Somnigroup International Inc. Q4 FY2021 Earnings Call

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Good day, and thank you for standing by. Welcome to the Tempur Sealy International, Inc. Fourth Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. Please be advised that today’s conference is being recorded. 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 today are Scott Thompson, Chairman, President and CEO; and Bhaskar Rao, Executive Vice President and Chief Financial Officer. After prepared remarks, we will open the call for Q&A. This call includes forward-looking statements that are subject to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve uncertainties and actual results may differ materially due to a variety of factors that could adversely affect the company's business. These factors are discussed in the company's SEC filings, including its Annual Reports on Form 10-K and Quarterly Reports on Form 10-Q, under the heading Special Note Regarding Forward-Looking Statements and 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 also include non-GAAP financial information. Reconciliations of non-GAAP financial information can be found on the accompanying press release, which has been posted on the company's investor website at investor.tempursealy.com and filed 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, everyone and thank you for joining us on our 2021 fourth quarter and full-year earnings call. I'll begin with a few highlights from our fourth quarter, Bhaskar then will review our record financial performance in more detail. Finally, we'll conclude with some comments on how our long-term initiatives will drive growth. The team continues to deliver strong results across the world and our omni-channel footprint. In the fourth quarter of 2021, net sales grew 29% year-over-year, driven by our successful company initiatives, our pricing actions, improved order-to-delivery times and a solid industry backdrop. The full-year and fourth quarter results were outstanding overall, especially considering the unexpected flare-up of COVID in the fourth quarter, causing disruption in most of our markets. We delivered strong performance across the international segment, ahead of our expectations. U.S. order trends in the fourth quarter were slightly below our expectations, particularly with low-end consumers. In the U.S., the rapid spread of the Omicron variant, combined with major retailers' inventory positions being stronger than anticipated, negatively impacted orders in the fourth quarter. But I should note we still achieved a record performance. The inventory dynamics largely normalized by the end of January. Adjusted earnings per share for the fourth quarter was $0.88, an increase of 31% versus the same period last year. This represents double-digit adjusted EPS growth for 10 out of the last 11 quarters. Consumer trends in health and wellness, advances in sleep technology and ongoing innovation in sleep products bode well for the long-term growth of our sector. We are well positioned to capitalize on this trend as the industry leader in innovation. As testament to our confidence in our potential, from 2016 through 2021, we have repurchased approximately 80 million shares of our stock, approximately 32% of our shares outstanding, at an average cost of about $23 per share. Those repurchases were made while maintaining low leverage, closing strategic acquisitions and, of course, reinvesting in the business and driving product innovation. To-date in 2022, we have opportunistically repurchased approximately 8 million additional shares and we expect our diluted share count to be 189 million for the first quarter. I would now like to review some of the key highlights from the quarter. First, our ability to service our customers improved throughout the fourth quarter. As you may recall, we entered the quarter with a record backlog of about $100 million in U.S. Tempur-Pedic orders. Our U.S. Sealy business and OEM customers were on forced allocation due to supply chain issues. As expected in the fourth quarter, normal seasonality allowed us to make significant progress in working down our Tempur-Pedic backlog. We were able to successfully take our customers off allocation for Sealy products at the end of October. Our U.S. Tempur-Pedic product delivery times significantly improved as well, and today Tempur is operating under a normalized order-to-delivery time. Second, I want to highlight the outstanding performance of our direct channel, where sales more than doubled compared to the prior year, driven by strong organic growth and the acquisition of Dreams. Our