Tempur Sealy International Inc (TPX) 2007 Q2 法說會逐字稿

Good day, ladies and gentlemen.

Thank you for very much for your patience, and welcome to the Tempur-Pedic second quarter earnings conference call.

My name is Bill, and I will be your conference coordinator for today.

[OPERATOR INSTRUCTIONS.]

I would now like to turn the call over to your host for today's conference, Barry Hytinen, Vice President of Tempur-Pedic Investor Relations.

Mr.

Hytinen, you may go ahead.

Thank you for participating in today's call.

Joining me in our Lexington Headquarters are Tom Bryant, President and CEO, and Dale Williams, CFO.

After prepared remarks, we will open the call for Q&A.

Please note statements made by Tempur-Pedic during the 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, including the Company's expectation 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-K 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 obligations to update any forward-looking statements.

The press release is posted on the Company's website at tempurpedic.com and filed with the SEC.

With that introduction, I'll turn the call over to Tom.

Thanks, Barry.

And to our listeners, thank you for joining us this evening.

Tempur-Pedic delivered another strong quarter with sales up 18% to $258 million.

EPS was up 30% to $0.39.

As we continued to take market share, mattress unit growth was up 14% in total, with 17% growth domestically and 10% internationally.

Additionally, pillow volumes were up 10% in total, led by exceptional successional domestic performance, up 19%.

Consistent with our strategy we elected to focus on established retail accounts during the second quarter, and saw productivity continue to improve.

Domestic and international retail partners are performing at improving rates, and we see opportunities to continue penetrating established accounts and selectively adding new ones.

Internationally we added approximately 50 net new retail doors, bringing the international door count to 4,670.

In the U.S.

we opened approximately 100 net new furniture and bedding doors.

This brings the U.S.

furniture and bedding door count to 6,150.

Incremental to this door count are new accounts added from U.S.

department stores, which we include as part of our specialty retail channel.

As we have discussed before, we recently completed a detailed analysis of consumer buying pattern, demographics by store type, and improved Tempur-Pedic brand awareness, among other factors.

This analysis led to our decision to selectively enter U.S.

department stores.

We recognize there's a considerable investor interest in our new U.S.

department store strategy.

We do not anticipate reporting department store results separately going forward.

However, for this initial quarter we will provide a few additional details.

The rollout is occurring on schedule and as anticipated.

We opened approximately 200 new department store doors and we expect to open new doors in the third quarter and going forward.

Initially, rollouts such as these begin with floor models and small amounts of stocking units.

In fact, our first U.S.

department store account tends to be especially lean in terms of inventory.

As this account is opened at the very end of the quarter, U.S.

department stores contributed less than half a million dollars to sales, which included floor models.

As floor models rollout, training is completed, and sell through begins we expect this to ramp.

Turning to our products, we are pleased to report our new mattress models began shipping during the quarter.

The Symphony began to ship in April, and the BellaSonna in late May.

Distribution for both models is meeting our expectations, and the rollouts continue.

Early indications are very positive.

Importantly, we also continue to gain distribution for our existing mattress line within our established accounts.

Speaking of expanding distribution, frequently we are asked, "What products Tempur-Pedic replaces when we gained additional floor space?" Now, surprisingly, we believe the largest share continues to come at the expense of innersprings.

However, we also believe Tempur-Pedic is taking floor space and market share from all forms of bedding, including air, memory foam, and latex.

We believe this trend validates our long-term view that Tempur-Pedic will become the world's largest bedding manufacturer.

In addition to the distribution gains during the first quarter, we raised the price on two U.S.

mattress models and several models internationally.

These actions allowed us to improve margins for Tempur-Pedic and our retail partners.

Based on additional market and pricing studies and the strength of the brand we have decided to raise the price on two additional U.S.

models.

Late in the third quarter we will raise the retail price of the classic by $100 and the deluxe by $200.

Similar to our first quarter pricing actions, because this action is not cost driven, we have the luxury of improving margins for Tempur-Pedic and our retailers.

Initial retail feedback has been very positive.

Turning to operations, we have seen significant improvement in a variety of areas.

Cost savings from sourcing and distribution are having a positive impact and productivity is improving at our manufacturing sites.

Our manufacturing facility in New Mexico continues to ramp, and we are very pleased with the performance to date.

By the end of the second quarter, it was shipping all U.S.

mattress models with the exception of the BellaSonna and the GrandBed, which it will begin producing in the second quarter.

Looking at our Medical Division, our joint product line with Hill-Rom has begun to see some traction.

While the acute care market has longer lead-times associated with purchasing cycles, we are pleased by the early feedback.

Over the past quarter our partnership with Hill-Rom has strengthened.

Their sales force has been trained, the valuation models are being distributed, and beta sites are completing testing.

