On this podcast, Stephen D’Aquila provides a range of insights and guidelines that will be valuable to lenders with borrowers involved in the mattress industry
On this podcast, Stephen D’Aquila provides a range of insights and guidelines that will be valuable to lenders with borrowers involved in the mattress industry
Steve Katz
Hey everybody, and thanks for listening in in our Hilco global smarter perspective podcasts. I'm your host, Steve Katz. And welcome. We're really glad you could tune in today. Today, we're going to be discussing some important considerations for lenders with borrowers or prospective borrowers who are involved in the mattress industry. And with us for that conversation is returning podcast guest Stephen D'Aquila, Senior Vice President of Hilco valuation. Stephen, welcome back to the podcast.
Stephen D'Aquila
Glad to be here, Steve, thanks for inviting me back on.
Steve Katz
Yeah, well, we're glad to have you. Last time, we had a really great conversation. So this time, we're switching up a bit and talking about the mattress industry. And I think it's probably safe to say that the general public has been somewhat confused by the industry for forever, really, with so many mattress types and furnaces. And the naming of some mattresses from a given manufacturer is seemingly different across at least what seems to be every different mattress retailer. I know, when my wife and I went to buy a memory foam mattress recently, we were pleasantly surprised that they were they were referred to by the same exact name. And everywhere we went, which was kind of kind of nice for a change. But for lenders, also the industry can be very confusing and complex. And there's certain things that can help to prepare and aid them when they're working with a new or existing borrower in the space. So what are some of the key things that lenders need to understand in regards to the mattress industry?
Stephen D'Aquila
Sure, you really bring up a lot of good points Steve and kind of going initially with your example of you and your wife shopping for a mattress. Really what we've seen is that these purchases are done on an infrequent basis, the repurchase rate of a mattress or the cycle rate of a mattress is called once every decade or so. So an individual is not really accustomed to buying mattresses on an ongoing basis. And because of that, they're going to experience some degree of shock when they walk into a retail store and see all the different models and brands options available to them. And so with that, what we're finding is a lot of consumers, thanks to the Internet are going to educate themselves in advance of going into the store location itself. But at that point, once they do get to the store, they're going to be met with a wide variety of price points. And the cost increases probably dramatically from the last time they purchased a mattress. So at this point, it really takes the knowledge and this the skill of an educated sales associate, to really walk through those consumers through the entire decision making and buying process. And now when it comes to the lenders themselves, and what they should be looking out for when it comes to mattress types deals, you really need to take a step back and think of the mattress industry as a whole. And you know how it's been really changing and evolving, you know, the competitive landscape, for example, and even product offerings that are available. Now originally, the industry was dominated by a handful of major players. But more recently, we've seen a number of disruptors entering the market. And these disruptors could be in the form of offering bed in a box type, product or even importers a product that could be direct shipping to customers from vendor direct to end customer location. Going back a number of years, the market was dominated by the innerspring offering from a variety of different providers, more recently called in the early 90s temperpedic came in with an introduction of the memory foam option. And since then, there's actually been a third option, which would be considered a hybrid. So a mix of the two. So you have the inner spring with the memory foam topper to it. So this just adds additional skew offerings for the for the customers to take a look at. And then beyond mattresses, the customers then also are exposed to a wide variety of complimentary type offerings. So if you're getting a mattress, maybe you're going to get pillows with it or protectors or a frame or sheets, etc. So all these just add incremental inventory type skews, etc. That all need to be properly managed and monitored by by a lender.
Steve Katz
Yeah, it's it is interesting because I think one of the other things that we noticed when we were shopping just bringing it back to that again, was there were all sorts of other things in the store that we didn't weren't used to seeing and originally it seemed like you'd go in there were mattresses and there were, you know, bedframes or maybe some basic headboards and things now there were all these other other things right pillows and sheets and accessories. So um have, you know a lot more to keep tabs on the business itself seems to be getting more complex. And when we compare the current period, which, obviously on a lot of fronts is presenting some really tough economic challenges for buyers and sellers, really, when we compare that with the pandemic period and previous years, how would you assess the current state of the industry right now?
