I will now introduce [inaudible] Press Conference Call. Mr. Mark Rupe, you may begin, sir.
Thanks, Kevin. 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 include 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/or risk factors, as well as the company's press releases. Any forward-looking statement speaks only as of the date on which it is made, and the company undertakes no obligation to update any forward-looking statements. 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 also 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'll provide an overview of our performance in the third quarter and then discuss our four key strategic growth initiatives. I'll then turn the call over to Dale, who will provide details on the third quarter financial results and discuss our financial outlook. Overall, our third quarter was in line with our expectations. The steps we have taken to improve Tempur North America's performance showed progress during the third quarter and led to a slight sales increase. Our Sealy business also showed growth during the quarter. However, Tempur International results were slightly below our plan due to continued weakness in Europe. In total, our third quarter sales were $735.5 million. Adjusted EPS was $0.73. Tempur North America entered the third quarter with sales weakness.
We had expected sales to decline 5%-10% in the second half of 2013 versus last year. As is evident with our third quarter sales increase of 0.6%, sales trends improved and were positive for the balance of the period. The commitment to investing in our strategic growth initiatives is beginning to produce results. Sales in our retail channel increased 2.4% with sales growth across our customer base. Sales of products priced at $2,000 and above grew and more than offset a decline in products priced below $2,000, resulting in an overall AUSP increase. Our marketing efforts were also successful in the third quarter. Our unique Labor Day holiday promotional event broke through the clutter and captured the attention of retailers and interested consumers. We supported the event with increased advertising and greater frequency of ads tagged for the promotion.
While we are pleased with the improved performance in Tempur North America, our efforts to restore sustainable growth are not complete. In a minute, I will talk about the number of steps we are taking in the fourth quarter and in 2014 to build on this initial success. Turning to Sealy, sales grew during the third quarter. While growth was slightly below our expectations, it was up against a very tough comparison from the prior year. We completed the rollout of the new Posturepedic offering and continue to see very strong demand across the line, both in a spring and hybrid. Increased consolidated sales from our joint venture with Comfort Revolution also contributed to growth. Comfort Revolution is growing very rapidly and is benefiting from expanded distribution. Sealy also experienced strong demand in Canada, with third-quarter sales coming in just shy of an all-time high for the third quarter.
In addition, Sealy's other international markets grew during the quarter, including South America and Mexico. Both Optimum and Stearns & Foster were down versus last year as they lapped prior year's successful launches. Both remain important parts of our business, and we are excited about their potential and their new product pipelines. Tempur International sales were down approximately 3% on a constant currency basis and were slightly below our expectations. Tempur International's performance is particularly important to our overall consolidated results, given that it has much higher margins than the remainder of our business. Our Asia Pacific business continued to perform well with good results in Korea, Australia, and China. Our Latin American business also showed significant growth off a small base. The economy in Europe, on the other hand, continues to be very challenging.
Most of the major European markets were negative during the quarter for us and for the industry. Now I'd like to discuss our strategic growth initiatives. My comments will include both our near-term initiatives and the longer-term initiatives supporting our 2016 growth targets. We are the world's largest bedding provider and the only provider with global scale. We believe our future growth potential is significant in our existing markets and through expansion into new markets. At our September 2013 Investor Day, we introduced new three-year growth targets and discussed the strategic initiatives we would implement to achieve them. 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.
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, as I said, is product innovation. We will continue to invest in R&D to leverage the combined technologies of our comprehensive portfolio of products to deliver a stream of innovative products. 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. Demand for the TEMPUR-Breeze product line, which was introduced this time last year, continues to be very high and is a perfect example of consumers' willingness to trade up for innovation.
The success of Breeze continues to exceed our expectations and is now one of the top sellers within our portfolio. The Ergo Premier, Posturepedic Hybrid line, and TEMPUR-Choice are other examples of our ability to drive higher AUSPs with new technology. We continue to roll out TEMPUR-Choice in North America during the third quarter and now expect to finish the rollout by the end of the year. With Choice, our retail customers have a clear opportunity to gain market share, we know that building consumer awareness is going to be key to the success of this product. In early October, we began airing a new Choice spot based on the Ask Me campaign, we will continue to invest to support this product line.
