Mattress Firm Holding's (MFRM) CEO Steve Stagner on Q2 2014 Results - Earnings Call Transcript

Sep. 4.14 | About: Mattress Firm (MFRM)

Mattress Firm Holding Corp (NASDAQ:MFRM)

Q2 2014 Earnings Conference Call

September 04, 2014 08:30 AM ET

Executives

Brad Cohen - ICR

Steve Stagner - President and CEO

Alex Weiss - SVP, Finance

Analysts

Michael Lasser - UBS

Brad Thomas - KeyBanc

Daniel Hofkin - William Blair

Jessica Schoen - Nomura Securities

Josh Borstein - Longbow Research

Bobby Griffin - Raymond James

Joan Storms - Wedbush Securities

Operator

Greetings, and welcome to the Mattress Firm’s Second Quarter 2014 Earnings Conference Call. (Operator Instructions) I would now like to turn the conference to your host, Brad Cohen, with ICR. Thank you sir, you may begin.

Brad Cohen

Thank you, operator. Good morning everyone, and thank you for joining us today for Mattress Firm’s second quarter fiscal year 2014 financial results conference call. Let me remind you that certain comments made during the call today may constitute forward-looking statements made in, and pursuant to, and within the meaning of, the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995, as amended.

Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those risks and uncertainties are described in the press release and Mattress Firm’s latest filings with Securities and Exchange Commission. The forward-looking statements made today are as of the date of this call, and the company does not undertake any obligation to update those forward-looking statements.

Also during the call today, the company may be discussing adjusted EBITDA or EBITDA, which are non-GAAP financial measures. Please see the company’s press release for reconciliation to net income, the most comparable GAAP measure. If you do not have a copy of today’s press release, you may obtain one by linking to the Investor Relations page of the company’s website at www.mattressfirm.com.

I would now like to introduce the management team at Mattress Firm: Mr. Steve Stagner, Chief Executive Officer; and Alex Weiss, Executive Vice President and Chief Financial Officer. Management will make some comments, and then we’ll be available for your questions.

With that, I will turn the call over to Mr. Steve Stagner. Steve?

Steve Stagner

Thank you Brad. Good morning everybody and thank you for joining us on our earnings call. Today I’ll briefly highlight our second quarter results provide an update on our recent to newly announced acquisitions including the recently announced acquisition of Sleep Train on the West Cost and Back to Bed in Chicago and Florida. And then provide perspective on the business for the remainder of the year. Alex Weiss our Chief Financial Officer will then provide a more detailed review of the past quarter. To begin we are very encouraged by the growth we have seen in the business during the second quarter evidenced by both our strong same-store and overall sales growth. We have also experienced an improvement in our operating margin results now that we’ve had the benefit of the summer selling season are done with the distraction of heavy floor model changeovers and have made it through the heaviest initial drag period from our prior Q1 and Q2 acquisitions.

We are also encouraged by the continuation of these trends through the recently completed Labor Day weekend. Our growth during the second quarter was highlighted by a strong net sales increase of over 35%, robust same-store sales growth of 9.7% our fourth consecutive quarter of positive same-store growth. The completion of one acquisition during the quarter that added 67 stores and allowed us to increase our relative market share position in Colorado and Arizona and opening 53 organic stores driving our company operated store base to over 1,400 units.

Let me provide some additional color on our second quarter results. Our acquired stores continued to outpace the overall chain and collectively contributed approximately 315 basis points to our same-store sales growth.

We are encouraged that even more than two years after the Mattress Giant acquisition those stores continue to outpace the balance of the chain reinforcing the benefits of our relative market share model. Our legacy stores experienced strong same-store sales growth as well. Combined with the success of our sales initiatives and the benefit of the new floor model hitting the floor we achieve 9.7% increase in same-store sales growth made up of 8.5% unit gain in the quarter and a positive 1.1% AUP gain. While we achieve success in driving unit sales, traffic trends continue to remain choppy, this was associated with a continuing overall soft consumer environment however consumer confidence in other economic metrics are beginning to improve.

We are encouraged that our adjusted operating income margin improved by 40 basis points as compared with the prior year due to the expense leverage we achieved as a result of our strong same-store sales growth.

Now let me give you an update on the three strategic acquisitions that we recently announced and the one acquisition that we completed during the second quarter. Prior to going into the details I want to share with you the three reasons why we are excited about these recently announced acquisitions.

First all of these acquisitions are expected to be accretive on a GAAP basis in 2015 excluding one-time cost. Secondly, by adding these established and successful businesses, primarily in the West Coast and Chicago, we achieved a solid and profitable foundation for extending our relative market share model and thus substantially extending our runway for growth.

Finally, these transformative acquisitions will further establishes the Mattress Firm brand as the first true multi-brand border-to-border, coast-to-coast, national bedding retailer which will help us serve our customers better. This acquisition of the Sleep Train brand portfolio, being the leading specialty retailer on the West Coast with approximately 310 high performing stores, will allow us to achieve immediate scale in those markets and will provide us with a clear runway for growth in the highly populated and attractive West Coast region where Mattress Firm has nominal presence currently.

Additionally, we are even more thrilled that Dale Carls and CEO of Sleep Train, whom we have tremendous admiration for, will be joining the team as our President and Chief Strategy Officer, and will be bringing with him his experience and deep management team as well as an exceptional corporate culture that will further strengthen the leadership of our Company.

