Tempur Sealy International, Inc.

Good day, and thank you for standing by. Welcome to the Temporarily Second Quarter 2022 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. To ask a question during the session, you'll need to press star 11 on your telephone. 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 Security Litigations Reform Act of 1995. These forward-looking statements include 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 filing, including its annual reports on Form 10-K and quarterly reports on Form 10-Q under the headings 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 statement. This morning's commentary also includes non-GAAP financial information. Reconciliations of this non-GAAP financial information can be found in the accompanying press release, which has been posted on the company's investor website at investor.temperzilli.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 2022 second quarter earnings call. I'll begin with some commentary on the second quarter, then spend some time discussing how we are continuing to drive our long-term growth initiatives in the current very fluid operating environment. Then Bhaskar will review our second quarter financial performance in more detail and discuss our updated 2022 guidance, which has been revised to reflect the changes in the market. Finally, I'll share a few closing remarks regarding how our business model would operate in a recessionary environment, and then we'll open it up for Q&A. In the second quarter of 2022, net sales were 1.2 billion in adjusted EPS with 58 cents, both slightly below our expectations, primarily due to the U.S. market and a 30 million sales backlog on U.S. Sealy as we brought our new ERP system online. We made significant progress in this backlog and expect to return to normalized lead times by the end of the third quarter. The second quarter was also impacted by three additional factors. First, flare-ups of COVID variances internationally, particularly in our Southeast Asia markets. Second, commodity inflation impacting our costs ahead of the timing of our price increases, which went into effect at the end of June and will benefit future quarters. And third, operational investments to secure our supply chain to retain labor in order to maintain product quality and customer service. Our international operation performed in line with our expectations, even as we faced challenges. In North America, the overall operating environment deteriorated during the quarter as the forward outlook for the economy and our sector diminished for all the reasons that have been well reported. We believe that the overall U.S. mattress industry, our largest market, had its toughest volume decline in 15 years, with units down 20 to 25% this quarter compared to last year. This environment again gave us a chance to demonstrate the resilience of our business model as we generated profit, invested in our business, returned capital to our shareholders, and outperformed the market. The team continues to focus on execution. First, we continue to work on expanding our leading position in the domestic U.S. betting industry. The last few years, our growth initiatives and industry-leading products have driven a meaningful outperformance relative to the market. We continue to drive market outperformance with our focused delivery of best-in-class product quality and customer service. We completed our multi-year journey of transitioning more than 50 of our global subsidiaries and using five different ERP systems to using one common system. This investment in consolidating our operations is expected to drive long-term efficiencies across our global operations, enhance cybersecurity, facilitate customer communications regarding order status, and improve our direct consumer capabilities. We now are truly one company if this completes the merger of Sealy and Tempur. I personally want to thank all of the employees who worked on this critical project. Great job. Third, Stearns and Foster performed very well relative to the market in the second quarter and is currently our fastest growing brand in the domestic market. Additionally, we launched the Stearns and Foster e-commerce website this quarter, although still very small. It's performing ahead of our expectations and ahead of where we were at this time when we launched our successful online cocoon by Sealy. Consumer research has identified that there is an unmet market need for high-end traditional industry and budding products, and our strength and foster e-commerce channel is designed to provide additional opportunities to serve this demand. Our approach is similar to our direct temper strategy in that we drive meaningful brand awareness to the benefit of Stearns and Foster sales across all distribution channels, growing ASP, driving advertising dollars, and profits for all of our partners. We'll launch our all-new collection of Stearns and Foster mattresses in the fourth quarter. The new Stearns and Foster line is designed to further distinguish our high-end traditional innerspring brand with superior technology, clear product step-up stories, and new contemporary look. Fourth, in addition to Stern's and Foster's launch, the other new product launches in our pipeline continue to be on track and on plan, furthering our objective to bring industry-leading innovation to market. In the second quarter, we completed the rollout of our new premium Sealy products, which offer improved comfort and support technology. We also launched our new Sealy Natural Collection, which was thoughtfully designed with our commitment to sustainability and environmental sustainability. environmental preservation mind. In the fourth quarter, we