Stephen D'Aquila
Well, a lot has happened. And I think you're going to see some of the same points that are raised on other industries that have influenced the mattress industry in general. So if you take a step back, and you think about, you know, once the pandemic started, there was obviously a switch in terms of what customers were spending their money on, the spending was diverted away from travel and entertainment. And as you were stuck in your house, you're buying more type items that are called in home type purchases, and for IN HOME use, and with that, you see a corresponding favorable impact for mattress sales among a variety of different other product categories. And then as the pandemic progressed, individuals that might have been living in the city said, You know what, I'm going to move into the suburbs. And then when they move from that one or two bedroom apartment into a three, four plus bedroom house, you need to now fill these rooms with additional bedding type items, including mattresses. And then on top of that, then you have the introduction of the economic stimulus. And with the economic stimulus, consumers wallets were fatter, they now had opportunity to spend money on larger ticket items, mattresses included. So all that led to a boom in overall sales performance for most, if not all the mattress companies within the industry. But then from there, as the economy started to open up, as consumers were able to spend more on an outside travel are going out, they then began to push dollars away from in home purchases, where the demand was pulled, and now toward other options. And then more recently, you have rising interest rates. And as interest rates rise, you see the housing market slowed down. And then you have the fact that the interest rates are also tied to financing, which is very, very popular within you know, higher ticket type purchase items, including mattresses. So we're seeing definitely a pullback in sales velocity and unit volume within the mattress inventory in comparison to you know, the last few years. But all that being said, mattresses are purchased on a repeat cycle, there's a very normal buying process that that occurs. I mean, you're looking at a market that sells maybe 36 or so million dollars or a million units of mattresses per year. It has a market of 75,000 employees within it. So it's a very robust industry with a standard type of sale through rates. And it's just experiencing right now a little bit of softness, given the current market conditions.
Steve Katz
Yeah. And that's consistent with what I think we're seeing in a lot of industries. Certainly, as we've had these conversations, that impact on the consumer, from so many directions is taking a toll. But as you said, it's a pretty predictable industry, which is in at least in for that as at some level of simplicity for lenders, but it is a complex topic. So let's dig into the areas that you would consider essential for a lender to have in order to possess a firm grasp when it comes to the industry and borrowers in the market. Today, what what what are some of those areas?
Stephen D'Aquila
Sure I mean, one of the first areas and there's a number of different collateral monitoring points that I would suggest looking at on an ongoing basis. But one of the first one comes to mind is you mentioned earlier about going into a store and seeing a wide variety of different offerings. And so, SKU count how many different models and individual SKUs that are available, are within the company's product mix. So when you think of just mattresses by themselves, you have traditional sizing, that's going to be twin, twinXL, full, queen, king, California, California king, and then from there, you have firmness options. And then if you're a multi brand retailer, you'll have multiple brands. So you start extrapolating this and that becomes a build an overall SKU count. And so what we do to really get an understanding of how items are performing models or performing our sizes are performing is what we like to do on our appraisal is request and review inventory by size and then corresponding sales by size. And we could see what those percentages are and if there are any imbalances there and we really hone in on what may or may not be a backlog of inventory. Generally speaking your queen mattress is going to perform the strongest from a sales velocity standpoint, that's going to be usually followed by a twin as well as a King. And then from there the full size and the California king earlier a little bit lower velocity type type items beyond looking at just the mattresses themselves and for imbalances there, you have to think of all the other items that are also going to be size specific that we'll call it non mattress inventory. So whether it's sheets or duvet, or foundations, all of those items from a sizing and a sales to inventory mix position should also be monitored. And in addition to sizing as I mentioned earlier, you have firmness, so you might have a soft or medium or a firm type mattress. Or if it's pillows, you could have a standard size, or a king size and various lofts and firmness. So as you can imagine, this really is a large amount of different variations of product. And all of that should really be understood. From there, I think another area to look at is bedframes. And bases. Companies are more likely offering in store adjustable foundations to become very popular in the last several years. And adjustable nominations are size specific. But when a customer comes into a store location, they're