I would now introduce your host for today's conference call. Mr. Mark, you may begin, sir.
Thanks, Kevin. Thank you for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President, 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'll provide an overview of our performance in the first quarter and then discuss the progress we're making on our key strategic growth initiatives in 2014. I will then turn the call over to Dale, who will provide details on the first quarter financial results and 2014 guidance. We had a lot going on in the first quarter. The majority of our strategic growth initiatives launched late in the period, and we remain in the middle of implementing them. In light of this, we're satisfied with our overall performance. Tempur International's performance in the first quarter exceeded our expectations, with solid sales growth in Europe, Asia, and Latin America, driven by advertising, new products, and expanded distribution. Sealy's first-quarter sales were in line with our expectation.
Solid growth in the U.S. was driven by continued strong demand for Posturepedic Innerspring and hybrid products and a return to growth for Stearns & Foster, which more than offset declined Sealy and Optimum. Outside of the U.S., Sealy sales declined, and this was exacerbated by unfavorable foreign exchange. Tempur North America first-quarter sales were in line with our expectations, down mid-single digits. As we said in February, we had expected first-quarter sales to be muted in the U.S. due to the poor weather in the first part of the quarter and by the transition of our core product line in the latter part of the quarter. Of note, during the quarter, sales of products priced at $2,000 and above grew for the fourth consecutive quarter, driven by continued strong demand for our Breeze collection and initial shipments of our new products.
I'd like to discuss the progress we're making on our four key strategic growth initiatives in 2014. The first strategic initiative is product innovation, and our goal is to provide consumers the best bed and the best sleep of their life and to provide our retailers a complete and optimal offering across brands, products, and prices to drive their growth. In the first quarter, we began rolling out several of our new products, including the new Tempur North America products I just referenced, as well as our new Stearns & Foster and Tempur International Breeze products. In April, we began rolling out the new Optimum line. The magnitude of these new product launches is significant given their importance to our overall business and their concentrated rollout timeline. The new TEMPUR-Cloud and TEMPUR-Contour launches are the largest in Tempur-Pedic's history.
We shipped more floor model units than we planned in the first quarter and completed approximately 65% of the rollout. As of the end of April, we had shipped 80% of the total, which positions us and our retail customers to benefit from having them placed on the floor in advance of the key Memorial Day holiday. We also completed approximately 45% of our new Stearns & Foster product rollout by the end of the first quarter. As of the end of April, we had shipped 75% of the total. We're particularly encouraged with the demand for the upper-end Lux Estate and Lux Estate Hybrid collections. In April, we began a very concentrated rollout of the new Optimum line and have already shipped 50% of the total. This line has been well received by customers. In fact, the trade has been enthusiastic about all these launches.
As a result, all three have exceeded our slot placement expectations. In addition, we're in the process of launching the TEMPUR-Breeze mattresses in several European markets, and here, too, floor placements are exceeding plan. In aggregate, the scale of this launch activity is unprecedented, but it has gone well, and we're pleased with our execution. We expect to finish all of the North American product launches during the second quarter. While it's still very early, we're pleased with the initial signs we're seeing. There has been broad retail customer support for the new products, and consumer acceptance so far is what we had expected. Enthusiasm of retail sales associates for the new Tempur-Pedic and Stearns & Foster products in particular has been very encouraging and appears to be building. We're expecting the launches of these new products to be important drivers of our growth in 2014.
Our second strategic initiative is marketing. This includes advertising as well as in-store marketing and direct sales. In 2014, we will increase our investment in marketing. This will be most evident in the second quarter as we ramp our in-store marketing investment and increase our advertising spend with the launch of new television creatives. In April, we began airing nationally a new product-specific TV ad for the new Cloud and Contour beds. In May, we will launch a new Ask Me campaign. We also expect to begin benefiting from more impressions per dollar spent as we reinvest synergies realized from our combined media buy. We will also support Stearns & Foster, Optimum, and Posturepedic with consumer advertising, including TV, digital, and print.
The third strategic initiative is new market expansion. This includes our expansion into new international markets and, over time, into non-consolidated markets where our brands are currently represented by others. On our last call, we announced that we had signed an agreement to regain Tempur-Pedic distribution rights in Mexico, previously held by a third-party distributor. At the time, it was the first deal since our combination with Sealy. In early April, we announced the signing of a definitive agreement to acquire the Sealy brand rights in Japan. Today we announced the signing of a definitive agreement to acquire the Sealy brand rights in continental Europe. Each of these transactions represents significant future growth opportunities. In Japan and continental Europe, we will leverage Tempur's sales and marketing infrastructures to further increase our penetration as well as expand our product offering and distribution footprint to capture market share.
