I would now like to turn the call over to Mark Roope.
Thanks, Jamie. Thank you for participating in today's call. Joining me in our Lexington headquarters are Mark Sarvary, President and CEO, and Dale Williams, EVP and CFO. After our prepared remarks, we will open the call for Q&A. Forward-looking statements that we make during this call are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that forward-looking statements, including the company's expectations regarding sales, adjusted EBITDA, earnings, or adjusted net income, or the integration with Sealy, involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company's business. The factors that could cause actual results to differ materially from those identified include economic, regulatory, competitive, operating, and other factors discussed in the press release issued today.
These factors are also discussed in the company's SEC filings, including but not limited to annual reports on Form 10-K under the heading Special Note regarding forward-looking statements and/or risk factors. Any forward-looking statement speaks only as of the date on which it is made. 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, are posted on the company's website at tempurpedic.com and filed with the SEC. With that introduction, I will turn the call over to Mark Sarvary.
Thanks, Mark. Good evening, everybody, and thanks for joining us. We have a lot to cover on tonight's call. As you are aware, we completed the acquisition of Sealy Corporation on March 18th, which was a transformative event for our company and for the industry. Clearly, we're just at the start of what will be a multi-year process to capture the full potential of this deal. Both Larry Rogers, the Chief Executive of Sealy, and I are pleased with our early results. As we previously announced, we intend to change our corporate name to Tempur Sealy International and are currently seeking stockholder approval at our upcoming annual meeting of stockholders in May. We are now a much larger and more diverse business. We have the strongest brand portfolio with the most highly recognized brands in the world.
We also have the most comprehensive suite of bedding products available in the market, with products for almost every consumer preference and price point. In fact, our products are distributed through more channels and to more places globally than any other bedding company. This is just the beginning. The combination of Tempur and Sealy will be exciting for consumers and retailers. Our long-term sales and earnings growth potential is significant, and our pace of innovation will remain vibrant, and we are committed to brand marketing investments. In addition to the very attractive cost synergies we expect to achieve, in the next few years, we expect to realize attractive upside from revenue synergies as a result of a broader product offering and access to more channels, including international expansion. At the same time, our strong cash flows will enable rapid debt reduction.
With that introduction, here's the agenda for tonight's call. I will start with a brief overview of our performance in the first quarter, then provide an update on the Sealy integration, and then discuss our near-term strategic initiatives. I'll then turn the call over to Dale, who will provide details on the first quarter financial results and then discuss our updated full-year 2013 guidance. Our first quarter results were in line with our projections for both Tempur North America and Tempur International. Excluding the Sealy segment, Tempur-Pedic sales declined 11%, with North America sales down 16% and international sales up 2%. As indicated on our last earnings call, the first quarter was expected to be our most challenging comparison of 2013. Not only did we achieve record sales levels in both North America and international in the first quarter of 2012, but the industry also experienced historic growth.
Despite an industry backdrop that was softer than anticipated in the first quarter of 2013, we did meet our projections. Our North American business was stable, with flat sales on a sequential basis. The continued success of our recent new products, Breeze and Waveless, offset a somewhat softer-than-expected base business. We remain confident that the Tempur North American business is now positioned to return to growth, with the expectation that the second quarter will show positive net sales growth driven by the launch of several compelling new products. Tempur International continued to perform well in certain key European markets, such as Germany and France. However, weak economic fundamentals across the continent pressured our overall European performance. Conversely, our Asia Pacific business continued to perform well during the period, reflecting solid performance in the key markets of Korea, Australia, and Japan.
Although Sealy was only part of the new company for two weeks in the first quarter, Sealy's full fiscal first quarter sales for its last standalone quarter, ended March the 3rd, 2013, increased 8.8% to $339.6 million. Now I'll provide an update on the Sealy integration. As I indicated in my introductory remarks, fully capitalizing on a major acquisition like this will take some time, but we're off to a very good start. The integration so far is progressing smoothly and as planned. I am pleased with the combined organization and continue to be impressed with how both Sealy and Tempur leaders are working together to capitalize on the opportunities presented by the combination.
Our collective teams are quickly implementing plans to capture synergies they identified before the deal was completed and developing additional plans and strategies for both near and long-term opportunities that, prior to closing, we were restricted from discussing. We are pleased with our progress to date on identifying and implementing cost synergies. They are coming in slightly higher and slightly faster than planned. We currently expect to realize approximately $15 million in cost synergies in 2013 through areas such as improved purchasing leverage and combined transportation and distribution. We remain committed to achieving cost synergies in excess of $40 million by the third full year. One of the positive aspects of the combination is that these cost synergies provide us with incremental opportunities to strengthen our business.
