Somnigroup International - Q2 2023

Transcript

Operator (participant)

Good morning, and thank you for standing by. Welcome to the Tempur Sealy Second Quarter 2023 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you'll need to press star one, one on your telephone. You will then hear an automated message advising you your hand is raised. To withdraw your question, please press star one, one again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Aubrey Moore, Investor Relations. Please go ahead.

Aubrey Moore (VP Investor Relations, Insights and Analytics)

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 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 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.tempursealy.com and filed with the SEC. Our comments will supplement the detailed information provided in the press release. Now, with that introduction, it is my pleasure to turn the call over to Scott.

Scott Thompson (Chairman, President and CEO)

Thank you, Aubrey. Good morning, everyone, thank you for joining us on our 2023 Second Quarter Earnings Call. I'll start by sharing some highlights from our second quarter performance, then Bhaskar will review our worldwide financial performance in more detail. After that, I'll share some closing comments before we open the call up for Q&A. Today, we are pleased to report one of the strongest second quarters in the company's history, second only to the same period in 2021. Importantly, these results were delivered against headwinds from a less favorable market than we expected, the impact of which was partially mitigated by company-specific performance. Sales growth for the quarter was 5%. Adjusted EPS for the quarter was consistent with prior years after absorbing higher interest costs, major launch costs, and elevated taxes. GAAP EPS grew 2%.

We believe these results are a reflection of our innovative products, strong sales culture, solid expense controls, and our passion for execution. In our largest market, the US, we believe industry units declined at least low double digits in the quarter, resulting in historically low aggregate industry volumes for the quarter and first half of the year. Overall, we believe the US market has stabilized at trough unit levels, with the upper end of the market demonstrating a bit more resilience compared to the entry-level market. Today's results demonstrate the robust earnings power and cash flow attribute to the business as we realize solid earnings and cash flow against this challenging backdrop. As we look to the back half of the year, we anticipate US-produced mattress units trends will slowly improve but remain negative year-over-year.

Bhaskar will have more information on the 2023 guidance in a minute. Turning to a few highlights for the quarter. First, we continue to extend our lead as the largest global bedding company in the world. All three of our leading U.S. brands, Tempur, Sealy, and Stearns & Foster, performed well in the quarter, significantly ahead of where we believe the industry trend is. We were pleased with the second quarter performance of our international business. The successful Tempur International launch, combined with Dreams' crisp retail execution, are driving continued outperformance worldwide and positioning us well for the future. Second, we opened our third domestic foaming pouring plant in Crawfordsville, Indiana, expanding our manufacturing capacity to meet expected demand for years to come. We designed this state-of-the-art facility to optimize our manufacturing capabilities across bedding products and components.

In addition to pouring Tempur-Pedic material, we have the flexibility to leverage the plant's foaming pouring capacity to manufacture bedding products and components for our Sealy and Stearns and Foster brands, as well as our non-branded OEM operations. This facility enhances our ability to service our customers in the Northeast market, creating opportunities to shorten lead times and reduce per-unit logistics costs. This plant also provides additional storage for chemicals, mitigating the risk of future supply or pricing disruption. With the opening of this facility, we've completed our three-year strategic capital CapEx program and expect to see CapEx investments moderate significantly going forward. In the second half of this year, we expect CapEx to be down by 50% versus the same period last year, certainly beneficial to free cash flow. Third highlight, we completed the rollout of our new TEMPUR-Breeze products and our new smart base in the US.

Next generation TEMPUR-Breeze mattress builds on the success of our proven legacy Breeze products to deliver next level sleep solutions with enhanced Tempur-Pedic feel characteristics. Featuring new technologies designed by our Tempur-Pedic scientists, the new lineup presents the next generation of consumer-centric solutions focused on helping to alleviate aches and pains. We also continue to raise the bar in cooling performance with our new TEMPUR-LuxeBreeze model, feeling 10 degrees cooler all night long, presenting the best-in-class solution for the more than 60% of the households that have at least one person who sleeps hot. Retailers and consumers' response to the incremental technologies have been overwhelmingly positive. We and retailers are seeing positive mix and higher average ASP.

In tandem with the Breeze mattress refresh, we also introduced an updated adjustable base lineup, which is driving all-time high retailer advocacy and attachment rates, reaching new records in May and June. Our new smart base features our new Sleeptracker-AI 2.0 technology, the accuracy of which was validated by a Stanford medical study and offers industry-leading automatic snore detection and response, addressing a leading sleep concern among consumers. This new lineup also features incremental multi-sensory relaxation features to help consumers wind down and prepare their bodies and minds for deep, rejuvenating sleep. Over the Memorial holiday, we supported these Tempur lineups with all new Breeze and smart base multimedia advertising campaigns. These efforts drove incremental search interest in Tempur year-over-year and drove solid e-commerce traffic trends over the Memorial Day selling period.

