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

Hello, everyone. Thank you for joining us, and welcome to the Somnigroup business update call. [Operator Instructions] I'll now hand the call over to Lauren Avritt, Director of Investor Relations. Lauren, please go ahead.

Good morning, and welcome to the Somnigroup International Business Update Call regarding the closing of our acquisition of Leggett & Platt. Joining me today are Scott Thompson, our Chairman, President and CEO; and Bhaskar Rao, our Executive Vice President and CFO. Before we begin, I'd like to remind you that this call contains forward-looking statements within the meaning of federal securities falls, including statements about expected synergies, accretion, future financial performance and capital allocation. These statements involve risks and uncertainties, and actual results may differ materially from those expressed or implied. Please refer to our SEC filings for a full description of the risks and factors that could cause results to differ. With that, I'll turn the call over to Scott.

Thank you, Lauren, and good morning, everyone. Today is a significant day. We have officially closed the Leggett & Platt transaction. and I'm pleased to welcome the Leggett & Platt team to the Somnigroup family. This milestone marks the next chapter in our strategic journey and one we believe strengthens Somnigroup's competitive position around the world. A few facts on Somnigroup post closing. Over $11 billion in trailing 12-month sales, over $750 million trailing 12 months net income, $20 billion enterprise value, $15 billion market cap. Over 170 manufacturing plants around the world. 2,800-plus retail stores with various formats customized for each international market. Over 40 e-commerce websites, selling direct to consumer with aggregate sales of over $500 million per year. 36,000 talented associates led by a very experienced management team. And customers, both retail and wholesale in over 100 countries. We are building a special vertically integrated company with numerous competitive advantages, outstanding cash flow generation attributes, a diversified customer base and a passionate workforce dedicated to customers in various markets and industries. What we see in Leggett & Platt is a company with 143-year long legacy of exceptional people, world-class manufacturing, strong commitment to customer service and best-in-class expertise in bedding components. They also have a long track record as one of our most important suppliers. We know them well, and they know us well. That familiarity is an asset as we move forward as a combined company. First and foremost, the combination deepens our vertical integration, and it adds significant scale expanding sourcing opportunities, enhancing operational flexibility to a portfolio of assets that is already industry-leading. It also extends our reach across industries beyond bedding which will provide the company's solid free cash flow and growth as markets normalize and these strategies are implemented. Strategically and economically, this is the right deal at the right time with the right partner. Let me take you through how this transaction advances the strategic pillars we outlined at our Investor Day last March. Global scale and vertical integration, relentless consumer-centric innovation, relentless cash generation, disciplined capital allocation and a uniquely favorable position in the $120 billion global bedding markets recovery. The Leggett & Platt acquisition checks every one of these boxes. Most directly, it strengthened our vertical integration advantages. Leggett & Platt is a primary supplier of important components to the bedding industry and particularly to our own manufacturing operations. They supply innerspring units, specialty foam and other key components to producers around the world, bringing their capabilities in-house further fortifies our supply chain in an uncertain world and allows us to optimize cost and drive quality end-to-end in the supply chain. The combination brings component engineering closer to mattress design and closer to the consumer insights we generate every day across our retail platform. That proximity supports accelerated innovation cycles. It means we can develop more cost-effective and consumer-centric products. In addition to expanding our addressable market in bedding, Leggett & Platt's product portfolio includes automotive seating systems, furniture components, geo components, and hydraulic cylinders also allow us to participate in industries beyond global bedding. These diversified sales streams as well as Leggett & Platt's geographic footprint broadens our earnings base, and mitigates reliance on any single category, product or geographic market. Let me say a word about how we intend to operate Legget & Platt within the Somnigroup portfolio. Leggett & Platt will operate as a stand-alone business unit within Somnigroup, consistent with our approach with Tempur Sealy, Mattress Firm and Dreams. We believe this decentralized operating model is one of our structural advantages. It allows each business unit to stay close to its customers and markets and quickly respond and develop strategies in an ever-changing world, while also benefiting from Somnigroup's expertise, scale, strong balance sheet and operational leverage. A word on leadership. First, we're very fortunate that Leggett & Platt has an experienced workforce dedicated to quality and customer service, which is led by a strong committed executive team with depth and a passion to succeed. To enhance their leadership structure, you most likely saw we announced the appointment Tyson Hegel as President of Leggett & Platt. Tyson is a 25-year Leggett & Platt veteran with a broad expertise across all corners of the business, including strategic planning, operational leadership and M&A. Most recently, he served as President of the Bedding Products segment, delivering results and operational improvements through some of the most dynamic conditions in the industry has ever seen. He knows Leggett & Platt well, including the non-bedding components. Karl Glassman will continue to lead Leggett & Platt as CEO over the near term, working closely with Tyson, and Somnigroup executives as we bring the companies together. I'm looking forward to working with Karl and Tyson. Moving to near-term strategic initiatives. We expect some early wins. We have long believed that high-quality innerspring systems represent a meaningful point of differentiation and important feature for customers. While the mattress category has traditionally emphasized finished product branding, we see the opportunity to elevate awareness of underlying technologies and components that contribute to comfort, support, durability and overnight fleet quality. Simply put, what is in your mattress matters. As a result, we are working to amplify the differentiated innovation by incorporating Leggett & Platt innerspring branding on the exterior selected mattress products. We believe this approach helps highlight the value of the technology inside the mattress while creating greater transparency and confidence for customers at the point of purchase. This initiative will initially roll out with our launch of the all-new Stearns & Foster collection this fall. It represents an important step in our broader strategy to increase consumers' recognition of the premium component of engineering that differentiates our products. We believe stronger visibility of the Leggett & Platt innerspring technology can enhance the consumer shopping experience, support our retail partners merchandising efforts and further reinforce the value proposition of mattresses that incorporate our technology. Ultimately, we view this as much more than a branding initiative. This is a reflection of the strategic vision behind the acquisition of Leggett & Platt's bedding business and the unique capabilities that the transaction creates by bringing ownership of innersprings, the heart of the bed, into the portfolio we are now able to more closely integrate component innovation, mattress design, driving consumer engagement. We believe that position enables us to set higher standards for innovation, durability, quality and transparency across the industry, while creating connection between the technology inside the mattress and the magic consumers experience every night. We should also note that Mattress Firm as it continues to focus on customer first, recently communicated to its supplier base, new and more stringent merchandising criteria, including the qualification of key component inputs, both Leggett & Platt's innerspring systems and the foams produced by ECS, their specialty foam operations have been qualified under these enhanced standards. This is direct validation of the quality and consistency that Leggett & Platt brings us to our supply chain. I'll say it again, what is inside your mattress matters. In closing, I want to leave you with a few key thoughts. We are the leading vertically integrated bedding company in the world. We now forge our own steel, create our own springs and foam. We design and build our own products. We develop and market our brands and sell our products, which cover all price points in a balanced omnichannel format across the world. We believe that the $120 billion global bedding market remains structurally intact and positioned to normalize from its historically depressed levels. Now let's be clear, the bedding market has experienced an extended period of weakness, and we have used that time deliberately to build the platform you see today, while also growing adjusted EPS and deleveraging. We are investing ahead of the recovery and building our brands, driving upper funnel advertising and strengthening our infrastructure. It's not a question if the bedding market is going to turn around. It's a question of when and whether you are positioned to lead when it does, and we are positioned to win and win big. With that, I'll turn the call over to Bhaskar.

