Somnigroup International Inc. Q1 FY2023 Earnings Call

Moore - Vice President of: Scott Thompson - Chairman, President, and Chief Executive Officer Bhaskar Rao - Executive Vice President, and Chief Financial Officer

Good day and thank you for standing by. Welcome to Tempur Sealy’s First Quarter 2023 Earnings. At this time, all participants are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. And please be advised that today's conference is being recorded.

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 report on Form 10-K and quarterly report 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 the non-GAAP financial information can be found in 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 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 2023 first quarter earnings call. I'll start by sharing some highlights from our first quarter performance, and then Bhaskar will review our financial performance in more detail. After that I will share some closing comments before we open the call up for Q&A. In the first quarter of 2023 net sales were approximately $1.2 billion and adjusted EPS was $0.53, which represents a 75% growth in sales and approximately 300% growth in adjusted EPS over the first quarter of 2019, a pre-COVID period. Compared to the same period last year, this represents a 3% decline in sales and a 23% decline in adjusted EPS, driven by launch costs to support our new innovative products in a less robust macroeconomic environment. Our wholesale channel performed well. We reported wholesale sales stable to prior year as our continued global market outperformance mitigated the heightened macroeconomic headwinds. Our direct channel performance was more impacted by the current environment. Unfavorable foreign exchange rates presented a challenge to our international operations and cost us $0.03 per share this quarter. As I noted, though industry conditions were less favorable than expected, it is very clear we continue to outperform the market and units appear to be stabilizing at a historical trough level. In the second quarter our expectation is that our sales will return to growth year-over-year, driven by continued global market outperformance and the rollout of our new products. We also anticipate industry demand will slowly improve in the back half of the year as comps ease. As a reminder, U.S. produced mattress consumption declined approximately an unprecedented 24% in 2022 representing trough unit production for the last 10 years. Most of the decline was post first quarter of 2022. As we've now fully lapped the challenging prior year comps, we anticipate the industry will slowly recover, resulting in a more stable U.S. bedding environment in the full year 2023 with the back half unit trends stronger than the first half. Turning to highlights and some key wins in the quarter. First, we continue to see positive momentum in our brands and private label products at wholesale. Our high quality products and leading customer service continues to drive third-party retailers to lean into our brands and non-branded products. Our third-party retail partners in the U.S. are especially supportive of the new Stearns & Foster product. We are tracking to expand our third-party retail slots of Stearns by approximately 20% compared to the previous collection. We believe these slots will be coming from competitors, enhancing the total presence of Tempur Sealy brands on U.S. retail floors. We continue to make progress towards our goal of making Stearns & Foster our next $1 billion brand, more than doubling its current size today. On the product side, we're well underway with our rollout of the new Stearns & Foster collection in North America. The new products are designed to further differentiate our high-end traditional innerspring brand, while also offering an extended lineup of products that address the needs and differences of consumers. The collection's superior innovation, enhanced step-up opportunities, and elevated design together create unprecedented luxury innerspring product that meets the needs of what we believe is an underserved consumer seeking a premium innerspring product. Overall, Stearns & Foster performed well relative to the U.S. market in the first quarter, and we believe it's currently the fastest growing major brand in the U.S. The second highlight of the quarter is the launch of our new TEMPUR-breeze product and our new innovative line of smart adjustable bases in the U.S. These products build on the success of our prior generation of breeze and adjustable bases to provide even greater consumer benefits to America's most highly recommended mattress. The new TEMPUR-breeze product features our latest Tempur material innovation, which delivers greater Tempur yield characteristics and greater cooling benefits. In our new line of adjustable bases, we enhanced our connected-sleep platform with a continued focus on improving sleep and overall health and wellness of consumers. In addition to our sense-and-response technology for snoring featured in our previous smart base collection, the new bases also feature lumbar support at the touch of a button and advanced technologies, including our industry-first acoustic massage and a range of relaxation features that help prepare customers' bodies and minds with deep rejuvenative sleep. TEMPUR: We pre-built inventory to support a seamless transition across our valued Tempur-Pedic retail partner network. Most retailers will be floored