All of our new Tempur products and supporting advertising initiatives are strengthening Tempur's appeal to the premium, wellness-minded consumer and driving improvements in attach rates and ASP for our third-party retailers. Fourth highlight, our investment in Stearns & Foster products, distribution, and marketing continue to drive meaningful sales growth and expand brand recognition. In the second quarter, Stearns delivered its third sequential quarter of year-over-year sales growth, significantly outperforming broader market trends. This was possible thanks to the recent investments in brand and the rollout of our all-new Stearns & Foster collection, with superior innovation and elevated design and enhanced step-up opportunities. The new product lineup is delivering strong results. We've grown Stearns' third-party retail distribution by more than 20% compared to the previous collection, with gains in both legacy and incremental Stearns retailers.

We're seeing this product resonate with the historically underserved premium innerspring consumer, resulting in strong mix and again, driving ASP expansion. Our channel diversification strategy is also driving strong brand momentum. The Stearns & Foster e-commerce site we launched last year continues to drive brand recognition and highly profitable incremental sales. Finally, our launch of our all-new international Tempur products continue to track with our expectations. We are launching the new international lineup in over 90 markets worldwide. In the first half of the year, we kicked off our Tempur European and Asian markets. We expect to be fully floored in our last market in the UK in the first half of 2024. The UK has some country-specific fire retardant regulations, which add some complexity to the product launch.

The consumer-centric innovation and new collection will appeal to our legacy ultra-premium consumers at prices of $3,000 and above, while also broadening our price points to expand our addressable market to meet the needs of consumers shopping for mattresses between $2,000 and $3,000. We are streamlining the manufacturing process for this lineup to unlock this incremental price point without materially altering the margin profile of our Tempur International business. As we continue to stagger the rollout by individual markets, we're currently manufacturing both the new line and the old line of products in our international Tempur plant. We plan to optimize production of the new line after the transition period, providing a tailwind to gross margins in 2024. I'll turn it up the call over to Bhaskar Rao.

Bhaskar Rao (EVP and CFO)

Thank you, Scott. In the second quarter of 2023, consolidated sales were approximately $1.3 billion, and adjusted earnings per share was $0.58. We have approximately $13 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, primarily related to costs incurred in connection with the planned acquisition of Mattress Firm, a $4 billion U.S. bedding retailer. Turning to North American results. Net sales increased a solid 5% in the quarter. On a reported basis, the wholesale channel increased 6%, and the direct channel increased 3%. North American adjusted gross margin improved to 39.9%, driven by pricing actions and favorable commodities, partially offset by increased product launches and operational headwinds.

North American adjusted operating margin improved to 17.4%, driven by the improvement in gross margins. Turning to international. International net sales increased 3% on a reported basis and 4% on a constant currency basis. Our current year full year expectations for 2023 contemplates neutral FX, both the sales and adjusted EBITDA. As compared to the prior year, our international gross margins improved to 54.9%, driven by favorable mix and pricing actions. Our international operating margin declined to 13.4%, driven by launch-related expenses, including discretionary advertising investments, partially offset by the improvements in gross margin. Global commodity prices continue to trend largely in line with our expectations. We continue to expect favorable commodity prices into the back half of the year, though remaining significantly elevated to 2020 levels.

Now moving to the balance sheet and cash flow items. At the end of the second quarter, consolidated net debt was $2.7 billion, and our leverage ratio under our credit facility was 3.1x, slightly ahead of the target range of 2x-3x. We expect to return to our target leverage range in the back half of the year. We generated second quarter operating cash flow of $150 million. In total, we had more than $250 million of operating cash flow in the first half of the year, continuing to demonstrate the attractive cash flow attributes of the company. As expected, our inventory levels declined in the quarter as we have completed the vast majority of our domestic product launches. This resulted in a sequential 6-day improvement in the cash cycle.

As we enter the back half of the year, we expect inventory levels to further decline, as well as some improvements in working capital, further improving our cash cycle. We have temporarily suspended repurchases under our share repurchase authorization as we work towards closing the Mattress Firm transaction. Over this interim period, we expect to significantly deleverage as we plan to use the cash to pay down debt ahead of the closing. After the acquisition closes, we would anticipate our leverage ratio to be between 3x and 3.25x. Turning to 2023 guidance. Due to revised industry expectations, we are trimming the midpoint of our 2023 guidance by approximately 3% on both sales and adjusted EPS. We now expect adjusted EPS to be in the range of $2.50 to $2.70.

