Somnigroup International Inc. (SGI) Earnings Call Transcript & Summary

Thank you for being here. I'm Bobby Griffin, one of the consumer analyst at Raymond James. Today, I have the pleasure to introduce Tempur Sealy at our conference. We're going to do a little bit different of a setup here. Scott is going to go through a little bit -- a couple slides as well as talk about a market update, and then we're going to switch right to Q&A. But before, let me just go ahead and introduce everybody. We have Scott Thompson, Chairman and CEO; Bhaskar Rao, CFO; and Lauren and Aubrey from Investor Relations. So with that, I'll turn it over to you, Scott, and thank you again for being here.

Good morning, and thank you for your interest in Tempur Sealy. As Bobby said, we're going to do a couple of slides, but then we really want to spend more time on kind of a market update. Obviously, in the current market and the volatility, it seems like giving you most current information would be the most meaningful rather than doing the -- what I'll call the standard presentation. Let's start with our purpose at Tempur Sealy is to improve the sleep of more people every night all over the world. And our background, we're a market-leading, vertically integrated, global company that develops beds, retail beds, both online and offline, we manufacture and make beds in about 100 different countries. Our long-term strategy is to drive earnings growth through high return on invested capital. We certainly have robust cash flow attributes. And of course, we drive to achieve industry-leading sustainability and environmental initiatives. You can see from the quick financials, the split between international and North America. And what I really want to spend some time on is really a market update. Normally, I don't spend a lot of time talking about the stocks. Stock's down, I'm going to call it, 25% in a week and a half. And I want to make sure the market understands what our exposure is to the current situation and what the current trends are. Starting with North America. Our sales growth, above expectation driven by a very profitable direct channel, the strong demand across all channels, and that's through this weekend. Very strong President's Day in North America. We're comfortable with our supply chain. When you look at our North America operations, most of our products are made in-country. We do import our adjustable bases from China. If we look at our adjustable based product, we have plenty of adjustable bases in inventory. We have plenty of adjustable bases on the water. The organization that produces our adjustable bases in China is fully operational and is producing bases. We are their largest customer. As you might guess, we're being treated very well. And we see no issues on adjustable bases in China at this point. If I turn to international, the international business is stable with growth above plan in Europe offset by underperformance in Asia. If we look at Asia, in China specifically, we run most of the business through a 50-50 joint venture. So part of the impact is mitigated through that joint venture. If I look at China in total, okay, both the Tempur business, the joint venture, we usually make about $4 million a quarter out of China, okay, that region. I would expect that to be about breakeven in the first quarter. I also, from what we see today, and things could change, I think probably the first quarter will be the weakest quarter in our China operation. If you go through the region, we will feel some impact in some other countries, although I expect it to be minimal. But in total, Asia will slightly underperform what our expectations are, with which we expect to be offset by our European operation, which is performing very well. So in total, international might be slightly down, but not anything, what I would call, material at this point. Turning to capital allocation. We've told the market before to expect about $50 million of stock buyback per quarter. We've also told the market before that we would be opportunistic in our stock repurchase, and we have been, I would expect for the first quarter rather than $50 million of stock buyback, I expect that we'll be closer to $100 million. And we are currently buying just about all we can under the exchange rules. So that's the kind of the current update of the marketplace. And if you have any questions, I'd like to go ahead and take the questions on the update now.

Scott, I'll go ahead and start. If anyone, I'll pass it off to the audience, too. But above expectations, can you just maybe connect where that -- is that in reference to the 25% to 30% year-over-year growth you talked about on the call for 1Q?

Yes, to just give people background. On the earnings call, we told people -- we normally would not give revenue guidance for a quarter, but we had a lot going on in the first quarter. So we thought in order to help The Street we actually gave revenue guidance for the first quarter a few weeks ago. And we said that we expect to grow between 25%, 30%. When I say we're running above expectations, it would be slightly above that guidance that we gave on the earnings call.

Anybody from the audience?

Up here, Bobby.

Obviously, with the corona, there's a lot of impacts here, whether it be kind of demand, depending whether in the U.S. or versus kind of Europe and international and then from the supply side. I mean, did you have -- kind of had to rank order your areas of concern there on the go forward? Obviously, you're doing a great job offsetting it. It's a diversified business in a lot of respect. Can you just walk us through kind of the risk factors here on the go forward do you think to be a supply risk versus demand? And if it is a demand risk, what to think about U.S. versus Europe? And just kind of -- obviously, I know you're not a doctor, but just trying to get a sense of the kind.

