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TPX > SEC Filings for TPX > Form 10-Q on 2-May-2014All Recent SEC Filings

Show all filings for TEMPUR SEALY INTERNATIONAL, INC.

Form 10-Q for TEMPUR SEALY INTERNATIONAL, INC.


2-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the accompanying Condensed Consolidated Financial Statements and accompanying notes included in this Form 10-Q. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are subject to numerous risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" and "Risk Factors" elsewhere in this quarterly report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2013. Our actual results may differ materially from those contained in any forward-looking statements.

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the three months ended March 31, 2014, including the following topics:

• an overview of our business, including the acquisition of Sealy Corporation and its subsidiaries ("Sealy") that closed on March 18, 2013 ("Sealy Acquisition");

• the effect of the foregoing on our overall financial performance and condition;

• our net sales and costs in the periods presented as well as changes between periods; and

• expected sources of liquidity for future operations.

Business Overview

General

We are the world's largest bedding provider. We develop, manufacture, market, and distribute bedding products, which we sell globally. Our brand portfolio includes many of the most highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic®, Optimum™, and Stearns & Foster®. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.

We sell our products through three distribution channels in each operating business segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); Direct (e-commerce platforms, company-owned stores, and call centers); and Other (third party distributors, hospitality and healthcare customers).

Business Segments

We have three reportable business segments: Tempur North America, Tempur International, and Sealy. These reportable segments are strategic business units that are managed separately based on the fundamental differences in their operations. Our Tempur North America segment consists of two U.S. manufacturing facilities and our Tempur North America distribution subsidiaries. Our Tempur International segment consists of our manufacturing facility in Denmark, whose customers include all of our distribution subsidiaries and third party distributors outside our Tempur North America and Sealy segments. Our Sealy segment consists of company-owned and operated bedding and component manufacturing facilities located around the world, along with distribution subsidiaries, joint ventures, and licensees. We evaluate segment performance based on net sales and operating income.

Strategy

We are the world's largest bedding provider and the only provider with global scale. We believe our future growth potential is significant in our existing markets and through expansion into new markets. In order to achieve our long-term growth potential while managing the current economic and competitive environment, we will focus on the key strategic growth initiatives discussed below:

Product Innovation

We will continue to invest in research and development to leverage the combined technologies of our comprehensive portfolio of products to deliver a stream of innovative products. Our goal is to provide consumers the best bed and best sleep of their life and to provide our retailers a complete and optimal offering across brands, products, and prices to drive growth. We will also pursue opportunities to enter or develop new product categories.


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Marketing

We will continue to invest in advertising to increase consumer awareness, preference and loyalty for each of our key brands. We will also invest in in-store marketing and direct sales to maximize our sales opportunity driven from national brand and retailer advertising.

New Market Expansion

We will pursue opportunities to expand into new international markets and over time into non-consolidated markets where our brands are currently represented under licensee, joint venture or third party distributor agreements.

Supply Chain ("Easier To Do Business With")

We are committed to building a world-class supply chain that is "easier to do business with." Our goal is to improve efficiencies related to purchasing and delivery, as well as inventory management to drive sales growth.

Our strategic growth initiatives will be supported by cost synergies realized from the Sealy Acquisition as well as through our ongoing cost productivity initiatives.

Factors That Could Impact Results of Operations

The factors outlined below could impact our future results of operations. For more extensive discussion of these and other risk factors, please refer to "Risk Factors", under Part I, ITEM1A of our Annual Report on Form 10-K for the year ended December 31, 2013.

General Business and Economic Conditions

Our business has been affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The global economic environment continues to be challenging, and we expect the uncertainty to continue. In light of the macroeconomic environment, we continue to take steps to further align our cost structure with our anticipated level of net sales. We continued to make strategic investments, including: introducing new products; investing in increasing our global brand awareness; extending our presence and improving our Retail account productivity and distribution; investing in our operating infrastructure to meet the requirements of our business; and taking actions to further strengthen our business.

New Product Development and Introduction

During 2014, we will roll out several new product lines across our Tempur and Sealy brands. These launches represent a significant replacement of our core product lines. New product introductions represent a significant investment of time and resources in research and development to improve our existing product offerings and introduce new product lines. There are a number of risks inherent in our product introductions, including the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, product introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, which could impact profitability.

Competition

Participants in the bedding industry compete primarily on price, quality, brand name recognition, product availability, and product performance. We compete with a number of different types of mattress alternatives, including standard innerspring mattresses, viscoelastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These alternative products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, Internet, telemarketing programs, television infomercials, television advertising and catalogs.

