Somnigroup International Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to the Tempur Sealy First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Aubrey Moore, Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone and thank you for participating in today's call. Joining me are Scott Thompson, Chairman, President and CEO; and Bhaskar Rao, Executive Vice President and Chief Financial Officer. After the prepared remarks, we will open the call for Q&A. Forward-looking statements that we make during this call are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Investors are cautioned that these forward-looking statements, including the company's expectations regarding sales, EPS, net income and adjusted EBITDA and anticipated performance for 2021 and subsequent periods involve uncertainties. Actual results may differ due to a variety of factors that could adversely affect the company's business. The factors that could cause actual results to differ materially from those identified include economic, regulatory, competitive, operating and other factors discussed in the press release issued today. These factors are also discussed in the company's SEC filings, including, but not limited to, annual reports on Form 10-K and the company's quarterly reports on Form 10-Q under the heading Special Notes regarding forward-looking statements and/or Risk Factors. Any forward-looking statement speaks only as of the date on which it is made. The company undertakes no obligation to update any forward-looking statements. This morning's commentary will include non-GAAP financial information. The press release contains reconciliations of this non-GAAP financial information to the most directly comparable GAAP information except as otherwise discussed in the press release as well as information regarding the methodology used in our constant currency presentations. We have posted the press release on the company's investor website at investor.tempursealy.com and have also filed it with the SEC. Our comments will supplement the detailed information provided in the press release. And now with that introduction, it's my pleasure to turn the call over to Scott.

Thank you, Aubrey. Good morning and thank you for joining us on our 2021 first quarter earnings call. Our thoughts continue to be with those around the world whose lives have been impacted by the global health crisis. I want to say a sincere thank you to our entire global team, who continue to work hard every day to ensure the safety of our employees and customers. I will begin with a few highlights on our record first quarter financial performance and a discussion about our future growth. Bhaskar will then review our financial performance in more detail. Finally, I'll conclude with an update on our long-term initiatives, some thoughts about capital allocation, and an update on our current market trends.

Thanks, Scott. Before going into the details, I would like to highlight a few items as compared to the prior year. Gross margin improved 60 basis points to 44%. Adjusted operating margin improved 330 basis points to 18%. Adjusted EBITDA increased 52% to $230 million and adjusted earnings per share increased 88% to $0.64. As Scott mentioned, our first quarter results would have been stronger had we not experienced supply chain constraints for innersprings and chemicals that are used across the entire bedding industry. While the supply of innersprings greatly improved during the quarter, the disruption from the winter storm in the Gulf is causing a temporary industry-wide reduction in chemical availability. This disruption is impacting commodity prices on what we believe is a short-term basis. These supply issues have impacted our North American Sealy and Sherwood businesses, resulting in our backlog remaining elevated throughout the first quarter and into the second. In addition, had we been unconstrained we estimate our sales could have been stronger by $80 million to $100 million during the quarter. Based on our current outlook, we anticipate the chemical constraints will largely be resolved by the end of the second quarter. These issues also caused our operations to run inefficiently, reducing this quarter's gross profit by approximately $10 million. We expect the same inefficiencies will repeat in the second quarter. In addition to working through supply constraints, we have also been managing a high inflationary environment for key bedding inputs. We implemented pricing actions in the fourth quarter of 2020 and again at the beginning of the second quarter of 2021 to mitigate the known commodity headwinds. Commodity prices have continued to increase since our last update, as the winter storm has pressured chemical prices, but we believe these increases are temporary. We have chosen to absorb the short-term cost increase for now, but we will take price actions in the future if costs do not normalize. Based on our current commodity outlook, we expect to be negatively impacted by approximately $25 million predominantly in the second quarter, which will not be offset by price.

