Tempur Sealy International Inc (TPX) 2008 Q1 法說會逐字稿

Hey, everyone, and welcome to the Tempur-Pedic First Quarter Earnings Results Conference Call.

Today's call is being recorded, and at this time, I'd like to turn the conference over to Barry Hytinen, Vice President, Investor Relations.

Please 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.

Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.

Investors are cautioned that forward-looking statements, including the Company's expectations regarding sales and earnings, involve uncertainties.

Actual results may differ due to a variety of factors that could adversely affect the Company's business.

The factors that could cause actual results to differ materially from those identified include economic, competitive, operating, and other factors discussed in the press release issued today.

These factors are also discussed on the Company's SEC filings, including the Company's Annual Report on Form 10-K under the headings Special Note Regarding Forward-Looking Statements and Risk Factors.

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

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

Now, with that introduction, I will turn the call over to Tom.

Thanks, Barry.

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

In total, Tempur-Pedic net sales declined 7% to $247 million.

As we previously announced, our production plans and operating expenses were incurred assuming a much higher sales level.

As a result, earnings were substantially pressured and resulted in earnings per share of $0.18.

The primary area of sales weakness was in the U.S.

The U.S.

microeconomic environment deteriorated during the quarter, which attributed to what we believe was a slowdown in the mattress industry.

Additionally, based on industry data and retailer feedback, we believe average selling prices in the industry are trending lower as many premium buyers defer high-end mattress purchases.

We believe these factors are the primary reason our domestic net sales were below prior expectation.

[I-Channel], our U.S.

direct business, was much more severely impacted, down 45% to $10.7 million.

As we have mentioned before, the U.S.

direct channel generally serves a lower consumer demographic than our core retail customer.

Therefore, we believe it is likely that this sharp drop-off in sales is caused by weakening consumer confidence and corresponding lower spending by [ER] consumers.

While we planned for this channel to be down, it was worse than expected, resulting in gross margin deterioration, which Dale will speak to shortly.

The U.S.

retail channel, while down less than direct, was also much weaker than planned with a decline of 14% to $129 million.

Retailers reported much slower traffic trends throughout the quarter as consumer confidence weakened.

In the U.S., we opened approximately 100 net new furniture and bedding stores in the quarter.

This brings the U.S.

furniture and bedding door count to 6,450 versus our long-term goal of 7,000 to 8,000.

Our medical business was up, reflecting continued progress with our partners, especially Hill-Rom.

Lastly, our U.S.

third party channel delivered $4.3 million of net sales, an increase of $1.3 million, but that was coming off of a weak comparison in the first quarter of 2007.

At this point, it appears U.S.

sales trends may have stabilized.

However, we are mindful that the environment is unstable, and we are not planning for a near-term improvement.

Turning to the international business, we saw weakening trends in many of our key European markets.

While our reported results reflect a 10% increase in sales to $99 million, this is driven by favorable foreign exchange rates.

On a constant currency basis, our international sales actually declined about 3%.

International retail sales were up 14% to $79 million.

We added approximately 70 net new retail doors during the quarter, bringing the international door count to 5,060.

International segment trends worsened in the second half of the quarter, which we believe is consistent with weakening consumer confidence throughout many of our markets.

[Where] lower-than-planned sales and inflationary cost pressures, profitability was considerably impacted.

A combination of large declines in the direct business, raw material cost inflation, and lower volumes resulted in lower gross profit margin.

In addition, first quarter operating expenses were planned and incurred to support a much higher sales level, which negatively impacted operating income.

I will let Dale provide an explanation in a few moments.

Going forward, we are not assuming the sales environment will improve in the near term.

Therefore, we have taken decisive actions to align operating expenses and production plans with revised sales expectations.

We have reduced our operating expenses, aligned variable costs with sales, and reduced our headcount.

The headcount reductions were approximately 10% of our total U.S.

workforce, which we expect will result in about 2.5 million of annualized salary and benefit savings.

We are firmly committed to our business model, our advertising strategy, and our premium product focus.

Our new advertising campaign is helping to drive brand awareness.

Our annual study of brand awareness indicates that our U.S.

total awareness has risen to 89%, reflecting success of the new ad campaign.

As our brand awareness continues to grow, we plan to offer consumers more product choices.

Over the next few quarters, we will begin the most extensive new product launch in the Company's [inaudible] history.

This launch will include new mattress models, advanced technology, and new pillow concepts, as well as an upgrade to the most widely distributed mattress model in our line-up.

