Tempur Sealy International Inc (TPX) 2005 Q2 法說會逐字稿

Welcome to the Tempur-Pedic second quarter conference call.

At this time all participants are in a listen only mode.

Following management's prepared remarks, we will hold a Q&A session.

To ask a question, please press star followed by one on your touch-tone phone.

If anyone has difficult the hearing the conference, please press star zero for operator assistance.

As a reminder, this conference is being recorded, July 21st, 2005.

I would now like to turn the conference over to Harriet Fried of LHA.

Please go ahead ma'am.

Good afternoon and thank you for joining us on today's conference call.

We will begin with prepared statements from Bob Trussell, Chief Executive Officer, Tom Bryant, President, and Dale Williams, Chief Financial Officer.

After those remarks, we will open the call for questions.

We will conclude today's Q&A session at six o'clock Eastern time, and ask that participants limit themselves to one or two questions each.

Please note that any statements made by Tempur-Pedic International during this call that are forward-looking are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Investors are cautioned that forward-looking statements involve risks and uncertainties and that actual results may differ due to a variety of factors that could adversely affect the Company's business and prospects, including economic, competitive, operating and other factors discussed in the Company's filings with the SEC.

Any forward-looking statements speak only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement.

In addition, I'd like to note that some of management's comments made reference non-GAAP financial measures.

A reference to the most directly comparable GAAP financial measure and other associated disclosures is contained in this afternoon's earnings release, which is posted on the Company's Website, and has been furnished to the SEC on form 8-K.

With that, I'll turn the call over to Bob Trussell.

Please go ahead Bob.

Thanks for joining us on our call today.

As the press release we issued this afternoon indicates, Tempur-Pedic International had an excellent quarter in what is traditionally a seasonally slow period for the retail furniture industry, as consumers turn their focus to outdoor products and pastimes.

Through the quarter our Company's net sales increased 27% to 192.6 million.

GAAP net income rose 47%, 24.8 million, or $0.24 per diluted share, while pro forma net income rose 58%, to 25.5 million, or $0.25 per diluted share.

These are strong results, and we think they illustrate how successful we've been in truly changing the way the world sleeps.

Our superior product, powerful distribution model, and comprehensive advertising campaign are all helping us build market share and continue to firmly established Tempur-Pedic as a major player in the bedding industry.

At the midpoint of the year we are right where we thought we would be and we are extremely confident about the growth prospects for our products going forward.

At this point, I'd like to ask our President, Tom Bryant, to go through our results in more detail and update you on other highlights of the quarter.

Thanks Bob.

As indicated in this afternoon's press release, our strong results were driven in great part by the continued successful expansion of our retail channel and consumer's enthusiastic response to outgrowing line of premium mattresses, which offer more comfort and better sleep.

Since the continued expansion of our distribution channels is such an important part of Tempur-Pedic's business strategy, lets start our review of the second quarter by sales channel.

During the quarter, sales in our retail channels overall rose by 35%.

This reflects our emphasis and continued success in penetrating furniture and specialty stores, a place most consumers go to purchase the mattresses.

Our growth was especially robust in the U.S., where retail sales increased 42%, led by furniture retail at 51%.

Internationally, they rose by 24%.

As a side note, our products are sold more and more through the furniture retail channel.

So it's not surprising that, as Bob mentioned earlier, seasonality in the retail furniture industry is becoming more noticeable in our business.

We have predicted this for some time.

Our increase in retail sales is an outgrowth of two primary factors.

First, it reflects the fact that we substantially increased the number of furniture retail stores in which we sell our products.

In fact, we added a net of approximately 400 new stores in the U.S., well above our target number of 80 to 90 per month.

Internationally, we added approximately 180 stores, also ahead of our target of 30 to 40 per month.

As of the end of June, our products were offered in approximately 4830 furniture and bedding stores and 1500 specialty stores domestically.

Internationally, our products were offered in approximately 3650 stores.

A second factor is the strong growth we generated in our established accounts, which are sales to accounts the Company has opened for at least 12 months.

As you know, Tempur-Pedic is not itself a retailer, and therefore, it's not able to track directly same-store sales.

However, we do monitor our sales in the U.S. furniture retail market by accounts.