Thank you, Scott. Let me start with some housekeeping items on our reporting structure going forward. Leggett & Platt will be reported as a single consolidated reportable segment within Somnigroup, consistent with our other reporting segments, Tempur Sealy North America, Tempur Sealy International and Mattress Firm. Now moving to synergies. When we announced this transaction, we identified approximately $50 million in synergy opportunities on an annual run rate basis, focused on sourcing, operations and product innovation. That figure was based primarily on our internal diligence work at that time. Since then, we have worked with Leggett to refine our expectations. As a result of the team's combined efforts, we are increasing that synergy estimate by 50% to $75 million on an annual run rate basis. With additional opportunities in our synergy funnel, that will be evaluated over the next year. Within sourcing, we see opportunities to expand profitability by bringing select components in-house and/or improving purchasing economics across our supplier base. To date, we have included $35 million of sourcing related synergies in our target. One of the most immediate and tangible examples is innersprings. Beginning in January 1, 2027, we expect to manufacture over 90% of our total U.S. innerspring needs internally, creating a meaningful cost savings opportunity and further strengthening integration across the business. We are reviewing additional supply chain opportunities and expect our combined sourcing efforts to support greater cost efficiency, particularly in chemicals. In addition, we expect the broader platform to create savings across third-party professional services. Beyond procurement, we also see opportunity and how the combined company operates. Leggett's global manufacturing and logistics capability, together with global manufacturing and logistics networks of the legacy Somnigroup business create opportunities to improve the combined cost structure. To date, we have included $30 million of operations related operating opportunity in our synergy target. This includes projects to optimize manufacturing and capture efficiencies across logistics, including chemical storage, warehousing and ocean freight, as well as the elimination of duplicative public company costs. Finally, turning to our innovation pipeline. The acquisition brings component engineering, mattress design and consumer insights closer together, supporting more cost-effective and consumer-centric product development. Our current synergy target contemplates a $10 million EBITDA benefit from these opportunities. Taken together, these initiatives reinforce our confidence in the transaction's value creation potential. We believe they will enhance operational efficiency, support sustainable cost savings and drive long-term value creation. In terms of timing, we expect to realize approximately $25 million of synergy benefit to the calendar year 2027, with full realization over a 3-year period. In addition, over time, we expect to identify more benefits of this combination. Turning to the financial impact of Somnigroup. The transaction is expected to be approximately $0.35 to $0.40 accretive on an annualized run rate basis before synergies based on the current operating environment. We expect approximately $0.10 of EPS accretion for the partial year 2026 on sales from Leggett of approximately $1.2 billion after intercompany sales elimination. We are revising our annual guidance up by $0.10 as a result. We expect approximately 6.5% of Leggett sales in the period will be to other Somnigroup segment and therefore, will be eliminated for financial reporting purposes. Consistent with prior expectations in accordance with GAAP, Somnigroup expects to incur approximately $50 million of annualized noncash expense from the adjustment to fair value of the acquired Leggett business, which will primarily impact cost of goods and we expect to incur approximately $10 million of annualized noncash expense from the adjustment to fair value of acquired Leggett bonds, which will impact interest expense. We anticipate these noncash items will be pro forma financial adjustments in accordance with the terms of our credit facility. The transaction has reduced Somnigroup's net financial leverage by approximately 0.2x and Somnigroup expects to end the year towards the midpoint of a target leverage range of 2 to 3x adjusted EBITDA. The combination with an all-stock transaction valued approximately $2.3 billion based on Somnigroup's closing share price on August 25, 2026, and inclusive of Leggett's existing net debt. We have issued approximately 20.6 million shares in connection with the transaction. We expect our weighted average share count for Q3 to be 221 million shares and for a full year to be 220 million shares. A few words on our long-term targets. At our March Investor Day, we set a 2028 EPS target of $5.15 representing a 24% compound annual growth rate from 2025. That target was set in the first quarter prior to the close of this transaction. Our plan is to incorporate the Leggett impact and updated industry conditions at that time into our long-term outlook when we report Q4 results. With that, let me turn the call back to the operator to open it up for questions.