We are thrilled to be working with a company of Hill-Rom's quality, and we look forward to developing a mutual rewarding long-term relationship.

Before turning the call over to Dale, let me briefly discuss our new U.S.

advertising campaign.

We began airing our new short form ad and refreshed our website in May.

Early indications are positive, and we expect the campaign will enhance our brand image, expand our awareness, and appeal to key consumer demographics.

In the third quarter we have begun airing our new long form TV ad, which highlights the same campaign theme.

In summary, we had a strong quarter, and we also achieved an important milestone with our last 12-month sales exceeding $1 billion.

At this point, I will turn the call over to Dale to review the financial results in more detail.

Dale.

Thanks, Tom.

Let's take a look at the second quarter in a bit more detail.

Sales grew 18% with approximately 2 points attributable to foreign exchange.

Our growth continues to be led by retail.

Domestic retail was up 23% and furniture and bedding retail was up 25%.

Our international retail business grew 18%.

Direct sales were up about 3%, which we view as a positive given our expectation that this channel will decline as retail distribution expands.

We expect direct will decline slightly in the second half of 2007.

On the product side we delivered growth across all products in both geographic segments.

Mattress sales grew 20% in total, which is quite strong, especially against a 15% mattress sales comp last year.

Domestic mattress sales were up 21%.

This growth was attributable to 17 points of unit growth and the balance on price and mix.

International mattress sales were up 18%, driven by 10 points of unit growth.

Pillow sales were up 9%, led by continued strong domestic pillow unit growth.

U.S.

pillow revenue grew 16%, while units grew 19%.

U.S.

growth was driven by the continued success of our ongoing pillow strategy.

International pillow sales were up 5%.

Other products, which typically go along with the sales of the mattress, grew 16% in the quarter.

Gross margin for the quarter was 48.3%, down 30 basis points from the prior year, and up 30 basis points from the first quarter.

On a YOY comparison this performance includes an incremental $2.5 million of depreciation costs, largely related to our new manufacturing facility.

Gross margins in the quarter were also negatively impacted by floor model discounts for new mattress models.

This includes distribution to new doors, as well as expanding floor space of our existing mattress line in established accounts.

The discounts associated with these activities temporarily depress average unit selling price.

We continue to anticipate 2007 will be the trough year for gross margin.

We expect to see improving gross margin in 2008 as incremental unit volume will leverage fixed costs in our plants.

In addition, we expect continuing operational productivity and selective pricing actions to improve product margins.

Operating income was $55 million or 21.4% of net sales.

Operating income was positively impacted by modest leverage of SG&A expenses despite continued expansion of our investment in R&D.

Net income was $32.9 million, an increase of nearly $7 million from the second quarter of 2006.

Regarding our corporate tax rate, as I mentioned last quarter, we were monitoring potential changes in certain international countries.

We're pleased to report that some of those changes have been enacted, which has resulted in continuing tax rate improvement.

We now expect approximately a 34.5% tax rate for 2007.

It is possible that the rate could improve further this year, and we continue to believe that the tax rate will gradually decline over the long term.

Fully diluted EPS was $0.39, compared to $0.30 last year, an increase of 30%.

Second quarter EPS includes $0.02 related to the YTD impact for the lower tax rate and shares repurchased during the quarter.

Capital expenditures were $2 million, down from $9 million last year.

Regarding CapEx, we now believe our full year 2007 capital expenditures will be approximately $15 million, which is down from our prior expectations, reflecting our ability to drive productivity with our existing plants and equipment.

The Company increased and paid its quarterly cash dividends of $0.08 per share in the second quarter.

In addition, the Company repurchased 2.3 million shares of its common stock during the second quarter, at an average price of $26.33, for a total cost of $60.8 million.

Repurchases in the quarter completed our prior $100 million authorization.

The strength of Tempur-Pedic cash flow generation capabilities has been proven over a long period of time.

With the recent completion of our third factory, over the next several years we do not anticipate significant new capital expenditures.

As a result, we expect strong cash flow growth going forward.

With this backdrop and consistent with our belief that share repurchases remain an excellent means to return value to shareholders over the long term, we are pleased that our Board has authorized a new repurchase program in the amount of $200 million.

Now, I would like to address recent order trends.

To date in the third quarter we have experienced strong order momentum, especially in our U.S.

retail business.

I would now like to address our guidance for the full year 2007.

Given the Company's performance through the first half and our continued positive outlook for the rest of the year, the Company is increasing its financial guidance for 2007.

The Company currently expects full year net sales to range from $1.065 billion to $1.085 billion, an increase of 13 to 15% as compared to 2006.

The Company also expects full year, fully diluted EPS to range from $1.63 to $1.66 as compared to its prior guidance of $1.54 to $1.58.

