Oct 19, 2010
Executives
Barry Hytinen – SVP Mark Sarvary – President and CEO Dale Williams – CFO
Analysts
Bob Drbul – Barclays Capital Mark Rupe – Longbow Research Budd Bugatch – Raymond James Brad Thomas – KeyBanc Joe Altobello – Oppenheimer Keith Hughes – SunTrust Jack Murphy – William Blair John Baugh – Stifel Nicolaus Joan Storms – Wedbush
Operator
Good day, ladies and gentlemen, and welcome to the Tempur-Pedic's Third Quarter 2010 Earnings Conference Call. Today's call is being recorded.
At this time, I would like to turn the call over to Mr. Barry Hytinen, Senior Vice President.
Please go ahead, sir.
Barry Hytinen
Thanks Elizabeth, and thank you everyone for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO; and Dale Williams, CFO.
After prepared remarks, we will open the call for Q&A. Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.
Investors are cautioned that forward-looking statements including the company's expectations regarding sales and earnings 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, competitive, operating and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings including the company's Annual Report on Form 10-K under the headings, “Special Note Regarding Forward-Looking Statements and Risk Factors.”
Any forward-looking statement speaks only as of the date on which it is made. The company undertakes no obligations to update any forward-looking statements.
The press release which contains a 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. And, now as a reminder, the company will be hosting an Investor Day presentation in Q&A session on November 11th, 2010 in New York.
There will be a live webcast of the event available. For more information, you may visit the company’s website or email us at [email protected].
And, now with that introduction, it’s my pleasure to turn the call over to Mark.
Mark Sarvary
Thanks Barry, and good evening, everybody. Thanks for joining us tonight.
Today, I’ll provide a brief overview of our performance in the third quarter, an update on some of our strategic focus areas and commentary on our outlook. Dale will then provide a detailed review of the third quarter financial results and will discuss our revised guidance.
We’re pleased with the market share gains and the sales and earnings growth we’ve achieved in the third quarter. Sales are up 32% from last year and earnings per share were up 82%.
Our focus on improving gross margins and operating costs also continues to be very effective. Fixed cost leverage and our productivity program helped to increase gross margin by 340 basis points year-over-year to 51%.
And with that improvement partially offset by strategic investments, our operating margin expanded by 480 basis points year-over-year to 23%. As a result of this better than expected performance and continued good indications for the remainder of the year, we are raising our guidance for the full year, and Dale will go into the details.
Now, we’re doing this in an environment that’s still quite unpredictable, and we hear from many of our retailers that consumer traffic is still not back to normal. But we believe that our business will continue to grow and our share gains will continue.
Now, here’s a brief update on some of our strategic focus areas for 2010 and beyond. Firstly, I’m very pleased with the progress we made this quarter to ensure those are TEMPUR mattress and pillow that appeals to everyone.
The Cloud Collection which appeals to those consumers who prefer a softer feel continued to sell very well and helped to expand our market shares significantly. The price increase we took on the Cloud Supreme in the second quarter is not affecting consumer demand and the product continues to be very successful.
We are essentially complete with the rollout of the entry-level Cloud model and late in the quarter we began the rollout of the Cloud Luxe. Retailer interest in the Luxe is high and we believe it will also help us grow share and improve average price.
We are at this moment in the final stage of commercializing a Cloud line of mattresses to be launched in our international geographies and we’ll begin distribution early next year. And similar to our kick-off events in the US, we will be focusing a lot of attention on the Cloud as it begins its international distribution.
The second strategic focus area that I want to discuss is our commitment to ensuring that everyone knows that they would sleep better on a TEMPUR mattress and pillow. This quarter, we increased our total advertising investments to 37% above last year to $25 million, primarily by ramping of our “Ask Me” marketing campaign in the US.
We believe awareness of our brand is a key component of market share and top line performance in every geography where we can be. During the quarter, we also launched a new much enhanced website.
If you haven’t seen it, I encourage you to visit tempurpedic.com. The site does a much better job communicating our product architecture and allows us to more effectively link our direct activities with our retailer networks distribution.
It’s also designed to be much easier for the consumer to use. Our third strategic area is our commitment to ensure that TEMPUR is available to everyone.
We began opening some new accounts during September and October adding about 200 doors and expect further increases in the fourth quarter. During the quarter, we also expanded our average number of slots in our retail partner stores with the completion of the Cloud rollout.
Aligned with several of our key initiatives, including our commitment to ensure TEMPUR continues to deliver the best sleep, we utilize extensive consumer research and testing. And, as we discussed last quarter, we’re in the process of conducting a significant amount of strategic research across the globe.
