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

All right. Good morning, everyone. My name is Peter Keith. I'm a senior research analyst at Piper Sandler, covering the hardlines and leisure space. Very pleased to kick off day 2 of the Piper Sandler Growth Frontiers Conference with Tempur Sealy. So joining me on stage is CEO, Scott Thompson. And then in the front row here, we have Bhaskar Rao, CFO. We have Aubrey Moore, VP, I want to give the introduction right VP of Investor Relations; and then Lauren Avritt, the Investor Relations Manager. So thanks, everyone, for coming and supporting our first year at the conference.

Thank you, and thank you for having us. Peter.

Yes. So most people here probably know Tempur Sealy, but just by way of quick background. So they're the global leader in bedding products, note for 3 key brands, Tempur-Pedic, obviously, Sealy, which is powered by Posturepedic and then Stearns & Foster. They are manufactured also private label products, they're OEM manufacturer for some other products. And in my view, the company is in one of the best competitive positions in its history. All right. So let's kick it off with that, Scott. Let's talk about the competition. There's been a lot of changes over the last couple of years. How do you think the competitive drop has evolved for you in the last few years? And then how do you see competitive backdrop changing over the next 3 years?

Sure, working on a 3-year back and 3-year forward kind of framework in your question. Look, I mean, obviously, for everybody, the last 3 years has been interesting. It's been volatile. And I think from a competitive standpoint, if you look at the winners during that period, and that would be -- when I think about winners, I'm talking about retail and manufacturers, not just Tempur Sealy. The thing that really jumps out at me is the strong players got a hell of a lot stronger during that 3-year period. And the other thing that really jumps out at me is that companies that had the ability to be flexible and identify and change and rapidly change with the winners. And the ones that weren't took a step backwards. If you go and kind of think about 3 years forward, I think the same kind of attributes are going to be in the marketplace is stronger and get stronger. And again, that's both retail and manufacturing. And you've got to stay agile because it's a very dynamic environment, and we've got to be able to change rapidly. The other thing I would say in a 3-year forward look that I think is going to be really important is going to be cash flow. In the prior 3 years, there was still quite a bit of money in the marketplace that was willing to fund unprofitable ventures or we'll call it speculative adventures into various industries it would appear that's changed. And I think the ability to raise capital for businesses that are clearly making money or have a very clear path to be profitable. It Looks like to me that has become a lot more difficult. And I think that's going to be a problem for business models that aren't successful today. It's going to be hard to embrace capital in the future.

Okay. Great. Well, let's kick it off for a second question. Just talk about maybe some recent trends because everyone is sort of very curious about Labor Day weekend. Its like some of the biggest selling weekend of the year for the mattress industry. In our view, just based on some preliminary checks, it looked like it was a relatively successful weekend. I think sales were up year-on-year after appreciated by several months of year-on-year declines. How do you guys feel about Tempur Sealy performance over the weekend?

First of all, shock you need to have a current trend question. Thank God, we have to be protected. A couple of things. First of all, you're right, Labor Day is the largest weekend of the year. And from a preliminary standpoint, all the channel checks both that the Street has done and that we've done and the data that we've seen would indicate that it was very good to very strong holiday weekend. And so obviously, that's the most important current read. And you're also accurate that before that weekend, the industry continued to be a little bit challenged. But it's basically come in as we expected. We were expecting the back half of the year to be better than the front half of the year from a growth standpoint. And that's what we're seeing. But now there's no question. The retailers did a great job with advertising. There's new product in the marketplace, and it's very good to see a very successful labor.

Okay. Any opinion on what drove the performance? People are skeptical and other people are optimistic.

And we're talking in the industry to start with. This is very high level. There's no mathematical way to prove it. My gut feel is that in the first half of the year, retailers have gotten a little bit complacent because the business has been so good. They pulled back on advertising, promotions and everything. And then the industry kind of slowed down a little to call it first quarter, second quarter, and the retailers got back on their game and got back into retailing, much more aggressive in their advertising more high energy today kind of promotions as opposed to image kind of advertising. And then the manufacturers have some great new products in the marketplace. And as we expected, consumers are in good shape. And when we look at what I -- what I can see in my numbers and what I think I can see so far in the industry is exactly what you would expect, the high-end customers are doing better and high-end products are doing better than the low end, i.e., the Tempur brand is stronger than we'll call it, the medium price or lower Sealy brand. And I think you're going to see continued winners in the marketplace in the premium section and maybe a little more softness in the lower end.

