Tempur Sealy International Inc

NYSE:TPX

Earnings Call Transcript 2021-Q3

[Operator]

Thank you for standing by, and welcome to the Tempur Sealy Third Quarter 2021 Earnings Conference Call. [Operator Instructions].

I would now like to turn the conference to the host, Mr. Aubrey Moore of Investor Relations. Please go ahead, ma'am.

[Aubrey Moore, Director, IR]

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 the 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 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.tempursealy.com and filed with the SEC. Our comments will supplement the detailed information provided in the press release.

And now with that introduction, it's my pleasure to turn the call over to Scott.

[Scott Thompson, Chairman, CEO & President]

Thank you, Aubrey. Good morning, everyone, and thank you for joining us on our 2021 third quarter earnings call. I'll begin with a few highlights of our record third quarter financial performance. Bhaskar then will review our financial performance in more detail. Finally, I will conclude with some comments on our building blocks for future growth.

We're pleased to report robust third quarter results. The team continues to deliver strong results all around the world. In the third quarter of 2021, sales grew 20% year-over-year, with strong performances across North America and the International segments and with growth across all brands, channels and price points. Our strong sales performance was driven by our company initiatives, strong demand for Tempur-Pedic products in the U.S. and a solid bedding industry backdrop worldwide.

Adjusted earnings per share for the third quarter was $0.88, an increase of 19% versus the same period last year. I should also note that we've grown sales and adjusted EPS double digits for 9 out of the last 10 quarters.

I'd now like to highlight a couple of items from the quarter. First, we are pleased to officially welcome the Dreams organization, our recent acquisition in the U.K., to the Tempur Sealy family. The addition of Dreams furthers our vertical integration and omnichannel growth strategies. We are successfully integrating the business, and it is performing well. It's ahead of its initial expectations, both from a top line and bottom line perspective. We expect over time to leverage our combined track record of operational excellence to realize unbudgeted synergies, which will further drive profitability.

Second, consistent with our legacy of launching innovative products, we're excited to highlight some of our new products in North America and around the world.

Starting with North America. We plan to launch a Sealy mattress with a best-in-class pressure-relieving gel grid layer at a consumer-appealing mid-market price point designed to target the niche market of consumers looking for a nontraditional feel at a non-premium price point. We're also planning to launch a Sealy-branded eco-friendly mattress collection made with responsible sourced material. Furthermore, in early 2022, in addition to the emerging niche markets we plan to address, we are launching a new line of premium Sealy products targeted to a wide variety of customers, which includes a new lineup of industry-leading hybrids. This new Sealy lineup is intended to extend the brand's leadership in the industry by offering superior support and new proprietary material.

Looking ahead to late 2022, the team is also working on the next line of Stearns & Foster products. These products are designed to further distinguish our high-end traditional Innerspring brand from the competition, and appeal to consumers that prefer a traditional Innerspring mattress. While Stearns & Foster is on track to have record sales this year, supported by a record amount of advertising dollars, we see ample opportunity to further expand consumers' awareness of this segment through the introduction of new products and continuing advertising.

Turning to International. As we've previously announced, we are launching a new line of Tempur products in our European and Asia-Pacific markets next year. These new products will feature the innovative Tempur-Pedic technologies that experienced great success in the U.S. and will be sold at a wider price range compared to legacy Tempur International offerings.

Next, I'd like to highlight our recent capital allocation activities. During the last 12 months, we've allocated over $1 billion in capital acquiring Dreams, repurchasing shares, paying dividends and investing in our ongoing operations. At the same time, our robust earnings drove a reduction in our leverage ratio. In the third quarter, we opportunistically repurchased $190 million of our shares, bringing our total share repurchase over the last 12 months to approximately $700 million at an average price of $36 per share.

Regarding recent investments in the business, over the last 12 months, we've opened 3 new manufacturing facilities. Additionally, we recently broke ground on our third domestic foam-pouring plant in Crawfordsville, Indiana, which is planned to be operational in 2023. And we're also expanding our manufacturing footprint within existing facilities and overall warehousing space in several locations. We're investing to dramatically reduce our exposure to future supply chain disruptions by expanding our capacity to hold key chemical inputs and expand safety stock of certain products. The operational investments we are making today are part of a broader strategy to expand our North American manufacturing capacity, which will allow us to service the long-term demand outlook that we see for our industry's leading brands and products. As you know, Sealy and Tempur brands are currently ranked as #1 and #2 best-selling mattresses in the United States.