On August 28th, we announced an agreement to acquire approximately 135 stores, including approximately 110 Back to Bed and Bedding Expert stores in and around the Chicago area and approximately 25 Mattress Barn stores in Florida. This acquisition will give us an immediate scale in the Chicago market, which is the third largest metropolitan market in the United States, additionally allowing us to fortify our presence and relative market share in the Florida market. We look forward to welcoming an outstanding team of leaders with a long and successful history in the Chicago land market as we farther our position in this important market. On August 18th, we announced an agreement to acquire the stores operated by best mattress in Pittsburgh operating under the Mattress Discounters brand. These 15 stores will increase our relative market share in the Pittsburgh market.

Lastly, we closed the acquisition of the operations of Mattress Liquidators, which operated BedMart and Mattress King locations during the second quarter, and have begun our conversion process. We are encouraged by the performance of the business out of the gate and are very excited with the future of the Colorado and Arizona markets. Pro forma for these acquisitions Mattress Firm will have over 2,000 stores and nearly $2 billion in pro forma sales and positions us for continued growth. Together, we believe we can deliver significant synergies from this transaction and provide the customer with a higher level of selection, service and convenience.

Alex will provide additional details on these acquisitions.

Looking forward, we are very excited that the bedding industry has begun experiencing some positive momentum and are excited by the transformational benefits that these acquisitions will bring to our Company for the balance of 2014. We are encouraged by the following items. While not back to historical levels, the pullback in industry level advertising directed towards the high-end consumer continues to improve off of significantly reduced prior year levels; the new luxury products placed on our floors have resonated well with consumers allowing us to gain consistency with our sales performance and build back in some margin improvements; finally, while we don’t specifically discuss the sales performance of any particular holiday, we are excited with the sustained sales momentum that we have seen throughout the summer and in through the important Labor Day weekend.

In closing, during the second quarter, we achieved solid sales and earnings growth commensurate with our historical performance measures, further integrated our recent acquisitions, and laid the foundation for future growth with the announced acquisitions. We continue to believe in our relative market share model and strategy for growth, we are optimistic for the remainder of 2014 and expect to benefit from the recent acquisitions as we continue creating additional value for our shareholders.

I will now turn the call over to our Chief Financial Officer Alex Weiss.

Alex Weiss

Thanks Steve and good morning. I’ll focus my commentary on the fiscal second quarter that ended July 29th. During the second quarter, we reported adjusted EPS of $0.61. Adjusted EPS excludes acquisition related activities, cost of our ongoing ERP implementation project, and impairment and severance charges that are included in our GAAP results. Diluted earnings per share on a GAAP basis, including these costs, were $0.41 based on weighted outstanding diluted shares of 34.5 million.

Net sales in the second quarter were 410 million, an increase of 107.5 million or 35.5% over the same period of the prior year. The improvement in sales during the second quarter included comparable store sales growth of 9.7% adding 28.8 million in sales. Stores we opened and acquired added incremental net sales of 83.5 million and stores we closed reduced net sales by 4.8 million during the quarter.

Comparable store sales growth in 9.7% was comprised of 8.5% increase in unit sales and a 1.1% increase in AUP. Furthermore the comparable store sales increase for the quarter included the positive effect of approximately 315 basis points from the former Mattress Giant stores acquired in November 2011 and May 2012, Mattress Express stores acquired in October 2012 and Mattress Source stores acquired in December 2012.

During the second quarter sales of specialty mattress products comprised 43.3% of our net sales compared with 42.7% during the prior year quarter. While sales of conventional mattresses comprised 47.7% of our net sales compared with 49.1% during the prior year quarter. During the second quarter the Company opened 53 stores and acquired 67, while closing five bringing the total number of company operated stores to 1,480 at the end of the second quarter.

Gross profit increased 35.7% to 163.4 million in the second quarter compared to the same period of the prior year. As a percentage of sales gross profit increased 10 basis points to 39.9% over the prior year. This increase has several significant components.

First, comparable store sales growth drove leverage over store occupancy and other constant recurring costs resulting in gross margin expansion of 130 basis points during the second quarter. Second, product gross margins decreased 60 basis points from the prior year, half of the decrease resulted from the impact of current year acquisitions as we sold off acquired products and merchandize these stores with our standard products set.

In addition product gross margin was impacted by ongoing sales initiatives we have discussed in recent quarters that continue to drive unit sales growth but have also contributed to some short-term product gross margin reduction.

Third new stores in existing markets and our entrance into new markets continue to cause lower leverage over store occupancy, warehousing and other operating costs while we ramp up sales which resulted in 50 basis points of expense deleverage.

Fourth, recent acquisitions as Steve mentioned have resulted in some ongoing drag on occupancy and operating costs as we continue to integrate and convert the acquired stores. For the second quarter this caused 20 basis points of gross margin drag. Finally there was a combined increase in gross margin of 10 basis points across several categories due primarily to normal fluctuations in delivery and depreciation costs.

Sales and marketing expense was 100 million for the quarter compared to 75.8 million in the prior year quarter. Sales and marketing expenses as a percentage of net sales was 24.3% for the current quarter compared to 25% during the prior year period. The advertising component of sales and marketing expense increased 8 million to 38.8 million for the second quarter.

Advertising as a percentage of net sales was 9.5% for the current quarter which reflects 70 basis points of leverage compared to the prior year period. The non-advertising components of sales and marketing expense consisting mainly of sales and compensation increased 16.2 million to 61.2 million for the quarter primarily as a result of the increase in net sales. This expense as a percentage of net sales was 14.9% and was unchanged from the prior year period.

General and administrative expense on a GAAP basis was 36.9 million for the second quarter as compared to 19.7 million in the prior year. This expense as a percentage of net sales delevered by 250 basis points to 9%, compared to the prior year period on a GAAP basis. On an adjusted basis general and administrative expense increased 7.6 million for the second quarter to 26.3 million excluding 1.7 million of ERP implementation cost, 7.7 million of acquisition related costs and 1.2 million of other non-recurring costs in the current year and 0.9 million of ERP implementation costs and 0.1 million of acquisition related costs in the prior year.