During the past 12 months, we have accelerated the pace of innovation with products that feature new technology, we anticipate that this rate of innovation will continue. We're planning several significant and exciting product launches for 2014, including new innovation across our entire brand portfolio. At the recent High Point Furniture Market, we showcased our entire brand portfolio together for the first time ever. Both Tempur-Pedic and Sealy product lines were featured in our Trinity campus showroom. Here, we also previewed several of our planned 2014 product introductions, were very pleased with the customer reaction. You will begin to see initial closeout activity for some of our products prior to year-end to make way for new product introductions. As you might expect, we're not prepared to provide specific details on these new products tonight for obvious competitive reasons. The second strategic initiative is marketing.
A key component of our three-year plan is significantly increasing our advertising investment to increase consumer awareness, preference, and loyalty for each of our key brands, most notably for Tempur-Pedic. During the third quarter, we increased our advertising in Tempur North America by 18% versus last year, 40% versus the second quarter of 2013. We went back to Ask Me television ads during the period, also adjusted the media mix to improve frequency. We will also invest in in-store marketing and direct sales to maximize our sales opportunity driven from national brand and retailer advertising. The third strategic initiative is new market expansion. As we said in our Investor Day presentation, our international opportunity is significant. Over time, we expect to realize over $300 million in revenue synergies from our international markets.
We're making progress on several of these opportunities. We'll speak in more detail about them in 2014. Our fourth strategic initiative is our commitment to building a world-class supply chain that is easier to do business with. Our goal is to significantly improve efficiencies related to purchasing and delivery, as well as inventory management, to drive sales growth for our retail customers. We're making significant progress on several initiatives as it relates to this area of focus. We'll be in a position to speak more openly about them also in 2014. Before handing the call over to Dale, I want to make two closing points. First, although we have seen some progress in Tempur North America, demand remains volatile week to week. There is an overall level of uncertainty in the market. As a result, there's a certain degree of caution in our outlook.
That said, my second point is that we remain very confident in our company's long-term potential. Our pace of innovation will remain vibrant. We are committed to brand marketing investments. In addition to the attractive cost synergies we expect to achieve, we will realize upside from revenue synergies as a result of a broader product offering, access to more channels, and international expansion. With that, I will now hand the call over to Dale.
Thanks, Mark. I'll focus my commentary on the third quarter financial results. I'll discuss our financial outlook. I'll address the performance on a consolidated basis. I'll speak to the performance for each segment and provide commentary on the key areas or items where there is notable variance from the prior year. As a reminder, the company completed its acquisition of Sealy in March 2013. Results for 2012 do not include the Sealy results of operations. Consolidated net sales for the third quarter were $735.5 million. Tempur North America net sales were up slightly. Tempur International net sales were down 3.6%. On a constant currency basis, Tempur International sales were down 3.1%. Sealy sales were $389.9 million. By product, bedding net sales for Tempur North America increased 0.2% to $220.6 million on a unit decline of 4%.
Tempur International bedding net sales declined 4.7% to $76.5 million on a unit decline of 7%. Sealy's bedding net sales were $365.2 million. By channel, Tempur North America retail net sales increased 2.4%. Direct net sales declined 30.5%. Tempur International retail net sales decreased 6.5%. Direct sales increased 20% to $12.5 million, driven by growth in company-owned stores and e-commerce. Third quarter gross margin was 40.6%. As we stated on previous conference calls, inclusion of Sealy has altered the consolidated gross margin profile of the business. On a year-over-year basis, third quarter gross margin declined to 40.6% from 49.2%, 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 increased to 40.6% from 38.6%, primarily due to the lack of inventory revaluation charge in the third quarter and lower new product launch costs.
These were partially offset by rework costs associated with our new Tempur-Up adjustable base of approximately $3 million. Consolidated advertising spend, which includes both national and cooperative, was $88.4 million, or 12% of sales in the third quarter. Tempur North America advertising spend increased 18% versus last year. As Mark indicated, we remain committed to our advertising investment to reinvigorate consumer activity around the Tempur-Pedic brand, as well as the other key brands in our portfolio. Consolidated operating income was $81.2 million as compared to $63.4 million in the third quarter of 2012. Operating income in the third quarter of 2013 included $8.5 million of transaction and integration costs related to the Sealy acquisition. Operating income in the third quarter of 2012 included $3.6 million of transaction costs related to the Sealy acquisition, as well as a benefit of $8 million related to an adjustment to long-term incentive stock compensation.