and selling for Memorial Day, which is when our new breeze and smart base advertising campaigns begin. This is the first North America Tempur mattress launch in four years. The third highlight is that we've significantly fortified our supply chain and we're executing orders within normalized order-to-delivery times. Our U.S. operating team and plant personnel have worked significant amounts of overtime to get us to the point of normalized order-to-delivery times. The overtime and expediting cost hurt us a bit in gross margin in this quarter, but we're thrilled to be back on normal customer service ahead of the prime selling season of the second and third quarter. This is especially positive and we've accomplished this while outperforming the broader market. The final highlight is that we successfully kicked off the rollout of our new Tempur International product this quarter. This all-new lineup of mattresses, pillows, and bed bases have been strategically designed to optimize Tempur's global addressable market. The expanded price points and consumer-centric innovations in the new collection will continue to appeal to our legacy ultra-premium consumers at prices of $3,000 and above, while also meeting the needs of consumers shopping for mattresses between $2,000 and $3,000. We streamlined the construction of the new products to drive future manufacturing efficiencies and enhance our ability to adapt our products to individual markets' needs. This updated process has enabled us to feel confident in unlocking a broader price range without materially altering the margin profile of our Tempur International business. We're manufacturing both the new lines of products and the old line of products as we transition. This is a heavy lift for our overseas team, and after the transition period, we plan to optimize production of the new line, which we expect will be a positive driver for gross margins. We are launching the new lineup in over 90 markets worldwide, and we're staggering the rollout of these new products to allow for a customized approach by region. In the first quarter, we kicked off the launch in our temporary European markets. We expect the rollout to be completed for all of our subsidiary markets in Europe and Asia by the third quarter, and to be completed by the end of the year for our third-party distributors. We expect the total rollout to be completed by the end of 2023, except for the U.K., which has some country-specific industry fire retardant regulations. We expect the U.K. to be fully floored by the first quarter of 2024. The early reaction to the new lineup has been very positive. With that, I'll turn it over to Bhaskar. We pre-built inventory to support a seamless transition across our valued Tempur-Pedic retail partner network. Most retailers will be floored and selling for Memorial Day, which is when our new breeze and smart base advertising campaigns begin. This is the first North America Tempur mattress launch in four years. The third highlight is that we've significantly fortified our supply chain and we're executing orders within normalized order-to-delivery times. Our U.S. operating team and plant personnel have worked significant amounts of overtime to get us to the point of normalized order-to-delivery times. The overtime and expediting cost hurt us a bit in gross margin in this quarter, but we're thrilled to be back on normal customer service ahead of the prime selling season of the second and third quarter. This is especially positive and we've accomplished this while outperforming the broader market. The final highlight is that we successfully kicked off the rollout of our new Tempur International product this quarter. This all-new lineup of mattresses, pillows, and bed bases have been strategically designed to optimize Tempur's global addressable market. The expanded price points and consumer-centric innovations in the new collection will continue to appeal to our legacy ultra-premium consumers at prices of $3,000 and above, while also meeting the needs of consumers shopping for mattresses between $2,000 and $3,000. We streamlined the construction of the new products to drive future manufacturing efficiencies and enhance our ability to adapt our products to individual markets' needs. This updated process has enabled us to feel confident in unlocking a broader price range without materially altering the margin profile of our Tempur International business. We're manufacturing both the new lines of products and the old line of products as we transition. This is a heavy lift for our overseas team, and after the transition period, we plan to optimize production of the new line, which we expect will be a positive driver for gross margins. We are launching the new lineup in over 90 markets worldwide, and we're staggering the rollout of these new products to allow for a customized approach by region. In the first quarter, we kicked off the launch in our temporary European markets. We expect the rollout to be completed for all of our subsidiary markets in Europe and Asia by the third quarter, and to be completed by the end of the year for our third-party distributors. We expect the total rollout to be completed by the end of 2023, except for the U.K., which has some country-specific industry fire retardant regulations. We expect the U.K. to be fully floored by the first quarter of 2024. The early reaction to the new lineup has been very positive. With that, I'll turn it over to Bhaskar.