This considers sales to be consistent to slightly up over the prior year. This includes the execution of our key initiatives, new product launches, and the wraparound impact of pricing. This also assumes global industry headwinds, primarily in the low end, sales and marketing investments of $20 million to support our product launches, and maintaining our commitment to record advertising spend of over $500 million as we continue to support our leading brands and new products. This will result in adjusted EBITDA of approximately $940 million at the midpoint of the range.

Our guidance also considers the following allocations of capital in 2023: A quarterly dividend of $0.11, representing an increase of 10% relative to 2022, and CapEx of approximately $200 million, which includes $90 million of growth CapEx, primarily to fund the completion of our Crawfordsville facility. I should note that going forward, we expect our CapEx to return to a more normalized level of spend. We think of annualized CapEx as approximately $150 million, driven by maintenance CapEx of $110 million, and growth CapEx of approximately $40 million. Lastly, I would like to flag a few modeling items.

For the full year of 2023, we expect D&A of approximately $190 million-$200 million, interest expense of about $135 million-$140 million, a tax rate of 24%-25%, and a diluted share count of 178 million shares. With that, I'll turn the call back over to Scott.

Scott Thompson (Chairman, President and CEO)

Thanks, Bhaskar. Great job. Before opening the call up for questions, I want to provide a couple of updates. First, I want to address the cybersecurity event affecting certain parts of our IT system, which was disclosed Monday in our 8-K. Following the discovery of the event, our team activated its CEO-approved Incident Response and Business Continuity Plan.

the plan was approved years ago, and it's designed to contain incidences. The plan included proactively shutting down certain IT systems, resulting in the planned temporary interruption of our operations. We began bringing our systems back online last Friday, and it's expected to take time to return to normal operations. Our investigation remains ongoing, and we continue to work to determine the impact of the disruption. If we determine that any personal information was involved, we would of course, comply with any reporting obligations we have under the applicable law. Currently, we're working hard to catch up with the lost production from the shutdown. In total, our systems were down for a week, and we are currently working to get back to full production. We expect that cyber-related expenses net will be adjusted from our third quarter financial results.

Lastly, I'd like to provide a brief update on our pending acquisition of Mattress Firm. We're currently responding to the Federal Trade Commission's second request and continue to expect to close the transaction in mid to late 2024. Over this interim period, Mattress Firm's leadership team provides us with a high-level update of their financial performance. Mattress Firm's quarterly results, which they reported yesterday, were consistent with our expectations, and we look forward to bringing the Mattress Firm team on board. With that, I'll open up the call for questions, operator.

Operator (participant)

Thank you. As a reminder, to ask a question, please press star one one on your telephone and wait for your name to be announced. To withdraw your question, press star one one again. Please limit yourself to one question and then re-queue. Please stand by while we compile the Q&A roster. Our first question comes from Bobby Griffin with Raymond James. Your line is open.

Bobby Griffin (Director of Equity Research)

Good morning, everybody. Thanks for taking my questions. Congrats on a good quarter with a lot of moving parts.

Scott Thompson (Chairman, President and CEO)

Thanks, Bobby.

Bobby Griffin (Director of Equity Research)

I guess, my first one is to maybe follow up on the guidance reduction and just maybe get a little more clarity on some of the moving parts assumed in there. Is the reduction in earnings and sales all just a function of the industry maybe being a little bit softer than we originally anticipated when we laid out, or are you baking in some conservatism that this IT event or the cyber event will, will have some type of impact on earnings and revenue in the second half?

Scott Thompson (Chairman, President and CEO)

Yeah, let me, it's kind of, let me answer. It's a little bit of a long answer, but let me be, be clear about it. You know, first of all, from the cyber event, you know, great job by the IT, internal IT department. They did a great job. In fact, it was an enterprise-wide effort, and congratulations to all the people internally. We also had a lot of help from external IT teams that we had on retainer for these kind of events, and a great job by Microsoft's elite team. Let me go, kind of go through the estimates of what we know today. You know, obviously, this is not an easy estimate, but let me tell you what we know based on all the information that we have right now.