The increase in EPS guidance reflects higher net sales and corresponding earnings, as well as shares repurchased in the second quarter, additional interest expense resulting from second quarter share repurchases and the lower tax rate.

We are using a weighted average full year share count of 84.2 million shares for this guidance.

However, this guidance does not take into effect the affects of any new share repurchases.

As of June 30th, 2007 the Company had $131 million available under its newly amended credit facility.

In addition, the facility provides an option for an incremental $100 million, which we may choose to utilize if, for example, share repurchases are completed quickly.

Turning to the long term for a moment, into 2008 and beyond, we continue to anticipate significant operating margin expansion, driven by improving gross margin and SG&A leverage.

We fully expect this business will deliver operating margins of 25% or more in the coming years.

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.

Turning to an upcoming event, we would like to invite our investors to join us for a webcast of our first Annual Analysts Day on September 6th.

In the coming months, we will issue a statement with further details, and we look forward to the opportunity to spend more time reviewing our business and the long-term market opportunities.

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

Thank you very much, sir.

[OPERATOR INSTRUCTIONS.]

And our first question comes from the line of Mark Rupe of Needham & Company.

Please proceed.

Guys, congratulations on another great quarter.

Thanks.

A couple quick questions.

On the -- the margin, obviously, you've had several negative margin pressure points from the product and channel shipped over the last three or four years and then New Mexico this year.

You say you may get back up to 25% in the next couple of years, how much do you think -- how fast do you think you can rebound in '08?

Any kind of -- I mean could we see 150 basis points on the operating line probably next year?

Mark, we really haven't, you know, done detailed planning for next year yet.

It's probably a little premature to give you that level of direction for next year.

Certainly, we believe --

Okay.

-- that we'll see up side in both gross profit and overall operating margins, but I -- I'm not comfortable at this point in kind of giving you a ballpark.

Fair enough.

I -- let me ask it this way, is the negative pressure right now, you know, absent the price increase in the third quarter, is -- with New Mexico is that -- is that subsiding going into the third quarter, or will there be still some overhang from that?

Well, certainly, you know, one of the big pressures from Albuquerque is the depreciation.

Right.

It hits every quarter.

Right.

From here on out.

You know, that started in the first quarter, and it will continue until the facility is completely depreciated.

Exactly.

But, you know, we did have startup costs in the first quarter which continued into the second quarter with continuing to ramp the production there, and the key effort in the second quarter being increasing the complexity of the build, taking on the higher end models.

We -- we've got Albuquerque building all the products now with the exception of the Grand and the BellaSonna, the BellaSonna just because it's brand-new.

Right.

And just because it's the most complex.

We will be having those products started to be manufactured in Albuquerque as this year progresses.

So, you know, most of the startup related costs are behind us now.

A little bit associated with those two products going in there.

But, you know, I would say Albuquerque is running great.

We were out there a couple of weeks ago.

It looks great, and so most of the startup is behind us.

Okay.

And then on the -- on the retail landscape, you cited that you're taking share from obviously more than just innerspring, but also other specialty products.

Are the retailers keeping up with adding specialty as a whole or are you basically -- are they keeping it flat and you're just basically taking that much more share of the category, the specialty category in the store?

Well, we think the total category is growing, as well.

You know, if you look at the statistics, the last time the trade association put the specialty numbers out it was obviously growing at a very rapid rate, so I think the retailers are realizing that there's tremendous opportunity in the specialty category, so it's just not Tempur-Pedic, obviously there are others, as well.

Right.

But it seems like you guys are -- are hitting on all the irons right now, and some of the other guys are having a little bit more trouble.

Is there anything that you're doing that you can cite that is differentiating?

Obviously, the brand and the product, but from a kind of fundamental point of view, dealing with the retailers that some of the -- maybe the competitors aren't doing?

Nothing that we're prepared to elaborate on, outside of the two critical areas that you mentioned.

Of course, the product, the superiority of the product, and our marketing strategy and execution.

Okay.

And then just real -- lastly, on the advertising campaign, any idea on when you'll have a good complete picture on whether or not [you're meeting] kind of what you set out for it?

Well, certainly, you know, we're very optimistic at this point because of all of the testing that we did.

But in terms of -- of the actual feedback, it will take some time to get the read from that, but certainly during the back half we'll have an overall understanding of how effective the new campaigns are.

Okay.

Perfect.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question come from the line of Edward Yruma of JP Morgan.

Please proceed.

Hi, guys.

Thanks very much for taking my question, and congratulations on a very strong quarter.

Thanks, Ed.

Can you talk a little bit about some of the positive momentum you've had recently in domestic pillows, how sustainable is that and can we expect additional product innovation on that front?

Yes, we've been very pleased with our pillow business.

I think for those who have been following the Company for awhile, you'll recall that we changed our strategy awhile back on pillows, we put more resources behind that segment of our business, both from an R&D standpoint, coming up with some new products, merchandising, marketing.