Thank you, Scott. In the first quarter of 2023, consolidated sales were approximately $1.2 billion and adjusted earnings per share was $0.53. We have approximately $10 million of pro forma adjustments in the quarter, all of which are consistent with the terms of our senior credit facility. These adjustments are primarily related to costs incurred in connection with the exploration of strategic acquisition initiatives. Turning to North American results, net sales decreased 1.3% in the first quarter. On a reported basis, the wholesale channel decreased 1% and the direct channel decreased 4%. North American adjusted gross margin improved to 37.9%, driven by pricing actions partially offset by operational headwinds and increased product launch expense. North American adjusted operating margin declined to 15.3%, driven by investments in advertising and product launch initiatives, partially offset by the improvement in gross margin. Now, turning to International, on a constant currency basis, International sales increased 1.7%, but decreased 6.4% on a reported basis as we experienced $25 million of headwind in the quarter from unfavorable foreign exchange rates. Foreign currency remains volatile, though recently we have seen rates trend favorably. Our current full year expectation for 2023 contemplates a slight FX headwind to both sales and adjusted EBITDA. As compared to the prior year, our International gross margin declined to 54%, driven by product launch expense, partially offset by pricing actions. Our International operating margin declined to 15.3%, driven by investments in advertising and product launch initiatives, the decline in gross margin, and the agent joint venture performance. Commodities, which we think about as inclusive of raw materials, logistics costs and labor, have been highly inflationary across the global bedding industry for more than two years. In the first quarter, global commodity prices largely trended in line with our expectations. We anticipate that commodity prices could continue to ease a bit throughout the year, although we expect commodity prices in 2023 will continue to trend significantly ahead of 2020 levels. Now turning to 2023 guidance. Consistent with previous communications, we expect adjusted EPS to be in the range of $2.60 to $2.80. This considers sales growth of mid-single digits, primarily driven by the execution of our key initiatives, and also benefited by the sell-in of discounted floor models and the wraparound impact of pricing. Sales and marketing investments of $20 million to support product launches, and record advertising spend of over $500 million as we continue to support our leading brands and new products, which will result in adjusted EBITDA of approximately $980 million at the midpoint of our EPS range. Our guidance also considers the following allocations of capital in 2023: CapEx of approximately $200 million, which includes $90 million of growth CapEx primarily to fund the completion of our Crawfordsville facility and a quarterly dividend of $0.11 representing an increase of 10% relative to 2022. Lastly, I would like to flag a few modeling items. For the full year 2023, we expect D&A of about $200 million to $210 million, interest expense of about $135 million to $140 million, a tax rate of 24% to 25%, and a diluted share count of 178 million shares. With that, I will turn the call back over to Scott.

Nice job. Thank you, Bhaskar. I'm excited to share that we have announced this morning that we've signed a definitive agreement acquiring Mattress Firm, the nation's largest mattress specialty retailer. This acquisition aligns with our strategy of acquiring companies that extend our competitive advantages, enable us to move closer to consumers and facilitate continued innovation. This combination will complement Tempur Sealy's extensive product development and manufacturing capabilities with vertically integrated retail. First and foremost, Mattress Firm has been a valued retail partner for more than 35 years, and we look forward to welcoming their talented workforce and more than 8,000 employees to the Tempur Sealy family once the deal is closed. The transaction is expected to close in the second half of 2024, subject to satisfactory and customary closing conditions and applicable regulatory approvals. Mattress Firm is expected to operate as a separate business unit within the Tempur Sealy organization and to continue to provide customers with brands and products they desire. This morning, we released a separate press release and investor presentation related to this transaction. Both can be found on our investor webpage. These documents provide further details on the transaction and the strategic rationale. We see this transaction as being attractive both strategically and financially. And with that, we'll open up the call for questions. Operator?

And our first question is from Susan Maklari with Goldman Sachs. Please proceed.

Thank you. Good morning, everyone. My first question…

Good morning, Susan.

Good morning. My question is around the acquisition that you announced this morning, appreciating what the synergies are, but how do you think about managing some of the perhaps channel conflicts that are going to come through with this and some of the adjustments that will need to be made in terms of product and offerings and logistics and those types of efforts in there, and just how are you thinking about some of those elements of this deal?