The next highlight is our worldwide wholesale business, which grew a robust 11% this quarter as compared to the same period last year. We're pleased with these performances, especially given the strong prior year sales comp and the fact that we were unable to ship all of the market demand in the quarter. As expected, our customers continue to be on allocation, and we exited the quarter with a record backlog. Post quarter end, the normal market seasonality has allowed us to make significant progress on working down our Sealy backlog. Thus, we recently took customers off of allocation. Unfortunately, due to the tremendous demand for Tempur-Pedic products in North America and domestic supply chain issues, the backlog for Tempur-Pedic expanded in the third quarter. We expect to work down this backlog in the fourth quarter and enter 2022 better positioned to fully meet consumers' demand. Across both brands, our total backlog has increased from the end of the second quarter by about $100 million as of September 30, 2021.

Turning to the final item I'd like to highlight. Our direct-to-consumer business had another record quarter, growing 79% over the third quarter of 2020 and growing 17% excluding the Dreams acquisition. With this quarter's strong performance, our third quarter direct-to-consumer sales has grown a compound annual growth rate of 45% over the last 5 years. On an annual run rate basis, our direct channel is now on track to generate over $1 billion of sales. Our company-wide retail stores had a standout performance this quarter. The Dreams stores and our legacy company-owned stores both drove double-digit same-store sales growth year-over-year.

Our e-commerce operation also performed very well this quarter. We continue to see robust sales growth driven by double-digit improvement in conversion and average order value. Our commitment to investing in the online presence of Tempur-Pedic brands is paying off. While we are pleased with our results, I should once again remind you that both our wholesale and direct sales in North America have been constrained in the quarter. The supply chain constraints once again forced us to turn away business this quarter. We estimate that it was about $100 million. Considering this and the unrealized sales from our increased backlog, our sales could have been higher by over $200 million this period.

Turning to our growth outlook and drivers. I'm pleased to reaffirm our expectations that 2021 sales will grow approximately 60% over 2019, a period not impacted by COVID. Our sales and earnings growth over the 2-year period has significantly outpaced the overall industry. So I'd like to take a moment to remind you what we said last quarter about the components of this growth. We estimate about half of our 2-year growth is attributable to our new retail partnerships. Another 35% of our growth is derived from our M&A activities and share gains from previously untapped addressable markets. We estimate only about 15% of our expected 2-year growth comes from the broader industry.

We attribute our performance to our commitment to driving our 4 key initiatives: first, to develop the highest-quality bedding products in all the markets that we serve; second, promote worldwide brands with compelling marketing; third, optimize our powerful omnichannel distribution platform; and fourth, drive increased EBITDA and prudently deploy capital. Our clear long-term initiatives, robust free cash flow and solid balance sheet have supported the explosive growth that we've generated over the last 2 years. We expect to drive future double-digit sales and EPS growth in 2022 and beyond.

With that, I'll turn it over to Bhaskar.

[Bhaskar Rao, EVP & CFO]

Thank you, Scott. I would like to highlight a few items as compared to the prior year. Sales increased 20% to over $1.3 billion. Adjusted EBITDA increased 7% to $298 million. And adjusted earnings per share increased 19% to $0.88. As expected, there were a few transitory items impacting this quarter's margins compared to the records in the same period last year. These included: price increases to customers without margin benefit; operational inefficiencies to provide the best possible service to our customers while dealing with supply chain issues; and unfavorable brand mix, again, driven by supply chain issues. As expected, we have been neutralizing the dollar impact to commodities through our pricing actions. Our gross margin was impacted as sales increased with no change in gross profit dollars. This accounts for 350 basis points of the year-on-year change in consolidated gross margins for the quarter.

This rate dilution was expected, and the underlying margins for the business remain strong. I also want to reiterate our belief that driving incremental bottom line profitability is the best way of returning value to shareholders.

