As a reminder, this conference call may be recorded. I would now like to turn the conference over to Mr.
Mark Group. Sir, you may begin.
Good evening, everyone. Thanks 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 and earnings, 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, competitive, operating and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings, including the company's annual report on Form 10 ks under the heading Special Note Regarding Forward Looking Statements and 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 a reconciliation of non GAAP financial measures to most directly comparable GAAP measures, is 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. As we previously communicated in early June, changes in the competitive environment in North America during the Q2 had an adverse effect on our performance. During the period, there was a marked increase in the number of premium competitive products on many of our leading retailers' floors, the majority of which were new offerings from our primary competitors who were supporting them with aggressive on air and in store marketing and incentives. As a result and contrary to what we had expected, we believe a material number of consumers who otherwise would have bought Tempur Pedic ended up buying a competitive product. Sales overall were down 4% and earnings per share were down 41%.
On a constant currency basis, North American sales decreased 8%, while international sales increased 17%. In a few moments, Dale will provide details of the Q2 results as well as discuss our outlook for 2012. But first, I'd like to briefly make some comments regarding the current situation. As I noted, there have been significant changes in the competitive environment for Tempur here in the U. S.
Over the last few months. Our strategic goal, however, is unchanged. We intend to be the world's favorite mattress and pillow company, and we are as committed to that as ever. The key to our success to date and what will continue to be the key going forward is our systematic introduction of innovation year after year. Our innovations grew our business, grew the specialty category, grew retailer average selling prices and most importantly, broadened the Tempur consumer base, by far the most satisfied owner group of any major brand.
Our innovations started with the original Tempur Pedic line based on our proprietary Tempur material that created the revolution that has resulted today in a world in which the majority of premium mattresses are non spring and no longer even considered specialty. We then invented Tempur HD technology that allowed us to create the Rhapsody Bed, a $3,500 product that for many years was our best selling product and today is still one of our best sellers. Just 3 years ago, we created the Tempur ES material, the core component of the cloud line, which today is our biggest product line and one of the biggest in the industry. And earlier this year, we introduced the Simplicity line, which is based on our new Tempur Essential material. From time to time over the years, competitors have introduced products that competed with Tempur, most recently a series of products using gel infused foam.
These gel products have had some success, primarily driven by their lower prices and effective install marketing. However, they use an existing technology and the one that has proven to be ineffective in its central claim that it purports to help consumers sleep cooler. Going forward, we will continue to work with retailers to provide unique and consumer valued products that allow them to improve their average retail selling prices and get a greater and greater number of consumers on Tempur Beds. In addition, we will work with to ensure that retailers' overall profitability is maximized by selling Tempur products. We have been implementing a series of initiatives that will become increasingly apparent to the investment community over the next few weeks.
They include: number 1, in Las Vegas next week, we will introduce a host of new products that are differentiated from what's currently offered in the category, proven to be preferred by consumers and that will raise average retail unit selling prices. And we won't stop there, though. Our pipeline of innovative new products is very robust, and you should expect to see a continuous stream of them coming to market in 2013 and thereafter. Number 2, a comprehensive review of our consumer and wholesale prices, our integrated advertising programs and all our other consumer programs customer programs that drive growth. We intend to ensure that all our retail customers have every incentive to sell Tempur products.
And number 3, a continuation of our commitment to consumer advertising, in store as well as on TV and new copy supporting our new products. Month by month, we will evaluate the effectiveness of these initiatives, and we will modify or change them as necessary. We are committed to returning to growth. And if in the short term this requires some reduction in our overall margins, we're prepared to accept that. For obvious competitive reasons, we will not be sharing specific details on these initiatives tonight.
We will, however, be unveiling several of them at next week's Industry Trade Show in Las Vegas. To be clear, though, and as Dale will also discuss, our financial outlook incorporates the initiatives I've just described. In closing, we know that people who sleep on Tempur sleep better than those who don't. And so we are going to continue to focus on returning to growth by pursuing the four elements of our strategy: making sure that there's a Tempur that appeals to everyone, making sure that everyone knows that they would sleep better on Tempur, make sure that Tempur is available to everybody, and make sure that we continue to deliver the best sleep. We are the leader in a large and growing category, and we have significant growth opportunities here in North America as well as overseas.
With that, I'll now hand the call over to Dale.
Thanks, Mark. I'll focus my commentary on the financials and our 2012 guidance. Let's begin with an overview. In total, 2nd quarter net sales were $329,000,000 a decrease of 4% over the same period last year. On a constant currency basis, net sales decreased 1%.
North American net sales were down 8% and international net sales increased 8%. On a constant currency basis, international net sales increased 17%. Now by channel, in North American retail, net sales were $206,000,000 a decrease of 9%. Our North American direct channel increased by 3% to $18,000,000 Internationally, retail sales were $82,000,000 up 14% and up 24% on a constant currency basis. By product, mattress sales were down 4%, while units increased 1%.
North American mattress sales decreased 8% on a 6% decrease in units. ASP declines were due primarily to the rollout of Simplicity floor models and promotions. In the International segment, mattress sales increased 11%, driven by a 15% unit increase. On a constant currency basis, international mattress sales were up 20%. Total pillow net sales decreased by 2% on a 1% decrease in units.