Thank you, Bhaskar. Great job to you and the team. Our competitive positioning and record first quarter earnings are a result of our commitment to our long-term corporate initiatives. These initiatives guide our actions and jumpstart the flywheel effect that is powering the momentum at Tempur Sealy. Our first key initiative is to develop the best bedding products in all the markets we serve worldwide. We're incredibly proud that Tempur-Pedic, Stearns & Foster and Sealy products lead the market in each of their respective categories. In our business, long-term success starts and ends with products. Both our product portfolio and our innovation pipeline have never been stronger. Tempur has successfully addressed the two biggest reported issues associated with poor sleep: sleeping hot and snoring. Over the years, we've addressed sleeping hot with our proprietary cooling technology. To address snoring, we developed the Ergo Smart Base Sleeptracker. This past quarter we completed the rollout of this Smart Base to our North American third-party retail partners. The Sleeptracker is the only sleep system on the market with technology that automatically detects and responds to snoring. It also monitors key health metrics and sends personalized sleep analytics and coaching to consumers via a personal app. Retailers continue to tell us they are thrilled with the consumer response to this product, citing improved average selling price and adjustable base attachment rates. As an additional benefit, the sleep data from this product brings us closer to the consumer and provides critical insights for our research and development processes. Turning to Sealy, the number one mattress brand in the U.S. We're proud of the achievements of our Sealy brand. It was rated America's number one selling mattress brand last year. It was most recently voted America's most trusted mattress brand according to the 2021 BrandSpark American Trust Study. We continually innovate and invest in the products, and this year we are refreshing the Sealy portfolio with the launch of the new models across our central Posturepedic and Posturepedic Plus lineups. The updated Sealy mattresses offer superior support and include our Sealy Chill and Surface-Guard technology. We expect to complete the rollout of the Essential and Posturepedic mattresses in the second quarter, and to begin shipping the higher-end Posturepedic Plus line in the back half of the year. We're excited about these new products and expect they will further extend Sealy's lead as the number one mattress brand in the U.S. Our second key initiative is to support our global brands with compelling marketing. Robust order trends combined with the strength of the market has driven us to increase our 2021 advertising investment by an additional $50 million to a projected $450 million. This will be the largest advertising investment in the company's history, and provide even more momentum for growth in the future. Consumer demand for the brand is strong, and our consumer research shows record levels of purchase intent and consideration. Our investments in advertising, our best-in-class sales force, our data-driven media investments ensure our products remain top of mind for consumers throughout their purchase journey. A portion of our 2021 advertising dollars is being dedicated toward the Stearns & Foster brand. The brand is celebrating its 175th anniversary this year. We have a new campaign that highlights the brand's heritage and high-quality products. We believe the amplification of the brand story will raise consumer awareness and consideration for luxury innerspring and hybrid products, benefiting third-party retailers and the company. Our third key initiative is to optimize our powerful omnichannel platform to be wherever the customer wants to shop. The largest pillar of our omnichannel distribution strategy is our third-party retail partners. We continue to build momentum as we've added to our diverse third-party retail footprint, and now include over 25,000 retail doors. This broad footprint ensures that consumers can easily find and experience our products in person. This is critical to our research as our research shows that about 90% of consumers want to touch and feel a mattress before they buy. We have strengthened our retail relationships with our Retail Edge program, as well as our in-depth sales training, innovative advertising solutions, market-leading consumer insights, and robust logistics and manufacturing capabilities. To ensure our products are present where, how and when customers want to shop, we continue to expand our own direct-to-consumer channel, both online and with brick-and-mortar retail stores. Our direct-to-consumer channel had a great quarter. In our company-owned stores, we saw increased traffic as more consumers felt comfortable shopping in store. This resulted in double-digit same-store sales growth. Our web sales grew over 100%, which includes robust triple-digit growth on our compressed bedding products, likely comparing favorably to others in the industry. At the same time, we experienced favorable customer acquisition costs compared to the first quarter of 2020. I want to note that our web sales are still growing at a strong rate even as we begin to lap the triple-digit growth rates in prior years. We do expect the web sales growth rate to diminish as 2021 comps get very hard. Our worldwide direct business is on a run rate of over $600 million and is highly profitable. In fact, over the last three years our direct business has grown at a compounded annual rate of 35%. Another one of our market expansion initiatives is to grow our share of the North American OEM bedding market. We believe the OEM market is a sizeable opportunity as the recent enactment of antidumping duties has disrupted the market. We are well equipped to take advantage of this disruption and service the market. Our OEM business performed well in the quarter and ran slightly ahead of our expectations. Our fourth key initiative is to drive increased profits. We have been and remain committed to balancing top-line initiatives with expense control and operational improvements to optimize profitability. This has enabled us to deliver record earnings in the quarter and positions us to drive earnings growth over the long term. Turning to capital allocation. Our business generates a significant amount of cash flow as demonstrated by our first quarter operating cash flow of $86 million and a cumulative cash flow of over $600 million over the last 12 months. We've taken opportunistic capital structuring actions to optimize our balance sheet. Over the last few quarters, we extended the maturity of our long-term debt by six years and lowered our annual run-rate interest expense by approximately $23 million. We also reduced our target leverage ratio range to 2x to 3x. And we've chosen to stay slightly below the range as we manage through the global health crisis. We view our financial strength and flexibility as a competitive advantage. Under our capital allocation strategy, we run a balanced approach supporting the business, returning value to shareholders via share repurchases and dividends and, on an opportunistic basis, acquiring businesses that enhance our global competitiveness. Over the last 12 months, we've allocated capital as follows: capital expenditures of over $100 million and returns to shareholders of approximately $460 million. This includes investing over $445 million in share repurchases, which is approximately 6% of our shares outstanding during the period, and paying $14 million in cash dividends. Given the progress we've made and the confidence we have in our long-term outlook, we did accelerate our share repurchase this quarter. I also want to briefly touch on our latest order trends. In the U.S., current orders accelerated relative to the first quarter on a two-year basis, which we view as the most useful comparative given the COVID-19 impact on prior year numbers. That makes the comps unreasonably low if compared to year-over-year alone. This acceleration is built upon our prior momentum and likely also a firming economy, a robust housing market and fiscal stimulus related to COVID. We anticipate the temporary lift from COVID relief checks is now behind us. Our international trends are volatile as those markets reopen and close. Company-wide, we are internally targeting second quarter sales growth approximately equal to the first quarter at about 50% versus the second quarter of 2019. I'm proud of how the entire team stepped up to meet the challenges the pandemic has presented over the last 12 months. There have been a lot of ups and downs during this unprecedented period, but the groundwork that we've laid over the previous years established a strong foundation and allowed us to become even stronger. The team and I are incredibly excited about what the future holds. With that, operator, will you please open the call up for questions?