And, while not yet complete, the findings are reaffirming our long-term plans. In particular, we’ll be focusing more attention on growth throughout our international markets, where we see marketing, product development, and distribution gains as the keys to achieving our objectives.
For example, we plan to increase brand awareness in Europe and Asia, by increasing our investment in advertising. Next month, at our Investor Event, when we have more time to review long-term plans, we will share more of these findings.
Throughout 2010, we have grown sales in profit, while improving our competitive position, strengthening our product line, improving the effectiveness of our marketing, and increasing our margin. We continue to project considerable potential for growth in Tempur-Pedic for Tempur-Pedic over the coming years.
And over the coming quarters we will invest to capitalize on this opportunity. With that, I’ll now hand it over to Dale.
Dale Williams
Thanks Mark. I'll focus my commentary on the financials and our 2010 guidance.
In total, third quarter net sales were $295.8 million, an increase of 32% over the same period last year. Foreign exchange rates were unfavorable during the quarter, such that on a constant currency basis, net sales increased 34%.
North American sales were up 47% and international sales were up 4%. On a constant currency basis, our international sales were up 11%.
By channel, in North American retail, net sales were $198 million, an increase of 52%. Our North American direct channel was up $4 million or 34%.
Internationally, retail sales were up 4% to $64 million. On a constant currency basis, international retail sales were up 10%.
On a product basis, mattresses were up 33%, driven by a 29% increase in units. North American mattress sales increased 46% on a 47% increase in units.
In the International segment, mattress sales increased 3%. On a constant currency basis, international mattress sales were up 10%.
International mattress units increased 3%, reflecting our comping the successful sensation mattress collection launch, and a continued sluggish economic environment in Europe. In total, pillows were up 20%, driven by 19% increase in units.
North American pillow sales increased 39% on a unit growth of 35%. International pillow sales were up 3% on a 1% increase in volumes.
Sales of our other product line, which includes items that are normally sold along with the mattress, were up 37% in total and 52% in North America. The other product line grew faster than mattress is largely related to improved attach rates of our adjustable beds.
Gross margin for the quarter was 51%, up 340 basis points year-on-year, and 230 basis points sequentially. On a year-over-year basis, the gross margin improved principally related to three factors.
One, increased production volumes to support higher sales, resulted in fixed cost leverage; two, our ongoing productivity programs generated improved efficiencies in manufacturing and distribution; and third, favorable product and channel mix. Partially offsetting these benefits were higher commodity costs and unfavorable geographic mix.
On a sequential basis, our gross margin was up primarily related to fixed cost leverage and improved product mix. Our third quarter operating profit was $68 million, an increase of 60% year-over-year.
With significant sales growth, we drove over 480 basis points of operating margin improvement. Our operating expenses were up reflecting our commitment to investments in sales and marketing initiatives to drive growth.
In addition, the increase in G&A expenses primarily reflects cost associated with the strategic research we had discussed last quarter. Interest expense was $4.1 million, and our tax rate was 30.5%, down from prior year driven by a one-time gain due to the reversal of a previously uncertain tax position.
Net income was $44.2 million, up from $25.7 million. Given our improved profitability, EPS was $0.62, up from $0.34 last year.
Now I'll turn to the balance sheet and cash flow for a brief review. Our accounts receivable balance was up reflecting sales levels.
However, DSOs were down four days from last year. Inventories were up $20 million year-on-year and modestly from last quarter.
Inventory days were up five days year-on-year, yet down one day sequentially. Payable days were up three days from last year and seven days sequentially, reflecting seasonality and our focus on improving cash flow.
We generated $72 million of operating cash during the quarter and capital expenditures were $6 million. Through open market purchases, we bought back 1.8 million shares during the quarter.
With first half activity, this brings our year-to-date buyback to 8.5 million shares for a total spend of $250 million. This repurchase activity and $6 million of capital expenditures, our debt was essentially unchanged from the second quarter, while cash was up $23 million from the last quarter.
Our funded debt to adjusted EBITDA ratio was 1.7 times well within our current desired range of 1.5 and 2 times. We are pleased that our Board has authorized an expansion of our share repurchase program by $50 million, bringing the total authorization to $150 million.
Since we bough back $50 million of stock in the third quarter, our remaining authorization currently stands at $100 million. Now, I would like address our updated guidance for full-year 2010.
While our business continues to perform well the macro environment continues to be uncertain. We currently expect net sales to range from $1.095 billion to $1.115 billion.
And we currently expect EPS to range from $2.05 to $2.10 per diluted share. We expect our gross margin to be up approximately 250 basis points for the full year driven by fixed cost leverage and our ongoing productivity plans, partially offset by geographic segment mix and commodity costs.
We expect interest expense for the year to be $14.5 million. We anticipate the full-year tax rate to be approximately 33%, despite the lower rate in the third quarter.
