What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-08-06 compared with 2020-05-07 · 386 added, 239 removed, 301 unchanged (67% of the section changed)

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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, 2020, including the following topics:

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the three and six months ended June 30, 2020, including the following topics:

• an overview of our business and strategy, including uncertainty relating to COVID-19;

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Business Overview

We are the world's largest bedding manufacturer.

We develop, manufacture and market bedding products, which we sell globally.

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Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels and price points.

Our distribution model operates through an omni-channel strategy two distribution channels in each operating business segment:

Our distribution model operates through an omni-channel strategy with two distribution channels in each operating business segment:

Wholesale and Direct.

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We evaluate segment performance based on net sales, gross profit and operating income.

Uncertainty Relating to COVID-19

Prior to the global COVID-19 health crisis, our iconic brands and products had been performing very well throughout the world.

We had been experiencing growth in all markets and especially strong growth in North America, with over 30% sales growth in January and February of 2020 compared to the corresponding prior period.

Most recent trends have shown a sharp decline in the U.S.

and Europe as order trends were down 80% for a few days in early April as compared to the same period in 2019.

As of the date of this Report, second quarter to date orders are down approximately 55% as compared to the same period in 2019.

Our operations in Asia began to feel the negative impact of COVID-19 in February as the virus began to spread throughout the region.

Since then, the Asian market has shown varying degrees and stages of the impacts within the region primarily based on government infrastructure and response to the pandemic.

Given these varying impacts in different regions at different times, we are monitoring markets on a country-by-country basis.

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The COVID-19 pandemic has resulted, and is likely to continue to result, in significant economic disruption and has and will likely continue to adversely affect our business.

As of the date of this filing, significant uncertainty exists concerning the magnitude of the impact and duration of the COVID-19 pandemic.

Many stores of our third-party retailers within the Wholesale channel are closed in the U.S.

Business Update

We continue to study and optimize our operations in response to the challenges from the COVID-19 crisis.

We have taken and continue to take precautionary measures to mitigate health risks during the evolving situation resulting from COVID-19.

We experienced a major reduction in total net sales when COVID-19 began materially impacting our North America business segment in mid-March.

In the second quarter, order trends reached their lowest point in early April when they had declined approximately 80% as compared to prior year.

Order trends began to improve thereafter, with orders down approximately 55% for the full month of April as compared to the same period in 2019.

During April and May, many stores of our third-party retailers within the Wholesale channel, as well as our company-owned stores within the Direct channel, were closed or operating under restricted conditions in the U.S.

and around the world.

In addition, company-owned stores within the Direct channel are either closed or operating under restricted conditions.

These closures have negatively impacted sales at the end of the first quarter and may negatively impact sales until the COVID-19 pandemic moderates.

Our e-commerce operations remain open globally and ready to serve our customers, as do the e-commerce operations for many of our third-party retailers.

We experienced significant and accelerating improvement in order trends in late May and throughout the remainder of the second quarter.

This improvement was primarily due to the reopening of brick-and-mortar stores as restrictions were lifted, the acceleration of e-commerce business trends and a

shift in consumer spending habits towards in-home products, including bedding products.

We believe this may be a long-term shift in consumer spending habits, which could be favorable to our business.

This unexpected and rapid increase in demand for bedding products has challenged the entire bedding industry and supply chain, including our business.

The broad-based increase in demand coupled with labor and supply chain constraints has created operational challenges in the production of Sealy bedding products in the U.S.

These operational challenges have resulted in longer order to delivery times.

Sealy orders in the U.S.

have exceeded our manufacturing capacity in the second quarter and through July.

The Tempur-Pedic manufacturing process has not been as impacted by the current supply chain constraints as it is less labor-dependent and has fewer components than the Sealy manufacturing process.

We are in the process of increasing U.S.

production capabilities across our entire portfolio of products to meet this heightened demand, but expect to continue experiencing capacity constraints on Sealy bedding products through the third quarter of 2020.

Additionally, the U.S.

government has mandated that domestic suppliers of certain materials used in the production of bedding products be redirected towards the production of personal protective equipment.

Our supply chain remains constrained with respect to these materials and we have taken certain steps, including pricing actions, to attempt to mitigate this impact.

We are targeting third quarter 2020 sales to increase approximately 25% from the same period last year.

If favorable order trends were to continue, and if there are no significant changes in supply chain or manufacturing capacity, or other unfavorable impacts due to the global pandemic, it is possible that our third quarter or fourth quarter financial performance could trigger vesting of our long-term aspirational plan.

