Tempur Sealy International Management Discusses Q1 2014 Results - Earnings Call Transcript

May. 1.14 | About: Tempur Sealy (TPX)

Tempur Sealy International (NYSE:TPX)

Q1 2014 Earnings Call

May 01, 2014 5:00 pm ET

Executives

Mark Rupe - Vice President of Investor Relations

Mark A. Sarvary - Chief Executive Officer, President and Director

Dale E. Williams - Chief Financial Officer and Executive Vice President

Analysts

John A. Baugh - Stifel, Nicolaus & Company, Incorporated, Research Division

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Budd Bugatch - Raymond James & Associates, Inc., Research Division

Joshua Borstein - Longbow Research LLC

Denise Chai - BofA Merrill Lynch, Research Division

Jessica Schoen - Nomura Securities Co. Ltd., Research Division

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Carla Casella - JP Morgan Chase & Co, Research Division

Jon Andersen - William Blair & Company L.L.C., Research Division

Operator

Good day, ladies and gentlemen, and welcome to the Tempur Sealy First Quarter 2014 Earnings Conference Call. [Operator Instructions] I will now introduce your host for today's conference call, Mr. Mark Rupe. You may begin, sir.

Mark Rupe

Thanks, Kevin. Thank you for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO; and Dale Williams, EVP and CFO. After our prepared remarks, we will open the call for Q&A.

Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements, including the company's expectations regarding sales, adjusted EBITDA, earnings or adjusted net income, or the integration with Sealy, involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company's business.

The factors that could cause our actual results to differ materially from those identified include economic, regulatory, competitive, operating and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings, including, but not limited to, annual reports on Form 10-K and the company's quarterly reports on Form 10-Q under the heading Special Note Regarding Forward-Looking Statements and/or Risk Factors, as well as the company's press releases. Any forward-looking statement speaks only as of the date on which it is made and the company undertakes no obligation to update any forward-looking statements.

The press release, which contains reconciliations of non-GAAP financial measures to the most directly comparable GAAP measures, is posted on the company's website at tempursealy.com and filed with the SEC.

With that introduction, I will turn the call over to Mark Sarvary.

Mark A. Sarvary

Thanks, Mark. Good evening, everyone, and thanks for joining us. Today, I'll provide an overview of our performance in the first quarter, and then discuss the progress we're making on our key strategic growth initiatives in 2014. I will then turn the call over to Dale, who will provide details on the first quarter financial results and 2014 guidance.

We had a lot going on in the first quarter. The majority of our strategic growth initiatives launched late in the period, and we remain in the middle of implementing them. In light of this, we are satisfied with our overall performance. TEMPUR International's performance in the first quarter exceeded our expectations, with solid sales growth in Europe, Asia and Latin America, driven by advertising, new products and expanded distribution.

Sealy's first quarter sales were in line with our expectation. Solid growth in the U.S. was driven by continued strong demand for Posturepedic innerspring and hybrid products, and a return to growth for Stearns & Foster, which more than offset declined Sealy and Optimum.

Outside of the U.S, Sealy sales declined, and this was exacerbated by unfavorable foreign exchange.

Tempur North America first quarter sales were in line with our expectations, down mid-single digits. As we said in February, we had expected first quarter sales to be muted in the U.S. due to the poor weather in the first part of the quarter and by the transition of our core product line in the latter part of the quarter. Of note, during the quarter, sales of products priced at $2,000 and above grew for the fourth consecutive quarter, driven by continued strong demand for our Breeze collection and initial shipments of our new products.

Now I'd like to discuss the progress we're making on our 4 key strategic growth initiatives in 2014. The first strategic initiative is product innovation. And our goal is to provide consumers the best bed and the best sleep of their life, and to provide our retailers a complete and optimal offering across brands, products and prices to drive their growth. In the first quarter, we began rolling out several of our new products, including the new Tempur North America product that I just referenced, as well as our new Stearns & Foster and Tempur International Breeze products. In April, we began rolling out the new Optimum line. The magnitude of these new product launches is significant given their importance to our overall business and their concentrated rollout timeline. The new TEMPUR-Cloud and Contour launches are the largest in Tempur-Pedic's history.

We shipped more floor model units than we planned in the first quarter, and completed approximately 65% of the rollout. As of the end of April, we had shipped 80% of the total, which positions us and our retail customers to benefit from having them placed on the floor in advance of the key Memorial Day holiday.

We also completed approximately 45% of our new Stearns & Foster product rollout in the -- by the end of the first quarter. And as of the end of April, we had shipped 75% of the total. We're particularly encouraged with the demand for the upper-end Lux Estate and Lux Estate Hybrid Collections. In April, we began a very concentrated rollout of the new Optimum line and have already shipped 50% of the total. This line has been well-received by customers. In fact, the trade has been enthusiastic about all these launches. And as a result, all 3 have exceeded our slot placement expectations.

In addition, we're in the process of launching the TEMPUR-Breeze mattresses in several European markets. And here, too, floor placements are exceeding plan. In aggregate, the scale of this launch activity is unprecedented, but it has gone well, and we are pleased with our execution. We expect to finish all of the North American product launches during the second quarter.

While it's still very early, we're pleased with the initial signs we are seeing. There has been broad retail customer support for the new products, and consumer acceptance so far is what we had expected. Enthusiasm of retail sales associates for the new Tempur-Pedic and Stearns & Foster products in particular has been very encouraging and appears to be building.

We're expecting the launches of these new products to be important drivers of our growth in 2014.