We are using a share count of 72.8 million for the full year. And this implies a share count of approximately 70.5 million in the fourth quarter.
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. This concludes our prepared remarks.
And at this point, operator, we’d like to open the call to questions.
Operator
Thank you. Ladies and gentlemen, the question-and-answer session will be conducted electronically.
(Operator Instructions). Our first question today comes from Bob Drbul with Barclays Capital.
Bob Drbul – Barclays Capital
Hi, good evening.
Mark Sarvary
Hi Bob.
Dale Williams
Hi Bob.
Bob Drbul – Barclays Capital
Could you just – on the – I guess, can you talk a little bit about the Cloud Luxe and how it did post-Labor Day, any thoughts around that, is my first question. And on the Cloud internationally, are there any like metrics around the ramp-up of doors or how we should think about it from that perspective?
Mark Sarvary
Well, this is – the Cloud Luxe is really early in its rollout Bob. I mean, anecdotally it seems to be going very well.
There’s a lot of retailers’ interest, we have a very good timetable of how it’s going to rollout, but it’s going to take several months to rollout materially, and it’s going to take something like seven or eight months to rollout completely. So, quite frankly, it’s just too early to make any serious comment about it, other than all indications are that it’s doing well.
So it’s doing fine so far, but it’s too early to make a real database judgment. As for the – as for international, it’s a significant opportunity, but it’s going to rollout kind of country area by country area, so it’s not going to rollout all in one go.
And we anticipate that it will get very significant penetration. The only – but perhaps not as great of a penetration as we’re going to get in the US, just because in general as a rule, people in Europe and in Asia prefer firmer beds than they do in America.
So, while there is a demand for this bed, it’s going to be somewhat less, and that’s going to be reflected in the number of doors and ultimately the number of sales. But the time it will take to get to the same proportion of distribution that we have here in the States is going to be – it’s going to take a little while to get there.
Bob Drbul – Barclays Capital
Okay. And then, just one last question is on – for Dale, can you talk a little bit about – and you talked about raising input costs or chemicals – any pressure is on the chemical costs around poly oil or TDI?
Dale Williams
Well, Bob as you may recall, we’ve talked all year that we expected kind of a quarterly increase on our primary chemicals. We had an increase right at the end of last year, we had an increase in the first quarter, but we did not see an increase in the second – late in the second quarter or late in the third quarter as expected.
So, right now, we’re – we’ve been fairly stable from a commodity cost standpoint since kind of the March timeframe. Now, as we get into the New Year, our expectation is we’ll see some pressure there.
But, right now and for the balance of the year at this stage given our contractual relationships, it’s stable and somewhere it’s been for the last six months.
Bob Drbul – Barclays Capital
Great, thank you very much.
Operator
Our next question comes from Mark Rupe with Longbow Research.
Mark Rupe – Longbow Research
Hi guys, congratulations on the quarter. Mark and Dale, on the fourth quarter kind of thought process on the outlook, is there anything that’s different in what the trends that we’ve seen so far as it relates to kind of the US business and the international business as we head into the fourth quarter?
Is there any change at inflection, demand trends, or expectations?
Mark Sarvary
Not fundamentally. The – as you know very well, the comps that we’re going up against that differ in the latter part of the year than they where in the first half of the year, so –
Mark Rupe – Longbow Research
Right.
Mark Sarvary
If you look at it from a comp basis, it’s different. If you look at it on a sequential basis – bottom-line, the sort of simple answer to your question is nothing fundamental, beyond the fact that there is a certain degree of the industry is reporting that they are expecting a weaker second half than they had in the first half.
Mark Rupe – Longbow Research
Right.
Mark Sarvary
And to some extent that’s fact today. But, if you look at our numbers sort of sequentially, as you can see the trends are essentially the same.
Mark Rupe – Longbow Research
Okay. And then –
Dale Williams
Mark, I would just add that, what we have laid out in this guidance is kind of pretty typically seasonality.
Mark Rupe – Longbow Research
Okay.
Dale Williams
Our US business will be a lit bit softer in the fourth quarter from the third quarter. International business little bit stronger.
Mark Rupe – Longbow Research
Okay. Okay, perfect.
And then, I know on the last call, you commented just briefly on kind of in the core business non-Cloud, anything you can offer on how that’s doing as we speak?
Mark Sarvary
Well, we’re quite pleased to be honest. We, obviously, the Cloud has driven a lot of our growth this year.
Mark Rupe – Longbow Research
Right.
Mark Sarvary
And we had anticipated when we launched it that there would be a material amount of cannibalization. The cannibalization of the Cloud has been less than – less than we had anticipated not quite as significantly, and the base business is growing sequentially too, so it’s pretty good.