This would result in a non-cash stock-based compensation charge in the range of $33.0 million to $49.5 million in the quarter that the performance metric is probable of acheivement.

During this time of uncertainty, keeping our employees safe and healthy is a top priority.

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While providing a healthy and safe work environment is a top priority during these unprecedented times, our entire organization is also focused on our commitments to our customers, suppliers and shareholders.

We are also working with various government and healthcare organizations to provide products and services in this time of crisis.

For more than a decade, we have donated tens of thousands of mattresses annually to charities and organizations in need across the country.

For the immediate future, we are focusing all of the power of our philanthropic efforts on getting our products to governments, healthcare organizations and charities that have a need related to the pandemic.

The situation surrounding COVID-19 remains fluid, and we are actively managing our response in collaboration with customers, government officials, employees and business partners.

Our business model has a highly variable cost structure that naturally adjusts with changes in sales.

Given the sudden and significant change in volume beginning in mid-March, actions were quickly implemented to further mitigate the financial impact.

These actions included reducing expenses by approximately $300 million on an annualized basis, with approximately $225 million expected to occur in the last nine months of 2020.

These reductions are primarily in advertising, personnel, including a furlough of 35% of U.S.

salaried employees, other staffing related expenses and variable compensation.

Additionally, we ceased share repurchases, delayed certain capital projects and canceled or suspended non-critical projects.

Despite these cost actions, we expect significant headwinds to gross margin in the second quarter of 2020.

Within recent trends, we have seen a reduction in average selling price as consumers are purchasing lower priced products during this crisis period.

In addition, we expect deleverage as fixed manufacturing costs are spread across fewer manufactured units.

This will create deleverage in gross and operating margins resulting in an expected operating loss and negative unadjusted earnings before interest, tax, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, in the second quarter of 2020.

Going forward, we anticipate operating income in the third and fourth quarter of 2020 to be dependent on the pace of the sales recovery in the markets impacted by COVID-19.

Additionally, to provide greater financial flexibility in response to the continued impact of COVID-19, we elected to hold approximately $200 million of cash by borrowing on our revolving senior secured credit facility.

Total remaining availability under our revolving senior secured credit facility is $101.9 million.

We have no major debt maturities until 2023, and our senior secured credit facility matures in 2024.

However, given the uncertainty and the nature of this crisis, we are in advanced discussions with our commercial banks to obtain additional incremental liquidity.

During the second quarter, we began offering our Clean Shop Promise TM protocol to third-party retailers and our company-owned stores, which is being broadly adopted to provide customers with a sense of comfort as they return to shopping in stores.

During the second quarter, we also worked with various government and healthcare organizations to provide products and services in this time of crisis.

Our business has a highly variable cost structure that can flex with changes in sales.

Given the sudden and significant change in volume early in the second quarter of 2020, actions were quickly implemented to mitigate the financial impact.

We primarily reduced advertising spend, temporarily furloughed employees and decreased variable compensation.

As order trends improved throughout the quarter, we immediately reversed these actions and began making investments to ensure we could service our customers.

Additionally, as liquidity improved, we began reinvesting in the business at similar levels prior to the impact of COVID-19.

Given the market uncertainty of the crisis, we entered into a new $200 million 364-day term loan (the "364-Day Loan") on May 13, 2020 to increase overall available liquidity and strengthen the balance sheet.

We had $611.5 million of liquidity as of June 30, 2020, including $146.8 million of cash on hand and $423.9 million available under our revolving senior secured credit facility.

We will continue to actively monitor the situation and may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, customers, suppliers and stockholders.

While we are unable to determine or predict the nature, duration or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity or capital resources, we believe that it is important to share where our company stands today, how our response to COVID-19 is progressing and how our operations and financial condition may change as the fight against COVID-19 progresses.

For further information regarding the impact of COVID-19 on the Company, please refer to "Risk Factors" in ITEM 1A of Part II of this Report.

For further information regarding the potential impacts of COVID-19 on the Company, please refer to "Risk Factors" in ITEM 1A of Part II of this Report.

Product Launches

In 2020, we are introducing the Tempur-Ergo Smart Base Collection with Sleeptracker technology and a new Sealy Posturepedic Plus line.

