Tempur Sealy International, Inc.

Good day, and thank you for standing by. Welcome to the Temporarily Third Quarter 2022 Earnings. 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 will need to press star 11 on your telephone. You will then hear a message that your hand is raised. We do ask to please limit your questions to one. 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 of 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 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.tempersealy.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 third quarter earnings call. I'll begin with some highlights for the third quarter, followed by an overview of the current operating environment in our North American and international markets. Then Bosco review our third quarter financial performance and update our 2022 guidance. Lastly, I'll share a few closing remarks regarding our competitive advantages and then open the call up for Q&A. In the third quarter of 2022, net sales were approximately 1.3 billion and adjusted EPS was 78 cents a share. This represents a 56% growth in sales and 140% growth in adjusted EPS as compared to the third quarter of 2019, a pre-COVID period. Compared to the same period last year, this represents a 6% decline in sales and an 11% decline in adjusted EPS as we continue to perform well in a less robust market. Our results were challenged by headwinds from unfavorable foreign currency and an overall less robust operating environment. I'd like to begin with highlighting some key wins in the third quarter. First, I'd like to discuss our exciting progress on our Stearns and Foster brand. We are pleased to share that we expect to expand our Stearns and Foster spots by third-party retailers in the U.S. by over 20%, demonstrating retailer support for our expansion strategy. To be clear, we believe these slot gains will be from competitors, not other Tempur-Sealy brands. Many of these incremental slots will be filled with our new Stearns and Foster Luxe Hybrid and our new Stearns and Foster Reserve mattress. Importantly, these are two of the highest-end mattresses in our new Stearns portfolio, with the Queen mattress in these lines ranging in price from $3,299 to $6,499. These price points are critical to unlocking the premium innerspring consumer that we and our retailers are targeting. This will support our growth plans for Stearns and Foster in 2023 and beyond. This is a great start towards our goal of making Stearns and Foster our next billion-dollar brand. In parallel to the product launch, we've also focused on driving Stearns and Foster's brand awareness, consideration, and purchase intent. In 2022, we doubled our investment in national Stearns and Foster advertising and continue to grow our advocacy at retail. To augment our wholesale distribution strategy and to be consistent with our being where customers want to shop, we also recently launched our Stearns and Foster e-commerce platform, which is performing well and has contributed to the growth in awareness and consideration for Stearns and Foster brands. Products are on track to be available through select retailers in the fourth quarter, and we expect a new lineup to be fully rolled out by the start of the 2023 President's Day holiday selling period. Investing in premium price points positions us well in the current macro environment, as we see resilience in premium demand in the face of economic uncertainty. Additionally, looking at historical industry performance, premium betting sales grow growth has outpaced other price points since 2015. Sales of mattresses above $2,000 have been growing seven times faster than the overall category. At the same time, there's been no consistent premium innerspring brand advertising at a national scale. The new Stearns and Foster lineup targets this underserved segment. Our second highlight is our recently launched Sealy e-commerce platform. The website's mattresses assortment includes Sealy FlexGrid, Sealy Natural, Cocoon by Sealy, and our most popular Sealy Posturepedic and Posturepedic Plus models. With the new Sealy website active, we are now operating direct-to-consumer website in the U.S. for each of our leading brands. Our North America direct channel grew at 8% in the quarter, driven by high single-digit growth in our e-commerce channel and same store sales growth in our company-owned stores. Our direct-to-consumer operations continue to reach customers who prefer to purchase directly from a manufacturer. We are now running in excess of half a billion dollars in annual sales in North America direct-to-consumer, with a robust five-year compound annual growth rate of 33%. Third, in addition to executing against our Stearns and Foster product launch, we also continue to exercise against our other product launches. Our domestic Tempur-Pedic and Sealy launches and our international Kemper launch are all on plan. As an example, we rolled out our Sealy natural collection in the third quarter, which is designed with sustainability and environmental preservation in mind. This product is open for nationwide distribution. We have seen this product resonate with West Coast retailers and consumers. We also recently launched our Sealy FlexGrid mattress line direct to consumer in the U.S. It is designed to target a niche market of consumers looking for a unique feel. The Sealy FlexGrid features best-in-class pressure-relieving gel grid that represents an evolution of the technologies in market today. Its unique manufacturing approach makes it more scalable and economic. This enables us to offer these products at mid-market retail price points, starting at $15.79 before promotion. We're also exploring opportunities to include our FlexGrid technology in our lineup of OEM offerings, and possibly as a component to other bedding manufacturers. Turning to our 2023 product pipeline. In the first quarter of 2023, we plan to begin launching our new Temper Breeze products and a new line of smart adjustable bases in the U.S. Building on the success of our proven Temper Breeze, the new generation will feature breakthrough temper material innovations that deliver even greater cooling benefits and enhanced temper feel characteristics. Our refreshed adjustable baseline also features incremental technologies, including new Sleep Tracker 2.0 technology. The current Sleep Tracker technology offers best-in-class sleep tracking with accuracy, which has recently been validated by a comprehensive Stanford medical study. In addition to breakthrough automatic snoring detection and response offered today, the new generation of bases will also be equipped with a range of relaxation features that help prepare customers' mind and body for deep, rejuvenating sleep. Following the launch of the new Breeze and updated SmartBase, we expect to expand our active Breeze product, our most customizable cooling system. We've been testing this product in select temporary retail stores, and found at a price point nearing $10,000, this system meets the needs of the ultra-luxury consumer focused on better sleep. We've also observed a halo effect from having this product on the floor, driving momentum to the high end of our Tempur lineup. In the first half of 2023, we also expect to begin the largest international product rollout in the company's history to more than 90 markets around the world. We plan to face launch over multiple quarters, which allow the team to implement market-specific launch plans. The rollout is expected to conclude by the end of 2023. This new lineup of mattresses, pillows, bed bases has been strategically designed to drive the addressable market of temper products internationally. The range features consumer-centric innovations to continue to appeal to our legacy ultra-premium consumers at prices of $3,000 and above, while also launching products at broadened price points unlock the incremental 2,000 to 3,000 segment. The new lineup is designed to build each mattress on a common platform. This common base will drive more efficient manufacturing processes and enhance adaptability to individual markets. This allows us, over time, to broaden our price points to drive meaningful expansion of our international total addressable market without materially altering our profit margin profile. Turning to our final highlight, we announced this morning Tempur-Pedic ranked number one in customer satisfaction among mattress brands in the J.D. Power 2022 report. We are thrilled to have achieved this distinction for the fourth year in a row in the retail