We're also advancing several other initiatives across the world, including broadening the distribution of our Tempur and Stearns & Foster brands in South America, where we have existing Sealy assets. Lastly, our fourth strategic initiative is our commitment to building a world-class supply chain that is easier to do business with. We're making progress on improving our distribution and warehouse network and are beginning to capture greater cost synergies. We're currently shipping Tempur and Sealy products together on Sealy trucks in one U.S. market and expect to layer in additional markets in 2014 and beyond. These efforts are also expected to improve customer service. We've also made good progress with our category management efforts, which we expect to result in improvements to both our own and our retailers' sales and profitability in 2014. Before turning the call over to Dale, I'd like to make a couple of closing comments.
First, we're now past the one-year anniversary of our combination. We're pleased with how it's gone. We still see many opportunities to create additional leverage. We're aggressively pursuing them. Cost synergies are being realized to plan. We are now beginning to see the benefits from revenue synergy. As most of you know, Larry Rogers retired after a long and extremely successful career at Sealy. His contribution to the Tempur Sealy merger and integration efforts was invaluable. We're thrilled that he will continue to provide value to our organization as a member of our board of directors. To summarize, Q1 was broadly in line with our expectations. Our major initiatives for 2014 are rolling out as planned. We remain very focused on their successful execution.
Our plan calls for an acceleration of our growth on a consolidated basis, specifically in the U.S. We are receiving positive feedback on the new products from retailers and consumers. It's still early, and we look forward to providing a more complete update when we report in July. With that, I will now hand the call over to Dale.
Thanks, Mark. I will focus my commentary on the first quarter 2014 financial results, discuss our 2014 guidance. I will address the performance on a consolidated basis, speak to the performance for each segment and provide commentary on the key areas or items where there's a notable variance from the prior year. As a reminder, the company completed its acquisition of Sealy in March 2013, and results for the first quarter of 2013 reflect only a partial period of results from March 18th through March 31st. Consolidated net sales for the first quarter were $701.9 million. Tempur North America net sales were down 5.7%. As we previously communicated, trends were somewhat soft in January but improved through the balance of the period. Bedding net sales declined 2.5% on a unit decline of approximately 5%.
It's worth noting that mattress and adjustable base units together were flat in the quarter, with the decline being driven by traditional foundations, a phenomenon we attribute to the significant floor model transition. While we don't break out mattress performance specifically anymore, given the magnitude of this rollout, we felt it was appropriate to provide some color on the transitory impact we experienced in the period. We shipped approximately the same number of mattresses in Tempur North America in the first quarter as we did last year. The mix of discounted floor model units was significantly greater this year. Remember, for every floor model we ship, a floor model needs to be sold off at retail. We replaced significantly more full-value orders with discounted floor model shipments in the first quarter. Excluding this discount effect, our gross mattress sales in the first quarter were positive mid-single digits.
Sales of other products, mostly pillows, declined 37% and accounted for more than half of Tempur North America's first quarter sales decline. By channel, Tempur North America retail net sales decreased 3.2%, and direct net sales declined 35%. Tempur International net sales were up 7%. Bedding net sales increased 6.6% on a unit increase of 2%. By channel, Tempur International retail net sales increased 4.6%, and direct sales increased 42%. Sealy net sales were $363.2 million as compared to $46.7 million last year. First quarter gross margin was 38.4% as compared to 48.3% in the first quarter last year. As we stated on previous conference calls, the inclusion of Sealy has altered the consolidated gross margin profile of the business. On a year-over-year basis, first quarter gross margin declined primarily due to a full quarter of Sealy results, product and channel mix, and higher new product introduction costs.
These impacts were partially offset by lower sourcing costs and positive geographic mix. On a sequential basis, gross margin decreased to 38.4% from 40.2%, primarily due to higher new product introduction costs and higher mix of Sealy sales. These were partially offset by positive geographic mix. Consolidated advertising spend, which includes both national and cooperative, was $73.8 million, or 10.5% of sales in the first quarter. Consolidated operating income was $62.4 million as compared to $44.5 million in the first quarter of 2013. Operating income in the first quarter of 2014 included $7.4 million of integration costs related to the Sealy acquisition. Operating income in the first quarter of 2013 included $16 million of transaction and integration costs related to the Sealy acquisition. Interest expense for the quarter was $22.2 million, and the first quarter tax rate was 29.3%.
First quarter GAAP earnings per share was $0.44 as compared to $0.20 per share in the first quarter of 2013. Adjusted earnings per share were $0.53 in the first quarter as compared to adjusted earnings per share of $0.62 in the prior year period. I'll turn to the cash flow for a brief review. At the end of the first quarter, inventory was up as planned due to the product transition, as we were carrying full supplies of both the old and new product lines. Receivables were also higher due to the timing of revenues in the quarter, as we discussed earlier. These two items were the principal factors that led to our slightly negative operating cash flow in the quarter. We expect cash flow to be positive for the balance of 2014 and consistent with our full-year plan.