Our second strategic initiative is marketing. And this includes advertising, as well as in-store marketing and direct sales. In 2014, we will increase our investment in marketing, and this will be most evident in the second quarter as we ramp our in-store marketing investment and increase our advertising spend with the launch of new television creative.

In April, we began airing nationally, a new product-specific TV ad for the new Cloud and Contour beds. And in May, we will launch a new Ask Me campaign. We also expect to begin benefiting from more impressions per dollar spent as we reinvest synergies realized from our combined media buy. We will also support Stearns & Foster, Optimum and Posturepedic with consumer advertising, including TV, digital and print.

The third strategic initiative is new market expansion. And this includes our expansion into new international markets and, over time, into nonconsolidated markets where our brands are currently represented by others. On our last call, we announced that we had signed an agreement to regain Tempur-Pedic rights in Mexico previously held by a third-party distributor. At the time, it was the first deal since our combination with Sealy.

In early April, we announced the signing of a definitive agreement to acquire the Sealy brand rights in Japan, and today, we announced the signing of a definitive agreement to acquire the Sealy brand rights in Continental Europe. Each of these transactions represents significant future growth opportunities.

In Japan and Continental Europe, we will leverage Tempur sales and marketing infrastructures to further increase our penetration, as well as expand our product offering and distribution footprint to capture market share.

We're also advancing several other initiatives across the world, including broadening the distribution of our Tempur and Stearns & Foster brands in South America where we have existing Sealy assets.

And lastly, our fourth strategic initiative is our commitment to building a world-class supply chain that is easier to do business with. We're making progress on improving our distribution and warehouse network, and are beginning to capture greater cost synergies. We're currently shipping Tempur and Sealy products together on Sealy trucks in one U.S. market and expect to layer in additional markets in 2014 and beyond. These efforts are also expected to improve customer service.

We've also made good progress with our Category Management efforts, which we expect to result in improvements to both our own and our retailers' sales and profitability in 2014.

Before turning the call over to Dale, I'd like to make a couple of closing comments. First, we now passed the 1 year anniversary of our combination, and we're pleased with how it's gone. We still see many opportunities to create additional leverage and we're aggressively pursuing them. Cost synergies are being realized to plan, and we are now beginning to see the benefits from revenue synergy.

As most of you know, Larry Rogers retired after a long and extremely successful career at Sealy. And his contribution to the Tempur Sealy merger and integration efforts was invaluable. And we're thrilled that he will continue to provide value to our organization as a member of our Board of Directors.

So to summarize, Q1 was broadly in line with our expectations. Our major initiatives for 2014 are rolling out as planned, and we remain very focused on their successful execution. Our plan calls for an acceleration of our growth on a consolidated basis, and specifically in the U.S., and we are receiving positive feedback on the new products from retailers and consumers. However, it's still early. And we look forward to providing a more complete update when we report in July.

With that, I will now hand the call over to Dale.

Dale E. Williams

Thanks, Mark. I'll focus my commentary on the first quarter 2014 financial results, and then discuss our 2014 guidance. I'll address the performance on a consolidated basis, then speak to the performance for each segment and provide commentary on the key areas or items where there's a notable variance from the prior year.

As a reminder, the company completed its acquisition of Sealy in March 2013. And results for the first quarter of 2013 reflect only a partial period of results from March 18 through March 31.

Consolidated net sales for the first quarter were $701.9 million. Tempur North America net sales were down 5.7%. As we previously communicated, trends were somewhat soft in January, but improved through the balance of the period. Bedding net sales declined 2.5% on a unit decline of approximately 5%. However, it's worth noting that mattress and adjustable base units together were flat in the quarter, with the decline being driven by traditional foundations, a phenomenon we attribute to the significant floor model transition.

While we don't break out mattress performance specifically anymore, given the magnitude of this rollout, we felt it was appropriate to provide some color on the transitory impact we experienced in the period.

We shipped approximately the same number of mattresses in Tempur North America in the first quarter as we did last year. However, the mix of discounted floor model units was significantly greater this year. Remember, for every floor model we ship, a floor model needs to be sold off at retail. We replaced significantly more full value orders with discounted floor model shipments in the first quarter. Excluding this discount effect, our gross mattress sales in the first quarter were positive mid-single digits.

Sales of other products, mostly pillows, declined 37% and accounted for more than half of Tempur North America's first quarter sales decline. By channel, Tempur North America retail net sales decreased 3.2%, and Direct net sales declined 35%.

Tempur International net sales were up 7%. Bedding net sales increased 6.6% on a unit increase of 2%. By channel, Tempur International retail net sales increased to 4.6%, and Direct sales increased 42%.

Sealy net sales were $363.2 million as compared to $46.7 million last year. First quarter gross margin was 38.4% as compared to 48.3% in the first quarter last year. As we stated on previous conference calls, the inclusion of Sealy has altered the consolidated gross margin profile of the business.

On a year-over-year basis, first quarter gross margin declined, primarily due to a full quarter of Sealy results, product and channel mix, and a higher new product introduction cost. These impacts were partially offset by lower sourcing costs and positive geographic mix.

On a sequential basis, gross margin decreased to 38.4% from 40.2%, primarily due to higher new product introduction cost and higher mix of Sealy sales. These were partially offset by positive geographic mix.

Consolidated advertising spend, which includes both national and cooperative, was $73.8 million or 10.5% of sales in the first quarter.

Consolidated operating income was $62.4 million as compared to $44.5 million in the first quarter of 2013.

Operating income in the first quarter of 2014 included $7.4 million of integration costs related to the Sealy acquisition. Operating income in the first quarter of 2013 included $16 million of transaction and integration costs related to the Sealy acquisition.