Tempur Retail Stores, Sleep Outfitters stores, Dreams, all of our company-owned stores had robust same-store sales of over 25% this quarter. We also continue to invest in growing our e-commerce channel, which had a solid fourth quarter performance, considering the difficult comp in prior years and inventory constraints, which were partially offset by double-digit increases in their conversion rate. We continue to leverage our direct channel to get closer to the customer. Over the last three years, we've increased the number of customers in our database by nearly 50%, leading to increased conversion and more effective and efficient direct marketing. Regarding our own stores, we now operate over 650 retail stores around the world through our wholly-owned companies and joint venture operations. These stores vary in format based on local market and consumer preferences, which results in a wide variety of sales on a per-store basis. Our average sales per store in 2021, including e-commerce, were over $2 million each, with our U.S.-based Tempur Retail Stores averaging over $4 million each. We see potential to continue to open additional retail locations as we see market opportunities arise. Third, I want to call out some exciting awards and recognitions we have received. Our Tempur-Pedic brand was awarded number one in customer satisfaction for the Retail Mattress category in the J.D. Power 2021 Mattress Satisfaction Report. This is the third year in a row we've won that award. We're thrilled to share with you that for the first time our Tempur-Pedic brand also was awarded the number one in customer satisfaction for the Online Mattress category in the same report. In addition to being ranked number one overall in customer satisfaction, Tempur-Pedic earned the number one ranking across all factors in the Retail Mattress category, which includes support, durability, comfort, variety of features, value, warranty and contact with customer service. In addition to the awards received by Tempur-Pedic, our Sealy brand achieved the number one selling mattress brand in the U.S. for the second year in a row in 2021, while also being named America's number one trusted mattress by Consumer Reports. This recognition from our customers is testament to our commitment to providing innovation and high-quality product solutions that address their sleep needs. It is also an important recognition of the growing importance of our online and retail businesses, which continue to be growth drivers for the company. A little later, I will discuss our 2022 product launch plans that will allow us to continue delivering industry innovation. Fourth, despite the many changes and challenges that we faced in 2021, we continued steadfast in our commitment to protecting the environment and the communities in which we operate. Success at Tempur Sealy is defined more broadly than just financial metrics, and it is inclusive of our environmental, social and governance impact. We firmly believe that ESG initiatives create value for our stakeholders and contribute to the long-term financial success of our business. Last month, we published our 2022 Corporate Social Value Report. The report detailed the significant progress we've made on our environmental goals in 2021. Notably, we furthered our goal of achieving zero landfill waste through improving the percentage of waste recycled in our U.S. manufacturing operations to 94%. We also achieved an 8.4% reduction in greenhouse gas emissions per unit produced, furthering our progress towards our goal to achieve carbon-neutrality by 2040. The full report includes additional information about our 2021 initiatives and progress, and can be found on our website. Finally, before turning the call over to Bhaskar, I want to take a moment and welcome two new members of our Tempur Sealy Board of Directors, Meredith Siegfried Madden and Simon Dyer. Meredith currently serves as a Director and the Chief Executive Officer for NORDAM Group Inc., a global aerospace manufacturing company, and brings over 25 years of experience to our Board. Simon currently serves as Chairman of the Board and Chief Executive Officer of the Dyer Group, which, among other things, operates our international joint ventures. Simon brings 35 years of leadership in the mattress and bedding industry to the Board, including extensive knowledge of the international bedding market. Meredith and Simon both have multiple areas of expertise, including international markets, strategy, sales, logistics, manufacturing and finance. We are thrilled to have them join the Board of Directors. With that, I'll turn the call over to Bhaskar.