We anticipate this launch will be well received by retailers and consumers.

For competitive reasons, much of the launch will remain proprietary until the July Las Vegas trade show.

However, we can tell you today as part of this initiative, we are adjusting our entry-level strategy [while] stay well above the $1,000 price point.

Leading into the formal launch, this will result in closeout activity on the Deluxe and Symphony models, as well as a -- selected sizes of the Original.

Our new models will be available in July.

In summary, while we are very disappointed in the first quarter results, we generated sufficient cash flow and reduced our net debt position.

We are right-sizing the Company to see us through the current headwinds and, importantly, to be in the right position when the market turns.

We know that independent third-party research leads us to believe that high-end U.S.

mattress shoppers are more likely to defer purchases as opposed to trading down in these economic times.

Therefore, we are positioning the Company to capitalize on this demand as consumers return to the market when the environment improves.

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 quarter in a bit more detail.

As Tom focused his commentary on the channels, let's start with products.

Turning to sales results by product, mattresses were down 9%, driven by a 12% decline in units.

Domestic mattress sales declined 18% on a 20% decline in units, reflecting modest ASP improvement despite the weakness in direct, which negatively [affected] ASP.

International segment mattress sales were up 12% on flat units.

In a weak consumer-spending environment, reduced levels of retail traffic, pillows were impacted.

In total, pillows were down 9%, driven by a 17% decline in units.

We experienced weak pillow volumes in both segments, with a 19% decline domestically and a 15% decline internationally.

Other products which typically go along with the sale of a mattress declined less than mattresses and pillows.

Other products declined 4% domestically and grew 16% internationally.

These results are primarily driven by our increased focus on adjustable bed [base attach] rates across the world, which we are improving despite the economic headwind.

We were pleased to see progress in this area as we focus on a complete sleep system.

Gross margin for the quarter was 43.7%, well below prior year and our expectations.

The gross margin was impacted by several factors -- direct sales were much weaker than planned; sales returns increased modestly, about 1 point; costs for raw materials were up sharply; and with lower volumes, fixed costs in our plants were spread across a smaller sales base.

Operating income was $29.3 million, or 11.9% of net sales.

Operating income was negatively impacted by de-leverage of SG&A expenses.

As Tom discussed, our SG&A expenses were planned based on an assumption of a much higher sales level.

When sales trends deteriorated, much of our cost structure was in place, and we were unable to take actions to mitigate de-leverage in the first quarter.

For example, advertising spend is typically committed for at least two months in advance.

Despite this, we still managed to reduce some of our advertising spend in the quarter, and in total, ad spend was about 12% of sales, or 200 basis points higher than we had planned.

Operating expenses also include a $600,000 charge for restructuring related to the headcount reduction, as Tom discussed.

As a result of the de-leverage in the P&L, fully diluted earnings per share was $0.18, compared to $0.35 for the first quarter of 2007.

Turning to the balance sheet, we are very focused on improving cash flow and working capital.

We generated $25 million of cash flow from our operations and reduced debt net of cash by $18 million from year-end.

I would like to point out that our revolving credit facility matures in 2012 and requires no mandatory principal payments until that time.

We are executing on a comprehensive plan to improve cash flow and substantially reduce inventories.

Inventories were high at year-end, as we noted on our last call.

Our plan was to reduce them in the first quarter.

However, with sales trends deteriorating, inventories grew modestly.

Going forward, our operating plan anticipates a large reduction in inventory levels.

We reduced labor in our plant and have decreased our manufacturing [plan].

We are also working to improve day sales outstanding and payable days to drive working capital.

In addition, we have reduced our capital expenditure plans to approximately 14 million for the year versus our $20 million prior forecast.

In the first quarter, we spent $2.8 million on CapEx.

Now, I would like to address our revised guidance for the full-year 2008.

For sales, the Company currently expects full-year net sales to range from 1 billion 10 million to $1 billion 70 million, a decrease of between 9 and 3% from 2007.

For earnings, the Company currently expects diluted earnings per share for 2008 to range from $1.20 to $1.45, a decrease of 31 to 17% compared to 2007.

From a net sales perspective, at the low end, we are assuming U.S.

sales trends do not materially change from what we experienced in the first quarter while allowing for the potential that the international segment deteriorates modestly.

I would like to take this opportunity to note that based on our model, even at the low end of our guidance, we expect to be in full compliance with our debt covenants for the entire year.