Yes. Great question. First of all, I could may just start talking, but it's based on what we know today and obviously, things could change. So give me that a little bit out to start with. When I kind of risk management and kind of think about it from a supply chain standpoint, you're not going to -- we're not going to say we're not concerned. We haven't seen anything that we would expect to impact our business and the supply side of the business worldwide. So supply side, monitoring closely, but don't expect any issues on the supply chain side. When I go geographically, obviously, Asia is the first area, which I've talked about and have kind of quantified the exposure there. Europe, as I've told you, is performing better than expectations. So it looks good there. So when you really look at what our primary item that we're watching, is really consumer confidence in North America. That would be your big risk. If, for some reason, whether it be the stock market decline or whether it be health issues, anything that impacts North America consumer confidence, is probably the material item that we watch closely. As preparing for this conference and to make sure that I was current, I talked to 5 other CEOs that are in the industry to ask them what are they seeing. What did the weekend look like? What do your orders look like yesterday? To kind of bring current, okay. All 5 of the CEOs in the industry I talked to felt like that their business was normal, that they were not seeing anything unusual and represented that their first quarter was solid, could change tomorrow. But as we sit here today, it feels very normal in the industry. If I look at our specific company and our best data we get is through our direct-to-consumer channel because we get those orders like every day. Our web business still growing at 20% clip. Our stores are still performing very well, and we're not seeing anything on the direct-to-consumer side. On the wholesale side because you have some inventory, you might be a delayed here or there. But on the DTC side very solid. If I look at my order bank, which I get, I can tell you yesterday was above plan. You have your good days and bad days, but there's nothing in the orders that look unusual on the wholesale side.

Scott, you have done a magnificent job as CEO navigating some really difficult issues that companies deal with, including right now, the -- obviously, the e-commerce issue that happened and has affected bedding. What do you see going forward now in mattress compression and e-commerce, direct web? You've grown that business beautifully. What can you tell us?

Great. As a little bit of background, obviously, the web business exploded in bedding over the last few years. We had some companies come in, and I'll call them web-based marketing, bedding companies, who are willing to spend enormous amount of money to buy customers and drive their business. I think what's happened -- I think what history will show is those companies spend a lot of money, lost hundreds of millions of dollars to educate consumers how to buy a bed online. By them spending their money to educate customers, it then allowed companies like Tempur Sealy to set up their web operation, which has been very profitable from day 1 because our brands are strong. So I think what's happened is that's turned into a huge opportunity for us. As I said, our web business is growing, call it, 20%-plus. It is the highest margin business we have. And so that's good as far as that base. Then what's happened is those companies ran into, we'll call it, the WeWork's effect, where they've had started having trouble funding their operations because they generally lose 20% of EBITDA -- 20% on every sale. And I believe that they're probably pulling back on their expansion. So I think net-net, all that's worked out. But if you're talking about this online bedding, online bedding is going to continue to grow. We see it -- whether it be at a costco.com, whether it be at mattressfirm.com, whether it be at tempursealy.com, the web-based business is growing faster than brick-and-mortar. Although I got to tell you, when you look through our customer base, the really good retailers, the brick-and-mortar business is very good. It's kind of a -- if you're a good retailer, you're doing better than you were before. And if you're not a very good retailer, you have some challenges. But you're going to continue to see compressed bedding, I think, for sure, at the low end and maybe in the mid-market. And we have the equipment and the expertise to take advantage of compressed bedding. 2 products that people don't usually notice because we got a lot of products and a lot of beds is we have a Cocoon product by Sealy, which is a compressed bed and we also have a TEMPUR-Cloud, which is a high-end compressed Tempur bed. We use those 2 products to target various companies online. And both those products, if I quoted a percentage increase, is very large, but they're often very small base. So we're very bullish on compressed bedding going forward.

Could you maybe just talk about how much slack you have within the supply chain, if things were to really become a lot worse than what you're talking about right now, just kind of what your days of inventory is? And how you think about that kind of contingency planning?

Yes. Let me try. It's different -- by product, it's different. Adjustable bases, I kind of talked about. They come from China. They're on the water. They're in inventory. And I think, for sure, we'd be at least through into third quarter if they stop producing today. Looking at my CFO. Is that easily, right? So that's the adjustable base is usually a lower-margin product. But clearly, we'll call it a couple of quarters worth of supply is already either in inventory or on the water. When you think about bedding, most beds could -- let's do the Tempur beds. Tempur beds, we produce for inventory. I can't think of anything that would come from the supply chain, as we know it today that would slow down the Tempur beds, but there's not much in inventory. We build kind of sorted order. On the Sealy side, we do build to order, and there's not much in inventory. But again, there's nothing in supply chain that would keep us from building those beds. I think your risk, as I've told you before, is really consumer confidence in North America. I think that's your sweet spot to keep an eye on. Now look, maybe the Fed cuts rates, maybe you get a little more housing formation, which would be positive, too. But it's consumer confidence because these are discretionary purchases, and at times, expensive discretionary purchases. So if you get a shock in consumer confidence, you usually get sub pullback in demand.