mattress category and the second year in a row for the online mattress category. We are honored by our customers' continued trust in our product. We are dedicated to continue to bring leading solutions to market. Turning to the current operating environment, our North America operations generally performed in line with our expectations in the quarter, driven by strong Labor Day holiday selling periods. This supports our belief that, after a change in behavior in recent years, the U.S. bedding consumer is returning to historical seasonality and concentrating their purchase behavior around key holiday shopping periods. We continue to see an impact on the U.S. consumers' behavior from macroeconomic pressures, particularly from strong inflation and a sense of near-term economic uncertainty. These factors are disproportionately impacting certain segments of the market. We continue to observe more resiliency of our premium customers, while the value-focused customer is more subdued. Our historical data indicates that consumer confidence and consumer sentiment correlate to betting domains. Our research also indicates that the number one reason consumers want to purchase a new mattress is to improve their sleep, while only 10% of purchase decisions are made in relation to a housing event. It's a bit early, and we don't have all the data yet, but preliminary indications are that we continue to outperform the industry in North America. Turning to our international operations third quarter performance, Overall, the team executed well against the turbulent backdrop and delivered results largely in line with our expectations. Our Asian operations continue to perform well, despite the headwinds from regional COVID lockdowns. Europe, as anticipated, was pressured in the quarter by the ripple effect of the war in the Ukraine, driving record low consumer confidence, energy concerns, and double digit inflation. Furthermore, Foreign exchange rates were a headwind to our international segment this quarter, as the majority of our international operations operate with the British pound or euro as their functional currency. Overall, we're pleased with both our quarterly results and the progress we've made on our long-term initiatives against an evolving macroeconomic background. We entered this complex macro period with retailers generally in good shape, a strong competitive position, and new innovative products to launch. We're watching the macro developments closely and adjusting to the market conditions while staying aggressive and on strategy. And with that, I'll turn the call over to Oscar. Thank you, Scott. In the third quarter of 2022, consolidated sales were approximately $1.3 billion. and adjusted earnings per share was 78 cents. We have adjusted $6 million of charges during the quarter, all of which are permissible adjustments under the terms of our senior credit facility and relate primarily to the transition to our new ERP system. We expect there may be a similar amount of adjustments related to these items in the fourth quarter, primarily from further investments in our new foam pouring facility. Turning to North American results. Net sales decreased 6% in the third quarter. On a reported basis, the wholesale channel decreased 7% and the direct channel increased 8%. North American adjusted gross profit margin improved to 40.2%, primarily driven by pricing actions to offset commodity inflation and favorable brand mix. This was partially offset by operational investments to service our customers. North America's third quarter adjusted operating margin declined to 19.8%, driven by increased advertising investments and operating expense deleverage, partially offset by the improvement in gross margin. Now turning to international. Net sales decreased 5% on a reported basis, On a constant currency basis, international sales increased 7% as we experienced a $30 million headwind in the quarter from unfavorable foreign exchange rates. As compared to the prior year, our international gross margin declined to 53.4%, driven by the acquisition of Dreams driving unfavorable mix and foreign exchange rate headwinds. Our international adjusted operating margin declined to 14.7%, driven by operating expense deleverage, the decline in gross margin, and the impact of COVID-related shutdowns on our joint venture operations in Asia. Turning to commodities, which have been highly inflationary across the global betting industry for more than two years. In North America, prices have generally trended in line with our expectations in the quarter, and we believe that the cost of certain inputs could be gravitating off their 22 peaks. while others have remained pressured. Easing of prices for our key inputs would allow our margins to normalize somewhat though we anticipate input prices will continue to trend significantly ahead of 2020 levels next year. In our international segment, the war in Ukraine has created incremental headwinds on availability and pricing of raw materials in Europe. In consideration of this trend, our international team has reinforced the supply chain and built safety stock to insulate the business from these risks. We have considered these dynamics and expect to offset the inflation on a dollar basis through strategic pricing of the new line. Turning to our operational investments. We are investing in operations to diversify our supply base, and 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 third quarter, and we anticipate these incremental investments to continue through 2022. We are set up to drive efficiencies as the global supply chain infrastructure continues to stabilize and our new ERP system drives productivity in 23. now moving to the balance sheet and cash flow items. In the third quarter, we had operating cash flow of $217 million. This year, we have taken actions to reinforce our safety stock of adjustables and raw materials to better support our customers across our global operations. We believe our focus on providing our customers with the best possible service has been a key driver of our outperformance relative to the broader industry. As we continue to reinforce our supply chain, we have improved our inventory by six days from the second quarter. We expect days to continue to improve in 2023 as the supply chain further normalizes. Our new foam pouring plant in Crawfordsville, Indiana is on track to start testing production in early 2023. The plant's location complements the existing manufacturing footprint and it is expected to enhance our ability to service our customers through providing shorter lead times while reducing per unit logistic expenses. In order to optimize production in this new facility, we will start each manufacturing line in phases to ensure the highest level of quality while we grow into the incremental capacity. We expect CapEx to moderate significantly in 23 and to return to a normalized level of spend thereafter. We think of normalized annual CapEx at approximately $150 million, driven by maintenance CapEx of $110 million and growth spend of approximately $40 million. At the end of the third quarter, consolidated debt left cash was $2.7 billion and our leverage ratio under our credit facility was 2.8 times within our target range of two to three times. Now turning to 2022 guidance. We have updated our earnings guidance range and now expect adjusted EPS to be in the range of $2.50 to $2.60 in 2022, which contemplates our current outlook for full-year sales to be flat to prior year. This outlook assumes full-year foreign exchange headwinds of $115 million on sales and $25 million to profits For the fourth quarter, this considers North American sales down high single digits and international sales down high teens as we anticipate the European consumer will continue to be pressured and foreign exchange rate headwinds of $65 million to sales and $15 million to profits. We expect launch expenses of $25 million to support the Stearns and Foster products, which includes $15 million of floor models and $10 million of sales and marketing expenses to support the launch. And we expect to maintain our level of advertising investments from the third quarter on a dollar basis as we continue to support our leading brands. Lastly, I would like to flag a few modeling items. For the four-year 22, we expect CapEx to be between $275 and $300 million, DNA about $180 million, interest expense of about $100 million on a tax rate of 23.5% 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'll turn the call back over to Scott.