Now turning to North America. Net sales increased 13% in the third quarter. On a reported basis, the wholesale channel increased 12% and the direct channel increased 20%. North American adjusted gross profit margin declined 490 basis points to 39.9%. This decline was driven by the previously mentioned items. We have implemented several pricing actions over the last 12 months to offset rising input costs. While we have been neutralizing the dollar impact, commodity prices have increased beyond our prior forecast. We expect additional pricing actions to offset these headwinds in 2022, although we will feel a bit of cost pressure in the fourth quarter.

North America third quarter adjusted operating margin was 21.2%, a decline of 260 basis points as compared to the prior year. This is driven by the decline in gross margin I previously discussed, partially offset by operating expense leverage.

Now turning to International. Net sales increased 73% on a reported basis, inclusive of the acquisition of Dreams. On a constant currency basis, International sales increased 72%. As compared to the prior year, our International gross margin declined to 54.6%. This decline was driven primarily by the acquisition of Dreams and pricing benefit without change in gross profit. Our International operating margin declined to 22.1%. This decline, again, was driven by the acquisition of Dreams, the decline in gross margin and operating expense deleverage as costs in the current year have returned to a more normalized level. As a multi-branded retailer, Dreams sells a variety of products across a range of price points. Their margin profile is lower than our historical International margins, which is driving the major change in year-over-year margins internationally. Excluding Dreams, the underlying sales and margin performance internationally was in line with our expectations across both Europe and Asia Pacific.

Now moving on to the balance sheet and cash flow items. We generated strong third quarter operating cash flows of $285 million. We are running very light on inventory, and we would expect that our inventory days would increase by the end of the year to support our expected sales growth in 2022. At the end of the third quarter, consolidated debt less cash was $1.9 billion, and our leverage ratio under our credit facility was 1.7x.

Our strong financial performance and balance sheet resulted in positive signals from the capital markets. First, we received multiple rating agency upgrades during the quarter, resulting in the strongest credit ratings in the company's history. Second, we issued an $800 million 3 7/8% 10-year bond, which was significantly oversubscribed by the market. This bond secures our long-term flexibility at historically low rates and resulted in record liquidity of $1.2 billion at the end of the third quarter. This transaction will have the near-term impact of an incremental $7 million of interest in Q4 2021. We are temporarily holding excess cash. And over time, these funds will be invested to drive incremental EPS.

Now turning to our 2021 guidance. We have updated our full-year guidance to reflect our third quarter performance, the expectations to reduce our elevated backlog and incremental costs we expect to incur to service our customers through the balance of the year. We currently expect 2021 sales growth to exceed 35% and adjusted EPS to be between $3.20 and $3.30, for a growth rate of 70% at the midpoint. I want to note that this expectation on adjusted EPS includes a headwind of $0.03 from the increase in interest expense I noted before. Consistent with our prior quarter's commentary, we expect the fourth quarter will be unusually strong as we work off the large backlog we carried over from the third quarter and remove customers off allocations. We expect this to result in sales and profits being higher in the fourth quarter than in the third quarter. At the midpoint of our guidance, this implies EBITDA to grow over 30% in the fourth quarter versus the prior year.

Lastly, I'd like to flag a few modeling items. For the full year 2021, we currently expect total CapEx to be between $140 million and $150 million, D&A of about $180 million, interest expense of about $62 million, a tax rate of 25% and a diluted share count of 204 million shares.

With that, I'll turn the call back over to Scott.

[Scott Thompson, Chairman, CEO & President]

Thank you, Bhaskar. Great job. I want to provide some additional details about our plans for future growth. We have complementary building blocks in place that we believe will drive growth in our business for next year and beyond. The first major building block is the launch of our new line of Tempur products in our European and Asia-Pacific markets. The new products will have a wider price range with the super-premium ASP ceiling maintained and the ASP floor expanding into the premium category. This will allow us to reach a new segment of customers, substantially increasing our total addressable market internationally. We will launch and invest in these new products across our international markets in 2022.

Second key building block is the continuation of our initiative to expand into the domestic OEM market. In 2020, we recognized whitespace opportunity for Tempur Sealy in the OEM market and successfully generated $150 million in sales in our first year. We believe that we can grow our sales by 400% to $600 million by 2025 due to continuing - continuation of utilizing our best-in-class manufacturing and logistics capabilities to manufacture non-branded product. This will allow us to earn our fair share of approximately 20% of the bedding market we believe is serviced by OEM. This also is expected to decrease our cost per unit for our branded product as we spread fixed costs and drive more advantageous supply agreements.