Interest expense for the quarter was $22.2 million, and the first quarter tax rate was 29.3%.

First quarter GAAP earnings per share was $0.44 as compared to $0.20 per share in the first quarter of 2013. Adjusted earnings per share were $0.53 in the first quarter as compared to adjusted earnings per share of $0.62 in the prior-year period.

Now I'll turn to cash flow for a brief review. At the end of the first quarter, inventory was up as planned due to the product transition as we were carrying full supplies of both the old and new product lines. Receivables were also higher due to the timing of revenues in the quarter, as we discussed earlier. These 2 items were the principal factors that led to our slightly negative operating cash flow in the quarter. We expect cash flow to be positive for the balance of 2014 and consistent with our full-year plan.

The company has consolidated funded debt, less qualified cash, of $1.8 billion. The ratio of consolidated funded debt less qualified cash to adjusted EBITDA was 4.6x, calculated in accordance with the company's senior secured facility. A calculation of this ratio is included in the press release. Capital expenditures in the quarter were $7.8 million.

Now, I'd like to address our 2014 guidance. Today, the company confirmed financial guidance for 2014. The company currently expects net sales to be in the range of $2.8 billion to $2.9 billion, which reflects growth of approximately 1% to 5% compared to 2013 had we owned Sealy for all of 2013.

Adjusted EBITDA to be in the range of $415 million to $435 million. And adjusted earnings per share to be in the range of $2.60 to $2.85. It's important to note that while our full-year financial guidance is unchanged, our current view of the profile has slightly changed.

We currently expect our full-year 2014 net sales to be at the upper end of the guidance range. In addition, we currently expect our full year 2014 adjusted EBITDA and adjusted earnings per share to be at the mid to upper end of their respective ranges. In addition, our guidance excludes any potential impact from the planned acquisition of Sealy brand rights in Japan and in Continental Europe, as well as excludes the impact of ongoing integration costs related to the acquisition of Sealy.

We are planning for second quarter 2014 sales to be up slightly as compared to the first quarter 2014 sales of $701.9 million. We expect floor model shipments to remain elevated in the second quarter as we complete all of the North American product launches. As Mark indicated, our in-store marketing investment will increase significantly in the second quarter, and we also plan to increase our investment in advertising with the new creative. As a result, we expect our operating margin in the second quarter to be approximately 8%.

The majority of our investments in 2014 are first half weighted. And therefore, we expect operating margins to improve significantly in the second half of the year as floor model shipments and incremental in-store marketing investments diminish. Through April, we're tracking to these projections.

In considering our guidance, it's possible that our actual performance will vary depending on the success of our new initiatives, macroeconomic conditions and competitive activities, or the consequences of other risk factors that we've identified in our press release and SEC filings.

As noted in our press release, our guidance and these expectations are based on information available at the time of the release, and are subject to changing conditions, many of which are outside the company's control.

With that, operator, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from John Baugh with Stifel.

John A. Baugh - Stifel, Nicolaus & Company, Incorporated, Research Division

The first question I had was on the product placement, the new product launches. We've been hearing that with the poor Q1 conditions in general, that clearance sales were a little slow, and that was slowing up the new product launches. It doesn't sound though, from your comments, if you're behind plan, you're behind plan by much. I would just love some color on that.

Mark A. Sarvary

Well, there's no doubt that the weather did have an effect certainly at the beginning of the quarter. And the transition, as you know, is not an event. Obviously, what we're talking about is what we've shipped to retailers. Some of the retailers are pretty much 100% converted, but many are not. Many are in the middle of transition, still in the process of selling off some of the floor models. So it's a process which is ongoing and, obviously, was slowed to some extent, by the fact that there was poor weather at the beginning of the quarter.

John A. Baugh - Stifel, Nicolaus & Company, Incorporated, Research Division

Super. And then secondly, if I could just ask about internationally, where there was a positive surprise, were those macro-driven, weather-driven, company-specific product marketing effort-driven? Any color. And then you mentioned the areas that were strong. I was wondering if any were particularly stronger than others.

Mark A. Sarvary

There was some macro strength. I mean -- and I'm talking here about Europe. We've had pretty good performance in Asia for some time, all through last year, and we continue to have that. Japan, Korea, Australia continued to be strong. Where we had weakness last year, certainly in the first part of last year, most of last year, was in Europe. And we saw some improvement of that kind of from a macro level in the end -- in the fourth quarter of last year, and we saw continuation of that and strengthening this quarter. But a lot of what's been happening in Europe can be pointed very distinctly to -- for us, I mean, can be pointed very directly to activities that we've done. In the U.K., for example, we've gained distribution that has had a material impact. In Continental Europe, we've been running advertising, which is always effective, particularly in the German-speaking countries. And in -- and so -- and we introduced the new products. We were participants in the -- in the big Koln Fair in Germany and new products had an impact. So while their macro improvement was part of it, a lot of it was due to activities that we did.

Operator

Our next question comes from Peter Keith of Piper Jaffray.

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Actually, this is Jon Berg on for Peter tonight. My first question, I wanted to focus on Canada, I guess. In looking at how strong your Sealy business is up there and the relationships you have, at this point, are you starting to see some more Tempur slots being allocated in some of your retailers? And if so, how many have you picked up on a per store basis?

Mark A. Sarvary

I don't want to break it down into that level of detail, but I will say that Canada -- I really think your question is on the money because Canada is a very good example of where Sealy's distribution and relationships and strength is greater than that of the legacy Tempur company. And so that is an area where we have now a unified team working together on the Canadian business, working with our retailers as a unified team. And we believe that is going to have great promise, and that we will see benefits of that this year. But I'm not going get down to details by customer. I will say, however, that is an area in which we do see some promise.