Thanks, Oscar. Great job. Before opening up the call for Q&A, I want to take a moment and share some closing thoughts. We have transformed the business over the last decade to fully hone its competitive advantages in the global marketplace and reinforce its resilience in the face of macroeconomic turbulence. Today, we're one of the largest global bedding companies in the world. We have in-house capabilities across our 70 plants operating in 24 countries to manufacture both branded and non-branded Interspring hybrid memory foam and latex mattresses. We have products that meet the needs of consumers looking for mattresses at value price points to ultra-premium price points. Our comprehensive product assortment supported by our leading R&D processes, robust sales force, and strategic marketing investments has driven our iconic brands to lead the globe in bedding marketing. We sell our mattresses, adjustable bases, pillows, bedding, accessories, through over 25,000 brick-and-mortar retail stores and e-commerce channels in more than 100 countries around the world. We access these channels through strategic combination of third-party retailers, our own mono-branded retail stores, our own multi-branded retail stores, our Tempur-Pedic, Stearns & Foster, and Sealy e-commerce platforms, our joint venture operations, and our licensing agreements. We've unlocked the omni-channel formula to be where the customer wants to shop. And we continue to aggressively monitor the market to keep pace with customers evolving needs and preferences. We're keeping the current operating environment in mind as we invest to lay the groundwork for our next stage of long-term growth. For the last couple of quarters, we've extended some capital project timelines. We've trimmed around the edges cutting back on expected hiring and advertising. Our preliminary 2023 thinking reflects the execution on our long-term growth initiatives, which are to, first, develop the highest quality bedding product in all the markets we serve. Second, promote worldwide brands with compelling marketing. Third, optimize our diverse omni-channel distribution platform. And fourth, drive increased EPS through operational execution and by prudently deploying capital. We believe this strategy will drive continued market outperformance across a range of macroeconomic environments. The global investments that we're making today in people, product, omnichannel expansion, manufacturing capacity, will position us well to deliver top and bottom line growth. And with that, Operator, will you please open up the call for Q&A?