First of all, the event itself is certainly not material to the intrinsic value of the enterprise. The event's not material to our 2023 expected sales or EBITDA. Before insurance, and we have an insurance limit of $5 million, but before any insurance, our best estimate is about $10 million-$20 million negative impact in EBITDA in the third quarter. Okay, we expect the vast majority will qualify as an add-back adjustment in the third quarter. In the estimate that I gave you on the impact of EBITDA, it really breaks out into kind of two pieces. You know, one, which is clearly incremental cost related to the activity and should be cleared by covered by insurance at some point, but of course, we'll account for that if we receive it.

Then 50% of it is from potential lost sales. When you look at the potential lost sales for the third quarter, you're talking about $20 million-$30 million. That's about maybe 2%-ish, give or take, of the quarter sales. Again, that's potential. And the vast majority of that would be Sealy US, okay? Because we had plenty of inventory in the Tempur organization. We've not experienced any material changes in our balance of share, and retailers, quite frankly, have been very understanding in the situation. Lastly, more kind of directly to your guidance question. You know, for the 2023 guidance, the event has been considered.

As we mentioned before, we would expect an add back in the third quarter for the cost, and certainly we'll, we'll account for the insurance whenever we ever file a claim, we'll call that out. Any other impact on changing the guidance, totally macro. When we look, look at the second quarter and, and okay, let's say we just kind of scraped out the second quarter. The market wasn't as strong as we expected it to be, but we also performed better and outperformed the industry by a greater extent than we expected. When you net the two, we, you know, we, we had a relatively solid, in fact, very solid relative to others in the industry in the second quarter.

Looking forward, we, we brought down our expectations for the industry, and that required us to fine-tune, 3%-ish from a, from a guidance standpoint.

Operator (participant)

Thank you. Our next question comes from Susan Maklari from Goldman Sachs. Your line is open.

Susan Maklari (Senior Equity Research Analyst)

Thank you. Good morning. Thanks for taking the questions.

Scott Thompson (Chairman, President and CEO)

Good morning.

Susan Maklari (Senior Equity Research Analyst)

Congrats on a good quarter.

Scott Thompson (Chairman, President and CEO)

Thank you.

Susan Maklari (Senior Equity Research Analyst)

Yeah, I, I think, you know, staying on the theme of demand, Scott, as you think about the macro setup with rates possibly at or very close to the peak, housing getting a little better, feels like, you know, maybe the consumer will start reengaging in spending in some of these other categories as, as travel starts to moderate a bit in there. How are you thinking about the industry's ability to start to see some level of improved demand as, as we move through the next couple of quarters, and your ability to continue to outperform relative to that as, as some of your peers perhaps, you know, move up off of these industry declines of the 25%-30% range?

Scott Thompson (Chairman, President and CEO)

Thank you for the 33 questions you asked me, Susan. Let me speak to it and see if I can answer, like, 30 and leave three unattended.

Susan Maklari (Senior Equity Research Analyst)

Okay.

Scott Thompson (Chairman, President and CEO)

you know, first of all, yeah, we're, we're very happy with the performance of the quarter, and we think it gives us an opportunity to show the strength of the business, even in a little bit of a down cycle and its cash flow generation. I would highlight in, in our numbers, because this goes to the consumer question you asked, if you look at our, our ASP, it was up 13% in the quarter. All but about... call it 2% of that's price. The vast majority of that is people mixing up. What that would tell you is the top end of the consumers are doing very well, and where, where you're seeing sales pressure is at the lower end.

If I do it by a brand standpoint, our, our high-end brands did better than our low-end brands, i.e., Stearns & Foster did better than Sealy. Stearns & Foster grew double digits in a market that, I don't know, pick your number, but was clearly down double digits. It grew double digits. I'm gonna say the strength of the high-end customer, everywhere we looked, looked very good. No, we look at individual mattresses within the Tempur lineup. The high-end Tempur products did much better than the low-end Tempur products. We're, we're continuing to be fairly bullish on, on the high-end customer. Where you feel the pressure is in the low end, and the, and the low end is, has gotten hit, has gotten hit very, very hard.

You know, you had a question in there about outlook as far as consumers going forward. We've been bouncing around the bottom in the bedding industry for probably 3 quarters. I don't know, you know, next quarter or two, we certainly think that the industry should start doing better. Some people can point to green shoots. Yeah, we, we see some, you know, you have some good weeks, and you have some slower weeks. The, the main thing from our perspective is we see our products incrementally performing very well in the marketplace against the competition. Any part of her question I missed, Bhaskar, that you can remember?

Bhaskar Rao (EVP and CFO)

How about competitive landscape?