[Operator Instructions] Your first question comes from the line of Susan Maklari from Goldman Sachs.

I wanted to ask a bit about the upside to the accretion. And as we get some of this volume that does flow into Leggett, I think you mentioned in your prepared remarks that over 90% of your inner spring production will now be internal. Legett has done a lot of work on their cost structure in the last couple of years. Can you talk about what that means in terms of the margin profile of the business? And how we should think about the upside to that profitability if we do that an industry recovery or when we get an industry recovery? .

Sure. Thank you, Susan. I'll take the first part of that, then I'll pass it over to Bhaskar to work on the margin a little bit. I mean, first of all, the acquisition, we're getting great people, both associates and leadership which obviously is our first filter on any acquisition or combination we're doing. I think what's interesting about this acquisition and your question kind of points it out, is we think we invested in Leggett's restructuring before Wall Street did. And we're putting our chips with the Leggett team on what we believe was a very successful restructuring just you couldn't see very well as the industry has been in decline here in the last few quarters. We think we purchased the company during a trough, which is great and the potential for the flow-through on the upswing, we think, is enormous, not even before you start talking about just the synergies. And we were able to deleverage the Somnigroup company a little bit, which, again, enhances the buybacks in 2027 and beyond. So from our standpoint, we feel really good about it. And what we're really doing, if you look at it, both with the Mattress Firm transaction, the Leggett transaction, we're not just making more SGI efficient, but we're quite frankly, making the bedding industry more efficient through these acquisitions and restructurings, Bhasker, you want to talk a little bit about the margin potential?

