Apr 8, 2008
Executives
Lawrence Rogers – Interim Chief Executive Officer, President, North America Jeffrey Ackerman – Executive Vice President, Chief Financial Officer Mark Boehmer – Treasurer Kenneth Walker – Senior Vice President, General Counsel and Secretary
Analysts
Albert Kabili - Goldman Sachs Keith Hughes - Suntrust Robinson Humphrey Chad [Bowman] - Raymond James Joel Harvard - Hilliard Lyons Ike Borcia - Morgan Keegan [Kerry] Martinson - Deutsche Bank [Christian Othen] – Lehman Brothers [Mark Group] – [Lebeau Research]
Operator
Good day and welcome to the Sealy Corporations first quarter fiscal 2008 earnings conference call. Today’s conference is being recorded.
At this time I would like to turn the call over to Mr. Kenneth Walker, Senior Vice President, General Counsel and Secretary of Sealy Corporation.
Kenneth Walker
Good afternoon everyone. I want to thank you for joining us on Sealy’s financial first quarter 2008 investor conference call.
Before we begin let me remind you that in accordance with the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995 the company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements. Such statements are subject to risks, uncertainties and other factors that may cause the actual performance of Sealy to be materially different from the performance indicated or implied by such statements.
Such risk factors are set forth in the company’s annual report on form 10K for the year ended December 2, 2007. Now I’ll turn the call over to Larry Rogers, Interim Chief Executive Officer of Sealy Corporation.
Lawrence Rogers
Good afternoon. Thank you, Ken.
I’d like to also thank all of you for joining us on our call to discuss Sealy’s first quarter results. Joining me today are Jeff Ackerman our Chief Financial Officer and Mark Boehmer our Treasurer.
On this call I will give an overview of our first quarter results as well as an update on the progress we are making on our Posturepedic launch and our strategic operating initiatives. Jeff will go into more detail on our first quarter results and then we will open the line to your questions.
I want to start out by expressing my commitment to lead Sealy as its Interim CEO during this important time in our evolution. I have been with the company nearly 29 years and during that time I have had the benefit of overseeing many aspects of our domestic and international businesses.
My transition into the Interim CEO role has been very smooth thus far thanks to our comprehensive succession plans and the breadth and depth of our management team. I have been responsible for managing our long-standing relationships with our customers for many years and I will continue to strengthen these efforts.
I have also already been fully involved in developing our key strategic initiatives including leading the important launch of our new Posturepedic line. As previously communicated, we are conducting a search for a permanent CEO.
In the mean time we will focus our efforts on what we can control including continuing to execute on the strategic initiatives that we outlined on our last call. We do not expect any significant changes to this strategy, but we do intend to be proactive from a product and cost perspective.
We are disappointed in our overall results for the first quarter which were below our expectations coming into the year. As we mentioned in our March 4 update, this is primarily due to a short fall in our domestic sales performance as the quarter progressed.
Throughout December and January our domestic sales trends were challenged, but generally in line with our expectations. In February our domestic sales dropped off further, beyond what we initially planned.
However, we have continued to see positive initial reception to our new Posturepedic products as they hit retailer’s floors. Let me provide some context to our results from an industry perspective.
The last time we experienced industry conditions such as we have today was the early 1970’s when the U.S. economy suffered from a combination of oil price shocks and high inflation among other issues.
The domestic mattress industry is certainly tough today. We are seeing manufacturers struggle with cost inflation in steel and foam.
The industry is experiencing regional weaknesses in Florida and California, which has added to the pressure retailer’s are feeling from the down turn in consumer spending has affected demand and customer traffic. We recognize the current situation in the industry is difficult but Sealy has weathered these times before.
We believe we are taking appropriate steps to manage our cost structure and make the right decisions to drive long-term profitability. In addition to industry headwinds, there are several factors that contributed to the significant softening in our domestic sales.
First, we are experiencing some of the negative sales and margin impact typically seen during a product line transition as accounts make room for our new Posturepedic line. Second, a few of our accounts such as Levitz and Wicks fell victim over the last year to the difficult economic environment which has had an impact on our sales as we lost some distribution.
However, we expect to get some of this business to return as those stores are sold and re-opened by different home furnishing and mattress retailers. Sealy is well diversified with respect to our domestic customer base with over 2,900 customers.
In the normal course of business customers, slots and skews evolve on an ongoing basis. We have also won some new domestic business that should help us make up these losses.
Therefore we do not expect these changes to have a meaningful, long-term impact. I now would like to provide an update on some of our strategic initiatives.
Our first initiative is to drive average unit selling price growth through: 1. Product mix shift with new introductions.
2. Slot conversion to higher price points.
3. Selective price increases.
We already began to realize progress in the first quarter improving our domestic average unit selling price by approximately 7/10 % compared to the fourth quarter of 2007. This is primarily due to the price increase we implemented in December 2007 taking hold.
We remain optimistic that the current launch of our new Posturepedic line in combination with our second half launch of additional Posturepedic latex specialty products will help us to recapture sales in this high end segment and drive further average unit selling price growth over time as we improve the sales mix. In the middle of March we began shipping floor samples of the new Posturepedic line which puts the launch on track with our current plans and we continue to expect to have the accelerated roll out completed by the end of the third quarter.
