As a reminder, today's conference may be recorded.
Now, my pleasure to turn the floor over to Mark Ruh. Sir, the floor is yours.
Thanks, Yui. Thank you for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO Dale Williams, EVP and CFO. After our prepared remarks, we will open the call for Q and A. Forward looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that forward looking statements, including the company's expectations regarding sales, earnings or the proposed transaction 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 ks under the heading Special Note Regarding Forward Looking Statements and or Risk Factors. Any forward looking statement speaks only as of the date on which it is made.
The company undertakes no obligation to update any forward looking statements. The press release, which contains the reconciliation of non GAAP financial measures to the most directly comparable GAAP measures, is posted on the company's website at tempurpedic.com and filed with the SEC. With that introduction, I will turn the call over to Mark Sarvey.
Thanks, Mark. Good evening, everyone, and thanks for joining us. Before we get into the quarter, I want to make just a few comments about our proposed transaction with Sealy. We are very excited about the potential for the combined company. Together, Tempa and Sealy will have a portfolio of highly complementary brands, products, technologies and geographic footprints that will provide a robust platform for growth.
We have initiated a process and are working with Larry Rogers and the Sealy team to prepare for a very successful integration once the required regulatory approval is received. I have been very impressed with the Sealy individuals I have met in the short time since our announcement. Now I'm sure that you understand our constraints in discussing details regarding this transaction, so we'll focus tonight's call on our Q3 performance and the updated financial outlook for Tempur. As I've said before, the competitive environment we are currently facing is very different than anything we previously experienced. I said that our competitive response would require a broad series of new initiatives and that these would be implemented over a period of time and their full impact would not be expected to be seen until early 2013.
And our Q3 performance is consistent with this. To summarize, our Q3 sales overall declined 9% and were down 7% on a constant currency basis. North American sales declined 14%, but were in line with our projection of slight sequential growth relative to the 2nd quarter due to seasonality. International sales increased 3% and on a constant currency basis increased 11%. While our international business once again delivered a solid quarter in what many would consider to be a difficult economic environment, our international sales were below our expectations.
We recorded a $0.03 loss per share on a GAAP basis. The loss reflects the provision for taxes that we recorded to reflect the anticipated repatriation of foreign earnings together with transaction costs related to the proposed Sealy acquisition. Excluding these items, adjusted earnings per share were $0.70 in the 3rd quarter, down 22%. I'll provide an update on the progress of our new initiatives and then I'll turn the call over to Dale for details of our Q3 results and the updated financial outlook. We indicated on our July 24, Q2 call and disclosed in an 8 ks filing with the SEC on July 30, we launched a broad series of new initiatives at the Las Vegas Industry Show.
They included 6 new product introductions, 5 new mattresses and a new adjustable foundation and the discontinuation and closeout of 2 U. S. Mattress models also wholesale mattress price reductions on certain U. S. Models to improve the margins of our U.
S. Retail customers, manufacturer suggested retail price reductions on 2 U. S. Mattress models and warranty extension of all of our U. S.
Mattress models to 25 years to improve the competitiveness of our products in the marketplace, and various other initiatives including customer program and integrated advertising adjustments to realign dealer incentives given our reduced financial year 2012 outlook. These actions were well received by our retail customers and believe by many to be the appropriate response. While some of these initiatives were implemented during August, many more have just recently been launched. Only in September do we begin shipping all of our new mattress models. Retailer enthusiasm for these new products has been high and our early read is that it appears we've gained some overall spots at our key retailers.
It's still very early. The rollout of these products is less than 50% complete, but we are witnessing some promising initial signs. Demand for some of our new products has been greater than we expected. And as pleased as we are by this initial reception, we are equally disappointed that as a result many of our retail customers are facing order backlogs or allocations due to our supply constraints. And we have been moving as fast as we can to very quickly ramp up our supply lines to address this demand and are now beginning to catch up on the backlog.
And we anticipate that supply will be normalized within the next few weeks. We launched the new Tempur Weightless collection featuring the Tempur Weightless Select and Supreme mattresses that have a unique to the market feel. The support of a Tempur combined with the easy mobility of a traditional mattress. We also launched the Cloud Supreme Breeze and Rhapsody Breeze mattresses, which optimize the sleep climate to produce an extra cool feel for people who feel that they sleep warm, While our existing beds are already proven to be cooler than the leading gel foam beds in independent tests, these new mattresses take our cool comfort advantage to the next level, featuring phase change material and proprietary Tempur Climate material. We also introduced the Tempur Cloud Select mattress at $19.99 which offers consumers a better value proposition than the cloud mattress it replaced.
It is both taller and has an improved color. These new mattresses are not only differentiated from competing products on the floor, they're also proprietary and further expand our growing and already extensive portfolio of innovations. We'll not stop here though. Our pipeline of innovative new products remains very robust. We have several compelling strategic initiatives and product introductions planned for the January August 2013 Las Vegas industry shows that we believe have the potential to contribute significantly to our overall business in the future.
It's important to note that these new initiatives have come at a price and are more costly than we had initially estimated. As we communicated in July, our objective is to return to growth even if that requires some reduction in our overall margins in the short term and our margin performance in the Q3 reflects this. While our immediate focus remains on returning to growth, we have already identified opportunities to improve margins, and we'll work on achieving these in the Q4 into 2013. Switching to our international business. Growth trends softened during the Q3, which we attribute to a persistent and weakening macroeconomic environment in Europe.