On an adjusted basis general and administrative expense as a percentage of sales de-levered 20 basis points to 6.4% compared to the prior year. The increase in expense in this category over the prior year reflects ongoing investment in our corporate infrastructure to support our growth initiatives and hire ongoing costs related to our new ERP systems.

On a GAAP basis operating margin was 6.6% in the second quarter. On an adjusted basis operating margin improved 40 basis points compared to the prior year to 9.3%. In summary the net increase in adjusted operating margin was comprised of a 10% basis point improvement in gross margin, a 70 basis point improvement from selling and marketing expense leverage, a 20 basis decrease from general and administrative expense de-leverage and 20 basis point of combined operating margin declines in other areas.

Total other expense for the second quarter consisting mainly of interest expense was 3.5 million as compared to 2.8 million in the prior year as a result of an increase in churn and revolver borrowings as compared to the prior year. The effective income tax rate was 39.1% for the second quarter.

I will now turn to the balance sheet and statement of cash flows for a brief review. During the second quarter, we generated 51.2 million in operating cash flows, incurred 15.4 million in capital expenditures and used 29.5 million of cash in acquisitions. At the end of the second quarter, cash was 18.1 million with approximately 98 million of availability under our revolving credit facility.

Total debt was 302 million with no outstanding revolver borrowings and net debt leverage was approximately 1.87 times without consideration of the pro forma effects of recent acquisitions.

Now, I will provide more detail on our recent acquisition activity. On June 4th of this year, the Company completed the purchase of the mattress retail operating asset to Mattress Liquidators, consisting of 67 stores that operate in the Denver, Colorado and Phoenix and Tucson, Arizona markets under the names Mattress King and BedMart.

The purchase price was 35 million and remained subject to working capital and other customary adjustments. We funded the acquisition with cash reserves, availability under our revolving credit facility and a 3.5 million seller note that is payable on quarterly installments over two years. We are currently in the process of rebranding the acquired stores as Mattress Firm. On August 18th of this year, the company entered into an agreement to acquire substantially all of the mattress specialty retail assets in operations of Best Mattress Co., which operates retail stores in Pittsburgh, Pennsylvania.

The Company anticipates this transaction will close in the third fiscal quarter of 2014. The acquisition will add approximately 15 mattress specialty retail stores to the Mattress Firm company-operated store base for an aggregate purchase price of approximately $6 million, subject to customary adjustments. The Company intends to rebrand these acquired stores as Mattress Firm after the transaction closes.

On August 28th of this year, the Company entered into an agreement to acquire substantially all of the mattress specialty retail assets and operations of four related entities which collectively operate as Back to Bed, Bedding Experts and Mattress Barn retail stores in Illinois, Indiana, Wisconsin and Florida, primarily in the Chicago and Orlando metropolitan areas. The Company anticipates this transaction will close in the third fiscal quarter of 2014. The acquisition will add approximately 135 mattress specialty retail stores to the Mattress Firm company-operated store base for an aggregate purchase price of approximately $60 million, subject to customary adjustments.

The Company intends to rebrand these acquired stores as Mattress Firm after the transaction closes. On September 3rd of this year, the Company entered into an agreement to acquire all of the outstanding equity interests in The Sleep Train, which operates stores in California, Oregon, Washington, Nevada, Idaho and Hawaii. The Company anticipates this transaction which is subject to the expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act will close in the fourth quarter of 2014.

The acquisition will add approximately 310 mattress specialty retail stores to the Mattress Firm company-operated store base for an aggregate purchase price of $425 million, subject to customary adjustments. As further consideration, we have agreed to assume certain additional liabilities totaling approximately $15 million.

Lastly, we will not be updating our guidance at this time until we have more certainty around the timing of closing of the announced acquisition.

This concludes our prepared remarks and at this point the operator will open the call for questions.

Question-and-Answer Session

Operator

Thank you. At this time we will be conducting a question-and-answer session. (Operator Instructions). Our first question today is coming from Peter Keith from Piper Jaffray. Please proceed with your question.

Unidentified Analyst

This is actually John on for Peter this morning. Congratulations on all your recent announcements. My first question was just if you could talk may be a little bit more about the timing of the Sleep Train synergies and how you expect them to be realized through 2017? And then also if there is any way you could maybe bucket out the synergies for us a little more?

Alex Weiss

Sure, thanks John. In terms of the timing, we expect to get $20 million of synergies over the three years, so by the end of the third year post closing we expect probably about half of those to come in the first year post closing. And then we would expect you to kind of split the difference in the middle. So, we expect 10 million in the first year, 15 million in the second year and 20 million by the third year and that all excludes one-time costs. And in terms of the exact buckets, we are not going to be splitting them into buckets at this time for a dollar figure. But if you refer to the investor presentation that we posted on our website the main areas where we’re going to derive cost synergies from are going to be sourcing and procurement, distribution and logistics, advertising, SG&A, professional services and other and then on the revenue side we think we have some real opportunities in exclusive and tertiary products, multichannel and omni-channel sales, strategic partnerships, enhanced use of customer financing and then various other opportunities.

Unidentified Analyst

Okay, great. Thanks Alex it’s helpful. And then just looking at the Sleep Train banner I mean at this point are you guys going to rebrand that to the Mattress Firm brand or you’re going to keep it as it is and do you think it will possible to really increase Sleep Train sales per store since I think they’re little bit higher than your typical stores average?

