As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Mark Rupe. Sir, you may begin.
Thanks, Sam. 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 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 headings "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.
Thanks, Mark. Good evening, everyone, and thanks for joining us. Today, I will provide an overview of our performance in the second quarter and then discuss the progress we are making on our key strategic growth initiatives in 2014. I will then turn the call over to Dale, who will provide details on the second quarter financial results and 2014 guidance. Our second quarter turned out largely as we expected. Sales growth accelerated slightly more than we had planned, but we invested heavily in new products, advertising, and in-store marketing support, and earnings were approximately in line with our plans. In total, our second quarter sales were $715 million and adjusted EPS was $0.39. Tempur North America returned to growth, with sales up 10%. Our new TEMPUR-Cloud and Contour beds have been well-received by consumers and retailers, and sell-through momentum is building.
Demand for our TEMPUR-Breeze beds and the new adjustable bases were also higher in the quarter. Tempur International's performance was in line with our expectations, with solid sales growth in Europe, Asia, and Latin America. Sales were up approximately 5% on a constant currency basis, with direct sales driving a majority of the growth. Sealy's performance was also consistent with our expectations. Strong demand for the new Stearns & Foster offering and continued growth of Posturepedic led to double-digit growth in the U.S. Sealy also saw improved performance of Optimum, adjustable bases, and Sealy-branded products. Sales outside the U.S. declined slightly, with both Canada and South America slightly below last year. I'd like to discuss the progress we're making on our four key strategic growth initiatives in 2014. The first initiative is product innovation.
Our goal is to provide our consumers the best bed and the best sleep of their life, to provide our retailers a complete range of brands, products, and price points that meet the needs of every consumer who comes to their store and thus drives their growth. We've talked a lot about the importance of investing in product innovation to drive growth. When the competitive environment changed in 2012, we said we needed to increase the scale and pace of our investment and to work with retailers to provide unique and consumer-valued products that allowed them to improve their average retail selling prices. In the past two years, we have delivered on this, systematically overhauling our Tempur North America offering with innovative products that command considerably higher average retail selling prices, as well as much higher adjustable base attachment rates.
Today, nearly all of Tempur North America's sales are from products introduced in the last 24 months. Through this heightened focus and investment in innovation, we have returned Tempur-Pedic to a position of strength in the marketplace. The benefits of innovation are not isolated to Tempur. During the second quarter, we completed the rollout of our new Stearns & Foster collection, with 15% more placement than last year. Feedback on sell-through and consumer acceptance has been excellent overall, and in particular for the upper-end Lux Estate and Lux Estate Hybrid collections. At its current pace, Stearns & Foster will eclipse the previous annual sales record. We also completed the rollout of our new Optimum in the second quarter. Customer response remains very good, and sales trends are improving. We also continue to see strong growth from our Posturepedic Innerspring and Hybrid collections, even though they are now in their second year.
We're encouraged by this and are optimistic that it shows the potential for lengthening the product refresh cycle. Frequent refreshes are a significant cost burden to both manufacturers and retailers and are often of very little benefit to the consumers. Internationally, we continue to roll out TEMPUR-Breeze beds in several European markets and will launch Breeze in Asia during the third quarter. Overall, Breeze has been very successful, where it has been launched, it has quickly become a strong seller. To date, it has been more cannibalistic of existing Tempur mattresses than we had originally anticipated. At next week's Las Vegas Bedding Show, we plan to introduce a new line of Sealy-branded value products. We have streamlined the collection and significantly enhanced its design and construction. We're also introducing new Tempur-Pedic pillows for North America. We expect both introductions to drive sales improvement in the coming periods.
In addition to product innovation, we're also very focused on improving our marketing effectiveness, which is our second strategic initiative. This includes advertising as well as in-store marketing and direct sales. In the second quarter, our advertising investment grew by 7%, primarily driven by an increase in Tempur North America. TV ad impressions grew at an even faster clip as we reinvested the synergies realized from the combined media buy. We began airing new TV ads nationally, featuring real Tempur-Pedic owners and our new mattresses and adjustable bases. While it's still early, the initial response has been quite good, with key metrics such as store locator visits improving markedly. We're also supporting Stearns & Foster, Optimum, and Posturepedic with consumer advertising, including TV, digital, and print.