That said, we continue to perform very well in certain of our key European markets and our Asia Pacific business was up strongly during the period, reflecting solid performance in markets like Japan and Korea. Still, visibility internationally is limited and the environment is more uncertain today than it was just a few months ago. While we had been expecting double digit growth to continue for the remainder of the year, given the uncertain economic backdrop we are no longer projecting this. In closing, I'd like to reflect on where we are today and where we're headed. Tempur Pedic was the key driver of change within the industry over the past decade.
And we've always anticipated that as we grew the specialty category, it would get more competitive, and that's what has happened. The landscape has changed and the new playing field is in the process of being established. It's a different competitive environment than the one we were in historically. However, we are not any less committed or less confident in our ability to resume growth and outgrow the overall industry once this new playing field is established. We have significant advantages from the strength of our brand, our integrated supply chain and our expertise in consumer focused innovation.
Nonetheless, Tempur is currently competing in a single area of the market against competitors who have the benefits of scale from competing in all segments of the market. The proposed combination with Sealy will address this issue, allowing the combined company to compete broadly across the whole market. With that, I'll now hand the call over to Dale. Thanks, Mark.
I'll focus my commentary on the financials and our 2012 guidance. Let's begin with an overview. In total, 3rd quarter net sales were $348,000,000 a decrease of 9% over the same period last year. On a constant currency basis, net sales decreased 7%. North American net sales were down 14% and international net sales increased 3%.
On a constant currency basis, international net sales increased 11%. Now by channel. In North American retail, net sales were $221,000,000 a decrease of 14%. Our North American direct channel decreased by 15% to $17,000,000 Internationally, retail sales were flat at $85,000,000 and up 7% on a constant currency basis. By product, overall mattress sales were down 11% on a unit decline of 2%.
North American mattress sales decreased 15% on an 8% decrease in units. In the International segment, mattress sales increased 1% on a constant currency basis were up 10%. Units increased 10% also. Total pillow net sales increased by 11% on a 10% increase in units. North American pillow sales increased 5% on a unit increase of 9%.
International pillow sales were up 16% on a 12% increase in units. A constant currency basis, international pillow sales increased 23%. Sales of our other products, which include items that are normally sold along with the mattress, were down 13% in total and down 16% in North America and down 3% internationally. On a constant currency basis, international other sales increased 5%. Gross margin for the quarter was 49.2%, down 3 10 basis points year on year and down 140 basis points sequentially.
On a year over year basis, gross margin declined primarily due to the following product mix and increased promotions and discounts. These were partially offset by positive geographic mix. On a sequential basis, gross margin declined 140 basis points as a result of the product mix and increased promotions and discounts. These were partially offset by improved efficiencies in manufacturing and fixed cost leverage on higher third quarter sales relative to 2nd quarter sales. As Mark indicated in the opening remarks, our new initiatives have been more costly than we initially estimated.
This factor along with lower than expected international sales and overall product mix led to Q3 gross margin coming in below our previous expectations. From an operating expense perspective, we were generally pleased with the progress we made during the quarter. We realigned cost to reflect the reduced North American sales projection as we communicated in July. Advertising spend in the 3rd quarter decreased 3% to $38,000,000 from last year's Q3 and decreased 16% on a sequential basis relative to the 2nd quarter. As a percentage of sales, advertising spend was 11% in the 3rd quarter compared with 10.3% in the Q3 last year and 13.9% in the Q2 of 2012.
Despite the slight reduction in advertising, we have continued to see positive results with brand awareness and purchase consideration. We also lowered G and A expenses during the quarter as reported after adjusting for the Sealy transaction costs incurred and the benefit from the long term incentive compensation reduction. During the Q3, the company recorded a benefit of approximately $8,000,000 related to grants from the 2012 2011 performance restricted share units due to the company's reevaluation of the probability of meeting certain required financial metrics. This benefit was offset by approximately $3,600,000 of costs related to the acquisition of Sealy. We continue to invest heavily in R and D, which was up 63% year over year.
Our 3rd quarter reported operating income was $63,400,000 or 18.2 percent of sales. As previously indicated, the reported GAAP financial results include both the $3,600,000 Sealy transaction costs as well as the benefit of approximately $8,000,000 related to the long term incentive stock compensation plan. Interest expense was $4,800,000 The tax rate, however, was 103%. The tax rate reflects the provision for taxes recorded with respect to the anticipated repatriation of foreign earnings, which in total was $42,000,000 Without this tax impact, the normalized tax rate for the quarter would have been 32.5%. The $40,000,000 tax amount reflects all of our historic foreign earnings and profits of approximately $350,000,000 For accounting guidelines, it was appropriate to record and accrue for the expense in the Q3 based on the timing of our decision to acquire Sealy.
The cash tax repatriation payment is also not expected to occur until the quarter following the transaction close. 3rd quarter GAAP EPS was negative 0 point 0 $3 as compared to $0.90 per diluted share in the Q3 of 2011. Adjusted EPS was 0 point 7 $0 which as detailed in the press release excludes the tax impact from the repatriation of foreign earnings and the Sealy transaction costs incurred in the Q3. Included in the adjusted EPS was an after tax $0.09 per diluted share benefit from the long term incentive stock compensation adjustment. Next, I'll turn to the balance sheet and cash flow for a brief review.
Our accounts receivable balance was up. DSOs were up 6 days from last year primarily due to timing. Inventories were down $4,000,000 year on year or 4%, principally due to greater emphasis on inventory management due to our reduced sales expectations. Payables were up 9 days, primarily due to the timing as we were ramping production of the new products. During the quarter, we generated $67,000,000 of operating cash flow and capital expenditures were $18,000,000 We decreased debt by $32,000,000 to $650,000,000 Our cash balance increased $18,000,000 to $152,000,000 primarily driven by international operations.