North American pillow sales decreased 10% on a unit decline of 9%. International pillow sales were up 5% on a 9% increase in units. On a constant currency basis, international pillow sales increased 12%. Sales of our other products, which include items that are normally sold along with the mattress, were down 5% in total and down 8% in North America, while up 4% internationally. On a constant currency basis, international other sales increased 13%.
Gross margin for the quarter was 50.7%, down 220 basis points year on year and down 2 90 basis points sequentially. On a year over year basis, On a year over year basis, gross margin declined primarily due to the following: increased promotions and discounts, deleverage and product mix. These impacts were partially offset by improved geographic mix. On a sequential basis, gross margin declined 2 90 basis points as a result of deleverage, increased promotions and discounts and higher commodity costs. Based on the lower than expected North American sales, coupled with the investments made during the quarter based on a plan that anticipate higher sales, we experienced significant operating expense deleverage.
We increased advertising spend by 28% to $46,000,000 or 13.9 percent of sales compared to $36,000,000 or 10.4 percent of sales in the Q2 of 2011. We also invested heavily in R and D during the Q2, which was up 48% year over year. It's also important to note that during the Q2, the company benefited from a favorable one time adjustment of $2,500,000 to the earn out payment related to a prior acquisition and a $1,600,000 favorable one time adjustment to long term incentive stock compensation. These items are reflected in G and A. Our 2nd quarter operating profit was $47,500,000 or 14.4 percent.
Interest expense was $4,200,000 The tax rate was 33.6 percent. EPS was $0.45 as compared to $0.76 per diluted share in the Q2 of 2011. Next, I'll turn to the balance sheet and cash flows for a brief review. Our accounts receivable balance was down reflecting sales levels. DSOs were down one day from last year.
Inventories were up $20,000,000 year on year or 23%, principally due to the lower than expected Q2 sales in North America. Payables were up 3 days due to timing. During the quarter, we generated $42,000,000 of operating cash flow and capital expenditures were $14,000,000 We increased debt by $117,000,000 to $682,000,000 Share repurchases during the period were 4,900,000 shares for a total cost of $138,000,000 Our remaining authorization under our existing share repurchase program is $100,000,000 Our cash balance remained flat at $134,000,000 Funded debt to EBITDA ratio was 1.85 times, near the high end of our targeted range of 1.5 to 2 times. We have evaluated this range and in light of the current business environment, we feel it is appropriate at this time. Now I'd like to address our updated financial guidance for 2012.
On June 6, 2012, the company revised its full year 2012 guidance. Today, the company maintained its outlook for full year 2012 net sales to be approximately $1,430,000,000 In addition, the company updated its full year 2012 earnings guidance and currently expects diluted earnings per share to be approximately $2.80 principally reflecting a lower weighted average shares outstanding for 2012. In light of the uncertainty in North American sales trends, our guidance assumes that sales for the 3rd and 4th quarters will each be approximately equal to the 2nd quarter North American sales adjusted for slight seasonality. We do not believe that our North American initiatives will have a significant impact until sometime in Q4 and their full impact will not be felt until early 2013. Our international business continues to perform quite well and we continue to expect double digit growth for the balance of the year.
And it is important to note that our guidance is based on recent trends, which can be volatile from week to week. Also, 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. The company currently projects gross margin for the full year to decline approximately 100 basis points year over year. However, in the Q3 as compared to the Q2, we're expecting gross margins to be relatively unchanged. The company currently projects operating margin for the full year to decline approximately 4.50 basis points year over year.
However, we expect improvement as the year progresses. In the 2nd quarter, our operating margin was 14.4%. We expect improvement in the 3rd quarter and ultimately get back to our Q1 2012 operating margin level by the Q4 of this year. In the Q3 as compared to the Q2, we are expecting operating margins to expand approximately 400 basis points due to realigning our cost structure. As Mark noted, our financial outlook includes an estimate for the cost impact of all of the new initiatives.
We currently anticipate interest expense for the full year to be approximately $17,000,000 We anticipate capital expenditures will be approximately $50,000,000 which includes the cost of our new office in Lexington. We continue to anticipate the full year tax rate to be approximately 32.7%. Given the reduction in our share count during the Q2, we're now expecting an average of 63,000,000 shares for the full year, with a current share count of 61,000,000. This share count does not assume any benefit from a potential further reduction in shares outstanding related to the company's repurchase program. As noted in our press release, our guidance and these expectations are based on information available at the time of the release and are subject to changing conditions, many of which are outside the company's control.
With that, operator, please open the line for questions.
Thank you. Our first question comes from Budd Bugatch from Raymond James.
Good evening, Mark. Dale and Mark, this is actually Chad Pinch hitting for Budd. A couple of questions. Dale, in your commentary regarding the forward guidance, can I just clarify, did you say 3Q gross margin would be relatively unchanged versus the prior quarter or was it the prior year? The prior quarter.
So, Q2, we were at 50.7%. We expect 3rd quarter to be about the same. Okay. And I guess maybe help me think through some of the puts and takes there because we know that 2Q was impacted by the simplicity floor samples. I would expect maybe commodities starting to head the right way.
Well, I guess what are some of the offsets? Well, as we think about 2Q to 3Q, obviously, we had a lot of simplicity floor models. As Mark mentioned, there'll be some new products introduced at Vegas next week. So we'll see a few of those. The bulk of those floor models probably would go out in 4Q, but there will be some floor models, but likely less than what we had in the Q2 with simplicity.