Our in-store marketing investments were elevated in the second quarter as we rolled out new point-of-purchase displays to support all of our new product launches in North America. These investments were planned, and they'll be lower during the remainder of the year. As you can see, we're very committed to innovation and marketing, and we'll continue to make decisions that ensure our investment dollars in these areas are maximized. That ties to the decision we made last month to exit our U.S. innerspring component business and to sell the related assets. The transaction will provide us greater flexibility to invest in innovation and brand building in the future. Our third strategic initiative is new market expansion, including our expansion into new international markets.
During the second quarter, we completed the acquisition of Sealy brand rights in continental Europe. During the balance of the year, we'll be rolling out a number of Stearns & Foster and Sealy hybrid products to retailers in several key markets. As Dale will discuss in a moment, while we don't expect much contribution from this acquisition in 2014, the growth opportunity is significant. We anticipate greater contribution in 2015. We also completed the acquisition of Sealy brand rights in Japan in early July. We absorbed a small amount of ongoing business, as well as integrated certain sales and marketing functions of the former licensee into Tempur Japan. Transition of customer relationships and integration has been in line with our expectations. We see many long-term revenue synergies from this combination.
Sealy's customer relationships and distribution footprint are highly complementary to Tempur Japan's. This has already resulted in some early wins, where Tempur has secured new distribution through leveraging Sealy's existing relationships. We're also advancing several other initiatives across the world. We'll be sure to update you at the appropriate time. Lastly, our fourth strategic initiative is our commitment to building a world-class supply chain that is easier to do business with. We continue to improve our distribution and warehouse network and are capturing greater cost synergies as a result. Equally important, however, we are also improving our customer service levels, specifically order management and delivery performance. We are now shipping Tempur and Sealy products together on Sealy trucks in four U.S. markets and plan to layer in additional markets in 2014 and beyond. We're also making good progress with our category management initiative.
Because of the breadth of our portfolio, we're in a unique position to use data and analysis to help our retailers optimize their merchandising and promotion to maximize their sales and profitability. Before turning it all over to Dale, I'd like to make just a couple of closing comments. Q2 turned out largely as we expected. Our plans called for growth to accelerate, this occurred across our segments. We are pleased with the trends we are seeing, we're very focused on executing our strategy to build on this positive early momentum. That said, our plans for the balance of the year call for our growth on a consolidated basis to continue at rates similar to the second quarter. The market environment globally is still far from robust.
Traffic continues to be fairly stagnant in the U.S., demand remains uneven in parts of Europe, particularly challenging in Germany and Benelux. We look forward to providing you an update on our progress when we report again in October. With that, I'll now hand the call over to Dale.
Thanks, Mark. I'll focus my commentary on the second quarter 2014 financial results then discuss our 2014 guidance. We'll address the performance on a consolidated basis, then speak to the performance of each segment and provide commentary on the key areas or items where there's notable variance from the prior year. Consolidated net sales for the second quarter was $715 million, up 8.2% versus last year. Tempur North America net sales were up 10.1%, driven by strong demand for our new TEMPUR-Cloud and Tempur-Contour products, as well as our TEMPUR-Breeze beds and adjustable bases. Bedding net sales increased 12% on a unit increase of approximately 9%. Sales of other products declined 16%. By channel, Tempur North America retail net sales increased 12%, direct net sales declined 8%. Tempur International net sales were up 9%, on a constant currency basis, up 5.4%.
Bedding net sales increased 10% on a unit increase of 1%. By channel, Tempur International retail net sales increased 5%, direct sales increased 40%. Sealy sales increased 6.8%, driven principally by double-digit growth in the U.S. Bedding sales were up 8%, other products declined 17%. By channel, Sealy retail net sales increased 9%. Second quarter gross margin was 37.5% as compared to 38.6% in the second quarter of last year. On a year-over-year basis, second quarter gross margin declined primarily due to product and channel mix unfavorable foreign exchange. These impacts were partially offset by the lack of purchase price allocation inventory adjustment associated with the Sealy acquisition that was recorded in the second quarter last year. Looking at operating expenses, consolidated advertising spend, which includes both national and cooperative, increased 7% to $78.4 million, was 11% of sales.