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Okay, great. And then we've seen your new ad spot on TV that features the Contour and the Cloud, that looks good. And I'm just curious what's the consumer reaction to this? And I mean, to the extent that you can talk about it, I mean, is this going to be really the ad that you lead into the holidays with, along with the Ask Me? Or what are your plans around advertising?

Mark A. Sarvary

Yes. The ad that you're referring to is an ad which is -- let me just step back a minute. As you know, last year, we went back to our Ask Me campaign in the fourth quarter and we've been running it ever since. And we were -- as I -- and I'll talk in a minute about it. We will continue with that going forward. However, during this month and this quarter, this launch of Tempur products is quite unique for Tempur. It is a brand-new look of the product, brand-new characteristics of the product, with brand-new features, with the removable top and a washable top and a cooling layer. So we really felt it was important to have an ad that just spoke very simply and very eloquently to the new characteristics of the product, both for the consumers, but also for retailers. It was a -- this is the -- a very well done but matter-of-fact product commercial. As we get into the second half of this month, you'll see the new evolution of the Ask Me. We call it the Ask Me campaign because it's made by the same people and it's made in the same tonality. But it is a clear, very logical, and we're quite excited about it, evolution of the ad, which we think is very much more, frankly, it's more -- appeals to your heart and your emotions than to simply the matter-of-fact method of this other ad works for. So what we see is that the ad that's running right now will continue to run because it's an important ad, but it won't be the backbone of our strategy going forward. What we think is the nice part about that ad though is it's designed and, in fact been made, in such a way that retailers can customize it to use for their advertising because it works very well with retailers to bookend it.

Jonathan N. Berg - Piper Jaffray Companies, Research Division

Okay, great. And if I can just sneak one really last quick one in for Dale. Dale, it looked like the tax rate came in a little bit lower than what you guided the full year to on the last call. Should we expect that tax rate to build through the year? Is there some change in thinking there?

Dale E. Williams

Yes, on the last call, we said that the tax rate for the year would be about 31%. It did come a little bit lighter than that in the first quarter. That was principally due to geographic mix, with International being stronger, domestic being a little bit softer, and domestic being a higher tax rate. So for the year, I would think that the tax rate might come in a little bit from that 31%, but not dramatically.

Operator

Our next question comes from Brad Thomas with KeyBanc Capital Markets.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

I wanted to just ask a couple of questions on the guidance. For the second quarter, specifically, just at a high level, if you could help us think through this, it feels like Tempur North America is moving in the right direction, International's taking a step in the right direction. But you're still making investments on the new product rollout, and that's probably still pressuring margins. Is that what the reason is behind the gross margin outlook being a little bit worse than what we have been modeling going into the quarter?

Dale E. Williams

Yes. From the gross margin, let's break it down into a couple of pieces. From a gross margin standpoint, at the beginning of the year, we thought -- we said, the first half gross margin would be about 40%. So obviously, the first quarter was 160 basis points less than that. But keep in mind, when we're talking on here, we're talking pro forma. So the integration cost was about 30, 40 bps of that difference. The balance, though, was, in the first quarter, we had some more floor models, as Mark said, the retailers are very excited about the new product lines, not just Tempur, but Stearns & Foster. And so we're getting more floor models than we had anticipated. Also, the Direct, and this is a Tempur-specific item, the Direct business and the pillow business are much softer than we expected. Yes, they started the year soft, they continued to be soft, it's something we're not happy about, and we'll be turning our focus to those areas of the business with new products getting out. But we do expect for the first quarter -- I'm sorry, for the first half for gross margins to be slightly less than what we had anticipated at the start of the year. We do think gross margins will improve some in the second quarter from the first quarter as we have continuing product rollouts. But we'll be getting to the end of that, and certainly, another factor there is getting to the end of the closeout pricing on the old product line, then working through the rest of the P&L from an expectation standpoint. In the second quarter, we do expect to increase the advertising spend as a percent of sales. First quarter advertising was about 10.5%. We expect it to be higher than that in the 11% range. Also, the big outstanding expense in the second quarter is rolling out all the new POP that you saw at Vegas. In the first quarter, that new POP, only a little bit of it was shipped because some of the big customers don't use their POP, and the big customers were the first ones to start getting the new products. But in the second quarter, as the new products get broadly distributed, there'll be a significant investment in -- isolated to Q2 around that POP that's driving the operating margin issues. Also, FX was pretty -- it was a factor in the first quarter, very nominal factor in the first quarter, but on a comparative basis, FX should be worse in the second quarter.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Okay. Great. That's very helpful, Dale. And so just, with that as the outlook for the second quarter, you hadn't given second quarter guidance to us, but we'll obviously be needing to go down if we go to your numbers. For the full year, you guys are saying that EBITDA and EPS should be towards the mid or higher end of your range. What is it making you more positive on the back half of the year?

Dale E. Williams

Well, I mean, our plan all along was for the back half of the year to be much stronger from a revenue and a earnings perspective because of the impact of the floor models in the first half, as well as the POP investment in the first half. Keep in mind, it's been a long time since we, particularly on the Tempur business, that we had this magnitude of a change in the line, as in never. And so we have to really do a significant expenditure to get the floors of the retailers, POP, to look like we want it to look and like you saw at Vegas in late January. So the plan all along was once we got through this major investment in the first half, that we would see much better performance in the second half and -- from an earnings standpoint, and the new products will deliver growth in the second half and we'll start getting leverage on the business as we move forward in the year.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Great. If I can just squeeze one more question in on pillows. Not something that we usually talk about on earnings calls, but it was a pretty big drag here in the first quarter. Do you think that will continue to be a headwind or was there something unique here in this quarter?