The third building block of future growth is our expectation that we'll be able to service the entirety with a robust demand for our brands and products through the wholesale channel. Throughout 2021, because of supply chain issues, we've had to turn away new North American customers opportunities and have had our existing customers, including our e-commerce and retail operations, on allocation. Beginning in 2022, we anticipate being able to fully service demand and reengage with those new customers who approached us in the past about bringing on our brands and non-branded products. We also expect to return to a normalized brand mix dynamics as supply chain improves for both Tempur and Sealy operations.

The fourth building block is continued expansion through our direct channel. As I've said before, we believe that we have one of the fastest growing, most profitable direct-to-consumer bedding businesses in the world. We expect both our e-commerce and company-owned stores to have robust growth opportunities going forward. Our e-commerce will continue to focus on converting customers interested in purchasing online directly from a brand, while our retail operations are driving both same-store sales growth and expansion of new store counts. We currently operate over 600 retail stores worldwide and see opportunities to further increase our store count organically, about double digits annually for the next several years.

The fifth building block that will drive our future growth is continued investment in innovation. Consumers are growing - consumers have a growing appreciation for the importance of sleep to overall health and wellness and, as a result, are increasingly searching for new solutions and technology to help improve their sleep. We have a strong legacy of delivering award-winning products that provide breakthrough sleep solutions to consumers, backed by over a century of knowledge and industry-leading R&D capabilities. Our planned 2022 product launch simplifies how we will relentlessly drive innovation to continue to bring consumer-centric solutions to market.

Lastly, we expect to continue to execute on our capital allocation strategy. We run a balanced capital allocation plan, which contemplates supporting the business, returning value to shareholders via share repurchase and dividend and, on opportunistic basis, acquiring businesses that enhance our global competitiveness. We believe that our execution across these key building blocks will sustain double-digit sales and EPS growth in 2022 and position the company very well for sustainable long-term growth.

In closing, I briefly want to touch on ESG. We've embedded environmental, social and government factors into our core strategy to help deliver long-term value. For example, our new eco-friendly mattress collection I discussed a moment ago. We made a responsibly sourced material. We also expect our new U.S. foam-pouring facility to allow us to hire approximately 300 local employees. Our average annual salary for our U.S. manufacturing employees is above the national average, and it's about $42,000 a year. This facility will also include state-of-the-art equipment, which is expected to improve energy efficiency on a per product basis.

With that, operator, will you please open the call up for questions?

[Operator]

[Operator Instructions]. Our first question comes from Curtis Nagle of Bank of America.

[Curtis Nagle, Bank of America Merrill Lynch]

Scott, just a question on the '22 sort of - and beyond comments, right, double-digit sales and earnings. I don't think it's new, per se, in terms of sort of what you guys have said in the past, but it is in print, which I think is important. So I guess, what gives the confidence? And then just a very quick one on what are the biggest supply chain issues that are hitting Tempur at the moment. Yes, that's it.

[Scott Thompson, Chairman, CEO & President]

Thank you for your question. I mean you're asking about our confidence going into '22. I mean look at it from our standpoint. We just reported, I think, this is the ninth out of the last 10 quarters we've had double-digit sales and EPS growth. So a lot of momentum to start with within the business.

If you look particularly at the third quarter, I think we were at 20% growth in sales, but clearly highly constrained. We tried to outline the impact of that constraint. We had an increase in our backlog of about $100 million, primarily driven by Tempur. And then we've had customers on constraint, and that's primarily been North America Sealy. So I mean if you really put the $200 million, we feel we were constrained in the quarter, the underlying demand for our product was probably closer to 40%, and the organization wasn't able to realize that demand. You can see from our comments that we're working very hard to increase our capacity.

So assuming no macroeconomic events, assuming the virus is trending the way it is, we go into '22 feeling very good about demand. And it's really about just our ability to produce, and that's something that we're relatively in control of, assuming the supply chains kind of normalize. But feel very good, particularly about Tempur worldwide.

I'd also say, if you look at our direct business, which is a business that we obviously have total control over, the compound annual growth rate and that's what, 40-plus percent over the last 5 years, the stores, I think we called it out in the prepared remarks, are running 20% same-store sales. So our expertise in retailing continues to give us confidence.