Funded debt to EBITDA ratio was 1.98 times. Now I'd like to address our updated financial guidance for 2012. Today, the company lowered its outlook for full year 2012 net sales to be approximately $1,400,000,000 In addition, the company lowered its full year 2012 earnings guidance. The company currently expects 2012 adjusted EPS of approximately $2.55 The company notes that its expectations are based on information available at the time of this release and are subject to changing conditions many of which are outside the company's control. The company also noted its adjusted EPS guidance does not include tax provisions expected to be recorded in the Q4 in connection with the decision to repatriate foreign earnings or transaction costs related to the proposed Sealy acquisition due to uncertainty of timing and magnitude of these items.
In addition, the company's net sales and adjusted EPS guidance assumes the Sealy transaction is not completed during 2012. In light of the current market and our limited visibility, our updated fiscal year 2012 sales guidance assumes that our 4th quarter aggregate sales are a continuation of the 3rd quarter aggregate sales, although there may be some variation between the North American and International segments as compared to the Q3 due in part to seasonality. Given the amount of current uncertainty, we feel that this methodology remains the best approach. Through the 1st 3 weeks of October, we are tracking to these projections. 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.
The company currently projects gross margin for the full year to decline approximately 170 basis points and expects gross margin in the Q4 to be similar to the Q3 gross margin rate. The company currently projects operating margin for the full year to be 18.2%, excluding the 3.6 $1,000,000 of transaction costs. In the Q4 of this year, we are expecting operating margin to be approximately 16% as we continue to roll out new products and we'll have a full quarter of the new initiatives. We currently anticipate interest expense for the full year to be approximately $18,000,000 We anticipate capital expenditures will be approximately $50,000,000 which includes the cost of our new office in Lexington. We now anticipate the full year tax rate excluding APB23 to be approximately 32.5%.
We continue to expect an average of 63,000,000 shares for the full year based on the current share count of 61,000,000. 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.
Understood, sir. Our first question comes from the line of John Baugh with Stifel Nicolaus. Please go ahead. Your line is open. Thank you.
Good afternoon.
If we could start with the gross margins and talk a little bit about some of the puts and takes. Was there much of a change in production or capacity utilization? And then maybe comment on raw materials and then comment on how the incentives or wholesale price reductions were impacting the gross margins? Thank you.
Yes. Obviously, when in the second quarter when the business slowed down, we did curtail production. Production was curtailed, if you recall from the Q2 call inventories were high. So we continued to curtail production partway through the Q3. As we got a little bit further into the quarter, we started ramping production back up a little bit and ramped it up even more going into the end of the quarter as we start to produce and ship the new products.
So from an overall productivity standpoint, capacity utilization dropped a little bit and then returned as the quarter went on. Not a big factor in fact. From an overall productivity standpoint, we still were
able to
deliver positive productivity in the factories, but not at the rate that we have experienced before or that we would have expected earlier just because of the lower volumes also. A lot of our effort was redirected to getting the new products going as opposed to improving the cost position of other products. From a commodity standpoint, John, there really wasn't any change. Commodities were not a factor one way or the other in the quarter. Commodities have been pretty stable for some time.
As we said earlier, if we look at the mix of the business in terms of the gross margin impact, part about 40% of the impact was related to mix, about 40% was related to pricing actions. And then the other 20% was related to the floor models that went out. We did have more floor models going out than we had originally anticipated of the new products. And those were as we said earlier partially benefited from the productivity initiatives. But the other factor that plays in there was the geographic mix was not what we expected.
We did expect international while international had a good quarter, we did expect international to actually do much better than it did. We saw the trends in Europe change. And so that's been reflected not only in Q3 actuals, but also in our outlook for the balance of the year.
And thanks for that color, Dale. Is there you mentioned the implementation of a lot of these things is still ongoing in the Q3. So as it relates to incentives with the dealers, Is that something that accelerated as you went through the quarter and would therefore have more of a negative impact in the Q4 or that they work through pretty much in the Q3?
Yes. John, there is going to be a greater effect in the Q4 because they were implemented in the Q3, but they weren't all implemented at the beginning. So I would anticipate a certain there will be as we projected out there's going to be a greater impact in the Q4. It's more of a run rate or more of a kind of full quarter effect than it is of a change of the run rate. Okay.
And Mark you made the comment about I think sales stabilizing with some of these changes. Could you quantify that or what does that mean precisely?
Well, in the U. S, our sales in the Q3 are essentially up a little from the Q2, which is what we had what we were projecting to do. So we have stabilized the decline and we've got the degree of the little bit of seasonality that we had anticipated. And as we look forward, we said the 1st period of October, Dale said, has been consistent with the projection, which is also a continuation of this sort of steady state. So that's what we're saying about stabilizing.
And my last question quickly is on advertising. As you think about ad spend in 2013, is that going to be a source of leverage to earnings?
We're not going to talk about the specifics of guidance for next year, but so I can't get into that level of detail. But what I will say is that advertising is going to remain to be an important part of our business going forward. I don't see it being a source of great leverage or a source of great cost.
Thank you.
Bill, you had something you want to add? Yes.
I just wanted to add a couple of points there
on the
stabilizing. Obviously, John, if you look at just the North American business, it shows that it was down more in the Q3 than it was in the Q2. But it's down not as bad as the trends at the end of the second quarter. And as we're leaving the Q3, the trends are better than what they are reflected for the full quarter. So our expectation for the rest of the year would be that the North American business is still going to be negative, but it's not as negative as it was in the Q3.