We are using a share count of 76 million shares and a full-year tax rate of 34.5%.

As has been our custom, this guidance does not assume the benefit of share repurchases.

We remain focused on improving operating performance and maximizing shareholder value.

We are carefully monitoring business conditions and will be prepared to take additional actions to protect profitability if necessary.

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.

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

Thanks very much.

(OPERATOR INSTRUCTIONS)

And first up, we'll take a question from Piper Jaffray's Tony Gikas.

Hi.

Good afternoon, guys.

A couple trends.

Maybe you could just start out with has there been any change with April sales trends following the quarter.

Also, maybe just a little bit more color on the entry-level strategy, how many new products are coming there, and maybe just a little bit about pricing.

And then two questions on competition.

Is the competition getting better in this category with the visco product?

Are they taking share due to their lower price points?

And do you see the competition taking more pricing action that might also be benefiting their business?

Hey, Tony.

This is Dale.

I'll answer the first part and then have Tom answer the rest.

In terms of the business trends, what we have seen in April is that the business seems to have stabilized.

We're still only about halfway through the month, but the trends in the business overall, as we look at the average for the first quarter, seem to have stabilized in April.

As to your second question, in terms of the new products, we're not going to be in a position to give a lot of details, including how many models we plan to introduce in July.

I would say that you can tell from our closeout announcement that we are closing out two complete models and a couple of sizes in the Original.

And then in July, you'll see a somewhat new strategy as it relates to the entry-level price point for the Company.

But at the same time, I would emphasize that we will continue to focus our attention on the $1,000-and-above price point, so the premium category.

I think your last question had to do with the competition, and first of all, all of our testing -- we do extensive testing.

You may recall about a year ago we invested a considerable amount of money in building a new test facility not only for our products but for the competitors' products.

We haven't seen any significant improvement in the competition.

I think that most of our competitors are buying their memory foam, as they call it, from the same suppliers, so we haven't seen a lot of investment in new facilities or R&D.

As to what's happening out there at retail, we have seen an increase in activity at the retail level in terms of incentives and what we would have seen in the past as temporary [stiffs] and other types of discounts going on.

But from what we've been able to tell, and our best indicator has traditionally been looking at our own account base, those accounts with competing visco compared to accounts where we still have an exclusive footprint in the stores, and we still haven't seen any type of change from the performance of those stores.

So that's not to say that they're not having some success out there.

What we don't know at this time and won't know until we have better data later in the year is exactly how much cannibalization is taking place within a lot of the innerspring brands themselves.

Okay, just a last question is more of a housekeeping -- you talked about headcount reductions, approximately 10% of the workforce.

Could you characterize the headcount reductions in the production facilities?

Yes, I don't think we broke that out specifically.

I think what we said was that we sort of did this across the board.

About the only department that -- two departments that we didn't touch were the sales group and our research and development organization in terms of continuing to develop these new products.

So virtually -- I would say virtually every other department and certainly the production groups were impacted by this, but I don't think we broke out any specific numbers around them.

Okay.

Thank you, guys.

Good luck.

Thanks.

Next up, we'll take a question from John Baugh at Stifel, Nicolaus.

Good afternoon.

Can you discuss the sort of productivity run rate in the first quarter and what you see for the second quarter or the rest of the year as it relates to trying to bring inventory down?

And I guess the offset will be -- it'll be either reducing ad spend or other corporate spending, but I'm just kind of interested in the interplay there, how that affects operating margins going forward.

Yes, this is Dale.

In terms of what we're doing to get inventories down, we have significantly cut back production.

We took out a shift in one of the factories.

So we're trying to get inventory right-sized for the business run rate that we have, and it will probably take a couple quarters to get it completely to where it needs to be, but we're trying to take a pretty good whack at it right now.

And those actions, in terms of cutting back production levels, started in the first quarter, but so that will give us some negative impact in terms of fixed-cost leverage on the flow-through.

That's built into our guidance expectations.

In terms of other costs, we cut costs across the business, discretionary costs.

We have cut back advertising.

We've cut back general marketing.

We've cut back in terms of other corporate spending.

We took out the -- headcount out of the G&A areas.

So we're trying to curtail costs and get costs in line with what -- the profitability level that we feel is minimum acceptable to our standards at a lower volume level.

And as a follow-up [inaudible] inventory, is there any breakout between WIP and raw and finished?

I don't have those right in front of me.

They'll be in the Q, but finished goods continues to be -- just directionally, I think finished goods continues to be higher than we would like.