The company has consolidated funded debt, less qualified cash of $1.8 billion. The ratio of consolidated funded debt, less qualified cash to adjusted EBITDA was 4.6 times, calculated in accordance with the company's senior secured facility. A calculation of this ratio is included in the press release. Capital expenditures in the quarter were $7.8 million. I'd like to address our 2014 guidance. Today, the company confirmed financial guidance for 2014. The company currently expects net sales to be in the range of $2.8 billion-$2.9 billion, which reflects growth of approximately 1%-5% compared to 2013, had we owned Sealy for all of 2013. Adjusted EBITDA to be in the range of $415 million-$435 million, and adjusted earnings per share to be in the range of $2.60-$2.85.
It's important to note that while our full-year financial guidance is unchanged, our current view of the profile has slightly changed. We currently expect our full-year 2014 net sales to be at the upper end of the guidance range. In addition, we currently expect our full-year 2014 adjusted EBITDA and adjusted earnings per share to be at the mid to upper end of their respective ranges. In addition, our guidance excludes any potential impact from the planned acquisition of Sealy brand rights in Japan and in Continental Europe, as well as excludes the impact of ongoing integration costs related to the acquisition of Sealy. We're planning for second quarter 2014 sales to be up slightly as compared to the first quarter 2014 sales of $701.9 million. We expect floor model shipments to remain elevated in the second quarter as we complete all of the North American product launches.
As Mark indicated, our in-store marketing investment will increase significantly in the second quarter, and we also plan to increase our investment in advertising with the new creative. As a result, we expect our operating margin in the second quarter to be approximately 8%. The majority of our investments in 2014 are first-half weighted, therefore, we expect operating margins to improve significantly in the second half of the year as floor model shipments and incremental in-store marketing investments diminish. Through April, we 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 risk factors that we've identified in our press release and SEC filings.
As noted in our press release, our guidance and these expectations are based on information available at the time of the release and are subject to changing conditions, many of which are outside the company's control. With that, operator, please open the line for questions.
Ladies and gentlemen, if you have a question or a comment at this time, please press the star and the one key on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. We also ask that you limit yourself to one question and one follow-up, and feel free to jump back into the queue. Our first question comes from John Vlaholis, Stifel.
Good afternoon.
John.
The first question I had was on the product placement, the new product launches. We've been hearing that with the poor Q1 conditions in general, that clearance sales were a little slow, and that was slowing up the new product launches. It doesn't sound, though, from your comments, if you're behind plan, you're behind plan by much. I would just love some color on that.
There's no doubt that the weather did have an impact, certainly at the beginning of the quarter. The transition, as you know, is not an event. Obviously, what we're talking about is what we've shipped to retailers. Some of the retailers are pretty much 100% converted, but many are not. Many are in the middle of transition, still in the process of selling off some of the floor models. It's a process which is ongoing and obviously was slowed to some extent by the fact that there was poor weather at the beginning of the quarter.
Super. Secondly, if I could just ask about internationally, where there was a positive surprise. Were those macro-driven, weather-driven, company-specific product marketing effort-driven? Any color, you mentioned the areas that were strong. I was wondering if any were particularly stronger than others. Thank you.
There was some macro strength. I'm talking here about Europe. We've had pretty good performance in Asia for some time, all through last year, we continue to have that. Japan, Korea, Australia continue to be strong. Where we had weakness last year, certainly in the first part of last year, most of last year, was in Europe. We saw some improvement of that kind of from a macro level in the fourth quarter of last year, we saw continuation of that and strengthening this quarter. A lot of what's been happening in Europe can be pointed very distinctly to, for us, I mean, can be pointed very directly to activities that we've done. In the U.K., for example, we've gained distribution that has had a material impact. In continental Europe, we've been running advertising, which is always effective, particularly in the German-speaking countries.
We introduced the new products. We were participants in the big Cologne Fair in Germany. New products had an impact. While the macro movement was part of it, a lot of it was due to activities that we did.
Thank you. Good luck.
Thanks. Thanks, John.
Our next question comes from Peter Keith with Piper Jaffray.
Great. Thanks a lot. Actually, this is John Bergen for Peter tonight. Thanks for taking our questions. My first question, I wanted to focus on Canada, I guess. In looking at how strong your Sealy business is up there and the relationships you have, at this point, are you starting to see some more Tempur slots being allocated in some of your retailers? If so, how many have you picked up on a per store basis?
I don't want to break it down at that level of detail. I will say that I really think your question is on the money because Canada is a very good example of where Sealy's distribution and relationships and strength is greater than that of the legacy Tempur company. That is an area where we have now a unified team working together on the Canadian business, working with our retailers as a unified team. We believe that is going to have great promise and that we will see benefits of that this year. I'm not going to get down to details by customer. I will say, however, that is an area which we do see some promise.
Okay, great. We've seen your new ad spot on TV that features a TEMPUR-Contour, and the TEMPUR-Cloud looks good. I'm just curious, what's the consumer reaction been to this? I mean, to the extent that you can talk about it, is this going to be really the ad that you lead into the holidays with, along with the Ask Me, or what are your plans around advertising?