not coming in for a foundation or adjustable base, they're coming in for a mattress, and maybe they buy an adjustable base if the price is right, or the incentive is there. So when we look at the overall inventory mix, we have to understand the general attach rate historically of ancillary type products for every mattress purchase, because as you would imagine, when you're running a sale event, and you run out of all the mattresses, then how do you sell those ancillary items that we require deeper and deeper discounts to sell them through. And that's why we look at product turnover rates. And so when we look at product turnover, we look at how our mattress is turning, you know individually as a segment. Historically, most mattresses have been purchased from domestic providers, and more of a just in time basis. Because as you imagine a mattress is big and it's bulky, and it's not freight efficient. So you're going to want to purchase it from a provider that's that's close by to your store. But with the entrance of Bed In A Box that cubes out much more efficiently, and is much more cost effective from an import freight perspective. So we've seen the importers of mattresses, namely bed in a box, mattresses are now procuring those goods, those have longer lead times. So the turnover rates of those particular mattresses might be slower in comparison to their domestically sourced alternatives. And then when you think of the accessories, all the accessories that I mentioned, the non mattress type items, those are generally important as well, and would have slower turnover rates. So from an appraisal perspective, the way we look at this is we effectively segregate mattress versus non mattress. Because the expected multiplier and the general recovery value for those two different asset classes will differ. And overall, within this business, you're generally not going to develop a strong multiplier for the mattress inventory, because of the fact that it's a long replacement cycle. If you don't need a mattress, you're not just going to go out and buy a mattress because there's a liquidation going on. So we consider that all in our overall appraisal disposition strategy within our reports.
Steve Katz
Yeah, that makes a lot of sense. What about and we've talked about this in regard to some other industries. But what about factors like dumping where products are sold into the US market at a price point that's way below comparable market pricing?
Stephen D'Aquila
That's a great point, Steve. So when you think about dumping this is when a competitor, typically an international competitor is trying to gain market share within the United States. And what they will do is they will produce a product and then sell it into the United States, potentially at or below cost. So it's effectively a non competitive pricing strategy. And with that, oftentimes, these companies will get support potentially from the government themselves to be able to do that without going out of business. So you'll see that practice predominantly in China, but it's expanded out to other countries as well, Malaysia, Indonesia, just just to name a couple. And in response to that the US has enacted various anti dumping policies to kind of even the playing field. And in doing so the US will place additional duties and those duties can be very pricey could be 100 plus percent of the initial selling price to the product on those goods. And with that, you'll see that now the buyer the domestic buyer, of whatever accompany might be sourcing these mattresses will now have to evaluate, does that added duty offset the value that they're receiving from a cost basis. So one thing that I would recommend lenders doing is if the company is importing product to understand where it is being sourced from what duties do apply to the product being sourced, and if there's been any changes historically, or going forward in the future on on those duty policies. And then one other point that I just thought of is delivery. And if you think of delivery, that's a very big part of the mattress and industry from a customer standpoint. So typically, when you go to the store, it's generally not cash and carry, you're not putting a mattress on the top of your car, very few people are doing that, instead, you're looking to have that mattress delivered to your house. And whether it be a threshold delivery, or call it a white glove type treatment, where they bring it up flights of stairs and positioning in your room and, you know, maybe ordered an adjustable base, and they'll assemble the adjustable base for you. And with all that, you know, obviously there's a cost for the company associated with it. But in addition to that, you have the potential for a revenue stream as well for the company. So when we look at delivery, for an appraisal perspective, we would have to assume that these type of delivery options will continue in a liquidation, we have to assume the historical expense run rates this and we keep an eye on how have these expense run rates changed from year to year. In addition to that, what we've noticed is speed to customer is is key to winning the competitive advantage. So the companies that have really mastered this have multiple distribution points within their sales territory. And when you do have multiple distribution points that could be to inventory build, and just overall incremental cost. So these are additional considerations that we look at to understand the overall operating expense structure that we would employ within our appraisal.