Steve Stagner

John first of all regarding the Sleep Train banner we really appreciated over time the brand equity the Sleep Train has built in the markets and so we’re going to be carefully and thoughtfully evaluating our options before we determine a long-term branding approach in that market. With that being said, we are firmly committed to a national multi-brand strategy and as you know Sleep Train has a portfolio of brand and we’ll be learning a lot from Sleep Train's successful multi-brand operations.

We too have some with recent announcement of Mattress Firm have been experimenting with multi-brand. So what we anticipate happening as that we will be introducing the Mattress Firm brand for the first time in California as we look to open new stores and expanding out through the market place over time. Regarding the store averages I certainly will never use the word impossible I think there is a lot opportunity in the space to introduce more value to the consumers and I think that together Dale and I believe that we can over time try to help improve store averages to look back over the past 35 year store averages have been going up. So I wouldn’t use that term.

Operator

Thank you. Our next question today is coming from Michael Lasser from UBS. Please proceed with your question.

Michael Lasser - UBS

Can you help us frame how profitable Sleep Train is and where do you think that that business can ultimately end up from a margin perspective?

Alex Weiss

Sure. This is Alex and we’ll be providing more specific profitability information at a latter dates but just to give you a little bit of color Sleep Train is not at the same profitability percentage as the Mattress Firm company and the primary reason for that which is actually really nice complement to us is that Sleep Train focused their efforts on driving sales growth and growing their overall stores and the ability on a per store basis whereas Mattress Firm has focused kind of on market level profitability and penetration in relative market share. And so we think this is a really unique opportunity to grab the best of all worlds where they should be able to help us increase our sales per store and we should be help Sleep Train increase their relative profitability.

In terms of bridging their profitability up to our profitability we think the synergy benefits will help a lot because as you know we have some inherent benefits just because of our scale that allow us to achieve a higher profitability. And so we’re excited knowing they have a lower profitability percentage now which we’ll give more color on in the future.

Michael Lasser - UBS

So you’re suggesting there is nothing structural aside from the fact that they’ve been growing, there is nothing structural that will prevent the Sleep Train business from becoming just as profitable as the Mattress Firm level of profitability, because we look back in 2006 Mattress Firm operated 301 stores, had a 13% adjusted EBITDA margin and 9.5% operating income margin, our math would suggest that Sleep Train today is meaningfully lower than those levels.

Alex Weiss

Yes and so over time we absolutely think there are no structural elements that should prevent us from raising their margins up to our margin level. They have strong positions in their markets and they are extremely good operators, the biggest difference is that they have focused on sales growth and overall sales numbers so they’ve traded off a little bit on the margin side to grow their overall sales and over time mixing in just the operational capabilities that both sides will really held with each other because we expect that we can raise their margins and they can help us raise sales and help us raise our margins as well. So we think it’s going to be a great combination.

Michael Lasser - UBS

And when you see that when they’re trading growth for margin, do you mean that the product margins are a little bit lower or they’re absorbing more start-up cost associated with new store growth then and perhaps -- which is perhaps influencing the margins?

Steve Stagner

I know I’ve talked to you a great detail about this over the years. The real structural opportunity here is relative market share. The reality is the Sleep Train enterprise is very successful. And as Alex pointed out, they have a great culture and they focus on high levels of store productivity and our focus is on keeping those up and growing those, as I mentioned on the last question. But in addition to that, one of the [sauce] [ph] of Mattress Firm has been to focus on carefully and selectively penetrating further markets, leveraging that advertising across a broader scale, driving our profitability. And that’s an art that we thought we’ve mastered across our 1,500 stores. So, we certain again as Alex pointed out the combination of Dale’s enterprise focusing on that high ticket, high sales per store plus mixing in our RMS, we think will have a great combination moving forward.

Michael Lasser - UBS

And so two last questions, one is if you breakdown Sleep Train stores on a market level basis and then compared to your model, how many of their markets would be fortified and maybe you can give us some sense of the breakdown of leadership Fortress and development markets. I mean Steve maybe you can also comment on why now? What drove the timing to be right especially as you are consummating a bunch of stores that you’ve acquired in the last couple of quarters and does all this activity mean that you’re going to take a pause in the quarters ahead? Thank you.

Alex Weiss

And Michael I’ll answer the first part and I’ll let Steve answer the second part. In terms of the Fortress market share, Sleep Train has a very strong presence in the Seattle market, in the San Francisco market, in the San Diego market, and the Portland market and in various other markets throughout California where again Idaho, Nevada, Washington and now Hawaii with their recent acquisition. So, in a descent chunk of their markets, they have a strong Fortress penetration in some of their other markets, they’re still ramping up to scale. And so, we think it’s a nice combination because in those markets that aren’t up to scale there is a lot of growth, and in their markets that you have more scale we think there is more penetration to come.

Steve Stagner

And I’ll just add a little bit to that. They have a strong penetration Michael, but it’s also bifurcated across multiple brands. If you separate the brands out between Sleep Train and Mattress Discounters, you don’t get into a heavy Fortress. We think that there is expansion opportunity by expanding into those markets and developing a high single Fortress and that’s something that we’ll develop as a plan together over time. And then at that point you leverage more of your advertising that drives our profitability. We think when you compare it to our chain, they’re more in the strong leadership position from disappear market penetration point of view, but Fortress from a sales point of view because of their outperformance and sales. So, we’ll leverage that up.