Yeah. The ad that you're referring to is an ad. Well, let me just step back a minute. As you know, last year, we went back to our Ask Me campaign in the fourth quarter. We've been running it ever since. I'll talk in a minute about it. We will continue with that going forward. However, during this month and this quarter, this launch of Tempur products is quite unique for Tempur. It is a brand new look of the product, brand new characteristics of the product, brand new features with the removable top and the washable top and the cooling layer. We really felt it was important to have an ad that just spoke very simply and very eloquently to the new characteristics of the product, both for consumers but also for retailers.
This is a very well done, matter of fact product commercial. As we get into the second half of this month, you'll see the new evolution of the Ask Me. We call it the Ask Me campaign because it's made by the same people and it's made in the same tonality. It is a very logical, and we're quite excited about it, evolution of the ad, which we think is very much more, frankly, it more appeals to your heart and your emotions than to simply the matter of fact method that this other ad works for. What we see is that the ad that's running right now will continue to run because it's an important ad, but it won't be the backbone of our strategy going forward.
What we think is the nice part about that ad, though, is it's designed and in fact been made in such a way that retailers can customize it to use for their advertising because it works very well with retailers to bookend it.
Okay, great. Thank you. If I can just sneak one really last quick one in for Dale. Dale, looks like the tax rate came in a little bit lower than what you got at the full year two on the last call. Should we expect that tax rate to build through the year, or is there some change in thinking there?
On the last call, we said that the tax rate for the year would be about 31%. It did come a little bit lighter than that in the first quarter. That was principally due to geographic mix, with international being stronger, domestic being a little bit softer, and domestic being a higher tax rate. For the year, I would think that the tax rate might come in a little bit from that 31%, but not dramatically.
Okay, great. Thanks a lot, guys. Good luck in the rest of the year.
Thank you.
Our next question comes from Bradley Thomas with KeyBanc Capital Markets.
Hey, good afternoon, guys.
Hi, Brad.
Brad.
I wanted to just ask a couple of questions on the guidance. For the second quarter specifically, just at a high level, if you could help us think through this. It feels like Tempur North America is moving in the right direction. International's taking a step in the right direction. You're still making investments on the new product rollout, and that's probably still pressuring margins. Is that what the reason is behind the gross margin outlook being a little bit worse than what we had been modeling going into the quarter?
Yeah. Let's break it down into a couple pieces. From a gross margin standpoint, at the beginning of the year, we said the first half gross margin would be about 40%. Obviously, the first quarter was 160 basis points less than that. Keep in mind, when we're talking on here, we're talking pro forma. The integration cost was about 30, 40 basis points of that difference. The balance, though, was that in the first quarter, we had some more floor models, as Mark said. The retailers are very excited about the new product lines, not just Tempur, but Stearns & Foster. We're getting more floor models than we had anticipated. Also, the direct, and this is a Tempur-specific item, the direct business and the pillow business are much softer than we expected. They started the year soft. They continued to be soft.
It's something we're not happy about, we'll be turning our focus to those areas of the business with the new products getting out. We do expect for the first half for gross margins to be slightly less than what we had anticipated at the start of the year. We do think gross margins will improve some in the second quarter from the first quarter, as we have continuing product rollouts, we'll be getting to the end of that, certainly another factor there is getting to the end of the closeout pricing on the old product line. Working through the rest of the P&L from an expectation standpoint, in the second quarter, we do expect to increase the advertising spend as a percent of sales. First quarter advertising was about 10.5%. We expect it to be higher than that in the 11 range.
The big outstanding expense in the second quarter is rolling out all the new POP that you saw at Vegas. In the first quarter, that new POP, only a little bit of it was shipped because some of the big customers don't use our POP, and the big customers were the first ones to start getting the new products. In the second quarter, as the new products get broadly distributed, there'll be a significant investment isolated to Q2 around that POP that's driving the operating margin issues. FX was a factor in the first quarter, very nominal factor in the first quarter, but on a comparative basis, FX should be worse in the second quarter.
Okay, great. That's very helpful, Dale. Just with that as the outlook for the second quarter, you hadn't given second quarter guidance to us.
Right
Obviously, we need to go down if we go to your numbers. For the full year, you guys are saying that EBITDA and EPS should be towards the middle or higher end of your range. What is it that's making you more positive on the back half of the year?
Well, our plan all along was for the back half of the year to be much stronger from a revenue and a earnings perspective because of the impact of the floor models in the first half, as well as the POP investment in the first half. Keep in mind, it's been a long time since we, particularly on the Tempur business, that we had this magnitude of a change in line, as in never. We had to really do a significant expenditure to get the floor of the retailer's POP to look like we want it to look and like you saw at Vegas in late January.
The plan all along was once we got through this major investment in the first half, that we would see much better performance in the second half from an earnings standpoint, the new products will deliver growth in the second half, and we'll start getting leverage on the business as we move forward in the year.
Great. If I could just squeeze one more question in on pillows. Not something that we usually talk about on earnings calls, but it was a pretty big drag here in the first quarter. Do you think that'll continue to be a headwind, or was there something unique here in this quarter?
