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

All right. Thanks, everyone. So happy to kick off the Piper Sandler Growth Frontiers Conference here in Nashville, first fireside chat, and we kick off with one of the best Tempur Sealy. We're very pleased to have you here today. As many of you know, Tempur Sealy is the leading bedding manufacturer not only in the U.S. but in the world and has quite a bit of growth in front of it. So just by a quick introduction with me on stage is CEO, Scott Thompson. We're going to try to stay alert and awake in these comfortable chairs. And sitting up front here, we have Bhaskar Rao, CFO. We have Aubrey Moore, as VP of Investor Relations; and Lauren Everett as Investor Relations Manager. So thank you, everyone, for coming, and we'll jump right into it.

Thank you, and thank you for inviting us to the conference.

Great. So, Scott, the competitive landscape has evolved quite a bit during your, I guess, now, 8-year tenure?

8-year tenure.

Yes. And you guys have really, I guess, moved up in your competitive positioning. But maybe just even in the last 6 to 12 months, how would you kind of size up the competitive environment today? Your biggest competitor just recently emerged from bankruptcy. Some of the online players are continuing to pivot more towards wholesale. Amazon still seems to be a force at the low end. What's your view of the landscape?

Sure. And thank you for the question. Clearly, we managed the company to enhance our competitive position every quarter, and that's kind of how we look at the company. If you just kind of take a broad swap through the industry, I mean you mentioned Amazon, I think some people forget that Amazon, I think some people forget that Amazon and Wayfair, those folks are our customers. And so we just see them as another distribution channel, and we're doing very well in those distribution channels. If you're talking about like the last 6 months, probably one of the biggest changes would be Silicon Valley bank failing. And we'll call it risk-off when it comes to companies that don't make money. So I think capital costs have certainly changed in the last 6 months. And in our industry, there are some companies that have burned through some money, we'll call it over-investing in customer acquisition costs. And so I think that's changed the game from that segment of the marketplace. You mentioned our largest competitor, Serta Simmons that recently exited bankruptcy. We really haven't seen any significant change in how they operate even before they went bankrupt and they went bankrupt, they came back out of bankruptcy because nothing really changed from an operating standpoint. They just flipped some debt into equity, but made a few management changes, but from a competitive standpoint, haven't really seen any changes. And I expect that when the third quarter is over and we look at the analysis, some of the trends that we had the last couple of quarters will continue going forward.

Okay. I know just to play off of that Serta Simmons started to advertise just in the last couple of weeks. Aubrey and I were talking casually last night, that does anything, I guess, maybe just raises the profile of the bedding industry...

Yes. I think the advertising actually is a net positive. I mean, the industry in total, needs more advertising dollars and to put more people in the top of the funnel. And so we're very supportive of other manufacturers' advertising, retailers' advertising because we think if you get people into the funnel that our brands are strong enough, we'll get our share plus some. So we would see that as a net positive.

Okay. So well, speaking of getting people into the funnel, let's think about the most recent funnel, which is Labor Day weekend. So we're a week after, the dust has maybe settled a bit. What's your view on the industry performance for that important weekend and even more specifically, Tempur Sealy's performance...

If you look at the Labor Day holiday period, which is really the Super Bowl for bedding, we'd say it was a very solid holiday for the industry. We would expect for that period for sales, we're talking U.S. here, U.S. sales to be up probably 1% to maybe 3% for that particular period. To be fair and balanced, though, you have to say that the troughs, the non-promotional periods have been deeper and have been negative. So when you look at -- if you're looking at kind of -- well, I'm guessing at this point, obviously, in the total quarter for the industry, I think it's going to be about what we said during our earnings call, the second quarter, which is probably down mid-single digits for the quarter for the industry, maybe a little bit more than that, give or take. Now Tempur Sealy's specific performance, we had a very strong Labor Day period, positive, and we feel very good about when the numbers settle in that we'll have taken a good bit of share in the third quarter, much like we did in the second quarter.

Okay. So our conversations with various industry retailers and [ cellular ] products. We heard very good things about TEMPUR-Breeze, which launched earlier this year as well as Stearns & Foster, which started to launch in Q4. So I think those are your 2 biggest U.S. product launches. Maybe comment on those, how those have been going so far. And then even if pivot to 2024, any preview of what could come.

9 Okay. And then '25, then '26 and '27...

We'll just go 1 year, I don't want to step over...