These accounts can range from mom-and-pop stores with one or two doors, to a large chain with more than 200 stores.

As you will recall, our goals this year for the U.S. established accounts growth at 30 to 35 percent.

Outperformance in the second quarter and year-to-date makes us very confident in this goal.

During the quarter we also continued to expand our retail trainer and sales forces, which means more attention and better support for our established accounts.

You may recall that in our first quarter conference call we mentioned that we saw especially strong sales through last quarter as some retailers bought ahead on our February first price increases and ran special beat the price increase promotion.

At the time we estimated that our first quarter volume benefited from this onetime promotion by approximately 10 to 12 million.

We also said that it would take some time to determine if the retailers' action resulted in business being pulled forward from the second quarter.

Looking at the way our order intake developed in the second quarter we do believe that forward buying by retailers in Q1 impacted Q2 sales by approximately seven million.

Our direct sales channels grew in line with our expectations in the second quarter, with total sales increasing almost 15%.

Most of this increase came from the U.S., and was aided by the unique advertising campaign we'd undertaken to help build our brand-name recognition in the marketplace.

This campaign would generate over 3.6 billion consumer impressions per month has been very effective.

In fact, in the U.S. it's enabled our aided brand awareness to increase 60% in 2003 to 71% in 2004.

Our international direct sales business was up marginally for the quarter, reflecting progress in the UK.

Sales from our health-care channel were also up slightly as we continued to rationalize our selling and promotional programs and improve and innovate in the way we do business.

We are continuing to develop a new strategic plan for our Tempur-Pedic medical division that would help us capitalize on the many opportunities that exist to expand distribution in the U.S. health-care market.

Finally, consolidated sales from our third party distribution channel were essentially flat to last years second quarter.

Performance in U.S. was strong, as was performance in most of our international markets, offset by a strategic pullback in certain markets.

I'll discuss the reason for this trend in just a minute.

Now let's talk from moment about our sales by products.

As you can see from the breakdown included in our press release, our mattress sales grew very significantly, as they did in the first quarter of 2005 and throughout 2004.

In both the U.S. and internationally sales increased approximately 40%, driven primarily by strong unit sales growth.

Year-to-date, our mattress sales were up 53%.

Demand in U.S. for our higher priced Celebrity and Deluxe mattresses remained strong.

In fact, together these two premium priced products accounted for nearly 67% of our domestic mattress sales.

Turning to pillows, sales of these products grew nicely in U.S., increasing by 14%, but this was more than offset by a decline in our international sales.

As we explained in last quarter's call, we recently assessed this part of our business and implemented some strategic changes in our international third party business, taking steps to grow company-owned distribution operations in certain markets.

Although, as we predicted, these steps are having a short-term negative impact on our results, in the long run we believe this strategy will protect our product and our brand positioning and will be very positive for our business.

Finally, sales of other products, which include a diverse group of products, such as foundation, adjustable bed, rose by 28% during the quarter, performing well both in U.S. and internationally.

At this point I'd like to give you an update on some of the operational goals we have set for the quarter.

In U.S. we recently began shipping the EuroBed by Tempur-Pedic, and have been getting an outstanding reception from retailers.

We are expecting to get more exposure for the EuroBed at the new Las Vegas tradeshow next week.

This is the first year for Las Vegas show, and as a result the industries or less attendance at the High Point Show last April.

Consequently, at the high end of our product line we are going to focus our attention on the EuroBed next week.

We have continued to grow our investment in R&D and new product development, and have been testing a number of new mattress concepts at a variety of price points.

As a result of significant advances in our proprietary manufacturing process, we are very pleased to be able to introduce a new lower-priced entry-level mattress offering, while maintaining our established product margin rates.

We will launch this product, which we have named The Original by Tempur-Pedic at the Las Vegas show next week, with a suggested retail price of 1199 for a queen.

We believe this addition to our line will enable us to attract a broader universal consumer to our premium offering and also will leave consumers with little reason to consider lower quality imitators.

The launch of our futon products in Japan, which is foldable, lightweight, and storable, is proceeding according to schedule.

You may recall that in the first quarter we delivered futons to the country's largest department stores, where our sales reps have been introducing customers to the features and benefits of this new product.

In the second quarter we began phase two of our product launch, shipping to bedding and futon stores throughout the country.