Okay. So you guys do have some premium product launches coming up. So maybe just update us on what's rolling out for the this year? And then any early could be rolling out in 2023?

Yes. First of all, we probably have one of the busiest launch periods here over the next 6 months than we've had in the history of the company, when you look at the total. Going through it. But see, probably the most significant one in the marketplace near term would be the Stearns & Foster brand, premium brand, Innerspring. We've been feeding advertising dollars into the marketplace early, the last 2 quarters, 3 quarters or so to prime for it. In fact, Stearns & Foster grew in the second quarter, 4% in a market that was down. That's in marketplace this fourth quarter should be incremental slots is what we're seeing. But more importantly, the retailers are really fired up about it. And what we're doing is trying to take that brand from not really kind of a niche brand for us now and take it into a major national brand, and we've got good retailer support for that. We've got a couple of niche products that are in the marketplace. If you go to Sealy Natural, is our first step into kind of natural marketplace. It's out it won't be material to the consolidated financial position, but it's important to certain markets, primarily like on the West Coast, but it's completely incremental kind of product for us that's in the marketplace. We have the flex grid or the crushable wafer of what you want to call it, if you're looking for kind of a waterbed kind of field. Again, that's a different kind of market that we haven't been in. We've got a product coming out by the end of October. That will be a DTC product to start with. Then if you go to jump over internationally, we've got a very large international launch on Tempur that's taking. Internationally, Tempur is a very premium, more premium than it is in the U.S. and we're bringing down another group of SKUs below the premium Tempur products that are also new. But the main thing is we're trying to increase the addressable market of Tempur internationally. Worked on that project for like 3 years. We've delayed the launch due to some conflicts obviously over in Europe, but that will be launching in the first quarter. We think that, that will open up some growth potential to the international market that we've been driving towards. And I think that's all comes to mind. But it's a lot -- and of course, we'll freshen up U.S. Tempur Sealy -- Tempur in '23 sometime.

Okay. So could more new Tempur product in the U.S.

Yes, in '23.

Yes. Okay.

But I mean, really exciting some of the launches like they were delayed because of COVID incrementally new technology and just about every brand and strong advertising dollars to support all launches.

Yes. Okay. Well, that's exciting a lot coming. So you touched on international. I know you pushed back the Tempur launch there by a year. What are you seeing in the international business today to remind the audience, it's about 20% of sales over index to Europe. What's going on there?

It's kind of -- it's more complicated. But through second quarter internationally has actually overperformed our expectations even with the conflict that we have in Europe, and a few walk downs over in China. So let's go through kind of do it pieces. Asia, core demand really good, really strong, feels great long term. Occasional slowdown the blips when China decides to close the market. So that's kind of the China issue, and it's relatively controllable and minor from a consolidated standpoint, the places like South Korea and others over there are very robust. When you go over to Europe, it gets a little more complicated up to the second quarter feeling really good about their performance. The Dreams acquisition, which for those who don't know, the retailer we bought, about a year ago or so, has continued to perform over its pro forma acquisition numbers and quite they continue to take market share. They've done a great job at Dreams. But you do have to say that we've dealt with what we call it the war for whatever reason in Europe. We've dealt with that issue very well, and the markets have dealt with that issue very well. The issue that we're watching now is energy prices, energy prices, primarily in Germany and in the U.K. And that's an unknown. We're working through that. So to date, really good, but we are keeping a watch out for the energy prices. And Germany and U.K. would be our major markets in Europe.

Okay. Energy prices impacting the consumer.

Consumer, not us but the consumer and how they do it because their energy price inflation is off the chart from a consumer standpoint.

Yes. I think everyone's worried about that. Well, since you brought up energy, let's just pivot that to then input costs because there is some hope, I guess, its the your key input costs could fall over time. Maybe just remind the audience, what are your key inputs are you seeing any movement there?