Thank you, Scott. I would like to highlight a few items as compared to the prior year. Sales increased a robust 29% to approximately $1.4 billion. Adjusted EBITDA increased 24% to $297 million, and adjusted earnings per share increased 31% to $0.88. Turning to North American results. Net sales increased 19% in the fourth quarter. On a reported basis, the wholesale channel increased 18% and the direct channel increased 24%. North American gross margin declined to 41.6%. This was driven by operational inefficiencies related to COVID and the pricing benefit to sales with no immediate improvement in gross margin. These declines were partially offset by favorable brand mix. Our fourth quarter gross margins improved sequentially as expected, driven by favorable brand mix, resulting from working down our elevated level of Tempur backlog from the prior quarter. Leveraging our pricing power, we have implemented multiple price increases in the last four quarters to offset the dollar impact of the highly inflationary environment. These increases demonstrate the power of our brands and products. North American fourth quarter operating margin improved to 21.6%. The improvement was primarily driven by operating expense leverage, partially offset by the change in gross margin. Now turning to International. Net sales increased 82% on a reported basis, inclusive of the acquisition of Dreams. On a constant currency basis, International sales increased 85%. As a multi-branded retailer, Dreams sells a variety of products across a range of price points. Their margin profile is lower than our historical International margins, which is driving a major change in year-over-year margins. Excluding Dreams, the underlying margin performance internationally met our expectations across both Europe and Asia Pacific. As compared to the prior year, our International gross margin declined to 54.8%. The decline was driven by the acquisition of Dreams, the pricing benefit to sales without improvement in gross margin and operational inefficiencies associated with COVID. Our International operating margin declined to 20.2%. The decline was driven by the change in gross margin and operating expense deleveraging. Now moving on to the balance sheet and cash flow items. We generated a robust fourth quarter operating cash flow of $126 million. Our inventory days extended throughout the quarter as we began to enhance our Tempur inventory in the U.S. We expect to further build our inventory in the first quarter to support our expected sales growth in 2022. At the end of the fourth quarter, consolidated debt less cash was $2.1 billion and our leverage ratio under our credit facility was 1.8 times. As Scott mentioned, in 2021, we executed on our balanced capital allocation strategy to return value to shareholders. We allocated approximately $1.5 billion of capital. This included investing over $800 million in share repurchases to buy back approximately 10% of our shares outstanding, paying $63 million in cash dividends, acquiring Dreams for approximately $475 million and reinvesting $123 million back into our operations. Now turning to 2022 guidance. The company expects EPS to be in the range of $3.65 to $3.85 in 2022, representing an 18% growth from the midpoint. This includes expected benefit from strong year-on-year sales growth of between 15% to 20%. Specifically, we expect to invest incrementally approximately $50 million in expenses related to new product launches around the world. Additionally, we plan to invest a record amount of total advertising, including ceding the upcoming Stearns & Foster launch and Tempur International products. Our 2022 expectations also include targeted share repurchases of at least 10% of our shares outstanding, including the 4% of share repurchases we have made through the first quarter thus far. In the first quarter, we have seen softness from the lower-end consumer, which we believe is temporary. We are maintaining labor and advertising expenses that would otherwise naturally flex with sales. For the first quarter, we would anticipate this results in incremental operational expenses and advertising spend that would have otherwise flexed. Lastly, I would like to flag a few modeling items. For the full year 2022, we currently expect total CapEx to be between $250 million and $280 million, which includes maintenance CapEx of $100 million and investments in our U.S. manufacturing capacity, including a new foam-pouring plant; depreciation and amortization between $195 million and $205 million; interest expense between $85 million and $90 million; a tax rate of 25%, and a diluted share count of 183 million shares. With that, I'll turn the call back over to Scott.