This is significantly ahead of our launch in 2006 and should help us start to realize the financial benefit from the new line during the third quarter. Importantly, our roll out is well underway to two of our first tier retailers and we continue to receive positive feedback on the product and its associated point of sale materials from these customers.
Our second strategic initiative is to implement new advertising and marketing strategies for our retail and direct to consumer advertising on our Sealy Posturepedic brand. We have already developed and are in the process of distributing new simplified point of sale and advertising materials for our Posturepedic line based on the “No Toss and Turn” position.
Regarding the second stage of our marketing plan for later in the year we have focused on making certain this strategy is well planned, backed with quantitative research and will be effective with our customers. Our approach will be very targeted and will focus on return on investment.
Our third strategic initiative is to improve our gross margins. While our December price increase benefited our first quarter margins, this was more than off set by the impact of heightened cost input pressures.
We cannot control raw material prices but we remain focused on mitigating their impact and looking at ways to reduce our exposure to the highest cost materials. We have started to see improvements in our specialty margins as we took pricing and began to realize improvements in our supply chain.
We expect specialty margins to continue to increase as the result of cost engineering, further supply chain enhancements and our improved product mix. Our overall specialty margins currently remain below the company average but we believe this represents an opportunity for us over the long term.
Additionally, we anticipate that the step up [straight] our new Posturepedic line which features improved manufacturability will drive a mix shift to higher sales into higher margins above the $1,000 price points. Our fourth strategic initiative is to reduce our fixed operating expenses; selling, logistics and infrastructure as well as our product launch costs.
We already realized progress towards this goal in the first quarter as some of our initiatives to rationalize our costs began to take hold enabling us to report a decrease in SG&A on both a dollar basis and as a percentage of revenues. As we previously announced we took additional action at the end of the first quarter with the implementation of several initiatives designed to accelerate our cost reductions.
These include organizational realignments and reducing our product launch costs among other areas. We will continue to work to reduce our compensation costs and look for opportunities to refine our headcount as necessary without sacrificing our execution or performance.
We are looking for additional opportunities to reduce our cost structure and build on the actions we have previously implemented. Our fifth strategic initiative is to continue our commitment to building the specialty business.
Our specialty business continues to be healthy helping to mitigate the softness we are experiencing in our domestic inner spring business as we are able to leverage our broad distribution with our strong product offerings. Over the past few years our specialty business has grown significantly in size and is now a meaningful part of our business.
While the growth rate moderated in the quarter and is off on a larger base and our branded specialty sales were still up a solid 17%, balance between a 9% growth in units and a 7% increase in average unit selling price over the first quarter of 2007. Given this ongoing success with our latex products, we continue to believe this product line is going to be a major driver of our business over the long term.
As I previously mentioned we are planning to introduce several additional Posturepedic Latex products in the second half of 2008. We have also already begun our second latex line at our U.S.
manufacturing facility. As we previously communicated we expect this line to be fully operational by the end of the third quarter which will help support our growth plans and eliminate the current need to import cores from Europe.
Our final key strategic initiative is to continue to build our international momentum as we drive towards capturing 1/3 of our growth from this business. In our first quarter our international sales increased 15% driven by solid performance in Europe where we are seeing improving profitability in addition to performance in South America, Mexico and our Asian joint ventures.
As I mentioned in our last call, Canada is experiencing some of the same pressures as the U.S. but we expect to continue to outperform the market due to our strong positioning and the similar reaction we are receiving on our new Posturepedic inner spring launch.
We believe our strategic initiatives are key to driving profitable growth in the future. The industry environment is shaping up tougher than we anticipated and the market continues to be competitive but we will continue to make progress on these initiatives and keep a diligent focus on managing our costs.
As announced today we decided to suspend the dividend. This decision was taken to strengthen our balance sheet and support continued investment in the long term growth of the business.
We felt it was a prudent action at this point and time to improve our financial flexibility given the high level of uncertainty in the economy, particularly around the credit markets, commodity inflation and the retail environment. We can’t control the external factors but we are focused on managing the parts of our business that we can control.
We have seen challenging times before and I have helped Sealy weather these periods and emerge a stronger company due to our diversity in terms of geographies, technologies and products. This time is no different.
The strength of our brand and our customer relationships form the basis of our industry leading position. We are going to continue to focus on successfully executing on the launch of our new Posturepedic line and building on the solid growth in our specialty and international businesses.
We know we must execute, innovate and operate more efficiently to retain and grow our position as the industry leader. We are still driving towards our long term goals and we are confident that our company will continue to deliver positive cash flow.
I will now turn the call over to Jeff Ackerman, our CFO.
Jeffrey Ackerman
Thanks Larry. I would now like to walk you through the financial details.
For the first quarter total sales were $391.9 million, a decrease of 5% compared to the prior year. Net income was $16.2 million or $0.17 per diluted share compared to $24.6 million or $0.26 per diluted share in the same period of 2007.