Other selling and marketing expenses increased 15% due to higher in-store marketing investments to support the new product launches. Consolidated operating income was $50.3 million as compared to $44 million in the second quarter of 2013. Operating income in the second quarter of 2014 included $5.2 million of integration costs related to the Sealy acquisition. Operating income in the second quarter of 2013 included $11.9 million of transaction and integration costs related to the Sealy acquisition. Interest expense was $23 million, and the second quarter pro forma tax rate was 28.2%. Second quarter GAAP earnings per share was a loss of $0.04 as compared to a loss of $0.03 per share in the second quarter of 2013. Adjusted earnings per share was $0.39 in the second quarter as compared to adjusted earnings per share of $0.36 in the prior year period.
On June 30th, 2014, we completed the sale of our three U.S. innerspring component production facilities and related equipment to Leggett & Platt for approximately $48 million. The net value of the assets disposed was approximately the same as the total deal consideration. However, this did not include the associated goodwill value allocated to these facilities. In short, when we acquired Sealy in 2013, the divested assets were written up for book purposes to market value, and as a result, we did not incur a loss on the divested assets. We did incur a $20.4 million loss on the disposal of this business, which is essentially the non-cash write-off of the allocable goodwill. For tax purposes, the tax basis of the assets carried over to our books in the Sealy acquisition, and accordingly, we incurred a $29 million gain on the asset sale for tax purposes.
During the third quarter, we will pay approximately $11 million in taxes on this business disposal. I'll turn to cash flow for a brief review. At the end of the second quarter, our inventory and receivables were up slightly as planned due to the growth of the business and the build of Stearns & Foster and Posturepedic inventory in anticipation of launching product into Europe in the third quarter. These were offset by higher payables, which were up due to timing. Operating cash flow during the quarter was $74 million, and free cash flow was $65 million. The company has consolidated funded debt, less qualified cash, of $1.7 billion. The ratio of consolidated funded debt, less qualified cash, to adjusted EBITDA was 4.3 times, calculated in accordance with the company's senior secured facility. A calculation of this ratio is included in the press release.
I'd like to address our 2014 guidance. Today, the company updated its financial guidance for 2014. The company currently expects net sales to be in the range of $2.925 billion-$2.975 billion, which reflects growth of approximately 5.5%-7.5% compared to 2013 had we owned Sealy for all of 2013. Adjusted EBITDA in the range of $410 million-$430 million. Adjusted earnings per share is expected to be in a range of $2.60-$2.85. Our sales guidance is based on improved trends within our Tempur North America business, both Sealy and Tempur, as well as our recently acquired Sealy brand licenses in Japan and Continental Europe, partially offset by Tempur weakness in Central Europe.
Our earnings outlook factors in very limited contribution from the Sealy International acquisitions and that our higher-margin international business is being pressured by the weakness in Central Europe. Our guidance is pro forma and does not include costs related to the disposal of the three U.S. innerspring component facilities or transaction and integration costs related to the Sealy acquisition. For the third quarter, we expect consolidated sales to be up approximately 8% on a year-over-year basis. We expect our third quarter operating margin to be approximately 12.5%. As the majority of our investments in 2014 were first half weighted, we expect our second half operating margin to increase significantly as compared to the first half operating margins. Through the first three weeks of July, we are 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 factors we have identified in our press release and SEC filings. As noted in our press release, our guidance and these expectations are based on information available at the time of the release and are subject to changing conditions, many of which are outside the company's control. With that, operator, please open the line for questions.
Thank you, sir. Ladies and gentlemen, if you have a question at this time, please press star then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. We ask that you please limit yourself to one question and one follow-up. Our first question comes from Brad Thomas of KeyBanc Capital Markets. Your line is now open.