Steve Katz
Yeah, the delivery piece seems just even by itself pretty complex. And obviously, the expectation for delivery has really increased over the past several years. So make sense that that would be something you'd have to factor in. What else what else should lenders be aware of? Not that not that there's a shortage of topics here. But it seems like there are a lot of things are there other other things they should be looking at when working with borrowers and industry?
Stephen D'Aquila
Financing comes to mind. I mean, if you think about it, you're spending 100,000s of dollars potentially on a mattress. And particularly in today's economy, the ability to make that upfront payment might not exist for a number of consumers. And what the furniture industry in general has realized is that multi year, interest free financing options are a driver of of sales velocity for companies. So that multi year interest refinancing is something that was pioneered by the furniture industry. And these mattress specialty companies really have to follow suit. The challenge is, is that during the current economic environment with rising interest rates, the cost to provide these programs whether it's internally or externally provided through a third party, it becomes more of a cost burden. In addition to that, with macro economic headwinds, hitting consumers that might also influence credit scores and approval rates and the approved credit amount, for example, or even the default rate. So all these variables then influence overall financing activity, which is a key piece of the puzzle, because if consumers are not given a financing option, it becomes much more difficult to make that purchase on a one time basis. Then from the financing, and I guess, to kind of help customers navigate, you know, not just what product to buy, but also how to finance it, you need sales associates that are competent in providing customers with all this information. And the sales associates are commission based generally or have some sort of incentive to, to attract and retain them with with the company. And those commissions or incentives could be a function of what type of product is being sold or the margin that's achieved or the overall sales that is being generated. With that these the sales associates will receive a commission and the Commission's could sometimes be fairly material. And those commissions could be netted against any customer returns. And usually within this industry customers are given 100, 100 Plus Day Night trials and then could can return the product and exchange the product if they don't like it. And so there's always a lag between making the sale and receiving that commission for a sales associate and it could be a week or two. So there's generally going to be an unpaid commission liability that the company may be on the hook for. And that's an area that the lender should investigate to understand that overall risk. From an appraisal perspective, the Commission's would need to continue the sales associates you would be, it's important to retain them for the duration of the sale, especially in the retail environment. And so that type of expense is something that we incorporate into our inventory appraisal. In addition to that, you have seasonality. Unlike most retailers who have that big fourth quarter, you're not going out to buy a mattress because it's around the holidays. There's a certain cycle of when customers buy a mattress, and that's obviously first and foremost dependent upon need, or the replacement need. But then the traffic into the store is also driven by promotional events that the industry runs. And the industry runs on a pretty set cadence. They revolve around key holidays, Memorial Day, Presidents Day, etc. So you'll see sales demand fluctuate by promotion timing, as opposed to time of year from a strict sale sale seasonality standpoint. So based upon all this, in our opinion, when we look at inventory appraisals, we might provide 12 monthly annualy these for a mattress company, but end of the day, the deviation between the animal V in month one versus month two versus month three will be very limited because of the lack of materials seasonality within the business.
Steve Katz
Yeah, I was gonna ask you about that changes over time. So that's thanks for making that point. What about, you know, commodity markets, perhaps material composition that might be influenced by prices, anything?