Commodities have oil has dropped. Our chemical prices have not changed dramatically, but at least the pressure that we were expecting earlier has eased. We have all the new programs that are going into place that are going to have some cost to the business. So there's a variety of puts and takes. We'll continue to get productivity.
We still have a very strong productivity program that we're driving. So we see a lot of puts and takes, but that's our best estimate at this time. Okay. And I guess, Mark, on the last call, you had made a comment referred to sort of the Cloud Supreme promotion as maybe not quite optimal. I would now that the promotion is wrapped up and you've had some time to evaluate it, could you share with us maybe a little bit about what you learned from that and maybe give us a sense of what we can expect from Tempur in the future with regard to the magnitude and cadence of price promotion?
I mean, I think that we learn from everything. We learn from every promotion that we do. And you know us well enough to know that we try to measure and evaluate everything we do. And this promotion was no different. I think if we look back on it, we had wanted to announce it very close to its period of introduction so that it couldn't be duplicated in the marketplace, which worked on one front.
But on the other hand, we realized made it difficult for retailers to implement it as effectively as we would have liked them to have done. On the other hand, the promotion did have some positive effect. We believe in net net, it did lift our business. And so we've learned from it. We will whether we'll ever repeat that exact promotion, I don't know.
But that we will continue to do promotions in this promotional environment, of course we will. So, we learn from it. Some things work better than others. We learn from it.
Okay. And Dale, you talked about ad spend in quarter. Can you give us a sense of what you're expecting or what you're assuming in your guidance for the full year? Yes. We'll see ad spending coming down as a percent of revenue in the back half of the year.
The 14% was well above, obviously, what we had intended to spend at the start of the year. But as you get into a quarter and midway through the quarter, plans change, it's hard to adjust advertising effectively. But we will dial advertising back some to a more historic level of what we have tended to run, which is in the little bit lower than that 14%, kind of in the low teens as the year goes on. We will continue to advertise strong in the 3rd quarter, a little bit lower run rate, but still, it's Labor Day is an important time. So we will still be doing a lot of advertising and a little bit less in the 4th quarter.
Okay. Well, thanks guys for taking my questions. Good luck to you. Thanks. Thank you.
Our next question comes from John Baugh from Stifel Nicolaus.
Good afternoon. Just a couple of quick things. First of all, Dale, you made a comment about 400 basis point increase in some line item, and I didn't understand which one it was due to realigning costs. Yes, the
400 basis point increase in operating margin. So from 2Q to 3Q. So we're at 14.4 percent in 2Q. We expect 3Q to be about 400 basis points better. Obviously, I also said gross margin rate would be about the same.
So what you'll see is improving cost around advertising, other marketing, G and A. So in the operating expenses, we'll see some improvement there. Great.
Okay. And then any color on simplicity? What's looking back on the launch now and where it's placed, rate of sale, any color around the product? Yes.
It is placed very broadly. It's essentially rolled out. And as we anticipated, we have gained significant slots from it. And as I said on the last call, our rate of sales of it are not as high as we would have liked, but they're within the band of what we had expected, albeit at the low end, as a proportion of our total sales. But all that said, it hasn't been a blockbuster that it might have been.
But we're very committed to simplicity. We believe it's an important product, and it's something that it's an area that we will continue to focus on.
And then on the international business, can you comment on how Europe performed in the context of everywhere else, I guess?
Well, the International business is up quite well, as Dale said. And it is across the board, but very much so in Europe, which, as you know, is our most important or our biggest single block overseas. And what is very good to see is that the reasons that we're up are those strategic things that we initiated a year ago, essentially, where we started to roll out the broader collection of products led by the cloud, but also invested in advertising in the major countries in Europe. And both those things are really paying dividends. So it's quite exciting to see what's happening in Europe from our business point of view because it's paying off according to what we had anticipated.
Now we are seeing, obviously, pockets. Of some countries which are being affected by the general malaise in Europe, and that is having an impact on our business, but overall not enough to bring down our overall performance. That said, and as Dale made the point in his comments, obviously we are watching the European macro environment carefully. We have assumed that there is no in our assumptions, there is no assumption of a fundamental change in the European macro environment. We assume that our trends continue as they are and that the macro environment continues essentially as it is.
Yes. I would just add there, John, the European macro environment has not been good for some time. And we've had pockets of strength and pockets of difficulty in various markets around Europe that hasn't fundamentally changed at this time. The European business is doing extremely well broadly, but there are some areas that have been weak and have been weak for several years. So unless there is a significant change in the overall trends in Europe, we feel comfortable there.
And I guess my last question, thanks for that color, would be back to the U. S, whether all of the competitive environment we've seen, has there been any change in cadence from any source in the last couple of months? Or is most of the damage that's been inflicted on your Q2 results of the result of things that happened earlier in the year?
The way that we one of the reasons that we're sticking with the style of guidance, just the point guidance, is because and the way that we are doing the projections using a relatively formulaic approach is because there is still a degree of uncertainty of lack of visibility in the environment. Now having so that's the first thing that we it's not perfectly clear. Our assumption is that the impact of the increased competitive environment is going to continue to affect us and impact us and probably grow as some of the rollouts continue. Having said and that we implicitly assume that the initiatives that we're taking are going to counteract that. So we don't what we're assuming is that the sales rate that we saw in the Q2 is going to continue in the 3rd and 4th adjusted for seasonality, which implicitly says that there will be continued and increased impact of the competitive environment offset by the initiatives that we're taking.