Scott, can you maybe talk about how it's still early, but the Sherwood acquisition integration is going? Private label, where you see private label playing in the industry?

Sure. Good question. We're a branded product generally, and that's about 75% of the market. Here recently, we bought a small company, Sherwood, which does private label. And we'll call private label as an industry in North America, about 25% of the market. It was an opportunistic acquisition. Steinhoff Group needed to sell it and we quote, bought it right. And we're able to apply our supply contract expiration, which we buy, whether it be textiles or foam probably as well as anybody in the world because we're the largest bedding company in the world. So we instantly get the synergies coming through the supply contracts. We also have 300-plus salespeople. We're able to source private label sales opportunities for Sherwood, who has about 3 salespeople. So we should get some sales synergy. We think that makes this acquisition, although small, makes us a much stronger company because now when we go to a customer we can provide them private label. We can provide them low, entry-level pricing on a Sealy-branded bed. We can provide them Stearns & Foster high-end spring or, of course, Tempur-Pedic. So we -- literally any bedding retail, we can cover every product you ever needed, whether it be compressed, noncompressed, whether it be branded or nonbranded. We think that's unique. And we're -- we expect good things from that positioning.

I guess as a little bit more to follow-up on the market update, clearly, things going well now, but maybe just talk about how the cost structure is set up. If we do go into a little period of this slowdown in the U.S., leverage up and pull, fixed versus variable and kind of how you would attack that?

Sure. First of all, the fact that we're probably not planning on going into a downturn would tell you how optimistic we are about it. But if you did get a downturn, 75% of the cost structure comes down immediately, which is just basically the COGS and the price of the bed. Obviously, advertising expense is a big variable, which can flex down. And then the management pay structure is very variable. So one of the things about this business that really attracted to me early on was the flexibility that the business has, if you do hit a downturn. It really rightsizes fairly easily without having to do anything. You also normally get a lift in commodities because commodity prices go down. And that savings that you get on commodities, we generally don't pass on to consumers. So if you look -- if you're of a recession mind, this is one of the businesses that is built to flex down pretty easily. Your EBITDA is going to come down, but it's very manageable.

Anybody else from the audience?

Okay, cool. I'll do some more slides if there's no questions.

No, I'll follow-up on one. But clearly, hard to take out the coronavirus, but clearly there's a lot of tailwinds if you take that out going on in the industry. So maybe can you just talk about the health of the industry? One of the questions we get a lot from investors is, is 2020 as good as it's going to get for Tempur? We -- peak earnings because of expanded distribution. And maybe talk about what's been happening, some of the tailwinds there and kind of what the longer-term outlook is?

Yes. No, I mean, if you step back from the industry, you could see it in our fourth quarter numbers and you could see it in other people's fourth quarter numbers that the industry bedding was doing very well. And probably in the best shape that I've seen it in the 5 years that I've been in the industry, rational pricing. Mattress Firm is stronger, big advertiser helps drive North America. The U.S. consumer seems to be in very good shape. Commodity price is kind of coming down a little bit, obviously, coming down a lot more here lately, which is positive for the industry. And we'll call it the so-called the group, although there will be winners and losers in that group, certainly is not the competitive threat that some people might have thought it was, and there's certainly not as much capital being thrown at it. So when we were doing the 2020 budget, we always wind up what's going well and what's not going well for the Board. To be frankly honest when we were doing the 2020 budget, we were having trouble figuring out what the headwinds were going to be in 2020. It was hard to find a balanced presentation because most of what was going into 2020 were tailwinds. We've got new -- and when you go to Tempur Sealy, specifically, we got new distribution from Mattress Firm. We've got new distribution from Big Lots. Our own stores are doing very well. And as I've mentioned before, the online stuff is doing very well. So yes, I've been very clear numerous times that we would expect 2020 to be the best year in the company's history. And when you combine that statement with the free cash flow that the business generates, the free cash flow, then, of course, generates other opportunities, whether it be through stock buyback or through the deployment of some small acquisitions for high return on invested capital, it would look like we're in a position to, we'll call it, we do EPS -- grow EPS well into the future. I would not expect 2020 to be the top of the company's performance.

So you talked about your stock going down, but it seems that every time the market gets dislocated, whether it's Q4 of '18 or since the last few weeks, people go and screen for the high debt levels and you're still fairly high leveraged. I look here at 2018 when your bonds went from 102 to 90 in a few months. Have you -- you generate tons of cash. Is this still a level you're very comfortable because if the market wanted to go more defensive, you'll probably be lagging the market despite your buybacks?