expect to launch a Sealy mattress with a best-in-class pressure relieving gel grid layer at a consumer-appealing mid-market price point. This product is designed to target a relatively small category of consumers looking for a non-traditional mattress feel. In 2023, we expect to begin to roll out our lineup of all-new tempered mattresses, pillows, and bed bases across both Europe and Asia. This new product lineup features exciting customer-centric innovation, allows better channel and customer differentiation, and has a wider price point. Retailers' reaction to this new product and price points today has given us confidence that this updated product strategy will enable us to significantly increase our total international addressable market. In addition to Asia and Europe rollouts, in the first quarter of 2023, we plan to introduce our new line of Temper Breeze products in the U.S., along with a new line of adjustable bases with incremental consumer-focused features and benefits. We have made substantial investments in 2021 and 2022 to prepare for these launches, and we're looking forward to bringing these new consumer solutions to market. Turning to the final highlight, in the first half of 2022, an incremental 10 plants diverted 100% of manufacturing byproducts from landfills. We continue to be on track to achieve our goal of zero landfill waste at our wholly owned temper and sealing manufacturing operations worldwide. by the end of the year. Our focus remains on delivering shareholder value through the execution of our long-term strategies by investing in our brands, products, people, and capacity. We also continue to allocate capital to share repurchase as part of our commitment to returning capital to shareholders. We've repurchased over 8% of our shares outstanding year-to-date and plan to repurchase at least 10% in 2022. Our key initiatives, which have driven growth from a $500 million company at the time of our IPO to a $5 billion company today, are the underpinning of our confidence and our ability to continue to extend our leading position in the global betting market. These key initiatives include, first, develop the highest quality betting product in all the markets we serve. Second, promote worldwide brands with compelling marketing. Third, optimize our powerful omnichannel distribution platform. And fourth, drive increased EPS through operation, execution, and by prudently deploying capital. These initiatives have shaped the building blocks to our next stage of growth, which we're laying the groundwork today. In the US, we're investing in new products, compelling brand advertising, expanding channel diversification. In our international operations, we're investing in the 2023 launch of our all-new temper products in Europe and Asia to increase our international total addressable market. Our operations are also an investment focus this year as we execute on four key priorities, complete the transition to our new ERP system, to stand up a third U.S. foam pouring plant, Three, strengthen our supply chain worldwide. And four, increase safety stock of imported products, key components, and inputs with long lead times. With that, I'll turn the call over to Bhaskar. Thank you, Scott. I would like to highlight a few items. Consolidated sales increased 4% to $1.2 billion. Adjusted earnings per share was 58 cents. And we repurchased over 4 million shares in a quarter. At the end of the second quarter, we successfully implemented a new round of pricing action. This follows previous rounds of pricing, all of which were designed to fully offset the headwinds from rising input costs. Our pricing actions are diluted to gross margins as sales increase with no meaningful change in gross profit. Since 2019, this dynamic has accounted for 400 basis points of headwind to consolidate a gross margin. We believe that designing price increases to cover the dollar impact of inflation is both beneficial for near and long-term retailer advocacy and end consumer demand. We expect certain input costs may ease beginning in the back half of the year. If this relief were to come to pass, we anticipate the unfavorable margin dynamic that we have experienced over the past couple of years will reverse, providing a tailwind in 2023. As Scott mentioned, we are leveraging our industry-leading balance sheet and cash flow attributes to invest in the business, laying the groundwork for future growth. We have made investments to diversify our supplier base to fully support our customers while managing through a fragile global supply chain and a tight labor market. We invested an incremental $10 million in our operations in the second quarter to maintain our high standard of product quality and customer service. We anticipate these incremental investments to continue to a lesser degree in the second half of the year. For 2023, we are set up to drive efficiencies as the global supply chain infrastructure stabilizes and our new ERP system drives synergies. We have adjusted $17 million of charges during the quarter, all of which are permissible adjustments under the terms of our senior credit facility. $9 million of those adjustments were related to the transition of our new ERP system, which, as Scott noted, was completed in the second quarter. In addition, we had $4 million of organizational restructuring costs and of operational startup costs relating to expanding our capacity. We expect there may be a similar amount of adjustments related to these items later this year, primarily from further investments in our new foam pouring facility in Crawfordsville, Indiana. Now turning to North American results. Net sales decreased 5% in the second quarter. On a reported basis, both