Great. Thank you. See you next week. Thank
you. Our next question comes from Keith Hughes from SunTrust.
Thank you. Mark, I want to get back to your prepared comments where you referred to a comprehensive review of wholesale and retail prices. Is that the results of that review, will we hear about that next week, will be rolled out over time? How will that look?
You'll hear about some of it next week. Some we it is what it is. It is what I said, which is a review of every aspect of our pricing strategy. But some of it you will see. Some of it is going to be something that will be between us and customers.
But it's some of it you'll see, some of it you won't.
Okay. And the promotion on the Cloud Supreme, will we see more individual mattress or individual product groupings promotion for limited periods of time? Is that what we're going to look at in the future? Or can you give us any color on that?
I can't because for competitive reasons, obviously. Part of our challenge is, obviously, we don't want to talk about promotions too far in advance. But as I said, we will what we're going to look at is evaluating promotions effectiveness. And as I said, we learn from everyone we do and we will continue to innovate in that front. We will do one of the things about like any good promotion is it needs to be newsworthy to the consumer and to the retailer, and we will continue to ensure that we will do that or optimize that.
Some will be so I can't really give you any characterization beyond that right now.
Final question you had referred you or Dale, I can't remember, had referred in the prepared comments about, I guess, sacrificing margin in the near term to get the growth back going in the company, would that imply the promotions would be for a short period of time and then go away? Or is this something that's going to be kind of a way of life that's ever been moving forward?
Well, first of all, we are saying and we are implying by the fact that the margins for the full year are going to be lower than they are for the last year. We are deliberately and for the second half, we're deliberately making a policy that we're going to strive to get growth, and that is going to implicitly require some investment. And furthermore, and I would reiterate this before I come to the promotion point specifically, that we are being very specific also that we are going to evaluate these initiatives as they go. And if they're working splendid, and if they're not, we'll change them. We're very committed to this.
But now when you talk about promotions, remember, A, we have been promoting for a long time. We've done different types of promotions for years now. And this is a very promotional industry, and it is something that drives what people call consumer activation. Consumers move on the belief that they have a promotion to act upon in a short period of time. So we anticipate that we will continue to do that.
Exactly the design of those promotions, how we implement them, how we implement them with customers, we're going to continue to evolve and innovate.
And my final question on inventory, Dale, will we have to ramp back production? Inventory was up substantially more than sales in the quarter. Well, we have rolled back production, and we started rolling back production in June. And we had to reduce some hours in the plants. We had to unfortunately lay some people off in the plants.
We will get our inventory back in the right levels. With a bunch of new products coming here in the 3rd quarter, It may not get completely corrected here in the Q3 as we're adding new products to the mix. But by the end of the year, we expect for inventories to be back into a reasonable level for our projected revenue. Okay. Thank you.
Thank you. Our next question comes from Jessica Schone from Barclays.
Hi, everyone. You mentioned the simplicity in the promotion impacts of your initiatives that you set forth in the Q1. I was wondering if you could talk about your integrated ad program with the dealers and the nationwide advertising heavy up and some of the impacts or lessons learned and takeaways you've seen from those.
The integrated advertising is part of the overall pricing and promotion programs that, as I said, we are reviewing. So that is in the bucket of things that we're reviewing. And we'll talk more about it in Vegas, but there will be some changes made to that. We've learned how to make that how we can make that even more effective. I don't want to talk about the specifics on the call right now.
In terms of the heavy up of advertising, clearly, it has the effect of we continue to see improvements in awareness and preference for Tempur. And we've just conducted an independent research which has just reconfirmed that for us. So we know that, that works. What we're very keen to make sure that happens also though is that we once the consumer goes to the store, that they have a good experience and end up coming in wanting to buy a tamper and end up buying 1. So we're making sure that we balance both sides of our investment, both getting the people to come to the store and then making sure that they buy when they're in the store.
But as Dale said, and as I said in my comments, advertising is a crucial part of our brand differentiation and we will continue to invest in it.
Okay. And then on the international, the context of the kind of underlying macro environment is very helpful. I was wondering if there's any other observations as far as how the overall mattress market industries are trending in some of those companies like sorry, some of those countries such as the popularity of specialty and other sort of industry dynamics?
Yes. Well, that varies by market, Jessica. That's the great thing about international is every market is different. The competitors are different in every market. In terms of specialty, in some markets, there's no such thing as spring.
Other markets are similar to the U. S. 5 years ago, still primarily spring. Other markets are at varying stages in between. So it's a very mixed bag.
Every market is different even within Europe. Two countries side by side will have a very different mix of products and technologies and competitors from just crossing a little border. The international business overall, first part of your question was about Europe, how the overall mattress market is doing. By and large, the mattress market in Europe has been flat to negative for several years. And we don't see that changing dramatically one direction or another.
Obviously, we're not seeing a surge of growth right now in the overall market in Europe, but we haven't seen a significant deterioration either. Now part of that is we're a smaller player. We're less in Europe. We're less penetrated in Europe than we are here. So we're able to gain share there a little bit easier because we're not as penetrated.