Scott Thompson (Chairman, President and CEO)

Competitive landscape. Look, we've got, it's a very competitive market. There's lots of competitors in bedding worldwide. Other brands that have brand strength that we, that we all know. They're out there, they're competing every day. I haven't seen anything in any of the competitors that I would call a significant sea change in their activities or their strategy, but it's a competitive market, and we'll continue to, to compete the best we can.

Operator (participant)

Thank you. We have a question from Keith Hughes with Truist. Your line is open.

Keith Hughes (Managing Director of Sell Side Equity Research)

Yeah, you had talked earlier about raw material costs as coming down, still at available levels. Can you give me kind of quantification, how much they're down, either in the quarter or your estimates for the second half of the year?

Bhaskar Rao (EVP and CFO)

Absolutely.

Keith Hughes (Managing Director of Sell Side Equity Research)

Dollars.

Scott Thompson (Chairman, President and CEO)

What I would say...

Keith Hughes (Managing Director of Sell Side Equity Research)

Dollars would be helpful.

Bhaskar Rao (EVP and CFO)

Sure. Let me, let me think about it this way, that we did have an expectation from a commodity standpoint as we, as we entered the year. Largely speaking, those, those commodities are coming in very much in line with those, with our expectations. We would expect to continue to see incremental commodity benefit as we get into the back half. However, all contemplated in our, in our initial thoughts as it relates to what we thought commodities were gonna do. As it relates to the commodity benefit that we saw in our GP rate, we'll have a little bit more information.

Our queue is gonna drop here in a little bit, but I'll, I'll go ahead and give you a peek on it, is from a commodity standpoint, is what we've wanted to expect to see is about 150 basis points of improvement.

Operator (participant)

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

Steven McDermott (Internet Equity Research Analyst)

Hi, this is Steven McDermott for Curtis Nagle. Just for your Mattress Firm acquisition, I know you called out kind of second half of 2024. Is there any changes in what you are seeing from a regulatory approval standpoint? Then, as far as gross margins, kind of touch beyond just the commodities, how are we thinking about the cadence going into 2H and kind of all the puts and takes there? Thank you.

Scott Thompson (Chairman, President and CEO)

Yeah, thank you for your question. I'll, I'll do FTC, and I'll give Captain Margin the question on, on margins. Look, as you, as you know, the FTC process is, is long and complex. What I would say is we're working through the process. There have not been any surprises in the process, we're providing them significant information on their second request. Lawyers and, and folks are meeting and discussing professionally, as we both learn, each other's perspective. And I think that process will continue to go on, you know, for several months, and probably sometime in, in the fourth quarter, we'll probably, you know, get down to the point where we figure out whether or not we have a meeting of minds or we don't have a meeting of minds.

I would tell you that, process is progressing normally. Everybody's working cordially together, and they have they have responsibility on their side, that we certainly respect, and we look forward to continuing to visit with them.

Bhaskar Rao (EVP and CFO)

When I think about gross margins going from the first half to the second half, first thing I would point out is I would, I would anticipate the normal seasonality of the business. Generally, the second half is bigger than the first, therefore, we get some leverage upon our fixed. Clearly, is I would anticipate that that would happen. In addition to that, is that we had some unique events that were investments that we made in the first half, whether it be product launch expenses, whether it be the floor models that we have out there. As we get into the back half of the year, is that that's not gonna be a headwind to, from a gross margin standpoint. Finally, I will call out, is that we've been making some investments in, in our, in our supply chain, in our operations.

Let's call that we've been filling some EBITDA to make sure that we've been servicing our customers. As we, as we think about the back half of the year, is that those headwinds should turn into tailwinds. What all that means is what I would anticipate is that gross margin continues to step up, with Q3 being the highest of the year. I would also say, as we think about or just margins overall from a go-forward standpoint, is, is that I feel like we have a number of tailwinds to margin, whether it be the product mix, whether it be the operational initiatives, that we have, not only this year, but as those to continue. We're very excited about our direct-to-consumer business. DTC should be a tailwind for us from a go-forward standpoint. Then finally, I'll close it down with international.

International, as we spent many, many years in developing a product that will let's get a new total addressable market. Generally, international margins are higher than, than the US, so I'd anticipate as international continues to grow, is that that will be a tailwind as well.

Scott Thompson (Chairman, President and CEO)

Yeah, the only thing made me think as you were talking, Bhaskar, is in margins, that we probably should have called out in the second quarter, our advertising expense. We, we spent the same amount as last year, i.e., even though the market was choppy, we didn't pull back on advertising to try to optimize EBITDA or something like that. In fact, if you look at our, our direct advertising, our direct advertising, to support, quite frankly, a little weaker market is, is up double digits, in the second quarter in, in support of the marketplace.

