I would now like to introduce your host for today's conference call, Mr. Mark Ruppe.
You may begin sir.
Thanks, Kevin. Thank you for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvery, President and CEO and Dale Williams, EVP and CFO. After our prepared remarks, we will open the call for Q and 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 ks 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 data 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 attempersealy.com and filed with the SEC. With that introduction, I will turn the call over to Mark Sarrey.
Thanks, Mark. Good evening, everyone, and thanks for joining us. Today, I'll provide an overview of our performance in the Q1 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 Q1 financial results and 2014 guidance. We had a lot going on in the Q1.
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 Q1 exceeded our expectations with solid sales growth in Europe, Asia and Latin America driven by advertising, new products and expanded distribution. Sealy's 1st quarter sales were in line with our expectation. Solid growth in the U.
S. Was driven by continued strong demand for Posturepedic Inner Spring and Hybrid products and a return to growth for Stearns and Foster, which more than offset declines Sealy and Optimum. Outside of the U. S, Sealy sales declined and this was exacerbated by unfavorable foreign exchange. Tempur North America 1st quarter sales were in line with our expectations down mid single digits.
As we said in February, we had expected 1st quarter sales to be muted in the U. S. Due to the poor weather in the 1st 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 4th consecutive quarter driven by continued strong demand for our Breeze collection and initial shipments of our new product. Now I'd like to discuss the progress we're making on our 4 key strategic growth initiatives in 2014.
The first strategic initiative is product innovation and our goal is to provide consumers the best bed and the best sleep of their life and to provide our retailers a complete and optimal offering across brands, products and prices to drive their growth. In the Q1, we began rolling out several of our new products, including the new Tempur North America products I just referenced, as well as our new Stones and Foster and Tempur International Breeze products. In April, we began rolling out the new Optimum line. The magnitude of these new product launches is significant given their importance to our overall business and their concentrated rollout timeline. The new Tempur Cloud and Contour launches are the largest in Tempur Pedic's history.
We shipped more floor model units than we planned in the Q1 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 and Foster product rollout by the end of the Q1. And as of the end of April, we achieved 75% of the total. We're particularly encouraged with the demand for the upper end Luxe Estate and Luxe Hybrid collections.
In April, we began a very concentrated rollout of the new Optimum line and have already shipped 50% of the total. This line has been well received by customers. In fact, the trade has been enthusiastic about all these launches. And as a result, all 3 have exceeded our slot placement expectations. In addition, we're in the process of launching the Tempur Breeze mattresses in several European markets and here too floor placements are exceeding plan.
In aggregate, the scale of this launch activity is unprecedented, but it has gone well and we're pleased with our execution. We expect to finish all of the North American product launches during the Q2. 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 and Foster products in particular has been very encouraging and appears to be building.
We're expecting the launches of these new products to be important drivers of our growth in 2014. Our second strategic initiative is marketing and this includes advertising as well as in store marketing and direct sales. In 2014, we will increase our investment in marketing and this will be most evident in the Q2 as we ramp our in store marketing investment and increase our advertising spend with the launch of new television creators. In April, we began airing nationally, a new product specific TV ad for the new cloud and Contour Beds. And in May, we will launch a new Ask Me campaign.
We also expect to begin benefiting from more impressions per dollar spent as we reinvest synergies realized from our combined media buy. We will also support Stearns and Foster, Optimum and Posturepedic with consumer advertising including TV, digital and print. The 3rd strategic initiative is new market expansion and 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 and today we announced the signing of a definitive agreement to acquire the CD brand rights in Continental Europe. Each of these transactions represent 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 and Foster brands in South America, where we have existing Sealy assets. And lastly, our 4th strategic initiative is our commitment to building a world class supply chain that is easier to do 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 CV products together on CV trucks in 1 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 1 year anniversary of our combination and we're pleased with how it's gone. We still see many opportunities to create additional leverage and we're aggressively pursuing them. Cost synergies are being realized to plan and we are now beginning to see the benefits from revenue synergy. As most of you know, Larry Rogers retired after a long and extremely successful career at Sealy and his contribution to the Tempur Sealy merger and integration was invaluable and we're thrilled that he will continue to provide value to our organization as a member of our Board of Directors.
