sounds like, given all the floor models you're shipping.
Yeah. It will continue some into Q2.
Yeah, it will.
Okay. Just one last one in terms of the overall environment. Obviously, you guys are stepping up the advertising spend, and I think your retail partners are very happy about that. What are you seeing across the competitive landscape? Are others in your space coming to the realization that maybe heavy promotion is not the way to go and really shifting those dollars to more of an advertising-based model is probably smarter for everybody?
I think what the industry, certainly what retailers tell us and what we know, is that first and foremost is great product. We mentioned it, but Sealy had a great quarter in the fourth quarter. You can attribute it to a lot of things, but it's because the new Posturepedics were really well-liked by consumers. It really worked well. First and foremost, I think that what everybody realizes is product drives the game. I think what we showed in Vegas, what we showed in Cologne, on both the showrooms, was something that we're very proud of, and we really believe that's the backbone, and I really do believe that the industry believes that, too. Secondly, I think people believe that advertising is driving people to the stores. We know that, and we also know that the continuity of advertising is important.
It's not good to just do it in spurts, and that requires sort of conviction to do that. We're going to do that, and I know that the retailers appreciate that, too. I think the third thing is a kind of worldview that it is best to make products that are premium-priced products that consumers are prepared to pay a premium for. Having ASP grow by having a focus on the better-end product is something that's in everybody's interest. I think certainly we think that, and I believe from all of the conversations we've had with retailers, that's a common belief there, too. I can't really speak for our competitors.
Okay. Great. Thanks, guys.
Thank you, sir. Next question in queue will come from the line of Karru Martinson with Deutsche Bank. Please go ahead. Your line is open.
Hi, it's Karru Martinson with Deutsche Bank. When we look at the step-up in advertising, I've certainly noticed a pick-up in how many times I'm seeing your commercials already. When you look at the spend, are you shifting more dollars out of co-op into that kind of national advertising campaign, or do you feel that co-op dollars will kind of stay the same?
Well, one thing is that fundamentally, just as a kind of backdrop, the way that Tempur and Sealy have gone to market for many years is different, as you know, and both of us have direct-to-consumer and co-op. We're not going to change the proportion that Tempur has on direct-to-consumer is different and will remain so, and the same is largely true for Sealy. In terms of overall, I think that we are committed to advertising. One of the things that I mentioned briefly in the prepared notes is that one of the synergies that we hope to see the benefits of this year is that by putting together the media buying for the combined companies, and we went through a formal process with RFPs and the whole thing to negotiate a good buying rate of media, to negotiate good prices for media.
We have not only been able to, as we said, we're maintaining our level of spending, but we're also being able to get more bang for the buck. We'll be able to get more GRPs for our dollar. That I think is going to be something we will see, and that's going to affect particularly direct-to-consumer advertising. Fundamentally, there's not a change in how we're allocating it, but what I think is we're going to see is the greater effectiveness as we're able to combine the two together.
Okay. When we look at the first quarter and into the second quarter, the rollout of the new beds, do you feel that you've picked up significant additional floor spots with the new product launch, or do you feel that this is more of replacing the SKUs and possibly putting a higher turn product out there?
We hope that we will gain some floor space, but it is important to note that this launch, particularly for Tempur, it is true for Stearns too, is a replacement. Historically, most of our new launches have been a new product that's an addition. We're very conscious of this and investors should be, too, that this is a replacement, and therefore, we are going to be, to a great extent, swapping out floor models. However, we do hope to gain some floor space with it because the new collection of seven products from Tempur has been very well received, and it's too early to tell right now, but the initial indications are that that's going to be positive. We do hope for that. What we're really counting on, though, is the increased turn per slot as a result of these new items.
In the case of Stearns, I think the exact same thing could be said. The new Stearns product line has been received extremely well. People are very positive about it. They particularly like, and interestingly and importantly, the high end, and it comes back to the thing I was saying a little earlier, is very much appreciated by retailers. We're hoping that we'll gain more spots, but what we're also hoping is that we're going to get better turn, and we're also hoping that we're going to get higher ASPs.