Thank you. And as a reminder, to ask a question, you will need to press star 11 on your telephone. In interest of time, we remind you to ask just one question. Please stand by while we compile the Q&A roster. And our first question comes from the line of Peter Keith with Piper Sandler. Please go ahead.

Hey, thanks. Good morning, everyone. Just wanted to maybe focus specifically on the reduction of the guidance. It sounds like there's a couple of moving pieces, certainly with FX, and I think a little bit of a sales downtick for US and international. Could you maybe just break apart what caused that 15% reduction at the midpoint, just so we can understand the different moving pieces better?

Absolutely. Peter, good question, and you got it. So if you think about it, is international, the FX versus what we thought entering the third quarter and where we exited, it was a headwind for us. So the combination of the continued geopolitical matters in the international community coupled with FX, what I would say would be about a half of it. And then you've got our expectations from an industry standpoint, we thought it would be a bit more robust than what it actually turned out to be. So the combination of those two factors resulted in our change.

One moment for our next question, please. And it comes from the line of Curtis Nagel with Bank of America. Please proceed.

Great. Good morning. Thanks very much. So just kind of curious on performance in the U.S. and in wholesale, any notable deviations across, you know, not necessarily partners, but some of the major channels you guys have relatively consistent?

Sure. And good morning. I mean, I think the standout performance would be in our direct business for the quarter, and you saw that in the release. If you kind of think about wholesale and kind of go through the retailers, in general, you would see that the entry-level retailers generally suffered more and probably considerably more than more of the premium-focused retailers. And you'd see that in our brands. The Temper brand performed better than the other brands. And then maybe even more importantly is when you go inside of the brands and you look at particular SKUs and you look for things like trade-down or those kind of things, we didn't see any of that within the brands. Temper specifically, the high-end temper beds performed much better than what I'll call the entry-level temper beds would be from a characteristic standpoint. Anything else you can say just as a blend? from a channel standpoint. But the big standout performance would probably be direct from our standpoint. But we had some wholesale retailers also have strong quarters.

Thank you. One moment for our next question. It comes from Bobby Griffin with Raymond James. Please proceed.