Today, the reaction by Japanese consumers has been very positive and we are on track with our plans for the introduction.

Another positive development during the quarter was the ease of use commendation we received from the Arthritis Foundation for three of Tempur-Pedic's mattresses and our adjustable base.

Under the Arthritis Foundation's program, patients evaluate the accessibility and ease of use of products.

We are especially proud that our mattresses were the first to be recognized as helping provide comfortable night's sleep for arthritis sufferers.

We believe this testifies to the support and relief from pressure our proprietary Tempur material offers.

Finally, I want to mention that our new manufacturing facility in Albuquerque New Mexico, which will help us meet our growing demand in North America, has been proceeding on budget and on schedule.

We continue to expect the initial capacity to come online in the second quarter of next year.

At this time, we will no longer need to import mattresses from Europe, which will have a positive effect on our gross margins.

At the moment, we continue to import key mattress models from Europe to satisfy demand in U.S.

I'll now turn the call over to our Chief Financial Officer, Dale Williams, to discuss our financial results in more detail.

Dale?

Thanks Tom.

Let's first talk about our sales performance for the quarter.

As Bob mentioned earlier, for the three months ended June 30th 2005, the Company achieves net sales of $192.6 million, compared to $151.6 million for the same period last year.

This represents an increase of $41 million, or 27%.

For the first half, our sales were $415 million, up 36% over 2004.

We experienced strong growth in both our domestic and international businesses as we continued to execute on our core worldwide strategy, penetrating existing channels and investing to build our global brand awareness.

Domestic net sales grew to $124.1 million in the second quarter, as compared to $91.7 million for the same period in 2004, an increase of $32.4 million or 35%.

Domestic sales accounted for 64% of our total net sales as compared to 60% in last year's second quarter.

International net sales grew to $68.5 million in the second quarter, as compared to 59.9 million for 2004, an increase of $8.6 million or 14%.

Our growth in net sales was attributable primarily to an increase in the U.S. retail channel of $28.6 million, and a $9 million growth in the international retail channel.

As Tom mentioned earlier, at the time of our first quarter release we were unable to determine if there would be any carryover impact on the second quarter from the activities around the first quarter price increase.

We've now estimated that approximately $7 million of business pulled into the first quarter, which negatively affected in the second quarter.

In addition, the U.S. dollar strengthened significantly during the second quarter.

If exchange rates had been the same in the second quarter as they were in first quarter 2005 revenue would have been approximately $3 million higher.

Therefore, on a normalized basis our first quarter to second quarter revenue change could have been within the 4 to 5% decline that is the seasonal norm for the retail furniture industry.

Due to the price increase effect, we believe the best way to value our performance for 2005 is to look at the results for the first half of the year.

Regarding profitability, as noted in the press release for the three months ended June 30th 2005, GAAP operating income was $44.6 million compared to $33 million for the same period in 2004, growth of $11.6 million or 35%.

Excluding stock based compensation expense of $0.7 million, as previously disclosed, our pro forma operating income was $45.3 million or 24% of sales in the second quarter, an increase of 31%.

Growth in profitability for the business was principally driven by the increase gross profit of $17.7 million on higher net sales.

Gross profit for the quarter was 51.1%.

Gross profit rate decreased from 53.3% in the prior year.

As we discussed in the first quarter call, due to our exceptional U.S. growth we have been importing key mattress models into the U.S. from Europe to supplement strong demand, just as we did in 2003, utilizing the capacity we added in Europe in the fourth quarter of 2004.

In the second quarter, we used the imports to build inventory in key mattress models in preparation for our historically stronger second half of the year.

We incurred incremental shipping costs on these products and this will continue until additional capacity comes online in the U.S. at our new manufacturing facility in the second quarter of 2006.

Other factors that contributed to the gross margin pressure include channel and product mix.

Retail, our fastest-growing channel, has lower margins because we sell at wholesale prices, decreased, as Tom discussed, and pillows sales internationally, which carry a higher margin than mattresses, impacted our margins in the second quarter.

In addition, our other products like frames and adjustable beds, items that we often sell along with mattresses, carry lower margins but continue to grow as a percent of our overall business.

We continue to expect some impact on margins for the rest of the year due to the overall shift in product mix toward mattresses and other products, and in channel mix toward retail.