Interest expense was $24.6 million and included $0.7 million in interest fees related to the company's refinancing of its Term A loans under its senior secured credit facilities, which was completed in July of 2013. The tax rate was 27.8%. The tax rate for the third quarter reflects geographic mix and certain non-recurring items. The normalized tax rate was 30.4%. Third quarter GAAP earnings per share was $0.65 as compared to a loss of $0.03 per share in the third quarter of 2012. The 2012 loss reflects tax charges related to the Sealy acquisition. Adjusted earnings per share were $0.73 in the quarter, as compared to adjusted EPS of $0.70 in the prior year period. Next, 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. During the quarter, we had operating cash flow of $116 million, primarily as the result of working capital and improved net income related to performance and less Sealy acquisition-related transaction and integration costs. Capital expenditures were $9 million. We've begun to benefit from our tax-efficient structure created through the Sealy acquisition. Free cash flow generated during the quarter was $107 million, which enabled us to reduce our debt by $84 million during the third quarter. Our cash position was $126.6 million at the end of the quarter. It enabled us to further reduce our debt by $36 million during the month of October. As a result, our leverage has improved. The company has consolidated funded debt, less qualified cash of $1.8 billion.
The ratio of consolidated funded debt, less qualified cash to adjusted EBITDA, was 4.3 times, calculated on a combined basis in accordance with the company's senior secured facility. This is an improvement from 4.6 times as of the end of the second quarter. The calculation of this ratio is included in the press release. Now I'd like to address guidance. As a reminder, our guidance and related commentary reflects a full year of Tempur results, with only Sealy results from March 18th, 2013. Today, the company confirmed its financial guidance for 2013. The company currently expects net sales to be in the range of $2.425 billion-$2.450 billion. Adjusted EBITDA to be in the range of $370 million-$385 million.
Adjusted earnings per share to be in the range of $2.25-$2.40, including $0.14 per share of depreciation and amortization related to the Sealy purchase price allocation, or PPA. It's important to note that while our full-year financial guidance is unchanged, the profile has changed. We currently expect our full-year 2013 net sales to be towards the upper end of the guidance range. In addition, we currently expect our full-year 2013 adjusted EBITDA and adjusted EPS to be closer to the midpoint of their respective guidance ranges. The principal driver of this variance is unfavorable mix. We're also providing the following additional full-year 2013 guidance assumptions. Depreciation and amortization of approximately $90 million, with an annualized run rate of approximately $100 million. This includes PPA depreciation and amortization of $13 million in 2013, with an annualized run rate of approximately $17 million.
Interest expense of approximately $83 million, excluding transaction-related charges, with an annualized run rate of approximately $95 million. The tax rate to be approximately 31% for the full year and 31.5% for the balance of the year. Share count to be approximately 61.6 million shares for the year. Capital expenditures of approximately $50 million. It's important to note that our 2013 adjusted EBITDA and adjusted EPS guidance does not factor in transaction and integration costs related to the acquisition of Sealy or interest expense costs on the financing transactions prior to the March 18th close, or expenses incurred on the recent repricing financing transactions. 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 consequence of other risk factors we have 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.
Ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touchtone telephone. If your question has been answered or you wish to move yourself from the queue, please press the pound key. We also ask that you limit yourself to one question and one follow-up. Our first question comes from Budd Bugatch with Raymond James.
Good afternoon, Mark, Dale, Mark. Good to see the sales growth, certainly in North America. I guess my question, Dale, for you is, I just want to make sure that Tempur North America gross margin. Can you give a comparison to that year-over-year?
Sure. One second, Bud. Ask your second question, I'll get that back to you.
Okay. The second question is kind of looking at Sealy pro forma for the remainder of the fourth quarter. I remember last year they had an extra week and the months changed. I'm trying to understand what the comparison is if we looked at it pro forma for Sealy in the three months, I guess October, November, December.