Thank you, Bhaskar. Great job. These past two years further solidified Tempur Sealy's position as a market-leading, vertically-integrated, omni-channel, global company with solid fundamentals and a growing category. I'd like to take a moment to review the company's initiatives that have driven this performance. We estimate that about half of our growth over the last two years was driven by distribution through new retail customers. Another 35% of the growth is derived from our M&A activities and share gains from previously untapped addressable markets. This includes our acquisition of Dreams and Sherwood Bedding and the addressable markets that were unlocked through our direct and OEM initiatives. The remaining 15% of our two-year growth can be attributed to the growth in the industry overall. I'd like to review how our four long-term initiatives underpin our confidence in our ability to continue to achieve above-market performance going forward. Our first key initiative is to develop the highest quality bedding products in all the markets that we serve. We think about our products and brands as award-winning products that provide breakthrough sleep solutions to consumers around the world. We are committed to furthering sleep innovation and are in the process of launching a new line of premium Sealy products in the U.S. This updated product line includes a significant upgrade to our industry-leading hybrid mattresses and an all-new collection of premium foam mattresses. This line features improved comfort and support, and also utilizes innovative technologies that sleep up to 33% cooler than our previous models. By offering superior support and technologies, we aim to grow Sealy's strong position in the industry. Later in 2022, we will be launching all-new Tempur products in Europe and Asia-Pacific. This new line of products will have a broader price range with the super-premium ASP maintained and the ASP floor expanded into the premium category. The expanded price range is designed to unlock a new segment of customers, which is expected to substantially increase our international total addressable market. We plan to launch and invest in this new Tempur line beginning in 2022 with the first market to be launched over the summer. The team is also working on evolving our Stearns & Foster brand, the oldest American-owned and operated bedding manufacturer in the country. We recently celebrated its 175th anniversary, demonstrating its longevity, which is supported by its history of producing high-quality products. We believe there is currently an underserved segment of customers who are looking for premium mattresses with a traditional innerspring feel. The rich legacy and unparalleled craftsmanship of our handmade Stearns & Foster products has attracted a number of these customers to the brand and we see an opportunity to further expand it in the future. In order to capitalize on this opportunity, we expect to launch a new line of products in the U.S. late in the year. The new line is designed to further distinguish our high-end traditional innerspring brand with superior technology, a clear product step-up story and a new contemporary look. In addition to launching these new products, we're doubling down on our efforts to increase Stearns & Foster's brand awareness with customers. And as Bhaskar previewed, we will be investing significant advertising dollars to support this goal. Based on these investments in products and brand awareness, we expect Stearns & Foster sales to more than double to become our third billion-dollar brand. We also plan to tap into emerging niche markets through launching new products this year. We expect to launch a Sealy mattress eco-friendly collection. These new mattresses are designed for the growing segment of consumers who are interested in natural and sustainable bedding products. We also plan to launch a Sealy mattress featuring a best-in-class pressure-relieving gel grid layer at a consumer-appealing mid-market price in 2022. This product is designed to target a relatively small category of consumers looking for a non-traditional mattress feel. This will be priced at a non-premium price point. Our second key initiative is to promote worldwide our brands with compelling marketing. In 2022, we expect to continue to reinforce the moat around our business with thoughtful marketing investments that provide strong near-term returns and significant long-term brand awareness across all of the brands and products. Our brands are among the most highly recognized, recommended and desired in the industry. And we plan to invest a record $550 million in advertising dollars in 2022 to continue to strengthen this leading position. Our third key initiative is to optimize our powerful omni-channel distribution platform. Last year, supply chain disruptions forced us to turn away new customers, put our existing customers on allocation, and extend our order-to-delivery lead times for consumers. As I noted earlier, we enter 2022 in an improved position to meet customer's demand for our brand and products. We've removed customers from allocation and our lead times have normalized. Now that we're able to fully serve demand from our existing customers, we're reengaging with prospective customers looking to represent our brands and products. We also had a significant opportunity to grow through our direct channel, which is currently running in excess of a $1 billion annual run rate. We see potential growth opportunities for both our e-commerce and company-owned stores going forward. For e-commerce, we'll continue to focus on converting customers interested in purchasing online directly from the manufacturer. In our retail operations, we expect to drive both same-store sales growth and expand our store count. We currently operate over 650 retail stores worldwide and expect to increase our store count organically through opening an average of 60 new stores per year over the next few years. Turning to our growing OEM business. In 2020, we recognized a whitespace opportunity for the company to participate in the OEM space through utilizing our best-in-class manufacturing and logistics capabilities to manufacture non-branded products. In 2021, our OEM business grew over 50% over prior years. We are pleased with these results, especially given the significant supply pressure impacting our ability to service OEM demand during the year. Furthermore, we're targeting to grow our sales to $600 million by 2025. This will allow us to earn our fair share of the approximately 20% of the bedding market we believe comprises the OEMs. As a secondary benefit, future OEM sales growth will decrease our cost per unit for all of our branded products as we spread our fixed cost and drive more advantageous supply agreements due to enhanced volume. Our fourth key initiative is to drive increases in EPS and prudently deploy capital. The new product launches and marketing investments and omni-channel expansion opportunities that I just described are all expected to deliver strong returns on invested capital, driving increases in EPS. We continue to execute on our capital allocation strategy in 2022. Our capital allocation approach strikes a balance between investing capital back into the business to facilitate long-term growth, returning capital to shareholders via repurchase and dividend and on an opportunistic basis acquiring businesses that enhance our global competitiveness. For example, in 2022, we will continue to invest in expanding our manufacturing capacity. Our investment in our third domestic foam-pouring plant in Crawfordsville, Indiana is underway and the plant is expected to be operational in 2023. We're also making investments to expand our manufacturing footprint within existing facilities and overall warehouse space in several facilities. We expect to invest an incremental $300 million over the next couple of years to support these initiatives. We also expect to continue to return capital to shareholders via quarterly dividends and share repurchase. We've increased our quarterly dividend in 2022 by 11% to $0.10 per share. Additionally, in the fourth quarter last year, the Board increased our share repurchase authorization to $1.5 billion. Lastly, as Bhaskar mentioned a moment ago, we expect to repurchase at least 10% of our shares outstanding during this year. To conclude, our guidance shows that we are expecting robust sales and EPS growth in 2022. This expected growth is well ahead of anticipated industry trends for the year and we're confident in our ability to capitalize on our brand strength, new channels, and the acquisition of Dreams to achieve that growth. Moreover, we expect to deliver double-digit growth, while continuing to make strategic investments to support the long-term trajectory of the business, repurchasing our stock, paying cash dividends, and maintaining low leverage. I think this clearly highlights the strength of our global business model. With that, operator, will you please open the call for questions?