And then, lastly, with the new product rollouts, and without talking about any specifics, would the plan be essentially a similar targeted gross margin and albeit maybe at an average lower price than the two that you're dropping and whatever [origins] you're replacing?

Or any color on the sort of expected profit margin of the new products?

Yes, one of our goals has been and continues to be -- any time we introduce a new product is to have equal or better margin on that product, and that will still be the direction that we go in with these new products.

Thank you.

Next up, we have a question from Joe Altobello at Oppenheimer.

Hey, guys.

Good afternoon.

First question is on the gross margin side.

There's a couple of different sort of crosswinds here.

You've got raw materials going up, and I imagine you'll be taking out a lot of variable costs in your cost of goods.

So in terms of the gross margin decline in the first quarter, would you expect the declines going forward to be greater or lesser than what we saw in 1Q?

Well, the anticipation that we have is that the gross margin impact that we saw in 1Q, which was severe, would be a little bit less as the year goes on.

We're going to be take -- certainly, cutting production does impact the fixed cost portion.

Fuel -- from a fuel surcharge standpoint, fuel costs are through the roof right now, so we're incurring heavy fuel surcharges on freight, but the chemical costs are in, so we've seen that.

We've experienced it now.

We would expect as the year progresses for the productivity initiatives that we have in the business this year to gain more traction and be able to deliver more results.

So we would at this point think that we would see some modest improvement in gross margin as the year progresses.

Okay.

And then in terms of your retailers, are they at sort of a disadvantage with your product given that consumers are obviously moving down to lower price points or the retailer can offer your competitors' products with a promotion, whereas they sort of have their hands tied behind their back with your products as they can't promote on that?

Have they given you any pushback on that no promotion sort of dictum?

No, they haven't.

I mean, obviously, our partners -- our retail partners continue to promote and advertise in the local markets Tempur-Pedic, and tying in with our extensive national campaign, but in terms of pushback or, for example, allowing them to discount the products the way they do the competitors, no, we really haven't had any pushback there.

Okay.

And then, lastly, the international business, ex foreign exchange, looked like it was weak, not as weak as the U.S.

but still relatively weak.

Are the issues internationally similar to the ones you're seeing in the U.S., where you've got just low consumer sentiment and a slowing economy?

Yes, we -- as the quarter progressed, and really in March, we saw the international business weaken.

The U.K.

as a country -- not that we're going to get into details about the individual country performance -- but the U.K.

has been the first economy in Europe to react to -- or to share in the U.S.

economic weakness, and that really started last year.

But as the quarter progressed, we saw other markets in England -- Europe start to have some impact as the economic weakness spreads a little bit.

We think that we have a good view of where it's at and where it's going in terms of our business in Europe, but part of the reason why we had a little bit broader range is -- you know, at the low end, as we said, the low end of our range that we've now put out there does not assume improvement in the U.S.

and calls for Europe to get a little bit softer.

Okay.

And then, lastly, if I could, two quick ones.

Your plans for any share buybacks and progress on the new CEO search?

I'll take the first one.

In terms of the share buyback, we have a credit facility.

Any share buybacks that you would do are somewhat limited by the current credit facility in terms of available capacity.

In times of economic weakness and uncertain business environment, I think the most prudent thing to do -- not that we would rule out buying shares at any time, but at this point, I think the most prudent thing to do is to make sure that we're monitoring and completely confident in the liquidity of the business, which we are today, but it's something that we have to make sure is there.

So share buybacks would have -- be a lower priority than they've been at other times in our history.

And as far as your second question on the search, without giving out any details, we'd just say that the search is on schedule and progressing, and it's about where we expected it to be at this point in time.

Okay, great.

Thanks.

Question now from Morgan Keegan's Laura Champine.

Hi.

Could you give us any more clarity on what is driving the -- it's a 51% year-over-year increase in inventory, but also, it's a sequential increase.

Can you give us what of that is attributable to higher raw materials, prices, differences in your purchasing, lead-times, and what's just because of the sales declines?

In terms of year over year, we were still trying to build inventory last year, and we've built the inventories through the first -- actually, we built it all year.

We ended up ending as -- the year with more inventory than we had planned and expected to have as the business started to soften in the fourth quarter.

We talked about that at length on the call discussing the fourth quarter result.

Our plan at that time was to try to impact inventories in the first quarter, but as the business continued to deteriorate, it's hard to catch a rock rolling downhill.