The truth is, it has been a headwind for a while, and our pillow business has declined. There's some reasons for this. The way that retailers use them as gifts, as incentives for people when they buy beds and so on, is diminishing. The fact is, our pillow business is a very important part of our business. Consumers have a very high awareness of our pillows, and the people who have them are as rabid fans as the people who own our mattresses are. It's something that we're going to put great focus on. Obviously, we put a lot of focus on these new TEMPUR-Cloud and TEMPUR-Contour beds from the Tempur-Pedic part of the portfolio in this last period. In the second half of this year, you'll see a range of new pillows, which we're quite excited about, which we'll be launching.
It will be the start of a renewed focus on pillows. It's a very important part of the overall portfolio, both because it's good sales, good margins, but also very iconic and part of our product differentiation.
Great. Thanks very much.
Thank you.
Our next question comes from Budd Bugatch with Raymond James.
For Budd, thanks for taking my questions.
Hi.
Real quickly, Dale, I just want to make sure I understand the 2Q operating margin guidance. The 8% is a GAAP or a normalized margin number?
That's a pro forma number.
All right, thank you. Perfect. Then can you maybe give us a little color on the operating margins and the gross margins by segment for quarter one?
Yeah, I'll give you GAAP numbers that you'll see in the Q that will be filed here in the next day or so.
Perfect.
From a Tempur North America gross margin, 40.3%. Tempur International, 59.7%. Sealy, 29.9%. Again, these are all GAAP numbers. Operating margin, Tempur North America, 5.2%. Tempur International, 22.3%, and Sealy, 6.4%.
Thank you. Just real quick, for 2Q, can you maybe talk a little bit about by segment top-line wise, where you expect Tempur and at least International to end up wise? Are you still expecting another strong quarter in International?
Yeah, we would expect International in 2Q to have a similar performance to what it had in Q1, which was up 7%, up 5.8% on a constant currency basis. We expect Tempur North America to turn very positive and be up mid-single digits to high single digits. The trends that we saw in the quarter, the gross sales that I mentioned, it was up mid-single digits in the first quarter. As we get through the floor model rollout, we expect to see Tempur North America to pop to the high single digits here in the second quarter. Sealy was 3% growth in the first quarter, ballpark. The domestic business was up 7%. With some FX issues on the international side, but we saw good growth from Sealy in the first quarter, and we expect that to continue with their new products.
The Stearns & Foster completing its rollout, Optimum being rolled out. We're looking for a strong performance across the portfolio.
Thank you. That's it for my questions, and best of luck going forward.
Thank you.
Again, ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touch-tone telephone. Our next question comes from Joshua Borstein with Longbow Research.
Taking my questions and congrats on a good quarter. On the branding rights in Continental Europe, I know you said not to expect too much here in 2014. Is it possible to flesh out your expectations for what we may see there on the top line or earnings line in 2015?
It's too early to talk about that now. The deals are not signed yet.
Not closed.
Not closed yet. Sorry. They're signed, but they're not closed. I mean, there's still closing conditions. We will talk about it more during the year. I think that what you do need to bear in mind for Europe is that there's a very small business there right now. What we anticipate doing is launching new products under the Stearns & Foster and Sealy brand names through the infrastructure and the sales organization that we have there. That will kick in, we believe, in 2015 in reality. We'll give you a better feel of that second half of the year. It's too early to do it right now. As Dale said, it's not going to be a material contribution this year.
Okay, great. Thanks for that. Just on the new products, is it possible to isolate them and just give an indication? You obviously expect to see an increase in velocity. I know it's early, do you think you're seeing that increase as anticipated?
As I said, we're in this transition period, and what data we can get is always anecdotal. We can speak to retailers, we can look at what's happening. The anecdotal data we're getting is good. The anecdotal data we're getting is that some of the key products like the Rhapsody Luxe and the Cloud Elite are being very well received. We're seeing good things. We're not in a stage here where we can actually use any-
Transition.
It's a transition. Remember, as I said earlier, the transition takes time. It takes time because even a retailer who's putting product on the floor will often have, at the same time, the old product being sold at a discount right beside it. It takes time. We don't have numeric or statistical data. What we do have is anecdotal, and that's what we're sharing with you right now.
Okay, great. Maybe just more of a qualitative comment then on, you had mentioned that RSAs are more enthusiastic so far about the new products. Could you say in what way they're more enthusiastic, or what's different about these new products that RSAs are gravitating towards versus the old products?
Well, they're positive about all three sets of products that we launched, the new Tempur products, the new Stearns products, and the new Optimum ones. I'll do them in reverse order. The Optimum ones, while they're just shipping right now, they like the look of them, they like the feel of them. They think the aesthetics are very good, and they think they're slightly redesigned, and they're taller, and people really like that. That's positive. RSAs like that. The Stearns & Foster are considered to be among the most beautiful products that we've ever made or that frankly anybody's ever made. People really think they're beautiful, and they love them. They display well. The hand, the feel of the products for the consumer is really good. The Tempur products are the most dramatic change from what was before compared to what they're replacing.