Mark Rupe – Longbow Research
Great. And then just lastly, on the gross margin, I know you had this four-year productivity plan in place, you’ve done – had great strides so far.
Just curious to see what kind of the near term or mid-term opportunity is on that and what kind of the key focus initiatives are right now?
Mark Sarvary
Well, remember, that the gross margin target is a long-term plan, and it was set in place in a different – frankly in a different world. But –
Mark Rupe – Longbow Research
Right.
Mark Sarvary
The long-term plan is still the long-term plan. But on the other hand, there are investments that we are making, a need to make in things like advertising to build awareness, which we’re going to continue to do.
So, from time-to-time, from quarter-to-quarter, we’re going to flex this. It’s a long-term target it’s not something that we’re going to adhere to quarter by – month-by-month and quarter-by-quarter.
Mark Rupe – Longbow Research
Okay. Perfect, thank you.
Operator
We’ll now hear from Budd Bugatch with Raymond James.
Budd Bugatch – Raymond James
Hi, good evening, Mark, and Dale, and Barry, and congratulations on the performance.
Mark Sarvary
Thanks.
Budd Bugatch – Raymond James
Again, trying to piggy back on something you said, Mark. You said that the average slots per door are up I think.
And anyway to give us a quantification on that? How would we look at that?
Mark Sarvary
We haven’t traditionally given that. But we haven’t traditionally given that.
And, in fact, we only set a precedent here right now. We obviously are very focused on it, because it’s a very important metric, and obviously also the importance of Cloud particularly is that it is bringing in a new consumer to the retailer, and therefore, it justifies its additional slots.
We’re growing slots, but I’m not going to break the precedent here and not actually say what the number is right now.
Dale Williams
Budd, I would just say that, we’re well on the path that we had set out when we introduced the Cloud where we said we wanted to get two incremental slots. We’re tracking absolutely on that path and we’re very comfortable with that so.
Budd Bugatch – Raymond James
If we set a timeframe for getting those two incremental slots?
Dale Williams
Basically, it’s within all three years fully rolled out.
Budd Bugatch – Raymond James
So that would say that by maybe September of next year or actually mid part of next year that you think you would have two incremental slots per door.
Dale Williams
Yes, we would expect that the Cloud Luxe will essentially be fully rolled out by probably end of the first quarter kind of timeframe ballpark-ish. Mark, I think said, seven or so month.
So, kind of by that timeframe, we should have achieved that target.
Budd Bugatch – Raymond James
Okay. And how about quantifying for some the percentage of sales or units that are now a Cloud versus non-Cloud the company and how that – you’ve said that most of the growth are – significant portion of the growth has come from Cloud, how do we think about the percentage of total units now that are Cloud domestically?
Dale Williams
Well, we’re not going to break down our revenue by product line. What I will say is consistent with what we’ve said before, the base business is outperforming the industry this year and outperforming it pretty well, and the Cloud as Mark has said has been significantly incremental, much more incremental as in like plant.
So we’re getting good growth on the core business and the Cloud has been a very nice upside for us, but we’re not going to get in the trend of breaking out the business by products.
Budd Bugatch – Raymond James
Okay. I keep trying.
Dale Williams
That’s all right, you can try, we’ll just keep not answering.
Budd Bugatch – Raymond James
We’ll keep – we’ll keep adding. Domestic versus international for the fourth quarter, I know you said that international is typically stronger fourth quarter – I apologize for that.
The – is it going to be just normal seasonality for that or should it be somewhat different than that?
Dale Williams
We’re expecting kind of the normal seasonality. It’s just that US business tends to be just slightly down in the fourth quarter from the third quarter based on historic seasonality, recent years are not normal.
But – and the international business tends to step-up in the fourth quarter and tends to – generally the fourth quarter is the strongest quarter of the year for the international business, so that’s how we’re expecting the fourth quarter to transpire.
Budd Bugatch – Raymond James
Okay. And I was quite taken with the working capital improvement, particularly in the receivables that had a four-day improvement.
Is that sustainable? I think that maybe the lowest receivable days that I’ve seen since looking at the company.
Dale Williams
We have had tremendous improvement in the receivable performance going on two years now even through the difficult times. And, in terms of further improvements in days, it may be getting a little bit tougher to get further improvements in days.
But certainly we would not expect to have degradation in days and what – the only thing that would naturally cause some degradation would be if there was a growth shift where we had more international business, because the days tend to be little bit longer internationally than they are in the US.
Budd Bugatch – Raymond James
But, am I right to calculate the composited days at about 39s?
Dale Williams
Yes.
Budd Bugatch – Raymond James
And is that the right number? And is that within your terms?
What are your domestic terms typically on terms of days outstanding?