Good morning, Bobby. Thank you for taking my questions.

Good morning.

Dr. Bobby. Could you maybe talk a little bit about capital allocation in this environment and your prepared remarks you called out, you know, tightening down a little bit on expenses and things like that, but you're still repurchasing shares during the quarter. So just help us walk through or think through capital allocation and the leverage profile going into 2023.

Sure. And let me start with kind of going into 22. We went into 22, and I think I used the term in an offensive position. Bought quite a few shares back. Had the organization in North America geared for increased volume, so pretty well staffed up. We're doing quite a few things to make sure that we could service the customers in what we thought was going to be a more robust market. Clearly, trimming around the edges is what we've been doing. Cutting back on hiring. Share repurchases is mitigated and moderated So now you go into where are we now? Look, it looks like the industry, we're doing North America right now, stepped down sometime during the year. And if you look at the unit volumes, I guess you could probably call the market down 25% in units. We're certainly not down anywhere close to that number and taking a good bit of share. And it looks like it's stabilized at that point during the third quarter. And so now we're focused and we're going into 23 as we think about the budgets and how to position the company. In a more conservative framework, working on optimizing productivity at the plants and thinking about it more as a less offensive approach, although it's on strategies. So you roll that into kind of more the guts of your question, which is, okay, how's that roll through capital allocation? Rolls through capital allocation is looking at acquisitions and stuff, but we're going to probably look at our leverage, make sure we stay between two and three during 2023 and watch the markets.

Thank you. One moment for our next question, please. And it comes from the line of Seth Basham with Wetbush. Please proceed.

Thanks a lot, and good morning. If we could just follow up on some of the cost pressures you're experiencing in the fourth quarter and then into 2023 relative to your prior expectations, including launch costs, the operational investments, FX, and then commodities versus price, that would be helpful.

Sure. I'll start with that, and then Bosco can clean it up. But from a commodity standpoint, stuff goes up and down. If you're talking about near term, it's probably in line with what we thought. And if you're looking at 2023, based on what we know today, you would think commodities would be net a good guy in 23. But as you know, that's highly, highly volatile. When you go to, you know, we'll call it pressures on inflation in production, you've got to step back. because one of the big numbers that are in the 2022 numbers is productivity at the plants. And that's been challenged. And to be fair to operations, we had a spring shortage when COVID started. Then we had a chemical shortage when we had the hurricane. Then we had all the COVID stuff at the plants. Then hiring's been a little more difficult and turnover's been a little bit more difficult. Then we drew in an AX conversion into our Sealy plants. that we desperately needed to get done, and we got done successfully. So during all of that, oh, and the last part, strategically had the organization set up for expansion, expansion in units, and ended up having severe industry contraction. So we kind of whipsawed the plants. And so it wouldn't be inflation. It would be productivity. And that would be one of the major initiatives in 23 is to get back from plant standpoint back to our historical productivity metrics. Any other cost pressures or anything? FX?

If I were to just disaggregate that a bit, some of the items that were mentioned is when you do think about FX, it has been quite interesting, principally euro, principally pound. And on a year-over-year basis, from a bottom-line standpoint or EBITDA standpoint, it's costing us about $15 million on the bottom with $65 million on the top. Also, as always, is that we want to invest in the future, so we are very excited about what we're doing with Stearns, and we have that launch coming out. From a launch cost standpoint, that's costing us about $25 million, and that $25 million, think of it, $15 million going through floor models and about $10 going through sales and marketing lines.

And then what I would close with is, again, supporting our brands is advertising. A bit down on a year-over-year, but consistent with the third quarter. We want to make sure that we're supporting those brands, especially Stearns and Foster in a period of a launch. Yeah, and I think that's a good point, Oscar. I mean, we're going to get a big return on those investments. It'll be primarily next year. But a 20% increase in incremental slots on Stearns and Foster is material. And I think clear evidence that the launch is going well and is being well received by third-party retailers.

Thank you. And one moment for our next question. It comes from the line of Keith Hughes with Truist. Please proceed.

Thank you. There was a comment in the prepared statement about North and the guidance, North America being down high single digits. I guess my question is, Is that fourth quarter? And that seems like a step down from what you've seen the last couple of periods. If you could give any details of what's going on there.