I’ll now go into more detail on the components of our first quarter sales results. Total domestic net sales fell by 11.2% year-over-year to $281.3 million.
Wholesale domestic net sales, which exclude sales to third parties from our [component] plants were down 11.7% to $276.8 million and were impacted by a 10.5% drop in our unit volume and a 1.4% decrease in our average unit selling price (AUSP). Our domestic AUSP fell slightly in the quarter on a year-over-year basis due to a shift in our inner spring mix.
However, our AUSP started to increase sequentially up 0.7% from the fourth quarter due to the pricing increase we implemented which started to take effect in January. In order to maintain year-over-year comparability starting with our first quarter we made the decision to provide wholesale domestic AUSP and unit growth data.
By excluding sales from our component plant in the U.S. we believe these metrics will yield better insight into our core business.
The decline in our wholesale domestic unit volume is primarily attributable to company specific factors such as customers transitioning to our new Posturepedic line and the store closures that Larry mentioned earlier. In addition we continue to experience a lower mix of Sealy promotional product sales due to the success of the Sealy Posturepedic Reserve Line which offers higher AUSP’s but lower sales velocity.
Over time we expect many of these slots to be replaced by our new Posturepedic products. All of this was partially off set by continued unit growth in our branded specialty bedding where we believe we continue to gain share.
Branded specialty bedding sales increased 17% in the U.S. composed of a balanced 9% unit growth and 7% AUSP increase.
This was driven by the continued strong demand for our branded latex business which was up 24% in the first quarter as well as 9% increase in our TrueForm business. Internationally sales grew to $110.6 million, an increase of 15% over the comparable year period or 9% on constant currency basis.
The growth in our overall international business was driven by a 18.6% increase in unit volume. This was partially off set by a decline in AUSP primarily due to increased sales of lower priced OEM products in Europe as we continue to experience OEM sales that out pace finished goods sales as we work to better utilize our available capacity in Europe.
Our Canadian sales were up 10% but that market is facing some of the same pressures as the U.S. On a local currency basis sales decreased 6% due to a 7% declining unit partially off set by a 1% increase in AUSP.
In our European market sales were up over 21% in the quarter or 7.5% on a local currency basis. The growth in sales and local currency turn was driven by a 44% increase in unit volume which was partially off set by a 25% decline in AUSP.
Both the unit growth and decrease in AUSP were driven by higher sales of our OEM latex bed cores which carry both lower prices and margins. Our total gross profit fell by $24.1 million from the same period a year earlier to $153.2 million.
Domestic gross profit was 41.1% of domestic net sales in the first quarter of 2008 compared to 44.4% in the first quarter of 2007. This was primarily driven by the increase in material costs including $5 million in incremental FR costs as well as price inflation on steel and foam inputs.
The year-over-year impact of FR costs should dissipate in the back half of 2008 as we anniversary last year’s July 1 compliance deadline for the new FR standards. Gross margins were also impacted by higher warranty reserves and de-leveraging of our overhead expense on lower volume.
Partially off setting these items were continued improvements in manufacturing efficiencies including improved labor productivity and lower product scrap costs. International gross profit was $40.5 million or 36.6% of international net sales as compared to 38.2% in the first quarter of last year.
While our gross profit margin in Canada remained essentially flat at 43% of net sales, the decline in our overall international gross margins was driven by a product mix shift in our European business. SG&A expenses declined by $10.2 million or 8% from the same period a year ago to $116.7 million.
As a percent of net sales, SG&A expenses improved by approximately 100 basis points to 29.8% from 30.8% in last year’s first quarter. The decrease in SG&A expenses in both absolute dollars and as a percent of sales was driven primarily by initiatives to reduce advertising, compensation and other corporate overhead expenses in addition to low product launch costs.
These factors were partially off set by higher delivery expenses from increased diesel fuel prices, higher foreign currency valuations relative to the U.S. dollar and increased volumes in Mexico and Europe.
In addition we implemented initiatives at the end of the first quarter to accelerate our cost reductions which resulted in $900,000 of severance costs associated with personnel reductions but are expected to provide additional annualized savings of approximately $2 million. As we previously communicated, we are reviewing our cost structure to identify further opportunities to take costs out of our system.
Now on to the balance sheet. Looking first to the accounts receivable, our domestic day sales outstanding was 36 days, which was one day better than the same period a year ago.
International day sales outstanding were four days higher. Overall day’s inventory on hand increased two days, driven by our domestic inventory on hand which increased by approximately two days to 25 days from the prior year.
This was due primarily to an increase in in-transit inventory from suppliers. Internationally days on hand was two days better than the same period last year.
Our day’s payable increased five days. Domestic day’s payable decreased by one day as compared to the same period a year ago to 62 days and international days payable increased 13 days.
Turning to cash flow. For the first quarter of 2008 cash flow from operations declined by $1.7 million over the prior year to $2.5 million as the decrease in net income we experienced was partially off set by improvements in working capital.
Capital expenditures totaled $9.1 million for the first quarter ended March 2, 2008, down from $12.9 million in the prior year. The company’s debt net of cash was $795.2 million on March 2, 2008 compared to $803 million at the end of the first quarter of fiscal 2007.