Mark A. Sarvary

The -- to be -- the truth is it has been a headwind for a while. And our pillow business has declined. And there's some reasons for this. The way that retailers use them as gifts when people add incentives, people when they buy beds and so on is diminishing. But the fact is our pillow business is a very important part of our business, very much as -- consumers have a very higher awareness of our pillows. And the people who have them are as rabid fans as the people who own our mattresses are. And so it's something that we're going to put great focus on. Obviously, we put a lot of focus on these new Cloud and Contour beds from the Tempur part of the portfolio in this last period. In the second half of this year, you will see a range of new pillows, which we're quite excited about, which we'll be launching. But it will be a start of a renewed focus on pillows. It's a very important part of the overall portfolio, both because it's good sales, good margins but also very iconic and part of our product differentiation.

Operator

Our next question comes from Budd Bugatch with Raymond James.

Budd Bugatch - Raymond James & Associates, Inc., Research Division

Real quickly, Dale, I just want to make sure I understand the 2Q operating margin guidance. The 8% is a GAAP or a normalized margin number?

Dale E. Williams

That's a pro forma number.

Budd Bugatch - Raymond James & Associates, Inc., Research Division

All right. Perfect. And then can you maybe give us a little color on the operating margins and gross margins by segment for quarter 1?

Dale E. Williams

Yes, I'll give you the GAAP numbers that you'll see in the Q that will be filed here in the next day or so. From a Tempur North America gross margin, 40.3%; Tempur International, 59.7%; Sealy, 29.9%, and again these are all GAAP numbers. Operating margin, Tempur North America, 5.2%; Tempur International, 22.3%; and Sealy, 6.4%.

Budd Bugatch - Raymond James & Associates, Inc., Research Division

And then just real quick, for 2Q, can you maybe talk a little bit about by segment to topline-wise, will you expect Tempur and at least International end up wise? Are you still expect another strong quarter in International?

Dale E. Williams

Yes, I mean, we would expect International in 2Q to kind of have a similar performance to what it had in Q1, which was up 7%, up 5.8% on a constant currency basis. We expect Tempur North America to turn very positive and be up mid-single digits to high-single digits. The trends that we saw in the quarter, the gross sales that I mentioned is -- that was up mid-single digits in the first quarter as we get through the floor model rollout, we expect to see Tempur North America to pop to the high-single digits here in the second quarter. Sealy was 3% growth in the first quarter, ballpark. The domestic business was up 7%. So we -- with some FX issues on the international side, we saw a good growth for Sealy in the first quarter, and we expect that to continue with their new products. The Stearns completing its roll out, Optimum being rolled out, so we are looking for a strong performance across the portfolio.

Operator

[Operator Instructions] Our next question comes from Josh Borstein with Longbow Research.

Joshua Borstein - Longbow Research LLC

On the branding rights in Continental Europe, I know you said not to expect too much here in 2014. Is it -- is it possible to flesh out your expectations for what we may see there on the topline or earnings line in 2015?

Mark A. Sarvary

It's too early to talk about that now. We really haven't even -- the deals are not signed yet.

Dale E. Williams

Not closed.

Mark A. Sarvary

Not closed yet. Sorry, they're signed, but they're not closed. I mean there's still closing conditions. But we will talk about it more during the year. But I think that what you do need to bear in mind for Europe is that there's a very small, a very, very small business there right now. And what we anticipate doing is launching new products under the Tempur -- I'm sorry, under the Stearns and Sealy brand names through the infrastructure and the sales organization that we have there, and that will kick in, we believe, in 2015 in reality. We'll give you a better feel of that second half of the year. It's too early to do it right now. But as Dale said it's not going to be a material contribution this year.

Joshua Borstein - Longbow Research LLC

Okay. Great. And then just on the new products, is it possible to isolate them and just give an indication? You obviously expect to see an increase in velocity. I know it's early, but do you think you're seeing that increase as anticipated?

Mark A. Sarvary

As I said, it's -- we're in this transition period, and what data we can get is always anecdotal. We can speak to retailers, we can look at what's happening. And the anecdotal data we're getting is good. The anecdotal data we're getting is that some of the key products like the Rhapsody Luxe and the Cloud Elite are being very well received. So we're seeing good things. It's just -- we're not in a stage here where we can actually use any...

Dale E. Williams

Transition.

Mark A. Sarvary

Yes, it's a transition. I mean it's -- and remember, as I said earlier, the transition takes time. It takes time because even a retailer who is putting products on the floor, will often have at the same time the old product being sold at a discount right beside it. So it takes time. But the -- what we don't have quite a numeric or statistical data, what we do have is anecdotal, and that's what we're sharing with you right now.

Joshua Borstein - Longbow Research LLC

Okay, great. And then maybe just more of a qualitative comment then on the -- you mentioned that RSAs are more enthusiastic so far about the new products. Could you say in what way they're more enthusiastic or what's different about these new products that RSAs are gravitating towards in versus the old products?