Our Tempur North America segment competes in the non-innerspring mattress category and contributed 30.3% of our net sales for the three months ended March 31, 2014. The non-innerspring mattress category is highly competitive, with several non-innerspring competitor products supported by aggressive marketing campaigns and promotions. As a result of this competition, our results could continue to be challenged.


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Financial Leverage and Liquidity

As of March 31, 2014, we had $1,845.3 million of debt outstanding, and our stockholders' equity was $151.5 million. Higher financial leverage makes us more vulnerable to general adverse competitive, economic and industry conditions. There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowing will be available. As of March 31, 2014, our ratio of funded debt less qualified cash to EBITDA was 4.6 times, within the covenant in our debt agreements which limits this ratio to 5.0 times for the three months ended March 31, 2014. For a table setting forth the principal financial covenants under the 2012 Credit Agreement, by quarter, see "Item 2 - Liquidity and Capital Resources - Debt Service". For more information on this non-GAAP measure and compliance with our 2012 Credit Facility, please refer to the section set forth below "Non-GAAP Financial Measures".

Sealy Integration

Our Sealy Acquisition is significant, and we may not be able to successfully integrate and combine the operations, personnel and technology of Sealy with our operations. Because of the size and complexity of Sealy's business, if we do not successfully manage integration, we may experience interruptions in our business activities, a deterioration in our employee and customer relationships, increased costs of integration and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations. We may also experience difficulties in combining corporate cultures, maintaining employee morale and retaining key employees. The integration may also impose substantial demands on our management. There is no assurance that improved operating results will be achieved as a result of the Sealy Acquisition or that the businesses will be successfully integrated in a timely manner.

Gross Margins

Our gross margin is primarily impacted by the relative amount of net sales between our business segments. The Sealy segment operates at a significantly lower gross margin than the Tempur North America and Tempur International segments. If Sealy's net sales increase as a percentage of total net sales, our gross margin will be negatively impacted. Additionally, our Tempur North America gross margin has historically been lower than that of our Tempur International segment. Our gross margin is also impacted by fixed cost leverage; the cost of raw materials; operational efficiency; product, channel and geographic mix; volume incentives offered to certain retail accounts; and costs associated with new product introductions. Future increases in raw material prices could have a negative impact on our gross margin if we do not raise prices to cover increased cost.

Our gross margin can also be impacted by our operational efficiencies, including the particular levels of utilization in our manufacturing facilities. If we increase our net sales significantly the effect of this operating leverage could have a significant positive impact on our gross margin. Conversely, if we experience significant decreases in our net sales, the effect of this operating deleverage could have a significant negative impact on our gross margin. Our margins are also impacted by the growth in our Retail channel as sales in our Retail channel are at wholesale prices whereas sales in our Direct channel are at retail prices.

In 2014, we expect gross margin to benefit from cost synergies and leverage, offset by investments in new products and foreign exchange. Floor model shipments will be elevated in the first half of 2014 as we complete our new product roll-outs. However, we expect floor model shipments will be much lower in the second half of 2014.

Exchange Rates

As a multinational company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign exchange rates. We use foreign exchange forward contracts to manage a portion of the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as between our subsidiaries themselves. These hedging transactions may not succeed in effectively managing our foreign currency exchange rate risk.


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Sealy Acquisition

On March 18, 2013, we completed the Sealy Acquisition. Our results for the first quarter of 2013 include Sealy's results of operations from March 18, 2013 through March 31, 2013. Our Sealy segment manufactures and markets a complete line of bedding products under the Sealy®, Sealy Posturepedic®, Optimum™, and Stearns & Foster® brands. Sealy's results of operations are reported within our Sealy reportable segment. Refer to Note 2, "Business Combination", in our Condensed Consolidated Financial Statements included in Part I, ITEM 1 of this Report for a discussion of the Sealy Acquisition. The total purchase price was $1,172.9 million, which was funded using available cash and financing consisting of our 2012 Credit Agreement and Senior Notes. Refer to Note 4, "Debt", in our Condensed Consolidated Financial Statements included in Part I, ITEM 1 of this Report for the definition of these terms and further discussion.


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Results of Operations

A summary of our results for the three months ended March 31, 2014 include:

• Earnings per diluted share ("EPS") in the first quarter of 2014 were $0.44 compared to EPS of $0.20 in the first quarter of 2013. The 2013 and 2014 results reflect transaction and integration costs related to the Sealy Acquisition. We completed the Sealy Acquisition in March 2013, and results for the first quarter of 2013 include Sealy's operations from March 18, 2013 through March 31, 2013.