Dale Williams
Domestic terms are typically 30 days. International terms they vary by country on average, it’s probably closer to 60 days.
Budd Bugatch – Raymond James
Okay. All right, thank you very much.
Congratulations again and good luck for the fourth quarter and for the season.
Mark Sarvary
Thanks Budd.
Dale Williams
Thanks Budd.
Operator
(Operator Instructions). We’ll now hear from Brad Thomas with KeyBanc.
Brad Thomas – KeyBanc
Thanks. Good afternoon, guys, and congratulations on another great quarter.
Mark Sarvary
Thank you, Brad.
Brad Thomas – KeyBanc
I just wanted to follow-up a little more on – on the Cloud and then ask kind of question on its rollout and I think in a different way. Could you maybe just talk a little bit about the floor space you’re getting by the different line and maybe kind of what you’re in and how many doors you’re in?
I mean it seems like the Supreme that even going back to last quarter wasn’t just about every door you thought it would get in and we are pretty far along on the entry-level Cloud as well. But could you just maybe characterize it from that perspective?
Mark Sarvary
I think the way, I mean, very broadly speaking we think that the Cloud Supreme should be in every one of our retailers. And, if it isn’t, it’s going to – it nearly is and it will be.
You know what I mean, it’s very, very, essentially penetrated. We think the Cloud is going to be in the big majority of our retailers.
It’s not going to be in every one, it’s not going to have quite the same penetration, but it is going to be a very, very well distributed product. And the Luxe for a premium product, which by nature is going to have a lower distribution is going to be one of our highest distributed premium product.
So I think there is sort of like one, two, three in terms of number of doors that we’re going to end up with all of them material, starting with the Cloud Supreme essentially every where. Does that make – is that useful?
Brad Thomas – KeyBanc
Yes, that’s helpful, Mark. And then, within your other category, I know during the quarter you rolled out the entry-level priced adjustable foundation.
Could you tell us a little bit about what you’re seeing in terms of the initial response and is that getting more people to buy the foundation or having – are you seeing anything in the way of cannibalization?
Mark Sarvary
It’s early days again. And so, again, it’s longer days than the Luxe, but it’s still early days in terms of how long we’ve had it in the stores.
But what we’re seeing is, as of now, interestingly no – no impact on – the minimal impact on the –
Dale Williams
Advanced.
Mark Sarvary
On the advanced. In fact, in some ways, many of the retailers are telling us, we’ve heard from than one account, we held this people talk up.
You know if you’ve introduced them with the lower price one then you can move into the higher price one. So, in fact, it’s actually an aide to selling the higher price one.
So we’re seeing very little cannibalization at this stage. It’s – but again very early days.
I want to be cautious about how I characterize it. But we’re very pleased with how it’s rolled out.
It’s been well accepted. Too early to really comment on it.
Brad Thomas – KeyBanc
But, I mean, you really had some phenomenal results within the – within the other category for the last three or four quarters here, and it seems to be a big opportunity within foundations. I mean where are you guys from a slotting standpoint in terms of having your foundations on the floor, and if you could just talk a little bit about your strategy there?
Mark Sarvary
Well, the thing about – I mean, we – I don’t know if I’m exactly correct, but we’re essentially a 100% distributed with those bases. It’s the issue of how many of the slots are carrying the base.
And if we find the retailers who have the greatest number of their beds with a – all go with underneath them, their attachment rate is higher, and in fact, those customers have higher USP in general, so it’s a win-win. And most of – it’s a conversation that we have with our customers and they – and it’s something that – that it’s the kind of demonstrability of that is something that’s driving the growth of our other business this year, because our attachment rate is growing because people are doing.
It really is a function of making sure that the consumer can try an adjustable base whatever bed that they prefer. It’s very – what the bed – what customers find is that it’s much easier to tell somebody the adjustable base if the bed that they prefer has an adjustable base under it rather than having to show them how it works on another bed.
And that is what we’re driving and we’re growing the number of slots per store to carry – carry it and that is one of the primarily drivers of that growth of business.
Brad Thomas – KeyBanc
Great. Thanks Mark.
And then, just lastly, if you guys could give us an update on how things are progressing on Canada – in Canada, that would be great.
Mark Sarvary
Good. It’s a – it’s a great – it’s a – obviously a very important business for us.
The transition has gone well. The – we’ve – we’re – they’re fully integrated as our subsidiary now of ours.
And I’m not going to get into again setting a precedent of breaking our business, but I will tell you they’re doing quite nicely, and we’re quite pleased with how they’re doing so far.
Brad Thomas – KeyBanc
Great, thanks Mark. Look forward to seeing everybody in November.
Mark Sarvary
Good. Look forward to seeing you.