Operator (participant)

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

Peter Keith (Managing Director and Senior Research Analyst)

Hey, good morning, everyone. Congrats on the continued share gains. I guess a two-part question, hopefully related. Number one, could you give us the sales lift in the second quarter from the product launches that you had? Then secondarily, it looks like now your guidance implies the revenue is gonna slow in the back half. At the same time, I think the industry trends, what we're seeing general agreement on, is that things are kind of getting less bad, and you're kind of guiding for things to get worse. Hopefully, you could reconcile that dynamic.

Scott Thompson (Chairman, President and CEO)

Sure you want to work on that, Bhaskar?

Bhaskar Rao (EVP and CFO)

Absolutely. The way I would think about it is, specifically as it relates to floor models in the second quarter, let's call that 2%-3%. That's the, that's, that's the lift we got there. What I think about the back half, reasonable as it relates to what the back half looks like from a sales standpoint. However, here's the way I think about it, is in the first half of the year, we did have some benefit from the the last round of pricing actions that we took in 2022. That lapsed in the first half, meaning that we don't have that benefit as we think about the back half of the year. Finally, is that our floor models, which again, are gonna support future growth, is that those are largely in the first half of the year.

When you think about our expectations in the back half of the year, what that does imply is, is that from an organic standpoint, is it that those initiatives are going to continue to allow us to grow in a very challenged market. How I think about that is, from a sales being flat to slightly up, is what that would imply in the back half of the year, is that we would see a bit of growth and really being fueled by those initiatives in a very challenged market.

Operator (participant)

One moment for our next question. Our next question comes from Seth Basham from Wedbush Securities. Your line is open.

Seth Basham (Managing Director of Equity Research)

Thanks a lot, and good morning. I have a follow-up question, to Peter's, just on the outlook for the industry for the balance of the year. If you take into consideration what's happening from a macro standpoint and a credit availability standpoint, what are you expecting industry units to do, for the full year and for the back half of the year that underpins your guidance?

Bhaskar Rao (EVP and CFO)

Good question. The way we think about it is, let's call it mid-single-digit, mid- to high-single-digit decline. What that would imply is for the back half of the year, call it mid-single-digit declines. It's our expectation that for the second quarter, is that when the information comes out, our estimate is that we'll see low double from a decline standpoint.

Operator (participant)

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

Brad Thomas (Managing Director and Associate Director of Research)

Hi, thank you. A couple of follow-ups, if I could. Scott, I believe you talked about thinking that you may not have as much from share gains in the back half as what you've been seeing in the first half. I was wondering if you could elaborate on that any more. Then, Bhaskar, I was hoping you could talk a little bit more about the commodity component of margins and maybe how you're thinking about that from a big picture standpoint, and perhaps maybe how that sets up as a potential tailwind for you even as you move into 2024. Thanks.

Scott Thompson (Chairman, President and CEO)

Yeah. Yeah, thanks for the question. Let me, let me be a little clearer. It's more the way we do budgeting, more than expectation when it, when it comes to share gains or outperformance in the marketplace. You know, clearly, we, we continue to take, have quite a bit of outperformance in, in the marketplace. When we actually put our budgets together and we do guidance, we don't anticipate that activity. We let that, we let that activity flow into the numbers. As a good guy, maybe it offsets an unknown bad guy.

As far as, like, you've just asked me like, "Okay, what do you really think, your, your share gains are gonna be?" We, we haven't seen anything in the marketplace from any of the competitors that would make us think that our share gains would, would slow down. Our, all of our brands, had really strong second quarter, and we haven't seen anything that would make us think that wouldn't continue, in, in the third quarter. That's probably me misspeaking or thinking about our budgeting process more than anything else.

Bhaskar Rao (EVP and CFO)

As it relates to the components of gross margin, just cleaning up one of the questions that I got earlier from Keith Hughes, let's call it about $15 million, the commodity benefit in the quarter, and that will triangulate to the about 350 basis points of rate improvement. As we think about commodities, largely speaking, is that we had a perspective on what the full year would look like. What we assume there is that we continue to see some favorability as the year progressed. Within some puts and takes, I would say largely, that is coming in and around what we would anticipate.

What that does imply for the rest of the year is that we continue to see, on a sequential basis, commodity improvement, as well as obviously year-over-year as well. All that said, we are still well off the, our 2019 levels from a commodity standpoint. When you think about that mathematical equation that was happening, where we had taken price and without any gross margin, that, that would fall through from a rate standpoint, that phenomenon is still there. We have recouped some of that as commodities have come in. We are well, well off of where we used to be from a historic standpoint, commodity prices versus 2019. You would anticipate, with the fullness of time, things would, would normalize. It would be...