We're seeing improve by stabilizing what we mean by that is we're seeing while still negative trends, those negative trends improving some.
Great. Thank you for that color. Good luck. Thank you, sir.
Our next question in queue comes from the line of Anmuthatch with Raymond James. Please go ahead. Your line is open.
Yes. I have a few questions. Good afternoon. Just making sure on the adjusted EPS that the only two items that are adjusted in there are the tax provision on the repatriated funds and the transaction costs related to the DOS so far? Correct.
Okay. And the $8,000,000 of savings that came from the recalibration of the LTIP, I take it that that money will actually show up again in the Q4 and so that benefit will not recur, is that right?
That benefit will not recur, correct. Okay. But it's we're calling it out because it was important to the quarter, but it's we historically have had to make LTIP adjustments up or down at various times as we've reevaluated our position on those programs.
Okay. And I hate to beat this horse, but I think I'm a little confused on the stabilization issue. You had sales down domestically down 14% and you said that the trends at the end of the quarter were not as bad as the trends at the beginning of the quarter. What does your guidance imply for domestic sales year over year for the Q4?
Guidance would imply domestic sales being down in the neighborhood of 10%.
Okay. All right. On the accounting for the tax of the repatriation, make sure I understand that you basically tax effect all of the embedded earnings that have not been taxed before to bring back the cash? Correct. And how much cash are you planning to bring back from offshore in that number?
Well, I mean, we from a book standpoint, we recognized a $42,000,000 expense and that's related to $350,000,000 of not previously taxed foreign earnings and profit. So sitting here today, we would expect that we would bring back at least $350,000,000 over the next few years. However, we will be and we are looking at opportunities within the because of the acquisition to enhance the efficiency of our international tax structure. And we believe we might could do better than that, but we'll as time goes on and we get that firmed up, we'll let you know at a future point in time what that could look like.
So you could bring back dollar for dollar of the repay of the taxes of the income so taxed?
Correct.
Is that what you're saying? Yes. Okay. And when you put the inventory down and the inventory was down nicely, obviously that has some impact on the gross margin. Can you quantify what that might have had in terms of inefficiencies of drawing down the inventory?
Is there any way to look at that on an ongoing basis?
Well, I think the important thing about it is it was early in the quarter and by the end of the quarter production was back up at a more efficient level. It was not a material thing. It was built into the productivity, which was an overall benefit. But certainly, as we were getting to the end of the quarter, building the new products, starting to get those shipped that caused production to go back up a little bit. In fact inventory ended a little bit too low as Mark mentioned.
We've had to allocate some of the new products. But we're getting out of that hole here in the next couple of weeks.
All right. But that would also imply probably a mix variance that was not positive too because as you develop new product that takes a lot of learn how to make that product efficiently. Would that be a fair assumption?
Right. 2 negative mix issues there, but you've got A, floor models going out. Obviously, floor models are discounted at 50%. You also have not all new products cause mix problems, but new technologies cause mix problems. And there's a lot of new technologies in these new products.
And there's a learning curve on those. They're never real efficient when you first start making them. So as time goes on and you produce more of them, you get more efficient and you find ways to improve the cost of those over time. So as we go forward into next year and start getting down the learning curve, we would expect to see some good productivity on the new products that we've launched here in the last month.
Okay. And I have just two quick other questions. Your DSOs were up, I think the 42 days, if our calculation is right, up 6 days. You said that was timing, there is no additional terms being granted to your dealers?
No change in terms. It really was a function of the as we got to the end of the year, you've got I'm sorry, the end of the quarter. September was better than the other months of the quarter, plus you had those 4 models going out.
That's good to hear that that's September issue. That's I hope that continues. And finally, the new ad I saw on the web, Love Waking Up, what does that imply for the Ask Me campaign? And will we see that Love Waking Up campaign exported more to the general broadcast media?
Well, the primary advertising on for the next little while is going to be is going to continue to be Ask Me. And the fundamental premises of Ask Me are going to continue going forward. We plan to evolve our advertising in the 1st part of next year and we'll talk more about that at the appropriate time. Okay.
Good luck on the quarter.
Thanks a lot, Budd.
Thank you, sir. Our next questioner is Keith Hughes with SunTrust. Please go ahead. Your line is open.
Thank you. A couple
of questions. You'd referred to the allocation issues on the new products. I assume that was all new products. I guess that's number one question. And then number 2, with it being rolled out in such limited numbers at this point, I was surprised that was a problem.
Can you address that?
Well, what do you It's not when we rolled it out, we had anticipated it has always been anticipated that these products will be in broad distribution. And as we in general, we have a sequence of rolling them out in stages. And we were following that normal sequence. And the sales sell through has been higher than we had anticipated. So reorders were quicker than we anticipated.
And so what we have done is as a kind of temporary measure is stopped the rollout of to the next wave of customers. Obviously, it's frustrating for those customers, but we felt that it's less frustrating than having product on the floor which they can't get for customers. And then unfortunately there are some of our customers who are in that situation. And as I said, we're moving heaven and earth to get this fixed. It's not something we're pleased about and we're addressing it as quick as we can.
And but we do believe we'll have it sorted in a couple of weeks. So it's an issue and we're not happy about it, but we're working hard
to fix it. But it is related to the new products?
Yes, sorry. It is the new products we're referring to here.
Do you have an estimate of when you'll continue the rollout or when we'll be done maybe is the question?