The RSAs very much like the aesthetics. They very much like the logic of the sequence and the way that the products fit together. You can logically step a customer up from the entry-level products right through to the highest-end products and with a good logical case for each step. Perhaps the thing that they've been saying to us that they find the most desirable about these new products is the demonstrability. As you know very well, these products are designed to have the covers removed, which allows the consumer to look underneath the hood and put their hand on the cooling layer and touch the Tempur foam.
That demonstrability, we're hearing time and again, is something that really captures the attention of consumers, but also is something for an RSA to do to kind of show why this bed is different than the other ones on the floor.
Terrific. I appreciate it. Good luck on the rest of the year.
Thank you.
Our next question comes from Denise Chai with Bank of America Merrill Lynch.
Great. Thanks for taking my question. First, in terms of international, looks like the gross margin was down year-on-year. Can you talk a little bit about what was pressuring it?
Yeah. On the international business, gross margin was down a little bit year-on-year. A combination of factors, some new product rollout, the TEMPUR-Breeze rolling out. As Mark mentioned in his comments, the TEMPUR-Breeze was very well accepted, getting more floor replacements than expected. We didn't really have a new product last year at the same time. Also, some geographic mix. We had some new distribution. A variety of factors around just putting a little bit of pressure on the international business as well as actually a little bit of cross-currency mix that doesn't flow through the top line, but flows through the cost side because of the different foreign currencies we deal with internationally and the product being produced in euros and the relationship to the euro versus the pound or the yen or the Australian dollar or the Korean won.
The cross currency gave us a little bit of pain as well.
Okay. Got it. Just sticking with international, can you kind of size up a little bit your Sealy business in Europe and kind of compare that to Tempur-Pedic, for example, how many doors are the two brands in?
The first approximation, there isn't any. There's very, very little Sealy business in Europe. Yeah.
At the Investor Day last year in September, we said that if you look at Europe, Tempur is about 10 times bigger than Sealy in Europe, and that's continental Europe. However, that equation has magnified because one of the reasons why it was important for us to get control of continental Europe was the Sealy business in Europe through the licensee was quickly eroding.
Okay. Mm-hmm.
That's why we view that business as one that's really a from-scratch organic growth story.
Okay. Got it. Thank you.
There's a lot of opportunity. One that we feel pretty good about.
Okay. Just one more question here. You said that you're also starting to deliver Tempur-Pedic and Sealy on the same trucks. Just how widespread is this, and can you talk about the difference it's making to your business?
It's relatively small right now. It's in one of the markets. We do anticipate it is going to roll out going forward, and it has a number of benefits. One is that frankly, it means that we can fill the trucks up fuller, which is a good economic thing. It also means that we can have frequency of delivery, which is very desirable to retailers, which allows them to have more frequent deliveries and less inventory. What it requires in order to do it is obviously the same truck, but it requires us to have places where we can put the inventory together. That is part and parcel of what Dale referred to when he talked about the evolution of the distribution network, is what we're doing. That initial test, while relatively small, has been quite good.
We are moving full speed ahead on doing that through the whole country. Having said that, this is a job that will take a couple of years. It's not something that you can just switch on.
Got it. Thank you very much.
Our next question comes from Jessica Sheng with Nomura.
My first question was on the granularity you provided on the gross margin. I was wondering if there's any way you could kind of help us think about how big are the impacts that are more unusual versus what are the more lasting impacts.
Yeah. Well, the bulk of the gross margin, you're talking here in the first quarter, first half?
Yes, that's correct.
Okay. Well, the bulk of the impact is related to kind of one-off things, which is this massive product rollout. Just the product discounts in the first quarter was 200 to 250 basis points of gross margin hit. On top of that, we also had well, people don't recognize it, but Mark mentioned the discounted product being sold out. All of our old product was at a closeout pricing. That was another 150 to 200 basis points of gross margin erosion because all of the old product that we sold was sold at a discount also. I mean, those two factors alone, if you look just at the Tempur North America business year-over-year, its gross margin was down about 500 basis points.
If you take those two items and you isolated just the Tempur North America, those two items were significantly more than the total that Tempur North America's gross margin was down.
As we get through this transition period and the closeout pricing goes away, the floor model discounts go away, we start seeing a very quick reversion back to normal gross margins for Tempur North America as well as the business.
Got it. That's very helpful. Then my other question was just an update on the cost synergies throughout the rest of the year. You were just mentioning the one truck delivering both products. What other things can we kind of be thinking about for the balance of 2014?
Well, cost synergies covers a lot of areas. We have cost synergies around SG&A. A lot of the big cost synergies we got immediately and last year was around sourcing, but we continue to see ongoing cost synergies on the sourcing side of the business. We're seeing cost synergies in warehousing. We're seeing cost synergies in manufacturing. We're seeing cost synergies in media, where we're getting much better pricing because of the combined buys. When we first announced this deal, we thought there would be about $40 million of cost synergies last September. At our investor day, we updated and said we now believe that we'll get in excess of $70 million of cost synergies and potentially as much as $100 million in cost synergies for this year, 2014.