I think there's some things that are just gonna be more stickier than others as it relates to getting back to those pre-pandemic levels.

Operator (participant)

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

Atul Maheswari (Equity Research Analyst)

Good morning. Thanks a lot for taking my question. Bhaskar, just to follow up on the commodity, piece of gross margin.

Bhaskar Rao (EVP and CFO)

Mm-hmm.

Atul Maheswari (Equity Research Analyst)

Based on your estimate, as it stands today, how much of a- If I, if I back up a step, I think in the past, what you've mentioned is that commodities have collectively been a 400 basis points headwind to gross margin over the last few years. As of the end of 2023, how much of that do you expect to recover, just so that we can properly calibrate what's left outstanding for 2024 and beyond?

Bhaskar Rao (EVP and CFO)

Sure. Let me do that. Let me do that math kind of, as I'm thinking about it. I think we're well off of our, of, of where we were in the pre-pandemic levels. I don't think we're approaching, let's call, half of where we were before. Somewhere between 150-200 basis points, perhaps, is what we've captured, and that's consistent with what we've seen, let's call it, in the first half of the year. I'd anticipate that to play through a little bit. Really that reinforces the point, is that, things are, things are better than where they were, obviously, during the pandemic. However, from just from a pure inflation standpoint, is that we still got a ways to go.

Operator (participant)

Thank you. We have a question from Laura Champine with Loop Capital. Your line is open.

Laura Champine (Director of Research and Senior Consumer Analyst)

Thanks for taking my question. If I look through the quarter that Mattress Firm just reported, it looks like their sales declined 6%. Do you view them as holding on to market share in a weaker market, or is there an issue there that you would need to turn around should you become the owner of the Mattress Firm assets? You know, recognizing that it would be a year.

Scott Thompson (Chairman, President and CEO)

Sure. We don't, we don't have all the information yet, and that we get in the marketplace to, to fully answer that question. Certainly, the early indications are that, you know, from a retail perspective, I suspect the retailers were down double digits in, in total. I'm looking at Bhaskar to agree, 'cause we don't have all the numbers, we triangulate. So they were down 6% in sales and up, I think, 3% in EBITDA, in a market that I would say probably sales for retailers were double digits. I, I think they, they probably took a little bit of share.

If you were to segregate the market between what I'll call the big retailers and the small retailers, they were probably, I'll call it, in line, maybe with the large retailers, because generally the trend has been larger retailers have been taking share from smaller retailers. Their, their report, which is their third quarter, our second quarter that came out last night, was very much in line with our expectations of what they were going to do this year, pre-signing the definitive agreement. They're, they're tracking to our, our internal expectations.

Operator (participant)

Thank you. Again, if you would like to ask a question, please press star one, one on your telephone. Our next question comes from William Reuter from Bank of America. Your line is open.

William Reuter (Managing Director)

Hi, good morning. I just have one. Given a little bit of the weaker demand at the lower end, and, and lower commodity prices, do you expect that you may either be more promotional? Do you expect you would reduce list prices? Have your retailer partners come to you with any suggestions on how to increase volumes there? That's it. Thanks.

Scott Thompson (Chairman, President and CEO)

No, I don't, I don't really see any pricing actions at the lower end. Is it promotional? Yes. The low end is always very promotional, and in the industry, the low end doesn't have much profit in it, so there's not a lot to work with at the low end. Where we've seen retailers aggressively try to promote and drive, we'll call it lower end, generally we've seen those activities not be successful from a return on advertising or promotion dollars. The, the low-end market is, is just, is just not right, not there right now. Again, maybe in marketing terms, the, the fish aren't there right now. No. As far as, are we continually looking for ways to help stimulate the market?

Yes, I don't, I don't think it's really a, a pricing issue. You know, if I, you know, got to be king for the day, what I'd like to see is, is, you know, more advertising in the marketplace by, you know, other manufacturers, and others to help, you know, just stimulate activity. I think there's, there's quite a bit of dollars out there in the middle of the market and the upper end of the market, but entry level is, entry level is just tough right now.

Operator (participant)

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

Carla Casella (Managing Director)

Hi, I'm wondering about inventory and working capital and your thoughts. Third quarter I know is usually a big cash flow quarter for you. Are you expecting that again this year and for the full year, do you still expect working capital release? Do you expect to be able to fully pay down your revolver in the next quarter?