Wow, five questions in one. Great job. Great question. First of all, let me talk about channel conflict. One of our expertise is the ability to manage omni-channel strategy throughout the world and have been doing it for a number of years. If you look at the most recent acquisition before this, Dreams, as kind of a maybe a beta test, Dreams is obviously a large retailer in the U.K. We're obviously in the U.K. and we did not have any problems with channel conflict in that acquisition. And we've been working on this, at least this has been in the marketplace where people have thought about this for years, probably five or six years. I doubt there's anybody in bedding that is surprised with this transaction. And if you move over to the States, we're in retail stores. We've got our Sleep Outfitters operation, which is a direct competitor to Mattress Firm in the marketplace and we've got our Tempur stores. And although years ago, and I'm going to say what, four or five years ago, Bhaskar, yes, there used to be a little bit of noise in the system. I think once retailers saw how we operate our stores — and I'm going to say we're a good retailer and we're not really trying to steal share from anybody — it hasn't been a problem. Additionally, over the years we have discussed this concept with various of our customers, large and small, and I think we have a good understanding of what their expectations are. It's going to depend on us having quality product, quality service, quality advertising and servicing them correctly, and making sure that they are not put at a competitive disadvantage. And so I'm not expecting any significant channel conflict as long as we deliver quality product at the right price with the proper support around it. You asked about logistics, and I assume you're kind of moving towards synergies. You know, they're both very large companies. We've put a $100 million down on a piece of paper. The sort of things you should be thinking about are warehousing and logistics. There are cities where we literally have warehouses within five miles of each other. On a Tempur product, we would make the product in our plant, put it on a truck, take it to our warehouse, take it off the truck, put it in the rack where it would sit and wait for an order from Mattress Firm. Then we would get another truck, take it down from the rack, put it on the truck, and we would take it to their warehouse. Then they would take it off the truck, put it in their rack, and they would wait for a customer order, at which point they'd get another truck, take it down from the rack, put it in, and take it to the customer's house. That's just the way the systems work. We've never been able to get the two companies to figure out how to clean up some of the logistics. So we think there's good synergies in logistics and warehousing. The other thing that may not be as evident to people who aren't in the business is on the manufacturing side — and this would be on the Tempur and Sealy side, not the Mattress Firm side. I think everybody knows we're order-to-delivery on Sealy. That means we don't know what beds we're going to make until we get an order from somebody. And I'd generally call it three or four days. These are manual manufacturing operations. So we whipsaw the workforce. There are some days they show up at work and we've got lots of orders and we want them to work overtime. Some days they show up at work and we don't have enough orders, and they only get to work four hours. At most plants we decide on Friday afternoon if they're going to work the weekend and of course there's overtime involved in some of these swings, but it's also just a quality of workforce and the ability to hire people because the hours are variable. If we had real committed orders and had certainty of distribution, we could pre-build and level out the manufacturing. On days that we don't have specific orders, if we knew for sure we were going to get some orders, we could go ahead and build some product and level it out. I think that's a big quality improvement for us. It's a workforce issue and there's also, I believe, significant cost savings. We would have the normal insurance savings and some overhead savings. I think another thing that's not obvious is COVID really highlighted that the supply chain around the world is not very robust. If you stop and think about it, the reason it's not very robust is a little bit of what I just said: nobody down in the supply chain knows for sure what their orders are. So everybody's working just in time. Being able to have fully committed distribution, I think, will allow us to fortify the supply chain by giving suppliers more certainty and being able to sign long-term contracts, which I think will also have synergies. Another item: we have very sophisticated labs that test the quality of product. It's core to Tempur, it's core to Sealy — best-in-class ability to analyze foam, springs, durability. One thing we can do that would help a retailer is we can make sure the products that are put on their floor are the quality that they're supposed to be and continuously test to make sure that we're getting what we're paying for. I think that will make the product sharper at Mattress Firm. That's good for the customer, and I suspect we'll find some opportunities from a cost standpoint once we do the hard analytics and test the product. So that's my high level on channel conflict, logistics, manufacturing, supply chain and quality labs.

Thank you. One moment for our next question and it comes from the line of Bobby Griffin with Raymond James. Please proceed.

Good morning. Thanks for taking my question. Scott and Bhaskar, it won't be a five-part, but it's going to be a two-part question at least. So first, Scott, can you maybe just talk about the timing of it? I think the strategic rationale of this acquisition makes a lot of sense and a lot of investors will understand that, but there is some clear economic concerns. Maybe just talk about the timing of it? And then Bhaskar, can you share any financial details for Mattress Firm that's getting used in kind of the accretion analysis, whether it's 2022 or 2023 EBITDA? Anything there would be helpful.