Yeah. For our outlook for the business, let me just answer the next question that's related to that. For the fourth quarter, we would expect Tempur North America to be flat to slightly up. They were slightly up in the third quarter, 0.6%. We would look for TPNA to be zero to low single digits growth. Tempur International, we're currently expecting to be negative, low single-digit growth, which would imply Sealy being roughly about a mid-single-digit growth.
Against what? I don't think we have those numbers for the three months. We don't have a pro forma.
Yeah. Unfortunately, Budd under SEC rules, we can't provide really comparable numbers because they were not ours.
Okay. All right. It's just hard to know what to compare against it. I guess the last two quick questions, you can give me the gross margin answer. AUSP, I know Mark said above 2,000 was positive. Can you kind of parse that between 2,000 and 3,000 and above 3,000?
I'm not going to break it down to that level, Budd, I will say that the AUSP was up. It was largely driven by some of the products like Breeze, for example, which was selling very well, which is the above 3,000, but not the very highest part of the portfolio. It was driven by the above median part of the 2,000 and above area. We don't have it split by specific groups within that.
Okay. Dale, did you have the gross margin issue? Maybe if you can't give us the Sealy comparison number, maybe you can give us the Sealy expectation number, a dollar number.
Sealy number.
Sales
Of sales?
Yes, sir. What you expect in guidance, if you can't give us the comparison to do the % math on.
For sales for the fourth quarter, we would be looking for Sealy to be in the low $300s. Sealy, particularly with their calendar shift, has a higher seasonality than the Tempur business traditionally has. On your other question, TPNA in the third quarter of 2012 was a gross margin of 43.6%, and on this year it was just slightly below that. Tempur-Up, which I mentioned Negative driver on the sequential basis from Q2 to Q3, obviously, is the TPNA issue. That was $3 million-
Yeah
of negative gross margin on that. It's going to cost us another $1 million-$2 million in the fourth quarter.
To get whatever the issue was resolved?
Yeah. Obviously, what we booked in the third quarter was all the rework costs, there's certain costs that you can't accrue upfront until it's known. We're incurring some expediting costs to get the new pieces that we need as we've fixed it. We've got to go back and fix all the inventory that we had pre-built and get it ready to get shipped again.
Okay. When will the 10-Q filed so we'll get all the segment operating numbers?
Friday.
Terrific. Thank you, Dale. Thank you, Mark, and congratulations. Good luck on the fourth quarter.
Thank you.
Our next question comes from Brad Thomas with KeyBanc Capital Markets.
Thanks. Good afternoon. Wanted to just follow up on the advertising comments. There were obviously a couple of big changes that you made in the quarter in terms of going back to the Ask Me campaign and greatly increasing the advertising dollars after it having been an area of savings for you in the past year. Could you maybe just comment on what kind of response you're seeing to this change in advertising and how much that specifically may have helped business in the quarter?
Well, as you know, it's hard to exactly parse these things. Our feeling is positive about it. We feel that it has contributed. There's no doubt that our expectations for Tempur North America three months ago were lower than they turned out to be, the advertising clearly had something to do with that. On a fundamental level, we attribute some of the improvement in our performance directly to that advertising. We can look at other things that are indicators. Visits to the website, for example, are up double digits. People going to the dealer locator on the website is also up double digits. There are some indicators of it. It's really hard to say exactly this much came from the advertising, we feel good about it. We're advertising Tempur-Choice now, that too seems to be helping.
As far as I can tell, and you know how imprecise a science this is, this is going appropriately. What we said before, and we reiterate now is, in the first part of this year, we were not advertising sufficiently. We recognize that, we've taken steps to address that, we will address it for this quarter, also going forward.
Great. If I could just follow up on Tempur North America and the trends that you're seeing. When we had the earnings call back in July, I believe the 4th of July holiday had not performed up to your expectations. It seems like there was a notable acceleration in trends. The consumer data points over the last six weeks or so have been pretty spotty. Could you maybe give us a little bit more color on how things have played out and how confident you feel in Tempur North America growing in the fourth quarter?