Mark A. Sarvary

Well, I mean, let me do -- I mean, they're positive about all 3 sets of products that we've launched. The new Tempur products, the new Stearns products and then the Optimum ones. The new -- I'll do them in reverse order. The Optimum ones, while they're just shipping right now, they like the look of them, they like the feel of them, they think the aesthetics are very good, and I think they're slightly redesigned and they're taller, and people really like that. That's positive RSAs like that. The Stearns & Foster are considered to be among the most beautiful products that we've ever made and frankly, anybody's ever made. There are real -- people really, really think they're beautiful, and they love them, and they display well the hand. The feel of the products for the consumers is really good. The Tempur products are the most dramatic change from what was before compared to what they're replacing. And the RSAs very much like the aesthetics, they very much like the logic of the sequence -- the way that the products fit together. So you can logically step a customer up from the entry-level products right through to the highest end products, and with a good logical case for each step. But perhaps the thing that they have been saying to us that they find the most desirable about these new products is the demonstrability. One of the -- as you know very well, these products are designed to have the covers removed, which allows the consumer to look underneath the hood, and put their hand on the cooling layer and touch the Tempur foam. And that demonstrability -- we're hearing time and again, is something that really captures the attention of consumers, but also is something for an RSA to do to kind of show why this bed is different than the other ones on the floor.

Operator

Our next question comes from Denise Chai with Bank of America Merrill Lynch.

Denise Chai - BofA Merrill Lynch, Research Division

So first, in terms of International, it looks like the gross margin was down year-on-year. Can you talk a little bit about what was pressuring it?

Dale E. Williams

Yes, on the International business, gross margin was down a little bit year-on-year. A combination of factors, some new product rollout, the Breeze rolling out. So we're -- as Mark mentioned in his comments, the Breeze was very well accepted, getting more floor placements than expected. We didn't have really have a new product last year at the same time. Also some geographic mix, we had some new distribution. So a variety of factors around just putting on a little bit of pressure on the International business, as well as actually a little bit of cross currency mix that doesn't flow through the top line, but flows through the cost side because of the different foreign currencies we have to deal with internationally and the product being produced in euros, and the relationship of euro versus the pound or the yen or the Australian dollar or Korean won. So the cross currency gave us a little bit of pain as well.

Denise Chai - BofA Merrill Lynch, Research Division

Okay. Got it. And just sticking with International. Can you kind of size up a little bit your like Sealy business in Europe, then kind of compare that to Tempur-Pedic? For example, how many doors are the 2 brands in?

Mark A. Sarvary

So the first approximation, there isn't any -- there's very, very little Sealy business in Europe.

Dale E. Williams

Last -- at the Investor Day last year, in September, we said that if you look at Europe, Tempur is about 10x bigger than Sealy in Europe. And that's Continental Europe. However, that equation has magnified because one of the reasons why it was important for us to get control of Continental Europe was the Sealy business in Europe through the licensee was quickly eroding. And there's -- that's why we view that business as one that's really a from scratch organic growth story. But on the -- a lot of opportunity.

Mark A. Sarvary

Yes, one that we feel pretty good about.

Denise Chai - BofA Merrill Lynch, Research Division

Okay. Just one more question here. You said that you're also starting to deliver Tempur-Pedic and Sealy on the same trucks. So just how widespread is this? And can you talk about the difference it's making to your business?

Mark A. Sarvary

It's relatively small right now, it's in one of the markets. But we do anticipate that it's going to roll out going forward. And it has a number of benefits. One is that it, frankly, it means that we can fill trucks up fuller, which is a good economic thing, but it also means that we can have frequency of delivery, which is very desirable to retailers, which allows them to have more frequent deliveries and less inventory. And -- but what it requires in order to do it is obviously the same truck, but it requires us to have places where we can put the inventory together, and so that is part and parcel of what Dale referred to when he talked about the evolution of the distribution network is what we're doing. That initial test, while relatively small, has been quite good. And so we're in full speed ahead on doing that through the whole country. But having said that, it's going to -- this is a job that will take a couple of years. It's not something that you can just switch on.

Operator

Our next question comes from Jessica Schoen with Nomura.

Jessica Schoen - Nomura Securities Co. Ltd., Research Division

My first question was on the granularity you provided on the gross margin. I was wondering if there's any way you could kind of help us think about what -- how big are the impacts that are more unusual versus what are the more lasting impacts?

Dale E. Williams

Yes, well the bulk of the gross margin -- you're talking here in first quarter, first half?

Jessica Schoen - Nomura Securities Co. Ltd., Research Division

Yes, that's correct.

Dale E. Williams

Okay. The bulk of the impact is related to kind of one-off things, which is this massive product rollout. We have -- just the product discounts in the first quarter was a couple hundred basis points of 200 to 250 basis points of gross margin hit. On top of that, we also had -- people don't recognize it, but Mark mentioned that discounted product being sold out, all of our old product was at a close-out pricing. And that was another 150 to 200 basis points of gross margin erosion, because all of the old product that we sold was sold at a discount also. So I mean, those 2 factors alone, if you look just at the Tempur North America business year-over-year, its gross margin was down about 500 basis points. If you take those 2 items and you isolated just the Tempur North America, those 2 items were significantly more than the total -- the Tempur North America's gross margin was down. So as we get through this transition period and the close-out pricing goes away, the floor model discounts go away, we start seeing a very quick reversion back to normal gross margins for Tempur North America, as well as the business.

Jessica Schoen - Nomura Securities Co. Ltd., Research Division

Got it. That's very helpful. And then my other question was just an update on cost synergies throughout the rest of the year. You were just mentioning that one truck delivering both products, what other things can we kind of be thinking about for the balance of 2014?

