Tempur Sealy International, Inc. (NYSE:TPX) Q3 2023 Earnings Call Transcript

Tempur Sealy International, Inc. (NYSE:TPX) Q3 2023 Earnings Call Transcript November 2, 2023

Tempur Sealy International, Inc. misses on earnings expectations. Reported EPS is $0.77 EPS, expectations were $0.8.

Operator: Good day and thank you for standing by. Welcome to the Tempur Sealy’s Third Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. [Operator Instructions]. 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, Vice President, Investor Relations. Please go ahead.

Aubrey Moore: 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. 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. Any forward-looking statement speaks only as of the date on which it was made.

The company undertakes no obligations to update any forward-looking statements. This morning’s commentary will include non-GAAP financial information. Reconciliations of the non-GAAP financial information can be found in the accompanying press release, which is 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 is my pleasure to turn the call over to Scott.

Scott L. Thompson: Thanks Aubrey. Good morning everyone and thank you for joining us on our 2023 third quarter earnings call. I will start by sharing some highlights for my third quarter performance and then Bhaskar will review our financial performance in more detail. After that I will provide an update on a proposed acquisition of Mattress Firm before opening up the call for Q&A. Today we are reporting the third best third quarter sales and ETF in the company’s history. For the third quarter of 2023, we reported net sales of approximately 1.3 billion and adjusted EPS of $0.77. Our results are approximately consistent with the third quarter of last year despite a more challenging macroeconomic operating background. The U.S. betting industry as a whole underperformed our expectations with estimated volume down low double-digits in the quarter.

We mitigated the impact of the softer than expected U.S. market with solid company performance that exceeded our expectations on both a relative market performance and year-over-year gross margin expansion. Internationally, the betting industry and our operations performed in line with our expectations. Overall, despite down markets and the disruption of a major cyber security incident in the third quarter, our strong relative performance and cash flow generation demonstrate strong — strength of our brands, operations, and team. We believe Tempur Sealy is well positioned for continued success. Turning to highlights for the quarter. First, our industry leading brands and products continue to resonate with the U.S. consumer, driving our strong performance relative to the broader market.

All of our new Tempur products and supporting advertising initiatives has strengthened Tempur’s appeal to the premium, relative minded consumer. The incremental cooling and comfort innovation of our new lineup of breeze mattresses generate robust retail advocacy and favorable mix in the quarter compared to the prior year. The lumbar feature acoustic massage, the wake up and wind down technologies, and our new smart based lineup continue to strengthen the value proposition of our adjustable offering driving an improvement in detachment rates year-over-year. These innovations drove a 5% increase in Tempur Mattress and Foundation ASP in the third quarter. Looking ahead to 2024, we expect to complete the full refresh of our U.S. Tempur portfolio by introducing our next generation of adapter products.

We expect strong returns on investment and our new products for years to come. Over the quarter we continued to support our new Tempur products and along from health of our Tempur brands with continued investments in national and digital Tempur-Pedic advertising. These marketing investments support very solid e-commerce performance and drove an increase in US Tempur search interest year-over-year. Our strategic investment and product distribution and marketing also continue to drive strong performance and expand brand awareness of Stearns & Foster in the U.S. market. We completed the roll out of our all new Stearns & Foster mattress collection earlier this year. We continue to see these new products connecting with the premium traditional inner spring consumer driving sales growth year-over-year.

The consumer centric innovation, elevated design, and pants step up opportunities are resonating with premium inner spring customer. We are thrilled that our high end products are performing well and the ASP of Stearns & Foster product is up double-digit from last year. Additionally, Stearns & Foster’s search interest and e-commerce traffic were up 50% this year. Clearly our multiyear strategy for Stearns & Foster is working well for us and our retailers. Second highlight, our international operation is performing well and driving solid sales growth amid the current macro backdrop. We successfully launched our new international Tempur lineup in over 90 markets worldwide including the rollout in nearly all the key markets in Europe and Asia.

The launch is on track and will be substantially completed before the end of the year. The new products are being well received. Additionally, Dreams our UK retail operation is also performing well in both sales outperforming versus the broader market and has a record customer satisfaction. This quarter performance demonstrates the strength of our international strategy and pain [ph], highlighting the long-term opportunity for the international operations. Third, we choose significant consolidated growth margin expansion year-over-year, and are progressing towards normalized margins. After multiple years of COVID overhang, rapid inflation, macroeconomic disruption, pressured margins for a while, we are pleased to report 340 basis point improvement to consolidated adjusted gross margin year-over-year thanks to the successful management of commodity fluctuations, improved supplier contracts, and operational improvements.