wholesale and direct channels decreased 5%. North American adjusted gross profit margin declined to 38.7%. This decline was driven by operational investments to service our customers and pricing benefit to sales with no gross profit. These factors were partially offset by favorable mix as Stearns and Foster performed well in the quarter. North American second quarter adjusted operating margin declined to 16.5%. This was driven by the decline in gross margin and advertising investments in Stearns and Foster ahead of the planned fourth quarter launch. Now turning to international. Net sales increased 59% on a reported basis, primarily driven by the acquisition of green. On a constant currency basis, international sales increased 68% as we experienced $10 million of headwind this quarter from unfavorable foreign exchange rates. Foreign exchange continues to fluctuate, and we believe that FX will be a larger headwind for us going forward. If current FX rates were to hold, we estimate a year-over-year headwind of at least $80 million to international sales and $15 million in profits in the second half of 22. This has been considered in our revised guidance. As compared to the prior year, our international gross margin declined to 53.1%. This decline was driven by the acquisition of Dream's mix pricing benefit to sales with no gross profit. As a multi-branded retailer, Dream sells a variety of products across a range of price points, Their margin profile is lower than our historical international margin. This is driving the major change in year-over-year margins internationally. Our international operating margin declined to 14.5%. This was driven by the decline in gross margin, the impact of COVID-related shutdowns on our joint venture operation, and operating expense deleverage. Now moving on to the balance sheet and cash flow item. In the second quarter, we had a slight use of operating cash flow our inventory days extended throughout the quarter as we reinforce our safety stock of adjustable basis and raw materials to be able to better support our customers across our global operations. We believe our focus on providing our customers with the best service has been the key driver of our outperformance relative to the broader industry. At the end of the second quarter, consolidated debt left cash was $2.8 billion, and our leverage ratio under our credit facility was 2.7 times within our target rate of two to three times. Now turning to our revised 2022 guidance. We have updated our earnings guidance and now expect adjusted ETFs to be in the range of $2.60 to $2.80 in 2022. Our guidance contemplates full year consolidated sales to be consistent with the prior year. North American and international sales to be both down low single digits in the second half of 22 versus prior year. Gross margin to improve from the second quarter into the back half of the year as our latest pricing actions are now in effect. and our advertising rate in the back half of the year to be consistent with our second quarter advertising rate. Also included in our 2022 outlook is our plan to invest over $250 million in CapEx to support the long-term needs of our business. In addition to our maintenance CapEx of $100 million, we are making significant non-recurring investments in our U.S. manufacturing capacity which includes standing up a new foam pouring plant in our expanded chemical tank farm and warehousing. The team is on track for these major capital projects, and we anticipate in future years that CapEx will moderate as these investments roll off. Lastly, I would like to slide a few modeling items. For the full year 22, we expect DNA of about $185 million. interest expense of about $100 million, a tax rate of about 24.5%, and a diluted share count of 180 million shares, which includes our assumption to repurchase at least 10% of our shares outstanding. With that, I will turn the call over to Scott. Thank you, Oscar. Great job. Clearly, the risk of an economic slowdown has increased today relative to just a few quarters ago. But before opening the call up for Q&A, I want to take a moment to discuss the resilience of our business model. Our highly variable cost structure, working capital strength, and low leverage profile insulates the business during challenging periods from the pressure to make unhealthy short-term decisions that may hurt the strength of our brands, or impede the business from capitalizing on new opportunities. Our global and geographic diversity mitigates the impact from market-specific downturns. The business has faced global sales declines in 2017 and 2020. In both periods, the flexibility of the business model allowed us to focus our efforts to come out of each situation stronger than we were when we started. This is a good reminder of how our business is well-structured to weather challenging periods. As sales trends change, first, approximately 70% to 80% of our costs flex down to accommodate for declining unit demand. Second, our input costs normally decline as they're normally tied to global economic activity. Third, our working capital needs reduce, freeing up cash. Fourth, our capital expenditures flex down to maintenance CapEx. Note, the last few years, we've been leaning in to growth investments. Regardless of the market environment, we have a track record of executing and outperforming the industry. We're not in a defensive situation today, but we have cut back on expected hiring. We've elongated some of our capital project timelines. Additionally, our early 2023 planning reflects the change in the operating environment. with a greater focus on driving operating efficiencies. With that, operator, will you please open the call up for Q&A?