The punch line here, which I think is most important, is, there is tremendous opportunities to add stores across the whole West Coast, and I highlighted that in my call. There is a great opportunity to open up a lot more stores. Now, regarding why now and pause, which is the second part of your question, obviously I would love, and I’ve talked about this for years, I’d love to be able to time all these where we do won and then we integrated and then we do another one. But that’s just not reality. The why now is, we have been highly committed to building a border-to-border, coast-to-coast chain, the timing is such has occurred to where these opportunities occurred, both in Chicago and here on the West Coast at this point in time and we think that the deals being that they’re accretive, we think that they make a lot of sense for us. We think it puts us in a position to leverage a host of benefits on a national scale from potential national advertising to potential other distribution benefits.

But beyond that, regarding the question of a pause or how we digest all of these, one of their great things about this acquisition in particular the Sleep Train acquisition is their deep management team. Their culture and their management team is highly aligned with Mattress Firm’s culture and management team. And we’re extremely confident that what we just did is we just added to our bench some great leaders and together the two organizations who have a lot of respect and admiration for each other can certainly handle building up this national team across the country in a very immediate fashion. So we have a ton of confidence around that. Whether or not we take a pause or not, that’s unknown. Our focus right now is going to be continuing to drive our business everyday like we are; we’re highly focused on our business right now. Ken Murphy has done a great job of driving the -- we’ve been dividing and conquering, he has been driving the daily sales as you can see by our sales in the quarter. Certainly I have been a little bit busy and we’re focused on integrating these companies and what we’re going to do is keep that focus and I think we’re going to add to it with this team.

Operator

Thank you. Our next question today is coming from Brad Thomas from KeyBanc. Please proceed with your question.

Brad Thomas - KeyBanc

I wanted to just follow up on that last point about integrating and digesting and just putting to perspective that I think if you close the Sleep Train deal by the end of the year you’d be at a point where you have over 60% growth in stores year-over-year and so maybe Steve you could just give us a little bit more color on how you manage that much growth in such a short period of time. And then from a financial perspective what the cadence may look like before it really starts to take in and be accretive?

Steve Stagner

So as far as managing that I think that Brad as you know we’ve really been focusing for years on building our organization. We have a very deep team, very experienced and deep management team here. We went through a restructure earlier in the year, that restructuring has really paid off some very good dividends in terms of getting the organization aligned so that decision makers could focus on what they do best. And we’re seeing some great results, certainly this is a lot of effort and a lot of work and I take my hat off to our team for all the challenges that they have been through but they have been, they have kept the head up high and held their head up high and they have been able to really accomplish everything in a very controlled manner.

So I feel confident that we can handle, if you look at Pittsburgh and Chicago we’re very prepared to handle those, in Chicago the proprietress Glenn and Vito are the owners there. They’re going to stay onboard; they have deep Chicago history over the past 20 plus years. They’re going to stay onboard and help us integrate that chain, we welcome their entire team onboard so that’s not going to be as dramatic as one might seem, because we’re gaining excess incredible history and knowledge.

And the same thing goes for the West Coast; in fact we’re going to be keeping a West Coast presence, the Sleep Train headquarters is going to remain in Rockland just outside of Sacramento. We anticipate, we know their team very well. We anticipate that their team is going to continue on as they have and we’re going to be looking how we can leverage best practices and move forward. I mean -- but we’re picking up a championship team over there.

So we’re going to leverage those two teams together and continue on with what we’re doing. So I have a lot of confidence around our ability to handle that growth. Outside of that Brad it’s just organic growth and new stores and the Mattress Firm organization has really built a good cadence in handling that.

I’ll let Alex talk about the cadence.

Alex Weiss

So Brad the other element we’re really excited about is that starting in the first full fiscal year post closing. So if we’re able to close in 2014, then in 2015 we would expect to get mid-single digit accretion, so basically getting immediate accretion right off the bat. And the way that we’re able to do that is a number of reasons. One we’re assuming as we mentioned earlier that about half of the synergies come in in the first full year post closing, so about 10 million of synergies on top of the base business.

And then in addition to that we structured the transaction so that we’re paying about 90% cash, 10% equity and as a result debt based on the current financing markets is at fairly historical lows and on top of that we were able to generate a lot of cash flow in the quarter, over $50 million of operating cash flow. And we’re also hitting the cash generative portion of our year once we get through the Labor Day period which we just did. And so we have a lot of confidence that we paid down some debt, we’ve growth our EBITDA, we’re in a good place from a financing perspective. And from an accretion perspective this should be mid-single digit additive in the first full year post closing.

Brad Thomas - KeyBanc

And then just a couple of house-keeping items on that. With the acquisition last week of Back to Bed, Bedding Experts and Mattress Barn, what’s the accretion expectation for 2015 coming from those deals?

Steve Stagner

So we’ll go into that more when we give you full guidance for 2015 later in the year. We wanted to call out specific accretion dilution for the Sleep Train transaction because it’s so meaningful. But given that the Chicago transaction is going to close in 2014 we don’t expect much or any accretion in 2014 but there definitely will be positive accretion from the transaction 2015 what is need to refine it more as we get later in the year and give our overall 2015 guidance for the year.

Brad Thomas - KeyBanc

Okay and then just one more if I can maybe step back and Steve ask you about the organic openings outlook now that you’ve done these other acquisitions and have a nice foothold on the West Coast, what you think the pace of openings will look like in tuck-ins versus new markets over the next couple of years?

Steve Stagner

I would suggest that just organically that we are going to stay on the same kind of cadence we have for the past year. I would suggest that we seek to have about a 10% unit grow a year organically that’s really our focus and we have been able to do that and we see a lot of opportunity to continue that pace. Brad, as you can probably imagine, we are well into ‘15 and even into ‘16 now on new stores, so in terms of deal that we have signed or looking at. So, we have a lot of confidence around that. Tuck-ins as we always say acquisitions are a part of our strategy. They are very hard to predict. We love doing tuck-ins and so we'll keep our eyes out there and I am sure we will get some phone calls at some point but our focus is just on trying to maintain that growth period, that growth as I described.