Absolutely. So when you think about the restructuring that Leggett has accomplished, really fantastic job by that management team, let's call it, about $70 million on a run rate annualized basis, that the team has been very successful in taking out. And when you think about the industry, and when you think about it coming back, traditionally, I think about the flow through, the contribution margin, somewhere around 25% to 30%. And as you think about the -- specifically the bedding industry coming back, typically, it trends toward the higher end of that range, call it, 35%. So with the combination of the restructuring activities that Leggett has accomplished and even before thinking about the synergies and when you think about innersprings as an area where the volume could come back as the industry comes back, as I would think of as something in excess of that 35% would be a reasonable way to think about it.

I think to be also clear, Bhaskar, you don't have any revenue synergies in your number that we're committed to at this point. And I think it's interesting what we're doing. We're working on the branding of the Leggett & Platt spring technology. And also, quite frankly, just having some influence and having some friends in the industry, and helping them look at some of the components that Leggett & Platt produces in its bedding area.

Your next question comes from the line of Pedro Gil with Morgan Stanley.

Congratulations on closing the acquisition in good timing ahead of schedule. I wanted to ask you about the 2025 financial targets, realizing it's still early and we'll get more detail down the line. But how should we think about Leggett's contribution to the overall earnings power going into 2028, coupled with the potential for a longer or slower path to industrial recovery that you alluded to on the last earnings call. Is $5 per share or slightly above $5 per share still the right level to think about for Somnigroup's earnings power in 2028? And what are the levers that get you there in terms of share gains, synergies, capital returns, et cetera?

Sure. Thank you. And we talked a little bit about this on the second quarter earnings call. When we did the [ 515 ], obviously, we didn't have the Leggett acquisition. We had some capital allocation in the model, but not very much and didn't have much benefit from the allocation of capital, which is, obviously, it's important to note that, that's internally generated capital as opposed to leverage. And so clearly, the Leggett transaction is structurally before any advantages from a synergy standpoint or any industry recovery is structurally very accretive. And I think Bhaskar added like $0.35 to $0.40, and I'm just going to call that structurally accretive that is not included in that projection, we'll call it. At the same time, as you know, in that projection, we were looking for the industry to begin its turnaround a little earlier than we've currently experienced. So you've got one, we'll call it, a good guy in our terminology, you got one bad guy that you will have to roll through in the 515. Having said that, what I said on the second quarter earnings call, which I certainly believe it probably even more now, if we got to know more and more about Leggett is that the 515 is certainly still in play. There's going to be some moving around of some of the assumptions in any long-term projection. But I would consider 515 certainly build in the game. And with the Leggett acquisition, the upside on those numbers in an industry recovery in the out years is higher. And I guess, to do a little bit on the building blocks, Bhaskar, you can help me a little bit, but you open a whole new funnel of synergies which we didn't have before like Bhaskar said in his part, we've got a commitment of 75. But I think the whole group and the people working on it would be disappointed if that was all that ultimately came from a synergy standpoint.

Your next question comes from the line of Bobby Griffin of Raymond James.

Congrats on the deal and the time this morning. I guess, Scott, I wanted to touch on a comment you made in your remarks about an updated communication with just Mattress Firm suppliers I think that's kind of interesting just in the sense that there's been probably an expansion of suppliers of components in this industry over the last 3 to 5 years. So can you maybe expand upon that aspect and the narrowing of their supplier kind of base or list? And then how do we think about that potential upside in the context of your $75 million synergy target. If I'm hearing you correctly, it seems that, that would not be included in the $75 million, and that seems like it could be a decent bit of upside, especially if it's driving business back into Leggett's legacy facilities, which are now at a low utilization given where the industry is today and all the fixed costs they've taken out?