But we are gaining a lot of share in Europe in every market that we play in and having our strategy that we that we play in and having our strategy that we embarked on internationally and broadly Europe specifically in the last couple of years is paying a lot of dividends right now.
All right. Thank you. That's very helpful. Thanks for taking my question.
Thank you. Our next question comes from David MacGregor from Longbow Research.
Good morning, everyone. I guess I realize there's a limit to what you want to talk about in terms of specifics, given that most of your competitors are probably in on this call. But is there anything you can say at a higher level about your commitment to developing RSA advocacy for the brand? Maybe just start with that, if anything at all, please.
Well, that is a and it's clearly you're right on both counts. There's a limit to what we'll say, and RSA advocacy is a very important thing. You're right. I mean, I think that and we know that, and it's always been the case. And we have systematically been we've talked about it earlier in the year about wanting to make sure that retailer profitability is something we're focused on.
As we've been improving our cost structure, said more than once that it's important for us to make sure that retailers benefit from the improvements that we can make. And then obviously retailers have enormous influence on the advocacy of their RSAs by the way that they structure their commission programs as well as other things. So that is a very important part of it. But also the support that we provide to the RSAs in terms of training and frequency of calls are things that we're also investing in. But and there's no doubt that in our industry, it's a 2 there are 2 sides to this.
And we have the advantage of having the strength with the direct to the consumer, and we want to make sure that we also maintain the strength that we have with the advocacy of the RSAs.
Since our early June call, have you seen any let up in the levels of spiffing and kind of incentives from some of your competitors to these RSAs?
Well, it's I mean, it's no is the answer. But I mean but on the other hand, it's not a very precise science. A lot of our customers don't allow spiffing. So it is frequently used in some customers in some areas and not in others. And it is always it is an endemic thing in the industry.
And I haven't seen I mean, I don't have any information that tells me it's significantly better or worse. Okay.
And then finally, just with the pullback in advertising, how do we think about slot productivity in the second half? I wonder if you could just talk about the puts and takes there as you think about second half versus first half.
Slot productivity is obviously very important, and that is what we're focused on. And it's the balancing of all the aspects of the marketing mix that is important. And advertising, without doubt, is very important. And as we've said repeatedly, even though we'll be pulling back in terms of percentages, we'll still be spending at a very heavy level and a very significant level because it's the backbone of our brand. And every retailer will tell you that they love having the advertising because it really brings people into the store.
But at the same time, there are the other parts of the marketing mix, including in store marketing and including new product introductions and so forth and promotions. And the balancing of all those different things is what we always do and in particular now as we go forward with these new initiatives we're very focused on doing.
Thanks, Mark. Thank
you. Thank you.
Our next question comes from Brad Thomas from KeyBanc Capital Markets.
Thanks. Good afternoon and thanks for taking my question here. I wanted to just follow-up on one of your comments, Mark. You mentioned really the key is innovation. And as we've all alluded to in our questions, we know you can't really tell us exactly what you're going to do.
But can you help us just think a little bit more about how this company is going to operate over the foreseeable future? I mean, should we be expecting multiple bed launches per year versus what historically had been more like once a year or once every other year? I mean, how should we think about how you put that innovation into practice?
Well, obviously, I'm and I don't mean to sound silly, but I'm low to say things too specific because of the exact reason that you said. But the way we think about it is this, is that since the day that Tempur was introduced, we have been focused on improving the way that people sleep, that our long claim to fame is people who sleep on Tempur sleep better than those who don't. And we have really made this a backbone. And then, for example, when we introduced the cloud and it gave such a wide range of people a product that allowed them to sleep better, be better supported and so forth in a bed that was more comfortable that appealed to this, what type of comfort layer they like. And I think that the way we characterize what constitutes innovation is those improvements to or additions to our product line line that will allow a consumer to perceive an improvement over what they could buy in the marketplace before, what was available for them from a sleep surface.
And so as we think about innovation, what we think about is the constant search for ways to improve the way and quality of how people sleep and how their beds how they like their beds. And so what I hope you what I believe you'll see from us, what I know you'll see from us is innovation, but innovation that has value to a specific set of consumers and that does what it says it's going to do.
Great. And then to follow-up on that, you in your prepared remarks, Mark also talked about the claim of some of the gel manufacturers that their bed sleeps cooler, and I believe your website now has a study that says that Tempur Pedic beds sleep cooler than a gel bed. Does this are you in a position where you're therefore limited to not enter that arena of a bed that is that makes the claim that it will sleep cooler? Or is there an opportunity perhaps to address that market?
The pivotal thing that we have communicated on the website, we've communicated on TV, and we've communicated with all pretty much every RSA in the country is that the research that has been done by an independent party in Germany, very properly done, shows that not only do these gel beds not sleep cooler, that our beds actually sleep cooler than them. And I think it's a very important thing, and we will continue to make sure that we communicate that. From time to time, people have asked us whether we'll make a gel bed. And we wouldn't because if it doesn't work, why would we? But on the other hand, nothing precludes us from doing anything.
But right now, our key focus is on communicating the fact that on this very important thing, which seems to be in the ether, even though it is not a real issue, one of the I think you know this is that the heat complaints for sleeping hot is such a tiny, tiny percentage of people who actually own Tempur as to be almost negligible. But it is something that's in the ether and has been created to some extent by the focus perhaps of some of our competitors. It's been important that we just put the record straight on that.