Operating expenses for the second quarter of 2005 decreased relative to the second quarter of 2004 as the revenue growth continued to provide leverage in excess of our ongoing investment in the business.

We substantially improve our operating leverage on a year over year basis with respect to both selling expenses and G&A.

Our net sales growth substantially outpaced our growth in the selling infrastructure.

It's important to note however that our advertising as a percentage of sales was slightly higher than last year, at 10.6% of sales in 2005 versus 10.3% of sales in 2004.

This shows our intent to continue to invest in the growth of our brand and consumer awareness of our product.

A significant improvement in G&A leverage was primarily driven by the reduction in expenses associated with Sarbanes Oxley 404 compliance, non-cash stock based compensation expenses compared to 2004.

GAAP net income for the three months ended June 30th 2005 was $24.8 million compared to $16.9 million for the same period in 2004.

Pro forma net income was $25.5 million or $0.25 per fully diluted share, compared with a $10.4 million or $0.18 per fully diluted share, representing a growth in pro forma net income of $7.1 million or 38%, and 39% growth in EPS.

Pro forma net income excludes the previously disclosed stock based compensation expense.

Fully diluted share account was 103.4 million shares in the second quarter of 2005, compared with 103.1 million shares in 2004.

In addition to the operating results of the business, I want to provide a few key balance sheet metrics.

Our total outstanding debt as of June 30th 2005 was $292.6 million, an increase of $2.9 million from December 31st 2004.

The increase in debt in the quarter related to the construction financing for the Albuquerque factory.

Net debt, as of June 30th 2005, was $264.4 million.

Cash on hand, as of June 30th 2005, was $28.2 million.

The Company continues to evaluate the possibility of utilizing the provisions of the American Jobs Creation Act of 2004, in order to repatriate foreign earnings and profits which would enable us to better balance our capital structure between the U.S. business and the international business.

We expect to reach a conclusion on this evaluation in the third quarter.

Net accounts receivable grew $2.9 million to $96.7 million.

Inventory grew $15.4 million to $81.6 million, as we increased our inventory due to the longer lead time required to bring in product from Europe.

Accounts payable decreased $4.3 million to $30.5 million.

Second quarter depreciation and amortization costs were $6.8 million, and capital expenditures for the quarter were $30 million, of which $26.8 million related to the construction of our Albuquerque New Mexico facility.

Regarding guidance.

In reviewing our guidance the company took into consideration many factors that could have a significant effect on the Company's performance in 2005, including the following - emerging seasonality of the business, our actions related to third party business mix in major, the strengthening of the U.S. dollar, and our expectations that our new mattress products will not represent a significant portion of our sales for the remainder of the year.

We are concerning the full year guidance that we provided on April 21st of 2005.

We continue to expect net sales for 2005 to range from $880 million to $890 million.

We expect pro forma diluted net income per share to range between $1.10 to $1.13.

We also expect GAAP diluted earnings per share to range between $1.08 to $1.11.

As noted in our press release, 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.

This concludes our prepared remarks and at this point, operator, we would like to open the call to questions.

Thank you.

Ladies and gentlemen we will now be in today's question-and-answer session, which will conclude that six o'clock PM.

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One moment please for the first question.

Your first question comes from Bob Drbul, with Lehman Brothers.

Good evening.

Hi.

Hi Bob.

Two questions, if I could.

The first one would be with the launch of the EuroBed as well as the original bed, can you maybe give us an idea the expected penetration of those SKUs in the back half of the year and how you expect them to play out from a sales perspective?

Well we don't actually have numbers that we are going to share in terms of those penetration projections, but I can tell you that the Euro we started shipping this month.

So that product is starting to appear in the marketplace, so obviously it will, in terms of the back half, it will have greater penetration then the Original, which we will show for the first time next week, and actually, will start shipping in September.

So we will have to wait and see how well the two new models do in terms of getting floor space out there, but we are very optimistic about it.

The second question is around the competitive landscape, and with the introduction of the Original can you just talk a little bit about how you are tracking the competitive issues in terms of how you are defending your market share and what you are seen from retailers that may sell the additional SKUs beside the Tempur products on the visco side?

