Tempur Sealy Discusses Results
Scott L. Thompson – Tempur Sealy International, Inc.
Good morning, everyone and thank you for joining us on this call. Today, I’d like to take you through the highlights of our record financial performance, update you on our recent new product launches and provide you with some thoughts regarding operations subsequent to the contract termination of our largest customer in North America. Then Barry will take you through the details of our financial statements and our 2017 guidance.
First, our financial performance. For the fourth quarter, adjusted EBITDA increased 4% and adjusted EPS increased a robust 19%. It was our seventh consecutive quarter of double-digit adjusted EPS growth over the same period last year. We are pleased with these results, especially considering the North America market was distracted by very noisy presidential election and our largest customer was rebranding a thousand of its stores. For the full-year, adjusted EBITDA increased 14%; adjusted EPS increased 27%; and adjusted operating margin expanded 170 basis points.
Our robust earnings growth and margin expansion in the fourth quarter and full year were driven by continued progress in improving our operations. Key drivers included improving Sealy manufacturing, reducing our overhead and price actions taken in early 2016. While I’m pleased with our progress over the past year, there is more room to improve and the team will continue to work towards driving improvement quarter-after-quarter.
As we’ve discussed previously, the entire organization remains focused on a few key initiatives that are designed to drive earnings growth over the long-term. Let me take a minute and reiterate these initiatives. First, develop the best most innovative bedding products in all the markets we serve worldwide. Second, invest significant marketing dollars to promote our brands. Third, expand North American margins, while maintaining market share. We’ll talk more about that in a moment. Fourth, grow our market share outside of North America. And finally, optimize worldwide distribution to make sure our products are properly represented in all channels. The team’s done a nice job over the past year, and I’m confident that by maintaining our commitment to each of these initiatives, we will continue to drive earnings growth over the long-term.
Turning to new product launches. In January, we launched new products for both North America and the international markets. In North America, we have new products for Tempur-Pedic and Sealy. First, let’s discuss Tempur-Pedic. To celebrate 25 years of sleep innovation, we’re introducing the new limited-edition TEMPUR-Legacy mattress. This mattress is priced at $2,499 for a queen set and we expect it to drive growth in $2,000 to $3,000 segment. As you might recall, this is a pricing segment Tempur-Pedic had trouble with in 2016.
We also have brand new campaign for Tempur-Pedic called Tempur-Pedic Sleep is Power. This campaign features real life high-performing people, who’ve experienced the Tempur-Pedic difference and how sleep on Tempur-Pedic has changed their lives.
I should also note that we’ve listened to feedback from our bedding customers and we’re simplifying the pricing structure of Tempur-Pedic mattresses in North America. Pricing step-ups are now consistent across all Tempur-Pedic product lines. And, we’re making it easier for retailers to present products to customers and for customers to find the right product.
Our most significant 2017 product announcement is the exciting launch of Sealy brand. We are revamping the line with better aesthetics, better support, and better value to the market. Additionally, we are uniting the Sealy products under one master brand. This year, we’re introducing the Response Line, which is all Sealy’s innerspring mattresses, and the Conform Line, which is Sealy’s memory foam line.
Posturepedic will no longer represents own brand, but become Posturepedic Technology, and will be a premium feature offered on mid and high price point Sealy products. This will help us further simplify our brand portfolio by clearly differentiating product line, which will result in easier selling process for retailers.
The new lines in Sealy products are designed with compelling features that consumers want and with strong step-up features to help retailers drive higher average selling price. Also, it’s important to note their design for manufacturability. We’ve reduced our Sealy SKUs by 20% and significantly reduced the number of unique components across the line. We expect these actions to lower overall labor cost, are resulting in significantly better product quality and durability. At the same time, we’ve invested in higher quality and more innovative components like the Duroflex edge system that provides support feature at the edge of the bed. Feedback from our retail partners has been outstanding, with many commenting that this is the best Sealy product line they have ever seen. I’m very proud of the teamwork between sales, marketing, and manufacturing in bringing our new Sealy products to market.
Internationally, we’re re-launching our flagship line of Tempur-Pedic mattresses. This features the iconic aesthetic similar to the Tempur-Pedic mattresses that you see in North America. The upgraded design elements as well as the EasyRefresh cover have been well received by our international retail partners.
As these products rollout this year, we expect them on a constant currency basis to drive double-digit sales growth in our international markets. I should point out on a worldwide basis, we are launching more products than any time in the company’s history and these products will be supported by a record amount of direct advertising in the U.S.
Now let’s turn to the termination of the contracts with our largest North American customer Mattress Firm, wholly-owned subsidiary of Steinhoff International Holdings. During the week of January 23, Mattress Firm initially communicated a surprise verbal termination of our contracts and subsequently demanded significant economic concessions.