• Adjusted EPS were $0.53 in the first quarter of 2014 as compared to adjusted EPS of $0.62 in the first quarter of 2013. For a discussion and reconciliation of EPS to adjusted EPS, which is a non-GAAP measure, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information".

• Net income in the first quarter of 2014 was $27.4 million as compared to net income of $12.5 million for the first quarter of 2013. We reported adjusted net income of $32.6 million for the first quarter of 2014 as compared to adjusted net income of $38.2 million for the first quarter of 2013. For a discussion and reconciliation of net income to adjusted net income, which is a non-GAAP measure, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information".

• Net sales increased 79.9% to $701.9 million in the first quarter of 2014 from $390.1 million in the first quarter of 2013. The net sales increase was due to a full quarter of Sealy net sales in the first quarter of 2014 of $363.2 million as compared to $46.7 million in the first quarter of 2013, which included the period of March 18, 2013 through March 31, 2013.

• Gross profit margin was 38.4% as compared to 48.3% in the first quarter of 2013. The gross profit margin decreased primarily as a result of the inclusion of a full quarter for the Sealy business, which has lower margins than the Tempur North America and Tempur International segments, as well as changes in product mix and higher new product launch costs, offset partially by geographic mix and lower sourcing costs.

• Operating income was $62.4 million as compared to $44.5 million in the first quarter of 2013. Operating income in the first quarter of 2014 included $7.4 million of integration costs related to the Sealy Acquisition. Operating income in the first quarter of 2013 included $16.0 million of transaction and integration costs. The higher operating income reflects a full quarter of Sealy results in the first quarter of 2014.


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The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales:

                                                         Three Months Ended March 31,
(in millions, except per common share amounts)           2014                  2013 (1)
Net sales                                        $ 701.9      100.0  %   $ 390.1     100.0  %
Cost of sales                                      432.4       61.6        201.7      51.7
Gross profit                                       269.5       38.4        188.4      48.3
Selling and marketing expenses                     143.0       20.4         86.4      22.1
General, administrative and other                   70.3       10.0         58.7      15.0
Equity income in earnings of unconsolidated
affiliates                                          (1.7 )     (0.2 )       (0.2 )       -
Royalty income, net of royalty expense              (4.5 )     (0.6 )       (1.0 )    (0.2 )
Operating income                                    62.4        8.8         44.5      11.4

Other expense, net:
Interest expense, net                               22.2        3.2         27.9       7.2
Other expense, net                                   1.0        0.1          1.5       0.4
Total other expense                                 23.2        3.3         29.4       7.6

Income before income taxes                          39.2        5.5         15.1       3.8
Income tax provision                               (11.5 )     (1.6 )       (2.6 )    (0.6 )
Net income before non-controlling interest          27.7        3.9         12.5       3.2
Less: Net income attributable to non-controlling
interest                                             0.3          -            -         -
Net income attributable to Tempur Sealy
International, Inc.                              $  27.4        3.9  %   $  12.5       3.2  %

Earnings per common share:
Basic                                            $  0.45                 $  0.21
Diluted                                          $  0.44                 $  0.20

Weighted average common shares outstanding:
Basic                                               60.7                    60.0
Diluted                                             61.9                    61.2

(1) Results of operations for the three months ended March 31, 2013 include Sealy results from the post-acquisition period March 18, 2013 through March 31, 2013.


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                              CONSOLIDATED SUMMARY

                           Net sales and gross profit
                                                   Three Months Ended    Three Months Ended     % Change 2014
(in millions, except percentages)                    March 31, 2014        March 31, 2013          vs 2013
Net sales                                          $       701.9         $       390.1             79.9  %

Net sales by segment:
Tempur North America                                       213.0                 225.9             (5.7 )%
Tempur International                                       125.7                 117.5              7.0  %
Sealy                                                      363.2                  46.7            677.7  %

Gross profit                                               269.5                 188.4             43.0  %
Gross margin                                                38.4 %                48.3 %

Three months ended March 31, 2014 compared to the three months ended March 31, 2013

Net sales increased $311.8 million, or 79.9%. The increase was due to the increase in Sealy's net sales of $363.2 million for the three months ended March 31, 2014 compared to net sales of $46.7 million during the post-acquisition period March 18, 2013 through March 31, 2013. The increase in net sales was partially offset by decreases in our Tempur North America segment in bedding net sales, driven by decreases in our Retail and Direct channels. Additionally, our Tempur International segment net sales increased primarily due to strong performance in Europe, Asia-Pacific, and Latin America.