Thank you. Our first question comes from Keith Hughes with Truist Securities. Your line is open.

Thank you. Just a question on pacing of sales—you talked about some order weakness towards the end of the quarter. If you could just talk about the last couple of months, specifically here in February around President's Day and how the pace has gone?

Sure. Thank you for your question. I think you're primarily talking about the U.S., but to be fair and balanced, I would bring it out for the whole world. The International group started off the first quarter strong and solid. When you move to the U.S., you've got a story of two different segments. If you look at the high-end, the high-end is doing well with increasing ASP both from a pricing standpoint and quite a bit of mixing up. So we have seen solid business at the high-end—our Tempur flagship stores started off the first quarter solid and then we moved into President's Day, which I would call strong with same-store sales so far in President's Day running over 20%. If you look at entry-level bedding, the lower-end customer, that's been a challenge probably beginning in the fourth quarter and continued into the first quarter and we don't have complete information yet on President's Day. But in general, I would say that you should expect the entry-level customer—or we'll call it the stimulus-motivated customer—to be somewhat of a challenge or a little bit weak here for a period with the higher-end customer continuing to be very strong. I also think the other thing that's happening in the bedding industry is we're normalizing from what I call the COVID period. During the COVID period the valleys were not that low and the peaks weren't that high—little more steady. I think we're going back to more of the traditional trajectory on a month-to-month basis or promotional and non-promotional periods, where non-promotional periods the comps will be difficult and maybe even negative, then in the promotional periods the comps will be positive. I'd call it back to a normalized bedding business.

Thank you. Our next question comes from Curtis Nagle with Bank of America. Your line is open.

Good morning. Thanks for taking my question. So maybe just piggybacking a bit off of Keith's question. How should we think about the proportion of sales and sales growth in each half? You talked about 1Q with low-end a little weak, Dreams adding in the first half, pricing from last year still there, but in 2H you have product launches. Proportionately, how should we think about the makeup of the year between the two halves?

Sure. Great question. I'll handle it, then I'll pass it off to Bhaskar to give a little more color. We expect a reasonably solid first quarter. We don't do quarterly guidance, obviously, but we would expect certainly double-digit sales growth in the first quarter. You do need to think about some of the investments we're going to be making during the year. Let me point a couple of those out. First, we continue to advertise throughout the fourth quarter and the first quarter as we would preface some of the product launches, which is not normal for us. We're doing something a little different, because the product launch for Stearns & Foster is so important to us as we build a $1 billion brand and the expansion of the International Tempur product is so important to us, we're advertising before those products are in the market incrementally. But the other thing we're doing, obviously, last year was a tough year of having our customers on constraint and we've committed as a management team to get back to the service levels that our customers expect. So we've pre-hired and we are carrying, I don't know, 250 to 300 extra people during the slow period of the first quarter from a seasonality standpoint, because we want to be ready for the second and third quarters. That's different than we normally do, but in the current labor market, we think it's the right thing to do. We're committed as a management team to do everything necessary to make sure that this next year we deliver in a way that we're used to for our customers. So you're going to get some different seasonality on the EPS growth line. But from the sales line, it should be very good. Is that a good way to explain, Bhaskar?