Good question, Keith. And yes, it does refer to the fourth quarter. When one thinks about the North American segment, just be mindful that – or one should be mindful that in prior year, we did have a backlog coming out of the third quarter into the fourth quarter. So when you think about the comp, it is a bit more difficult of a comp versus what we had in the third quarter. So if you were to normalize for that, it's really steady as she goes. with our updated expectations from an industry standpoint.

Yeah, another way to say that on a gap basis, it is a step down because of the backlog last year. But if you look at it on an order basis between the third quarter and the fourth quarter and what we've experienced, we're not seeing a step down going into the fourth quarter. I would say that it's stable and it's stabilized. Maybe it's a tad up, but I call it stable between the third and fourth quarter from an order basis, which is probably a better way to look at it.

Thank you. One moment for our next question, please. And it comes from the line of Atul Maheshwari with UBS. Please go ahead.

Good morning. Thanks a lot for taking my question. I know you're not providing too much color on 23, but really, the expectation for many at this point is that there could be a recession at some point next year. So my question to you, Scott, is how is the category positioned to react to such a downturn? The industry has already declined 20%, 25% this year, as you pointed out in the call. especially on a unit basis. So does that really mean that the declines could potentially be moderate from here, even if there is a recession? Or would you expect industry declines to intensify in such an economic backdrop?

Yeah, I think you hit a great question. It's really something that we've spent a lot of time looking at. You know, look, I'm looking at a sheet of 26 years of betting history as we speak and looking at unit volumes over a 26-year period. And the first thing that jumped out at you, and let's just call this year down 25% in units, give or take, but 25%, you can't find another year anywhere in the last 26 years that is anywhere close to a 25% downdraft in units. And even if you go back to the Great Recession, which I think all of us would say was maybe the Great Depression, and you look at, call it a three-year period there, and you aggregate up that downturn, that downturn in total over the three-year period was about 25%. So it took three years to go down 25% during the Great Depression, I'll call it, and we managed on doing it in one year. So it's very strange. And if you correlate that to consumer sentiment, it's very interesting because you also, as you know, consumer sentiment's about as bad as it's ever been, even though employment's good. So the guts of the question to me is really when did the betting industry go into recession? And the question is maybe the overall U.S. industry hasn't been in recession yet or may not. But I would argue that if you look at the data, it would look like the betting industry went into recession maybe the end of last year and certainly by the first quarter and has been experiencing a betting recession currently. So then you go to the question like, okay, well, could it take another step down? It wouldn't look like it, looking at the historical data, that you've got another step down. It would look like you've already taken your step down. And if you look at it from an order basis, it feels like it's stabilized, is probably our current thinking. Who knows? But you do have to remember, I mean, we are dealing with like a war in Europe, COVID shutdowns in Asia. and negative sentiment everywhere, and FX, it's a pretty rugged period of time. And even during that period, you know, I mean, we printed 78 cents per share, give me a couple of pennies for FX, which is kind of a who knows which way FX went. So normalize it without FX, you're about 80 cents. And if you seasonalize that, I mean, you're going to show up with, call it this quarter's earnings capacity with something like $2.90, $2.95 on an annual basis, which gives us, I guess, a good bit of confidence. And if you look at the most recent holiday period, which we've told you that the betting market is moving back to its more traditional demand curve where holiday periods are very strong and during non-holiday periods you have weakness, I mean, it was a strong holiday. around the industry, not just for Tempur-Sealy. So that's a long-winded answer to say we don't really know for sure, but all indications are that the betting industry is already experiencing its recession and is in a more stable position.

Thank you. One moment for our next question. And it comes from Susan McClary with Goldman Sachs. Please go ahead.

Thank you. Good morning, everyone. Perhaps building on your comments, Scott, can you talk a little bit about the health of the consumer overall? What is the actual effectiveness of the promotions on the ground that we're seeing? Because you noted in your commentary that the higher end continues to stay intact while the lower end feels like it's what's moving away in there. And so as we think about that, can you also talk to pricing as we think about 23 and the ability to sustain the pricing that's been put through over the last two years, and especially maybe as you think about it across the different brands and price points?