Sure. Let me kind of step back a second. First of all, I would say if you're talking about real timing, the timing has been probably seven years. It's always been on our chalkboard as something that made a lot of sense strategically for some of the reasons Scott mentioned and others, but it never was right. Both at times we weren't right, at times they weren't right, at times the market wasn't right. So it's been on the board; it's not like a new concept or a new idea. Second of all, we've been engaged with the Mattress Firm folks for the last two years as they put the company up for sale or in a process, and they ran a dual process. So we've been engaged for the last two years exchanging data, getting price discovery, and thinking about it. We filed an HSR in October of 2022. The two companies filed an HSR, which then gave us access to the FTC folks, and we could get some feedback on some of their thinking. So before we got down to a definitive agreement, both parties had some data on the FTC process. That kind of explains the timing. This has been a long and thorough review by both companies as to what would be in the best interest of both companies. Now, you're also looking at economic cycle timing. There's different ways to think about it. For where we are and where we're sitting and the data we look at, it looks like the bedding industry, U.S. units produced, are probably the lowest they've been for more than 20 years. The unit production is at trough numbers that we've never seen as an industry. Both companies are very profitable even at these trough units. So it would appear to us it's the trough and it feels like we've been bouncing around the bottom of the bedding industry for the last three quarters or so. It has not shown a lot of recovery. You decide: do you want to transact under that basis, or wait and see green shoots? There's a price to waiting. We feel very confident in our ability and we feel pretty good about the market. The transaction will take a while — we're not closing this deal next week. So the real economy that you're looking at when you're trying to find the right price and normalized earnings is really 12 to 18 months from now, not tomorrow. So if there is some near-term volatility, it doesn't affect us as much. We're effectively buying the company in the future. Now, when you think about accretion a year post-acquisition: all those things Scott mentioned matter and there is a bit of time between now and where we'll be a year or so from now. From a targeting perspective — lots of uncertainty could happen between now and then — but from a targeting perspective, I would think somewhere between $0.20 to $0.25 of incremental EPS in that first year. And then when you get a couple of years out after that with full run rate synergies, I would anticipate about $1 of incremental EPS.

Thank you. One moment for our next question and it comes from Peter Keith with Piper Sandler. Please proceed.

Thanks. Good morning. Congrats on seeing the big deal after seven years of work.

I appreciate it.

I'm not sure how much you'll be able to answer this question, but I want to ask because it sounds like you have been engaged with the FTC for a number of months. Has there been any preliminary opinion or any insights that you've gained on getting approval or how this could all look post acquisition?

Sure. I mean, first, it's early days. We've been engaged with them. It's given us some preliminary information, none of which was particularly surprising. Those folks have a job, all very talented men and women, and we look forward to working with them. But obviously, we wouldn't have moved forward if we didn't think that ultimately, we would be able to clear the process either in the traditional sense or through litigation.

Thank you. One moment for our next question and it comes from Curtis Nagle with Bank of America. Please proceed.

Great. So maybe I'll just break with the question a little bit. One question just on the business as it stands now. Bhaskar, curious if you could talk to how much of a headwind for floor models and some of this catch-up and overtime to get shipping correct or back to normal, how much did that hit gross margin? And then just a quick follow-up in terms of with — first Dreams and now Mattress Firm — is this the go-forward model in terms of how you guys continue to expand, particularly internationally; do we have the template now?

I'll take the latter. Now that these are pretty unique transactions, there are only a few large specialty retailers in bedding in the world, and we've got two of the best. There's not really one sitting in every country. We could maybe do some other relatively smaller deals in some countries, but these two would be the lion's share. There may be two or three others we'd think about. But again, we don't have to do these; when the time is right, the price is right and it lines up strategically for that market, we'd certainly want to look at them.

From a gross margin perspective, I was pleased with the performance overall — a 40 basis point decline year-over-year. However, in the face of the floor model launch and operations, we did have some headwinds, all driving future growth. Specifically, globally, I would call out about 100 basis points of a headwind from operations, as we did carry into 2023 a bit of a backlog. We prioritized meeting our customers' needs, so we incurred incremental overtime associated with clearing out that backlog. Regarding the launch, on a global perspective, we had about 100 basis points of headwind. Once we get through the floor model launch side and the operational improvements, the earnings power of the business is very attractive.