So all of those efforts have continued to pay-off as we've expanded our distribution and, also, our sell through at the retail level.

So we think that, you know, there's no reason why we can't continue to grow the pillow business.

It's an important segment of our overall business, as well as very profitable for the Company and the retailers.

Great.

I know you talked a little bit about the margin drag because of some of your new product introductions and the corresponding floor models.

Can you quantify that for us?

Is that on the magnitude of the additional D&A from Albuquerque or it significantly smaller than that?

No, not that much.

You know, if you look at the unit volume YOY, you know, we have floor models in every quarter, so it's not something that's completely unique to us, but floor models that we had in the second quarter this year as compared to the prior year, you know, we had about 2,000 more floor models than we had last year.

So, you know, that does create little bit of a drag there.

Got you.

And my final question, I noticed that D&A fell a little bit sequentially.

Is this kind of the run rate of D&A going forward?

Yes.

Great.

Thank you very much.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Robert Straus of Merriman Curhan Ford.

Please proceed.

Congratulations on the quarter, guys.

Thank you.

Can you give us a little bit more detail about what you're seeing in mattresses internationally, and talk a little bit about some of the successes that you're having with new products there?

Sure.

Well, I think you could see from the numbers for the international business during the quarter that our overall strategy of continuing to penetrate retail and expand our distribution in those stores, we've been introducing new products that's been very successful in Europe.

You know, we've been talking about a new mattress that we've been working on for Asia.

We'll start shipping that product in September.

So right now a lot of the same overall business strategies that have worked well for us in the U.S.

are working for us on the international market.

We've continued to invest marketing dollars, media dollars in the key markets, and right now we're very pleased with -- with the results.

The distribution in Asia for mattresses, I know that you are looking at some other retail stores, can you give us an update on how that's going.

Yes.

We've got the sales force and, specifically, I think when we were talking previously we were talking about Japan where we saw an opportunity to expand into furniture and bedding stores with our futons, as well as mattresses.

And so we've got the structure in place, we've identified the stores and, obviously, with the new products that we will start shipping, as I mentioned, in September, now that will be the opportunity to expand into those stores with a mattress that's specifically designed for the consumer in that market.

Congratulations.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Tony Gikas of Piper Jaffray.

Please proceed.

Hey, good afternoon, guys.

My congratulations, as well.

A couple of quarters, maybe just a little more detail on the Federated rollout, if you can where you're at in that initial rollout?

Did that get completed in June or is there still more to come, maybe just number of stores, number of slots, and what percentage of the shipments there were -- were floor models?

The second question, any further thoughts on pricing strategies just beyond the two, the classic and the deluxe that you announced today?

And then I have a follow-up.

Okay.

As to the department store strategy, as we mentioned, we opened or actually put floor models in approximately 200.

That gives us about half, almost half of the target that we have to continue to roll into that particular chain, so we'll continue to do that this quarter.

As to, you know, if we look at the business that that department store contributed last quarter, it's roughly about a half million dollars, but that included floor models.

So most of that volume was floor models compared to inventory, and so we're about halfway through and we'll continue to do that.

As to our pricing strategies, you know, we've been taking a very selective approach to pricing, and we think that's the right thing to do compared to, you know, taking an across the board increase.

We look at the individual products, where they're selling based on the demographics and the types of products, as well as the margins that we're contributing to our retailers.

So I think we will continue to look at it from that direction compared to across-the-board increase.

So with this announcement that we're going to be increasing, you know, two of our very strong models, the deluxe and classic, and give the retailers some more margins on those, that's been received very well.

Okay.

And then could you just give us -- let us know where you're at with capacity in the New Mexico facility?

And then maybe just a little update on the competition is -- you know, are they getting any better?

On Albuquerque, you know, where we don't want to talk specifically about capacity, utilization rates at each factory because it's -- now that we have capacity, you know, we put on a lot of capacity with Albuquerque.

The focus in the second quarter was not ramping it further in terms of production output, but ramping it in terms of complexity.

So, you know, we're running at about the same rate we were running at by the end of the first quarter.

And the second part of your question was related to competition.

We're not seeing any, you know, change, nothing real new that's impactful from a competitive standpoint.

Okay.

Just to follow-up then, back on Albuquerque, I guess in a related comment, we talked to recently one of -- a major retailer who was saying that you were out of stock during the quarter on two or three different models.

Are you still having a little shortage issues on any specific models, or is that really not an issue at this point?

Well, we, you know, we have a -- a distribution network throughout the country, and from time to time it's possible that we'll be out of a particular SKU.

If you look at the number of sizes that we offer with each product, but, you know, so that is possible that we have some shortages but nothing across the board or nothing that I would call out of the ordinary.

Okay.

Thank you, guys.