This is a significant step towards driving profitability, which the team remains laser focus on achieving. The growth driver of our gross margin improvement is our ability to pass on pricing to offset commodity inflation. As you may recall we experienced approximately 400 basis points of margin compression between 2020 and 2022. This commodity price has increased at a historical pace. Now that pricing changes have been implemented, the commodity prices have started to normalize. You can see the positive results in our reported financial statements. Additionally, we’re optimistic that our scale in the market and our new product innovations would drive further gross margin expansion. The second driver of gross margin improvement is operational efficiencies.

In 2022 we invested approximately 80 million above normal operating levels to ensure we met our customer’s needs during period of supply chain disruptions. All these actions were critical to maintaining and strengthening our third party retail relationships during the period of uncertainty that put significant pressure on our margins. Beginning in the back half of 2023, operations began to drive year-over-year improvements in supply contracts, labor productivity, and logistic efficiencies. As we look ahead we remain focused on cost reductions and achieving our multiyear operational targets. Third driver to gross margin improvement is our brand and product mix. Our new Tempur and Stearns & Foster products are continuing to resonate with our premium consumers driving momentum at the.

high end of the portfolio. We’re also seeing a favorable mix [indiscernible] as premium consumers are less impacted by the current softness in the market. Lastly, our final highlight is the JD Power Award announcement we made this morning. The Tempur-Pedic ranked number one in customer satisfaction with batches online in the JD Power 2023 report. We are thrilled to achieve this distinction for the third year in a row for online mattress category and the fifth consecutive year of winning at least one of JD Powers Awards. Now I’ll turn the call over to Bhaskar to take you through our financial statements in more detail.

Bhaskar Rao: Thank you, Scott. In the third quarter of 2023, consolidated sales were approximately $1.3 billion and adjusted earnings per share was $0.77. While these results were slightly below our expectations, we believe we continue to outperform our competitive set in a challenging market. We have approximately $32 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 cost incurred in connection with the planned acquisition of Mattress Firm and the previously disclosed cyber event. Turning to North American results. Net sales declined 3% in the third quarter. On a reported basis the wholesale channel declined 4% and the direct channel declined 1%.

North American adjusted gross margin improved a very robust 300 basis points to 43.2% driven by favorable commodities and operational efficiencies partially offset by deleverage. North American adjusted operating margin improved 50 bps to 20.3% driven by improvement in gross margins partially offset by investments in growth initiatives. Now turning to international. International net sales increased a very solid 12% on a reported basis and 7% on a constant currency basis. As compared to the prior year, our international gross margin improved a robust 320 basis points to 56.6% driven by commodities, mix, and favorable leverage. Our international adjusted operating margin improved a 150 basis points to 16.2% driven by improvements in gross margin partially offset by investments.

Global commodity prices continued to brand largely in line with our expectations. We continue to expect favorable commodity prices for the remainder of the year, though remaining significantly elevated from 2020 levels. In addition to the benefit of favorable commodity markets we assigned multiple agreements with certain global suppliers who have recognized our scale momentum. These relationships will benefit our gross margins over the long-term Now moving on to the balance sheet and cash flow items. We have paid down approximately $200 million of debt over the first nine months of this year. At the end of the third quarter, consolidated net debt was $2.5 billion and our leverage ratio under our credit facility was 2.9 times within our historical target range of two to three times.

We generated third quarter operating cash flow approximately $230 million. In the last five years the company has realized over $2.5 billion in operating cash flow, proving the business model and providing financial flexibility. I’m pleased to highlight that over the last few weeks we have successfully refinanced our credit facilities. With this refinancing, we have meaningfully extended our debt maturities, improved our financial flexibility, and increased our potential of total senior credit funding all while maintaining our current cost of funds in what is clearly a tight commercial banking market. As we previously reported under the terms of our purchase agreement with Mattress Firm, we have temporarily suspended repurchases under our share repurchase authorization as we work towards the closing of the transaction.

Over this interim period between sign and close, we expect to significantly deleverage as we plan to use cash to pay down debt. After the acquisition closes we anticipate our leverage ratio to be between 3 and 3.25 times. Now turning to 2023 guidance. We now expect adjusted EPS to be in the rage of $2.30 and $2.50. We have maintained a $0.20 range which reflects the global uncertainty. The midpoint of our revised annual guidance is based on sales consistent with prior year. This includes our updated expectation that the U.S. industry volumes will be down low double-digits year-over-year versus our prior expectation of high single-digits and the execution of our key initiatives, new product launches, and the wrap around impact of pricing. Sales and marketing investments of $20 million to support product launches, and record advertising spend of approximately $480 million as we continue to support our leading brands and new products.

All this result in adjusted EBITDA for the year of approximately $885 million at the midpoint of the range consistent with prior year. I should point out the adjusted EPS range as well as foreign exchange rates that are unfavorable versus our previous expectations. Our current outlook for 2023 now contemplates an FX headwind indicating our fourth quarter 2023 adjusted EPS has been reduced $0.04 versus our previous expectations. Our guidance also considers the following allocations of capital, a quarterly dividend of $0.11, representing a 10% increase relative to 2022 and CAPEX of approximately $200 million, which includes $90 million of growth, primarily to fund the completion of our Crawfordsville facility. Going forward, we would expect our CAPEX to return to a more normalized level of spend.