You also slipped in an extra question because you're very skillful at that. So you kind of threw in a supply question. Look, the supply chain, I would say, in general, is getting better. I think we all still have to realize that the supply chain in the world is a little bit fragile, so it could get shaken up by something we don't know about. But as we sit here today, the supply chain issues are improving. As I think we called out last quarter, we are hoping we get normal seasonality, particularly in Sealy North America, where we've been constrained. We have gotten some normal seasonality in the fourth quarter on Sealy, and we've rapidly caught up in the backlog as it relates to Sealy. And the good news about that is it takes our customers off constraint in North America starting probably in the last week or so. But that's the first time they've been unconstrained - what, Bhaskar, about a year?

[Bhaskar Rao, EVP & CFO]

Correct.

[Scott Thompson, Chairman, CEO & President]

So thrilled to get the salespeople back out in North America to drive new customers and feel really good about our times to delivery on Sealy that we've struggled with over the last year. Thank you for your question.

[Operator]

Our next question comes from Seth Basham of Wedbush Securities.

[Seth Basham, Wedbush Securities]

Nice quarter. Just a couple of quick questions combined on the guidance. First, on the fourth quarter gross margin outlook, how should we think about that relative to the third quarter given some of these moving pieces? And then secondly, why no explicit EBITDA guide for the full year?

[Scott Thompson, Chairman, CEO & President]

Sorry. What was the last question?

[Seth Basham, Wedbush Securities]

EBITDA guidance for the full year. I didn't see that in your press release relative to what you had with the third - with the second quarter results.

[Scott Thompson, Chairman, CEO & President]

Okay. Got it.

[Bhaskar Rao, EVP & CFO]

Sure. So the easy way to think about GP percent in the fourth quarter is, as we called out, we did accumulate backlog on the Tempur side, and that's about $100 million. And the way I think about that is just flipping in the fourth quarter. So sequentially, we should see meaningful improvement from a GP perspective going from 3 to 4.

As it relates to EBITDA, for the full year, we did give a way to think about the fourth quarter where we said we would grow plus 30% on a year-over-year basis. So if you add the first 3 months - sorry, first 3 quarters of actuals, you can get to it.

[Scott Thompson, Chairman, CEO & President]

Yes. And I think on the EBITDA thing, we're trying to just move to simplify our guidance and pointing more towards EPS going forward.

[Operator]

Our next question comes from Robert Griffin of Raymond James.

[Robert Griffin, Raymond James & Associates]

Congrats on a good quarter. A long-term question, but a lot of interesting and powerful initiatives going on in the business, Dreams, OEM, some of the growth of the brand stuff. When you think long term and that algorithm you laid out, do you still see margin opportunities? Or is this model more of let's hold EBITDA margins here in the low 20s, generate robust cash flow in and drive EPS growth above peers?

[Scott Thompson, Chairman, CEO & President]

Great question. The way we think about margins is on a business unit basis. So there's margin opportunity in the various business units. But as those business units mix into the total, I don't know how to really think about the consolidated GP. And a lot of that's going to be determined based on what customers' preferences are and our execution. And as an example, the OEM business, which is a great business for us, but the margins are lower certainly than our Tempur business. We're just getting started in the OEM business. So it may blend differently. So what I would tell you is when I look at the individual businesses and we roll them up through our budgeting process, we continue to see margin opportunity in individual businesses, but how they mix is a difficult question at this point to answer.

[Operator]

Our next question comes from Atul Maheswari of UBS.

[Atul Maheswari, UBS]

Scott, you mentioned that the fourth quarter demand grew nearly 40% - or rather the third quarter demand grew nearly 40%, but the fourth quarter guidance implies about 30% revenue growth when you're expecting to work through some of the backlog as well? So is the guidance assuming that core demand slows? And if so, why would that be the case?

[Scott Thompson, Chairman, CEO & President]

I think what you're bumping into - and Bhaskar, you can weigh in on this - is, as we've mentioned, we have returned to what I call normal seasonality going into the fourth quarter. The third quarter, as you know, is the most - usually the most robust quarter for the industry. And as you come into the third quarter, we have felt some normal seasonality, primarily in Sealy, Tempur has plowed right through. Is that probably what he's running into?