Operator
Our next question will come from Joe Altobello with Oppenheimer.
Joe Altobello – Oppenheimer
Thanks, good afternoon, guys. First question, I just want to go back to the gross margin for a second.
And, Dale, you talked about the productivity program and fixed cost leverage. But it just seemed like it was much higher both year-over-year and sequentially than I was looking for.
Is that just because the sales base is so much bigger this quarter that the fixed cost leverage was that much greater?
Dale Williams
Yes, I mean, certainly that’s one of the components. We have – obviously the third quarter was a record quarter for us, it’s our best revenue quarter ever that generated lot of fixed cost leverage.
If we look at the improvement in gross margin, fixed cost leverage was probably about half the improvement on a year-over-year basis, we’re on a sequential basis and productivity and the channel mix being the other half. The productivity program continues to progress very well.
The team is driving tremendous cost improvements throughout the business and so we’re very pleased with the productivity program. It’s still tracking slightly ahead of schedule.
And there are some the negatives, the segment mix is more US less international does drive a little bit of pressure. And on a year-over-year basis, chemicals does create some pressure even though they’ve been stable for about six months, there is still year-over-year pressure there.
So we’ve been able to get very good improvement across the business.
Joe Altobello – Oppenheimer
Got it, okay. And then, in terms of your longer-term targets, you talked about a 50% gross margin, and you’re just about there now, and a 25% operating margin as a target.
I thought that was about a four-year target and this I guess is year one of that. I mean are you still on target to get to that 25% EBIT margin by let’s call it 2012 or 2013?
Dale Williams
Well, it is a four-year target to get to 25%. And, actually it’s a four-year target to get to 50% on gross as well.
But it was a very different environment. So, with chemicals being a little bit easier than they were in 2008 and much higher volume, we’ve gotten there much faster.
And I will reiterate what Mark said before that, there is not a magical arm that goes off when we hit 50% that says now we have to do something that that was a long-term target with assumptions that some of those assumptions are not as bad as what that was assumed back in 2008 when we said that. That gives us some flexibility to continue to maybe a little bit over 50% and drive the kind of investment that we think we need to help drive the international growth in the business.
The 25% operating margin target, that was a four-year target going out to kind of the 2013, 2014 timeframe. And I would say, we’re well ahead on that target and pleased with our performance, and we like better than to get there sooner, but we’re not going to project that yet.
Joe Altobello – Oppenheimer
Got it, okay. And then just one last one, I think you talked about doing some consumer research, particularly on the international side, international is about what 30% of your sales.
What could that number be three, four, five years out?
Mark Sarvary
Well, I think that the – the thing that the consumer research has shown and we’ll discuss more when we’re – when we’re together in next month is that there is very significant potential internationally in Europe and in Asia. And that the penetration that we have in those countries is significantly lower than it is in the United States and that there is no fundamental reason why it cannot grow quite significantly and that’s what we’ll share with you, and also the path to what needs to be done in order to make that growth is also quite clear.
At the same time, however, we believe there is enormous opportunity for growth in the US. So I’m not projecting in percentages relative size of the two businesses.
I think that both sides – both the domestic business and the international business has significant growth potential. So whether the ratio of their sizes changes I don’t know, because they’ll both grow.
Joe Altobello – Oppenheimer
I see. Okay, great, thank you.
Operator
We’ll now hear from Keith Hughes with SunTrust.
Keith Hughes – SunTrust
Thank you. You talked earlier about 200 new doors.
Were those domestic, international, any kind of color on that would be helpful?
Dale Williams
Yes, that was domestic. 200 new doors domestically.
Internationally, we had – it looks like international in the fourth – third quarter it was kind of flattish.
Keith Hughes – SunTrust
Flattish. And what kind of doors are there in the US?
Are they specialty sleep or what type of retailer?
Dale Williams
A mix of specialty sleep and I’m not sure how to categorize the other one. I don’t know, mixed retail environment.
Keith Hughes – SunTrust
And in terms of advertising, the number you referenced earlier, is that what we’re going to be seeing for quarter in the future?
Dale Williams
The $25 million.
Keith Hughes – SunTrust
Yes.
Dale Williams
Well, I would think as we keep growing the business, we’ll see higher advertising. We’ve said all year that our goal is to get advertising back up to 9%, we’re not quite there.
We’ve been chasing revenue all year. It’s a good kind of problem.
And so we have – still are tracking below the 9% of revenue. And, overtime, we’ll get there.
Keith Hughes – SunTrust
All right, thank you.
Dale Williams
Thank you.
Operator
From William Blair, we’ll now hear from Jack Murphy.
Jack Murphy – William Blair
Thanks. I just like to start by asking about the quarter, how it trended?