We think of annualized CAPEX as approximately $150 million driven by maintenance spend of $110 million and gross spend of approximately $40 million. Lastly, I would like to flag a few modeling items. For the full year 2023 we expect D&A of approximately $185 million to $190 million, interest expense of about $130 million on a tax rate of 25%, and a diluted share count of 177.5 million shares. With that, I’ll turn the call back over to Scott.

Scott L. Thompson: Thanks. Nice job, Bhaskar. Before opening up the call for questions let me provide a brief update on our pending acquisition of Mattress Firm. Consistent with our expectations we’re currently responding to the Federal Trade Commission’s robust second request, which we expect to complete in the fourth quarter of 2023. We continue to expect the transactions to close in mid to late 2024. We continue to work closely with Mattress Firm’s leadership team. We received high level updates on numerous topics, including their financial performance. Mattress Firm has an October 3 fiscal year end and will report their physical results when their audit is complete, most likely in early December. The preliminary results are in line with our expectations.

Finally, I’m pleased to share that Tempur Sealy and Mattress Firm continue to make joint progress in planning for post-closing, including solidifying key supplier relations ahead of the expected close. Since announcing the acquisition in May Tempur Sealy has signed numerous post-closing supply agreements with existing Mattress Firm suppliers and one supply agreement for the company not currently supplying Mattress Firm. These contracts are consistent with our expectation for Mattress Firm to continue as a multi branded retailer post-closing. A few additional discussions regarding supplier relations are ongoing. In summary, our progress towards the transaction close is on track and we look forward to joining with the Mattress Firm team. And with that, I’ll open up the call for questions.

Operator.

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Q&A Session

Operator: Thank you. [Operator Instructions]. Our first question comes from the line of Susan Maklari with Goldman Sachs. Your line is now open.

Susan Maklari: Thank you. Good morning, everyone. Scott, why don’t we start by talking a bit about the demand environment. I think that, obviously things felt a little softer in the quarter than maybe some had anticipated and appreciating the color you gave in your comments. But, can you talk a bit more about how things trended during the quarter, any sort of anything of note in there, and how you’re thinking about the business as we progress through the balance of this year?

Scott L. Thompson: Sure. Thanks for your question, Susan. I mean, first of all, let’s not overlook that the international team had good solid growth in the quarter. And I think your question is really more directed towards North America. And then to kind of streamline your question even further, our Mexico operations had a great quarter and Canada was solid. So kind of ratcheted down our largest market, which is where your question is really focused is the U.S. market. As far as how that quarter progressed, the same trends that I think we talked about probably in the second quarter we saw in the third quarter, which is in non-holiday periods, the troughs had gotten deeper and then during holiday periods, we’re seeing growth in the market.

But the holiday periods haven’t been strong enough to offset the trough. So that would be we’ll call that in quarter kind of trend. That’s the same trend that we would expect in the fourth quarter. It continues to be what I’d call the normalization of the seasonality that the business used to incur before COVID with maybe slightly deeper troughs, and slightly higher peaks during the holiday period. I think you also kind of asked in general, just like demand. I mean, I think as you well know, the industry has been — from a unit standpoint has been in decline for nine quarters, making it where we currently are sitting at great recession kind of volumes in the industry that we’re working through and ensure some of that has to do with slowdown in the general economy.

And we’re talking U.S. here and wallet shift. There’s probably some minor pullback, a pull forward from COVID. Although we’ve never really thought that that was a big number. I think the biggest thing that the industry is working through is really advertising. And, as you know, we’ve got a lot of smart people, a lot of analytics that go on to look at advertising both ours and the effectiveness of it, what goes on in the industry. And in looking at it as we tried to understand why the industry is having such a tough slug compared to historical volumes that were offered trend lines. If you look at it manufacturer advertising over the last three years is down 40%. And if you look at the retailer’s, their advertising is down 20%. And yeah, that’s an issue.

But I think probably a bigger issue is when you dive into that reduced advertising and you look at the mix of what people are doing both from a manufacturing standpoint and a retailer standpoint. They’ve moved from top of funnel advertising over the last three years to the bottom of the funnel. The manufacturers have moved about 40% of their advertising from the top of the funnel to the bottom. And retailers have also moved probably 40% to 40% plus of their advertising from the top of the funnel to the bottom of the funnel. So what’s that mean? That means we’re not putting enough customers in the funnel triggering, they’re thinking about mattresses, and we’re all kind of fighting for the few customers that happen to trip into the funnel is what’s going on in the industry.