[Bhaskar Rao, EVP & CFO]

Absolutely.

[Operator]

Our next question comes from Peter Keith of Piper Sandler.

[Robert Friedner, Piper Sandler & Co.]

It's Bobby Friedner on for Peter Keith. Just wanted to ask around high-end versus low-end sales trends and if there's anything to call out there as to a bifurcation between the two with the high-end leading feedback we hear from retailers that premium has been very strong. So wondering if you're starting to see any divergence in trends between the 2?

[Scott Thompson, Chairman, CEO & President]

Yes. I don't have any analytical data to prove it. But my gut feeling is exactly what you said. I think high-end and premium is doing the best. I think at the lower end it's probably cooled off some from what might have been a little bit of stimulus checks earlier in the year, but still good, but premium is clearly leading the way. And some of that may be from consumers more focused on health and being willing to spend on health and wellness as it relates to their experience with the pandemic, yes.

I think that's absolutely true. And quite frankly, that's a good trend for the manufacturers. Because obviously, we make more not just dollars, but margin, on the higher-end product in Tempur and Sealy and Stearns & Foster are certainly well positioned within the industry at the premium end.

[Operator]

Our next question comes from Keith Hughes of Truist.

[Keith Hughes, Truist Securities]

I had questions about the new Sealy product launch, the gel, the gel product. Can you just talk about how many SKUs will be part of that when you think you're going to get that out in the market and any other details you're willing to share?

[Scott Thompson, Chairman, CEO & President]

Sure. I'd tell you kind of the crushable wafer is kind of my slang word for it. We've got the product developed. It will be a Sealy product, call it middle market. Exact number of SKUs hasn't been determined. We expect it to be in the market in 2022. It's in testing to make sure it's best in class as we sit here today. I don't think it's a big product. I don't think it would be material to the organization. It's another one of those examples of where we find niche opportunities. And as the largest bedding manufacturer in the world, there's probably not a bed we can't make if we believe that there's a market there that's worth attacking. And so we're going to attack that market.

[Operator]

Our next question comes from Brad Thomas at KeyBanc Capital Markets.

[Bradley Thomas, KeyBanc Capital Markets]

Congratulations on all the momentum in the business here. Scott, I was hoping you could talk a little bit more about your channels in North America. It's been an unusual year as DTC was very strong a year ago, brick-and-mortar has bounced back. And I was wondering if you could just share a little bit more detail about where you're most optimistic from a channel perspective in North America as we look out to next year.

[Scott Thompson, Chairman, CEO & President]

Gee, that's a really interesting question. Because as you frame the question, you're right, there's been a lot of volatility within the channels in North America. I'm going to say without consulting people who probably know a hell lot more than me, if I had to pick a channel, I probably would say the in-store might grow a little bit faster next year than online. Not that online over the long term probably grows faster, but there's probably a little bit of. And they have got such tough comps. But I'm probably the most optimistic on in-store, which may sound a little funny. Because compared to online - over the next 12 months - and if you go kind of a 3-year, 5-year time frame, I'm probably more optimistic about the online experience.

We're seeing - like I mentioned before, really strong performance in the best-in-class retailers on their in-store performance. And I think customers are, when they go to a store, are clearly being are focusing on their health and wellness and moving to premium product. Online, it's good, but it's more difficult to move to premium product online. But probably right now, as we sit here, as I said before, more optimistic about in-store, which kind of sounds funny coming out of my mouth.

[Operator]

Our next question comes from Laura Champine of Loop Capital.

[Laura Champine, Loop Capital Markets]

I'm curious in your inventory balance, which grew significantly year-on-year. How much of that is from Dreams? And what should we expect in terms of inventory turns in that Dreams business that you've recently acquired?

[Bhaskar Rao, EVP & CFO]

Sure. So you're correct. The vast majority of the increase is associated with Dreams on a year-on-year and sequential basis. A way to think about it is - and if you look at the underlying, as I indicated, is that we're a little bit light on inventory. We would like to run with more inventory than we have now to be able to service our customers.

[Scott Thompson, Chairman, CEO & President]

The Tempur-Pedic piece.