Thank you. Good afternoon. Congratulations on a very strong revenue quarter here.
Thank you. Thanks a lot.
I wanted to just first ask about the guidance and the change in the guidance. It's clear that you've raised the revenue outlook, but by the same token, it looks like you've nudged down the EBITDA outlook. Could you just help to bridge that change?
Sure. On the revenue side, a couple pieces. Number 1, the Sealy Japan and Sealy Continental Europe license acquisitions. Continental Europe, we're starting that from scratch, but we do expect, based on our strong retail relationships, to see that business start to pick up and contribute in the second half. Sealy Japan, we are picking up a run rate business. The combined impact of those two license acquisitions in the second half is $20 million-$25 million of revenue upside, but essentially no EBIT. Those are going to be a little bit lower than normal Tempur International gross margin businesses, but there's startup costs associated with them from an operating standpoint that we're not anticipating EBIT on that business. Plus, the gross margins on that business will be a little bit lower, particularly in Europe, as we're putting new business in place and sending out floor models.
Anywhere that sells it has to get floor models. It really is a startup. As we said, on the rest of the business, we are looking at continued strong performance in Sealy U.S. and continued strong performance in Tempur North America. Tempur International is doing well in Asia. It's doing well in Southern Europe, U.K. We're seeing some good growth in South America. The weakness in Central Europe, which essentially is the German-speaking corridor, Germany, Austria, Switzerland, Benelux, which is a significant portion of the European economy, it was bad last year. It started to show some signs of improvement earlier this year, but in the second quarter, it actually started turning back down. We're anticipating that continues through the second half. From a revenue standpoint, that's the key components there.
From a margin standpoint, or what we're looking at in the second half in terms of profitability of the business, we are anticipating that on the U.S. side, we're going to see significant improvement in profitability from the first half as the floor models go away, as we get through the transition aspects that we were going through, particularly on the Tempur business, which continued well into the second quarter. With the higher volume, we'll start getting volume leverage on the U.S. business. That improvement's going to be partially offset by the weakness in Central Europe, which is a very profitable region for us, as well as ongoing difficulty around the currency mix that we're getting in our international business right now. While we got positive top line from currency, we're getting a bad currency mix on the cost side. That's what's muting the margin from an EBITDA standpoint.
I would point out that the decline from what we anticipated before is about $5 million lower in EBITDA. That's really two main pieces. One is with the continued outlook that we had, and really the outlook was in place in the guidance we had before, but we've made the determination that it does not look like the business is going to make the minimum requirement on our long-term incentive plan for this year. That reduces or affects the outlook by approximately $4 million for the year. It affected the second quarter by $3 million. Also, the transaction of selling the spring plants takes away some D&A from the business, a couple million of D&A. Those two things have affected the EBITDA outlook-
Got you
beyond the business fundamentals.
Okay. I'll just ask maybe one follow-up here. A common question that you all get when you do a big launch, can you help us to think about in 2Q, was there any quantifiable revenue number that you'd tell us for sell-in that we should think of as really being unique to this quarter and something that wouldn't necessarily continue going forward?
The way I think about it, Brad, is that the bulk of the growth came from increased sales through increased sell-through. We did have sell-in, obviously, the sell-in in the new models in the second quarter was roughly the same as the new models in the second quarter last year. Year-over-year, that was a relative wash. The lift we're seeing is due to sell-through.
Yeah. I would add to that, Brad, if you think about sell-in, yes, the retailers want to have a base level of inventory so that when a consumer walks in, they can sell it. You know what? They had a base level of inventory of the old product. They have to sell out the old product, which we're not getting any sales on, and then they rebuild their inventory with the new product. For us, it's a wash. We get no sales as they reduce their inventory, and then we get sales as they put that same base level of inventory back in.
Got you. In light of it being such a strong revenue quarter, just figured I would ask, thanks and best of luck in the second half, and look forward to seeing you all on Monday.
Good. Thanks, Brad.
Thanks, everybody.
Thank you. Our next question comes from Budd Bugatch of Raymond James. Your line is now open.