So to summarize, Q1 was broadly in line with our expectations. Our major initiatives for 2014 are rolling out as planned and we remain very focused on their successful execution. Our plan calls for an acceleration of our growth on a consolidated basis and specifically in the U. S. And we are receiving positive feedback on the new products from retailers and consumers.
However, it's still early and we look forward to providing a more complete update when we report in July. With that, I will now hand the call
over to Teo. Thanks, Mark. I'll focus my commentary on the Q1 2014 financial results and then discuss our 2014 guidance. I will address the performance on a consolidated basis, then speak to the performance for each segment and provide commentary on the key areas or items where there's a notable variance from the prior year. As a reminder, the company completed its acquisition of Sealy in March 2013 and results for the Q1 of 20 13 reflect only a partial period of results from March 18 through March 31.
Consolidated net sales for the Q1 were $701,900,000 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. Betting net sales declined 2.5% on a unit bedding net sales declined 2.5% on a unit decline of approximately 5%. However, it's worth noting that mattress and adjustable base units together were flat in the quarter, with the decline being driven by traditional foundations, a phenomenon we attribute to the significant floor model transition. While we don't break out mattress performance specifically anymore, given the magnitude of this rollout, we felt it was appropriate to provide some color on the transitory impact we experienced in the period.
We shipped approximately the same number of mattresses in Tempur North America in the Q1 as we did last year. However, the mix of discounted floor model units was significantly greater this year. Remember, for every floor model we ship, a floor model needs to be sold off at retail. We replaced significantly more full value orders with discounted floor model shipments in the Q1. Excluding this discount effect, our gross mattress sales in the Q1 were positive mid single digits.
Sales of other products, mostly pillows, declined 37% and accounted for more than half of Tempur North America's 1st 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 300 and $63,200,000 as compared to $46,700,000 last year. 1st quarter gross margin was 38.4% as compared to 48.3% in the Q1 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, Q1 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 percent 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 $73,800,000 or 10.5 percent of sales in the 1st quarter.
Consolidated operating income was $62,400,000 as compared to $44,500,000 in the Q1 of 2013. Operating income in the Q1 of 2014 included $7,400,000 of integration costs related to the Sealy acquisition. Operating income in the Q1 of 2013 included $16,000,000 of transaction and integration costs related to the Sealy acquisition. Interest expense for the quarter was $22,200,000 and the Q1 tax rate was 29.3%. 1st quarter GAAP earnings per share was $0.44 as compared to $0.20 per share in the Q1 of 2013.
Adjusted earnings per share were $0.53 in the Q1 as compared to adjusted earnings per share of $0.62 in the prior year period. Now I'll turn to cash flow for a brief review. At the end of the Q1, 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 20 14 and consistent with our full year plan. The company has consolidated funded debt less qualified cash of $1,800,000,000 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 $7,800,000 Now I'd like to address our 20 14 guidance. Today, the company confirmed financial guidance for 20 14.
The company currently expects net sales to be in the range of $2,800,000,000 to $2,900,000,000 which reflects growth of approximately 1% to 5% compared to 2013 had we owned Sealy for all of 2013 adjusted EBITDA to be in the range of $415,000,000 to $435,000,000 and adjusted earnings per share to be in the range of $2.60 to $2.85 It's important to note that while our full year financial guidance is unchanged, our current view of the profile has slightly changed. We currently expect our full year 2014 net sales to be at the upper end of the guidance range. In addition, we currently expect our full year 2014 adjusted EBITDA and adjusted earnings per share to be at the mid to upper end of their respective ranges. In addition, our guidance excludes any potential impact from the planned acquisition of Sealy Brand Rights in Japan and in Continental Europe as well as excludes the impact of ongoing integration costs related to the acquisition of Sealy. We are planning for Q2 2014 sales to be up slightly as compared to the Q1 2014 sales of $701,900,000 We expect floor model shipments to remain elevated in the second quarter as complete all of the North American product launches.
As Mark indicated, our in store marketing investment will increase significantly in the Q2 and we also plan to increase our investment in advertising with the new creative. As a result, we expect our operating margin in the 2nd quarter to be approximately 8%. Majority of our investments in 2014 are first half weighted and therefore we expect operating margins to improve significantly in the second half of the year as floor model shipments and incremental in store marketing investments diminish. Through April, we 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
Our first question comes from Jon Brauer with Stifel.