Yes, what we do is we take a look at all our accounts, our retail furniture and specialty accounts.

We then get a report from our sales force that they keep us up-to-date in terms of any new product that is starting to appear on the floors of those accounts, and then we track them as a group.

So in essence what we do is we have a group of accounts who are only stocking Tempur-Pedic beds, the only exclusive visco product on the floor, and then we have a group of accounts that would include all of the competitors out there.

And what we do is we track them to see how the accounts with competitive products on the floor perform each week and each month compared to the accounts where we, at this point, do not have any competition.

And Tom, when you look at what you've seen so far from the competitive you know landscape, as the activity force you to accelerate the launch of the original SKU that you are launching?

No, actually, when we look at our data we do not see any type of a negative impact in that universe of accounts where we currently have competition.

They are performing just as well as the ones without competition, and in some cases, they are actually performing better because we think it gives consumers a basis of comparison and they see how much better our product actually is.

The thinking and the reasoning behind the launch next week of the Original is more of a proactive approach.

We've taken a look.

We do a lot of consumer research and focus group testing, and we basically feel by introducing this product within the premium category, we are going to simply open up potentially more consumers to our brands.

OK, and maybe just one final question for Dale, within the sales guidance that you gave, what are your assumptions around the foreign currencies side of it when you look at the back half of the year, given the impact that we saw in the second quarter?

Our current expectations for the dollar is for it to continue to strengthen a little bit in the second half of the year, but we saw a significant ramp up and the strength of the dollar the second quarter.

Our current projections, and we look at a number of different bank forecasts, which we tend to amalgamate and try to come up with a consensus, and that is what we've built into our forecasts, but it shows the dollar continuing to strengthen to a degree from current positions for the rest of the year and we've included that into our guidance outlook.

OK, thank you very much.

You next question comes from Stephen Kim, with Smith Barney.

Hi, good evening.

This is actually an issue for Steve.

My first question is also on the Original product that you are introducing.

Now, your previous plans that you'd indicated were for an even higher price point mattress then the Celebrity to be introduced at the Las Vegas show, and now obviously it's a low-end -- a low price point product that you're introducing here.

Was that a strategic decision, not to kind of show your hand to your competitors or is this a fundamental shift in your strategy, instead of going upwards in the price point schedule, to go downwards now perhaps?

One of the things that we made sure that we did do, you know, and keep it confidential, we did not want to tip our hand, but also when we took a look at the attendance, as I mentioned in my opening remarks, the relatively poor turnout this year at High Point -- at the trade show, that we felt that simply majority of the accounts out there, our customers and potential customers, have not really seen our Euro.

So what we wanted to do, as far as the high-end product sets, we -- instead of trying, in essence, introduced two products to a lot of consumers -- or a lot of customers, was to focus on this Euro for the time being.

We think that that tremendous opportunity for us.

It's a proven winner in Europe, and by focusing in terms of our high-end emphasis on the Euro, and then introducing the Original at the entry-level price point of the premium category, then we think that that's a much wiser move for us at this point.

And how will you differentiate in the Original, in terms of the product profile perhaps or how you are presenting it to the consumer, so that there's sufficient differentiation between that product and the Classic?

The construction on the product will be different than the Classic, and also the cover will be different, so there will be an aesthetic difference, a cosmetics difference, and it will feel different than the Classic.

So there is a little different feel, different construction, and a different cover.

OK, and just one other question, on a different topic, the international pillow issue, with the licensees, how long will it take to recover the volume that -- or the sales volume that you've lost there?

And maybe if you could quantify that for us as well.

Well, I think one of the keys to success in getting our business back on track in Asia is the relaunching and the re-staging of our pillow design.

I think we mentioned that previously, and our plans at this point is to launch that in September, and in September when that product and those -- and the new packaging goes into that market, we think that's going to be a big benefit because not only is it something new, but it's also a point of difference if there is still any of the old packaging that came in through the gray market out there at retail, then our direct customers in Japan will be able to point out that this is the new product and what the discounters have out there would be the old product.

So that is a key to us, is to -- having that point of difference in the product line.

OK, that's it for me, thanks.

Your next question comes from Jonathan Shapiro with Goldman Sachs.

Hi, thank you.

Wanted to ask about discounting in the channel and what you guys are seeing out at your retailers.