Our first question comes from Peter Keith with Piper Sandler. You may proceed with your question.

Good morning and great results, guys.

Thank you.

You may have just answered my question with your Q2 sales guide, but what I did want to ask was the guidance raise was rather significant. It's a little bit uncharacteristic for you guys earlier in the year to take up guidance that much. Plus you also highlighted $25 million of input cost headwind and $50 million in extra ad spend. So the context of the question is what's giving you the confidence to raise the guidance by this much so far early in the year that may have changed from a couple months ago?

Sure. Thank you for the question. Basically everything. The economy worldwide continues to recover from the health crisis. We've become more comfortable that we can operate in an environment where stores open and close. Compared to the last time we reported, most everything we see feels stronger. In North America, sales increased 28%. That's a great number. As stores open, we didn't see a slowdown in the online business that we had expected. From a guidance perspective, we try to keep the guidance in the middle of the fairway. The strength of the underlying business was such that we felt we needed to move the guidance up.

Thank you. And our next question comes from Curtis Nagle with Bank of America. You may proceed with your question.

Thanks very much. Good morning, guys.

Good morning.

Maybe taking the focus a bit more on the long term here. So obviously, the numbers right now are really strong. But how are you thinking about revenue and earnings growth over the next few years? What do you think is a sustainable growth rate and what's the balance in terms of North America versus the rest of the world? It sounds like international is getting more focus and you've got new product launches that could be big. How should we think about that?