We're saying very modest growth, if any growth. What's implied in our guidance is essentially flat to very flat. On the other hand, not the -5 to -10 that we had believed when we last spoke. I would say that what happened is this, is that July 4th was as we said, we were disappointed with the July 4th promotion, and July as a whole was disappointing. Labor Day and August was good. We were quite pleased with that, and we saw a good response. You'll remember that we had a good promotion that was quite effective at that time, and that worked well. Then September moderated somewhat, but still better than the beginning of the quarter. What I think is the key, though, which is implied in your question is, you used the word spotty. I use volatile.
It's really quite intriguing how the market bounces quite a lot from literally week to week. We feel like we're in a better place from Tempur North America position than we thought we were in July, but there continues to be volatility.
Thank you so much, Mark.
You're welcome.
Our next question comes from Joe Altobello with Oppenheimer.
Good afternoon. I guess the first question I wanted to go back to the ad spend you mentioned in the third quarter, $88 million. Obviously, that number does bounce around a little bit from a seasonal perspective. What would we expect, I guess, on an overall level in terms of advertising spending in Q4?
Joe, this is Dale. In the third quarter, our consolidated advertising spend was right around 12%. We would expect it also to be right around 12% in the fourth quarter. TPNA in the third quarter was about 13%. International, slightly under 10%. The Sealy was right about 12%. That's more cooperative in nature, but some national advertising there. From an overall company standpoint, we expect the ad spend rate to be about the same as in the fourth quarter as it was in the third quarter as a percentage of revenue. Fourth quarter being seasonally weaker, we would expect maybe a little bit lower total spend, but as a percentage of revenue, the same.
Okay, that's helpful. Just in terms of, Mark, earlier, your comments about July 4th being disappointing, is that just from a Tempur-Pedic perspective, or are you seeing a shift in spending amongst consumers away from holiday spending in general?
No, I don't think that's what it is. In fact, I think that we continue to see consumers do spend at holiday periods, and that's something as an industry where over time we're going to have to try and mitigate. I don't think that fundamental trend has changed. I think that the July the 4th holiday was not good for the industry, but it was particularly not good for us. I don't think it's anything about holidays. I think it was about that holiday for the industry, and I think particularly for us.
Okay. Just one last one in terms of TEMPUR-Simplicity. Have we seen the worst now of the TEMPUR-Simplicity year-over-year declines in Q3?
As we've said, our focus is on the $2,000 and above area for Tempur North America, and that will continue to be the case. The Simplicity promotion that we ran in Labor Day was actually quite successful, and Simplicity still sells quite well. It's not going to be a focus area for us for growth going forward. I suppose the answer to your question in simple terms is, I imagine it will continue to diminish as a proportion of our total sales over time. I imagine it will still be here.
Yeah. The second quarter was the worst compared, Joe, and it gets a little bit easier. Third quarter was down, but the compares get a little bit easier.
Got it. Okay. Thank you, guys.
Thanks.
Our next question comes from Josh Borstein with Longbow Research.
Mark, thank you for taking my questions. Just a little bit more on the quarter. Did you guys witness a drop-off in the last two weeks of September? I know some other consumer categories like appliances witnessed that. Just was unsure if you saw something similar.
As I said, the Labor Day and the August period was better than the latter part of the quarter. We heard and we read the same things, that we saw weaker trends in the latter part of September like the rest of the industry.
Okay. On the gross margin, there's a lot of moving parts, I know, given the merger and all the product rollouts this year. Can you discuss gross margin puts and takes for Q4 here, things we might keep in mind when modeling the fourth quarter?
Yeah. From a modeling standpoint, I would have fourth quarter gross margin to be fairly similar to the third quarter. The real key drivers for us is the mix change. TPNA obviously doing better than what we thought before. As I mentioned, there is still some ongoing Tempur-Up extra cost in the fourth quarter in addition to what we had in the third quarter. Tempur International being much below our expectations when we set the guidance is a real negative driver for gross margin. The growth of Tempur North America is a positive. The Tempur International being down, because that's our highest margin business, is negative and a little bit additional cleanup on Tempur-Up will also give us a little bit of pressure there. Overall, quarter to quarter, we'd expect somewhat similar results on a gross margin standpoint.
Good. Thank you. That's helpful. Just one last one for me. On the TEMPUR-Choice, you had mentioned you started a national Ask Me campaign around that in October. Are you following that up also with RSA training or anything to get the RSAs more involved in the selling process?