And, in particular, did you see much difference between the beginning of the quarter through the end of the quarter in international? And, was there any you know particular month that July for example, that might have been weaker – weaker in the US and then recovery toward the end?
Dale Williams
I would say both domestically and internationally, we saw our pretty typical seasonality. And, what that means is, we tend to have a good July, and you see a little bit of ramp in the business going into Labor Day and it traditionally softens a little bit post-Labor Day.
And what we saw in the US business was very typical of the normal seasonality that we’ve seen in the business. And, conversely, I would say that what we saw in Europe was pretty typical from the seasonality also, where certain countries they have their vacation months.
Some countries it’s July, some countries it’s August, they’re all back to work in their home in September, so September tends to be little bit stronger internationally in the third quarter and that leads into the peak period for the international business which is 4Q.
Jack Murphy – William Blair
Okay. I just wanted to follow-up on some of the discussion earlier on commodity costs.
Obviously, you said that commodity costs were a drag year-over-year. But I was wondering if you could give us a sense of what type of benefits relative to guidance that commodity cost might have been given that you were expecting sequential increases that didn’t happen?
Dale Williams
Well, I think that we had said that or we were expecting to get kind of a low-to-mid single digits commodity increase if that’s – it may have been a small portion of – I didn’t look at it that way, but that probably contributed a little bit of upside to the gross margin performance this year, not a dramatic upside versus what we’re expecting.
Jack Murphy – William Blair
Okay. And, if may, just sort of a big picture question for Mark, and maybe you’re saving this for the meeting.
But as it relates to the research for Europe and international, could you just give us a sense of sort of the timeline on that research and development, and maybe at what point you think we would hear something specific around a new product and how that might fit into sort of brand architecture for Europe as it’s different from the US?
Mark Sarvary
Well, I think you’re asking the – I mean, I think [inaudible] we’ll talk about that. And I think that the implementation of it is going to start – it’s essentially starting, but it’ll start in the beginning of next year.
As I said a little earlier, it won’t be every country at once, because as you know, the situations in each country are different and the steps we have to take is slightly different. But you said an interesting word there the architecture.
The architecture which has been very important here in the US is something that we’re going to make as important than the rest of the world. And it has been a significant change in our ability to speaking not only to the consumer, but also to our retailers, so it’s easier for them to display and communicate our products, and even our internal people from the research and development and marketing point of view to focus how they’re doing it.
And while there are differences and we’ll talk about it between Europe and Asia and the US, they have great similarities.
Jack Murphy – William Blair
Okay, thank you.
Operator
(Operator Instructions). Our next question will come from John Baugh with Stifel Nicolaus.
John Baugh – Stifel Nicolaus
Thank you and congratulations. On the advertising spend, is it similar of the rate of sale in Europe or Asia versus the US or was it lower and you plan to go higher based on your feedback?
Dale Williams
Traditionally, we’ve spent at a little bit higher rate in the US than we do internationally. And, certainly, we would expect based on some of the early feedback from the research in terms of the opportunity.
That’s one investment area that Mark mentioned is we do need to step-up the level of brand advertising that we are doing around the world.
John Baugh – Stifel Nicolaus
Good. And I think the number was 3 million.
Correct me if I’m wrong on your strategic consumer research. Is that correct?
And did that – is that going to evenly fall in Qs three and four? And then what line on them again is that in?
Dale Williams
I’m sorry.
John Baugh – Stifel Nicolaus
What line –
Dale Williams
Yes, G&A [ph], yes the number was about 3 million. It was at the start of last quarter.
We said it would be fairly balanced between Q3 and Q4. It might skew a little bit more to Q3 at this stage based on the progress that’s been made, but there still will be some spending.
John Baugh – Stifel Nicolaus
And my last question is mainly for Mark. There seems to be some thought out there, I’m not saying this is my thought, that you had such a great year with Cloud that you can’t comp that.
In other words the initial sale rate is so high, in the subsequent years it will fall-off. I’ve certainly not seen that pattern in the mattress industry in general I’m not seeing that pattern with you.
So I was wondering of your comment specifically on that. And then also if you had any – I don’t know you wouldn’t us any specifics – but do you have any significant product rollouts planned for the United States in 2011?
Mark Sarvary
Well, let me do them in the order which you asked. I think that the two key things to think about when you think about the rollout of Cloud is that first of all from a very simple point of view, we didn’t have complete rollout of any [inaudible] for the whole year.
So if you just take, the proportion of the year where we have fully distributed versus this year, there’s a natural growth by that. The second thing is that, as you know, we do extensive consumer research, and I just literally a week ago saw some more, and which was looking at a specific segment of consumers, I’m not going into details of this, for which we were – we are evaluating products.