Question? I don't have the detailed plan, but I anticipate that we'll be sort of switching it back on again in a couple of weeks.
Okay. And a question for you Dale. With the revenue guidance and the flat sequential gross margin, it seems as though the EPS would be higher than what $2.55 for the year would imply. Is there anything below the line that's unusual that's going to be affecting the quarterly number?
No. The only thing unusual below the line in the Q3 you have a net benefit of approximately $4,000,000 between taking out the 3.6 of transaction costs and the LTIP benefits. We are continuing to increase our R and D spend because we have a lot of very good programs that we're pushing to bring to market early next year and other programs that are doing a lot of work on that are slated for mid next year. From an overall standpoint, one of the issues Keith is versus our prior expectations from a revenue standpoint, the revenue change is international. The Q3 international was less than what we expected in the Q4.
We had a significant impact around international. The international, particularly things that are more tangible, more variable become a little bit less variable in the short term. The commitment timeline around advertising is longer internationally than it is domestically. So we're already by the time we saw international or Europe slowing down a little bit, you are already committed for the quarter. So we're not seeing a lot of movement on expenses in the international business with the revenues slowing down there in the short term.
That said, I would add one other thing is that we've talked before about the fact that the international business does react well to the advertising particularly in Europe. We've seen that this year. What we're seeing in Europe is very different than what we have in the U. S. It's not a competitive situation, it's a macro situation.
And that our belief is that the ROI on the advertising it remains good. So while we're being cautious about it, we believe it's the most appropriate thing to do is to continue to invest in it.
In the near term until that takes hold is you expect in this guidance international deteriorate further in the Q4?
No. We think that we've got a from what we can see the trends internationally, we've got that reflected well in the guidance.
Thank you.
Thank you. Next questioner in queue comes from the line of Brad Thomas with KeyBanc Capital. Please go ahead.
Yes. Thanks. Good afternoon. And just to follow-up on that last line of questioning in Europe. What did the international trends look like as the quarter was wrapping up?
And can you give us a better sense of what you would be looking for? And in constant currency, are we still in an environment where you guys are going to be able to do positive sales growth?
From a projection point of view, we're projecting essentially flat give or take in a constant currency basis or the projection is essentially flat in a constant currency basis. It's just a reflection of a slowing down that we saw at the end of the Q3. We think it's appropriate to project that for the Q4.
Great. And then just along that same vein, Mark, the cloud rollout in Europe has really been a big success as it was in the U. S. Can you just talk about slots in Europe? And are we going to continue to see slot growth there?
Are there any other things you can do to drive more organic growth in spite of the slowing environment? Yes.
I mean, first of all, yes, we are growing slots and we are growing doors. And also and I know you know this, but it's not just Europe. Our international I mean, our Asian business is growing very well. For example, Korea and Japan are both growing very well. And in Europe, in particular, advertising is quite an effective tool and continues to be.
And I think that it's important to recognize that even in this tricky environment we grew 11% in the Q3 in Europe. It's just that we're all of us can see the macro environment is tough. We believe the fundamentals for Tempur Pedic and Tempur Pedic's relative growth and Tempur Pedic's market share are going to continue to develop. We see that is not something we see changing. It's more a reflection of the overall business.
Great, great. And if I could just ask one more question around the U. S. Business. Is there any color that you can provide around the price points?
I mean, if we look back at your actions during the summer, you lowered the prices on the Simplicity line, you exited the Kontoor model, you improved the cloud model, all price points $2,000 and below where you really made some actions. Is that where you've seen the greatest pressure? Or is it really across the whole line? Any more color would be very helpful.
Our AUSP has gone down. And if you break it down, the fundamental reason why, the addition of simplicity is clearly the biggest one. There was the adjustment to the Cloud Supreme price, which has had some effect too. But the decline in our business is relatively broadly spread across the different parts of the business relatively even. And I think what we're focused on and what I know a lot of customers are is that there's a focus on making sure that the $2,500 and above segment of the market continues to grow for the whole industry.
And that's an area where we're obviously we're very focused on maintaining growth. One of the advantages of the new products that we've just introduced, the cloud and I mean, sorry, the Breeze and the Waitlist, that they are providing consumers and retailers new products at those price points, which are raising the AUSP for the industry.
Very helpful. Thank you, Mark.
Thank you, sir. We also ask that you please remember to keep yourself to one primary question and one follow-up. Our next question in queue comes from the line of Jessica Schellen with Barclays. Please go ahead. Your line is open.
Good afternoon, everybody. Just following up on the question regarding the price points. I was wondering as you start to see some of the pressure moderating, is there any particular segment in your range of products where you see that stabilization coming back quicker than other parts? And is there any particular initiative you can point to that you have seen really have the most impact?
I mean truthfully not really. It is spread across the whole of our line. And the initiatives that we're doing particularly the advertising and promotional things are aimed across the board. So not really is the answer.
And then as far as the implication of the recently the pricing on the recently introduced products as for gross margin in the Q4, is there anything to be aware of or anything assumed in your guidance?
Can you say that again? Forgive me, say that again.
Sorry, the pricing of the recently introduced products, if there's any implication of that on gross margin in the Q4 that we should be aware of?
Not on price from a pricing point of view, but from a as Dale was saying earlier, like they have a lot of new technology in them. And as a rule, a new product with a new technology generally has we haven't got down the cost curve as much as we'd like on some of our more established products. And therefore, they generally have a slightly lower margin and that is the case for these products.
Okay, great. Thank you for taking my question.