Yeah. We are. You're right to say that. TEMPUR-Choice is a product that with an RSA who's confident and well-trained at selling it, is a product that sells well. It has very high consumer satisfaction. We know that the two keys to making it achieve its full potential is, one, getting awareness up so people come into the store knowing about it and asking for it, and the other is making sure that the RSAs are well-prepared and trained to sell on it. That is a big focus for our sales force across the board. It's one of the big initiatives to make sure that we put that as the top of the list of things to do for RSAs across the country, and that is a big focus.
Does that training consist of having the sales force get out and visit all your retail stores, or is it more point -of -sale materials and videos and things like that?
It includes materials and it includes training in classrooms. It very much includes everybody. The people who are calling on the stores up and down the country are training the people in the stores.
Okay, great. Thank you. Congrats on the quarter.
Thanks.
Our next question comes from William Reuter with Bank of America Merrill Lynch.
I wanted to take a step back and talk a little bit about marketing. When you talk about these four growth initiatives going forward, does that mean that marketing as a percentage of sales should go up as we think about 2014 and 2015, or are you going to look at the response? What's your plan there?
We're not going to give detailed guidance at that level. We've said, and it's important, that we will continue to increase advertising. That is what we will do. I've said before that using a percentage as a basis for calculating what's the optimal amount to spend has always struck me as rather silly. You're talking about awareness and driving awareness. Right now, we know we're not spending enough. We want to spend more. We will continue to spend more across our portfolio, particularly focused on Tempur. The exact ratios, I don't know at this minute. We are going to continue to invest in marketing and as the company grows. I don't want to tie ourselves to a percentage because I've always felt that's a bit silly.
On the other hand, at the moment, standing here today, I don't believe we're spending the optimal amount, and we will continue to spend more going forward. The other thing that we're going to do is looking at ways of improving the effectiveness of our advertising. That's something that both as the fact that we are now a combined entity, it gives us kind of a greater clout in the market. Also, we know that there are opportunities for us to improve that, and that's something we'll talk more about next year.
Okay. One follow-up from me. In terms of, you guys have been pretty focused on debt reduction here this year. As we think about future years, will that continue to be a goal of yours? How are you thinking about, I think in the past you've looked about, talked about long-term debt ratios that are closer to 2x. What will be your goal with free cash flow, and how do you think about leverage? That's it. Thank you.
Yeah. This is Dale. Our long-term debt ratio is the same as it was before this acquisition. In the 2 times level, we're looking to reduce the debt. We're committed to reduce the debt and get it back down to that level. Certainly, though, as time goes on and We don't have to wait till we're exactly at two times to start to consider other things to do with some of the cash flow. We will continue to reduce the leverage on the business. However, as we start approaching our longer-term ratios, then we can start considering other activities.
Great. Thank you very much.
Thank you.
Our next question comes from Keith Hughes with SunTrust.
Thank you. You had referred to Optimum and Stearns & Foster and as they come down off some product launches. Will we see more products from them coming next year to get that life cycle moving back in the other direction?
The short answer is yes. Both of them are important parts of the portfolio. Both of them had hard comps this quarter because of the launches last year. Both are important, and both will be products that we will have new products for in the first part of 2014.
Second question on the Choice line. You had mentioned in the prepared comment it's going to be rolled out by the end of the year. Given the training that was referred to in a previous question, what period do you think we will have a good view of what that product's going to do in terms of sales? Will it be well into next year, beginning of next year? What do you think?
I don't have an exact number on that, but I think it's going to take a little while. The comparable I would use is Breeze, which launched-
Third quarter
Third quarter of last year and is still growing as we speak. That's partly because Breeze is a relatively more, a slightly more complicated sale. Choice is more complicated yet. Yet, the satisfaction of the people who own it and the confidence of the people who sell it, both of those will grow over time. I do believe it's going to take a little time. I think that another thing that is very comparable when you're modeling this and thinking about it is the adjustable bases. When they first started, it was very much a function of which salesperson was selling it in any given store to judge what would be the attachment rate. Over time, as that has grown and grown, people have become more and more confident, and now it is something that essentially everybody does. That's the analogy that I think of.
It's a mechanical device. It takes more explanation, but the consumer, when they get it, really like it. I think it's going to take a little while. I think your question is right. The exact time, I don't know with precision.