As of March 2, 2008, Sealy’s leverage ratio of net debt to adjusted EBITDA was defined by our credit agreement was 3.9 to 1, below the required 5.5 to 1. The maximum leverage allowable in our credit agreement does step down to 4.25 to 1 in the second quarter and we have identified several opportunities to preserve our financial flexibility.
These include: reducing costs through the initiatives previously discussed, aggressively managing our working capital and scrutinizing the return on investment assumptions surrounding discretionary spending and potentially delaying or eliminating some additional capital expenditures. Let me now provide some brief commentary on what we are seeing thus far in the second quarter.
As Larry mentioned the initial feedback we are receiving from our customers on the new Posturepedic line continues to be positive and we are on track to have this fully rolled out by the end of the third quarter. Second quarter revenues are typically lower than first quarter sales and it is important to remember that floor samples are often discounted which as previously communicated will impact our second quarter sales and gross margin.
Material costs including our steel and petroleum based input products have also continued to rise and exert pressure on our margins. Now expect steel and foam prices to outpace the estimates we had at the beginning of the year.
Therefore we are taking additional actions to mitigate the effects of these increases such as opportunistically purchasing raw materials, identifying more cost effective FR solutions and exploring opportunities to utilize less expensive substitute material. However, we expect our product launch costs to be $15-20 million higher in the second quarter than the first quarter due to accelerated launch of our Posturepedic line.
Given the difficult industry conditions, we are focused on the items that we can control and we are doing everything we can to ensure our Posturepedic launch is a complete success. As Larry mentioned the launch is off to a great start and we remain on track to complete the full roll out well ahead of the time frame it took for the roll out in 2006.
We will continue to drive towards our long term goals of generating revenue growth through a well diversified mix of domestic, international and specialty products, improving profitability and continuing to deliver positive cash flow as we consistently strive to enhance our position as the world’s leading manufacturer. This concludes our prepared remarks.
Lawrence Rogers
Operator, just before we open up the line I would just like to clarify one thing. Our leverage requirement in the first quarter is 4.5 to 1, I apologize – not 5.5 to 1.
As I said in the second quarter that does step down to 4.25 to 1. So now we’d like to open the lines for questions.
So operator if you could please do that.
Operator
Thank you. The question-and-answer session will be conducted electronically.
If you would like to ask a question at this time please do so by pressing the * key followed by the digit 1 on your touchtone telephone. If you are using a speaker phone please make sure your mute function is turned off to allow your signal to reach our equipment.
We will proceed in the order that you signal. We will take as many questions as time permits.
Once again please press *1 on your touchtone telephone to ask your question and we will pause for just a moment to give everyone the opportunity to signal. We’ll take our first question from Albert Kabili with Goldman Sachs.
Albert Kabili - Goldman Sachs
Good afternoon guys. I guess a quick question for you, Larry.
If you could just talk about the new Posturepedic line. How much of the sales impact in the first quarter do you think is just the result of the new Posturepedic line?
Lawrence Rogers
We didn’t start rolling out the Posturepedic line until the middle of March so the reality is there is no impact to the first quarter based on the new line.
Albert Kabili - Goldman Sachs
I guess what I was asking more was would there be a negative impact to sales as customers were waiting for the new line to come in. Could you talk about that a little bit and have you seen a pick up as this line is launching?
Lawrence Rogers
Well typically you are accurate as we go through the launch of a new line people start to suspend purchasing of the current line and clearly that coupled with the current economic reality we are dealing with did have an impact on our business in the first quarter. It is a little bit difficult to really quantify what that is, but clearly we saw a typical slow down that comes from a line transition.
Albert Kabili - Goldman Sachs
Okay. Is there a way maybe to help answer this question by price point or just looking at the Posturepedic line?
How were sales in the quarter versus the other lines?
Lawrence Rogers
I would say that our sales of Posturepedic again showed evidence of a line transition. We had a good response in our specialty products as we indicated in the comments earlier.
But the reality would be Posturepedic was tailing off in the first quarter.
Albert Kabili - Goldman Sachs
Okay. And as we are looking at the second quarter can you talk about some of the trends you have been seeing in March and April?
Have we seen a pick up versus February? How is the new Posturepedic line doing in the early adopters?
Jeffrey Ackerman
Al, this is Jeff. In March, as Larry indicated, we just started shipping.
So to get any kind of read out on what the sell through is I think is a bit premature. I will say, though, we are very pleased with the initial feedback and the progress we have made so far on the launch and also the mix of products that our retailers are ordering.
Albert Kabili - Goldman Sachs
Okay. Then if we could shift to the SG&A a bit, there was a sequential or year-over-year decrease in SG&A by about $10 million.
Can you talk about what the key drivers were? I know you mentioned there were some cost cutting activity, but there was also advertising reductions as well.
Can you just talk about how much was driven by advertising reductions versus other types of cost cuts? What level is sustainable in terms of the cost savings you achieved in the first quarter?