Thank you, ma'am. Our next question in queue comes from the line of David MacGregor with Longbow Research. Please go ahead. Your line is open. Hi.
This is Josh Borstein in for David MacGregor. Thanks for taking my call. Just a point of clarification. Did you say the $2,500 an up price point was still growing?
No. No, no. No. Well, I didn't say that. And it may be I but frankly, I didn't say that.
And if I did, I misspoke because I wasn't talking to the whole industry. What I was saying is it's an area of focus for us and for the industry.
Okay. Thanks for that. And then with the world with the waitlist and the Breeze, you had some allocation issues. Could you say was it the waitlist or the Breeze that was on backlog?
It was a bit of both, but it was but the Breeze was the primary one.
Okay. And is that an indication just that at this point in time, it's selling better? Or was that due to some other reasons?
It's early and we're in the middle of a rollout. So it's sort of not just a question of how well it sells, but how well it sells against the forecast of the rollout schedule. So it's a little bit hard to read. Having said that, all indications are it's selling a little better than we expected and we're pleased about that.
And then just a final one on the drop of the price of the Simplicity. Have you noticed any change in sales since that was implemented? Do you think it's better succeeded in moving people up who would have spent $800,000 to $1,000 maybe moving up to that $13.99 price point?
We it's hard to tell frankly. But we think that there is some benefit. And the simplicity has not been the big success that we had hoped it would be. But it is still a material part of our business and we think that that pricing has had some effect. Okay.
And then if
I can just squeeze one more maintenance question. Could you give us an update on your door count for the U. S. And international?
Yes. Let me see if I can read it. North American doors, furniture and bedding, 8200. International is that right? International is 5,600.
And about 400 of those in Canada. Is that still about right?
Yes. About 400 in Canada.
Thanks for taking my questions. Good luck.
Thank you.
Thank you, sir. Next question in queue comes from the line of Joe Altobac with Oppenheimer. Please go ahead. Thanks. Good afternoon.
First, in terms of the competitive environment, obviously, you've had a pretty sizable influx of competitors and
they've been pretty active on
the promotion side throughout most of this year, well into the summer. Have you guys seen any slowdown or pullback on their part in terms of the level of dollars that's in the trade at this point?
No. I mean I can't say. As we've said there's been a degree from our perspective of stabilization, but there continues to be it continues to be a very competitive environment and we can detect no fundamental I can detect no fundamental change at this stage. Okay.
And just to follow-up on that on a related topic here, you mentioned earlier that the initiatives you're seeing or that you're implementing have been more expensive than you thought. Could you kind of drill down as to why that is? Is it that the price reductions that you put through did not drive the volumes you thought? Or is it
that you had
to increase the level of price increases and promotion activity throughout the quarter?
If you can just give a little
more color on that point that would be great.
Let me say I will and 2 pieces. First of all, when we talk about the new initiatives, we always are including the new products. And the new products because of what we've been talking about in terms of the cost of production have been more expensive than we had anticipated when we first projected what they would be. So part of the cost of it is the cost of the relative costiness of the new products. The other part though have been the promotions and things that we've done with retailers.
And we're learning how to do it. One of the things we said on the last call was that we were going to do initiatives with different retailers and in different areas of the country and then we were going to measure them and calculate ROIs and work out which ones work the best and which ones didn't. And we're doing just that. And we're learning frankly we're learning as we go and we're going to get better at this. And it is part of the world that we're competing in now.
But quite frankly some of them have been less given it to do again we wouldn't have done some of them. But on the other hand some work quite well and we're learning that. And so this is sort of part and parcel of learning as we go here in this new world.
Okay. Just one last one if I could. In terms of the international business, you mentioned trends seem to weaken a little bit and that was related to the macro. Why do you think it took this long for the macro to start to impact you guys? And are there additional distribution opportunities there?
Or are you guys really kind of where you want to be at this point in terms of Europe in particular?
Well, remember that our penetration in Europe in particular, our distribution is really quite good in terms of the number of doors that we have. There are clearly some opportunities country by country. We can always talk about 1 or 2 of the areas that we think that there's an opportunity for us to grow in distribution. But obviously, we are growing slots is a big area of focus, which is why the cloud rollout has been successful and the Sensation, which is essentially the to a large extent can be described as the wait list of Europe. Those three product lines are enabling us to increase our slots.
And awareness is the big one, which means which drives the turns in those areas. And those are the 3 areas that we are very focused on. And they continue to seem to be effective and continue to show up to make us believe that the penetration which we have in Europe right now which is much lower than it is in the U. S. Can get significantly higher.
In terms of why the macro environment hasn't affected us as much yet, I think partly it's because we haven't we're not seeing it because we have been growing. So we're sort of a little bit we're not seeing what the underlying trends are because we're doing quite well. And what we're seeing now as I said is still sporadic. It's not like a fundamental across the board. It's just a general sporadic weakening which is causing us to be a little cautious looking forward.
Okay. Thanks, Mark.
Thank you, sir. Our next question is Joshua Polan with Goldman Sachs. Please go ahead. Your line is open.
Thanks for taking my question. First, I would love to understand why Tempur Pedic is focused more on growth than on margin. From a returns perspective, it seemed like margin pays more from a returns perspective to shareholders. And I'd just love to understand the strategy.
That's a fair question, Joshua. And the answer is this. As we said when the environment changed for us quite dramatically earlier in the year that what we were going to do was that we believe very fundamentally that specialty is going to continue to grow and that we're going to be in a very strong position to grow in specialty, firstly because of our strong brand name secondly because of our cost advantages because of our vertically integrated supply chain and thirdly, because of our focus on consumer innovation. So we believe that the specialty category is going to continue to grow and that we are going to grow we should grow as fast or we should grow faster than it. And so we're very key it's very important for us strategically for a long term return to shareholders to have a strong and growing position in this large market.