Operator

Thank you. Our next question is coming from Daniel Hofkin from William Blair. Please proceed with your question.

Daniel Hofkin - William Blair

Just a couple of follow-up questions, one would be comparing the two most recent acquisition announcements today and late last week and kind of the price that you are paying let’s say per store or per dollar of sales is somewhat higher with today’s announcement versus the Chicago and Florida acquisition and just wondering what are the main things contributing to that whether it’s profitability come west versus Chicago and Florida or other factors? That would be my first question.

Steve Stagner

Yes, Daniel, I think we both can try to answer it but first of all the value of the acquisitions, they are very different organizations but the Sleep Train acquisition is a transformative acquisition and the reality is it’s a very high quality organization with very high store averages. And it’s an accretive deal and it’s a combination of the synergies and the store averages, the culture and the access to an entire footprint. The methodology that we use to think about acquisitions is all based around relative market share and this gives us a fantastic footprint to expand that relative market share in a very immediate fashion. And Alex, I think you wanted to go over some metric.

Alex Weiss

Yes and well I guess one other major point that I wanted to make, Dan, is that first-off while it looks more expensive on a cost per store basis, when you look at it on a cost versus sales basis, it’s more expensive than a typical acquisition but it’s much more in line with a more disciplined number. And so that gave us a lot of comfort and then the other element which I think is important to describe is we structured the transaction in such a way that we receive a tax step up and this is a pretty meaningful element of the transaction because the way we have structured it, we are able to receive a full tax basis on the purchase price paid.

And if we hadn’t structured it this way, we essentially would have no tax basis and hence no future deductions. And this is kind of a unique characteristic to our industry because in our industry there is a relatively small historical capital investment to go to business relative to the size at which it can be bought or sold. And we recognize that the price we paid without this step-up comes off to some people as being a high price which as Steve mentioned we have a strong reason for. But when you factor in the benefit of the tax step-up which will give us future deductibility of goodwill of roughly 11 million a year in annual cash tax benefits over its 15 year life and take the present value of that which if you apply a 6% discount rate, is about a 107 million.

That gives us a lot of comfort above and beyond all of the benefits that Sleep Train brings which we would have had really tough time achieving without the acquisition of Sleep Train.

Daniel Hofkin - William Blair

That’s very helpful. So given all of those given the synergistic and kind of platform and market share factors as well as the tax benefits because with structure maybe Chicago and Florida is a lower than average typical purchase price per dollar of sales maybe you could discuss kind of the -- I know you haven’t said how accretive you expect Chicago and Florida to be specifically next year but could you talk about how their profit margin is right now compared to Sleep Train?

Alex Weiss

Yes, let so the Chicago profit margins are pretty similar to the profit margins that we see for most of the acquisitions that we acquire, they’re slightly higher given that Glenn and Vito are very strong operators and that was a big reason for why we purchased the company. So they’re definitely a little bit above what we typically see and in a similar neighborhood to the Sleep Train profit margins, but we’ll go into that more in the coming period as we give more information on both of the acquisitions.

Daniel Hofkin - William Blair

And then I guess finally if you can just -- are they looking out further and obviously you got a lot on your plate, how many other acquisitions do you know out there are somewhere between let`s say these two sizes 100 and change to 300 and change stores?

Steve Stagner

It’s hard to specifically quantify, but we've had a less track record of doing greater than 20 acquisitions over the past since I’ve got here in '05 I think when I look across the country the West Coast has certainly a handful of great retailers over there that are of good size, there is a handful throughout the country and then there is quite a numerous amount of tuck ins that are smaller in nature. So I think -- and then there is obviously a large one out there. So there is certainly potential in other areas, we can’t really Daniel predict any of that or even comment on it because it’s too unknown and there is virtually no activity at this point I think I am demonstrating a lot of activity right now.

Operator

Thank you. Our next question today is coming from Jessica Schoen from Nomura Securities. Please proceed with your question.

Jessica Schoen - Nomura Securities

My first question is about the comp increase you saw in the quarter. I was wondering if you could talk about the 8.5% unit increase and how you'd really drove that conversion that allowed you to see that kind of unit increase even in the absence of traffic?

Steve Stagner

Yes, thank you for asking about our quarter Jessica. We are very excited about the great quarter that we had and we -- one, it’s our fourth consecutive quarter of positive comps and we’re excited to see that the unit activity certainly was good, it goes back to what we talked about over the past three quarters which was (this) [ph] continuing focus on unit capture. And I think that Ken and the team spend a lot of time focusing on some very specific things at the field level, better execution overall and that’s really where we got it, we also experienced some sustained AUP growth as well. So we were just very pleased to see this, the momentum sustain itself throughout the quarter and translated to great comps.

Jessica Schoen - Nomura Securities

Great. And then with the increase in AUP, as you called out strength of the high end, do you expect that to be a greater contributor to comp trends going forward?

Steve Stagner

We hope so, we’ve seen since the new line, since we, as we talked about earlier in the year Jessica, we got through all of those and I mentioned it on my prerecorded notes, once we got through the lining changes, the new lines have actually scored very well across the board, and we’re especially pleased with our specialty category business, that’s up sequentially, 250 basis points and up year-over-year, 60 basis points and in terms of velocity and AUP is also up sequentially and year-over-year as well. So we’re seeing a great growth there driven by we believe renewed interest in industry level advertising and that’s been very well received and we talked about that since 2012 ad nauseam and what we’ve always talked about is as that advertising comes back it will translate to results and we’re seeing that. So we encourage both the combination of the manufacturers and the retailers like us to continue advertising and driving that messaging out there because that's what's helping fuel our category get some good results right now.