Got you. Thanks so much and looking forward to seeing everybody next week.
You too.
Thank you. And our next question comes from Joe Altobello from Oppenheimer. Thanks. Good afternoon, guys. Just a few quick questions.
I guess first, in terms of
the new products you're going to launch or at least introduce next week, were those accelerated? Or was it your plan to always introduce them at Vegas in August?
We've said before that we had products in the pipeline, and obviously we did. And we don't decide until later in the year whether and when to launch products. And we did these products were ready to launch, but we decided to launch them now because the environment because, quite frankly, our business hasn't done well in the Q2. We want to start to turn the tide back to growth again.
Okay. So the original plan was probably for a January introduction?
I'm not getting into specifics, but yes, there was modification to the plan of what's the launch when. Okay.
Got you. And then in terms of the advertising, I just want to make sure that I've got this correct. I think earlier, Dale, you mentioned that you expect the advertising as plenty of sales to come down a little bit from QQ in the second half towards the low teens. And I think in the first half, you did about 13% of sales in terms of advertising, and it sounds like you're looking for another 13% in the second half. Is that correct?
No, I didn't say that. In the Q1, we did about 12%. In the Q2, it was 14%. I said in the back half, and it'll drop a little bit as the year goes on. It'd be more in the low teens.
Right, which is 13%.
Or lower.
Okay. And just lastly, in terms
of simplicity, you mentioned earlier that it was doing well, but it wasn't a blockbuster. Why do you think it wasn't a blockbuster?
Because at the time that we launched the product, a lot of other products were launched at the same price points from a lot of different people.
Okay. So it wasn't anything that was product specific. It was simply new entrants in the marketplace?
I think that was the primary cause. So, I mean, obviously, every product can be one can always think and we always do. We're always constantly looking at ways to evolve our products, and we've done it with any. And are things that we can learn that maybe could have been done differently. But the fact is the product was tested extremely well.
It is a very good product. The consumers who have it love it. The satisfaction rates are extremely high. Return rates are very low. It's a good product.
It's just that it arrived in the middle of a very large launch of products at the same sort of price point.
Okay, great. Thanks guys.
Thank you. Our next question comes from John Anderson from William Blair.
Good afternoon. Most of my questions have been asked at this point, but a couple here. First, Mark, when you talk about understandably talk about the investments that you plan to make to continue to drive growth, are these investments that the consumer will see in terms of pricing? Are they incentives between you and the retailer? I guess what I'm trying to get a sense for is you've kind of done a postmortem on some of the challenges more recently.
Is your sense this is a price sensitivity issue among consumers or more of a retailer advocacy issue?
There are parts of everything you said is part of the story. And it is not either one or the other. It's a bit of both as part of the answer. And as I said, you'll see some of it when you're in if you're in Vegas next week, and some of it won't be so apparent. But I can't go into specifics, but I will say it's a bit of everything.
Is it would it be fair to say and I know again you're not going to talk that much about the innovation at this point, but given I guess the move somewhat downstream with simplicity and it's come in, I would say, below the midpoint, at least, of your expectations. The innovation you're talking about going forward would be more focused what I would characterize as enhanced benefits versus lower price?
Yes. Although I would say that we're always yes, the short answer and the long answer is that we're always striving with all our products. The key importance of simplicity is to get people who otherwise would have bought an $800 bed to trade up by providing them with enough value and rationale to trade up that they would. So we always have that in mind. But yes, but the implicit in your question is yes, we're looking for increased value in terms of what the bed how the bed performs for
the consumer. Just a couple more quick ones. On Simplicity, how many slots did Simplicity, I guess, gain on average? And do you expect Simplicity to hold slots here, particularly in the face of the rollout of some new products in
the second half? Simplicity, the best data we have is always a bit suspect because it's but the best data we have and it's good data, it says that on average of the stores of the retailers that carry Simplicity, they carry approximately a little bit more than 2 slots each. So, A, we did gain and net net, our gain for the whole retailers was a little bit more than 1. So we and that's counting ones that didn't take on simplicity. So net net, it has been quite successful from that front.
As we go forward with the new products, you'll see also in Vegas that there's new products and there's other changes. We are anticipating, we're expecting, we're hoping to get increased slots as we go forward in the second half of the year, but we're also very focused on slot productivity. So we'll work with every retailer to make sure that they're maximizing their slot productivity. So, that could mean some changes. But in general, we're looking
for gains. Okay. Last one was just kind of housekeeping. Dale, I think you mentioned and I want to make sure I heard you right. In the Q2, there were 2 one timers that ended up about $4,000,000 or $0.06 per share.
Is that right? Yes, dollars 4,000,000 Yes. That was the $2,500,000 related to a earnout that is not going to happen and about 1.5% related to the long term incentive plan accrual rate. Okay. Thanks a lot guys.
Thank you.
Thank you. Our next question comes from Joshua Pollard from Goldman Sachs.
Hey, thanks for taking my questions. On the topic of sleeping cool, your competitors are advertising in the stores that they sleep cooler than you while you're educating on your website. That's a good thing. But I'm wondering, does it not make more sense to make an even cooler bed? Is that something that you guys can do?
And does that is that something that you guys think is worth focusing on from a product standpoint?