Jeffrey Ackerman
Al, the primary reductions were really a combination of lower advertising costs and lower compensation costs and those were being off set by some increased delivery costs. We actually saw just more spending efficiency and so on our advertising costs and that was the single largest driver.
So year-on-year that was the biggest improvement and again that was just really improvement on rate there. As I said we did also incur some…in addition to the higher delivery costs we did incur some costs around severance but that should going forward have a benefit annualized of about $2 million.
Albert Kabili - Goldman Sachs
Okay so on the lower advertising costs you mentioned it was rates. Are you advertising at the same level but you were able to save a lot on the rates you pay?
Is it driven on the mediums you were using? Give us a sense if you can on that.
Lawrence Rogers
Al I can take that. This is Larry.
As we mentioned on previous calls we were going to begin an initiative to make sure we were maximizing our co-op advertising spend. That wasn’t necessarily designed to do anything but get a fair and equitable return on investment.
We have been partnering with our customers and having conversations on their commitment to spend equal parts of their monies as we invest ours and we are getting a better play in those areas. So what you are seeing is more of an optimization of co-op advertising than anything else.
Albert Kabili - Goldman Sachs
Okay. Got it.
I guess the last question would be on the dividend. At what point would you think about re-initiating the dividend?
Jeff I guess a question for you related to that is how comfortable are you with the step down and leverage show in the second quarter? Do you feel you can meet that given all the higher roll out costs that we are going to see in the second quarter?
Jeffrey Ackerman
Sure. Al, first off let me answer your first question and the answer to that is we will, as we have always done, is we will review the quarterly dividend every quarter with our board.
As far as the covenant for the second quarter as you said we see a step down from 4.5 to 4.25. We are in at 3.9 right now.
There is really no single driver on this. What we are seeing is we just looked at all the volatility we are seeing in the credit markets, we are seeing in commodity costs, we are seeing in the retail markets, and so we are just taking what we believe are prudent actions and that is aggressively managing our working capital, looking for further cost reductions, reducing capEx and then lastly make a decision to suspend the dividend.
Again, the thing that I’d like people to keep in mind is the rates that we have right now are very attractive on our debt and we are focused on maintaining that and maintaining those rates and our financial flexibility.
Albert Kabili - Goldman Sachs
Okay. So you think you have enough flexibility with the dividend cut and the working capital to make the 4.25 ratio.
You talked about $15-20 sequential increase in SG&A, a pretty big jump and hit to earnings in the short term anyway.
Jeffrey Ackerman
I do think at this time we are taking all the right actions. The second quarter is going to be challenging.
As I mentioned we are having success with the new Posturepedic line but also included in that then, as I mentioned, is increased floor sample costs, increased product launch costs and those are probably going to be $15-20 million if you look increased sequentially from the first quarter. So we are just taking all the actions we believe are necessary to deliver the results we need to based on all the forward visibility we have.
Albert Kabili - Goldman Sachs
Okay. I’ll turn it over and jump back in the queue.
Thank you guys.
Operator
The next question comes from the line of Keith Hughes of Suntrust Robinson Humphrey.
Keith Hughes - Suntrust Robinson Humphrey
Thank you. Just following up on some of your prepared commentary.
Can you just give us an idea of how much specialty is of your business currently?
Lawrence Rogers
Keith, it is Larry. I don’t think we have ever shared that as a percentage of our total business.
It is becoming a larger portion of our business all the time. I think our comments were more directed to the increase is off a much larger base than previously and it is now at the point where an increase of that nature is meaningful to us.
Jeffrey Ackerman
Keith, you have seen our presentation and we were in 2006 we thought about a 6% share of the business of what we believe is a $1.6 million segment of the industry. I think our growth rate is in there.
Keith Hughes - Suntrust Robinson Humphrey
That is currently domestic only, is that correct?
Jeffrey Ackerman
Yes, the numbers we are referring to is our domestic specialty business.
Keith Hughes - Suntrust Robinson Humphrey
Domestic specialty business, okay. And on the dividend suspension I am still a little confused at why the timing right now?
Given where you are on the ratios, why wasn’t this done for example last year? Usually companies suspend dividends when they are in a lot worse financial shape than you are in now.
Can you give us a little clarity on that?
Jeffrey Ackerman
Yes. Look, as I said before we are focused on maintaining our financial flexibility and right now Keith as I mentioned there is so much uncertainty and so much volatility that we are seeing again in the credit markets, what we are seeing with commodity prices and in the retail environment, again we thought this was a prudent thing to do to maintain that financial flexibility.
Keith Hughes - Suntrust Robinson Humphrey
Okay. Is it fair to say that with those proceeds now is that going to go towards debt reduction in the future?
Jeffrey Ackerman
By suspending the dividend on an annual rate that is almost $30 million a year. We are really not changing our focus on the uses of cash.
It is what we have always been saying. We are going to focus on investing in the business and then focus on de-leveraging.
Keith Hughes - Suntrust Robinson Humphrey
Okay. That’s all my questions.
Thank you.
Operator
The next question comes from the line of Chad [Bowman] with Raymond James.
Chad [Bowman] - Raymond James
Good afternoon guys. Can you hear me okay?