Good afternoon, good evening, and congratulations on the revenues. I'm seeing Tempur North America and Sealy grow in the quarter. I am confused a little bit, Dale. Maybe I couldn't get the weeds right. I think your revenue guidance for the year went up by $75 million-$125 million from where it was, and the earnings stayed the same. I think I got the idea that there's some issues in Central Europe, but I'm trying to understand maybe the other parts of the business and why the earnings are not coming forward. Do I have it right?
The way I look at it, Bud, in April or May 2nd, I guess it was, we felt like we were at $2.9 billion. What we said we're going to be, we're right at the high end of that range, of the old range. We thought we were at $2.9 billion. We're adding roughly about $25 million. I view it as adding $25 million-$75 million. $25 million of that approximately is Japan and Continental Europe for the license acquisitions, which doesn't give me any profitability in this first six-month startup period. Really we're talking about 0-$50 million of benefit for improved Tempur North America, improved Sealy U.S., and international growth. The international growth being our most profitable segment is continuing to get hit negatively by cross-currency. It's continuing to get in the Central European region, the Germanic region, being hit negatively.
We're getting some bad mix internationally where we're getting growth in lower margin international segments and we're losing out on business in one of our most profitable segments in the world.
Okay. Just before I do my follow-up. Last year in the third and fourth quarter, if I remember right, the operating income for Tempur International was about $52 million, $22.9 million in the third and $29.4 million in the fourth. You're thinking that will be down this year when you report it for a combination of the bad guys and currency and perhaps some of the other pressure you're quoting. Is that what you're thinking?
Yeah. Tempur International profitability is going to be down. The gross margin is going to be down year-over-year 300 basis points or so. Of course, we'll try to manage operating expenses, most of that gross margin is going to fall through.
That's very helpful, Dale. My follow-up question is, we enticed you last time to start giving us the operating margin by segment.
Yeah.
Can you do that? Gross margin?
Absolutely. This is on a GAAP basis. Tempur North America for the second quarter, 3.5%. I always throw out the reminder, all of corporate is in that. A lot of Sealy corporate expenses moved into Tempur North America between last year and this year. Tempur International at 17.5%, Sealy at 6.2%.
Gross margin?
Gross margin, Tempur North America, 39.7%. Tempur International, 58.5%. Sealy, 29.9%.
Thank you, sir, very, very much. Good talking to you. Good luck on the second half.
Thank you.
I'll see you Monday.
Thank you. Our next question comes from John Baugh of Stifel. Your line is now open.
Good evening, and thank you. I want to just jump into ad spend. What are the thoughts there in the second half and maybe preliminarily into 2015 and any medium changes there?
Well, as we said in the comments, our ad spend was up in the first half, and we expect to continue the rate of spending in the second half at the same ratio. It's important to note on the ad spending that we have been able to get some quite measurable synergies out of the combination of our buy. Frankly, we renegotiated it, and we have more GRPs than simply the increased spending would represent. We're actually quite pleased with what we're getting. That's good. We're getting more impressions. What is quite encouraging is that we can quickly see that hitting our direct business. For example, our weekly site traffic is up something like 15% year-over-year since June, since we started running the new ads. Our store locator visits are up nearly 70%. It applies to Tempur, but it also applies to Stearns & Foster.
We're seeing some good response to this in a very measurable sense. In terms of the advertising spots that we're going to use, we launched a series of new ads to announce the new Oslo products for Tempur. We then had a set of new ads that we ran just before the end of the second quarter, and we've got some new ads that we're running right now. We're very pleased with the response that we're getting from these new ads. We're getting actually very positive response, measured response, test response, but also consumer and retailer response. What our plan is for now is that we're going to continue to run these spots for some time. They're good, and they're working.
Great. My follow-up is, you've given a lot of color around gross margin, channel mix, and all these things, I was wondering, within Tempur North America in the quarter, was there any appreciable mix of products sold that influenced margin, or was that in line with expectations or better than expectations?