Great question. International probably has a larger opportunity over a five-year period. Our balance of share internationally is relatively small and we're focusing on international over the next few years. It will take some time. When you talk about core growth rate, we've been studying consumer spending on household categories. Looking at data from Goldman on consumer spending in home, last year total spend in the home category was $314 billion, up about 4.5% from 2019. We were on an upward trend for the past eight years and spend on home was growing about 2% a year, and it ticked up a couple hundred basis points in 2020. Compare that to our North American growth of 28%. Yes, we got a tailwind from share-of-wallet shift, but the lion's share of our performance is clearly the impact of our advertising, the quality of our products and our new growth initiatives, whether OEM or direct. That gives me confidence these initiatives will continue to bear fruit and we don't have just a short-term spike. If you look at percentage of disposable income, it picked up a bit during the period but remains significantly less than in 2006–2008. I think there's a solid foundation for the industry. When the industry is healthy, retailers can advertise, which drives the market. We've defined the addressable market as $50 billion worldwide, so we have plenty of room to grow in various areas, including deployment of our cash flow via share repurchase, acquisitions or other growth initiatives.

Thank you. Our next question comes from Bobby Griffin with Raymond James. You may proceed with your question.

Good morning, everybody. Congrats on the great results. Scott, I just wanted to touch back on international — clearly an exciting time here for the company for growth for the next couple of years. You've talked a lot about product investment. Is there any other kind of capital investments we should be considering or on the expense side as well to really fund that growth going forward for the next few years from a distribution standpoint, production standpoint or even people on the ground that we should consider in the model?

I don't think so. Bhaskar, help me with that because as sales come, we will obviously add some people. From an advertising standpoint and from a production standpoint, the plant there has enough capacity to meet our objectives. So I don't think so. As always, we'll continue to look at acquisitions that can help us from a retail or supplier standpoint worldwide and we will continue to work in that area both domestically and internationally.

Thank you. Our next question comes from Keith Hughes with Truist. You may proceed with your question.

Thank you. My question is on international as well. Some fantastic results in that segment. If you look at the rest of the year, would the international segment be above company growth for the year or still a bit below?

No, the international group is going to be below the consolidated group. North America will drive the largest portion of the growth rate in 2021. We're highlighting initiatives that will hit in early 2022.

Thank you. Our next question comes from Seth Basham with Wedbush Securities. You may proceed with your question.

Thanks a lot and congrats on strong results. My question is around the Sealy and Sherwood businesses. First, are the pressures that you're seeing from a commodity standpoint primarily confined to those businesses relative to Tempur-Pedic? Secondly, are the sales left on the table — the $80 to $100 million — primarily in those areas and do you expect to capture them pretty much entirely in the second quarter?

First, the constraints that impacted sales — call it $80 million to $100 million of foregone sales in the first quarter in North America — primarily would have been in Sealy and Sherwood and perhaps a little in OEM. If you added those sales to our North American sales number, they would probably put about a 9% or 10% growth rate on it rather than 28% if you're doing adjusted, unconstrained sales. On commodity increases, commodities hit everything; they don't only hit Sealy and Sherwood. They hit Tempur-Pedic as well, but we had plenty of supplies for Tempur. Tempur is built to fill stock rather than built to order. As for the $80 to $100 million coming back, we'll learn more over the next few weeks as other people report earnings. We were constrained due to innerspring supply in the first quarter, although our major supplier did a great job and we think that's behind us. The chemical event from the freeze was a mess in the first quarter and we're going to feel the effects into the second quarter. Bhaskar called out that it impacted our plants from an efficiency standpoint. Although the first quarter was good, it certainly wasn't goldilocks. We had missed sales, planned inefficiencies, pricing increases didn't come into effect until April 1, so we were absorbing commodity costs in the first quarter. Parts of Europe were closed for most of the quarter and customers were on allocation. So while the numbers are good, they were achieved despite significant challenges.

How does that $80 million to $100 million come back? We expect to learn more as constraints resolve, and we anticipate efficiencies improving as chemical supplies normalize. We do expect some inefficiencies to repeat in the second quarter but believe the chemical constraints will largely be resolved by the end of the second quarter.

Thank you. Our next question comes from Jonathan Matuszewski with Jefferies. You may proceed with your question.

Thanks for taking my question. Scott, you mentioned the sleep data from the Smart Base bringing you closer to the consumer with the rollout now complete. Could you elaborate on that a little bit more? What's surprising you in the data? How is that informing your latest thoughts in terms of innovation efforts to solve consumer pain points beyond temperature and snoring in the future? Thanks.