So the key thing in terms of looking at inventory is sequential.

We were able to keep inventories -- with revenue in the first quarter being down significantly from fourth quarter, we were able to keep it to only a modest increase.

As the business softened, it was difficult to catch up to that, but we feel that we're now in a position to catch up and get inventories turned back the right direction this quarter.

We've taken pretty drastic action there, and we will get that corrected.

Year-over-year basis, it's really not a reasonable compare as last year.

We had shortages.

We were trying to ramp up a new factory.

We were trying to get inventories built to a higher level because they were too low.

Okay.

Can you give us an idea of where we ought to see inventory levels at year-end?

Well, that partly depends on where the business volumes are at that -- running at that point in time and how that plays on a go-forward basis.

We typically try to have roughly about 30 days forward of finished goods and a little bit more than -- raw and WIP on top of that, but that you would expect for inventories to be substantially lower than they are now and more in line with what -- where they were running throughout the year in maybe second and third quarter last year.

Okay.

And then just to get to your earnings guidance, I've got to make pretty aggressive assumptions about margins improving from the depressed levels in Q1, and you mentioned sales and marketing as an area of savings.

How can you execute savings and sales and marketing at the same time you've got a major product launch coming in the back half of this year?

Well, one of the things that we've said that we've always tried to do is align our marketing spend with our revenue growth, and we've talked extensively about trying to use media at around a 9 to 10% of revenue as an investment.

That still gives us substantial capital to put behind our brand.

And, also, I'd remind the listeners that we don't necessarily do product-specific advertising.

So when we launch new products, it's not like we're launching a new campaign.

We have a branded strategy in terms of our -- advertising our message, and that umbrella brand basically drives the overall model without having to spend specifically behind an existing product or new product.

So our plan is to continue to invest, still be the leader in the industry in terms of consumer advertising by a big, long range, so we'll continue that strategy.

Thank you.

(OPERATOR INSTRUCTIONS)

We will move on to Al Kabili from Goldman Sachs.

Good afternoon, guys.

I guess the first question on the gross margins is if you could perhaps break down for us how much of the decrease was raw materials versus fixed-cost absorption during the quarter.

Well, there were a number of factors that impacted gross margin, not just those two, a variety of things that gave us some -- the channel mix, you know, direct was down dramatically on a year-over-year basis.

Our U.S.

direct business was down 45%.

Our global direct was down 41%.

That's by far the highest margin channel.

Certainly, we expected direct to be down but nowhere near those kind of -- magnitude.

And so direct was a very significant factor in the gross margin de-leverage.

Certainly, factory -- fixed cost was a factor.

The chemical costs were up double digits.

We were expecting chemical cost increases.

The increases came in a little bit higher than what we were expecting, but we think that we can offset some of that as we go forward.

Sales returns were up about a percent and -- as I said, on the prepared remarks, and that's a big factor in gross margins.

Trying to understand why the primary thing is just as -- we believe as the economy weakens, consumers that had bought recently saw it as an opportunity to claw back some money, so all those factors contributed mightily to the gross margin erosion that we saw.

Okay.

And if I got that right -- so chemical costs were up double digits.

And if you don't assume that sales trends improve and you're going to take down your production levels to get your inventory down to where you want it, what's the offset to get the margins improved from the first quarter?

Well, we have a number of productivity factor -- projects that are underway, things that we're working on that we believe we'll be able to improve our cost of production and offset some of these factors, that will give us some margin improvement as we go forward.

Okay, because just with the 2.5 million run rate savings of the workforce reduction, it doesn't sound like that would be enough to do it.

That's the OpEx impact.

That's not the savings related to labor.

We didn't separately quantify the labor cost, but certainly, that's a very small component of our cost of goods and a variable cost.

The 2.5 million is SG&A-related cost savings for the people that were taken out of SG&A.

Okay, got it.

And any way to quantify in terms of on the cost of goods side, on the production side, what the opportunity is on the cost savings that is incremental to the first quarter?

You know, basically, all -- what I'll do from a quantification standpoint is say what I've said already, that we have a number of productivity projects that are underway that are being worked, and we believe that the first quarter gross margins will be the worst gross margins that we've -- have, and we'll see improvement from here.

Okay.

And then if you could just talk about the sales trends you saw throughout the first quarter.

Did it continue to decrease throughout the quarter?

Can you just kind of give us a sense on the sales progression throughout the quarter?

We don't give a lot of color on quarterly progression of sales trends.