Great job.

Okay.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Al Kabili of Goldman Sachs.

Please proceed.

Good afternoon, and congratulations, guys.

Thank you.

In terms of the margins, not to beat a dead horse, but should we be expecting any kind of margin expansion in the back half of '07 given the ramp-up of Albuquerque?

Well, our guidance that we just gave is basically consistent from a margin expectation to the guidance that we've -- that we gave for the year.

So, you know, we're looking for the margins to be, continuing to carry on about, you know, in the range of what we expected at the beginning of the year.

We saw a little bit of margin improvement from 1Q to 2Q.

You know, typically our second half, particularly from an operating margin standpoint, we have a much stronger margin in the second half of each year, and we would expect that to continue as we've seen historically.

Okay.

And in terms of raw material prices, what are you seeing on the TDI front?

You know, we've been hearing about potential upward price pressure there, and any other raw material pricing that could be potentially impacting you?

You know, we hear rumors of price increases on a periodic basis.

We've been able to maintain essentially the TDI and [Poly o] pricing that we've had really since they went up dramatically late in 2005 in the U.S.

Internationally, as we talked last quarter, we did see some price increase internationally on those core chemicals.

Where historically the U.S.

was less expensive than the international business, in 2005 the U.S.

got up ahead of the international business and now they're, you know, fairly close to parity.

So we did see some pressure internationally, that we talked about a quarter ago, but that's been fairly stable since then.

Okay.

And -- and -- and you're incorporating in your outlook -- you're not assuming or seeing much upward pressure on raw materials, would that be fair to say?

Yes.

Okay, great.

And then on international pillows, pillows have been very strong, I guess, internationally, lagging a bit domestically.

Is that because of Japan?

And is there a near-term opportunity to see some acceleration on the international pillow front?

Yes.

You know, we talk about things quite a bit.

Japan has stabilized.

It's starting to show some growth again, you know.

And a specific quarter-over-quarter comparison, as you recall, last year we had a pretty strong third -- international third-party number last year, and what we talked about on the call is we had discovered that some of the third parties were selling pillows into Japan and we were shutting them down.

So there was a -- you know, we were comparing against that last year, which has both the international third party, as well as the international pillow business a little bit weaker because of that leakage.

But the good news is we are seeing Japan recovering, and it's, you know, getting stronger and, you know, we think that, knock on wood, we'll continue to keep that gray market issue behind us now.

Okay, great.

And -- and then turning to the balance sheet, on inventory, you know, you're building clearly to support the higher sales levels.

What -- what should we be thinking about for a targeted inventory level in terms of either a percentage of sales or days?

And, you know, at what point do you stop building inventory going forward?

Well, at the -- on the first quarter call I said in the second quarter we would see a little bit of increase in inventory, principally because of adding two new models, so, you know, our stocking level -- we need stocking on those two models to support retail orders.

So that's what we saw here in this quarter, is a modest increase in inventory in the second quarter as we put the Symphony and the BellaSonna into our warehouse network.

You know, at this point we try to look at inventories on a day's basis, and we're trying to maintain a 30 to 35-day supply.

Okay, great.

And then as we think about the amount of free cash flow you're -- you're generating going forward with limited CapEx needs, how should we think about that in terms of the split between share repurchases or -- or further hikes in the -- in the dividend potentially?

And -- and would you also consider doing a -- a recapitalization, you know, given you're -- you're under levered versus other mattress peers?

Well, you know, the only thing I can really comment on there is that we raised the dividend, we initiated the dividend in January, in April we raised the dividend, and at that time we said that we wouldn't look at the dividend again for a year.

So we'll evaluate it in the early part of next year with the Board.

From a share repurchase standpoint, you know, we just -- the Board just authorized an additional 200 million.

You know, I think a pretty pertinent fact to look at is, now, if you look at our total debt as of June, it was $401 million.

If you look at June of 2006 we had $417 million of debt, so it's down slightly YOY, yet we finished up Albuquerque and bought 100 million shares, $100 million worth of stock in that year.

So, you know, as long as we see value, a value equation to our shareholders of continuing to repurchase, you know, my expectation is that we'll continue to repurchase.

Okay.

And then the last question is how should we think about door expansion going forward, given your entry into -- into department stores?

Are you looking there, is there a certain targeted door rate that -- that you would think about over the next year or two in terms of domestically that we should be thinking about?

Nothing that we're prepared to discuss today.

I would say that, you know, we're evaluating the channel.

As we indicated previously, our plan is to go into the department store channel on a very selective basis, so we'll continue to do that.

At this point, I think the only thing we would say about additional doors would be to complete the one project that we've already started and get the personnel at the store levels trained enough to see it on the product and make sure that we're having productive results, and then we'll continue to look at other opportunities, but we're not ready to make a target, at least public at this point.