Thank you. A moment for our next question and it comes from Atul Maheswari with UBS. Please proceed.

Good morning. Thanks a lot for taking my question. Scott, based on what you know today, what are the biggest risks to this transaction, like a few years from now, if the synergies are less than expected or if there are any revenue dis-synergies, what would be the most likely cause of that? And if I ask this question another way, what is the biggest risk that exists today based on what you know? And what are you working actively to avoid some of those pitfalls?

Great question. The biggest risk is macroeconomic — where we are in the cycle and what it looks like 18 months from now. After that, it's probably people and culture. The history of acquisitions can be checkered; generally, problems relate to people, structure and culture. The synergies we're talking about here, because this is vertical integration, aren't as complicated as many horizontal deals where many people lose their jobs. This is a relatively clean vertical integration. We still have people and structure issues to work through, but these companies have worked together for 35 years and we know each other well. Tempur Sealy from a manufacturing standpoint in the U.S. is strong. New products are doing well. Stearns & Foster is probably the fastest-growing major brand in the U.S. Mattress Firm has been gaining market share, and we would expect them to continue to outperform the market. So outside of macro risk and standard people integration risks, I can't think of anything else large that keeps me up at night.

To add, nothing is ever easy and things are always complicated. But to put it in perspective, when you think about the COGS that are available between the two companies, let's talk about $5 billion of combined spend. We're talking about $100 million of synergies on that $5 billion. I'm not saying it's easy, but there seems to be enough opportunity to make that manageable.

Thank you. One moment for our next question and it comes from Seth Basham with Wedbush Securities. Please proceed.

Thanks a lot and good morning. Congrats again on the deal. My question is revolving around some of the prior questions. First, in terms of the timeline to close, a year plus is a very long timeline. You mentioned that you're going to continue talking with the FTC, but are there concessions that you're expecting to have to make or any changes to the current asset base? And then secondly, in terms of the synergies, the dollar of potential synergies seems materially higher than the $100 million of cost synergies you talked to. Are you expecting some revenue synergies or are you seeing more signs of upside there?

Let me work through those. We're open and talking to the FTC. We'll consider doing things that make the FTC comfortable with the transaction; that could include divesting some stores. That's something we would look at and evaluate in terms of how it impacts future financials. On the revenue side, we're not relying on significant revenue synergies. We're not looking to force our manufactured products onto the floor; we've typically allowed retailers to own merchandising decisions and hold them accountable. We don't have a large amount of revenue synergies baked into the transaction. We're focused primarily on cost, operational, logistic and supply-chain synergies and on improving margin through optimization.

To clarify, when you think about it a year out or so, we've indicated it's accretive and assumed $100 million of synergies at run rate. A couple of years out, in a normal economy, Mattress Firm historically has captured market share and we expect that to continue, so you could see additional growth and improved margin flow-through combined with the synergies I mentioned earlier. That is how we get to the higher potential upside over multiple years.

Thank you. One moment for our next question and it comes from Brad Thomas with KeyBanc Capital Markets. Please proceed.

Hi, thanks for taking my question and let me add my congratulations on the deal announcement as well. I wanted to come back to the current trends in the business and the outlook for this year. I was hoping, Scott, you could talk a little bit more focused on North America about what you were seeing through 2Q and through 1Q and early 2Q. We've heard about a strong start to the quarter, but then some weakness in March. Just any more color on what you were seeing. And you made a comment about units hopefully bottoming, but this is happening in an economy that's still been relatively healthy in terms of employment and consumer credit. So just wondering your latest thinking on potential downside risk.

Sure. First, we've moved back to more traditional seasonality where holiday periods have become much more important than they were during the COVID era. So you have taller peaks and bigger valleys, similar to the industry pre-COVID. The quarter started out robust, slowed a little in March, and the second quarter started out with good order deliveries and shipments are growing, which gives us strong conviction that the second quarter will be positive from a sales standpoint. We feel good about the start of the second quarter. We share the same concerns about macro indicators — how long consumers can hold, savings, unemployment, etc. Overall, employment is holding well and the consumers who buy our higher-end products continue to be strong. The real weakness is in entry-level bedding. Entry-level retailers are experiencing the most pressure. That separation between entry-level and premium is clear, and the entry-level weakness is less impactful to our earnings.