Gross profit increased $81.1 million, and gross margin declined 990 basis points. The increase in gross profit was due to the inclusion of a full quarter of Sealy's gross profit of $108.6 million, offset by Tempur North America's gross profit decrease of $17.7 million. Sealy's gross margin for the three months ended March 31, 2014 was 29.9% which unfavorably impacted our consolidated gross margin by 700 basis points. The Sealy segment operates at a lower gross margin than the Tempur North America and Tempur International segments. Therefore, our gross margins have been negatively impacted as Sealy's net sales have increased as a percentage of our consolidated net sales. The decline in our consolidated gross margin was also due to unfavorable product mix, which reduced our gross margin by 230 basis points, and increased floor model discounts related to new product introductions, which unfavorably impacted gross margin by 160 basis points. These factors were slightly offset by lower sourcing costs and geographic mix. Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in this process. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.


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                               OPERATING EXPENSES

Selling and Marketing Expenses
                                                   Three Months Ended     Three Months Ended     % Change 2014
(in millions, except percentages)                    March 31, 2014         March 31, 2013          vs 2013
Total selling and marketing                        $       143.0         $         86.4              65.5 %
As a percent of net sales                                   20.4 %                 22.1 %
Advertising expenses                                        73.8                   41.3              78.7 %
As a percent of net sales                                   10.5 %                 10.6 %
Selling and marketing other                                 69.2                   45.1              53.4 %
As a percent of net sales                                    9.9 %                 11.6 %

Selling and marketing expenses include advertising and media production associated with our Direct channel, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials, and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing.

Three months ended March 31, 2014 compared to the three months ended March 31, 2013

Selling and marketing expenses increased $56.6 million, or 65.5%, and decreased 1.7% as a percentage of net sales. Our advertising expenses increased $32.5 million, or 78.7%, and remained relatively flat as a percentage of net sales. Sealy's selling and marketing expenses increased $53.8 million, including an advertising expense increase of $33.6 million, as compared to the post-acquisition period March 18, 2013 through March 31, 2013. The increase due to Sealy was slightly offset by decreased advertising expenses in our Tempur North America segment, which remained relatively flat as a percentage of net sales.

All other selling and marketing expenses increased $24.1 million, or 53.4%, and decreased 1.7% as a percentage of net sales. Sealy's other selling and marketing expenses increased $20.2 million, as compared to the post-acquisition period from March 18, 2013 through March 31, 2013. The Tempur International segment other selling and marketing expenses also increased $4.1 million, or 2.2% as a percentage of net sales, driven primarily by additional openings of company-owned stores.

General, Administrative and Other Expenses
                                                    Three Months Ended      Three Months Ended     % Change 2014
(in millions, except percentages)                     March 31, 2014          March 31, 2013          vs 2013
General, administrative and other expenses         $         70.3          $         58.7              19.8 %
As a percent of net sales                                    10.0 %                  15.0 %

General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation of buildings, furniture and fixtures, machinery, leasehold improvements and computer equipment, expenses for administrative functions and research and development costs.

Three months ended March 31, 2014 compared to the three months ended March 31, 2013

General, administrative and other expenses increased $11.6 million, or 19.8%. The increase was primarily due to the increase in Sealy's general, administrative and other expenses of $23.1 million, as compared to the post-acquisition period from March 18, 2013 through March 31, 2013. The increase due to Sealy was partially offset by an $11.8 million decrease in transaction expenses, which were not incurred in the current quarter.

Research and development expenses for the three months ended March 31, 2014 were $5.9 million compared to $4.8 million for the three months ended March 31, 2013, an increase of $1.1 million, or 22.9%. We plan to continue to invest in research and development to leverage the combined technologies of our portfolio to deliver innovative products.


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                                OPERATING INCOME
                                                    Three Months Ended      Three Months Ended     % Change 2014
(in millions, except percentages)                     March 31, 2014          March 31, 2013          vs 2013
Operating income                                   $         62.4          $         44.5              40.2 %
Operating margin                                              8.9 %                  11.4 %

Three months ended March 31, 2014 compared to three months ended March 31, 2013

Operating income increased $17.9 million, or 40.2%, and was primarily impacted by the factors discussed above. During the three months ended March 31, 2014, we also recorded royalty income, net of royalty expense, of $4.5 million and equity income in earnings of unconsolidated affiliates of $1.7 million. These amounts were immaterial during the three months ended March 31, 2013 due to the timing of the Sealy Acquisition. Our royalty income is based on sales of Sealy® and . . .

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