Absolutely. When you think about the sales phasing, and you called it out, Curt, Dreams is absolutely on the other side of that and contributes principally in the first seven months; the pricing wraparound effect from the 2021 price increases that we took, as well as the new one we put in place during the first quarter, is also mid-single digits. Overall, we would expect growth in all of our channels, all of our segments, all of our geographies. OEM had a great 2021, we'd expect growth from OEM as we get into 2022. DTC has nice momentum both in our online business as well as our bricks-and-mortar business and we would expect that to drive growth in 2022 as well.

Thank you. Our next question comes from Seth Basham with Wedbush Securities. Your line is open.

Thanks a lot and good morning. Just a follow-up on some of those questions. If you could, give us some color on how Tempur-Pedic performed through the President's Day weekend? And then secondly, what gives you the confidence that the low-end consumer softness we're seeing is temporary?

Great. First, you have to realize our information on President's Day takes a little while, so we're a few days ahead of having what I call hard information. Let me hedge my comments, it's mainly verbal right now. Tempur-Pedic had a great President's Day. It feels like we continue to take share at the Tempur-Pedic level and we're hearing very positive things from the Tempur side, U.S. Tempur. Our best information is our own stores, which we get that information instantaneously. From a same-store standpoint, our Tempur flagship stores are running same-store sales of over 20% in President's Day. The second part of the question—when do we think the entry-level customers come back and why are we confident—is more difficult. That customer segment we don't make that much money on; the lower-ASP beds don't have great margin, though they cover a lot of fixed cost. In the near-term, we have some tough comps when you look at March and the timing of stimulus checks. But if you step back and look at the U.S. market, that consumer segment's debt levels are in good shape, they've had solid wage growth, unemployment is low, and they generally have access to jobs. If you look at that segment, it looks like it should be in pretty good shape throughout the year. The timing of stimulus checks relative to wage growth may not match on a month-to-month basis, and it may take a quarter for that segment to fully reaccelerate. But the segment typically shows propensity to spend when they have money. So, as long as gas prices don't get too high and wage growth continues, we believe that segment will be in good shape. It may be a short timing issue, but that segment does not drive our profitability as much as the higher-end customers do.

Thank you. Our next question comes from Bobby Griffin with Raymond James. Your line is open.

Good morning. Appreciate you taking my questions. Scott, you called out a couple of times the inefficiencies due to COVID, supply chains, etc. What's the guide for the efficiency of the operations in fiscal year 2022? Do we get closer back to normal, halfway there—what are you assuming when you bake that in?

Interesting and complicated question. First, staffing issues have impacted some of our customers, not so much Tempur Sealy directly—specialty retail stores that only have one or two staff have had trouble keeping some stores open, and that has caused some closures and hurt us a little. On the supply chain, the good news is it's significantly better than it was at the beginning of the fourth quarter. Is it perfect? No. But we are close to normal on the supply chain. There may still be inefficiencies in manufacturing from absenteeism related to COVID, but chemicals are back, Tempur inventory levels are close to normal if not normalized, and we'll take a little more inventory into the second quarter because we're bullish on the second quarter. Springs are in good shape. I think the remaining inefficiencies are mainly people-related absenteeism. To protect ourselves and our customers from that risk, we've over-staffed, hired early and are training people. We're carrying extra people in U.S. manufacturing, primarily on the Sealy side to make sure we can get back to normal. There will be some cost we absorb in the first quarter, but I think by the second quarter, with no unforeseen events, we'll be back to normal operations both from time-to-delivery and efficiencies. The major accomplishment in the fourth quarter is we're back to normal and we're servicing our customers; our sales force can go back into hunter mode rather than servicing and chasing orders, which puts us in a very strong competitive position going into 2022.