Thank you. One moment for our next question and it comes from Robert Drbul with Guggenheim Partners. Please proceed.

Hi, good morning and congrats on the transaction. If I could follow Brad and just focus on some of the recent trends, can you talk a little bit about some of the new customer testing you've been doing within the opportunity down in the value channel and what you're seeing with some tougher trends there? Thank you.

We've tested some products at a large big-box retailer and that's gone very well. We've done about 100 stores and expect to run another 100 soon. Where we've had new customers and put our Sealy product in and taken other product out, the Sealy product has outperformed the product it replaced in every situation I can think of in the last few years. So we're doing well in that entry-level market even though it's relatively tough. We continue to pick up incremental distribution not just at the entry level. Stearns & Foster slots, for example, are expected to be up north of 20%, and those slots are coming from competitors. Stearns is a very powerful product for us and for retailers.

Thank you. One moment for our next question and it comes from the line of William Reuter with Bank of America. Please proceed.

Hi, I only have one. You provided the LTM EBITDA for Mattress Firm; I was wondering if they had provided to you their outlook for where the numbers could be this year. The question is a little bit in light of the fact that historically, you have had such a variable cost structure and I'm sure that they have a much more fixed cost structure. I was wondering if you could speak to how their fixed costs stack up relative to your own to the extent that you have that information at this point.

Sure. We've got management's projection of the future, which we're comfortable with. We've stress tested both our numbers and their numbers under various scenarios. Initially, you might think the fixed versus variable difference matters a lot, but when we worked through the fixed and variable characteristics as part of our stress testing, it's not as impactful as you might expect. Bhaskar can provide more color.

When you think about the fixed-versus-variable composition historically, we were around 35% fixed and 65% variable, let's call it 40% fixed and 60% variable now. Mattress Firm has improved its profitability coming out of the bankruptcy process and its cost structure is about 40% fixed and 60% variable. They've improved their footprint and remained in profitable stores while managing costs effectively. So from a consolidated standpoint, the fixed-versus-variable nature of our business doesn't change that much. One other point: in a downturn, it's beneficial to have certainty in distribution. Having certain distribution of your product can be more important than a small change in fixed versus variable cost. When you think of the consolidated company through a downturn, I don't think it's any harder to go through a downturn with Mattress Firm than without it when you consider all those variables. We also provided in our investor presentation a way to think about leverage when this transaction is contemplated to be complete; the expectation is the transaction will be complete in the second half of next year, and leverage at that point would be approximately 2.5x to 3.0x.

Thank you. And our next question comes from the line of Carla Casella with JPMorgan. Please proceed.

Hi, you mentioned you're going to fund the deal with cash, secured and unsecured financing. Is that something we could see sooner rather than later or is that something you just wait until you get closer? What hurdles do you need to see before you're comfortable going out there with financing?

We probably would be closer in timing. I don't think there'd be any reason to do it extremely early, but we might not wait until the very end either. We can be opportunistic and we've got a fairly large time period to work on it. If the market were to soften up, we have a tendency to do it earlier; if not, we can wait a little while.

Thank you. And our final question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed.

Great, good morning and I'll add my congratulations. My question is just on the future of the store base. I guess there's 2,300 Mattress Firm stores today. As you mentioned, Scott, over the next couple of months, maybe we'll hear from the FTC regarding any concessions like divestitures. Added to that, how do you think about go-forward unit growth when the chain is under your ownership? Thanks so much.

We'll listen to the current management team in more detail about their thinking. Our initial reaction is there are probably still too many stores. I would expect the store base total number to come down over time and it actually becomes more important where the stores are rather than how many there are. So there will be quite a few that might move to better locations, but the absolute number of stores I would expect to come down somewhat. There will be activity on both sides — some closures and some relocations — but total number down somewhat.

Thank you. And with that, I will turn the call back to Scott Thompson for any final comments.

Thank you, operator. To our over 13,000 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 its Board of Directors. This ends the call today. Thank you, operator.

Thank you, everybody and you may now disconnect.