In 2013, we plan to invest some of the upside realized from the cost synergies back into our business, including investing more in advertising and marketing. I will discuss some of our near-term strategic initiatives. Product innovation and brand marketing are the hallmarks of our company. We will continue to invest in innovation and further building our brands. From a product innovation perspective, we are quite optimistic about both Tempur's and Sealy's 2013 new product introductions that were launched at the January Vegas Bedding Show. Tempur introduced the Choice Collection, as well as the new TEMPUR-Ergo Premier Adjustable Base, the TEMPUR-Cloud Luxe Breeze, and the TEMPUR-Cloud Allura. The rollout of our new TEMPUR-Ergo Premier Adjustable Base started late in the first quarter, with the bulk of the floor models expected to ship during the second quarter.
We are not only replacing the advanced Ergo Adjustable, we are also getting incremental placement. The magnitude of this rollout is significant, with most of our retailers having multiple adjustable bases on their floors. The new TEMPUR-Choice Collection is initially comprised of two mattress models priced at the higher end of our price range and is designed to deliver the superior comfort and pressure relief of our proprietary Tempur material while offering the added benefit of adjustable firmness and support across multiple zones on both sides of the bed. We expect to begin shipping the new TEMPUR-Choice Collection in the next couple of weeks. In April, we started shipping the new TEMPUR-Cloud Allura. The TEMPUR-Cloud Luxe Breeze will ship later this quarter.
Retailer feedback and interest in the new Tempur products remains very positive. We are expecting placement to be slightly higher than we had initially anticipated at the time of introduction at the Vegas Bedding Show. At the Vegas show, Sealy introduced its new Sealy Posturepedic line, as well as new Stearns & Foster products. The new Posturepedic line consists of three collections, the Classic Series, the Gel Series, and the Hybrid Series. The Hybrid Series in particular is new for Sealy and is truly a hybrid since it is constructed of half memory foam and half springs. The market for hybrid mattresses in general is burgeoning. The new Posturepedic line began rolling out to customers in the first quarter. The bulk of the rollout will occur in the second quarter, with 75% of it expected to be complete by Memorial Day.
Placement of the new line is up relative to the previous 2011 launch. We are optimistic about its prospects. While still very early, the new Posturepedic offering is off to a good start, showing positive growth at those retailers where it's currently offered. Sealy will also be rolling out an addition to its Stearns & Foster Estate collection, consisting of five models, as well as the new Stearns & Foster Monogram Memory Foam collection, a three-bed offering. These new mattresses will also be floored primarily in the second quarter. Launching this many products in a single quarter will be a challenging task.
As Dale will discuss in a moment, we are expecting to ship nearly 70,000 new product floor models in the second quarter alone, which for Tempur will be a quarterly record and for Sealy will be its largest in the last six years. The lower margins of floor models, coupled with the cost of related point-of-purchase materials, will be significant and will pressure our margins in Q2. That said, the fact that the placements are better than initially anticipated bodes well for our growth in the second half. Going forward, we will continue to invest in R&D to leverage the combined technologies of our portfolio to deliver a stream of innovative products that will resonate with consumers and grow our retailers' businesses. In addition to innovative new products, we also remain very committed to building awareness through continued advertising investment.
Our advertising investment in 2013 will be significant and will accelerate as the year progresses. Both Tempur and Sealy will be introducing new advertising campaigns in North America in the second quarter. In closing, we are now a couple of months into working as an integrated company. Our confidence in the long-term potential of the combination is stronger than ever. While we are working hard to capture the synergies, we're also refining our long-term plan. We intend to share this with investors at an investor day in the fall of this year, probably September. With that, I will now hand the call over to Dale.
Thanks, Mark. I'll focus my commentary on the first quarter financial results, our new capital structure, and then our 2013 guidance. For the first quarter results, I'm going to focus on the legacy Tempur-Pedic results with comparisons against prior periods for Tempur. I will then address Sealy's first quarter results. Further, as a result of the combination with Sealy, we've updated our reporting segments as well as our product and channel categories. History. The first quarter results are presented in this new product and channel categories. Historical Tempur-Pedic data has been posted to our investor relations website. With all the data included in the earnings release, I'll provide a commentary on the key areas or items where there is notable variance from the prior year. Tempur-Pedic sales for the first quarter were $343 million, a decline of 11%.