Would you be able to break out for us in advertising spent co-op versus national during the quarter?
Lawrence Rogers
The vast preponderance of that is co-op.
Chad [Bowman] - Raymond James
Okay. And given some of the difficulties of Select Comfort as well as Tempurpedic here recently has that caused you at all to re-think the direct to consumer sort of national advertising strategy that you are working on right now?
Lawrence Rogers
Chad this is Larry. I don’t think it is causing us to change our strategy.
It is causing us to be very thoughtful about the strategy. It is making us a little more cautious before we pull the trigger and we are stepping back and watching this market unfold.
So it is not a change in strategy, it is merely being a little more cautious. I think caution is probably a pretty good buy word considering the economic environment we are all facing.
Chad [Bowman] - Raymond James
Okay. And Jeff maybe a little clarification in regards to the reorganization charge?
I guess how should we think about that in terms of the mix between SG&A and cost of goods sold? To be clear are you seeing some of that $2 million in annualized benefit already or when do you expect that to fully kick in?
Jeffrey Ackerman
We…your first question was whether or not the benefit would turn up in SG&A or cost of goods sold. That would almost exclusively show up in SG&A.
All the actions were taken at the end of the first quarter so over time sort of going forward on an annualized basis we anticipate $2 million benefit.
Chad [Bowman] - Raymond James
Okay. And maybe if you could give me an update you guys had talked about re-branding the latex spring free product.
Where do you stand with that? What would you anticipate as the timing of that?
Lawrence Rogers
We are proceeding with the re-branding Chad and we would think you should see some action relative to the new branding in the third quarter of this particular year.
Chad [Bowman] - Raymond James
Alright. Thank you, guys.
Operator
The next question comes from the line of Joel Harvard with Hilliard Lyons.
Joel Harvard - Hilliard Lyons
Thank you. Good afternoon everybody.
Larry, it was always my presumption and I haven’t had a chance to speak with you to get your perspective on this so sorry about the venue, but it was always my presumption that the strategy of shifting co-op ad from the independent retailer was going to be something that may involve a little bit of pain. I’m trying to understate this a little bit.
How is the company managing that? You have made it clear in previous comments that you want to be careful and prudent and cautious in how you approach it, but is it still very much a commitment on the part of management and can you give a sense of where you think that could go over the course of the next year or two?
Lawrence Rogers
Well let me see if I can separate those questions. First of all our approach as I stated going to be very targeted and focused on a return on invest.
Joel Harvard - Hilliard Lyons
That was a good comment.
Lawrence Rogers
We really believe that there are opportunities to perhaps bifurcate different parts of our portfolio and by that I mean you might see a different strategy on the specialty part of our business than you might on the more well-developed spring part of our business. We are having conversations with customers as you alluded to.
We continue that journey. As you might imagine in this difficult economic environment we need to be careful as we move with our customer base.
Joel Harvard - Hilliard Lyons
I’ll take that as another careful answer. This next one is a little easier but it is really wide.
Given your experience with the company and within the industry, your comments earlier likening the current environment to the 70’s gave me a bit of a shudder. Is there some ray of sunshine there?
We’ll leave the macros added. But how can you share with us how you managed to help the company manage its way through an environment of that nature?
Lawrence Rogers
Typically, Joel, stronger companies come out of those environments even stronger yet. We believe we are going to continue to focus on the basics of the business.
We talked about managing those things we can control. It has been referred that the suspension of the dividend is something we have already taken initiative on.
We are bigger. We have a more diversified portfolio and we have the geographic footprint that I believe is going to allow us to weather this particular economic downturn.
We have a meaningful competitive advantage given that we have the ability, and we’ve said on previous calls, our focus is to grow the business 1/3 in domestic inner spring, 1/3 specialty and 1/3 internationally. Clearly with the comments today I think you’ve seen good growth in specialty and international.
We’re going to stay the course and continue to I guess do the common things uncommonly well.
Joel Harvard - Hilliard Lyons
I appreciate the answer. Jeff, a couple of follow-up’s for you real quick.
The $20 million in incremental product launch costs that was for Q2? Did I hear that correct?
Jeffrey Ackerman
That is sequential. It is an increase of $15-20 million from Q1 into Q2.
Joel Harvard - Hilliard Lyons
I think you anticipated the rest of that question. And last, could you give us the units versus pricing dynamics in the Canadian market again?
Jeffrey Ackerman
It was down 7% in units and up 1% in AUSP.
Joel Harvard - Hilliard Lyons
Thank you very much. Good luck guys.
Operator
The next question comes from the line of Ike Borcia with Morgan Keegan.
Ike Borcia - Morgan Keegan
Hi. Good afternoon.
I’m calling in for Laura Champine. Two questions.
You had mentioned domestic sales being down and one of the factors was the bank seizing some of your customers. Is there anyway you can quantify the negative impact that had on you during the quarter?
Jeffrey Ackerman
We haven’t broken that out. I don’t think for competitive reasons we are going to but I’ll just reiterate that the single largest decrease was at accounts that are transitioning into new lines.