I know there had been one retailer that you pull your product from the first quarter, and then there was another one in the second quarter.

Are you seeing you know (inaudible) or is that -- sort of you had those two and that's about it?

No, that was about it.

I mean you know we continue to monitor and enforce our policy very diligently, but basically the two that you mentioned, those were the two.

OK, so as far as right now, we shouldn't be hearing about another one in the next week or two anyway.

I mean if it is, it's early on?

If it is, it will be a surprise to us.

OK.

And then, Dale, I was wondering can you just maybe take a minute and what back through the math on the adjustments that you were making to sort of -- you know, the comparability second quarter versus -- this year versus last year?

You know, we reported $222 million first quarter.

At the time we said that we felt that there was 10 to $12 million of additional business in that quarter.

I believe we were specifically asked on the call, you know, how much of that was deferred to and we said we don't know until time goes by.

So if you said the first quarter was roughly 200 million and taking out the time and opportunity second quarter being you know approximately $193 million we've quantified about $7 million of pull forward that gives you roughly 200 approximately that specifically identified the $3 million impact of the change in our tax rate, so roughly then you're looking at a 210 to a 203, which is well within the normal four to five percent industry seasonality.

Does that help?

It does.

Just to the clear on the math, how you are thinking about the first quarter.

So it's not -- so you think you lost seven in the second quarter, was pull forward, and then for the other I guess it would be five million, going from 222 to 210, that was just demand created by the fact that there was a promotion?

That's the best that we can figure at this point, yes.

There was kind of additional demand that didn't come out of the second quarter but was just created by all that promotional activity.

Your next question comes from Keith Hughes with Robinson Humphrey.

Thank you.

Just to clarify on the new bed in Vegas, the 1199 price you mentioned, is that for a queen?

And is that a mattress and box spring price?

No, that's the mattress only.

OK, how much with the platform be?

Look at it from the standpoint of our Classic which is 1599 for the queen mattress -- for the 1199 for the same mattress.

And I will add that the Original mattress really is the original mattress.

It's the same mattress that we built the business on back in the late '90s, and that's the same price.

Throughout the year, we've made little improvements to the Classic, and the Classic has gone up in price, especially -- notably this January, it went up $100.

So this is really the original Tempur-Pedic, and I think it's a very exciting product in that price category, in the lower end of the premium price category.

Would I add $400 on for a platform to get to kind of a set retail price?

300.

Your next question comes from Joe Altobello, with CIBC World Markets.

Thanks, good afternoon.

Just want to go back to the G&A issue for a second.

Obviously, down on year over year in dollars, despite the sales increase, you mentioned, Dale, you know, SarbOx costs coming down year over year.

How much did SarbOx costs coming down contribute to, or actually G&A?

As you recall last year in the second quarter, we said that we spent about $1 million in the second quarter on Sarbanes Oxley, hoping to help us really the second quarter was when we were really getting into that project.

Now, in the second quarter this year we probably spent 10,000.

So essentially a full million dollar savings in Sarbanes Oxley costs on a year over year basis.

In addition, you know, the numbers that we are talking about here being a GAAP number, significant decline in non-cash stock based compensation expense and year over year based because it's down between seven and $800,000.

OK, so is the 8% of sales or roughly what you did this quarter rate good run rate going forward?

Or do you bounce back up a little bit the back half of this year?

No, some of the things in G&A, things like some of the consulting that we -- studies that we periodically do, you know, it can cause us to fluctuate a little bit quarter to quarter, but roughly you know for the first half we run right about 8%, and that's probably a reasonable outlook for the year.

Your next question comes from Michael Cox, with Piper Jaffray.

Thanks a lot for taking my call.

The gross margin, I was wondering if you could touch on the different factors that -- if you could give any breakdown for the contraction, any specific details would be helpful.

Well, we imported about the same amount that we did in the first quarter, so that was about $1 million of freight cost in the second quarter, just as we had in the first quarter.

On less revenue, that has a bigger impact.

Additionally, you know, the other key thing to point out, that I've pointed out in my comments was look at the sales by product category you can see this -- for the first time (inaudible) in the first quarter other was about the same size as pillows.

In the second quarter, other is significantly larger than pillows.