Yes. So let me do the easy part of the question first, which is it is not included in any of the synergy numbers, that initiative, and I think you framed it correctly. It is hopeful that, that pushes volume into their organization, which has been rightsized. So that part is the easy part of the question. To kind of go off on a tangent a little bit. I mean one of the things that's been a little frustrating in the bedding industry is some people have been including components in their beds, sometimes even luxury beds, which I would consider to be less than optimal for the customer. And because the components are in the bed, you can't see them. I think the quality, some luxury beds has deteriorated as they try to get a cost advantage. That is not something that Sealy and Tempur have done. It's something that strategically, shoot, I think, 7 years ago. We made a firm decision that we were not going to do. And so I think the neat thing about what we're doing is Leggett is absolutely world-class in making springs. I think everybody in the bedding industry knows it. and being able to highlight their quality is important. And we have Mattress Firm leading the way as they've got a customer-first focus now, which is also part of their strategic initiative. Certainly aligns with them making sure they're giving their customers the best value. And so we've talked to the suppliers of Mattress Firm. We have formally kind of put a program in place that we're going to qualify internal components to make sure that the customers and Mattress Firm are getting the best and getting what they're paying for. And of course, obviously, that plays right into Leggett and ECS. And I think will probably result in some incremental volume. But each of the suppliers to Mattress Firm will have to decide what they think. And then hopefully, it influences other retailers and others do think about that because I think that's a big issue in the industry to make sure that we have quality components.

Your next question comes from the line of Rafe Jadrosich with Bank of America.

I just wanted to follow-up on the sourcing synergies that the 90% of the expectation that you'll be 90% internal sourcing for your Springs. Can you talk about where that is today, like what that delta is, how much you're getting from Leggett versus either other suppliers or internal right now. So like what that changes? And then does that include anything with Elite Comfort Systems and the foam side? Or is that all -- that sourcing number all innersprings?

Yes. We have -- we were under a long-term contract with Leggett pre-combination of 80% of our springs in the U.S.. This is just a U.S. comp discussion coming from Leggett, so you should think about it as incrementally $10 million, and we'll probably be a little bit north of 90% over time would be my guess. That number is in the synergies. There's nothing significant currently in the synergy number on the ECS side as we work through the ECS side of the house. We have a great supplier currently, where I'm going to call base foam , and they're doing a great job, and we're working with them and working with ECS and trying to find an optimal structure there. But we've got great suppliers on the base foam already.

Your next question comes from Peter Keith with Piper Sandler.

Congratulations on the combination. I wanted to just ask about Leggett's existing bedding customers. And if you or Leggett have had any interactions with them in recent months. Now that the two companies are combined, with some of the other third-party mattress manufacturers think of leaving Leggett, or are you trying to present the plan that might make it either difficult or too attractive for them to leave?

Well, it's interesting -- it's an interesting industry. And so obviously, I know their customers, they know our customers, and of course, I've had conversations with our customers and their customers all the time. I'm going to call in general, your question is about channel conflict, that the combination might bring. I'm not feeling any channel conflict and don't expect any headwind from channel conflicts related to the transaction based on conversations with customers, but probably more importantly, the quality of the products that Leggett produces is very high, and the way these products get produced in mass from a competitive standpoint, it's hard to stand up an operation that can be as efficient on the components. So there's an economic issue there. And there's really no strategic reason why one of their customers would think the combination threatens them in any way. We're here to serve all customers in an omnichannel strategy, which is similar to how we go to retail. If you think about Mattress Firm, that was a more complicated, what I call channel conflict strategy we had to work through. This is much less complicated than the Mattress Firm channel conflict strategy was.

Your next question comes from Brad Thomas with KeyBanc Capital Markets.

Congrats as well on closing the deal here. I was wondering Scott and Bhaskar, if you could talk a little bit about -- if you could talk a little bit about the outlook for sales and for EBITDA for the underlying business over the back half of the year and next year. I know that they've been seeing some pressure from challenges in the industry, but obviously going through some restructuring. Just kind of ex synergies, what are you guys modeling and what are some of the core assumptions in that?

If I didn't know better, I'd say you're asking -- hold on, he's trying to ask for 2027 guidance early, isn't he, Bhaskar? Would he be doing that?

Yes, we're very familiar with that concept.

Okay. We'll just talk but don't answer his question. Go ahead.