Jessica Schoen - Nomura Securities

Great, thank you. And just one last one on the product gross margin, I understand you're not giving guidance at this time. But is there anything you can tell us to kind of help us think about how that product gross margin has been built back over time and anything to keep in mind as we look forward especially in light of the announced transactions? Thanks very much.

Steve Stagner

Yes, thanks Jessica. The product gross margins increased sequentially by about 40 basis points, and still slightly the behind prior year. But as you know, about this time last year, we got into Q3 right after Labor Day. We had been experiencing three quarters of negative comps, now we’re on our fourth of positive. So what we did is we kind of sacrificed margin last year and went after the unit capture and then as the new lines came out we built back in margin with the new beds and we did that through pricing, very deliberate pricing strategies. And so the punch line is that we’re going to be lapping some easier numbers, lower numbers, and we’ve had a very consistent climb out on margin and we anticipate that to moderately continue to climb as we go throughout the year. So, that’s what we see.

Operator

Our next question today is coming from Josh Borstein from Longbow Research. Please proceed with your question.

Josh Borstein - Longbow Research

Steve and Alex, thanks for taking my questions, and congrats on the quarter. Just to stick with some of the trends of the last question. With respect to guidance, can you still talk about same store sales guidance I think they were mid-single digits that you talked about in your pre-announcement last time. And just how has sales trended into August? Are they consistent with 2Q trends? Any better, any worse?

Alex Weiss

So we’ve seen the consistency continue through August and through the Labor Day holiday, so which was definitely above our expectations. As you know, we’re getting into the part of the year where we lapse the selling initiatives from a year ago. So we expect same store sales to moderate significantly going forward past this point. But the trends have held up and have been very strong, that’s very encouraging. And as I mentioned kind of on the release and I know as you know, we didn’t update because we’ve announced these major transactions and we had just updated guidance two weeks ago. So we want to hold off until we have more certainty around the timing of closing of these transactions before we update our guidance.

Josh Borstein - Longbow Research

And Steve in another word, we’re two quarters into the fiscal year. Just trying to get your view on the overall health of the industry and consumer patterns? Do you feel any more or less optimistic about the industry as you were three months ago?

Steve Stagner

I feel more optimistic Josh. What we’ve seen since May 1st has been a very sustained and consistent result. The traffic although, the traffic is kind of odd because it’s not really coming back fully but we’re seeing national advertising pick up, we’re seeing consumer confidence break 90 for the first time since before September of 2007, and we’ve had two consecutive months over 90. So, that’s been a metric that I think has got some direct relationship to, consumer is feeling good about buying mattress. I feel like some of the pent up demand is coming back. The manufacturers have done a stellar job of being not only less promotional but also focused on their new lines and getting some really good quality stories out there. So we’re having good success with that. So I think a lot of things are hitting on the right cadence here.

Certainly, there is some macro and global issues out there that could cause consumers to have some concern. So that keeps us a little cautious. But generally speaking, we saw some growth and we take all the [indiscernible] numbers with a grain of salt or two grains of salt but the reality is the industry appears to be getting some tailwind. We’re seeing it. We feel like our peers are seeing it as well. So, I feel pretty good about it right now. We’ll see how it goes through Columbus Day and Veterans Day.

Josh Borstein - Longbow Research

And are there any regional differences that are evident in terms of sales trends out there?

Steve Stagner

Nothing to speak-up, it’s been pretty consistent across the board.

Josh Borstein - Longbow Research

And then just one more, can you provide us with an update on the adjustable foundation and attachment rates if they’re increasing, what maybe the margin implication is on a mix perspective if you see greater sales of adjustables?

Steve Stagner

We are seeing some increasing in adjustable sales. And even most recently through the Labor Day weekend, we saw even some pretty strong results in adjustable sales. And certainly it’s a similar margin profile but it’s maybe not as high as a percent but the gross profit dollars or so much stronger, it’s a great add-on from selling just a traditional foundation.

Operator

And next question today is coming from Budd Bugatch from Raymond James. Please proceed with your question.

Bobby Griffin - Raymond James

This is Bobby actually filling in for Budd. I appreciate you guys taking my questions, and congrats on the very nice quarter and the recent acquisitions. So, my first question is guess is towards you Steve. Can you may be talk or give a little color around the plans for the floor layout of the Sleep Train stores. I realize that differ a little bit in terms of where they over indexed to versus the traditional Mattress Firm store.

Steve Stagner

Yes, Bobby I think it’s sort of far too early talk about that. I mean Sleep Train is just announcing to their people as we -- yesterday announced what is happening with this acquisition. We haven’t spent -- we spent the last period of time kind of working on the deal. And that’s the kind of stuff we’ll spend some time on the future really fine tuning. We know a lot about their floor, they know a lot about our floor. But in general we’ll fine tune that over time. And I think even for competitive reasons we probably won't speak too much about it.

Bobby Griffin - Raymond James

Can you maybe provide any color on what the acquisition purchase price and then on kind of an EBITDA basis multiple or something?

Alex Weiss

Yes, we’re not going to give that specific number out right now. We’ll give more information around EBITDA at a later date. We want to go in and indulge into the numbers before we report anything out publically. But it’s a higher EBITDA multiple than we have typically paid if you just look at the total purchase price. However when you factor in the benefit of the synergies that we’re going to be able to achieve as we expect and also when you factor in the net present value of the tax step up it puts it in much more in line with a typical acquisition multiple.