Josh, we're not going to talk about new products until we launch them. So, I honestly I'm not speculating on that or any other type of new product for the obvious competitive reasons that you're very, obviously you're very, very close to.
Okay. Sounds good. On your initiatives, can you talk about a couple of things? Number 1, how much should we see in cost out as a result of those? And I know you said your guidance includes them, but if it's not touching on any competitive issues, how much you guys are actually spending on it?
And I was a little surprised. I was expecting some of your initiatives to be focused on your cost of manufacturing. And I was wondering if you could talk about what you guys are doing on your cost of manufacturing and whether or not it's cheaper to buy foam than it is for you to manufacture it?
Josh, this is Dale. Number 1, on the cost impact of the initiatives, it's included in the guidance. We're not going to break out how much we put in there related to the enhanced initiatives, new products, etcetera. In terms of cost of manufacturing, that's a continuous program. That's what we've been working on for 4 years now is continually improving our cost of not only manufacturing, but sourcing and distributing our products, that's the productivity programs.
We continue to get significant benefit. We believe that we have outstanding cost structure from an overall manufacturing capability standpoint, you can't buy our material from somebody else. And somebody else wouldn't be able to make our material. So by being vertically integrated, we're able to develop and produce the highest quality material in the world and do so very efficiently.
Okay. A couple of quick ones. Your margins by region, both on the gross and the on the operating side?
Yes. You'll see it in the Q in about a week.
Okay. The run rate on the LTIC in 1Q versus what you guys are expecting for the rest of the year?
I'm not sure what you're talking about, Josh.
Your long term incentive comp plan, you said that you had a bit of a reversal there in the Q2. And so from a modeling perspective, I'm trying to understand what it was in 1Q. I know that 2Q will look a little funky because of the reversal, but ultimately trying to see what you guys will be what would the impact be for long term?
The drive at Josh is what's G and A going to look like. So on the second quarter we had essentially $32,000,000 of G and A, but we had as I mentioned 2 one offs that contributed that impacted that by about $4,000,000 The G and A run rate in the balance of the year will be very similar to what it was in the Q2 without the one offs.
Okay. That's clear. And then my last question was just on your debt balance. I saw it went up from $5.65 to closer to 6.81 Obviously, I'm assuming that you guys tapped your revolver for your share repurchases. I'm wondering should we think about the cadence of share repurchases from here as coming out of cash, coming out of new cash flow?
Or are you guys willing to put a little bit more debt on the balance sheet?
Well, our revolver facility is a $770,000,000 facility. But as I said earlier, we have a debt to EBITDA target range, which is we've talked about for quite some time, 1.5 to 2 times. We reevaluate that on a regular basis. We did look at that again. We continue to feel very comfortable with that range.
Part of the reason for that range is to allow for potential disruptions to the business and still be very comfortable. And so sitting here today, we're comfortable with that range. We're at the higher end of that range right now. We will continue periodically to evaluate that range and assess if we want to or need to change it.
Okay. And the cadence of buybacks or let me just ask it this way. The amount of cash that you guys want to have on the balance sheet, what is that level?
We don't have a target to in terms of cash on the balance sheet. I think the thing that you need to understand is most of the cash, not all, but most of the cash on the balance sheet is in our international operations.
Okay, great. Thanks very much, Dale, guys. I appreciate it.
Thank you.
Thank you. The next question comes from Peter Keith from Piper Jaffray.
Hey, good afternoon, everyone. Just want to clarify a comment that was made earlier. It sounds like week you're going to talk at the conference about how you've reviewed your pricing strategy. Does that involve both a combination of cutting the retail price out to consumers and cutting the price to retailers to offer a better margin? Is it going to be a
combination of those 2? As I said, everything has been considered. And some of it so, as we've evaluated, we've looked at every part of it. And at next week's conference, some of it will become apparent, but not all. So, I can't really go into any more details other than to say all elements like both of what you've said have been considered and evaluated.
Okay. We'll look for that next week. And then just lastly, there's been some chatter out there in the channel that the Cloud Supreme promo may have cannibalized the upper end of your product range. Did you notice any deterioration in Rhapsody or any of your other more higher priced beds as the quarter progressed?
We heard the similar chatter, and it could be different customer to customer. But as we've looked at our aggregate data and we look at it by the various price slices, 1 to 2, 2 to 3 and 3 to 4, 3 and above. And we saw that, obviously, as the promotion was running, the Cloud Supreme well, first thing is, as the promotion was running, it seemed to lift our overall trend to some extent, although it's hard to discern with a difficult trend like we've got, but it seemed to be overall positive. But secondly, that the decline in other products was sort of essentially similar and that the above 3,000 or the Rhapsody type was no more effective than any other.
Okay. Thank you very much.
Thank you.
Thank you. And our next question comes from Eric Halawadi from Stephens Inc.
Hey, Dale and Mark. I realize we're going to get more information on the new products that you'll be launching next week. But in the meantime, in light of the fact that your most significant recent product launch in the form of Simplicity hasn't or I should say, has performed at the lower end of your expectations. What additional comfort, if any, can you give investors in the meantime that the new products that you're introducing to reinvigorate sales growth will be successful in getting the top line back on track?