We said on the call, talking about the fourth quarter results, that the first quarter did not start the way that we were expecting, so it started weak.

Then it continued the slowdown that we saw late in the year, things got a little bit worse, and then they seem to have been stabilizing now.

Okay.

From a stability standpoint, it's over the average of the quarter.

Got it.

Okay.

So when you're talking about stabilization in April, you're talking about from the average of the quarter, not necessarily from the low point in, say, March?

Correct.

Okay.

And then the final question is on the cash flow statement.

I see you -- there was a small, I think, $1.5 million acquisition, it looks like.

If you could just -- I assume it's an international distributor?

Yes, we bought New Zealand.

Last September, we bought Australia.

We bought -- went ahead and bought a distributor in New Zealand to fold basically as a branch under the Australia business.

Okay, and it sounds small.

Any quantification in terms of revenues that it --

We did about 300,000 in the first quarter in New Zealand, up a little bit from prior years, but it is a small business that -- at that kind of a price, it's not going to be a very big business.

Okay.

And then final question.

Any pressure that you're seeing from your retail customers in terms of pricing?

As we're going into a weaker environment, are you seeing pressure for increased incentives and volume discounts, anything like that?

No, we're not, and I think probably the reason for that is that the majority of our retailers that we've been doing business with for quite a while, they understand our approach to the business.

They understand that we are going to continue to invest capital behind the brand and driving consumers into the store compared to discounting and looking at short-term initiatives that will damage the brand in the long term.

Okay.

Thanks very much, guys.

Moving on now to a question from Mark Rupe, Longbow Research.

Hey, guys.

Just on the entry-level strategy, just going back to that real fast, outside of the fact that people are trading down and the economy's kind of in the tank, are there any changes that you've seen in that market opportunity over the past three years since you've kind of entered it with the Original?

Is there anything different that you're seeing?

No, I think that the premium market overall -- just as a reminder, that's the queen-size mattress selling at retail for $1,000 or above -- that premium market has been the key driver of the industry for a number of years.

There's still a relatively small percentage, if you will, of the installed base out there, and we think that there's a lot of upside within that premium market.

As a matter of fact, you can research that we recently saw -- indicated that while the premium sector is about 25% of the installed base, 46% of consumers surveyed who intend to buy a mattress over the next five years indicate that they will be buying a premium mattress.

Right.

So I think a lot of the consumers' perception around mattresses and price points and better night's sleep and all of those factors will continue to drive the premium market, but as we said, we also believe that some consumers are deferring -- the premium buyers are deferring compared to trading down necessarily.

Right.

I didn't know if there was a demographic issue going on, as well, but -- as it relates to the retailers, again, the last time that the industry probably went through something this bad, the retail landscape was a lot more fragmented, and you have a handful of power retailers kind of selling mattresses.

Curious to see if there's any kind of differentiation on the performance at retail right now between your furniture stores and your -- kind of your specialty bedding stores.

Generally, I think the bedding guys are not being impacted as bad, but from what we hear, they're all having difficulty.

Right.

And their business is down.

But the bigger bedding guys are probably compared to the masses performing a little better.

Perfect.

Great.

Thank you.

From SunTrust, this is Keith Hughes.

Thank you.

You've talked a lot about raw materials, but as we head into the second quarter, are you seeing more signs of potential raw material increases as you talk to your supplier?

Not at this time.

Certainly is something that we're mindful of and watching and working, but we think right now we've got what we're going to get.

Doesn't mean it can't change, but no pressure as of the moment.

No pending increase is what you're saying?

Right.

Yes, okay.

The -- if you do see more, will there be an attempt to try to raise price on existing models, or would you try to efficiency your way through it, as you discussed earlier?

Well, I guess that would depend on how things are going, but ideally, we are not happy with the first quarter business results.

It's not what we're accustomed to.

It's not what we -- how we want to run the business, and we're going to -- as we said, we've taken actions to right-size the business, to get cost structure back in line, to improve the profitability, and we're going to be prepared to take additional actions if we need to, but we're going to try to, for the time being, improve from where we're at based on the actions that we've already taken and continue to [efficiency] improvements.

Final question.

Dale, can you give us the units in pillows, international versus U.S.?

Let's see here.

U.S.

units in pillows were down 19%, and international pillows were down 15%.

All right.

Thank you, Dale.

We have a question now from Budd Bugatch at Raymond James.

Good afternoon.

Thank you for taking my questions.