We considered their demands, but we ultimately concluded that it was in our long-term best interest of our stakeholders to terminate the contracts with Mattress Firm. Upon termination, the original contracts called for immediate stoppage of orders and deliveries. However, to facilitate a more orderly transition with Mattress Firm, we signed an agreement to allow for a two-month wind down. Mattress Firm represents 21% of our consolidated net sales for 2016, and in light of their volume was the largest recipient of promotional dollars.
On the brand and product side, Tempur-Pedic product represented approximately 60% and Sealy product represented approximately 40% of our net sales to Mattress Firm. In making this distribution decision, we had to consider our other retailers that comprise almost 70% of North America sales. We feel strongly that we must focus on retail partners, who have the greatest commitment to promoting our premier branded products. We also feel strongly that it’s important to maintain a healthy competitive balance in the marketplace we serve.
Despite the challenge presented by an unexpected loss of our largest customer, we feel confident we have chosen the right path. Here are few reasons why we are confident? First, we have a premier portfolio of branded beds. Starting with Tempur-Pedic, we’ve invested over $1 billion in the past 15 years advertising the Tempur-Pedic brands to consumers, which has resulted in a significant brand advantage. Our research shows that more than 94% of Tempur-Pedic owners would recommend the product.
In addition to Tempur, we have two other strong mattress brands in Sealy and Stearns & Foster. Sealy is a 130-year-old iconic brand, known worldwide for its reliable support and quality. We believe Sealy has one of the highest brand awareness of any U.S. mattress brand. Stearns & Foster founded 170 years ago is known for rich quality and craftsmanship. In 2016, Stearns & Foster posted year-over-year sales growth, even without being on Mattress Firm’s floor for most of the year. We believe product, service and advertising is a winning formula.
Second, we have a strong network of retail partners throughout North America, who are committed to promoting our premium brands. In the U.S., excluding Mattress Firm, Tempur Sealy products are available in over 12,000 doors. Our network of retail partners is incredibly excited to capitalize on the fact that Mattress Firm will no longer carry Tempur-Pedic, Sealy and Stearns & Foster. We believe they fully understand the opportunity this creates for their business and we expect them to seize the opportunity.
Third, we believe our North American business is solid. In fact excluding Mattress Firm, our sales in North America grew 4% for the full-year and grew 7% in the fourth quarter with our direct business, up 84%. Halfway through the first quarter, excluding Mattress Firm, our TEMPUR sales are up 3%, which is an improvement from the fourth quarter, which was down 5%. This transition will be disruptive and will result in short-term sales, EBITDA and market share declines.
Additionally, we expect a one-time charge to the 2017 income statement. I’ve talked before about our highly variable nature of our cost structure. While the team is currently working through their plans to partially adjust our expense structure, it’s important to note that our near-term expense adjustment will be minimal on both manufacturing and the marketing side as we expect over time to recapture the majority of the lost sales volume.
On the manufacturing side of our operations, we’re expecting some lower operating efficiencies in the short-term to fully retain our high-quality manufacturing capabilities, which we expect the market will need. On the marketing side, we’ll be increasing our investment on both an absolute dollar basis and as a percentage of sales. This will be across all brands, Tempur-Pedic, Stearns & Foster and Sealy. Consistent with our long-term brand strategy, our products will stay top of mind for consumers and will continue to drive traffic to our retailers.
In short, we’re keeping our foot on the gas and promoting our brands and we expect our retailers to benefit greatly from our continued commitment to their success. This approach is consistent with our long-term strategy, which we’ve stated numerous times and reiterated earlier in the call to retain market share in North America and grow market share internationally. So, in North America, until we recapture the market share loss for the distribution chain, we will be in the market share recapture mode, and of course, we will continue our steady market share expansion internationally. Going forward, we will advise you periodically on how we’re performing against this plan.
Now before I turn the call over to Barry, for detailed financial review, I’d like to briefly discuss our capital allocation strategy. As we’ve mentioned in prior calls, we’ve gone through a thorough evaluation of the company’s capital structure and concluded our debt target would be 3.5 times adjusted EBITDA on a trailing 12-month basis with some ranging of 3 to 4 times. At the end of the fourth quarter, we were at 3.6 times.
When we set the debt target and stress-test the capital structure, we included many scenarios including unexpected but possible events. These include scenarios where sales declined in excess of the full amount of our Mattress Firm business in 2016. The business continues to generate significant profits and lots of cash flow. We remain committed to invest capital and opportunities with the highest return on invested capital while balancing our debt target.
In the near-term, we anticipate EBITDA trailing down, and using some of our cash flow to pay down debt. Over time, as we develop a better understanding of the North America sales trends, we expect subject to market conditions to repurchase shares with any excess cash flow. Thus we’ve expanded our stock repurchase buyback authorization.
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