Well, one can never be 100% sure of anything. That's why that's obviously. But what I a couple of things, though, is I think that if you look at our track record over the years, we've had quite a few that have worked. And as you said, simplicity is not a blockbuster, but simplicity is at the lower end of the range of our expectations. So it has done good for us.
But I would say also that we continue to invest time and money and energy into research of every product that we do with consumers. And I think one of the really strong conclusions one might draw is that if the research that was done on simplicity pointed to it being a much bigger hit than it turned out to be, then therefore research is wrong. That's a very bad conclusion and not one that we come to. We recognize that what is always we are always trying to improve the effectiveness and the quality of our research, but the concept of making products that consumers prefer and knowing that they do prefer them because you've tested it with them is the backbone of our business model, and it will continue to be so. So we are this is what has driven us on every major product we've introduced, and it pays dividends.
So we can't claim to be the best 1,000 percent, but we're believers in the fact that what will eventually drive growth is going to what always drives growth in the end is providing consumers something that they value and that they can't get elsewhere.
Great. Thanks, Mark. Look forward to seeing you next week.
Thank you. Our next question comes from Robert Schatz from Guilford Securities. Good afternoon, gentlemen.
Hi, Robert.
Just a few questions. And the first, I do want to ask about the Simplicity line and perhaps I missed it on the call, but what have you learned from the sales that you have achieved? I mean, you have said that Simplicity ended up at the lower end of your original expectations, but it sounds like it still did okay, not blockbuster, but still did okay. What did you learn from your retailers for the customers who are currently buying that product? We've
learned that for some of our customers it's been really quite successful. It has been really quite a hit for customers and not insignificant ones. I'm not going to talk specifics. But for some, it has been quite good. And they're finding that it does just what we said, which is lifting up people from what would otherwise have spent 800 dollars to $1,000 on a mattress to go up to $1500
Is your sense that the majority of those sales to date is in fact moving that customer base who would look at an $800 mattress up to that level rather than cannibalize any of your other products? Is that your experience so far?
Yeah. Again, data is never perfect on this, but we have obviously planned we had obviously planned a degree of cannibalization from Simplicity. And it's hard to detect given that the trend levels that we have across the board are difficult. But our best estimate standing here today is that the cannibalization of Symplicity, if anything, has been less than we anticipated.
Okay, good. And then could you just remind me where you are in the rollout of that product line?
We're essentially finished. I mean, there's still some more to go, but to all intents, for planning purposes, we're essentially rolled out.
Okay. I'd like to turn to the international opportunity that you have. First, I'd like to hear some additional comments regarding the trends in Asia. And then secondly, regarding Europe, I'd like to get a better understanding. Overall, your business in Europe sounds like it's doing quite well compared to what the macro environment is.
In those areas of softness in Europe, is that following suit with the macro trend there that is as we would all expect Greece, Italy, Spain to be weak but the northern countries to be doing better? I'm just curious about that.
On Asia, Asia is a very broad term for obviously, and we have businesses in several parts of Asia, but the big ones are Japan, Australia and a growing business in China and a small but growing business in China. Japan and Australia are very different. They're both doing quite well. And China remains small. We have several other smaller countries.
But overall, our Asian business is doing quite well. From a European point of view, you're right that the places that we're seeing the weakness are I'm not going to give you specifics, but are the countries that you would expect. And as Dale said a little earlier, this is not something that's just happened in the last few months. This has been going on for some time. Those weaker countries have been weak for some time.
And where we're seeing the greatest strength is, again, in the ones that you would expect, those central, developed European countries, which have the largest countries which we've been in for the longest time.
Great. And just a final question. In my travels, I've come across what I think is a new initiative by you and that is Tempur Pedic corporate retail stores. I've identified 2 so far. And I was wondering if you were willing to make any comments about that strategy.
Tell me where the other one is, I'd love to know. But as far as I know, there's only 1, and that's just opened up in Boston, which is a flagship store. And what these are is they're brand building. They're part of our advertising. The idea is that we will open stores in a small number of select areas where we can really give consumers who tend to gather in places where there are a lot of people, like malls, to get people to come and try the Tempur experience.
And the idea is to build awareness of the brand and give people the opportunity to try it. And the expectation is that it will lift sales in the area that surrounds it. In fact, we've done that in several countries around the world and we have found that it has worked quite well.
How many of those stores do you plan and or are you planning? And then secondly, is the mall strategy here specifically because maybe your research or your own internal thought process is that you perhaps are missing some of your customer opportunity with that mall traffic?
It's really a marketing thing. It really is. One of the things that we've known, for example, when some of our customers have stands in county fairs or state fairs, where you get a lot of people, people like to come and try Tempur. And so, one of the things that we're as I said, it's a marketing thing. It's part of building our brand.
The stores can be quite an experience. They can be fun. They can be something that people enjoy and do almost as a recreation to come and try the different types of Tempur beds. And what we think it'll do is a bit like the Nike store or the Apple store. It's build awareness of the brand over and above just being a marketing tool I mean a selling tool.
So it's a very small experiment. As I said, we do it in different countries around the world. And in all countries, it's a relatively small thing. But in all countries, it does seem to work.
Okay. Thank you very much and good luck.
Thanks very much indeed.
Thank you. This does conclude our question and answer session portion for today. I would like to hand the conference back over for any closing remarks.
Thank you. We look forward to talking to everybody again in October when we host the Q3 earnings conference call. Thanks for joining us this evening.