Dale E. Williams

Well, cost synergies covers a lot of areas. We have cost synergies around SG&A. We have cost synergies that -- a lot of the big cost synergies we got immediately, and last year was around sourcing. But we continue to see ongoing cost synergies on the sourcing side of the business. We're seeing cost synergies in warehousing. We're seeing cost synergies in manufacturing. We're seeing cost synergies in media, where we're getting much better pricing because of the combined buys. When we first announced this deal, we thought there would be about $40 million of cost synergies last September. At our Investor Day, we updated and said we now believe that we'll get an excess of $70 million of cost synergies, and potentially, as much as $100 million in cost synergies. For this year 2014, we're looking for the cumulative cost synergies to be up as much as $40 million, and that's in less than 2 years of having the businesses together. As we're moving forward, this continued increase in cost synergies, a lot of that's coming from distribution, warehousing, shared manufacturing, but this, what Mark was specifically talking about, would fall into the distribution side, and that's a cost synergy that will continue to build over the next couple of years as it gets fully implemented.

Operator

Our next question comes from Joe Altobello with Oppenheimer.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Just wanted to start with a couple of big picture questions. I think earlier, you guys had mentioned that you're expecting to be at the high end of your guidance range for sales and towards high end on EBITDA and EPS. And it sounds like, and correct me if I'm wrong here, but it sounds like you guys are getting a little bit more or better visibility with regard to the business going forward in terms of how you're seeing things play out this year. One, is that the case or am I misreading that? And two, from a consumer perspective, are you seeing some of the volatility that we saw in the last few years start to stabilize from 4Q into 1Q?

Dale E. Williams

Yes, let me hit a couple of areas and then I'll have Mark chime in to a couple of areas. From a visibility standpoint or a confidence level, yes, I think that our visibility and confidence level is improving. And if we just look at the first quarter, our sales in the first quarter came in a little bit better than we expected. International did better, particularly in Europe. Sealy business revenues came in a little bit better than we expected. Specifically, the Posturepedic business continues to perform very well. Stearns & Foster turned positive in the first quarter. So we're seeing good traction there in the Sealy brands, the Tempur business. Tempur North America business came in pretty much where we expected it to, but it had the biggest transition, but we did see improvement throughout the quarter in that business. January affected everybody from a weather standpoint. But we saw a significant improvement in the Tempur North America business as the quarter went on. We're getting more placement of floor models than was expected as it -- in each of the products. In the Tempur products, in the Stearns & Foster products, in the Optimum, retailers were asking for more floor models which portends good things for selling later on. We're seeing some incremental distribution, and we're feeling very confident and feeling more visibility around the revenue. From an earnings standpoint, we're getting a little bit more visibility with more time going by, we're getting a better understanding, getting a better fix on where the synergies are, where the cost -- having more floor models means more floor model discounts, so there is cost with that. And ideally, what we'll see is volume, additional volume later in the year that gives us the volume leverage and more improvement. Mark, other things you want to add?

Mark A. Sarvary

That's right. I mean, I think that we -- there are -- another quarter's worth of trends that we have, particularly in International and in Sealy, that we can project. And then we have the new products that have been well received. I mean, clearly, as we've said all through, we don't statistical data on how they're selling, but we have very good indications. So standing here today, we have that much more knowledge than we had when we made the last projection. So we do have more.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Okay. That's helpful. And just secondly, in terms of the traffic at the retail level, has that stabilized or is it still pretty choppy week-to-week at this point?

Mark A. Sarvary

It is choppy. It continues to be choppy. And I think that we and the retailers are all hoping for a good Memorial Day. I know that it should be good. People are hoping it's going to be good. I know there's a lot of excitement about it, but it continues to be choppy.

Joseph Altobello - Oppenheimer & Co. Inc., Research Division

Okay. And just one last one in terms of the incremental slots you guys picked up. You mentioned that you have gotten some additional distribution. Is there a way to quantify how many additional slots you've gotten from the Tempur North America launches? Is it 5%, 10% more slots?

Mark A. Sarvary

I'm not going to put a number on it right now. I mean, I think the thing is that it's 7 products replacing 6. So in some ways -- and most of our customers have taken the 7. So that's one way to look at it. But you can't just use that as a -- I'm not encouraging you to use that as a metric. What we had done is when we did the analysis, we used that kind of statistical model to say what we thought the first round of floor models would be, what we will get in the first rollout in the first quarter. And that has -- we have -- that has been higher than we anticipated. But that's just comparing a model to an actual. So to be honest with you right now, I wouldn't put -- I can't put a good figure on it. I think we're going to end up with more, I just don't know how many. I mean more -- by the way, I mean more in aggregate is what I'm getting at. More in aggregate. I know we're getting more floor models of this product. I mean, more in aggregate.

Operator

[Operator Instructions] Our next question comes from Keith Hughes with SunTrust.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

One question at -- getting to the top half or the top end of the sales guidance range, it's going to be up high-single digits in the second half. Do you have a view on what the industry is going to be or are you expecting any assist there or is this your own initiatives?

Mark A. Sarvary

These are really -- I mean, this is our own projections. I mean sort of fundamentally baked into it is it's something like a 3% growth for the industry. So implicitly, we have that as part of the inputs that we feed into the models that we say what we think we're going to have. So yes, there's sort of implicitly that, but it's more a buildup from the bottom of what we think we're going to sell of each product.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And I was a little surprised on your second quarter discussion on sales, that it's going to be up modestly given kind of -- seems like we had to push forward of weather. Any commentary around that?

Dale E. Williams

Well, we didn't specifically try to factor a catch up of weather. Our North America business -- Sealy had a very good first quarter. Yes, there was lot of bad weather in the first quarter, but we saw good trends, improving trends as the quarter went on. From a Tempur North America standpoint, we saw the business come in essentially where we expected it to. But we're looking at -- we didn't specifically say, "Oh, we'll see a little extra boost in the next quarter from a -- because of delays from weather." But we are looking for significant increase in changing growth [ph].