Good afternoon.
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.
Well, there's no doubt that the weather did have an impact certainly at the beginning of the quarter. And the transition as you know is not an event. Obviously, what we're talking about is what we've shipped to retailers. Some of the retailers are pretty much 100% converted, but many are not. Many are in the middle of transition, still in the process of selling off some of the floor models.
So it's a process which is ongoing. And models. So it's a process which is ongoing and obviously was slowed to some extent by the fact that there was poor weather at the beginning of the quarter.
Super. And then secondly, if I could just ask about internationally where there was a positive surprise. Were those macro driven, weather driven, company specific product marketing effort driven? Any color?
And then you mentioned the areas that were strong.
I was wondering if any were particularly stronger than others. Thank you. There was some macro strength. I mean, and I'm talking here about Europe. We've had pretty good
performance in Asia for some time all through last year and we continue to have that. Japan, Korea, Australia continue to be strong. Where we had weakness last year certainly in the 1st part of last year, most of last year was in Europe. And we saw some improvement of that kind of from a macro level in the end in the Q4 of last year and we saw continuation of that and strengthening this quarter. But a lot of what's been happening in Europe can be pointed very distinctly to for us I mean can be pointed to very directly to activities that we've done.
In the U. K, for example, we've gained distribution that has had a material impact. In Continental Europe, we've been running advertising, which is always effective, particularly in the German speaking countries. And so and we've introduced the new products. We were participants in the big Cologne fair in Germany and new products had an impact.
So while their 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 Berg on 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 CLE business is up there and the relationships you have, at this point, are you starting to see some more Tempur slots being allocated in some of your retailers? And if so, how many have you picked up on a per store basis?
I don't want to break it down into that level of detail, but 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. And so that is an area where we have now a unified team working together on the Canadian business working with our retailers as a unified team and we believe that is going to have great promise and that we will see benefits of that this year. But I'm not going to get down to details by customer. I will say, however, that is an area which
we do see some promise. Okay, great. And then we've seen your new ad spot on TV that features a contour and the cloud looks good. And I'm just curious, what's the consumer reaction bit of this? And I mean, to the extent that you can talk about it, I mean, is this going to be really the ad that you lead into the holidays with along with the Ask Me?
Or what are your plans around advertising?
Yes. The ad that you're referring to is an ad, which is well, let me just step back a minute. As you know, last year we went back to our Ask Me campaign in the Q4 and we've been running it ever since. And we as I and I'll talk in a minute about it, we will continue with that going forward. However, during this month and this quarter, this launch of Tempur products is quite unique for Tempur.
It is a brand new look of the product, brand new characteristics of the product, brand new features with the removable top and the washable top and the cooling layer. So we really felt it was important to have an ad that just spoke very simply and very eloquently to the new characteristics of the product both for consumers, but also for retailers. It was a this is a very well done, but matter of fact product commercial. As we get into the second half of this month, you'll see the new evolution of the Ask Me. We call it the Ask Me campaign because it's made by the same people and it's made in the same tonality.
But it is a clear very logical and we're quite excited about the evolution of the ad, which we think is very much more frankly, it's more appeals to your heart and your emotions than to simply the matter of fact method that this other ad works for. So what we see is that the ad that's running right now will continue to run because it's an important ad, but it won't be the back part of our strategy going forward. What we think is the nice part about that ad though is it's designed and it's 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 book end it.
Okay, great. Thank you. And if I can just sneak one really last quick one in for Dale. Dale, it looks like the tax rate came in a little bit lower than what you guided the full year or 2 on the last call. Should we expect that tax rate to build through the year?
Or is there some change in thinking there?
Yes. On the last call, we said that the tax rate for the year would be about 31%. It did come a little bit lighter than that in the Q1. That was principally due to geographic mix with international being stronger, domestic being a little bit softer and domestic being a higher tax rate. So for the year, I would think that the tax rate might come in a little bit from that 31%, but not dramatically.
Okay, great. Thanks a lot guys. Good luck in the rest of the year.