Then secondarily it was related to accounts that had to close. But again we expect over the longer term that due to the breadth of our distribution that business goes somewhere else and we will be there to pick it up and over the long term the effect of that will be marginalized.
Ike Borcia - Morgan Keegan
Okay. Lastly, on the last call you mentioned you felt the incremental FR costs in the first half of this year would be $14-16 million.
Is that still standing? Should we expect $9-11 million in Q2?
Jeffrey Ackerman
I’m not updating that. We were at $14-16 and at $5 in the first quarter.
Ike Borcia - Morgan Keegan
Thank you.
Operator
We’ll take our next question from [Kerry] Martinson with Deutsche Bank.
[Kerry] Martinson - Deutsche Bank
Good afternoon. In terms of the top line that you’ve lost from customers that have gone into bankruptcy is it a reasonable assumption that we’re not going to see those sales get replaced any time soon?
Lawrence Rogers
Actually when you look at one of the larger retailers that has gone out of business we have had a property management company move in, acquire the stores and shop them with current furniture and mattress specialty stores. So if I was to give you an example the Levitz stores in Southern California are going to re-open under re-branded Ashley stores.
Ashley is a significant customer of ours so we think we have the opportunity to replace some of this business in a fairly short fashion. I think that speaks to the point that Jeff made earlier that the consumer does not go away.
Perhaps the retailer does. But with 20 and under customers in the USA we have a strong base and typically over a reasonable period we get that business back.
[Kerry] Martinson - Deutsche Bank
Okay. That is certainly good news.
In terms of the launch that you are going to have the second quarter, how far will you be rolled out ahead of the Memorial Day start up selling season?
Jeffrey Ackerman
[Kerry] we haven’t actually disclosed that. The guidance we have given as we talked about this – we are very pleased with the progress we are making.
We are on track to do it in about half the time of the 2006 line and you should start to see a meaningful financial impact in the third quarter.
[Kerry] Martinson - Deutsche Bank
Okay. Then in terms of the SG&A, the lower compensation costs can you give us an idea of the magnitude here?
Are we talking about a couple of million dollars? 5-10?
What was size there?
Jeffrey Ackerman
The total SG&A decrease was $10.2 million and again the vast majority of that was co-op so we effectively had with the compensation as off setting some of the things we saw on increase in delivery costs and some of the severance and some of those things.
[Kerry] Martinson - Deutsche Bank
Okay. And in this type of an environment are you seeing a push back from your retailers on putting in price increases to off set the raw materials?
Lawrence Rogers
I think clearly the retailer is having a rugged fight out there right now and of course any initiative to increase the cost of them doing business and to lower the effective price they think they have in the market is meeting with some resistance. However, as we did say in the call our December 17th price increase has stuck.
We saw benefit of that to the tune of [710 per point] in margin gain in the first quarter. So it is evidence that you can take price you just need to be prudent and move carefully.
[Kerry] Martinson - Deutsche Bank
When you guys state that the industry headwinds have intensified, do you feel that the environment for the consumer has worsened since you gave your March 4 warning?
Jeffrey Ackerman
This is Jeff. I don’t know that we can really tell at this point.
I don’t know that we’ve seen it get worse. There is a lot of factors and we talked about what those were.
Again, we’re focused on what we can control. We know that we need to get our line out there and we think we can have success on that and we’re focused on that.
[Kerry] Martinson - Deutsche Bank
Okay. Lastly, you mentioned coming out of a difficult time period you feel that you take share from the smaller players.
Are you seeing that transition starting already in this type of an environment?
Lawrence Rogers
I would say it is too early to tell. But history would dictate some of that may happen, but later on.
[Kerry] Martinson - Deutsche Bank
Thanks guys.
Operator
Once again if you’d like to ask a question please press *1 at this time. We’ll take the next question from [Retha Bahasiday] with Lehman Brothers.
[Christian Othen] – Lehman Brothers
This is Christian [Othen] for [Retha]. Good afternoon.
I’d like to start with a housekeeping question. I know you provided AUSP and volume trends for several segments.
Can we get that for the overall business? I’m not sure I caught that.
Jeffrey Ackerman
I’m sorry, Christian?
[Christian Othen] – Lehman Brothers
Could we get volume and AUSP trends for the overall business? I’m not sure I caught that.
Jeffrey Ackerman
Yeah, we did not provide it. Here is why, Christian.
The European business as I mentioned has so much OEM business where we are selling cores as opposed to the domestic business which is focused on wholesale so it is a little bit of apples and oranges and for that reason we don’t consolidate those numbers.
[Christian Othen] – Lehman Brothers
Okay. And it sounds like you are scaling back capEx a bit?
Can we maybe get a capEx outlook for 2008?
Jeffrey Ackerman
Yeah, for 2008 you’ll find it in our 10Q. It is about $35-40 million right now is the outlook.
[Christian Othen] – Lehman Brothers
And might you take that down a bit more?
Jeffrey Ackerman
Again, we’ll be focused on what kind of return we’re going to get on the investment in capEx and we’ll make the decision accordingly.