Tempur North America sales were down 16% and international net sales up 2%. On a constant currency basis, international sales were up 3%. By product, bedding net sales for Tempur North America decreased 16% to $204.6 million on a unit decline of 10%. Tempur International bedding net sales were essentially unchanged at $89.3 million on a unit increase of 10%. Net sales of other products for Tempur North America decreased 13% to $21.3 million due to a decrease in pillow sales during the quarter. On a direct basis, Tempur North America net sales decreased by 41% to $14.4 million, which we believe is due to lower media spend during the second half of 2012. Tempur International direct sales increased 71% to $11.3 million, driven by growth in company-owned stores and e-commerce. Overall, first quarter net sales were $390.1 million and included $46.7 million of Sealy sales during the stub period.
As Mark indicated, some commentary on Sealy's fiscal first quarter results ended March 3, 2013, was included in our earnings release. Sales increased 8.8% to $339.6 million and were driven by growth in specialty products at premium price points and Comfort Revolution joint venture, offset by weakness in innerspring for the Sealy brand and Stearns & Foster brand, the latter of which had difficult comparisons from the prior year introduction. Operating profits were influenced by certain charges, as noted in the earnings release, as well as investments in national advertising. Excluding the impact of Sealy's results, Tempur-Pedic's gross margin decreased to 51.7% from 53.6% in the first quarter of 2012. On a year-over-year basis, Tempur-Pedic first quarter gross margin declined primarily due to the following: product mix, deleverage, and increased promotions and discounts. These impacts were partially offset by lower commodity costs and positive geographic mix.
On a sequential basis, Tempur-Pedic gross margin increased to 51.7% from 50% as a result of decreased promotions and discounts as there were fewer floor models, decreased distribution costs, lower commodity costs, and favorable geographic mix. The total, including two weeks of Sealy results, the first quarter gross margin was 48.3%. There are two key points that investors will need to consider on the combined gross margin of the business going forward. One, Sealy traditionally operates at a lower gross margin than Tempur. Two, Sealy historically recorded freight in SG&A, while Tempur has recorded it in COGS. As a result, by conforming to Tempur's accounting, Sealy's historical gross margin would be lower. Excluding Sealy, Tempur-Pedic advertising spend in the first quarter decreased 22% to $36.6 million from last year's first quarter.
As a percentage of sales, advertising spend was 10.7% in the first quarter, compared with 12.3% in the first quarter last year. We plan to increase our level of advertising investment as the year progresses. Overall operating income was $44.3 million or 11.4% of sales, as compared to $86.1 million or 22.4% of sales in the first quarter of 2012. Operating income in the first quarter of 2013 included $16 million of transaction and integration costs related to the Sealy acquisition. Tempur-Pedic operating income was $47.2 million, while Sealy had an operating loss of $2.9 million, principally due to the acquisition-related inventory revaluation and transaction and integration charges. Interest expense was $27.9 million and included approximately $19.9 million of certain costs incurred related to the Sealy acquisition, as presented in the earnings release and the reconciliation of net income to adjusted net income. The tax rate was 17.1%.
The tax rate for this quarter reflects certain discrete tax items. The normalized tax rate for the quarter was 30.1%. We recorded earnings per share of $0.20 on a GAAP basis for the first quarter of 2013. Adjusted earnings per share was $0.62 in the first quarter. Next, I'll turn to the balance sheet and cash flow for a brief review. As shown on the balance sheet, the primary changes are related to the acquisition and related accounting treatment. For the Tempur business, our total cash cycle on a year-over-year basis improved six days, primarily related to improved payable terms. During the quarter, we generated $37 million of operating cash flow and capital expenditures were $5.6 million.
As it relates to our capital structure, the company's senior secured facility, consisting of its Term Loan A, Term Loan B and revolving credit facility and senior notes, were funded with the closing of the acquisition. In addition, with respect to Sealy's 8% senior secured Third lien convertible notes due 2016, $96.2 million remained outstanding as of March 31, 2013, which represents the fair value of the notes. Going forward, the Sealy 8% notes outstanding will accrete interest semiannually through maturity in July 2016, unless converted prior to that date. As a result, the company now has consolidated funded debt of $2 billion. The ratio of consolidated funded debt, less qualified cash to adjusted EBITDA, was 4.4 times, calculated on a combined basis for Tempur-Pedic and Sealy, in accordance with the company's new senior secured facility. A calculation of this ratio is included in the press release.
We plan to improve our capital structure in the near term by repricing and downsizing our Term Loan B debt. As a result of a portion of the Sealy convertible notes remaining outstanding, we need less debt under our new senior secured credit facility than our current structure has. We believe that this repricing will lower our estimated annual interest expense. The fees associated with the repricing will have a payback period of less than one year. As we indicated last October with our third quarter results, the transaction has provided us the opportunity to create a tax-efficient structure, whereby we will have the ability to utilize in excess of $1 billion of future foreign cash flow to be principally used to reduce debt. We would like to ensure that our long-term investors appropriately understand the long-term value of this.