From a leverage standpoint, generally, you're talking about. On our last earnings call, we took down our formal leverage guidance. We were at 3 to 4x, was our leverage target. We were, call it, just under 3 when we reported. And we brought our leverage guidance going forward to 2.5 to 3.5. So we brought it down a full turn, which is kind of where we're comfortable. I don't see us bringing it down any lower than that. When we come up with those leverage targets, we work with some banks. We stress test it, everything else. I think that's probably the right leverage to target for us. We might run at the lower end, if it looked like there was a recession coming. Great opportunities. We might edge towards, of course, the top end of that range. But as I mentioned before, the flexibility of the operating expenses and the nature of the business, it's a business that can support, quite frankly, more debt than that I'm willing to put on it. And so we've probably been as high as 4 something, that felt a little high. So I think we're very comfortable in the 2.5 to 3.5 leverage ratio.

Scott, can you talk about maybe Mattress Firm's retail strategy today versus how it was when it was Comfort by Colors? Are they doing some different? How does that work for Tempur from there?

Sure, we'd have to pause a sec because it's a private company subject. Mattress Firm obviously went through some reorganization, new management team, new Board and from my perspective is a completely new company. It just happens to have the same name as the old company, but we think of it as new Mattress Firm as opposed to old Mattress Firm because so many things are different. The management team is moved more towards supportive of brands rather than Comfort by Color, where they put the beds, they had the same feel altogether, they're going to have galleries which supports kind of the brand message rather than growth at all cost. And we'll call it maybe expanding maybe too quickly. They've retrenched and are focused on the profitability of the stores, which, of course, has been very healthy in the industry and a much more sophisticated management team in all areas. So that relationship is in very good shape. And actually, we're very optimistic about Mattress Firm and what they're doing. And I think they're seeing the great results. From our standpoint, we've restructured the contract that's -- to be a little different than we were before, where they leaned very heavy into Tempur before, maybe too hard into Tempur. It will be more of a balanced relationship between the 2 companies, but it's working out very well, and they're performing in excess of our original estimates. When we originally put -- refloored Mattress Firm, we didn't know how the cannibalization would work in the marketplace. It's a 2,500 additional stores in North America, how that would impact our direct business, how that would affect our other retailers. And we built in some cannibalization to our thinking. As of today -- and things could change, we're not seeing any cannibalization of the Tempur product. When we refloored Mattress Firm, we've got about 3 months' worth of experience. So that's worked out very well. On the Sealy side, it's a little harder to tell, in that Sealy is a little more of a commodity brand against Serta Simmons. And we also floored Big Lots, but we aren't seeing any significant cannibalization either on the Sealy side. So right now, the reentry into that channel has worked very well and better than planned.

I'm newer to your company. I'm wondering if you could go through what rate the industry has been growing. What is your market share? Have you been taking share? And then in a recession, typically, what -- how much does the industry go down?

Yes. I'm going to use the normal 6% growth rate for the industry, probably last quarter up until -- we'll see what the first quarter comes out in the industry. Maybe it's a little bit down. But I would say we're probably running over trend for the last couple of quarters in the industry, so call it, trends, 6%. If you talk about market share, for sure, in 2019, we took a lot of market share in -- we're talking North America here. And I would expect in 2020 with the new distribution, Big Lots and Mattress Firm, we will take significant share in 2020. During a downturn, I don't know, industry, flat. Probably I might see a -- call it, the industry flat during the downturn. It depends on what kind of downturn, but it's probably that kind of volatility. Generally, Tempur has held up very well during a downturn. The people that buy Tempur beds usually are fairly comfortable from a financial standpoint and you intend to get hurt a little bit more on the Sealy side of house.

And your place in the market share?

35-ish.

We've got time for 1 more if there is.

You mentioned some of the rational pricing that you saw this past year. How does that compare to the history of the industry? And any reason to believe that, that's permanent or what do you expect?

Yes. I'd say a couple things have happened. The tariffs on China imports probably helped the entry-level pricing some and firmed up the very bottom of the industry from the tariffs. If you go back a little ways, during Mattress Firm struggle before they filed bankruptcy, they were fairly disruptive from a pricing standpoint as they tried to drive volume through very aggressive promotions, and what I would call being overly promotional. Obviously, it's a promotional industry. But you can -- there's a market for promotion, and you can be overly promotional. So we spent a year plus in an overly promotional environment as Mattress Firm was struggling. Since they've gotten stable and are doing well, that issue has dissipated, and they're "on market" for promotions, if you want to call it that way. And our largest competitor in North America, Serta Simmons, they're working through some of their issues, and they've been very, very good from a pricing standpoint. So in general, pricing feels pretty good.

Thank you. Thank you, everybody. We'll move to the breakout now. Thanks for the presentation.

Okay. Thank you for your interest.