Thank you. Our next question comes from Atul Maheshwari with UBS. Your line is open.

Good morning and thanks. I have a multipart question. What is the level of industry unit growth you've assumed in the guidance of 15% to 20% revenue increase for 2022? Related, can you provide more granular color on the contribution from the various building blocks that get you to this level of revenue growth? Finally, if low-end softness were to persist through the year, do you still believe you can achieve this guidance? Trying to understand how conservative the guidance is.

I'll start and Bhaskar will clean it up. Unit growth in the fourth quarter was negative while we still grew sales 29%, which shows mix is often more important than unit growth. Other industry experts have suggested U.S. unit growth for 2022 somewhere between zero and 4%—that sounds reasonable to me, though it's a chatter estimate. For us, mix is probably more important than actual unit growth. Bhaskar, do you want to walk through the building blocks?

The way I think about it is that, overall, we expect growth in all of our channels, segments and geos. Building components include Dreams, which contributes mid-single digits; the pricing wraparound effect from 2021 price increases and the new increase in the first quarter, which is also mid-single digits; OEM growth; and DTC momentum in both online and bricks-and-mortar. Those components together drive the 15% to 20% overall sales growth guidance. Regarding entry-level softness, our estimate for that segment is not particularly aggressive. We're expecting some pressure in early quarters given comps, but overall our guide assumes growth across the business.

Thank you. Our next question comes from Peter Keith with Piper Sandler. Your line is open.

Hi. Thanks. I want to look back to Q4. I'm having some difficulty reconciling comments. You had the $100 million backlog going into the fourth quarter, but you mentioned retailer inventory positions that were stronger than expected. Can you bridge those comments? Where did you finish the year with backlog that's carrying into the new year?

Good observation—there is an apparent conflict, and here's how to reconcile it. We left the third quarter with a strong backlog of Tempur orders of about $100 million. Over the long constrained period, retailers were aggressively building safety stock because manufacturers were not delivering on time. They probably increased inventories from what might be two to three weeks of natural stock to three to four weeks as a safety buffer. As supply normalized in the fourth quarter, and given seasonally softer period, retailers right-sized their inventories back to normal levels, which created a temporary reduction in orders versus expectations. That rebalancing surprised us. At the time retailers were asking for more inventory, but they had been gaming the system during the constrained period and had built up additional safety stock, so when things normalized they trimmed inventories back down, creating a temporary softness. As for year-end backlog, much of the elevated Tempur backlog was worked down through the quarter as we normalized deliveries.

Thank you. Our next question comes from Laura Champine with Loop Capital. Your line is open.

Thanks for taking my question. I wanted to ask about what looks like an inventory build as you exited the quarter. Did sales trends weaken relative to your expectations as you exited the quarter or did you build inventories because of the supply chain issues that plagued the whole year last year?

We are building inventory of Tempur—throughout the year we were light on Tempur and not optimized from an inventory standpoint. The plan is to go into the busy season heavier on inventory than last year. Since the product does not become obsolete, it makes sense to carry some strategic inventory to ensure we can service customers. From a phasing standpoint, towards the end of the fourth quarter sales were slightly softer, which ties to retailers normalizing their inventories. But the lion's share of the build you observed is strategic.

Yes, we did get into a better inventory position. Most of the build was associated with adjustables. We have a very long lead time for adjustables and we want to ensure that as we get into 2022 and around the holidays we have plenty of supply not only of mattresses but of adjustables and foundations.

Thank you. Our next question comes from Brad Thomas with KeyBanc Capital Markets. Your line is open.

Hi. Do you mind reminding me what the expectation is for commodities as an impact in dollars or basis points for this year? Also, could you put a little more context around what percentage of the business you think addresses the low end versus the mid versus luxury? I'm curious how much exposure you have to the low end.