Related to this, you will also recall in the third and fourth quarters, we incurred tax charges related to APB 23. With the closing of the transaction and new structure, certain adjustments were made, and we had a benefit in the first quarter that reduced the accrued tax expense. In the future, the company will no longer recognize APB 23 charges. Now I'd like to address guidance. The full year 2013 updated guidance issued today incorporates Sealy. To be clear, our guidance and related commentary reflects a full year of Tempur-Pedic results, but only Sealy results from March 18, 2013 through the end of the year. We currently expect net sales to be approximately $2.5 billion, adjusted EBITDA of approximately $435 million, and adjusted EPS of approximately $2.75, including purchase price allocation and tangible depreciation and amortization of $0.21 a share.
We expect PPA of $25 million on an annualized basis, with $19 million to be recognized during 2013. Due to our increased leverage associated with the Sealy acquisition and the importance of maintaining adequate cushion with respect to our financing covenants, we will have an increased focus on adjusted EBITDA while reducing our debt burden. We are also providing the following additional full-year 2013 guidance assumptions. Depreciation and amortization of approximately $97 million, with an annualized run rate of $108 million. Interest expense of approximately $89 million, excluding transaction-related charges, with an annualized run rate of approximately $107 million, which does not reflect any benefit from any proposed refinancing of loans under our new senior secured credit facility. The tax rate is expected to be approximately 32% for the full year, 32.5% on a go-forward basis.
Share count will be approximately 61.6 million shares for the year and 61.7 million shares on a go-forward basis. Capital expenditures are expected to be approximately $60 million. Given the lack of prior year comparisons, we are providing some color on the phasing from Sealy's prior fiscal year reporting calendar, as well as specific guidance for the second quarter in an effort to help investors. We do not typically provide quarterly guidance, but given the absence of comparative data, we determined it to be appropriate in this situation. Investors should not expect any future quarterly guidance. Sealy's fiscal year was approximately one month off a normal calendar year.
From a sales mix perspective, we expect that the shift of Sealy's business to a calendar year will increase their first and third quarters by approximately 70 to 90 basis points each and decrease Sealy's fourth quarter by approximately 150 basis points, with the second quarter essentially unchanged. In the second quarter of 2013, we are projecting net sales of approximately $670 million. This guidance implies 4%-5% growth for both Tempur and Sealy as compared to the calendar second quarter in 2012 and will be slightly down from first quarter sales had Sealy been included for the full quarter. We expect our gross margin to be approximately 41%. Our gross margin in the second quarter is being influenced by two fundamental items. First, Sealy has lower gross margins than Tempur, and incorporating Sealy into Tempur significantly lowers the overall gross margin.
We estimate that the inclusion of Sealy for the full second quarter alone will lower the overall margin by approximately 600 basis points. This includes the reclassification of Sealy's shipping and handling into COGS from SG&A, which on a comparative basis to Sealy's historic gross margins is a reduction. Record number of floor models being shipped in the second quarter for both Tempur and Sealy that will pressure not only gross margins, but also operating margins. As Mark indicated, we expect to ship nearly 70,000 combined Tempur and Sealy floor models in the second quarter. For the second half of the year, we would anticipate our gross margins to range from 43.5%-44%, as the bulk of the floor model shipments will be incurred in the second quarter. We expect our operating margin in the second quarter to be approximately 9.5%.
Our operating margin is being influenced by the lower gross margin, as just discussed, but also by higher sales and marketing costs to support the launch of the new products, as well as by increased stock compensation. Based on these factors, we are projecting second quarter adjusted EBITDA of approximately $90 million and adjusted EPS of $0.40. It is important to note that our 2013 adjusted EBITDA and adjusted EPS guidance does not factor in transaction and integration costs related to the acquisition of Sealy or interest expense costs on the financing transactions prior to the March 18th close. In considering our guidance, it is possible that our actual performance will vary depending on the success of our new initiatives, macroeconomic conditions, and competitive activities, or the consequence of other risk factors we have identified in our press release and SEC filings.
As noted in our press release, our guidance and these expectations are based on the 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 at this time, please press the star key and then the one key on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Again, to ask a question, please press star one. The first question comes from Brad Thomas from KeyBanc Capital Markets.
Thanks. Good afternoon, guys.
Hey, Brad.
Just a question on the guidance. I really appreciate all the details that you're providing on the call here today. I was hoping maybe you could kind of step back and talk about how you're thinking about the core Tempur-Pedic business compared to maybe the $255 estimate that you'd had before.
Right.
What you're looking for from Sealy. I think you said $15 million in cost synergies on top of that. Maybe if you could just address that'd be very helpful for us.