Just as you reflect on the first quarter, and I know you don't like giving any granularity as to how it progressed during the quarter, but as you reflect now based upon the way the quarter wound up, is there any likelihood that the price increase for January 2 -- how much volume that might've pulled forward and so that the -- all 14% of domestic retail is really higher than the market was off because the retailers had too much inventory going in the quarter?

Well, based on our internal data and looking at the SKUs and the various models that we took price on but also, obviously, the majority of the line that we didn't, we really couldn't draw any conclusions along the lines that you were -- question you were asking, so we really didn't see any significant pull forward from that standpoint.

Okay.

And with the large product launch coming forward, how do you plan to help your retailers clear their floor inventory?

Aren't there going to be -- have to give them that markdown money, and where does that get accounted for, and can you kind of size what you think that will be?

Sure.

Part of our closeout, and we've done this in the past when we've had closeout, is that we do offer some help to the retailers to help them push the product out the door.

In this particular case, it will amount to approximately about a 3% impact on those models that I mentioned that we were closing out.

And that is accounted for in the guidance that we've given, and we'll obviously run through on the margin line in terms of cost and discount.

So I'm confused a bit on that, Tom.

Is that on new product that you ship to them so your existing inventory, or is that on inventory that's on their floor to help them move goods?

That's on the products that we are shipping to them in terms of new orders.

So that will be -- that will be -- therefore, come off your sales line and, therefore, impact the gross margin line?

That's correct, yes.

So my question then is you -- Dale had promised or [insighted] into increasing gross margins, which is -- that's another thing that you'll have to overcome during the -- during the next couple of quarters.

How will you be able to do that?

And we factor -- obviously factor that into our guidance.

We -- as I said, if you look at it in terms of the percentage and the impact, it's not a major discrepancy from our normal margins, and that we've got, I think, a pretty good handle on it in terms of what we expect and built that in.

So it's 300 basis points on what you ship to do that.

Is there a dollar number you could elucidate on that?

Let me just correct one thing.

It's 3% off of wholesale price.

3% off of the wholesale price that you ship to them.

That's your sales dollar on the items you're going to ship to them, right, Dale?

Right.

And is there a dollar amount that you could -- [inaudible] and when will we see that, second or third quarter or both?

You'll see some of the impact of that in the second quarter and some clean-up in the early third quarter.

So 80/20?

80% on the second?

It's hard to gauge, but probably -- certainly, there's a couple months left in the second quarter, and the new products should be out there by the -- you know, late July.

So the bulk of that impact would be in the second quarter, yes.

So you'll have the product in place to the retailers by late July?

You're going to introduce it at Vegas and have it to the retailers by late July?

The plan is to start shipping it right away when it's introduced to the retailers.

But you've got 6,400 doors you've got to get it to.

You can get it all done in -- by late July?

The new products will be a transition in -- from July through the third quarter, but we plan to have them replaced fairly quickly.

Okay.

Just two other quick questions.

Do you usually break out R&D on the income statement?

Is there a reason why you haven't?

And will it be in the Q, or can you give us the number or --

Yes, it will be in the Q.

We didn't just because -- to try to clean it up a little bit because most people don't break it out.

In the first quarter, R&D was 1.8 million.

Okay.

And my last question.

I just want to make sure I understand the inventory bogie, and, actually, I have two more questions.

I apologize.

The inventory bogie, you said it's 30 days forward sales or cost of sales for the finished goods?

Is that right?

Plus WIP and raw materials?

Yes, that's what we typically try to run.

So it's 30 forward days cost of sales because that's your wholesale price, right?

Yes.

How would you characterize that, 30 days cost of sales or 30 days forward sales?

30 days on our cost.

30 days on your cost.

Okay.

And you -- finally, you did say you're not going to -- you don't believe you'll trip the covenant, and I can see in your guidance where you don't trip the three times debt-to-EBITDA covenant, but on the -- even on the high end of the guidance, it looks like you do trip to 2.5 times, at least at the current debt level, which would raise your current borrowing cost from that point forward of, I think, by about 30 BIPS?

Correct.

Does that mean you're either going to pay the debt down to lose -- to avoid that, or should we expect an increase in borrowing costs in the out years?

Well, I mean we expect to pay the debt down some as the year progresses with cash flow, and it's possible that we'll see a 30-BIP increase in borrowing costs.

Got you.

Thank you, Dale.

Thank you, Tom.

Next up from Hilliard Lyons, this is Joel Havard.