Regarding commodities, the inflation we've seen in 2021 was unprecedented, but we've been able to fully neutralize the dollar impact of commodity inflation through the pricing actions we've taken in 2021, and our expectation is that in 2022 we will be able to fully offset the commodity impact with the price increases we've implemented. We are seeing some slight increases since our third quarter call, but still within reasonableness. In our guidance we've assumed that commodity cost remains at the peak levels through the second quarter and stays at that level for the rest of the year. If there is deflation, that would be upside for us. Scott, on exposure to the low end—it's a matter of definition, but it's probably in the low double-digit percent range of our business.

I would add that we may take another price increase in the near term; we feel pretty good about the pricing versus cost position. On the exposure question, roughly 10% to 15% of our business is entry level, but our P&L is much more sensitive to mix, which is why we're focused on higher ASP segments and brands like Stearns & Foster.

Thank you. Our next question comes from Jonathan Matuszewski with Jefferies. Your line is open.

Thanks. Following up on mix from a different angle: there have been data points that mattress size preferences have evolved during the pandemic. To what degree has Tempur Sealy benefited from a shift from Queen to King over the past 24 months, and how sustainable is that shift?

No question there has been a shift toward larger sizes, with King leading the way. That likely comes from housing formation—moving from apartments to houses gives consumers the ability to upsize—as well as pandemic-related behavior like spending more time at home. This contributes to ASP growth and we think it's sustainable to some degree. Consumers moving to larger homes and continuing to value better sleep and comfort support continued strength in larger sizes.

Thank you. Our next question comes from Carla Casella with JPMorgan. Your line is open.

On the promotional market and lower end: you talked about valleys and peaks and returning to more normal promotional cadence. Does that imply more products will be sold on promotion so we could see margin pressure from that?

We did not change our promotional cadence or discounts last year from Tempur Sealy's standpoint. The promotional environment is more about retailers. Last year many retailers pulled back on promotions because they couldn't service customers due to supply constraints. Now that we're able to service them, retailers will return to historical levels of promotion and advertising. From our standpoint, increased retailer promotion shouldn't be materially significant to our financials; our own promotional posture did not change and we don't have a difficult comp in that area.

Thank you. Our next question comes again from Seth Basham with Wedbush Securities. Your line is open.

Thanks for the follow-up. A couple questions on margins. First, the fourth quarter margin degradation seemed high given most of the sales impact was at the lower end, which doesn't carry much margin. Can you help square that away? Secondly, for 2022, what are the building blocks for cost pressures—advertising of $550 million, what's that versus 2021, and what's incremental launch cost versus last year?

Dreams impacted margins in the fourth quarter and is a lower-margin retail profile relative to our historical International margins. Bhaskar?

Fourth quarter margins were in line with our expectations. Sequential improvement from the third quarter to the fourth was driven by backlog fulfillment and favorable mix. Year-over-year variance is caused by acquisitions like Dreams and the timing of pricing versus the commodity environment. Regarding advertising and launch costs, our detailed model will be posted tonight in our 10-K/earnings materials. The incremental launch investments we're calling out for 2022 are approximately $50 million. Advertising is up materially versus prior years as we invest ahead of key product launches and to build long-term brand awareness; we're investing $550 million in advertising in 2022. Both dollars and rate are increased relative to 2021 to support these strategic launches.

When you think about advertising, there are two ways to view it. We're not advertising aggressively to sell current product—we're making pre-investments ahead of major strategic launches. The Stearns & Foster repositioning is a major attempt to build a $1 billion brand with strong margins for both us and our retail partners, and that requires upfront investment. The Tempur international launch is also a multi-year strategic initiative to broaden the addressable market. Both efforts already show green shoots. Stearns & Foster grew like 35% in the fourth quarter before the new product reached the market. Our International group continues to perform above expectations even before product rollouts. We feel very good about these strategic investments and will get a clear read in the coming quarters on their productivity.

In 2022, talk about the advertising and launch costs.

This concludes the question-and-answer session. I would now like to turn the call back over to Scott Thompson for closing remarks.

Thank you, operator. To the over 12,000 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 Tempur Sealy's leadership team and the Board of Directors. This ends our call today, operator. Thank you.

This concludes today's conference call. Thank you for participating. You may now disconnect.