Question comes from Brad
Thomas with KeyBanc Capital Markets. Hey, good afternoon, guys. Hey, Brad. Hey, Brad.
Wanted to just ask a couple of questions on the guidance. For the Q2 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 is taking a step in the right direction. But you're still making investments on the new product rollout and that's probably still pressuring margins. Is that what the reason is behind the gross margin outlook being a little bit worse than what we had been modeling going into the quarter?
Yes. From the gross margin, let's break it down into a couple of pieces. From a gross margin standpoint, at the beginning of the year, we thought we said the first half gross margin would be about 40%. So obviously, the Q1 was 100 and 60 basis points less than that. But keep in mind, when we're talking on here, we're talking pro form a.
So the integration cost was about 30, 40 bps of that difference. The balance though was that in the Q1, we had some more floor models. As Mark said, the retailers are very excited about the new product lines, not just Tempur, but Stearns and Foster. And so we're getting more floor models than we had anticipated. Also the direct and this is a Tempur specific item, the direct business and the pillow business are much softer than we expected.
They started the year soft. They continued to be soft. It's something we're not happy about. And we'll be turning our focus to those areas of the business with the new products getting out. But we do expect for the first quarter or I'm sorry for the first half for gross margins to be slightly less than what we had anticipated at the start of the year.
We do think gross margins will improve some in the second quarter from the first quarter as we have continuing product rollouts, but we'll be getting to the end of that. And certainly another factor there is getting to the end of the closeout pricing on the old product line. Then working through the rest of the P and L from an expectation standpoint, in the Q2, we do expect to increase the advertising spend as a percent of sales. First quarter advertising was about 10.5%. We expect it to be higher than that in the 11% range.
Also the big outstanding expense in the second quarter is rolling out all the new POP that you saw at Vegas. In the Q1, 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. But in the second quarter as the new products get broadly distributed, there'll be a significant investment in isolated to Q2 around that POP that's driving the operating margin issues. Also FX was pretty it was a factor in the Q1, very nominal factor in the Q1. But on a comparative basis, FX should be worse in the Q2.
Okay. Great. That's very helpful, Dale. And so just with that as the outlook for the Q2, you hadn't given Q2 guidance to us, but we'll obviously be 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 mid or higher end of your range.
What is it that's making you more positive on back half of the year?
Well, I mean, our plan all along was for the back half of the year to be much stronger from a revenue and a earnings perspective, 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. And so we have to never. And so we have to really do a significant expenditure to get the floor so the retailers POP to look like we wanted to look and like you saw at Vegas in late January. So the plan all along was once we got through this major investment in the first half that we would see much better performance in the second half and from an earnings standpoint and the new products will deliver growth in the second half and we'll start getting leverage on the business as we move forward in the year.
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 Q1. Do you think that will 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. And there's some reasons for this. The way that retailers use them as gifts when people as incentives for people when they buy beds and so on is diminishing. But the fact is our pillow business is a very important part of our business, very much 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.
And so it's something that we're going to put great focus on. Obviously, we put a lot of focus on these new cloud and contour beds from the Tempur part of the portfolio in this last period. In the second half of this year, you'll see a range of new pillows, which we're quite excited about, which we'll be launching. But 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?
It's a pro form a number.
All right. Thank you. Perfect. And then can you maybe give us a little color on the operating margins and the gross margins by segment for Q1?
Yes. 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 percent Tempur International 59.7 percent Sealy 29.9 percent and again these are all GAAP numbers. Operating margin Tempur North America 5.2 percent Tempur International 22.3% and CLE 6.4%.
Thank you. And then just real quick for 2Q, can you maybe talk a little bit about by segment for top line wise where you expect Tempur and at least international and up wise, are you still expecting another strong quarter in international?
Yes. I mean, we would expect international in 2Q to kind of have similar performance to what it had in Q1, which was up 7%, up 5.8% on a constant currency basis. We expect Tempur North America to turn very positive and be up mid single digits to high single digits. The trends that we saw in the quarter, the gross sales that I mentioned is that was up mid single digits in the Q1. 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 Q2.
Sealy was 3% growth in the Q1. Ballpark, the domestic business was up 7%. So we with some FX issues on the international side, but we saw good growth for Sealy in the Q1 and we expect that to continue with their new products, the Stearns completing its rollout, Optimum being rolled out. So we're looking for strong performance across the portfolio.