It's a great long-term question. We have launched the base and it's doing better than we expected in the marketplace. Our retailers are extremely happy with increased attachment rates and increased ASP. We are just now gathering the data and our partners are analyzing it, so it's a little early to point to any specific insights. We're thrilled about getting closer to the customer and over time I'll be able to answer that question more crisply than I can today.

Thank you. Our next question comes from Brad Thomas with KeyBanc Capital Markets. You may proceed with your question.

Hi, thanks. Great quarter. My question was around ASP. Clearly a lot of favorable drivers that you have in terms of ASP. But the question that's often asked is how much price you're taking and how much that might open up risk to demand destruction or competitive pressures in the future. Scott, could you talk a bit more about the different drivers of ASP between mix and attachment rate, and how you're feeling about the trends and price right now?

When ASP is very strong, it reflects health and wellness trends, quality of products, and a great job by retailers explaining the benefits of higher-quality beds. The whole industry is also passing through commodity-driven price increases. I think the health and wellness factor is probably the bigger driver of ASP. From a competitive standpoint, we are at all price points with a suite of brands, so we can play at any price point and choose where to position products, which gives us optionality. I don't feel significant pricing pressure from competitors; most have been rational and moved price up as commodities moved up. Regarding the temporary spike from chemical pricing due to the winter storm, we chose not to pass that short-term increase to customers since such spikes historically have a tendency to spike and come back quickly. That seemed inappropriate to pass on immediately.

One thing to add is that ASP growth is not only price; it's also mix within Tempur and within Sealy. Mix changes are a significant component of ASP increases. Also note that in 2020 and this quarter, the Sealy brand was constrained. As it gets unconstrained, it's probable Sealy would grow faster than Tempur as we work off backlog and meet customer demand at that price point. Yes, that's what we should call out. Sealy was constrained, so as it becomes unconstrained, that will influence growth dynamics and ASP mix.

Thank you. Our next question comes from Carla Casella with JPMorgan. You may proceed with your question.

How has the M&A environment changed at all given the supply chain issues that you and others have seen?

The M&A environment changes frequently. There are lots of opportunities in our sector, generally smaller companies, both from a supplier and retail standpoint. There's a lot of liquidity in the marketplace, so sometimes pricing isn't rational. We've been patient and opportunistic. Specifically regarding supply chain, we're making sure we have the right relationships long-term and ensuring those relationships are robust. We're continuing to aggressively evaluate our supply chain to ensure we have the right partners long-term.

Thank you. Our next question comes from Atul Maheswari with UBS. You may proceed with your question.

Good morning. How much did stimulus benefit first quarter sales? Are you able to quantify that in any way? Second, regarding your guidance, the guidance would imply nearly a double-digit growth rate in the back half of the year for revenues, assuming the second quarter is up 50%. You will be lapping very tough comparisons in the back half and consumers may focus less on home as the economy reopens. What's giving you confidence you can achieve that level in the back half?

That's a multi-part question. Regarding stimulus checks, when they go through, our retailers feel it almost instantly at retail. Generally that's been lower-ticket product. I don't think it drives much from an EBITDA standpoint, but it likely helped the first quarter a bit. Whether they go away or not, the improving economy should more than make up for it as employment improves. As for the back half growth, barring any event that derails the economy, consumers in the U.S. and worldwide appear to be in strong shape. The savings rate was higher, interest rates remain controlled, and consumer confidence seems to be growing. We also look at markets that have reopened earlier, like China and Korea, and we're not seeing a big pullback in furnishing and bedding expenditures; those markets are doing well. So absent unforeseen events, we feel confident in continued growth.

We took note of the stimulus impact and will continue to monitor macro indicators. Our internal planning assumes the improving economy will support demand as stimulus effects normalize.

Thank you. Our next question comes from William Reuter with Bank of America. You may proceed with your question.

Hi, my question is about the $25 million number that you mentioned. I think that was inflation for '21 as a whole, but does that encompass more than just raw materials including ocean freight, etc.? And then as we think about another round of price increases, do you believe a subsequent round will prevent gross margin pressure in the back half of the year?