Great. Great job getting five questions in on one. And I wrote it down as fast as I could. We'll try to help me cover off on some of those questions that you slipped in. You want to feed them to me now that she's got five of them? Promotional environment. Promotional environment is normalizing. During the pandemic, it became less promotional. Those are generally expenses of the retailer, and so retailer margins were abnormally high during some of the COVID period. From a manufacturing standpoint, we didn't pull back on incentives or advertising or anything. So as they come back, it's just normalizing, and I expect it's going to just continue to pricing pricing over yeah yeah we took we've taken a lot of pricing as you know we did we don't have margin in our pricing we're just passing on cost we're not seeing that as an issue as I mentioned before the higher end actually did better we're not seeing any pushback from the consumer from a pricing standpoint what you do see is the lower end segment the volumes are way down. Some people might point to that as saying that's due to pricing. My personal opinion is that is just comparing to an overstimulated market where we had too much incentive in the system. And I don't think it's a pricing issue. I think it's we were overstimulated, so our compares are tough. Closing rates in general when customers come in for betting are high. And the general complaint you'll hear is floor traffic. But you don't hear like, oh, the customer came in and then looked at pricing and then walked away. So I think pricing is sustainable. And I think what you really need is consumer confidence. And that appears to be the big issue that you see. And again, like closing rates are fine. So I'm not seeing an issue from a pricing standpoint, but traffic is an issue.

Thank you. One moment for our next question. And he comes from the line of Brad Thomas with KeyBand Capital Markets. Please go ahead.

Hi. Thanks for taking my question. I was hoping we could just talk about, you know, your longer-term outlook for margins and if those have changed at all. You know, obviously a question we get regularly is, you know, what normalized margins, you know, look like for Tempur-Sealy. So hoping you could give us any updated thoughts on that. And then just maybe as a quick one, you know, historically there have been periods where the retail community experiences some stress. Just any insights you have on the financial health of your retail partners, particularly in the U.S. Thanks.

Are you talking about gross margin or operating margin, just to be clear, or both?

More so around the operating margin and overall profitability.

Okay, thanks. Brad, when I think about our operating margins, you know, flowing through from gross margins, it feels like to me there's a fair amount of tailwind. So if you think about our growth initiatives that we have, let's talk about DTC. DTC, we think it's got legs. It's going to grow faster than the fleet. Our DTC business, whether it's an international or whether it's in the U.S., the margins come in higher than the fleet. So that should help us from a go-forward standpoint.

Also is that we believe that Stearns and Foster, and we're putting our money where our mouth is around Stearns and Foster and that launch, and we believe that can be the next billion-dollar brand. And when you think about Stearns and Foster, it's the more premium end of our portfolio, so that should help from a margin standpoint as well.

A couple of other items that I would call out is, let's think about our international product launch. International is, though it will be hitting New price points, however, those price points are not that dramatically different than what the U.S.

has historically done, and typically international margins are more constructive than our North America. Therefore, that should be a tailwind for us as well. And then finally, I'll close down with a couple of things. As commodities, we've experienced unprecedented commodity inflation over the last little bit. Let's call it 400 basis points of pressure.

And the power of our brands from an industry standpoint is we've been able to offset dollar for dollar the commodity inflation that we've seen through pricing. So that's very constructive from a business model standpoint.

However, on the margin line, because there's no gross profit that falls through from that, it does create an accounting or a mathematical item.

Now, it feels like that from a commodity standpoint, depending on what side of the pond that you're on, is that it does feel like the commodities are coming off their 22 peaks, more so in North America, which fully contemplated now we're thinking about the current year, and international, a little bit of stress.

So you put all those items together, it does feel like we have more tailwinds than we do headwinds. And the only thing I'd add to that, Bob, is if you look at our competitive position in the marketplace, whether it be internationally or domestically, during this downturn, there's no question we're taking significant share There's no question that some of our competitors are stressed. And there's no question that some capacity is being taken out of the industry, which I think is going to put us in a better position. And I would probably highlight our launches. I mean, normally when Temper launches a new product, it is powerful enough to help drive the entire industry. And we've got high-end Breeze going first quarter-ish. And then after that, following with the rest of the Breeze product. So Normally in a year where Tempur is launching is usually a good year, not just for Tempur-Pedic, but usually a good year for the industry. Scott, Brad had a question about the retail community. Sure. I mean, look, the retail communities had a very healthy run here. They feel like they're, you know, well capitalized relative to where they've been in previous years. And I think we're The retailers from what we see today look like they're in very good shape, and I think receivables are in good shape. Absolutely. And I think during this period, multi-year period, a lot of the retailers closed some stores over the last few years and got more rational from a store perspective, and have certainly become much better retailers as we have, too, from an online standpoint and pushed back. on some of the new entries, and we're seeing our historical retailers, traditional retailers, become much more agile in internet marketing and sales and become much stronger entities.