Okay.

Thank you very much, guys.

Thank you very much, sir.

[OPERATOR INSTRUCTIONS.]

Our next question comes from the line of Bob Drbul of Lehman Brothers.

Please proceed.

Hi.

Good evening.

Hi, Bob.

Hi, Bob.

Just a couple of -- two questions, really.

On the gross margin, when you look at your expectations can you maybe break-down how much of what you're seeing in gross margin is -- is improving, or the expectations are for improvements due to the price increase, and how much of it is by gaining better scale on Albuquerque?

And the second question is, you know, can you just talk about the mindset around the price increases about determining, you know, the optimal split between what you guys will get on the gross margin and what the retailers are getting?

Yes, I'll take the first part of that.

In terms of gross margin, you know, we had said as to why 2007 will be the trough year, we've had over the last several years gross margin pressure related to the mix change in the business on two sides.

One being the channel mix where retail becoming a bigger and bigger piece of the business.

Now, if you look at our results this quarter 92% of the business is wholesale, that's retail plus the other channels, excluding direct, the direct [base] percent of our business on a global basis.

A quarter ago it was 9%.

So, you know, the big impacter from that channel shift was when direct was 30, 40% of the business going, you know, dropping to 11, 10, 9%.

You know, that was a big move over, you know, every quarter, it was dropping significantly.

Now that we're, you know, 91, 92% wholesale, it's going to continue to move that direction, but moving from 91% to 92% isn't a big impacter anymore like it is when it's moving 5 points at a time.

The other channel or the other mix impact has been the product mix where other, because it goes along with mattresses in the growth rate of mattresses, other became bigger than pillows.

As you will recall, other is predominantly things that we don't make, it's things that go along with the mattress that we are a distributor of and, therefore, have distributor margins as opposed to manufacturing margins.

So that mix shift where other became bigger than pillows created some negative pressure.

It is bigger than pillows.

It's -- we think it will probably stay kind of in the relationship that it is now, so that mix change is largely behind us.

2007 the big drivers, the Albuquerque startup costs, as well as the depreciation, that's a drag every quarter this year, and then next year Albuquerque becomes leverageable.

So, you know, we'll be able to leverage the Albuquerque cost next year, and we'll continue to get ongoing productivity in our sourcing and our production, and so we think that we'll be able to see the gross margins in the business start to improve again.

And then as to your second question, Bob, as far as our strategy on pricing, we start out by doing a complete evaluation of the market and looking at all of our products in terms of different price points.

And then once we've made a determination as to what the new retail suggested price is going to be, then we go through an evaluation process internally to determine what the wholesale price is going to be.

And in this case where we had the opportunity to improve our retail partners' margins, that's what we chose to do compared to simply maintaining those margins, even though those margins are, you know, high for the industry it's all, obviously, always appreciated by our retail partners when we can improve their margins.

Thank you very much.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Monica Aggarwal of Chapdelaine Institutional.

Please proceed.

Good evening, everyone.

How do you anticipate the selling process to be at a department store, and the implications on the ramp-up of this -- of sales through this channel versus a traditional mattress retail store?

Well, we think it will probably be a little different, but if you look at one of the key drivers of our business at retail, it's our advertising and driving consumers to stores asking for the product, so that part would be very similar.

And then I think in terms of the process that we go through with training, we have fulltime trainers who have been very active with the department store personnel, getting the personnel up-to-speed and trained.

And once they're educated on our product and their competence level gets up, then we would, you know, expect that the process and the interaction at the store level would be very similar.

Okay.

And what is the opportunity to sell pillows, you know, through this channel given Macy's for example, already appears to sell pillows in the $250 to $280 range?

Well, right now, our approach is for the mattresses, we're trying to get those -- focused on the mattresses, getting them out there and getting all of their people trained on our core product line.

So at this point, you know, we're focused simply on the mattress.

Okay, fair enough.

Thank you very much.

Thank you very much, ma'am.

Ladies and gentlemen, your next question comes from the line of Randy Scherago of First Albany.

Please proceed.

Hi, guys.

Just a few sort of housekeeping questions for you.

You mentioned in this quarter that you only had sort of nominal revenues, about $500,000 from floor models at Macy's, will we see in 3Q higher numbers from the stocking of the Macy's warehousing, warehouse facilities?

The second question is regarding the rollout at Hill-Rom, you mentioned during the conference call that you're at this time rolling out demos.

Will we see significant results from Hill-Rom in the third or fourth quarter this year?

And then, also, could you just address any sort of status that you might have as far as contracts or developments in the assisted living space or in the hospitality market?

Okay.

You want to take the first one, Dale?

Yes.

From a Macy's standpoint, we rolled into 200 stores.

We had stocking units, as well as floor models and stocking units and some sell through.

Certainly, we would expect Macy's performance to improve significantly from there.