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Acquisition of Sherwood Bedding

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Results of Operations

A summary of our results for the three months ended March 31, 2020 include:

• Total net sales increased 19.0% to $822.4 million as compared to $690.9 million in the first quarter of 2019.

On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 19.8%, with an increase of 24.5% in the North America business segment and an increase of 2.0% in the International business segment.

• Gross margin was 43.4% as compared to 40.8% in the first quarter of 2019.

• Operating income increased 74.0% to $105.3 million as compared to $60.5 million in the first quarter of 2019.

Operating income in the first quarter of 2020 included $11.7 million of charges associated with a wholesale customer bankruptcy.

Adjusted operating income, which is a non-GAAP financial measure, increased 89.3% to $120.8 million as compared to $63.8 million in the first quarter of 2019.

• Net income increased 110.2% to $59.7 million as compared to $28.4 million in the first quarter of 2019.

Adjusted net income, which is a non-GAAP financial measure, increased 143.3% to $72.5 million as compared to $29.8 million in the first quarter of 2019.

• EBITDA, which is a non-GAAP financial measure, increased 39.7% to $134.5 million as compared to $96.3 million for the first quarter of 2019.

Adjusted EBITDA, which is a non-GAAP financial measure, increased 62.9% to $151.2 million as compared to $92.8 million in the first quarter of 2019.

• Earnings per diluted share ("EPS") increased 117.6% to $1.11 as compared to $0.51 in the first quarter of 2019.

Adjusted EPS, which is a non-GAAP financial measure, increased 148.1% to $1.34 as compared to $0.54 in the first quarter of 2019.

• For the trailing twelve months ended March 31, 2020, leverage based on the ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, was 3.03 times as compared to 3.84 times in the first quarter of 2019.

A summary of our results for the three months ended June 30, 2020 include:

• Total net sales decreased 8.0% to $665.2 million as compared to $722.8 million in the second quarter of 2019.

On a constant currency basis, which is a non-GAAP financial measure, total net sales decreased 7.3%, with a decrease of 2.9% in the North America business segment and a decrease of 26.9% in the International business segment.

• Gross margin was 40.0% as compared to 43.4% in the second quarter of 2019.

Adjusted gross margin, which is a non-GAAP financial measure, was 40.6% in the second quarter of 2020.

There were no adjustments to gross margin in the second quarter of 2019.

• Operating income decreased 34.1% to $53.4 million as compared to $81.0 million in the second quarter of 2019.

Adjusted operating income, which is a non-GAAP financial measure, decreased 16.5% to $70.0 million as compared to $83.8 million in the second quarter of 2019.

Operating income and adjusted operating income, which is a non-GAAP financial measure, in the second quarter of 2020 included $7.9 million of costs associated with temporarily closed company-owned retail stores and sales force retention costs as a result of the novel coronavirus ("COVID-19 charges").

• Net income decreased 44.7% to $23.0 million as compared to $41.6 million in the second quarter of 2019.

Adjusted net income, which is a non-GAAP financial measure, decreased 20.8% to $35.1 million as compared to $44.3 million in the second quarter of 2019.

• Earnings before interest, tax, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, decreased 21.8% to $85.2 million as compared to $109.0 million in the second quarter of 2019.

Adjusted EBITDA (including COVID-19 charges), which is a non-GAAP financial measure, decreased 10.0% to $101.7 million and adjusted EBITDA per credit facility, which is a non-GAAP financial measure, decreased 3.0% to $109.6 million as compared to $113.0 million in the second quarter of 2019.

• Adjusted EBITDA per credit facility, which is a non-GAAP financial measure, excluded $24.5 million of asset impairments, incremental operating costs due to the global pandemic, COVID-19 charges and other items in the second quarter of 2020.

• Earnings per diluted share ("EPS") decreased 40.5% to $0.44 as compared to $0.74 in the second quarter of 2019.

Adjusted EPS, which is a non-GAAP financial measure, decreased 13.9% to $0.68 as compared to $0.79 in the second quarter of 2019.

Adjusted EPS, which is a non-GAAP financial measure, included $0.11 of COVID-19 charges in the second quarter of 2020.

• For the trailing twelve months ended June 30, 2020, leverage based on the ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure, was 2.83 times as compared to 3.65 times in the corresponding prior year period.

For a discussion and reconciliation of non-GAAP financial measures as discussed above to the corresponding GAAP financial results, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information."

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Refer to Part I, ITEM 3 of this Report for a discussion of our foreign currency exchange rate risk.