Thank you. One moment for our next question. And it comes from the line of Laura Champin with Loop Capital. Please proceed.

Thanks for taking my question. I wanted to drill back to Some of your earliest comments today, Scott, about the Stearns and Foster business taking slots not from TPX brands but from competitors. Is there one particular competitor that you're taking share from? And maybe you can talk about why your wholesale customers are choosing Stearns and Foster instead of that competitor set of competitors.

Now, look, when you look at it, we're taking those particular slots are coming from various competitors, not just from one. And we're providing retailers with a national brand that's supported with a good bit of advertising. And I think they see the wisdom in that as opposed to, we'll call it, third-party brands and others. So I wouldn't say there's there's there's just one um and if you go historically uh i think maybe the only thing i would call out on market share changes uh in the third quarter and again it's early we don't have all the information but my perception and early data i think would show maybe during the second and third quarter uh our market share accelerated as far as taking share from you know the bed in the box guys and the online guys and the new players. It feels like we've made more progress there over the last couple of quarters, maybe than historically, and less against the traditional competitors.

Thank you. One moment for our next question, please. And it comes from the line of William Ruder with Bank of America. Please go ahead.

Good morning. My question is a little bit of a follow up to a previous one. But when asked about capital allocation, you talked about maintaining a focus on a two to three times leverage ratio. You did say the word acquisition. I couldn't tell whether that was saying that you would be more cautious around acquisitions or whether you are continuing to see some opportunities. And if you are continuing to see them, you've bought a breadth of things, whether it's retail in the past or manufacturing capacity. What types of opportunities are most attractive? Thanks.

Yeah, let me be a little bit clearer. Look, in these kind of markets, you actually get more opportunities of people wanting to sell. Of course, at the same time, as a buyer, you're more conservative, and certainly multiples have come down in all things, and especially in our sector. So you become more choosy, you know, from a pricing standpoint. So we continue to be active and looking whether or not we make a transaction or not. I don't know. You never know. But it's certainly a dynamic market. But you're also right. At the same time, we're watching our own cash flows. We're watching the market and watching our financial resources. So I wouldn't say we're less aggressive or more aggressive. I would say we're basically doing the same thing. So probably the tone of the conversations have changed a little bit because, you know, most people in the sector, numbers are going backwards some, and multiples have gone down. But we're still, you know, from a strategy standpoint, looking for long-term investments that will make us stronger competitively for the long term. And the right deal comes along, we certainly would be in the marketplace.

One moment for our next question, please. And it comes from the line of Carla Casella with JP Morgan. Please go ahead.

Hi. I have a cash flow related question. With all of the launches coming and you talked about some supply chain disruption, what's your kind of view for how much inventory you need to be carrying? I know this is typically more of a just-in-time industry, but As we look into the launch process, do you expect working capital to be a bigger use of cash in the first half of next year than typically?

That's a very good question. So if I just take you back in a little bit of history, in 2021, we were very challenged from a supply chain standpoint, and the industry was, and the world was as well. So we got ourselves into, and the industry got ourselves into a situation where inventory was in a very challenged state. So when you think about where we are, and in order to be able to service our customers better, is that we've made the decision to carry some safety stock in the form of finished goods, as well as some raw material to take us through these disruptions that happen from time to time. However, with all that said, what we've been able to do is we've been able to take our days down, our inventory days from the second quarter, down about six days. And as I anticipate that from going forward into 2023,

is that as the supply chain continues to stabilize, is that our days would come down incrementally from where they are currently.

Thank you. And I'm not showing any further questions. With that, I will turn it back to Scott Thompson for his final remarks.

Thank you, Operator. To our 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, leadership, and its board of directors. This ends our call today. Thank you, operator.

You're welcome. And everyone, thank you for participating in today's conference. You may disconnect at this time. Good day.