Brad, this is Dale. From a guidance standpoint, we essentially are maintaining our existing Tempur guidance. As Mark mentioned, the first quarter came in as we expected. With Tempur as a baseline, we are then adding an expectation for the Sealy business. Keep bearing in mind that we really only have Sealy for nine months this year. We're also then adjusting for the purchase price amortization, which this year will be a negative for us of about $19 million. Interest cost versus our prior guidance is $69 million higher. If you recall, our prior guidance was based on no transaction and no change in the credit agreement.
Now that the transaction is completed, the credit agreement is in place, when you include the deferred financing costs related to setting up the new credit agreement it will impact us versus our prior guidance of $20 million for Tempur by $69 million. Then we have a benefit of the synergies that Mark mentioned. Part of that synergy we're going to allow to fall through, and part of it we're going to actually invest more in the business.
Okay, great. If I could just ask then one follow-up on the North America business. I was hoping you could just talk a little bit about the competitive landscape within memory foam and how you expect that to change, for one, now that you are lapping the difficulty that you had last year and for two, now that you own the Optimum brand, which had been one of your bigger competitors.
Well, first of all, you're right. We're lapping the difficult quarters of second, third, fourth quarter of last year. As we said, we do anticipate that we will have growth this quarter and indeed for the rest of the year. The driver of that obviously is some of the new products that we introduced in the second half of last year, the advertising that we're going to start this quarter, and of course, the new products that I talked about that are going to drive growth in the second quarter to some extent, but largely in the third and fourth quarters. Then from the point of view of Optimum is clearly another important competitor in the memory foam market. Until literally March the 18th, obviously both companies were operating with business plans that were not coordinated at all.
As time goes forward, we'll look to see how we can best utilize both these brands. Both of them are going to be very important brands going forward.
Sounds great. Congratulations on closing the deal. I'll turn it over to somebody else.
Thank you.
The next question.
Thank you. Just wanted to clarify one number. The $0.40 guidance you talked about for the second quarter, that does include some of the purchase price allocation, is that correct?
Yes, we are including the purchase price allocation in our guidance. As I said, that's for this year, $19 million. It translates to, for the year, given the tax rate and share count assumptions, it translates to about a negative $0.21. On a quarterly basis, it'll be a $0.07 per quarter drag.
Thank you, Dale. The TEMPUR-Choice launch, is it moving as expected in terms of the rate? Is that product currently in any retailers right now?
The product hasn't yet shipped to retailers. It's about to ship next week, I believe. The demand for it has been, as I said, the floor models that we are projecting, the demand for it has been quite good. We have yet to sell any to consumers, so it's too early to tell, but the initial indications are good, and the demand from retail has been very positive.
I guess final question, as you look both within Sealy and Tempur-Pedic's business, has the pace changed in the last month or two versus what you had seen in the previous periods?
Forgive me, the pace of what?
Pace of sales. Has it improved on, say, the same?
Essentially, there's been no dramatic change. The industry has been weaker over the last period. It continues to be a choppy environment, but there's nothing fundamental that we've seen change.
Okay. Thank you.
The next question comes from David MacGregor from Longbow Research.
Hi, this is Joshua Borus standing in for David MacGregor. Thanks for taking my questions here. What does the guidance assume for advertising costs in the quarter? I think you mentioned how it'll accelerate, but could you say how it's going to play out over the year?
Sure. Keep in mind that on a go-forward basis versus the first quarter, now we're on a combined business basis. On a combined business, though, we are looking for advertising to, I'm having difficulty seeing these numbers, be about 12.5% on a quarterly basis. It may fluctuate up and down a little bit. For the full year, it would translate to about 11.6%, as we said, we are planning to, on the Tempur business, increase the rate of advertising spend. We said we would increase the rate of advertising spend as we started the year. We continue to believe that's what we want to do and need to do. The advertising spend for the Sealy business this year is up significantly versus what they did last year.
Okay, great. Thank you for that. Then on the European business, could you just state, especially in relation to guidance, what you expect there? I think you had mentioned mid-single digit growth was your expectation. Is that still the case? In addition, you called out Germany and France. Are there any other countries of either strength or weakness you can point to?
Well, the countries Germany and France are doing relatively well, which is, as you know, it's surprising because those countries overall are not doing that great. Spain and Italy are places where there's particular weakness.
Benelux.
Benelux. The southern countries plus we, this quarter, have had some issues with Benelux.
I would add that in our original guidance, we said we thought the international business would grow low to mid-single digits. We were up 2% in the first quarter with growth in Asia offsetting weakness in Europe. I would continue to expect something in the, at this stage, low single digits as opposed to mid-single digits.
Great. Just one related one to the international. Can you update us on the TEMPUR-Original collection overseas, the rollout, and what countries now that rollout has transpired and what countries are left?