Yeah. In the second quarter, from a Tempur North America standpoint, as I mentioned, from a negative standpoint, we did have some ongoing transition effects where transition, just quite honestly, we said this on May 2nd, the transition was more complicated and took longer than we expected. The transition effects continued into May. That was a factor in the overall second quarter performance versus what we thought it would be. It did take us a little bit longer. Now, where we saw some benefit in revenue came in better adjustable attach rates. We saw upside revenue in a very low margin part of the business. Adjustable margins are much lower than mattress margins. We saw continued increase in attach rate, Tempur-Ergo really starting to get traction. Overall, those margins are not the same as selling mattresses.
Although they raise the AUSP for the retailer very substantially.
Yes. Absolutely.
They're a very important part going forward. They're a good margin. They're just not as good as the mattress.
That unit comment, just to be clear on Tempur North America, that's got foundations in it? Or maybe another way to ask it, just what were pure mattress units, Tempur North America year-over-year Q2?
The 9% is mattresses and foundations. The mix within that is less flat foundations, more adjustable foundations. With virtually every mattress that's sold, there's a foundation. We had good growth in mattresses in the second quarter. If you look at that 9%, adjustables was a little bit better than 9% growth. Mattresses, just a little under 9% growth. Flat foundations were just down a little bit of growth, but because of the mix change, very low single digits.
Great. Thanks for that color. See you Monday.
Thanks.
Thank you. Our next question comes from Josh Borstein of Longbow Research. Your line is now open.
Hi, Mark, Dale. Mark, thank you for taking my questions here. On the gross margin, can you help us a little bit with the second half, what the expectations are? I know we've talked about the 42% consolidated level. What are the assumptions today?
Right now, what we would say from a first half to second half, originally we thought it would be about 42%, but this first half came in lower. The second half expectation would be that gross margins will improve half-over-half to the tune of about 340 basis points. For the year or in the second half, we're looking at about a 41.5%, which would give us about 40% for the year. Just slightly lower than what the prior expectations were, and that's really a function of the combination of the News International Sealy business being a little bit lower margin. Also, the Central European negative influence there. Looking at the pieces, we expect Tempur North America's gross margins to be up dramatically in the second half, in the neighborhood of 550 basis points.
That's as the floor models go away and you start getting volume leverage. Sealy margins should be up again. Significant reduction in floor models and some volume leverage where Tempur International is going to be down in the second half versus the first half. Again, Central Europe pressure, as well as adding the new Sealy revenue at lower gross margin rates.
Okay. Will Tempur International have negative sales growth in the second half on a constant currency basis, do you think?
No. We will see growth in our Tempur International business. The profitability will be down because of currency, but we'll still see some top-line currency benefit, would be our expectation right now based on current currency rates. The cross-currencies, you got to remember our cost internationally is, at least our product cost, is DKK, which is tied to the Euro. What happens is, depending on what's happening in the relationship of the Euro currency versus the Pound or the Yen or the Won or the Australian Dollar, that's where we get cross-currency issues from a margin standpoint.
We do anticipate growth in Tempur in the second half.
Yep
internationally.
Okay, great. Just to make sure I heard correctly, Dale, you said the expectation for gross margin around 40% for the full year?
Yes.
Okay, great. If I can sneak one more in on the earnings guidance, do you still expect to be around the midpoint, as you had expected last quarter?
Yeah. Since we redid the revenue model of the business, we completely redid the relationships based on our latest, greatest data, et cetera. If we're at the low end of the revenue guidance, we expect to be at the low end of the earnings guidance. If we're at the high end of the revenue, we expect to be at the high end of the earnings guidance. We're giving you a range because right now that's what we think. We've got roughly a little over $1.5 billion of revenue still to go in the second half, and that $50 million range is about 3%. That's some puts-and-takes ability, but we've retied the model directly to those revenue points based on what we see as the outcome. Sitting here today, I'm not saying this is where I think I'm at in the range.
I'm giving you a completely new range. I'm going to be somewhere in it.
Okay, great. Thank you for that. Thank you very much. I'll see you Monday.
Thanks.
Thank you. As a reminder, ladies and gentlemen, if you do have a question, please press star, then one on your touch-tone telephone. Our next question comes from Keith Hughes of SunTrust. Your line is now opened.