Okay. Thank you.
Again, ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touch-tone telephone. Our next question comes from Carew Martinson with Deutsche Bank.
Good evening. When we look at the upcoming quarter and then the closeout of the prior lines, are you expecting any kind of margin pressure from that?
Into our expectations.
It is built into the expectations.
Yes.
Okay. When you look at the lessons learned from the rollout this year as you launched a number of Tempur initiatives, what would you do differently in the upcoming year as you guys roll out a suite of new products?
One of the things that we've done, I mentioned it in the last call, but it's important, is that we have put an organizational focus, but we have created an infrastructure of people and organization, partly as a result of the combination of the two companies, but frankly, a lot of it new, to oversee the product launch process. As it becomes a more frequent and important component of our overall business, we need to get better and better at it, and we are. I'm pleased with the progress we're making. Among the things that we'll do, for example, is we're going to strive to have greater levels of inventory at the times of initial launches, for example. Our testing would have been done earlier. We're going to move things forward to give ourselves more breathing room.
By planning in advance to be able to do that from the beginning, which we've now been doing systematically for some while, it's going to give us that amount of breathing room to do those things that will make sure that this greater frequency of product innovation and new product rollouts can be done as close to flawlessly as we can.
Thank you very much, guys. Appreciate it.
Okay.
Our next question comes from Peter Keith with Piper Jaffray.
Hey, good afternoon, everyone.
Good afternoon.
If you talk about the upper end of the line, $2,000 and up versus $2,000 and below, it sounds like the commentary was kind of similar with Q2 where $2,000 and up was positive, $2,000 below was still negative. Did both of those two directionally get better, or was one a bigger sign of improved performance?
2,000 and up did improve from the second quarter. Below 2,000 was less negative than the second quarter, a lot of that had to do with TEMPUR-Simplicity had a easier compare.
In short, the above 2,000 was more positive.
Yes.
That's good. Then, I don't think you quantified a synergy number for Q3 like you've done with last quarter. Is that something you could provide for us, Dale?
Yeah, it was about seven. We would expect seven in the fourth quarter also.
Okay. Terrific. Just lastly, just to understand the puts and takes around the guidance. Sales at the high end and EPS and EBIT at the middle, you talk about mix. Can we just pinpoint that directly to the weakness in International relative to expectations? Is that the simple reason for the EPS to be at the midpoint on better sales?
That and the cost around Tempur-Up, yes. Tempur International, when we gave the guidance, in July, we said that we were expecting Tempur International to be up low single digits, instead it's down 3%-4%. The profitability of Tempur International gives us a lot of pressure there as well as the Tempur-Up cost.
Okay. Maybe just even one follow on. With the Tempur North America gross margin, is that generally trending in line with how you thought, if you think it's going to be slightly down year-on-year? I was thinking that as you're kind of lapping some of the rollout costs with Breeze and Weightless, that you guys might begin to see some year-on-year improvement in North America about this time.
By excluding the Tempur-Up cost, Tempur North America's gross margin is up.
Okay. All right. Thanks for the feedback and congratulations on the sales number.
Thank you.
Our next question comes from John Anderson with William Blair.
Thank you for taking my questions, guys.
Hey.
I just wanted to ask about, with your ownership of Sealy now, that's clearly consolidated the industry at the manufacturing level to some degree. I always kind of thought one of the beneficial byproducts might be greater discipline in pricing and promotion. Is there any evidence that you're seeing of that, given kind of the change in the structure at the manufacturer level?
This is and it will remain a very competitive industry. So it was before it is, and it still is now, I'm afraid. I mean, just the fact it's how it is.
Okay. Mark, the volatility that you referred to, it does seem like it's been fairly extreme. Extreme might be too bold a term, I don't know. Are you thinking about this as kind of, is this the new normal or is this kind of abnormally high and you expect some kind of reversion to the mean over time? What do you think is kind of driving the volatility right now? Is it really the consumer and their willingness to spend? Is it kind of something going on from a product or innovation standpoint? I'm just trying to get a better sense for this volatility if we should expect it to continue.