I'm not sure exactly which ones are left. It's essentially rolling out across the country.
In the first quarter, it went through Northern Europe. It's hitting Southern Europe in the second quarter. Should hit Asia and the U.K. The U.K. is always towards the end due to a different regulatory environment. It should hit Asia and the U.K. in the third quarter.
I appreciate it. Thank you very much.
Again, ladies and gentlemen, if you would like to ask a question, please press the star key and then the one key on your touch-tone telephone. The next question comes from Jessica Schoen from Barclays.
Hi, good afternoon.
Good afternoon.
The guidance you mentioned for the rest of the year assumes a mid-single-digit revenue growth rate, I believe. I was wondering if you could tell us where that fits in the context of your expectations for the overall industry. Does it assume market share gains or does it assume a more in-line type of growth rate?
If you take the projections for the industry as a whole, given the weak start to the first quarter that the industry has reported, you would anticipate it based on our current run rates with some adjustments for the expectations of the new product. If you put that together, it says that basically we'll be growing at about the rate of the industry. Slightly more, but roughly in the same rate.
Okay, great. On the information you gave us about Sealy's first quarter and their 8.8% revenue increase, is there any color you can give us on different categories or regions as to how your business is trending?
Sure. The international business was up about 6%. Domestic in total was up about 9.5%. There was some benefit there from Comfort Revolution. That's the key.
Okay, great.
As I mentioned earlier, the drivers of the growth were the specialty line and Comfort Revolution.
Great. Thank you very much.
The next question comes from Chad Bolen from Raymond James.
Hey, good evening, Mark, Dale, and Mark. Let me add my congratulations on getting the Sealy deal done, thank you for taking my questions.
You're welcome. Thank you.
I guess maybe to piggyback a little bit on I think what Keith was asking earlier. I understand the tone of business for the industry has been a little sluggish so far this year, but could you address for us maybe the year-over-years in the domestic business through the quarter and maybe what you saw in April? I mean, did it get less bad? Did it turn positive? Sort of what was the cadence of business?
We're not going to go into the monthly splits out here. The word you said was right, which is that it has been a bit up and down, a bit choppy. From our experience, it was relatively meeting expectations. It continues to be still an uncertain environment, as you say.
Okay. Mark, you did kind of reaffirm the annual synergy target of $40 million. You did say you're pleased with the early results. They seem to be tracking a bit ahead for this year. You sort of seemed to hint at some opportunities or things that could develop from here now that you've had a little bit more of a look under the hood at Sealy. How do you feel about the opportunity to ultimately exceed that $40 million goal? Could you put any more specifics around how you're thinking about revenue opportunities?
Well, on the cost first. I think that the synergies that we have achieved so far are essentially ones that we had anticipated when we did our initial plan. It's not like we've found something that we didn't think about. We've been pleased about how quickly we can get them. They do seem to be coming in a little higher than we'd anticipated in the first period. We're genuine. It is quite good. It would imply that there may be more than the $40 million in the third year. We're looking at that. It's too early to change our position on that. It's certainly a better indicator than the alternative.
What we hope is that by the time we get to the meeting in September with the investor day, we'll take that opportunity to say whether or not it makes sense to change that $40 million target.
Okay.
On revenue. Yes, on revenue. Sorry. Clearly, revenue is important, but it'll take longer because obviously it'll take time for us to work together to do the things like building the distribution or building the new products as we work together, capitalizing on each other's international infrastructures and so on. Again, those things too, those synergies too, do appear to be as we had anticipated now that we've had a look under the hood. Again, they're going to take longer, but those two seem to be quite real and quite tangible.
Okay. Dale, I think you said the number for CapEx for this year was $60 million. Could you flesh out a little bit kind of what areas you plan to invest in? Should we expect maybe a stepped-up level of investments in the next year or two as you kind of integrate Sealy and longer term, what's maybe a normative CapEx level, and what does that mean for free cash flow? I guess a multi-part question for you. Sorry about that.
Yeah. No, that's great. Well, $60 million is roughly the amount that we expect from a go-forward basis for some period of time. I don't know if it's forever, the reason why I say it may not be forever is a component of that is we are putting some money into IT, and I think since the time we announced this deal, we said we'd need to put some more CapEx into IT. We want to get the businesses standardized on systems. That's not something, as you know, that you can do overnight. It takes multiple years. The good thing is Tempur has been in the process of standardizing on a new platform, and we'll incorporate Sealy into that process.