Mark A. Sarvary

Yes, because normally the second quarter is smaller than the first.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Okay. So that's -- maybe I was confused. You were talking about a sequential move in revenues?

Mark A. Sarvary

Yes.

Keith B. Hughes - SunTrust Robinson Humphrey, Inc., Research Division

Sort of flat sequentially? Okay. Then that was my mistake.

Dale E. Williams

Yes, we were expecting growth in revenue sequentially, which is counter to the normal seasonality.

Operator

Our next question comes from Joan Storms with Wedbush.

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

So I had -- so we've seen in several different retailers the beds on the floor, but I'm still sort of awaiting on the POP. So that is -- so the beds rolled out first then the POP comes with more of -- sort of towards the holiday as we get in there or?

Mark A. Sarvary

Rolling out right now. I mean, the thing that we -- the bulk of the POP is rolling out now. And we expect it to be in places, not everywhere, but in the majority of places by -- the majority of the places where it's going to be by Memorial Day. That is the target. And it's a big part of what Dale was talking about earlier, which is our investment in this quarter versus last quarter in terms of in-store marketing. There are some of the biggest retailers that don't use our POP. But that is an important part. It will be rolling out, and it's a significant investment that's going to happen this quarter.

Joan L. Bogucki-Storms - Wedbush Securities Inc., Research Division

Okay. So that's all in the selling expense. And then just quickly on the -- you bought first Sealy, the Japanese licensee and now Continental Europe. What -- can you quantify like how much that cost on a relative basis compared to -- obviously, you're going to benefit a lot more on the sales side, but can you quantify on a cost basis with that -- what those things cost?

Dale E. Williams

The acquisition of those, of each of those, again, they haven't closed yet. So we haven't paid anything yet. But the acquisition on these is immaterial to the business. We have a pretty good understanding of formula of how to do these things and it works well. The detailed terms have not and will not be disclosed. But the -- from a business -- what the business is spending for it will be immaterial.

Operator

Our next question comes from Carla Casella with JPMorgan.

Carla Casella - JP Morgan Chase & Co, Research Division

Most of the questions have been asked and answered. But I guess, I may have missed it, but did you give your expectation for input cost inflation for the coming year? Any key items to call out there?

Dale E. Williams

We didn't give a specific number. We do have every year when we put our plans together, put in an expectation for -- even if the market is telling us that commodity cost will be down, we still assume it's going to be up. We have assumed increases in steel. We've assumed increases in the chemicals that we buy. We have seen some market increase, but it's well -- at this stage, it's within what our expectations are that were built into the year.

Operator

Our next question comes from Jon Andersen with William Blair.

Jon Andersen - William Blair & Company L.L.C., Research Division

I just have a couple of modeling questions. Last quarter, you talked about the advertising ratio coming in at 10.5% to 11% for the full year.

Dale E. Williams

Yes.

Jon Andersen - William Blair & Company L.L.C., Research Division

Where are you thinking currently for the full year and are there any meaningful variations by quarter on that line that we should take into account?

Dale E. Williams

We still think advertising will be in that range, 10.5% to 11%. There's 10.5% in the first quarter. Second quarter will be probably slightly above that range as we put a big push behind the new product launches, once they get -- you don't want to put a lot of money behind it until they get broadly distributed. But as we're getting here in the next couple of weeks, we'll see an increasing push on the advertising, on the new products, as well as the new creatives that Mark was talking about. Then through the back half of the year, we should see advertising kind of back in that range.

Jon Andersen - William Blair & Company L.L.C., Research Division

Okay. And just so I'm clear the expenses related to the point of purchase materials that are rolling out, is that isolated in the selling and marketing line?

Dale E. Williams

Yes.

Jon Andersen - William Blair & Company L.L.C., Research Division

Okay. And that's kind of a largely second quarter event?

Dale E. Williams

Yes, you'll see a step up, a sizable step up in selling and marketing spend in the second quarter related to the POP rollout. And then in the third quarter, we will revert back to normal.

Jon Andersen - William Blair & Company L.L.C., Research Division

Okay. And I know this has been touched on several times, I apologize for coming at it again. In terms of gross margin for the year, and then maybe some color first half versus second half, you said, Dale, earlier, you expect some sequential improvement from Q1 to Q2.

Dale E. Williams

Correct.

Jon Andersen - William Blair & Company L.L.C., Research Division

Is that right? And then how are, I guess, you thinking about the full year? I think last quarter you've kind of indicated 41% for the full year?

Dale E. Williams

Right. When we gave the guidance for the year, we said it's 41% for the year, we would see the first half ballpark around 40%, second half ballpark around 42%. Again, that was a pro forma, so it didn't have integration costs in it. But what we're talking about right now is actual GAAP [ph], it has integration costs in it. But we do expect to see improvement in the gross margin as the year goes on. We'll see some improvement in the second quarter. We'll see a significant improvement in 3Q as we get beyond these floor model rollouts and closeout pricing. We'll see a big step up in gross margin through the year. We would still expect the overall gross margin to be in that close to 41%, probably maybe a little bit less than 41%, but in that ballpark.

Operator

I'm not showing any further questions at this time. I'd like to turn the conference back over to Mark Sarvary for closing remarks.

Mark A. Sarvary

Thank you. And we look forward to talking with you all again in late July when we will host our second quarter earnings conference call. Thanks for joining us this evening.

Operator

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect, and have a wonderful day.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!