[Christian Othen] – Lehman Brothers
Okay. As raw materials continue to increase might you look to take additional pricing actions?
Jeffrey Ackerman
Well, Christian, as I said the prices are increasing on raw materials. We are looking at really a whole variety of things and they start even with our FR costs.
We’re looking for more cost effective solutions. We’re looking at opportunities to do forward buying to beat some of the price increases.
We’re also looking at new ways to substitute new products and inputs that are more cost effective. So we’re working on a whole variety of things and we’re focusing first on getting the new line out and we feel like we have the opportunity to mix up the line substantially and improve our performance above $1,000 so I think we’d like to get that out and see that how that is performing and then we can start to analyze the pricing.
[Christian Othen] – Lehman Brothers
Okay. I just want to understand a little better…you mentioned some new advertising initiatives.
Is that a different type of advertising? Or is that going to incur additional costs?
Lawrence Rogers
I think what we said Christian was that we…the second stage for our marketing plans for later in the year we are very focused on making this strategy that is well-planned. We’re doing a lot of quantitative research right now.
Again, its got to have a return on investment. It is not different, it is more focused.
[Christian Othen] – Lehman Brothers
Potentially higher?
Jeffrey Ackerman
Potentially higher spending? Is that your question?
[Christian Othen] – Lehman Brothers
Yes.
Lawrence Rogers
There may be some investment at the beginning of it but overall it shouldn’t have a long term impact on our business.
Jeffrey Ackerman
Again, Christian, we are going to focus on looking at what kind of a return we are going to get on our investment. If we think we can drive incremental sales and we’ll get a pay back on it then yes, we would invest more.
[Christian Othen] – Lehman Brothers
Many thanks.
Operator
We’ll take our next question from Keith Hughes with Suntrust Robinson Humphrey.
Keith Hughes – Suntrust Robinson Humphrey
Just a follow-up. More of a strategic question.
Given some of the headwinds in the industry you have been discussing…it seems as though the high end, particularly specialty which has been pretty good compared to the rest of the industry and is now starting to feel this economic downturn, have you seen that in your order patterns? Two, given that the Posturepedic launch tends to come at the high end in the mix shift up, is that going to limit the success from the sales we’re going to see from that later in the year?
Lawrence Rogers
Keith, it is Larry. We saw a little bit of reaction to those headwinds in February.
But we have had a terrific response to our Viscal product that I think you actually viewed at the July market. The fact with the pressure dispersion pad and the cooling effect on the [ticking] seems to have provided us with a little more length than perhaps some of our competition is seeing.
We’ve also had a decent growth as you heard earlier in latex and the fact that our latex is a product that continues to gain increasing slots on a retailer’s floors; we think the growth and slots may mitigate some of that going forward. So we are pretty…
Keith Hughes – Suntrust Robinson Humphrey
Have you see in your high end inner spring business, is it starting to perform below the $1,000 price point? Or is it still better performance there?
Jeffrey Ackerman
Keith, was the question was it performing better below $1,000 or above?
Keith Hughes – Suntrust Robinson Humphrey
Below $1,000 or above $1,000?
Jeffrey Ackerman
Keith we haven’t broken it out that way. But as we have said in the past it is no secret our above $1,000 hasn’t been performing that well so we’re expecting with this new line to be much more competitive above $1,000.
Keith Hughes – Suntrust Robinson Humphrey
Alright. Thank you.
Operator
We’ll take our next question from [Mark Group with Lebeau Research].
[Mark Group] – [Lebeau Research]
Hi. Just had a quick question on the latex product offerings following up on Keith there.
I assume some of the growth as you said is coming from new slots. I’m just trying to get an idea of where you are on kind of the product curve on filling out the distribution with that product line and when might you see it kind of fully distributed?
Lawrence Rogers
Well there is really a couple of parts to that question, Mark. One of them is relative to our second line seeing a steady state and we need to certainly make certain that we have the ability to supply.
The last thing we need is a disrupted supply chain. I think we have stated that will be steady state some time nearing the end of the third quarter.
I still believe, however, there is an appetite for latex out there. We have had clear signals from our existing customer base, so we have heart for the vertical integration we have invested in.
Again, part of our strategy is to be supported by vertical integration where we think it makes sense and where we get the return investment. So we’re going to stay the course on the latex product.
[Mark Group] – [Lebeau Research]
Okay perfect. Just real fast, on the…can you quantify by chance how much new slots is actually driving the latex growth?
I think we would all agree there is demand for latex and it is growing, but of the 24% growth is new slots growth driving ½ of that? ¼ of that?
Jeffrey Ackerman
We can’t comment on that at this point, Mark.
[Mark Group] – [Lebeau Research]
Thank you.
Operator
And that does conclude this question-and-answer session. I’d like to turn the call back over to management for any additional or closing remarks.
Lawrence Rogers
Okay well thank you for attending our first quarter conference. We appreciate your continued interest in the company and look forward to our meeting in about 90 days and we’ll perhaps be able to discuss with more detail as 2008 unfolds.
Thank you very much.
Operator
That does conclude today’s conference. Thank you for your participation.
You may now disconnect.