The 2 biggest launches this year were TEMPUR-Breeze and the Stearns & Foster. Both launches have been very successful. They're both high-end brands and the high-end customer, is clearly doing a lot better than the entry-level customer. But I don't think there's any question that probably, Tempur, for sure, took the holiday season with TEMPUR-Breeze. And Stearns & Foster has grown double digits last 3 quarters in a row and what's been a relatively soft market. And we continue to get placements for new Stearns & Foster.

Okay. And probably, I guess, there'll be something in '24. We'll just have to wait and see.

Look, it's a little early, but we've been bouncing around the bottom in the bedding industry for at least 3 quarters, very stable, solid, but you'll get a few weeks of very positive activity than a few weeks of not positive activity. So we've been in, I think, recession, probably in the bedding industry for at least 3 quarters. I would assume that probably by 2024, we'll be back to our normal growth trajectory, which is, call it, 5% or 6% industry growth and then we would hope to outperform that.

Okay. So then I want to pivot to international because there's, I guess, a kind of product launches almost like a product line overhaul in our international markets. Could you give us an update on how that's progressing? I think you want to get that completely done end of Q3 end of this year. Maybe just update us and then pleasing on the -- there's a component part commonality that I think is really interesting that can make you more efficient.

Yes. When you look at Tempur internationally, it's always been priced super high. Think of it as a Ferrari internationally, maybe in the U.S., it's more like Mercedes. And so we've been super high priced, great margins. But as you know, the high end is thin. And so the growth trajectory of the international operations hasn't been what we would have liked. So about 4 years ago, we went through -- thought through it, said, we need to bring the price band that we serve with Tempur internationally down a little bit to get more in the meat of the market. But we, of course, still like our margins. So what we had to do is we had to reengineer the beds. So we have common components and so that we could hit the lower price points with the same margin profile that we enjoy. So it's been a more complicated launch for us internationally, much bigger launch. It's gone very well. You will see, as we expected strong sales internationally in the third quarter. We'll get all the way through it by the end of the first quarter of 2024. We're in 100 different countries. And so it's kind of a rollout through the countries. But the U.K. is the last country and it'll be the first quarter of '24. But it's very important to us, not just on a short term, but to be able to hit the meat of the market internationally to get the growth that we want long term. The margin has always been very good internationally, but we need a little higher growth rate.

Okay. And are you -- just to follow up on that, all of your international markets? Have you done anything -- any areas of the globe first...

Yes. We're pretty much 80% launched or so, I would say. So we're pretty far along in it. And that's why I say you'll see the sales impact.

Okay. All right. Maybe just moving down the P&L a little bit to Gross margin, more of a CFO question, but you're a good numbers guy. So input costs and FX, and just talk about the interplay between those, input costs, I know have been a big headwind on gross margin. You guys scale it at 400 basis points or size it up at that. How much do you think you're getting back with the input cost this year? And then what's happening with FX and the impact on your business?

Sure. You give me all the hard questions. So look, we passed on the commodity cost in the industry that came through the system. We had some inefficiencies, and we probably were down 400 basis points from the beginning to when we started turning it around. We recaptured about 150 basis points in, I think, the first 6 months. We've targeted to capture another 150 basis points in margin improvement in the back half. And we hope to get the balance of that 400 probably in 2024. Input costs have generally stabilized. They stabilized at a higher price point than they did before the commodity run-up. But really one of the great things about this industry is when you have these commodity input increases, we absorbed them for, call it, 6 months, and then the industry pretty well passes them dollar for dollar on into the industry. And then if commodity prices come down, we are usually able to hold, we actually always held the price up. On FX, for the year, FX, we think it will probably be flat as far as impact, with it being a positive in the back half of the year with a little bit of a bad guy in the front part of the year. Exposure is generally the pound, a little bit Canadian dollar and euro are probably the currencies we have to watch.

Okay. And the holding price, I think, is an interesting debate because kind of across the consumer landscape, there's talk about maybe some price cuts, if possible, mattresses are always unique. It's an infrequent purchase. Do you think it will be consistent prices held across the price spectrum or maybe hold the high end and maybe low end could come down a little bit?

No. I think it's historically held. I always hesitate just a little bit because I think if you had a sudden decrease in commodity prices, I mean sudden you might get something different. But if you have what you normally do, which is what I'll call trickle-down to normality, I think they'll hold. And you have to also look at -- if you look at the competitive landscape, the rest of the manufacturers of bedding would be very motivated to hold margin because -- well, there's other sort of struggling from a profitability standpoint.