But given the environmental changes that we had to do, we had to approach this very quickly. And we decided and we said it at the time that what we were going to do was step 1, we stabilize our business because we were declining very fast. We had to stabilize our business. Step 2 was to work out and implement plans that would drive growth. And step 3 would be to continue to put back our focus on productivity and cost improvement to get our margins back.
And so we have very deliberately and strategically approached it this way because we believe in the long run we're going to have the greatest return for shareholders having a big and thriving business with a very good margin than we would be if we were to just pull in our wings and allow the situation to do what it's doing. It was a very conscious strategic decision one that obviously your question is a fair one. This is the way we decided to approach it.
Okay. Have you guys considered cutting guidance given what's happening both on the competitive side and just a limited visibility. You take a look back to 2,004, 2005 timeframe and as you guys were going through different struggles at that time, there were a number of different cuts to guidance. Are you guys committed to giving guidance on a go forward basis?
Generally, we think it's a good idea and helpful to give you our thoughts. However, that's something that we can't evaluate it from time to time, but we're giving guidance today. And so that's still what we're doing.
Okay. You guys talked about the benefit of scale in competing across the whole market. Can you somehow quantify that or at least give some more qualitative color around that? I know you guys are changing your approach to the business with the Sealy acquisition, but I'd love to understand what the real benefit is of competing across the whole market.
Well, there are several benefits. But one of the obvious ones is that the raw materials of the company across the industry are very similar. So there's opportunities for manufacturing and purchasing savings across the portfolio. Another big one is distribution that although different products are made and targeted at different consumers, they can be carried in the same trucks and delivered to customers at the same time again in efficiencies. So there are areas of efficiency and there are also areas of benefit from for example shared R and D that can work across.
So we think there are quite significant benefits of working across the whole.
Okay. And then when you can you talk about the average hit to margin from bringing a new bed to the market? You are bringing new products to the market much more quickly than you used to. And so there's always a lot of talk about the impact from rollouts and distribution. So what I'm trying to understand is what impact were you guys seeing once a year that you'll now see somewhat closer to twice a year?
I can't put an exact number on that. And the answer because the answer is it will depend. And so I can't give an exact answer, but it will depend and it is a cost. And I think that one of the things that in this new environment we will continue to be innovative. We know that the thing that really drives growth is innovation in this industry.
And as it becomes more competitive it's going to be necessary for us to innovate more frequently. We have been innovators and we will continue to be. Getting more and more efficient at doing this is something that we're going to obviously focus on. But that is the price of poker in this new world. Okay.
Very last question. ROI on advertising, can you tell us what it was and what it is today in this new world? I'm just trying to understand. You guys have very high awareness and so I'm really trying to understand what the ultimate benefit is of an additional dollar of advertising in quantitative terms.
As soon as you get that, that will be very valuable to a lot of people. It's a hard thing to do. If you do it in internationally, in Europe, in countries where awareness is very low, one can actually over a relatively brief period see lifts in sales that can be attributed to advertising and is a very relatively easy calculation. In countries like the U. S.
Where awareness is quite high, it's a different thing. What it does drive is it drives it doesn't drive awareness as much as it drives propensity to buy and frequency of purchase. And it is a one of those things that is valuable and we know it is and obviously all the companies that are effective marketers would agree. But furthermore it's not something that has a return that happens the day you do it. It's not like you do it on Monday and you get a benefit on Tuesday.
It is beneficial over doing it over time. So it's something we are focused on. It's a very important part of our business mix, but we are very confident that building our brand is a key to our ongoing success.
Thank you, sir. Our next question in queue comes from Peter Keith with Piper Jaffray. Please go ahead. Your line is open.
Hi, thanks. Good afternoon, everyone. I just had two questions. First off, on the sales cadence for the quarter, I guess some of the chatter that we hear in the industry is that Tempur Pedic does pretty well on the off promotional weekends. But on those promo weekends like Labor Day when the competitive environment steps up with a lot of competitor TV commercials, that's where you guys see a real weakness.
And I guess if that's the case, it might explain why your sales had improved towards the end of the quarter. Is that a fair observation for what you guys saw in the Q3?
Not really. In the sense that first of all, our business follows the cadence of lift at promotional weekends. So that is we do also have a sales cadence that looks like that of the industry. Now the truth is historically a few years ago, we used to promote a lot less frequently. And therefore then in those days it was more true like you described.
But this is less so now. However, we are still a company as a proportion of our total marketing. Obviously, we still allocate a large proportion of it to direct to consumer. And therefore, we have less of a promotional bent than do some of our competitors. And this is something that we're kind of tweaking as we go forward because as we become as we said, we're putting more programs to be retailer and promotional targeted.
And that does imply that we're working more on that we're increasing our effectiveness at some of these promotions. So I would say that fundamentally it's not true, but it is an area that we can improve upon.
Okay. And maybe even just a follow-up on that Mark, because I appreciate the answer. With the sales improvement that you saw, is there something that you could point to whether it is particular new initiatives that are working or with the rollout of the new beds that picked up? Was there something that was a main driver or just general improvement overall?
I think the new products are contributing. But I also think that as I've said we are doing effective programs with different dealers and there are areas where it's clearly working. And so we've got to get this more widespread but it is clearly working in some areas.