[Bhaskar Rao, EVP & CFO]

The Tempur-Pedic piece, correct. So as you think about moving to the end of the year, I would anticipate overall that our cash cycle would increase by a couple of days, primarily driven by inventory days. As you think about Dreams specifically is as a retailer, they're also a manufacturer as well. So if you step back from that, retail generally has very - very low inventory and turns very quickly. However, given the manufacturing as well as retail nature of it, it would be a bit higher than what you'd expect from a retail - a typical retailer.

[Operator]

Our next question comes from Bob Drbul of Guggenheim.

[Robert Drbul, Guggenheim Securities]

I guess the question that I have is you talked about the inability to bring on new customers, but you do believe you'll be able to bring them on next year. Just wondered, is that something you anticipate like the first quarter of next year? And from like a supply chain perspective, you said it's getting better. I'm just trying to understand the expectations around the flow of bringing on some additional customers to the business.

[Scott Thompson, Chairman, CEO & President]

Right. we're talking generally in North America here that's been constrained. You should think about they come throughout the year. And they'll grow during the year because we're still going to be, I suspect, fighting some supply issues in the first quarter. So we'll be cautious, but I think you're probably talking about during the year and probably a little further back-loaded than front-loaded from a supply chain standpoint.

[Operator]

Our next question comes from William Reuter of Bank of America.

[William Reuter, Bank of America Merrill Lynch]

My question is on capital allocation. I think you mentioned that the share repurchases are now $700 million on an LTM basis. Given the strong cash flow generation that should be expected over the next year, how are you thinking about additional share repurchases? And I guess, what's the outlook for M&A like?

[Scott Thompson, Chairman, CEO & President]

Sure. Great question. Look, we've been running below our leverage target - 1.7, Bhaskar?

[Bhaskar Rao, EVP & CFO]

Yes.

[Scott Thompson, Chairman, CEO & President]

Yes, 1.7. And our range is really 2 to 3. We've been very clear, I think, that the reason we're below 2 has to do with the general health crisis around the world on the virus. And once, we'll call it, we're clear, we'd like to get back into our stated leverage ratio, call it, 2 to 3. Certainly, at the low end of that would be my perspective.

If you take that statement and play with a little bit of math, we've ably got some extra liquidity. We're going to generate a lot of cash flow. It's our estimates for next year. it would look like that we have significant powder to either do acquisitions or share repurchase, in fact, have to do 1 of those 2 or we'll drown in cash, and we'll be at a leverage ratio that would not be acceptable.

So my expectation right now is that next year will be a pretty robust year from a share repurchase standpoint. That could change depending on what goes on in acquisitions. As I've said before, we're constantly talking to people. We price stuff and then we patiently wait to see whether or not it makes a sense for the other side. I don't know. It's always hard to predict acquisitions. But I suspect we'll either be reasonably active in acquisitions or significantly active in buyback and probably a little bit above if I were guessing today.

[William Reuter, Bank of America Merrill Lynch]

Drowning in cash, that doesn't sound bad to me.

[Scott Thompson, Chairman, CEO & President]

It will, if I just use it to pay debt down, though. So I've got to do something with it. It's a high-class problem, but it's a problem we know how to deal with.

[Operator]

[Operator Instructions]. Our next question comes from Jonathan Matuszewski of Jefferies.

[Jonathan Matuszewski, Jefferies]

Scott and Bhaskar, nice quarter. I had a big-picture question on marketing. Obviously, we're in a supply-constrained environment. Some could say or some other folks have been pulling back on ad spend, but it feels like you haven't done this, and you guys have been all in on marketing. I think you commented on Stearns & Foster specifically in your prepared remarks. But just asking kind of more broadly your stance in terms of marketing going forward?

[Scott Thompson, Chairman, CEO & President]

Good. Great observation. We have chosen not to optimize the quarterly financial statements by trimming marketing. We thought about it. Because you're right, we're in a constrained environment, and you could ask like why spend the money because the demand is there. But we look at brand building as a long-term goal and part of what we owe to retailers. And so we have not pulled back on marketing. And we have been "all in." And we're going to continue to be all in from a marketing standpoint. We have called out Stearns & Foster because that's a historical change to lean into more advertising Stearns & Foster, a high-end brand that I think has, over a period of years, has outstanding opportunity to grow market share.

But no, we're all in on the advertising. We like the trends. We like the brand strength that we're seeing in our analytics. And again, it kind of goes back to a part of what gives us confidence in 2022. Because we're taking this momentum into next year as opposed to worrying about optimizing a quarterly income statement this year.