You know, we got into Macy's late in June, and so it's just an initial going in and a little bit of sell through.

So in the third quarter, as Tom mentioned earlier, we had looked to about double the number of stores.

That means more floor models, a little bit more stocking, but predominantly we'll be looking for the third quarter and into the fourth quarter for Macy's to grow and sell a lot of product.

Okay.

I was just wondering if they were stocking now in their distribution warehouses.

Macy's maintains, you know, across this industry people maintain not a lot of stock.

Macy's tends to maintain even less than other people.

Okay.

As to Hill-Rom, I think it's important to remember that the way that the buying is done in the medical market, the acute care market, the purchase patterns can be very long because of the contract sales.

So at this point what we've said is that, you know, we are going to work closely with Hill-Rom.

We've developed a product, we've -- we've done the training, we've gotten some demonstration models out there.

We've gotten our first order, small order that's come in, but -- but this is going to take some time to build-up, so we're not putting any additional color around, you know, what we're expecting in the back half, for example.

But, you know, we will continue to work closely with them, but it's going to take some time to build-up that business and to be in that zone of consideration when a purchasing agent comes time to replace their mattresses.

As far as contracts, you know, we don't have anything new to report in terms of nursing homes or assisted living.

We're continuing to try and penetrate that market, but as we've previously said it's a difficult market to get into as a result of reimbursements currently for treatment of -- of pressure sores, bed sores, compared to the government paying a facility to prevent that sore.

So until that changes we're not anticipating a lot there.

As to hospitality, we are putting a -- a lot more focus behind the hospitality sector.

We've got a separate sales organization that's out knocking on doors.

We started advertising in the trade publications, so, you know, we're going to -- now that we have capacity we're going to make that a much higher priority.

Okay.

And just regarding the Hill-Rom, today you're manufacturing mattresses for them out of the Virginia Facility, how many types will you eventually be manufacturing?

And will you also be manufacturing out of Albuquerque?

Well, we can manufacture the medical mattresses at both facilities, and it just depends on where we're shipping to, similar to the consumer products.

But we -- at this point, we have multiple models that we have designed, along with Hill-Rom, and as to what the line will look like when we're finished, I think it's a little too early to tell because we're still developing some other products for them.

Okay.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of John Baugh of Stifel Nicolaus.

Please proceed.

Thanks.

Congratulations.

My question is I would guess, say, five years ago, a $2,000 and up price point mattress just didn't account for 1 or 2% of industry sales, and they're significantly higher today, maybe 4 or 5%, I don't know.

What does your market research tell you that the, you know, how many $2,000 beds this country may ultimately buy?

Well, I think, you know, we don't have any specific research to share regarding the $2,000 and above.

We do have research industry data surrounding the premium market, which is $1,000 and up, where we compete, which is about half of the total market if you look at it from a value standpoint.

So we think, it's obviously trending to higher price point products as consumers, you know, start realizing more and more that, you know, you somewhat get what you pay for in this market.

So we're seeing more and more customers when it's time to replace their old innerspring mattress, not just automatically go out and, you know, look for products based on price.

They're doing a lot more research.

The internet is helping.

There's a lot of PR out there regarding the sleep problems.

You know, last year $3.8, $3.9 billion spent on sleeping pills in the country, so there's definitely a problem, and more and more people are realizing the solution may not be in drugging themselves but may simply be in getting a better mattress.

And when you think about the fact that a mattress, you spend a 30-year life on, our product lasts 20 years, that's not a very high price to pay.

Yes, I agree, and that's why I was just curious where now that we've seemingly opened up the consumers' minds and retailers have seemingly embraced a much higher price point product than this whole industry thought you could sell before that there could be still a huge opportunity, but you can't quantify that in any way?

No, but we would agree that there's certainly opportunity to continue to see that price point move higher, as well as the premium market continue to grow faster than the overall market.

Okay.

And then the second question is what do we expect those [inaudible] and percentages or dollars of ad spending to be roughly?

Spending it was about 10% which was about equivalent to last year, but obviously with higher revenue we were able to invest more in marketing.

And that's where we should be more or less for the year?

Yes.

We've been saying, I think, around 10 to 11?

Yes, 10 to 11%.

Great.

Thanks so much.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Joe Altabello, CIBC World Markets.

Please proceed.

Hey, guys.

Good afternoon.

Our first question is on the Federated agreement you guys have, is there any exclusivity agreements with them or you guys are free to go to any other department store beyond them?

No, we don't have any type of agreement with them.

Okay.

So the fact that you're only going with Federated right now is just you guys wanted to get up-to-speed on that channel?

It is, and we also, as we said, we want to be very selective, and if we do continue to expand in that channel that we're partnering with the right people and the right business.

Okay.