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THREE MONTHS ENDED MARCH 31, 2020 COMPARED TO THE

THREE MONTHS ENDED MARCH 31, 2019

THREE MONTHS ENDED JUNE 30, 2020 COMPARED TO THE

THREE MONTHS ENDED JUNE 30, 2019

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

Three Months Ended March 31,

Three Months Ended June 30,

(in millions, except percentages and per share amounts) 2020 2019

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General, administrative and other expenses 82.4 12.4 72.7 10.1

Equity loss (income) in earnings of unconsolidated affiliates 0.2 — (2.9) (0.4)

Equity income in earnings of unconsolidated affiliates (5.0) (0.7) (3.6) (0.5)

Operating income 53.4 8.0 81.0 11.2

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Interest expense, net 20.6 3.1 22.5 3.1

Other expense (income), net 0.5 0.1 (7.8) (1.1)

Other expense, net 0.3 — — —

Total other expense, net 20.9 3.1 22.5 3.1

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Income from continuing operations 23.1 3.5 42.7 5.9

Loss from discontinued operations, net of tax (1.2) (0.1) (0.4) (0.1)

Income (loss) from discontinued operations, net of tax 0.1 — (1.2) (0.2)

Net income before non-controlling interests 23.2 3.5 41.5 5.7

Net income attributable to non-controlling interests 0.1 — 0.2 —

Net income (loss) attributable to non-controlling interests 0.2 — (0.1) —

Net income attributable to Tempur Sealy International, Inc.

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Diluted 52.0 56.0

Table of C o ntents

Three Months Ended March 31,

Three Months Ended June 30,

2020 2019 2020 2019 2020 2019

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Total net sales $ 665.2 $ 722.8 $ 570.5 $ 588.1 $ 94.7 $ 134.7

Net sales increased 19.0%, and on a constant currency basis increased 19.8%.

Net sales decreased 8.0%, and on a constant currency basis decreased 7.3%.

The change in net sales was driven by the following:

• North America net sales increased $133.2 million, or 24.5%.

Net sales in the Wholesale channel increased $107.8 million, or 21.5%, primarily driven by the expansion of our retail distribution network.

Net sales in the Direct channel increased $25.4 million, or 60.2%, primarily driven by growth from company-owned stores, including the Sleep Outfitters Acquisition and our e-commerce business.

Excluding Sleep Outfitters, the Wholesale channel increased approximately 24% and the Direct channel increased approximately 20%.

• North America net sales decreased $17.6 million, or 3.0%.

Net sales in the Wholesale channel decreased $33.9 million, or 6.4%, as a result of the global pandemic.

Net sales in the Direct channel increased $16.3 million, or 27.3%, primarily driven by growth from our e-commerce business.

This growth was partially offset by decreased sales in our company-owned stores, which were closed or operating under restricted conditions as a result of the global pandemic.

• International net sales decreased $40.0 million, or 29.7%.

On a constant currency basis, International net sales increased 2.0%.

Net sales in the Wholesale channel increased 2.3% on a constant currency basis.

Net sales in the Direct channel increased 1.2% on a constant currency basis.

Three Months Ended March 31,

On a constant currency basis, International net sales decreased 26.9%, as a result of the global pandemic.

Net sales in the Wholesale channel decreased 30.3% on a constant currency basis.

Net sales in the Direct channel decreased 15.5% on a constant currency basis.

Three Months Ended June 30,

(in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin Margin Change

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operational efficiencies due to the utilization in our manufacturing facilities;

product, channel and country mix;

product, brand, channel and country mix;

foreign exchange fluctuations;

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Our margins are also impacted by the growth in our Wholesale channel as sales in our Wholesale channel are at wholesale prices whereas sales in our Direct channel are at retail prices.

Gross margin improved 260 basis points.

Gross margin declined 340 basis points.

The primary drivers of changes in gross margin by segment are discussed below:

• North America gross margin declined 290 basis points.

The decline in gross margin was primarily driven by product mix of 280 basis points and brand mix of 110 basis points, partially offset by decreased floor model expenses of 100 basis points and lower commodity costs.

We expect product and brand mix headwinds to gross margin to lessen in the third quarter of 2020 as sales of our premium products have improved since the second quarter of 2020.

Additionally,

we incurred $4.0 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which contributed to the decline in gross margin.

• International gross margin declined 200 basis points.