Our margins on the things like frames, foundations, adjustable beds, are much lower because those are a source product that we just resell and they're not things that we manufacture ourselves, we are not capturing the manufacturing margin of this product.

We've always said that the margin rate from those products are lower, so you can pretty easily determined that that category essentially replacing pillows can have a detrimental effect on the overall margin rate.

OK.

And it sounds as if you're anticipating a recovering in the pillows business in the back half.

Have you relaunched that in Asia?

I was wondering on the gross margin line you're running 51.3 roughly in the first half of the year.

Is that a run rate that you would expect in the back half of the year or should we expect that to move you know one way or the other as we look at the second half of the year?

For the -- I believe in the first quarter we said that you know we were running -- that we were 51.4 in the first quarter, we said give or take a little bit.

We thought we'd be somewhere in that vicinity for the year.

And so second quarter doesn't change that outlook.

Your next question comes from Mark Rupe.

Hi guys, just on the originals, I don't know if I heard it right, is it an eight inch mattress as well?

Yes, it is.

Do you think that you know that mattress will cannibalize any of the Classic or the Deluxe at a lot of your retailers now?

Or do you think it's not going to be an issue?

I think realistically then maybe some cannibalization.

We've you know look at that and we think overall it will be incremental volume for us because we think we are ahead of ourselves to consumers who simply wouldn't have considered our product at that $600 price point.

Your next question comes from Lee Cooperman, with Omega Advisors.

I just want to step back and -- you know there's lots of questions that people are asking, but if you go to the Barons article that appeared, which was less than flattering or you know brings up a concern, you essentially are in a market you have had largely to your self and you have a couple new competitors, old line competitors that have kind of missed the ball, giving this high-end luxury business to you.

You are now going to go from essentially -- and if I say anything that's incorrect, just please correct me because I'm not as knowledgeable as I'd like to be, but you are essentially going from ...

Well, actually, I correct you ...

OK.

... in your point that these guys -- we've had competition for seven years.

We've also had competition from some of the S's (ph) for quite a while, and a lot of them have introduced product, and then pulled them back, so this is not ...

Are the S's coming in in a more significant way now than they have been in the past?

I beg your pardon?

Have the S's coming out with new products directly targeting what you do in your segment?

Yes.

All right.

So my point is that the consumer goes into the store today, and instead of having you know one choice in your type of mattress, they now have three choices.

Generally speaking in the history of capitalism, new entrants into a market competes based upon products.

You've got a policy of price maintenance.

What I'm hearing from people is some of the retailers are seeing a falloff in demand for our product at our price point rather than in the S's product at a lower price point.

So you didn't suggest that you're saying is, but this would suggest that on a store for store basis that you would be experiencing some deterioration in your sales volume as you lose market share, maybe, to these other -- the S we will call them.

Are you in fact seeing this?

Or you are not seeing this?

Because I gather, listening to the call, you are not seeing is.

No, we are not.

Your next question comes from Mark Rupe, with Adams Harkness.

(inaudible) on the original again, that's shipping in September, what was the rationale on actually starting to ship in September and not waiting until possibly next year when you had the next facility up because I would assume that with the shipping costs so that mattress overseas, would probably impact margins more than it would on a normal price mattress.

A part of the strategy centered around capacity obviously.

Some of the benefits that we've gotten by a new addition you may recall to the management team last year at the end of the year when we brought on Matt Clift, and Matt's expertise in manufacturing and improving productivity and throughput, he's done a lot of great things for us in the first half of the year that actually has given us more capacity out of our facility here in U.S., and we expect that to continue.

So we think that we will continue to ring in some product from our Denmark facility, but we think that also if we were to continue to wait that that would not be best for our business long-term.

We think now is the time to do it and also obviously by having increased efficiencies and productivity at both of our plants we think we will be able to do it from a capacity standpoint.

Thanks.

Your next question comes from Avid Niking (ph).

Hi this is Mark for Avid.

First of all, I think you are pretty rude to cutoff one of your largest shareholders.

Second of all, all these issues that you brought up I think you were fully aware of these when you were to on the road at your numerous conferences in his past quarter and you guys sold an inordinate amount of stock.

How come you didn't come with these issues when you were at these numerous conferences?