Good question. The $25 million specifically reflects the temporary inflation we have seen related to the winter storm — primarily chemicals — that we do not expect to be offset by price during the second quarter. Commodity increases from 2020 to 2021 are larger than we've seen in a while. The $25 million is associated with a temporary inflation directly coming out of the winter storm that we believe is temporary, so we are not passing that short-term spike on immediately. The majority of that $25 million impact will be seen in the second quarter. If the cost increases persist longer, we will consider price actions going forward. The $25 million is predominantly associated with chemicals and related materials caused by the disruption from the storms.

Thank you. Our next question comes from Laura Champine with Loop Capital. You may proceed with your question.

Thanks for taking my question. To dig in a bit more on the supply chain: you mentioned Tempur builds to stock whereas Sealy and Sherwood build to order. What's your normal practice for chemical purchases in terms of weeks of supply? Is that changing as a result of recent supply chain issues?

First, kudos to our operations team. Over the last few years they requested capital expenditures to increase our tank size for these kinds of events to have more safety stock for chemicals. Those investments were made and have been helpful during this period. Days of supply depends on demand, which varies, but from a chemical standpoint we probably target around 30 days of supply. Additionally, we have intentionally increased inventory since about May last year in anticipation of a robust reopening. For Tempur specifically, our inventory targets are generally north of 30 days, which combined provides a cushion for events such as hurricanes. Tempur has been in stock and on shelf during this period while we've had constraints from innersprings and chemicals in other brands.

Yes, we increased inventory levels starting mid-2020 to provide a buffer. That has been a deliberate strategy to mitigate supply disruptions and support our build-to-stock model for Tempur.

Thank you. Our next question comes from Jenna Giannelli with Goldman Sachs. You may proceed with your question.

Hi. Thanks for taking my question. I know there have been several on supply chain, but one more for clarification. The $80 million to $100 million of potential sales headwind and the $10 million gross profit impact — in prior quarters, has it been about the same magnitude as we've dealt with supply chain headwinds? As we come out of it, what potential tailwind could we expect going forward?

I'd say the constrained sales have been slightly less in prior periods. We've been calling out about $100 million in potential constrained sales in the second and third quarters previously; for the first quarter it was probably closer to $80 million to $100 million. The plant disruptions were worse this quarter because we were hit by both the innerspring issue and the chemical freeze. The chemical shortages complicated plant operations more because it's hard to plan if you don't get the foam you need when you need it. So operational inefficiencies were worse this quarter by several million compared to prior periods.

I would quantify the incremental running-inefficiency impact at about $10 million versus what we've seen previously. We did face compounded issues due to the chemical shortages, and we do anticipate some operational inefficiencies in the second quarter as well, though the chemical constraints should largely resolve by the end of the second quarter.

To summarize, on the comparables for next year's first quarter, you should consider constrained sales, running inefficiencies, pricing effects that did not take place until April 1, and variable European operations. All those factors suggest there could be some tailwinds when conditions normalize.

Thank you. And our next question comes from Seth Basham with Wedbush Securities. You may proceed with your question.

I had a follow-up thinking about incremental operating margins. In the first quarter, despite the inefficiencies you had very strong operating margins. How should we think about the rest of the year? Should we think about the second quarter given these commodity headwinds, relative pricing being the lowest and then seeing acceleration again in the back half of the year?

Broadly speaking, think of gross profit on a full-year basis as stable. For the second quarter, given the temporary commodity pressure, we might see gross profit stable to slightly down. From an operating margin perspective, we intend to continue supporting our brands with investment in advertising as we think about the rest of the year, so that should be considered when modeling full-year operating margin. We expect to balance those brand investments with expense control and operational improvements to optimize profitability over the long term.

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Scott Thompson for any further remarks.

Thank you to the over 9,000 employees around the world. Thank you for what you do every day to make the company successful. To our retail partners, thank you for your outstanding representation of our brands. To our shareholders and lenders, thank you for your confidence in the Tempur Sealy leadership team and its Board of Directors. With that, that ends our call today operator.

Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.