Thank you very much, guys. Appreciate it.
Thank you, sir. Our next question will come from Keith Hughes with SunTrust. Please go ahead. Your line is open.
Question has been answered. Thank you.
Thank you, sir. Our next question will come from Jon Andersen with William Blair. Please go ahead. Your line is open. Your questions, please.
Good afternoon. Thanks for taking the question. Mark, you talked not that long ago about the importance of training and educating the RSAs, particularly on the more kind of complex products to overcome selling hurdles or to improve selling effectiveness. Can you just talk a little bit about where you sit today vis-a-vis that effort, and particularly in the context of the significant number of new product launches this year? Thanks.
There's no question that that's true. When we were talking about global challenges for the industry, I talked about the fact about product is important, marketing is important. No doubt about it, training the RSA is critical. Two things on that. I think that with the new products that have just been launched from Tempur, one of the things that is important is that the way that the product is demonstrated with the zip-off top is something that's very easy for an RSA to do, and yet it's very demonstrable and is very appealing and interesting to a consumer. It really passes the test of being relatively easy to do, but a valuable thing to have done, and therefore, easy to learn and easy to use. That is one of the reasons that our customers and our RSAs have responded very positively to the product.
The other thing is that our focus on POP, Tempur-Pedic, particularly because it has been something that we have put a big focus on for this launch, and Stearns & Foster consistently with the past, again, have put big focus on POP. In both cases, with an eye to making it easier for an RSA to sell. For example, the POP for Tempur products, the new TEMPUR-Contour and TEMPUR-Cloud products, have a very simplistic description of the product and its key differentiating features and its step-up story, which has people responding very well because, again, it's easy to train and easy to use. It makes the RSA confident about justifying why one product is better and more expensive than the next one.
In the case of the Stearns & Foster products, some of the POP enables the RSA to easily demonstrate what is inside a Stearns & Foster and how that is different, and what it looks like when you're looking at a Stearns & Foster hybrid. Again, we do believe that, and that's a very important part of the POP.
Thanks. That's helpful. Maybe just a quick one for Dale. Dale, how much stock-based comp are you forecasting for 2014? Is that included in or backed out of the EBITDA forecast? Thanks.
Stock comp is included in. Our stock comp will increase in 2014. Essentially, this is why stock comp builds on itself over time. Our long-term incentive plan is a stock-based plan. Partly options, partly PRSU. If we go back several years ago, the long-term incentive plan tends to be 3 years. Back in 2011, we had a new long-term incentive plan that would've accrued over 2011, 2012, 2013. In 2012, we had a LTIP plan that would've accrued over 2012, 2013, 2014. Based on the results in 2012, both those plans, because there were minimum hurdles, based on the results in 2012, both those plans were essentially blown up. If you recall, in 2012, we, at 2 different points during the year, had significant pullbacks where we essentially eliminated those 2 years of plan.
As we came into 2014, we started with a blank slate. We had a LTIP plan in 2013, I'm sorry. As we came into 2013, we basically had a blank slate, because the 2010 plan had finished. We have stock comp in 2013 for the 2013 plan. We will add a layer to that. If you think of LIFO inventory, we'll add another layer to that next this year in 2014, where you'll have the 2013 plan and then layer on the 2014 plan. It kind of builds up until you get 3 years in. Stock comp is in our earnings per share. It is in our guidance. It is in a D&A element. It's not included in EBITDA, but it is in EBIT. Is that helpful?
Yeah, that's helpful. Thank you.
Thank you, sir. Presenters, at this time, I'm showing no additional phone questions. I'd like to turn the program back over to management for any additional or closing remarks.
Thanks a lot. We look forward to talking with everybody again in early May when we host the first quarter earnings conference call. Thanks for joining us this evening.
Thank you, gentlemen, and thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation, and have a wonderful day. Attendees, you may now disconnect.