Yes, good. We get to a good topic. First of all, the business model is such that we have highly variable costs, input costs, variable costs, probably 70% to 75%. The major input cost, you talked about really our chemicals, lumber, steel, those kind of things. It's clear, at least what we see today, and we're talking about commodities, so it could change tomorrow. But what we see today is that we see -- we think we've seen the peak. We've managed to on all of the commodity dollar cost to the end user, which is great. And I just told you about holiday sales. So we're able to pass the cost into the retail market and not destroy that destroy volume because I just told you we had a very good holiday. It does affect our margin because we pass cost on margin through the system. And I would expect, and you would take the forecasting and the chemicals. But at least with what we see today, if you look at the forward curves, you would expect commodities to be favorable to us in 2023. The way our contracts work, there's a 3- to 6-month delay on what we'll call the spot price before it shows up in our contracts. But we've been fighting the commodity inflation for 3 years now. So I'm expecting '23, it looks like it could be a tailwind, maybe at worse, it's even. But compared to where we've been in the last 3 years, it's going to feel pretty good. We've passed over $400 million of cost to the end user successfully into the business model and been fully reimbursed for it. Sort in the second quarter this year.

Okay. Another topic I want to ask about was your direct-to-consumer efforts. It's growing nicely in recent years in the U.S. I think that 12% of sales now. Update us on how that's going, both with online and your store build-out. And then is there any percent of sales do you think is an ideal goal for that direct-to-consumer side?

Yes. Look, one of the things that changed in the business over the last 3 or 4 years is we've moved from almost 100% manufacturer to kind of a more vertical model. On a run rate basis, we're running about $1 billion of DTC from almost nothing worldwide. And we have 650 stores worldwide that we own, and obviously, we've got some Internet operations. If I go directly to your question, which is the U.S. we're probably on a run rate north of $500 million here in the U.S. and would be one of the top 5 retailers in bedding in the U.S. if we report it that way, which we don't report it that way, but if you report it that way. And then if you break down that DTC strategy by channel, we have a very active web page, the tempur.com. It's been very successful, high margin. We recently launched sealy.com and stearns&foster.com, minor businesses at this point. Again, highly profitable operations. We have our Tempur flagship stores owned by all Tempur-Pedic only products. Think about them in high-end shopping areas. We have about 100 stores, good growth there. We think that potential is probably to 150 stores because it's a niche strategy. But the interesting thing about that is when we put the Tempur stores in the marketplace, they're incremental because what we're not trying to do is take business from our other customers. That's not the strategy. These raised the brand awareness, and we've been able to prove to ourselves and our other retail customers. that when we add a store because we're only doing 1 or 2 in major markets, it's actually accretive to the Tempur brand. And then we have Sleep Outfitters, which is a separate retail concept, about 100 stores. It's more of a middle-market strategy, and we're expanding it slowly and working on that model. That one has long term would have the larger potential for more stores. We're just not sure yet how we're going to use it. Again, it's about 100 stores. So you kind of add all that together and it's going well. And as you said, I think we're about north of 20% globally direct-to-consumer. In the U.S., 12% sounds right on point. what's ideal? Well, first of all, I think the customer is going to decide because we don't try to direct the customer to a channel. That's the only way really to run the business model. I think the fairest way to run it. The customer is going to decide and every who treats the customer best, I think it's where the customer is going to show up. But I expect probably 20% North America would probably be what I would expect we would get to DTC probably got maybe if it's a ballpark and maybe twice what the wholesale market grows because we've got some greenfields that we can do. And our research shows us that if you ask the customer, where do you want to buy your bed. Do you want to buy your bed from a third party or you want to buy it directly from manufacturer. It runs in North America 20-ish-percent or so, maybe a little north of 20%, what the customer tells us they want to do. So that's kind of a long answer to your question.

That's a good answer. And the stores, the Tempur-Pedic stores are a great experience to try to set up a different shopping in.

It's really interesting. If you go to compete wholesalers around it, their business is up, too. It's not like we're taking their business. So I think that concept is a home run. We just have to make sure that it's a niche and about $150-ish door sound right. And then we'll look at it and if we feel like we can go further, we will, but we're good for 150 stores.

Okay. I want to pivot over to adding manufacturing capacity you guys have added some capacity this year in the process of adding some industry-wide, I think there's been a lot of capacity added. And we're sort of in this inflection point now capacity is ramping up and then unit demand for now is depressed.