Thank you. Question about Sealy in Europe. You had referred to the U.S. business being double digits and Europe. How much within Sealy does non-U.S. business represent? I believe there's a Posturepedic launch you had mentioned coming in Europe in the third quarter. How long will it take for that to potentially impact the revenues there?
We are launching in Europe in the third quarter, Posturepedic and Stearns & Foster. They're starting from zero.
A very tiny amount.
Okay. That's what you were referring to earlier. I was confused.
Yeah.
Let me just clarify, because this will be important when we announce the third quarter. That revenue is going to show up in Tempur International.
Good point.
Because it's fully integrated over there, and we're just building on the Tempur infrastructure, that revenue is going to show up in Tempur International, not be attributed back to Sealy segment.
Second question. The other products in both Sealy and Tempur down in the quarter. I know these are small numbers. What's kind of your outlook in the second half there?
On the Sealy other products, we would expect that business to go back to growth. That's primarily Comfort Revolution. We had some timing disconnects last year versus this year. It's a small business, growing business. If you get a big order movement from one quarter to another, it can still affect that kind of play. We expect for the back half and for the year Comfort Revolution to show good growth. On the Tempur business, that's pillows, that's some of the other accessories. That's an area we've been struggling and-
In Vegas next week, we'll be launching a range of three new pillows. Mattresses was our first area of focus, now the pillow business is not where it needs to be, and we're very focused on that and will be for the next period. The new products that we're launching in Vegas are the first foray into addressing that issue.
Thank you.
Thank you. Our next question comes from Jessica Schoen of Nomura Securities. Your line is now opened.
Hi, good afternoon.
Hi.
My first question is on the guidance for operating margin on the third quarter of 12.5%. Can you talk about some of the moving pieces in SG&A to be aware of in that context?
Yeah. In comparison to the second quarter. From an advertising standpoint, we're going to continue to keep the pedal down on advertising. Other selling, we'll see some improvement in other selling. There is still store POP going out as was anticipated. From a quarter-to-quarter standpoint, we'll see some improvement there because a lot of it shipped in the second quarter, but some of it does still continue to go out in the third quarter, which will then give you more benefit in the fourth quarter, from a leverage standpoint. With higher volume, we're expecting to see some leverage on the other components of SG&A.
Got it. A follow-up on the Sealy International question. In addition to the $20 million to $25 million from the licensees, which sounds like it'll be included in Tempur International.
Right
What's assumed in the guidance for how the other Sealy International regions, it sounded like they were under pressure this quarter? What's assumed in the guidance for those going forward?
We would expect essentially the current trend to continue. Obviously, the bulk of Sealy non-U.S. is Canada. Canada as a market has been weak and under some pressure. Also, if you look by channel, Sealy Direct, that is primarily Argentina, that business was down a little bit, but the Argentine currency has dropped dramatically. A lot of that decline is currency related. Because the currency is under so much pressure, obviously consumers there are not spending like they would before. Really the international business for Sealy is Canada, Mexico, and Argentina, predominantly. We don't see any change from where they've been.
Understood. Finally, you mentioned on the transaction selling the component facilities that you would see a little bit less D&A from that. Any other income statement items to be aware of where that could have an impact, especially as you're sourcing those components externally?
No, really that's the primary thing is some D&A goes away, but that effectively becomes part of what was the cost of the product. By and large, that D&A is a separate component, but part of the overall cost. It shifts from D&A to regular cost built into the price that we're getting from Leggett.
Great. Thank you so much for taking my questions.
Thank you.
Thank you. Our next question comes from Joe Altobello of Oppenheimer. Your line is now open.
Thanks a lot. Good afternoon, guys. First question, I guess just point of clarification, Dale, if I heard you correctly, the revenue from the Sealy license acquisitions will be in Tempur International?
Yes.
Okay. Just want to make sure. Just for context, how big is your Central European business from a revenue standpoint?