Bhaskar Rao (EVP and CFO)

Absolutely. Here's the way I would think about it. We made some investments in working capital as we exited 2023, whether it be in, in advance of the new product introductions that we have, as well as just carrying more safety stock as the supply chain was a little uncertain at that time. As we sit here today, our cash cycle, we've seen some nice improvements, specifically about six days in inventory. As the year plays out, is what I would anticipate is that we would see some continued improvement in working capital overall, a little bit from inventory, but I would expect something from the other components as well, that being payables and receivables. As we exit the year, what I would anticipate is, is that working capital will continue to be a source of cash.

Let's say, from a historic standpoint, is that the flow-through on EBITDA to cash flow is we should continue to see that same relationship. Absolutely, the back half of the year is that we generate more cash in the first half, so I would say that we would expect that again this year. What I would further say is, is that we feel very excited about what we've done from a new, new plant standpoint. That's in Crawfordsville. That was a $300 million investment in growth CapEx that we made over the last couple of years, and we're very excited to say that, that, we've got some units coming out of that plant. What that means is from a cash flow standpoint, a free cash flow, is that that investment is behind us.

On a year-over-year basis, free cash flow should, should be greater by about 50% than what it was in the prior year.

Scott Thompson (Chairman, President and CEO)

Then I guess the other part is we've, you know, we're not doing stock buyback while we're preparing for the Mattress Firm acquisition, so we're gonna be drowning in cash, and the leverage ratio should be falling significantly over the next few quarters.

Bhaskar Rao (EVP and CFO)

That's right. I think what we're anticipating is, obviously, in this, we'll get back within our range in the third quarter. As we sit here today, I would expect to be somewhere at the midpoint of our range of two-three as we exit the year.

Operator (participant)

Thank you. We have one last question from Brad Thomas with KeyBanc Capital Markets. Your line is open.

Brad Thomas (Managing Director and Associate Director of Research)

Oh, thanks for taking the follow-up question. A, a couple of things that investors have been asking us this morning, I was wondering if I could ask. For one, you know, it's, it's been an exciting year with some new retail partnerships like Sam's Club. Scott, was just wondering if you could just give us any update on, on distribution and how, you know, partnerships are going in, in, in floor space? Then, and then secondly, just a question on the cybersecurity issue. Is the expectation that operations are normal for the Labor Day selling season, or you think it goes into that at all?

Scott Thompson (Chairman, President and CEO)

Thanks again. Well, well, congratulations on slipping in one more question and then making it a five-point question.

Bhaskar Rao (EVP and CFO)

Well done.

Scott Thompson (Chairman, President and CEO)

Let me get back to that. First, first of all, you, you mentioned a large customer, Sam's. We think that, that, that's going well, and we think that, if you ask them, they would say it's going well. We're, we're, we're thrilled with, with that relationship. I think you know that Stearns & Foster captured 20% increase in slots, and we certainly feel, feel good about that. Clearly, from our, our sales numbers relative to the industry, whether you wanna compare it to other public companies or spring volumes or anything, we're clearly taking share. You know, floor space is increasing and velocities within those slots, you know, have, have been increasing.

Then I think you asked a little bit more about, like, kind of where is the organ-.

Cyber.

Cyber thing.

Bhaskar Rao (EVP and CFO)

Is it normal Labor Day?

Scott Thompson (Chairman, President and CEO)

Yeah. I mean, look, we obviously have the 8-K out. We're generally building and shipping beds. I mean, right now, we're taking orders, right now. We in generally lost about a week's worth of production, you know, around the world. Then as we bring up the systems, it usually takes a few days to get back to kinda normal efficiency. You know, so yeah, I, I don't know, that we also had some, some parts of the organizations that, that weren't impacted by any of the, the cyber event, like the Asian Joint Venture, Dreams, Sherwood, Sleep Outfitters, they weren't affected at all. Our worldwide e-commerce, it wasn't affected, except for a, a bit slow shipping.

No, I mean, I, I think, you know, we're working off backlog, but I think we're, we're gonna get caught up, and I don't really expect to leave the third quarter with any significant backlog. I, I don't think it's gonna have an impact, and we've certainly tried to work through that when we gave you estimates of the, of the impact of the, of the event.

Operator (participant)

Thank you. That's all the time we have for questions. I'd like to turn the call back to Scott Thompson for closing remarks.

Scott Thompson (Chairman, President and CEO)

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. Special call out again to our, our IT folks in a very difficult quarter and a great job in dealing with the uncertainty that we, we faced. 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, operator.

Operator (participant)

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