Beyond that, the other area that we had mentioned in terms of looking at Tempur is with a lot of the new products that we have been developing, particularly Choice, particularly the Premier Ergo, and the fact that we've taken that design capability and manufacturing ownership in-house. That leads to some production tooling around the electromechanical aspects of these products that we haven't been historically spending on. That's why we're expecting to spend a little bit more on CapEx than if you just add the two businesses together.
Great. Thanks guys for taking my questions. Best of luck to you.
Thank you.
The next question comes from Joe Altobello from Oppenheimer.
Hey, guys. Good afternoon. First question, I wanted to talk about the promotion environment. How would you guys characterize it today versus a year ago or even maybe last fall? It seems like we've got a little bit of an abatement of promotional activity. I'm curious if you think that's just a lull or is this sort of the new normal for the industry?
If anything, Joe, I would say it's slightly more promotional than it has been. Presidents' Day was a very promotional event. I certainly haven't seen anything that would tell me that the trend has changed, is what I'd say.
Yeah. You are, Joe, right now sitting kind of in the middle of a promotional lull just naturally in the calendar. The promotions tend to be around the major holidays. Last year, possibly in some of these lull periods, there was a little bit more promotional activity, not necessarily to the consumer though, as a lot of the new products were rolling out, but those tended to be retail-oriented promotions as opposed to consumer-oriented promotions.
Okay. It seemed like when discussing things with other retailers that the level of promotion activity had kind of subsided a little bit, but it sounds like that's not the case.
As I said, I haven't seen anything that definitively tells me that that's the case. People continue to promote around the holiday periods, and plans are that they will continue to do so. I haven't seen anything that's changed that fundamentally.
Okay. Secondly, in terms of the long-term outlook for this business, the combined Tempur Sealy, you guys have talked about the Tempur standalone long-term margins. I'm just curious if you're at this point capable of giving us what the long-term margins, gross and operating, are for the combined company at this point.
What we're going to do is, those longer term questions, obviously it's an important question, but it's a longer term question. First of all, I'd say that the positioning of Tempur as a premium mattress with a premium price at a higher AUSP and to fund both the investment in advertising and the investment in product R&D is going to continue. It's not as though there'll be some sort of changing of that strategy. The strength of Posturepedic and the other Sealy brands will also be leveraged. There's no plan to change that, change the basic way of going to market.
What that boils down to and what that's going to imply for a combined margin in the longer term, we're going to defer answering that until the investor day when we lay out the longer term plan and what our objectives are for top line growth and bottom line growth and the implied gross margins.
Okay, great. Thank you.
The next question comes from John Baugh from Stifel Nicolaus.
Good afternoon, Mark, Dale, and Mark. Quickly, just wanted to be clear on the advertising spend as a percentage of revenue. I guess maybe if we could just talk about it Tempur standalone and then maybe Sealy, because my understanding is their technical ad spend a lot lower than yours. I'm not sure how you're treating co-op. If you could discuss any of that, thanks.
Yeah, I think you're right, John. I think that it's one of those things that as you can imagine, we're putting together two different ways of recording all different aspects, and so there's a degree of apples and oranges here. If you talk about the Tempur spending, the Tempur spending in the first quarter is around.
10.-
10.
10.6.
10.6, we're projecting for the full year right now to be about 11. That may move a few tenths of a point as well. Sealy advertising is measured, they have it split differently than us. Their direct advertising, however, I'm not going to share the exact number with you, but it is going to be substantially up from last year. Last year was quite a high number, and their direct advertising is going to be substantially up from that. It's not at a 12.5% rate. That's what I'm trying to clarify. It's at a comparable rate to what they had last year in terms of absolute level, but it's going to be substantially-
More
more than that.
Sealy will switch out some co-op for direct, and the presumption is that .
Sorry, you're breaking up there. Say that again.
The presumption is that for Sealy, the total amount will be similar, but there will be more direct and less co-op. Then the presumption there is that the direct is working for them.
They do believe the direct is working. There will be more of it. How that's funded, whether it comes directly out of the co-op or not, that I'm not getting into right now. The fact is that their direct advertising, they're pleased with how it worked last year, and they intend to continue it and increase it this year.
Thanks for that clarity.
The next question comes from Peter Keith from Piper Jaffray.
Hi. Thanks for taking the question. I was wondering, Dale, actually if you could just comment on the Sealy business, which did see a nice revenue increase, but saw on an adjusted basis, the operating income decline $6 million. What were the kind of the puts and takes in that quarter that caused that decline?
Yeah. Well, selling and marketing was up specifically related to the advertising. Their national advertising was up significantly on a year-over-year basis, almost $5 million more than what they did the year before. That's part of what we're saying. The national advertising on Sealy is going to be up substantially this year compared to what they did last year.
Okay.
That was really the primary driver.