Yes. And the key inputs that I think we think about the Street is steel costs and then chemical cost to make foam. Are those both holding steady? Or is there any diverge between the 2?

Well, depending on what day you talk. But we also think about shipping costs with components from our basis coming overseas, labor costs in the plant. We do what I'd call a full inflation outlook. So when you look at it, it's generally going well.

Okay. So I want to move on to the capacity expansion. So you've opened up the third Tempur facility earlier this year. Maybe talk about how that is ramping for you? And then does that all bring it more, I guess, in-house production across the entire product spectrum?

Yes. First, we had about a 3-year capital program. So if you look at our historical numbers, our CapEx is over what we would consider to be normalized. And we're complete with that, and we would expect our CapEx numbers to fall significantly going forward. A big part of that was a new Tempur plant. And with this [ Tempur plant, ] you have to bring in with huge incremental volume. In Sealy operations, they're more smaller tilt-wall buildings. But when you do Tempur, think of it as kind of a large chemical plant. So we were getting a little tight on forecasted capacity, especially with our new OEM business. And so we stood it up, it's be operational on January 1. It's gone well. Probably more importantly is we've been able to sell some big contracts to get some production in there. So we would expect it to be not a drag on our earnings in 2024 and any incremental volume we get in that plant going forward should be highly profitable. It allows us to have shorter delivery times to the Northeast. It has some risk mitigation built into it with some larger chemical tanks. So in case of a disruption from a hurricane or any other issue relative to getting supplies or inputs in. We're able to mitigate that has rail access. So it gives us the ability to have capacity for Tempur for the foreseeable future. And we also -- until we needed to build new Tempur beds, we can in-source some foams that we're buying currently from third parties. So it's becoming a very productive asset.

Okay. It's a little bit of a headwind this year with the ramp and this should be more neutral next year.

And then you've built the capacity for the organization for a long time.

Yes. Okay. And on the Sealy side of the house, we've talked at the beginning of the year, there's been some inefficiencies there throughout COVID with labor and, I guess, inconsistent production schedules, big opportunity to get more efficient. How is that progressing for you in '23?

That's going well. We'll have a -- that will be a benefit in the back half of this year and an additional benefit going forward, and you should be able to see that in gross margin.

Okay. All right. Okay. So -- and I would be remiss if I didn't ask about the Mattress Firm acquisition, at least there's not probably not much you could talk about, but maybe just where we are with the FTC and what are the key synergies you've highlighted if that acquisition were to come through?

Sure. We announced the acquisition of Mattress Firm. We're currently in review with the FTC with a second request. As probably most of you know, it's just a very complicated and thorough process nowadays, and we're passing data back and forth. We'll continue to do that into the fourth quarter. And in the fourth quarter, I think what I term is people start playing their cards as to actually what positions they have. And we'll figure out whether or not the FTC will clear it with either as is or with some minor issues, or we'll need to move forward to litigation. There hasn't been anything in the process that's come to light that wasn't anticipated. So I consider that like good news. The conversations are professional thorough. The tonality is good at the FTC, and I think that is good, but I also consider that you don't really know anything until you get to substantial completion in the fourth quarter, and we'll visit with them on their thoughts.

Okay. And synergies, you've talked about even just stabilizing production because you have better visibility? Maybe just size up some of the big opportunities that people may not be thinking about.

Sure. A couple of things. First of all, just from the way we do acquisitions, we have synergies, but we don't price synergies into deals. That keeps you from paying too much for it. So we have a tendency to buy businesses based on what we think their normalized cash flows are and things that you know about. And then synergies get worked on over time and are kind of a net plus to the organization. So -- but it's not -- the deal is not predicated on synergies, but I'll talk about it here in a second. The teams have gotten together, and they're small groups working in each area to come up with synergies. But again, I think the most important thing is the operations of the company as opposed to synergies. Remember, this is a -- this is a vertical integration, so you're not going to have as many synergies as you would as a horizontal. A couple of ones that are really though that really are exciting. In bedding, it's order to delivery at Sealy. So they order the beds, and within 2 or 3 days, we deliver them the bed, okay? So what that means at the plant level, is you don't know what you're going to make, right? Your production is like you're going to see every day what you get. So your volumes by day go up and down, up and down, up and down. And there's so many SKUs in betting that you can't forward build very easily, okay? Because a number of sizes, number of SKUs. And so that means the workforce inside the plant gets whipsawed. Some days, they show up, maybe they only have 4 hours of work, okay? Some days they show up and it's going to be 12 hours of work. On Friday afternoon, we tell if they're going to work the weekend. That wasn't that bad a problem 10 years ago. But today's workforce, that's a problem. So from both a quality of life issue from an overtime mitigation issue, being able to have ownership of a large retailer and be able to push -- make them push their orders out further in the future so that we can level out the plant, we think we'll have significant benefits to the manufacturing side of the house. So that's the #1 quality of life for the manufacturing folks and savings. There's certainly going to be some marketing synergies as we combine 2 very large marketing budgets. Plus probably a little better syncing up of the message, I think, probably under common ownership. You're going to have some of the traditional synergies in various areas and overhead, certainly for sure.