So let me push back on your because -- if you're talking about have we added capacity, yes, I'm not -- I don't think the industry has. I mean, if you look through the industry, there are others who have been closing plants quite a bit. So I'm not sure -- I don't think the industry has actually added capacity.

Well, I guess some of them have open plants and then shut them down very quickly.

And I think they get most of the plants to shut.

Yes. Fair enough. So let's talk about your business specifically to update us on what you've added this year? And then as we look at '23, is there any risk of fixed cost deleverage because you're adding some more fixed cost, demand is down a little bit. How should we think about that?

First of all, let me kind of frame it. We've been investing heavily in the business really over the last 3 years and CapEx has been running above maintenance CapEx as we've been putting capacity and taken significant market share in North America, okay? And we positioned the company to continue to take significant market share in North America, which should tell you how -- what we feel about our competitive position. So I would expect after this year, maybe a little next year, CapEx will move back down to more normalized maintenance CapEx and I don't know, $150 million-ish for talking terms. So first of all, when you think about free cash flow, you should think about that. Then on point to your question, we're building a new Tempur facility. And the way that Tempur manufacturing works, you have to make step changes. And so this is a big step change to add capacity because you think of these as big automated plants, the computers and stuff kind of make the beds, not very many people. They really kind of need, frankly, honest. And we needed -- we needed more capacity, and we also wanted to lower our logistics costs. So we wanted to plant a little closer up to the Northeast. I don't know, $200 million or $300 million-ish kind of expenditure. And we'll bring it on in phases starting in the first quarter of next year. It will take 12 months to 18 months to probably get it to full capacity. So we'll have a little bit of a drag, but not -- I don't think it will be significant. One, because we see the demand, okay? And two, we were purchasing some foam from others for our current demand. So we'll just in-source some of that, which takes some of that risk off. But you might have some minor fixed cost deleverage, but I don't think it's going to be a significant issue, unless you're very bearish on the U.S. economy. And the way we think about the U.S. economy, not that we know anything is I really don't care if it's a recession or not a recession, whatever it's going to be, it's going to be 1% down, GDP or 1% of -- it's flat. It's just not going to be robust. And so the way we think about it is it's just not going to be very robust. And that's the way we've planned. Now we went into 2022, positioned fairly aggressively for the marketplace before the commodity blip, and call it the war and other things. And we're beginning to trim around the edges and be a little less aggressive as far as positioning the company. But still, from a growth standpoint because of our competitive advantage and taking share in the marketplace, we're feeling pretty good about the capacity we're putting in.

Okay. Great. So we have time for one, maybe 2 questions, we'll see. But I did want to touch on capital allocation. So how changing or shifting your capital allocation this year in light of its kind of industry depressed demand overall. How do you think about that leverage target goal that you have? And then are you seeing any interesting acquisition opportunities?

Sure. To be clear, we have a debt guidance of 2x to 3x. I think we'll stay within our 2x to 3x leverage target. And look, we basically take -- the business needs money. We go to the business first for growth capital. And that's what we've been doing lately over the last 3 years, a little heavy into operations. We see that coming down. Then after that, if we don't do something, we'll deleverage below our target. So we need to spend some money, a high-class problem to have, but still a problem. And you benchmark stock buyback versus acquisition opportunities. Acquisition opportunities have become robust, and a little slower market, our phone rings more doesn't really change our appetite much. We work of normalized earnings. And you benchmark in the stock and the stock multiple has obviously been depressed, so it becomes more advantageous to buy stock. So we've targeted at least 10% this year in stock buyback. I think we'll hit that target. We'll continue to talk to people. If something comes up, we may do something. But with the lower priced stock that hurdle rate becomes a lot a lot higher. The good news is we are a company that produces a lot of free cash flow, and we'll continue to invest. But I would guess it means we're going to be finding stock back every year. Because I don't think the acquisition opportunities are so great that you're going to use all your free cash flow for that. So I expect to be buying stock back in the marketplace, probably every quarter.

Okay. Well, I think that's a great note to end on with a cheap stock and a very dominant competitive position. So thanks for spending the time with us today, Scott and the rest of the Tempur team. Thanks for coming to Nashville.

Thank you for having us. Great conference.