[Operator]

Our next question comes from Seth Basham of Wedbush Securities.

[Seth Basham, Wedbush Securities]

My question is on the backlog. You talked about a $100 million increase from the second to the third quarter. What would that be on a normalized basis for seasonality? And what do you expect the backlog to look like at the end of the fourth quarter relative to the third?

[Scott Thompson, Chairman, CEO & President]

I would say probably, on a normalized basis, we wouldn't even talk about backlog.

[Bhaskar Rao, EVP & CFO]

Correct. That's right.

[Scott Thompson, Chairman, CEO & President]

So we like normal. I don't expect everybody to talk about backlog again. And the end of the fourth quarter, I think Sealy will be totally back to normal is my expectation. And Tempur is really a question of how strong the sales are. And as I mentioned earlier, Tempur continues to be robust, and it's possible that we have a backlog on Tempur, smaller one, with backlog on Tempur going into the first quarter. But that's a demand guesstimation.

[Operator]

Our next question comes from Keith Hughes of Truist.

[Keith Hughes, Truist Securities]

Yes. Just a follow-up on international. Can you give us an idea of what organic growth in International was without Dreams? And maybe any comment on margins there, too, would be helpful, without Dreams.

[Scott Thompson, Chairman, CEO & President]

Absolutely. So internationally, without dreams, we did grow for the quarter. Also, from a gross margin standpoint, as I mentioned, Dreams is accretive to the whole. However, when you think about International specifically, it is dilutive on the GP perspective. So the underlying margins for both Europe and Asia Pac outside of Dreams were in line with our expectations.

[Operator]

Our next question comes from Brad Thomas with KeyBanc Capital Markets.

[Bradley Thomas, KeyBanc Capital Markets]

I was hoping to just address the question of margins overall. And I know that there are a number of elements of your business that have helped to drive some structural improvements in margins, but a question that we get for much of our coverage is how much are companies over-earning right now, if at all. And how much may margins have to come back in the face of some normalization and to some supply chain headwinds. And so I was hoping you all could just talk about how you think about that going forward here.

[Scott Thompson, Chairman, CEO & President]

Sure. From my perspective, I don't see us overearning, and let me put some meat around that. As I've already mentioned earlier on this call, we didn't pull back on advertising, so we have not changed that expense. So there's no optimization there. When I go into the plans, the plans are not running at normal efficiency. These supply disruptions have been very difficult on operations. And so when we look at our plan operations and statistics, we're off plan. I mean there - I've used the term we're running sloppy, and I don't mean that disrespectful because people are working damn hard. But we are optimized from an operational standpoint at the plant. So those numbers, certainly, we're not over-earning in any way.

On commodities, the way this works is we get hit with commodities first, and then we pass them on to the retailer. There's been a lag there. So what you've seen in the reported numbers is that lag where we've experienced commodity costs but not fully passed them on yet. So that's in the numbers. So that doesn't feel like I'm over-earning.

And then when we pass those commodity costs on to our retailers, we don't pass them with profit on there. So we just pass them to offset our cost. And as Bhaskar has explained, that's a headwind to the margin rate, even though on the margin dollars we fully offset. Now the retailer gets a little bit of benefit there because we do pass cost on with margin, but the manufacturer does not make that.

So unless you think the sales volume is unusually high and the total sales volume is going to come down, I can't find anywhere in the income statement it looks like there's any over-earning. Bhaskar, can - I mean we're expediting beds and supplies to service customers. I don't see anything...

[Bhaskar Rao, EVP & CFO]

No, that's right, Scott.

[Scott Thompson, Chairman, CEO & President]

On the over-earning. I'm kind of hoping that things kind of go back to normal because I think you'd see some improvements in the other areas.

[Operator]

I'm showing no further questions at this time. I'd like to turn the call back over to Scott Thompson for any closing remarks.

[Scott Thompson, Chairman, CEO & President]

Thank you, operator. So nearly 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 in Tempur Sealy's leadership team and its Board of Directors. This ends the call today. Operator, thank you.

[Operator]

Thank you. Ladies and gentlemen, this does conclude today's conference. Thank you all for participating. You may now disconnect. Have a great day.