Stephen D'Aquila
Oh, that's that's another great point. So so if you think about the mattresses, you have innerspring, then you have foam and then you have a hybrid combination of the two, the inner spring and I mentioned earlier the adjustable base of steel construction there. And with that steel changes in the steel market will influence initial cost of the inventory. And then with the flow mattress that's influenced by changes in oil pricing. So that these are two different areas that you know we would look at and you know, there's others as well, but those are the two drivers. How changes in different commodity markets will influence the company's first cost and then consequently, will could influence pricing to the customer as well as achieved gross margin competitive market too. A lot of changes have occurred over the last several years. Even more recently, in the news was temper Sealy and temper Sealy has a definitive agreement currently to purchase Mattress Firm, which is the largest specialty mattress retailer in the United States. So that would be a huge deal that's expected to close in 2024. Also had Serta Simmons bedding they filed for Chapter 11 in January and Klaussner furniture and it's a brand that's been around for 60 plus years also shuttered its operations in August. So a lot of movement there in a competitive market consolidation, General headwinds to on financial performance is creating some changes that other lenders should be more aware of. And then I think finally, when it comes to the inventory, we talked a lot about the call it first quality inventory being sold, whether it be a mattress or an accessory type item, you also have the potential for floor models in retail setting as well as pre owned inventory, which is generated by customer returns. Once a customer returns a product. If it is to be sold, it would have to be reconditioned and labeled as pre owned. So one thing we take a look at is is this product, whether it's the pre owned inventory or the floor models, is it in inventory? And are they selling it? Or are they donating it or destroying it? And if they are selling it? What cost basis? are they holding it at? It's generally less than the cost basis on the first quality goods? And when they do sell it? What type of margin are they achieving on the product? So when you have a company that's a mattress, retail or any commerce player, we'd want to get an understanding of how frequent returns come in. Where are those returns in the process? Have they been quarantined? Are they evaluated? Are they now sellable? In addition to that there are routine floor resets and when a floor reset occurs, then the floor models that would be on the floor that are the call to the legacy models would then be potentially available to be sold. So getting an understanding of what's going on with all those different call it inventory types is important to know as a lender and how it pertains to the overall appraisal approach.
Steve Katz
Yeah, again, quite a bit to unpack in what you're talking about that last area in terms of what happens to that inventory? How you know how it's disposed of. Very, very interesting stuff. And I wish we could keep going, because obviously, there is so much to talk about. But we do have to wrap up anything else you just wanted to mention that we didn't cover before we finish up?
Stephen D'Aquila
I think we made good progress through a number of the key points as our listeners know by now, the actual written article is on our website. And they could definitely follow up on looking through that article to see more detail of going through all the points that we've raised, and then some, but I think I would like to just close on more of a general look as to what lenders should be looking at within the mattress industry for it's an ongoing type monitoring basis. And really, to me, when you think about it, what influences the purchase of a mattress is really dependent upon key lifecycle events for consumers, whether it be getting married, or moving into a new home or a larger home or having their children graduate into an adult bed or their children moving off to college and then needing a mattress for an off dormitory, an off site dormitory, and even divorce. So all of those life events are key areas that will influence overall mattress demand. But to me, one of the main points to look at is just changes in the housing market, new housing starts and existing home sales, as those fluctuate and that fluctuation can be found in the Case Shiller price index for housing, which will be a good resource for lenders to look at. But that will have an influence on overall demand within the mattress industry. In addition to that, changes in interest rates, interest rates are influential in a customer's buying decision criteria, particularly as it relates to the financing a product that also influences the company's ability to borrow because it has a direct impact on collateralized inventory borrowing. So, again, areas that no another lender would want to take into consideration as they review this type of industry.
Steve Katz
Yeah, absolutely. Well, listen, Stephen, thanks so much for joining us today to share all this important information for lenders to the mattress market. And if any listeners do want to reach out with follow up questions to discuss efforts they might currently be involved with, what's the best way for them to get in touch?
Stephen D'Aquila
Sure, happy to answer any questions or any follow up questions that anyone has I can be reached by email or phone my email address is S DAQUILA At Hilcoglobal.com. That's SDAQUILA at Hilcoglobal that HILCOglobal.com. And my phone number is area code 857-204-2841.
Steve Katz
All right, perfect. Thanks again, Stephen. Really great having you on again. And listeners if you're lending or looking to lend into a business that's involved in the mattress industry. Do be sure to connect with Stephen for details, I'm sure that he and the team can help to ensure your successful endeavors in the market. And as always, we hope that this smarter perspective podcast provides you with at least one key takeaway that you can put to good use in your business, or share with a colleague or client to help make them that much more successful moving forward. Until next time for Hilco global. I'm Steve Katz.