We're looking for the cumulative cost synergies to be up as much as $40 million. That's in less than two years of having the businesses together. As we're moving forward, this continued increase in cost synergies, a lot of that's coming from distribution, warehousing, shared manufacturing. What Mark was specifically talking about would fall into the distribution side, and that's a cost synergy that will continue to build over the next couple of years as it gets fully implemented.
Great. Thank you so much for taking the questions.
Thank you.
Our next question comes from Joel Altobello with Oppenheimer.
Hey, guys. Good afternoon.
Hey, Joel.
Just wanted to start with a couple of big-picture questions. I think earlier you guys had mentioned that you're expecting to be at the high end of your guidance range for sales and toward the high end on EBITDA and EPS. Correct me if I'm wrong here, it sounds like you guys are getting a little bit more or better visibility with regard to the business, going forward in terms of how you're seeing things play out this year. One, is that the case, or am I misreading that? Two, from a consumer perspective, are you seeing some of the volatility that we saw in the last few years start to stabilize from 4Q into 1Q?
Yeah. Let me hit a couple areas, then I'll have Mark chime in and hit a couple areas. From a visibility standpoint or confidence level, yes, I think that our visibility and confidence level is improving. If we just look at the first quarter, our sales in the first quarter came in a little bit better than we expected. International did better, particularly in Europe. Sealy business revenues came in a little bit better than we expected. Specifically, the Posturepedic business continues to perform very well. Stearns & Foster turned positive in the first quarter. We're seeing good traction there. In the Sealy brands, the Tempur North America business came in pretty much where we expected it to. It had the biggest transition, we did see improvement throughout the quarter in that business.
January affected everybody from a weather standpoint, but we saw a significant improvement in the Tempur North America business as the quarter went on. We're getting more placement of floor models than was expected in each of the products. In the Tempur products, in the Stearns & Foster products, in the Optimum, the retailers are asking for more floor models, which portends good things for selling later on. We're seeing some incremental distribution, so we're feeling very confident and feeling more visibility around the revenue. From an earnings standpoint, we're getting a little bit more visibility. With more time going by, we're getting a better understanding, getting a better fix on where the synergies are, where the cost. Having more floor models means more floor model discounts, so that there is a cost with that.
Ideally, what we'll see is additional volume later in the year that gives us the volume leverage and more improvement. Mark, other things you want to add?
No, that's right. I think that there are another quarter's worth of trends that we have, particularly in international and in Sealy, that we can project, and then we have the new products that have been well-received. Clearly, as we've said all through, we don't have statistical data on how they're selling, but we have very good indications. Standing here today, we have that much more knowledge than we had when we made the last projection. We do have more.
Okay, that's helpful. Just secondly, in terms of the traffic at the retail level, has that stabilized or it's still pretty choppy week to week at this point?
It is choppy. It continues to be choppy.
Okay.
I think that we and the retailers are all hoping for a good Memorial Day. I know that that should be good. People are hoping it's going to be good. I know there's a lot of excitement about it, but it continues to be choppy.
Okay. Just one last one in terms of the incremental slots you guys picked up. You mentioned that you have gotten some additional distribution. Is there a way to quantify how many additional slots you've gotten from the Tempur North America launches? Is it 5%, 10% more slots?
I'm not going to put a number on it right now. I think the thing is that it's seven products replacing six. In some ways, and most of our customers have taken the seven. That's one way to look at it, but you can't just use that. I'm not encouraging you to use that as a metric. What we had done is when we did the analysis, we used statistical models to say what we thought the first round of floor models would be, what we would get in the first rollout, the first quarter. That has been higher than we anticipated, but that's just comparing a model to an actual. To be honest with you, right now, I can't put a good figure on it. I think we're going to end up with more. I just don't know how many.
Okay. Great. Thanks.
By the way, more in aggregate is what I'm getting at, more in aggregate.
Yes.
I know we're getting more floor models of this product. I mean more in aggregate.
Got it. Okay. Thank you.
Again, ladies and gentlemen, if you have a question or a comment at this time, please press the star then the one key on your touch-tone telephone. Our next question comes from Keith Hughes with SunTrust.
Thank you. One question. Getting to the top half of, or the top end of the sales guidance range, it's going to be up high single digits in the second half. Do you have a view on what the industry is going to be? Are you expecting any assist there, or is this your own initiatives?
These are really our own projections. Sort of fundamentally baked into it is something like a 3% growth for the industry. Implicitly, we have that as part of the inputs that we feed into the models that we say what we think we're going to have. Yeah, there's sort of implicitly that, but it's more a build-up from the bottom of what we think we're going to sell of each product.
Okay. I was a little surprised in your second quarter discussion on sales that you're going to be up only modestly given kind of, seems like we had a push forward of weather. Any commentary around that?