You. That's it for my questions and best of luck going forward.
Thanks, Steve. Our next question comes from Josh Boorstein with Longbow Research.
Taking my questions. 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 flush 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. We really haven't even the deals are not signed yet. Not closed. Not closed yet. Sorry, they're signed, but they're not closed.
I mean, they're still closing conditions. But we'll talk we will talk about it more during the year. But I think that what you do need to bear in mind for Europe is that there's a very small very, very small business
there right now. And what we
anticipate doing is launching new products, kick in, we believe, in 2015 in reality. And we'll give you a better feel of that second half, kick in we believe in 2015 in reality. We'll give you a better feel of that second half of the year. It's too early to do it right now. But as Dale said, it's not going to be a material contribution this year.
Okay. Great. Thanks for that. And then just on the new products, is it possible to isolate them and just give an indication? You obviously expect to see an increase in velocity.
I know it's early, but do you think you're seeing that increase as anticipated?
No. 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. And the anecdotal data we're getting is good.
The anecdotal data we're getting is that some of the key products like the Rhapsody Luxe and the Cloud Elite are being very well received. So we're seeing good things. It's just hard we're not in a stage here where we can actually use any it's a transition. I mean it and 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.
So it takes time. But the what we don't have kind of numeric or statistical data. What we do have is anecdotal and that's what we're sharing with you right now.
Okay. Great. And then 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, I mean, let me do I mean, they're positive about all three sets of products that we launched, the new Tepa 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 and Foster are considered to be among the most beautiful products that we've ever made, that frankly anybody's ever made.
There are real people really, really think they're beautiful and they love them. And they display well. The hand, the feel of the products for the consumer is really good. The Tempur products are the most dramatic change from what was before compared to what they're replacing. And the RSA is very much like the aesthetics.
They very much like the logic of the sequence and the way that the products fit together. So you can logically step a customer up from the entry level products right through to the highest end products with a good logical case for each step. But perhaps the thing that they've been saying to us that they find the most the desirable about these new products is the demonstrability. 1 of the as you know very well, these products are designed to have the covers removed, which allows the consumer to look underneath the hood and put their hand on the cooling layer and touch the Tempur foam. And that demonstrability, we're hearing
time and again, is something that really captures
the attention of consumers, but also is something 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 in the rest of
the year. Thank you. Our next question comes from Denise Chai with Bank
of America Merrill Lynch.
Great. Thanks for comes from Denise Chai with Bank of America Merrill Lynch.
Great. Thanks for taking my question. So first in terms of international, it looks like the gross margin was down year on year. Can you talk a little bit about what was pressuring it?
Yes. On the international business gross margin was down a little bit year on year, a combination of factors some new product rollout, the Breeze rolling out. So we as Mark mentioned in his comments, the Breeze was very well accepted, getting more floor replacements than expected. We didn't have a really have a new product last year at the same time. Also some geographic mix, we had some new distribution.
So a variety of factors around just putting 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 for the euro versus the pound or the yen or the Australian dollar or the Korean won. So the cross currency gave us a little bit of pain as well.
Okay. Got it. And sticking with international, can you kind of size up a little bit your like Sealy business in Europe and kind of compare that to Tempur Pedic for example? How many doors are the 2 brands in?
To the first approximation, there isn't any there's very, very little Sealy business in Europe.
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. And there's 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.
Yes, 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. So 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. But we do anticipate it is going to roll out going forward. And it has a number of benefits. One is that it frankly it means that we can fill the truck stop fuller, which is a good economic thing.
But it also means that we can have frequency of delivery, which is very desirable to retailers, which allows them to have more frequent deliveries and less inventory. And but what it requires in order to do it is obviously the same truck, but it requires us to have places where we can put the inventory together. And so that is part and parcel of what Dale referred to when he talked about the evolution of the distribution network is what we're doing. That initial test, while relatively small, has been quite good. And so we are moving full speed ahead on doing that through the whole country.
But 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 Schong 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 what how big are the impacts that are more unusual versus what are the more lasting impacts?