Yes. And on the production, the Tempur side is very much automated, right, or Sealy is more manual...

On Tempur side, there aren't very many SKUs. And so we're able to produce to stock at Tempur. And so we produce that stock there in warehouses and you just pull from warehouses. You do eliminate what happens on the Tempur side of the house is we make a bid. It goes to our warehouse. It sits in our warehouse until Mattress Firm orders it then we take it from our warehouse and goes to their warehouse. And it sits there until the customer orders the bed, okay? And because retailers generally don't want to give us their customer data, you can't go straight to the customer. You have to go through this double warehousing thing. I think that we'll figure out how to eliminate some of the warehousing duplication that we have on the Tempur side of the household. I also think there's probably an opportunity for us. There's some private label bedding that's done at Mattress Firm. It's lower end but it could be a good business for us to work in that area because we're already driving trucks to the warehouses, and we may be able to find some opportunities in a market that we really haven't played in, in private label there.

Okay. On the production side, just thinking about Q3 and coming through Labor Day, you had the cybersecurity attack -- sorry, to bring up -- but it did shut down production for a week or so. Getting it ramped back up. How has that been progressing for you? You guys catching up? Or do you feel like you're caught up?

Yes. By definition, my cyber lawyers tell me I have to use these words first before I say anything, which is in a cyber attack, it's ongoing, another one could happen at any time, all that other stuff that everybody already knows. So now they made the lawyers happy. It's all behind us. We have not had any significant cyber -- negative cyber activity. Last time we reported. We called out some numbers on potential lost sales, $20 million or $30 million. In hindsight, I think we caught up, and I don't think we lost any sales. All around the world, all the plants are producing, delivering and stuff. We will have some incremental direct expenses related to it for consultants and those kinds of issues. Those will be treated as an add-back to normalize the numbers. We would expect -- we'll have some of that in the first quarter -- in the third quarter. But I think the important point, it's a little bit of a change since the last time we talked to the market was we called out some potential lost sales, and I don't think we lost anything in the third quarter.

Okay. Great. That's good to hear. So one last question to summarize. Maybe just the industry backdrop. And I think what people would love to hear your opinion on is what it's going to take for the industry to get back to positive unit growth, where looking at probably, I don't know, I think it's a bit 18, you could even argue 24 months of unit declines. And maybe even layering in the housing element that also is not supportive right now.

Sure. Like we went in recession early, bouncing around the bottom. It is possible that we're creating some pent-up demand. I won't know, but it certainly would look like it based on historical numbers if you look through it. Look, we need some healthy manufacturers advertising, and we need a good consumer confidence in the marketplace. And there's no reason to think that the trend line wouldn't be to get back to what's now a 20- or 30-year CAGR that we've just had a little blip here. And I think the blip is kind of a hangover from COVID that none of us had experienced and knew exactly how to predict. Probably a little bit of a hangover from some of the internet companies that were overspending in advertising, probably pulled forward some sales. But when you look at it, during that period, there was a lot of low-end bedding that was sold that was not designed to be long-term bedding, I kind of call it disposable beds. Think of the lower-in bed-in-a-box, those beds aren't holding up and they're coming back to market. So I actually expect that we're going to have a pretty robust market at some point. I just don't know if it's fourth quarter, first quarter, second quarter and when it turns. But all the key elements are out there, and it's been stable for quite a while. And during this period, Tempur Sealy's competitive position has taken great steps in strengthening and every quarter, we seem to get a little better from a competitive position. So I think we're very well positioned for the turn, but I can't pinpoint it.

Okay. All right. We'll wrap it up there. So Scott and the Tempur Sealy team, thank you very much for joining us today.

And thank you for having us.