Well, number one, we've talked about the tan (ph) issue -- not sure whether they're issues you are talking about, but ...

Talking about the dollar, talking about your costs, talking about your sales shortfalls, talking about the channel being stuffed.

Number one, we do not give quarterly guidance.

We have talked about the Japan issue.

We have said all along we could not determine the impact of the first quarter, and it wasn't a factor of channel being stuffed, it was a factor of the business volume that was done in the first quarter because retailers continue to order on a routine basis, and their feedback to us in terms of what they store and time going on.

Your next question comes from Jeff Cooley (ph) with Westfield Capital Management.

Hi.

Did you say what the impact of foreign exchange was in the quarter?

Yes, foreign exchange on a year over year basis was about 0.5 percent positive.

What I talked about was compared to the FX rates of the first quarter.

It was down significantly, and that first quarter rates revenue would have been $3 million higher.

So essentially for the second quarter FX had a very marginal impact on the business on a year over year basis.

OK, and did you talk about the -- what you believe the number of slots per store is?

Slots per store was 2.4 as of the end of June versus -- at first quarter it was 2.3.

A year ago, it was 1.9.

So we continue to get -- pickup each quarter in the slots per store.

Your next question comes from Paul O'Neill, with Omega Advisors.

Hey guys, to questions.

The high-end bed that you potentially put off, number one, is that dead or is that pushed off and you are just going to push the Euro?

And then the second question would be if you didn't have this distributor issue is there any reason to believe that when we look at -- you know, it looks like your U.S. mattress sales were good, your international mattress sales were good, your U.S. pillow sales were good, but it looks like the international pillows is where the issue is.

If you didn't have this issue, is there any reason to believe there's something different about the international pillows market, that it wouldn't be growing equipment only with the U.S. pillow?

First of all, we look at and have developed a number of new mattresses in our pipeline.

We still a very interested in the higher price point product and we will continue to evaluate that for potentially a launch at a later date.

We have a number of other tradeshows coming up over the next six to 12 months and we have other opportunities to do that.

In terms of the pillow business, we do think that based on our internal evaluations and assessments that we can track back these issues to a few of the third party distributors and we know the impact that it had primarily on our Japanese business -- pillow business, so that's a reason why, as I mentioned, a restaging and relaunching a new pillow line there and our intent is to get it back on track, where we think it should be.

Is there a magnitude that you think it would -- when I look at just sort of the year over year pillows internationally, you know, before you did (ph) it looks like 21 million and you did 16 1/2 million this quarter.

Do you think that that loss as opposed to a growing U.S. pillow market is entirely explainable by pulling that product?

Or is there something else going on in international?

We think that -- what we see in the business there is all related to the third party distributors and the gray market.

Your next question comes from Corey Johnson (ph), with Kanell Capital (ph).

Hey guys, thanks for taking my question.

I'm just curious why you guys not put on the balance sheet the cash flow statement.

It's a lot easier.

And on that, I'd also like to get a cash flow from operations.

Sorry, I couldn't hear the second part of your question.

Yes, I want to know if you have a cash flow from operations number you could provide.

Yes, the first part of the question was why we don't put out a balance sheet cash flow statement.

Never have, it's always in the Q. It's something that we are looking at from a timing standpoint of continuing to improve our processes to make it more available sooner.

The primary focus has been on the acceleration requirement to the SEC on filing Qs faster and faster, we have been focused on that portion.

I don't have it in front of me.

The operating cash flow year-to-date is 50 million.

That a help, thank you.

Your next question comes from Chris O'Donnell (ph), with Caxton Associates (ph).

Balance sheet question, do you have (inaudible) finished goods inventory (inaudible).

Could you repeat the question?

Inventory finished goods inventory at quarter and in dollars, do you have that yet?

Just had a total inventory of 81 million right now.

OK, thank you.

There are no further questions at this time.

I would now like to turn the call over to management for closing remarks.

Thanks again for joining us today to discuss Tempur-Pedic's results for the second quarter.

As we discussed, we are on track with our growth plans and are very optimistic about our ability to take advantage of this great market opportunity.

We look forward to giving you another update on our progress at the end of the third quarter.

Thanks.

Ladies and gentlemen, that concludes your conference call for today.

We thank you for your participation and ask that you please disconnect your line.