Well, we don't break down our international revenue by country, but Germany is, by a great large margin, the largest economy in Europe. If you think about Central Europe in total, where you're talking Germany, Austria, Switzerland, Benelux, Nordic, that are all very influenced by Germany, that whole region is seeing softness. That's a significant chunk of Europe.
Okay, if overall Tempur International is, call it, I don't know, between $450 million, $475 million in revenue, that's roughly $100 million-$150 million? I'm just trying to ballpark it.
I don't want to get to that level. Europe is roughly two-thirds of our international business, you're in the neighborhood.
Okay. That's fine. The premium segment, the north of $2,000 price point, it looks like that grew again this quarter. I guess that makes it five quarters in a row. Did that growth accelerate?
Well, yeah. All of the products that we sell basically are above $2,000 for Tempur. Tempur is growing very well, net-net, that's bound to be the case. Yeah, it did. I think that part of what we're really focused on is the AUSP and driving, especially for Tempur. Obviously, we've got a whole range of products, but the job of the Tempur portfolio is at that high end. One of the things that we've seen with the new product range is that if you look at likes for like products, people are essentially trading up. The average price is going up because the products that are being sold are not a direct replacement for the ones they replace. They're often the one that's a half a step up from the ones they replace.
The net of that is the average selling price is going up, which obviously is good for Tempur, it's good for the retailers.
Yeah.
Right.
Joe, we did see improving trends through the quarter. April and early May was still part of the transition
Right. That's exactly what I was trying to get at. Did it accelerate throughout the quarter?
Yes.
Lastly, I guess, the operating margin, even though gross margin was, call it, 100-plus basis points below, I guess, what we and you guys were expecting from early May, the operating margin on a pro forma basis was actually pretty close to the 8% guidance. It sounds like things are trending pretty nicely on the G&A side of things. Was there anything that was unusual in the quarter that led to that reasonable operating margin number?
There was a $3 million benefit on LTIP.
Okay, that's it. Okay. Thanks, guys.
Thank you.
Thank you. As a reminder, ladies and gentlemen, if you do have a question, please press star then one on your touch-tone telephone. Our next question comes from Jon Andersen of William Blair. Your line is now opened.
Thanks. Hi, everybody.
Hey, Jon.
A couple quick ones. Just an update on cost synergies, what you're expecting for the full year and over the next couple of years. Then, Dale, if you could just update, if necessary, some of the guidance items below the operating income line. I'm focused a little bit here on the tax rate-
Yep
which has trended lower in the first half, and also D&A in context with some of your comments. Thanks.
That's great. From a synergy standpoint, our goals for the year was to have $40 million of synergy be accumulated on accumulated basis this year. We still feel very good about that. By 2016, we said we would have $70 million. Still feel very good about that. The synergies are working. We did say that we would reinvest along the way some of those excess synergies from what we had previously expected. For example, the synergies that we got in media from the combined buy, we're absolutely reinvesting that. Rather than taking those savings to the bank, we're increasing the amount of advertising at similar dollars. Good question on some of the other components below operating margin. Just run down a list here. CapEx for the year, $55 million-$60 million.
I think last time we said 60, it's trending a little bit lower than that, but somewhere in that 55-60 range. D&A for the year, I now expect to be at $88, and that's a little bit lower than before, and that's, again, partly influenced by the Leggett & Platt purchase of the three spring facilities. Interest for the year, we're looking at about $90 million. Tax rate for the year, we do continue to see some benefits in taxes. For the rest of the year, we expect the tax rate to be around 29.5%, which is a little bit better than we thought before. The tax rate continues to get a little bit better. It's partly a function of country mix.
It's partly a little bit better manufacturing tax benefit than credited and expected, a little bit better R&D credit than we had thought we would have. You need anything else, or does that cover it?
No, that covers it, guys. Thanks for the color, good luck going forward.
Thanks a lot.
Thank you. Now I'd like to turn the call back to Mark Sarvary for any closing comments.
Thank you, everybody. We look forward to talking to you again in late October when we host our third quarter earnings conference call. Obviously, we'll see a lot of you next week in Vegas. Thanks a lot.
Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a wonderful day.