Thank you.

Good afternoon, everybody.

I guess I'm piling on the gross margin question, too.

If I'm getting this right, the product is in development.

It will be shown at market, shipped over the course of Q3.

Where do the closeout windows affect us?

Over the quarters because --

I'm sorry, Tom.

Is that Q2 and Q3 or kind of over the rest of the year?

How does that typically work?

Q2, Q3.

I mean we -- once we start shipping the new products in July, that transition will go pretty quickly.

Between now and July, we will be closing out the existing product, and that margin impact that we talked about, that 3% off the wholesale price, will start impacting us in the second quarter, and we'll run some of that through third quarter.

Got it.

Okay, and not to get too particular on the product itself, but did you say in your prepared remarks that there are three that are essentially being replaced and a totally new one or two, as well?

What was this?

Just to clarify, what we said was we would be closing out specific models --

Deluxe, Symphony, and Original, if I got it?

The Deluxe.

The Symphony.

The Original -- so we're only closing out a couple of SKUs in terms of sizes.

The majority of the product that we sell on the Original is being utilized at the -- what we call the youth market for kids, and so we're going -- we have a plan to capitalize on that going forward.

So we'll be -- we're not going to close out the total line on the Original but only the large sizes -- the queens, the kings, Cal kings.

So it's two models and some sizes on one of the third model, the Original.

Okay.

And there was or was not a totally new product platform in addition?

Yes, we talked about that we would be launching new products in July, but we didn't elaborate on --

I'm sorry, okay.

-- what those products are going to be.

All right, good.

Thanks.

One other for Dale.

Dale, when you mentioned that returns were up a percent --

Yes?

-- was that to say that they were kind of double last year's rate?

No.

Last year, returns were -- I don't have the last year's numbers.

I've got a note in my model that it was kind of running about a percent a year ago.

Did you mean it was running at 2% of sales right now on an annualized basis or that it was up just incrementally?

I -- up incrementally.

Last year, this [inaudible], it was 4 point -- it was running about 4.3% last year, and it's in the first quarter running about 5 point --

Four versus five.

-- 5.1-ish percent.

Got it.

Okay.

Thanks.

Good luck, guys.

[Inaudible].

I just wanted to make one clarifying item on the closeout.

Keep in mind, we've got nine models.

Really, we're only -- we're closing it out on two of the nine models in terms of full impact on the closeout, so it's not every product that we sell is suddenly going to be impacted by the closeout.

It's only a couple of -- two out of nine models.

We'll move on to the next question.

This is Bob Drbul at Lehman Brothers.

This is actually [Matt McClintock] filling in for Bob.

Good evening.

Hi, Matt.

Just a quick question.

I just -- I want to -- it's more theoretical than anything.

I just want to get an understanding of your thoughts between -- on how you want to manage production levels between Albuquerque and Virginia given the slowdown, how you think about that, and are you still shipping units from Virginia to California?

You may recall when we opened the new facility, we talked about how the demand for the product was pretty well split geographically in the West Coast/East Coast, and that the savings that we would get on the freight side from shipping out of Albuquerque is a Western and Northwest part of the country.

And that still holds.

I mean we'll still apply -- if you think about it, almost split down the middle of the country in terms of east and west.

Okay.

So you plan to do the production for the West Coast from Albuquerque still.

And are you actually still shipping units from Virginia?

Yes.

Okay, thanks.

Not to West Coast, though.

Not to the West Coast.

Okay.

No.

Thank you.

Virginia, as I said, would be supplying more of the East Coast.

Perfect.

Next up from Merriman Curhan Ford, this is Robert Straus.

Hi, guys.

How are you?

Hi, Robert.

Hi, Robert.

Just a -- really one quick question.

At retail for both existing stores, as well as new stores, what kind of trends have you seen as it relates to the slots that you have or the slots that you are looking to acquire?

We've -- we have continued to see our average slot per store go up, and as we prepare to launch these new initiatives in July, our expectations are that we will be successful at just continuing to gain incremental slots around some of those new products.

Thank you very much.

Okay.

With that, ladies and gentlemen, we will conclude the question-and-answer session.

I'd like to turn things back over to our presenters for any additional or closing remarks.

This is Tom Bryant.

We just wanted to thank you for joining us this evening.

We look forward to talking to you again in July, when we'll review the second quarter.

Thank you.

Thanks again for joining, ladies and gentlemen.

That will conclude the conference call.

Have a good evening.