Okay, that's great. And then separate question real quick. On the long term incentive compensation adjustment, I know it's clearly a painful adjustment for you. So right now you would not anticipate that as adjusted as reflected in your guidance. But I guess if there is further downside to your numbers whether it's Q4 or 2013 is that also something that could turn up from time to time in certain quarters again?
Well, yes. If you look at it our LTIP programs are 3 year programs. So, 2010 program is still in place. There's 2 months left on it. So, we have an assessment of where it will be.
And could that change?
Yes, it could.
It's been between here and the end of the year. But that one's almost over, 2011 2012. There's 2 components to these programs. There's an option component and then a PRSU performance restricted stock unit component. The PRSU component of these programs is variable.
There are a number of metrics that have to be met for those programs to vary and they can the variable component of it can be terminated. But based on the business performance this year, the 20 11 2012 variable component of the LTIP programs are no longer on the table. We broke the minimums.
Okay. Thanks a lot for the feedback. I appreciate it.
Thank you. Next question comes from
the line of John Anderson with William Blair. Your line is open. Good afternoon. Thanks for taking the questions. I understand that the new products as you roll those out the Breeze and weightlessness that the initial costs are perhaps higher than on some of the existing lines.
But how quickly can you kind of get up to comparable margins in those new product lines? Is there a do you have some visibility on that?
It depends. Dale said it a little earlier. He said it depends on the degree of new technology and both these new products have significantly new technology for us. So A, that means they're from a higher hurdle and B, it means that we've got a kind of a longer path to go down before we can get them down to comparable prices. So I mean there's no rule there's no single rule that applies to everything.
But it's going to take a little while. It's going to take a little while. I don't want to put an exact number on it. But this is not something that's going to get fixed in 3 months or 6 months. It will get better, but it will take time.
Okay. Is there any reason to believe that these new products with the new technologies you described Mark, you can't reach gross margin profiles in line with the balance of the portfolio over time?
In the long run that would be the intention. We always that's what we always target. But as I said it takes time and it will take more time for newer things.
Okay. And then in terms of the backlog that you experienced in the Q3,
how much
did that cost you in terms of sales? And do you expect to largely clear that in the Q4? You mean backlog of
new products? Yeah, the backlog. I think you said there was No, that was essentially within this that's relatively recent. That hasn't had any significant effect on the third one.
Okay. Fair enough.
And just for clarification on the G and A run rate, it gets to an earlier question. Dale, is it fair to assume you've kind of been at around $36,000,000 or so on a quarterly basis if you ex out the benefit of the or if you ex out the LTIP adjustment in that range as well. Is that a good way to think about the G and A run rate going forward? And you're including R and D in that?
Yes. Yes.
Okay, great. Last question guys. I know you can't talk much about Sealy, but is there any reason to believe that kind of the acquisition of Sealy and the combination that could bring more discipline to the industry in terms of pricing and promotion? Because it sounds like it's still quite aggressive at the moment. Thanks.
No. We've said that we think that the potential value for us, Acelia, is a full portfolio of products and brands and technologies. And obviously, there are some potential cost synergies, as I described a little earlier to a previous question. That's the way we're thinking about it going forward. Okay.
Thanks a lot, guys. Good luck. Thank you.
Thank you, sir. And we do have time for one final question. Our final question comes from the line of Eric Halwag with Stephens Incorporated. Please go ahead.
Yes. Hey, guys. Earlier this year, you opened your first company owned and branded store outside of Boston. And we've heard through the grapevine that a couple of others are in the works. And I'm wondering if you could just give us an update on what you've learned from the opening of that Boston store so far and how you're thinking about the company owned store angle as a strategic thrust going forward?
Thanks.
These stores are we call them flagship stores, but they're marketing stores. The purpose of them is to put Tempur Pedic in a showcase in a place where there are a very large number of people who generally are not considering buying a bed. That's the kind of the idea of these things. We're going to have probably 3 in the we're opening another one very shortly and we'll open another one in the beginning of next in the first half of next year. So we can see our way to about 3 right now.
And they're still an experiment. And the test that we're running with them is not just that they're successful at stores in their own right, but moreover the volume of the business in the kind of geographic area surrounding the store is lifted by them. And we've experienced this in Europe where we've got some stores like this. And it really does have an effect. It raises the awareness.
And if you think about it, people buy beds only once every 10 years. And when they do, they're only thinking about it for a very short period of time. What we know is that a very small proportion of the population has ever tried a Tempur Pedic because everybody pretty much everybody has heard about it. Very few people have ever tried one. If it's in a nice environment in a mall like these ones are, it gives people that opportunity.
And so what we're learning from this store that's been open a few months now is that that seems to be true. We seem to be getting a pretty good number of people coming in and just trying the beds who had no knowledge or intention of buying a bed in that period. Our sales are within the range of what we had hoped for to be able to kind of cover the costs. And so, so far the experiment seems to be going quite well. We're also learning obviously other things like managing a store and so on.
But I'm pleased with the process that we're making. I mean obviously another part about it is it's not just bedding, it's accessories and it's the other parts of that. But we're learning quite a lot. I'm quite pleased with how that experiment is going.
Thanks very much Mark.
Thank you, sir. And with that, I'd like to turn the program back over to Mr. Salisbury for any additional or closing remarks.
Thank you. And we look forward to talking with you all again in January when we host the Q4 earnings conference call. Thanks for joining us this evening.
Thank you again, gentlemen. Ladies and gentlemen, this does conclude today's program. Thank you for your participation and have a wonderful day. Attendees, you may disconnect at this time.