Yes. Well, the bulk of
the gross margin are you 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. We have just the product discounts in the Q1 was a couple of 100 basis basis points of 200 basis points to 2 50 basis points of gross margin hit. On top of that, we also had a lot of people don't recognize it, but Mark mentioned the discounted product being sold out. All of our old product was at a closeout pricing.
And that was another 150 basis points to 200 basis points of gross margin erosion, because all of the old product that we sold was sold at a discount also. So I mean those 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 isolate it just to Tempur North America, those two items were significantly more than the total that Tempur North America's gross margin was down. So 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. And then my other question was just an update on the cost synergies throughout the rest of the year. You were just mentioning that one truck delivering both products. What other things can we kind of be thinking about for the balance of 2014?
Well, cost synergies covers a lot of areas. We have cost synergies around SG and A. We have cost synergies that a lot of the big cost synergies we got immediately and last year was around sourcing, but we continue to see ongoing cost synergies on the sourcing side of the business. We're seeing cost synergies in warehousing. We're seeing cost synergies in manufacturing.
We're seeing cost synergies in media where we're getting much better pricing because of the combined buys. When we first announced this deal, we thought there would be about $40,000,000 of cost synergies last September at our Investor Day, we updated and said we now believe that we'll get in excess of $70,000,000 of cost synergies and potentially as much as $100,000,000 in cost synergies for this year 2014. We're looking for the cumulative cost synergies to be up as much as $40,000,000 and that's in less than 2 years of having the businesses together. As we're moving forward, this continued increase in cost synergies a lot of that's coming from distribution, warehousing, shared manufacturing. But this what Mark was specifically talking about would fall into the distribution side and that's a cost synergy that will continue to build over the next couple of years as it gets fully implemented.
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. And it sounds like and correct me
if I'm wrong here, but
it sounds like you guys are getting a little bit more or better visibility with regard to the business going forward in terms of how you're seeing things play out this year. 1, is that the case or am I misreading that? And 2, 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?
Yes. Let me hit a couple of areas and then I'll have Mark chime in and hit a couple of areas. From a visibility standpoint and a or a confidence level, yes, I think that our visibility and confidence level is improving. And if we just look at the Q1, our sales in the Q1 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 and Foster turned positive in the Q1. So we're seeing good traction there. In the Healy brands, the Tempur business, Tempur North America came in pretty much where we expected it to, but it had the biggest transition, but we did see improvement throughout the quarter in that business.
January affected everybody from a weather standpoint, but we saw a significant improvement in the Tempur North America business as the quarter went on. We're getting more placement floor models than was expected in each of the products, in the Tempur products, in the Stearns and 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 there is a cost with that. And ideally, what we'll see is volume additional volume later in the year that gives us the volume leverage and more improvement. Mark, anything you want
to add? That's right. I mean, I think that we there are another quarter's worth of trend that we have particularly in international and in Sealy that we can project. And then we have the new products that have been well received. I mean, clearly, as we've said all through, we don't have statistical data on how they're selling, but we have very good indications.
So standing here today, we have that much more knowledge than we had when we made the last projection. So we do have more.
Okay. That's helpful. And just secondly in terms of the traffic at your 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. And I think that we're we and the retailers are all hoping for a good Memorial Day. I know 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 mean, I think the thing is that it's 7 products replacing 6. So in some ways and most of our customers have taken the 7. So that's one way to look at it. But you can't just use that as I'm not encouraging you to use that as a metric.
What we had done is when we did the analysis, we used kind of statistical models to say what we thought the first round of floor models would be, what we would get in the first rollout of the Q1. And that has been higher than we anticipated, but that's just comparing a model to another to an actual. So to be honest with you right now, I wouldn't put I can't put a good figure on that. I think we're going to end up with more. I just don't know how many.
Okay. Okay. Great. Thanks.
I mean
more by the way, I mean more in aggregate is what I'm getting at, more in aggregate. I know we're getting more flow models of this product. I mean more in aggregate.
Got it. Okay. Thank
Our next question comes from Keith Hughes with SunTrust.
Thank you. One question. Getting to the top half or the top end of the sales guidance range, it's going to be up high single digits in the second half. Do you have a view on what the industry is going to be? Are you expecting me to assist there?
Or is this your own initiatives?