Well, we didn't specifically try to factor a catch-up of weather. Our North America business, Sealy had a very good first quarter. There was a lot of bad weather in the first quarter, but we saw good trends, improving trends as the quarter went on. From a Tempur North America standpoint, we saw the business come in essentially where we expected it to. We didn't specifically say, "Oh, we'll see a little extra boost in the next quarter because of delays from weather." We are looking for significant increase in growth.
Changing growth. Normally the second quarter is smaller than the first quarter.
Maybe I was confused. You were talking about a sequential move in revenues?
Yes.
Sorry, sequentially. That was my mistake.
Yeah. We're expecting growth in revenues sequentially, which is counter to the normal seasonality.
Okay. That's all for me. Thank you.
Thank you.
Our next question comes from Joan Storms with Wedbush.
Hi. Good afternoon. Thanks for taking my question.
Hey, Joan.
We've seen in several different retailers the beds on the floor, but I'm still sort of waiting on the POP. The beds rolled out first, then the POP comes with more of, sort of towards the holiday as we get in there? Or is that?
It's rolling out right now. The bulk of the POP is rolling out now. We expect it to be in places, not everywhere, but in the majority of the places where it's going to be by Memorial Day. That is the target. It's a big part of what Dale was talking about earlier, which is our investment in this quarter versus last quarter in terms of in-store marketing.
That don't use our POP. That doesn't even show. No, that is an important part. It will be rolling out, and it's a significant investment that's going to happen this quarter.
Okay. That's all in the selling expense.
Yep.
Just quickly on that, you bought the first deal with the Japanese licensee and now Continental Europe. Can you quantify how much that costs on a relative basis compared to Obviously, you're going to benefit a lot more on the sales side, but can you quantify on a cost basis what those things cost?
The acquisition of each of those, again, they haven't closed yet, so we haven't paid anything yet. The acquisition on these is immaterial to the business. We have a pretty good understanding and formula of how to do these things, and it works well. The detailed terms have not and will not be disclosed, but from a business, what the business is spending for it will be immaterial.
Okay, great. Thank you very much.
Thank you.
Our next question comes from Carla Casciola of J.P. Morgan.
Hey, most of my questions have been asked and answered, but I guess I may have missed it, but did you give your expectation for input cost inflation for the coming year? Any key items to call out there?
We didn't give a specific number. We do every year when we put our plans together, put in an expectation. Even if the market is telling us that commodity costs will be down, we still assume it's going to be up. We have assumed increases in steel. We've assumed increases in the chemicals that we buy. We have seen some market increase, but at this stage, it's within what our expectations are that were built into the year.
Okay, great. Thank you.
Our next question comes from John Anderson with William Blair.
I just have a couple of modeling questions. Last quarter, you talked about the advertising ratio coming in at 10.5%-11% for the full year.
Yep.
Where are you thinking currently for the full year, are there any meaningful variations by quarter on that line that we should take into account?
We still think advertising will be in that range, 10.5%-11%. It was 10.5% in the first quarter. Second quarter will be probably slightly above that range as we put a big push behind the new product launches. You don't want to put a lot of money behind it until they get broadly distributed, but as we're getting here in the next couple of weeks, we'll see an increasing push on the advertising on the new products as well as the new creative that Mark was talking about. For the back half of the year, we should see advertising kind of back in that range.
Okay. Just so I'm clear, the expenses related to the point-of-purchase materials that are rolling out, is that isolated in the selling and marketing line?
Yes.
Okay. That's kind of largely a second quarter event?
Yeah, you'll see a step-up, a sizable step-up in selling and marketing spend in the second quarter related to the POP rollout. Then in the third quarter, it will revert back to normal.
Okay. I know this has been touched on several times. I apologize for coming at it again. In terms of gross margin for the year then maybe some color first half versus second half. You said, Dale, earlier you expect some sequential improvement from Q1 to Q2.
Correct.
Is that right? Then, I guess you're thinking about the full year? I think last quarter you'd kind of indicated 41% for the full year.
Right. When we gave the guidance for the year, we said it's 41% for the year. We would see the first half ballpark around 40%, second half ballpark around 42%. Again, that was a pro forma, it didn't have integration costs in it. What we're talking about right now is actual, the GAAP. It has some integration costs in it. We do expect to see improvement in the gross margin as the year goes on. We'll see some improvement in the second quarter. We'll see a significant improvement in 3Q as we get beyond these floor model rollouts and closeout pricing. We'll see a big step-up in gross margin. For the year, we would still expect the overall gross margin to be close to 41%, probably maybe a little bit less than 41%, but in that ballpark.
Okay. Okay, great. Thank you guys very much. Good luck.
Thank you.
I'm not showing any further questions at this time. I'd like to turn the conference back over to Mark Sarvary for closing remarks.
Thank you. We look forward to talking with you all again in late July when we will host our second quarter earnings conference call. Thanks for joining us this evening.
Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.