Look, I'll share with you my opinion, but that's what it is because I don't have any crystal ball. What I know is that a lot of our retail partners are commenting on the fact that the number of visitors that they get to their stores can vary quite significantly from one week to the next. So it's very much to do with people coming out, coming shopping. I think one interpretation of this situation is that we are at this stage where there's a kind of at the beginning of the green shoots are coming out, but people aren't quite sure. If you have a government shutdown, that kind of knocks everything back for a while, and things look positive, then a little negative. I think people are just kind of nervous.
I think that we're at a point where it's going to eventually smooth one way or the other. There's always going to be a degree of volatility. I think over the last few months it's been particularly significant. I don't think there's anything systematic about why that should last forever. I think it's probably going to stabilize over time. I think the other thing is that when you look at it on very short periods, you're bound to see volatility. For example, last year there was Sandy, this year there wasn't. This year there was a government shutdown, last year there wasn't. This year the election's at a different time. By the time you've corrected for everything, it's less volatile than when you look at it week to week. My view is that there's nothing systematic that says this is how it should remain.
That's really helpful. One more question just on innovation. There's been a lot of innovation over the last 12 months. 12 to 18 months, I guess, from TEMPUR-Simplicity to Breeze to Choice and the new adjustable base. Does that pace of innovation perhaps moderate somewhat from here and the focus shift a bit more to execution in the market with new advertising and training of the RSAs? Do you think you try and maintain this pace of toward innovation as necessary?
As we said, there are four things that we're focused on. Innovation is one, marketing is the other, new product expansion, and supply chain. The two are marketing and innovation are the two. The fact is, I think that there is a requirement in order for us to continue to be successful and to continue our growth that we innovate on a regular basis. What the exact cadence is, we're still working out, and there is no doubt that too much innovation without good execution, and I think particularly in execution, it's effective rollout, effective training of the people in the stores and so on, is not valuable. We are committed to the fact that we have to innovate and execute very effectively as well as advertising and other forms of marketing.
I would say that from a planning purposes point of view, we do anticipate that this relatively high cadence of innovation is going to continue.
I really appreciate the comments and congratulations on the quarter.
Thank you.
Our next question comes from Carla Casella with JP Morgan.
Yeah, most of my questions have been answered, but can you just give me a sense for the market for cooperative advertising and what you're seeing on the competitive side on that front? Also, do you do any cooperative advertising for Tempur, or is this really just a Sealy phenomenon?
We missed the first part of your question there, Carla. I know it's about cooperative advertising. What was the first part of it?
Just whether that market has heated up the competition from the cooperative advertising standpoint.
We are in a competitive environment, and this is a component of the competitive tool set. I know that we and particularly the Sealy team are very focused on making sure as much of the cooperative advertising is used for advertising that really builds the brand and works in concert with the key brand messages. They are having quite good success with that team. The Tempur team have always done that. There is cooperative advertising from Tempur, but that's always been based on advertising linked to the Tempur national advertising. Both of those are showing some success. I think that where it's worked well is where advertising by retailers and the national advertising is done together. It's more valuable than one and one make more than two.
We as a company continue to focus on that as a tool. Overall, cooperative advertising, I wouldn't say is either more or less competitive than it has been.
Okay, great. Thank you.
You're welcome.
Again, ladies and gentlemen, if you have a question or comment at this time, please press the star then the one key on your touchtone telephone. Our last question comes from Budd Bugatch with Raymond James.
Dale, I should have asked this question because you've given enough pieces of it, and I apologize for getting back on the queue. Since you're going to put the 10-Q out on Friday, can you give us the operating margin number by segments?
Operating margin by segment?
Yes, sir. As you do in the Q.
Yeah. Well, keep in mind it's on a GAAP basis. Right?
Yes, sure.
Sealy was 10.8%. Total Tempur operating margin is at the, including corporate. Again, this gets mixed together. It's 13.3%. Hang on, I'm trying to read small print. Tempur International is at 22%. I don't have Tempur North America split out from corporate right now.
Okay.
You can see that Friday. I don't have that in front of me.
Appreciate as much as you can give us. Thank you.
I'm not showing any further questions at this time. I'd like to turn the conference back over to Mark Sarvary for closing remarks.
Okay. Well, thanks very much. We look forward to talking with you all again early next year. Thanks for joining us this evening.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.