These are really I mean, this is our own projections. I mean, sort of fundamentally baked into it is something like a 3% growth for the industry. So implicitly, we have that as part of the inputs that we feed into the models that we say what we think we're going to have. So yes, there's sort of implicitly that, but it's more a buildup from the bottom of what we think we're going to sell at each product.
Okay. And I was a little surprised in your Q2 discussion on sales, is it going to be up going modestly given kind of seems like we had pushed 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 Q1. Yes, there was a lot of bad weather in the Q1, but we saw good trends, improving trends as the quarter went on. From a Tempur North America standpoint, we saw the business come in essentially where we expected it to. But we're looking at we didn't specifically say, oh, we'll see a little extra boost in the next quarter from a wet because of delays from weather.
But we are looking for significant increase in growth. Change in growth.
Yes, because normally the second quarter is smaller than the first one. Yes.
Okay. So that's maybe I was confused. You were talking about a sequential move in revenues? Yes. Sorry, flat sequentially.
Okay. Then that was my mistake.
Yes. 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 Storoz with Wedbush.
Hi, good afternoon. Thanks for taking my question. So I had a so we've seen in several different retailers the beds on the floor, but I'm still sort of awaiting on the POP. So that is so the beds rolled out first, then the POP comes with more of sort of towards the holiday as we get in there?
Rolling out right now. I mean the thing that we the bulk of the POP is rolling out now and we expect it to be in places not everywhere, but in the majority of places by the majority of the places where it's going to be by Memorial Day. That is the target. And it's a big part of what Dale was talking about earlier, which is our investment in this quarter versus last quarter in terms of in store marketing. There are some of the biggest retailers that don't use our POP.
But no, that is an important part. It will be rolling out and it's a significant investment that's going to happen in this quarter.
Okay. So that's all on the selling expense. And then just quickly on that, you bought the first deal, the Japanese licensee and now Continental Europe. What can you quantify like 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 those of each
of those,
again, they haven't closed yet. So we haven't paid anything yet. But the acquisition on these is immaterial to the business. We have a pretty good understanding and formula of how to do these things and it works well. The detailed terms have not and will not be disclosed.
But the from a business what the business is spending for it will be immaterial.
Okay, great. Thank you very much.
Thank you. Our next question comes from Carla Casella with JPMorgan.
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 for 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 Jon Andersen with William Blair.
I just have a couple
of modeling questions. Last quarter you talked about the advertising ratio coming in at 10.5% to 11% for the full year. Where are you thinking currently for the full year? And are there any meaningful variations by quarter on that line that we should take into account?
We still think advertising will be in that range, 10.5% to 11%. It was 10.5 in the Q1. 2nd quarter will be probably slightly above that range as we put a big push behind the new product launches. Once they get you don't want to put a lot of money behind it until they get broadly distributed. But as we're getting here in the next couple of weeks, we'll see increasing push on the advertising on the new products as well as the new creative that Mark was talking about.
Then for the back half of the year, we should see advertising kind of back in that range.
Okay. And just so I'm clear, the expenses related to the point of purchase materials that are rolling out, is that isolated in the selling and marketing line?
Yes. Okay.
And that's isolated kind of largely a second quarter event?
Yes. You'll see a step up, a sizable step up in selling and marketing spend in the Q2 related to the POP rollout. And then in the Q3, it will revert back to normal.
Okay. And I know this has been touched on several times. I apologize for coming at it again. In terms of gross margin for the year and then maybe some color first half versus second half. You said, Dale, earlier you expect some sequential improvement from Q1 to Q2.
Correct. Is that right? And then how are 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 41% for the year, we would see the first half ballpark around 40%, second half ballpark around 42 Again, that was a pro form a, so it didn't have integration costs in it. What we're talking about right now is actual GAAP. It has some integration costs in it. But we do expect to see improvement in the gross margin as the year goes on. We'll see some improvement in the Q2.
We'll see significant improvement in 3Q as we get beyond these floor model rollouts and close out pricing. We'll see a big step up in gross margin. For the year, we would still expect the overall gross margin to be in that close to 41%, 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 Snobre for closing remarks.
Thank you. And we look forward to talking with you all again in late July when we will host our Q2 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.