Okay. Thinking about this ad spend for Sealy continuing to pick up, then, I'm not sure if you said it in the script, but within the guidance, does it assume then that that Sealy business grows their EBIT year-on-year, or is it going to continue to decline a little bit because of the higher ad spend?
No, we would expect some growth from Sealy, both on the top line and some EBIT growth. Last year, I don't want to comment on their last year. It was a very different environment. We would look to see some improvement and EBIT for that business with expecting mid-single-digit growth for this year. We would expect to see some growth in EBIT, even with the increased advertising spend.
Okay. That's great to hear. One last just quick clarifying question for me then on the second quarter. I appreciate all the detail. The gross margin is a bit depressed.
Yep.
It sounds like the floor model's shipping out. Is it fair to say that's about a 250-300 basis point impact to gross margin in Q2 from that dynamic?
Yeah. The floor models is the driver of the gross margin pressure in the second quarter. There are some other factors. We are experiencing a little bit of negative geographic mix in the second quarter. From a standpoint, the international business, the second quarter is their weakest quarter. On a sequential basis, it's hard to do sequential when we had Sealy for two weeks. In terms of the overall look, we are seeing a little bit of pressure on the geographic mix. The floor models is the primary driver of gross margin pressure in the quarter. Like we said, we believe that the run rate gross margin will be on the combined business, 43.5%-44%. The second quarter, we're looking at a 41%. A couple of points there is heavily influenced by floor models in both businesses. The 70,000 is both businesses.
Sealy is rolling out the majority of their new Posturepedic line in the second quarter. Tempur-Pedic is rolling out the Choice and the TEMPUR-Cloud Luxe Breeze. For Tempur, really the biggest item is the TEMPUR-Ergo Premier. The Ergo never was a big driver for floor models before because it was so gradually introduced, and it grew in floor space over time. The TEMPUR-Ergo Premier is replacing all the Ergos out in the marketplace, all basically for the most part, in one quarter. That's a significant distribution effort and a significant floor model impactor. It's not something that happens on a regular basis, but it is something that is needed to happen and is a real negative driver in the second quarter on the Tempur business.
All right. I appreciate all the clarity. Good luck the coming quarter.
Thank you.
Thank you.
The next question comes from David MacGregor from Longbow Research.
Hi, Geoff Borsut again. Thanks for the follow-up here. Just a question on the Stearns & Foster Monogram, I'm not sure if this is a fair question since you've only had Sealy for a while, That was a product that was developed to go head-to-head with Tempur when Sealy was a standalone. I was just curious, one, if it's on the floor right now. I think you mentioned that it's going to be rolling out here in 2Q, wondering if it's out currently, and second, how you're positioning it considering that it does go head-to-head with Tempur.
It does have some distribution, It is rolling out right now, It's already in some distribution. As we said, though, first of all, we have been operating as two different companies right up until six weeks ago. On the other hand, I think another thing that's important is A very important point is that the reason that we acquired Sealy, one of very big component was the strength of their brands. The Stearns & Foster is a very good brand, It appeals to certain types of consumers, Its positioning as being a handmade, handcrafted product with a long heritage is very valuable. I think that as time goes by, as I said in my prepared comments, we're working right now on refining our long-term plan.
There's no question that all the brands will have a role to play. The question is going to be how we optimally leverage the brand positioning Technology and method of manufacture. There could well be some mixing and matching here. Yes, it was designed in a different world, Yes, whether we would have done it had we been working together, I don't know. The concept of premium Stearns & Foster brands using different technologies is not out of the question.
Great. Thank you very much.
Thank you.
The next question comes from Joan Storms from Wedbush.
Hi, Mark. Hi, Dale.
Hi, Joan.
Hi, Joan.
Hi. Previously, you had given us some guidance or thoughts on expansion of door potential both in the U.S. and overseas. I was wondering, with the thought that you would continue to open new doors over time, will you be providing any communication on that with regards to the overall company or to both Tempur and Sealy? It seems that Sealy might have broader penetration, just having a broader brand name and products out there.
Joan, we definitely intend, both in the U.S. and internationally, to grow distribution both for Tempur and for Sealy. In some places, there will be opportunities where Tempur has an infrastructure Sealy can leverage and vice versa. I anticipate going forward that what we will report will be the combined numbers. That is, again, something we haven't yet fully worked out, but we will continue to focus on it. It's going to be an important thing, but it will be a combined thing.
Okay, great. Thank you very much.
Ladies and gentlemen, that is all the time we have for questions today. I would now like to turn the call back over to the presenters for closing remarks.
Thank you very much. Thanks for joining us, everybody, today, and we look forward to talking to you again in July when we'll host our second quarter earnings conference call. Thanks a lot.
Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.