Steve Stagner

Yes Bobby EBITDA multiples are part of the consideration the elements but we always look at the business on every acquisition on what it means to us going forward and that’s what Alex is talking about. How it looks to us going forward pro forma. Mattress Giant is a great example, that was a company that you know what we paid they weren’t making money. So the multiple would have been ridiculous but that’s a company that still after two years of comping 17% and driving tons of profitability to us. And that’s our focus, as we look at the business on how it’s going to drive profitability for our shareholders moving forward.

Bobby Griffin - Raymond James

And then Alex maybe can you comment a little on, out of the purchase price if my math is correct, about 42 million or so will be in stock and then the other 382 or so million will be in cash and debt. Can you maybe comment on how much of that will be cash and how much is going to come from the financing?

Alex Weiss

So in terms of the actual breakdown, those are good approximate numbers, however as we’re so diligent seeing the transaction fully. Those numbers could move around a little bit. And then the only other thing to consider is that we’ve agreed to pay the built in gains tax as part of the transaction and we expect that number to be up to $15 million. So you should factor that in as kind of an additional financing need. However when you consider how we’re going to fund that, we’ll have more details around that in the future, but we’ve been speaking with our lead bank and with our other banks. And we would expect to use some of our cash on hand and then going forward we would also expect to raise senior debt.

So the markets are very robust right now, we’re very confident that we can get an attractive rate on our financing. And we’re going to be moving forward with the financing process shortly.

Bobby Griffin - Raymond James

And one more just final quick one from me. Looking at the quarter it looked like the ad spending as a percentage of sales ticked down a little bit versus last year. Can you maybe talk about what the outlook is for ad spend going to the back half of the year?

Alex Weiss

Yes, so ad spending was up $8 million in the absolute and the beautiful thing about relative market shares we can spend more dollars and do it at a more efficient rate. So we gain 70 bps of leverage and a lot of that has to do with our increased market penetration which enable us to spend more dollars and drive up more profitability.

So just for clarification Bobby it wasn’t like down an absolute.

Bobby Griffin - Raymond James

Yes I saw that, I was just referring to a percentage of sales basis. I was just trying to get some color around how to model that percentage of sales or even absolute dollar value out going forward.

Alex Weiss

And going forward Bobby you should expect to see a fairly consistent percentage of sales. If we wanted to, we could potentially cut back on as a percentage of sales and generate some leverage. However given the trends that we’ve seen over the last quarter and through the Labor Day period as Steve has kind of been mentioning for the last couple of years when the customers out biting, we’re going to be out advertising. And so I think you’ll see us keep the throttle on for advertising.

Steve Stagner

Definitely Bobby, that’s a great point Alex. Going into this current quarter now we feel like there is a little bit of momentum here. So very cautiously and carefully but we’re going to put the throttle down a little bit. We encourage our vendor partners to do the same.

Operator

Thank you. Our next question today is coming from Joan Storms from Wedbush Securities. Please proceed with your question.

Joan Storms - Wedbush Securities

Most of my questions have been answered but just on the traffic question and I know Steve you’ve said you’ve been feeling better about sort of the momentum in the business and how that’s going. But during the summer holidays, was the advertising that's mainly around the holidays, how is traffic in between and it seems traffic must have picked up from the first quarter. So, can you comment on that and the outlook?

Steve Stagner

Slight improvement over time but overall it’s been pretty consistent in terms of the cadence volume through the summer month in between holidays and the holidays have been kind of in the same range. So, Joan, a couple of years ago it seemed like we would do really well in the holidays and then in between times weren't as good that’s not been the case this summer. The summer's been good pretty much every day, but the traffic overall has just been slightly improving but it hasn’t broke out yet.

Joan Storms - Wedbush Securities

Great and then Alex, I know you are providing guidance until we get through probably the next quarter or so but I don’t know if you could comment at all about where you thought consensus was toward sales and earnings for 2015 and then adding on a certain percentage adding in the sales through the acquisitions that we know that you are making and then on a certain percentage basis to next year. Were you comfortable with the street consensus where it was before the acquisition?

Alex Weiss

Yes, so as you know we'll go through our full 2015 guidance update as we get further into the year especially given how many moving pieces we have right now. I think in terms of when you are doing your model for 2015, we obviously think that we have opened a lot of stores this year. We have made a lot of acquisitions and so it’s important that you properly flow in the benefit of those acquisitions and particularly for the new acquisitions we put a little detail around sales for both Back to Bed and Sleep Train. And what we put in our release, if you look at our attached investor presentation, is that Back to Bed in 2013, they are doing a little over a 100 million in sales and Sleep Train was doing 471 million in sales.

And so we would expect some growth particularly from the Sleep Train side in 2015 over 2014. But to go into specifics right now would be a little premature, All I can say is that all of the acquisitions we have already done this year we are pretty excited because if those get into the fourth quarter and start to lap their prior year on a year-over-year basis in 2015 and we implement our relative market share model for them. There should be some real benefit and that I think you will see in 2015 once we acquire the Chicago acquisition and the Sleep Train acquisition. Assuming all of the closing conditions are met, we are pretty excited that as you go through and we integrate the business, there should be some real benefit.

Operator

Thank you. We have reached the end of our question-and-answer session. I would like to turn the floor back over to management for any further closing comments.

Steve Stagner

Okay. Well, we thank you for taking the time this morning on our Q2 earnings call and we look forward to speaking to you next quarter. Have a great day.

Operator

Thank you. That does conclude today’s teleconference. You may disconnect your lines at this time and have a wonderful day. We thank you for your participation.

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