We found that again the Cloud is extraordinarily preferred by a group of people that we hadn’t guessed would be the ones who would prefer it. And so it brings me to the fact that we haven’t fully reached anything like what I think is the potential of who it’s for.
And, the third thing is, as much as we have increased our investment in communication and we are – and we’re being sensible about it, we continue as Dale says, the chase is 9%. We continue to have opportunity, most consumers don’t know about the Cloud yet.
There’s a lot of work to be done just to get that across. So I think there is – right now I think there is still significant potential in the Cloud.
As for the other new products, I’m not going to tell you about anything. As you know, it's not our practice to talk about things before they’re done.
But I will say this, you can see that our investment areas where we put, the investment has been in marketing and advertising and in consumer and product research, and you will see we continue to do that and we’re not doing that ideally. Obviously, we’re being very thoughtful about it.
But we – we’re very serious about our objective to find a bed, to make a bed that appeals everybody. And so, we have a lot of opportunity areas that we’re working on right now.
Dale Williams
Hi John, this is Dale. I would just add that we don’t believe our base product line or core product line is fully there yet in terms of consumers knowing about it, consumers preferring it.
And our base product line, we still expect to grow significantly for the foreseeable future. And our expectations on the Cloud are no different.
There – we still have a tremendous opportunity with Cloud.
John Baugh – Stifel Nicolaus
That’s great. Thank you.
Mark Sarvary
Thanks John.
Operator
We’ll now hear from Joan Storms with Wedbush.
Joan Storms – Wedbush
Hi, good afternoon. Thank you and congratulations.
Mark Sarvary
Thank you.
Dale Williams
Thank you.
Joan Storms – Wedbush
And so, I wanted to ask about just push Dale and Mark a little bit further on the gross margin, because that seems to be a major opportunity going forward as we build new product lines into the business in particular when I visited the Albuquerque factory like you know you’ve sorted of talked about 50% goal and I know you’ll probably talk about at the Analyst Day, but can you delve any further into where you have some commodity price increases that you’re anticipating, but that seems pretty small compared to the opportunities that you have to get on 50%?
Mark Sarvary
I think the thing about the 50% is that we intend to make our products, continually evolve our products. The 50% number that you – I like [inaudible] there is no alarm going off when we hit it.
We’re trying to make our gross margin as good as we can. But at the same time what we’ll do overtime is improve the functionality of the products and improve the investment in advertising.
It doesn’t happen – this sort of steps don’t happen quarter-to-quarter, they happen year-to-year. And we – as I just said in the last question that there’s many new products and innovations that we’re looking at.
What the 51% or the 50% plus I should say, the 50% plus opportunity gives us is it allows us in the short term to do some of the things that we’re really trying to focus on right now, which is to make sure that people know about TEMPUR and TEMPUR Cloud. So we’re using it at the moment and we will periodically as the years go by appropriately.
But these targets are long-term four-year target.
Dale Williams
But I will also add Joan to your point there is still significant volume leverage available to the business. Sitting here today even with the tremendous growth we’ve had in this business this year, we still have ample capacity to utilize in our facilities.
We can again – our view is we can get somewhere between $2 billion and $2.5 billion in revenue, but that maybe in other facility. So that gives tremendous volume leverage available to the business.
The productivity program is not done. We’re not even halfway done in the original program and so that’s going to continue.
And once this original program ends, it doesn’t mean the productivity is just going to stop, that means there will be a new program and we’ll just keep adding to it year-by-year. So we will continue to drive for and improve cost and improved efficiency and getting the volume leverage which will provide tremendous benefit to offset future significant increases in oil prices if that were to come or fuel investment in the business where we see the opportunity for investments that will provide good payback or continue driving the improved profitability.
Joan Storms – Wedbush
That’s a very great answer. Thank you.
And then just a quick question on the Cloud pillow. How is that doing?
I heard it was sold online for period of time, so how are you doing there producing that product?
Mark Sarvary
Doing very well. We’re very pleased with the Cloud pillow and watch this space.
So it’s exciting. It’s – no, it’s doing very well, and it’s a great pillow.
It’s very different than our other pillows, people love it, and it’s setting very well.
Joan Storms – Wedbush
I’m waiting to get mine, so thank you. Have a great afternoon.
Thank you, guys.
Mark Sarvary
Thanks, Joan.
Operator
Ladies and gentlemen, that does conclude today’s question-and-answer session. I’d now like to turn the call back over to the company for any closing comments.
Mark Sarvary
Thank you. And thanks everybody for joining us.
We look forward to talking with you again next month at the Investor Event, we’ll be discussing in New York. But thanks for joining us this evening.
Thank you.
Operator
Ladies and gentlemen, that does conclude today’s conference call. And we thank you for your participation.
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