And then, secondly, on the price increases you guys took earlier this year, first, how did the competition respond?

Because it sounded like they actually cut prices, at the same time you were raising.

And, second, when you did raise prices, did you see a big impact on demand, or was the price increase really all incremental to you guys?

Well, the first part, we didn't really see, you know, competitors I don't think across the board follow suit, let's put it that way.

We haven't seen many taking price up, but we've seen quite a few companies who have been cutting prices.

But I think, you know, it's probably across the board because there are a lot of competitors out there, and it's difficult to track them all.

What was your second question?

In terms of the impact on unit growth, because it seems like, you know, the demand for these products is pretty inelastic, and it seems like you guys have a lot of pricing opportunities?

Yes, we -- you know, we have seen in the past as we've increased prices we really haven't seen any slowdown as a result of that, no impact on the negative side.

Okay.

And then, lastly, I guess a last question for Dale, it sounds like now going forward the long-term maintenance CapEx number is about $15 rather than $20 million?

No, I would still use it at $20.

What we said about that was we think roughly about $20 million a year is the right number.

Some years it's going to be a little bit more, some years it's going to be a little bit less.

This year, you know, as the year has progressed it looks like it's going to be a little less than that.

But I would still from a planning standpoint look at around $20 million a year on CapEx.

Okay, great.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Keith Hughes of SunTrust.

Please proceed.

Thanks.

Most of my questions have been answered.

Just one on the department store agreement, does the same pricing policy you've had about retail pricing apply in the new department store agreement as what has existed before?

Yes, the same -- the same policy that we have for all customers.

Okay.

Thank you.

Thank you very much, sir.

Ladies and gentlemen, your next question comes from the line of Steve Colbert from Canaccord Adams.

Please proceed.

Hey, guys.

Good afternoon.

Hi, Steve.

I think you mentioned 100 net new doors for U.S.

furniture.

Looking at that door count number, could you comment kind of on the impact from [Rockaway's] bankruptcy, then the purchase by Sleep-Eze?

What's included in that number?

Is it still sort of moving as that gets cleaned out or does the 100 net include kind of what we'll be at the end of it?

Well, I think it is still moving.

If you, you know, if you look at some of that development had been recent and so we're still trying to get a handle on it ourselves.

Yes.

You know, Rockaway did close some stores in the second quarter, those closures are included in that net.

And in terms of the number of stores that Sleep-Eze is going to end up with, that number keeps moving, so, you know, as we see them close or reopen, you know, we'll adjust as we go.

It's a fluid situation, we're trying to stay on top of it, but the closures that Rockaway did are netted out of that number.

Okay.

And then, you know, you've touched on it but what's -- anything further you can provide on what's behind the reduction in tax rate and, you know, without you going too far, how low do you think it might get to?

Well, you know, this year, as we mentioned on the last quarter where we saw a little bit of improvement in tax rate, and we said that we're watching some developments internationally -- essentially, what we're seeing is a couple of, you know, one or two countries within the last year made a move in terms of their corporate tax rates trying to, you know, make their countries more competitive.

Given the EU situation, that's kind of forcing other countries to follow suit.

You know, where it's going to end up I'm not exactly sure.

I do know of one additional country that has already enacted legislation to reduce its tax rate, but it doesn't go into effect until January of 2008.

The one that was the big driver this quarter enacted legislation to reduce the tax rate and made it retroactive to January 1st, which is why we had a YTD catch-up in taxes in the second quarter, which made the second quarter tax rate a little bit lower than, you know, what we're looking for for the rest of the year.

Okay.

So, okay.

What should we be looking for, specifically then for Q3 and Q4?

I mean is that -- that 32.5 is the full year number and a little bit higher, or?

No, as I said in my comments, for the year we expect the tax rate to be 34.5.

I'm sorry, yes, 34.5.

So, basically, if you look at the YTD number it's -- it's right about 34.5, that's what you should expect for the rest of the year.

Okay, perfect.

And then a final question just, you know, competition has obviously been around for quite awhile.

I know you've touched on it, but do you have any thoughts with Seeley is expected to launch their Vista line at the bedding show coming up?

No, no thoughts, except that as we've said, we've seen competition in this particular sector for a number of years, and it doesn't surprise us that people will continue to try and gain some foothold in this market.

All right, that's it for me.

Thanks, guys.

Okay.

Thank you.

Thank you very much, sir.

That does it for our Q&A session for today.

I'd like to turn the call back over to Mr.

Bryant for his closing remarks.

Thank you.

And thank you, everyone, for joining us.

We look forward to talking with you again in September at our first Annual Analysts Day, and then again in October when we'll get together to review the third quarter.

Good evening.

Thank you very much, sir.

Thank you, ladies and gentlemen, for your participation in today's conference call.

This concludes the presentation, and you may now disconnect.

Have a good day.