The decline in gross margin was primarily driven by fixed cost deleverage on lower unit volumes of 210 basis points and decreased royalties, partially offset by favorable country mix of 140 basis points.

Additionally, we incurred $0.5 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which contributed to the decline in gross margin.

OPERATING EXPENSES

Selling and marketing expenses include advertising and media production associated with the promotion of our brands, 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.

General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs.

Three Months Ended June 30,

2020 2019 2020 2019 2020 2019 2020 2019

(in millions) Consolidated North America International Corporate

Operating expenses:

Advertising expenses $ 55.1 $ 65.4 $ 49.8 $ 58.3 $ 5.3 $ 7.1 $ — $ —

Other selling and marketing expenses 80.0 97.9 51.4 63.5 25.5 31.7 3.1 2.7

General, administrative and other expenses 82.4 72.7 45.6 38.1 14.3 10.8 22.5 23.8

Total operating expenses $ 217.5 $ 236.0 $ 146.8 $ 159.9 $ 45.1 $ 49.6 $ 25.6 $ 26.5

Operating expenses decreased $18.5 million, or 7.8%, and were flat as a percentage of net sales.

The primary drivers of changes in operating expenses by segment are explained below:

• North America operating expenses decreased $13.1 million, or 8.2%, and decreased 150 basis points as a percentage of net sales.

The decrease in operating expenses was primarily driven by decreases in advertising and other selling and marketing investments as a result of cost reduction actions taken during the quarter.

These decreases were offset by $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment and incremental bad debt expense primarily related to the bankruptcy of one department store in the U.S.

• International operating expenses decreased $4.5 million, or 9.1%, and increased 1,080 basis points as a percentage of net sales.

The decrease in operating expenses was primarily driven by decreases in advertising and other selling and marketing investments, partially offset by increased bad debt expense.

Additionally, we incurred $3.4 million of restructuring costs associated with headcount reductions driven by the current macro-economic environment and $0.3 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

• Corporate operating expenses decreased $0.9 million, or 3.4%.

Research and development expenses for the three months ended June 30, 2020 were $5.2 million compared to $5.9 million for the three months ended June 30, 2019, a decrease of $0.7 million, or 11.9%.

OPERATING INCOME

Three Months Ended June 30,

(in millions, except percentages) Operating Income Operating Margin Operating Income Operating Margin Margin Change

North America $ 69.4 12.2 % $ 80.1 13.6 % (1.4) %

International 9.6 10.1 % 27.4 20.3 % (10.2) %

Corporate expenses ( 25.6 ) ( 26.5 )

Total operating income $ 53.4 8.0 % $ 81.0 11.2 % (3.2) %

Operating income decreased $27.6 million and operating margin declined 320 basis points.

The primary drivers of changes in operating income and operating margin by segment are discussed below:

• North America operating income decreased $10.7 million and operating margin declined 140 basis points.

The decline in operating margin was primarily driven by the decline in gross margin of 290 basis points.

Additionally, we recognized $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment and incurred $4.1 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

These declines were partially offset by lower operating expenses as a result of cost actions in the quarter.

• International operating income decreased $17.8 million and operating margin declined 1,020 basis points.

The decline in operating margin was primarily driven by fixed cost deleverage on operating expenses of 500 basis points, increased bad debt expense of 200 basis points and the decline in gross margin of 200 basis points.

Additionally, we incurred $3.4 million of restructuring costs associated with headcount reductions driven by the current macro-economic environment and $0.8 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

These declines were partially offset by the performance of the Asia joint venture.

• Corporate operating expenses decreased $0.9 million, which positively impacted our consolidated operating margin by 10 basis points.

INTEREST EXPENSE, NET

Three Months Ended June 30,

(in millions, except percentages) 2020 2019 % Change

Interest expense, net $ 20.6 $ 22.5 (8.4) %

Interest expense, net, decreased $1.9 million, or 8.4%.

The decrease in interest expense, net, was primarily driven by lower interest rates on our variable rate debt.

INCOME TAX PROVISION

Three Months Ended June 30,

(in millions, except percentages) 2020 2019 % Change

Income tax provision $ 9.4 $ 15.8 (40.5) %

Effective tax rate 28.9 % 27.0 %

Our income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of net operating losses for certain of our foreign operations.

Our income tax provision decreased $6.4 million however our effective tax rate increased, due to a decrease in income before income taxes.

Our effective tax rate for the three months ended June 30, 2020 as compared to the same prior year period increased by 190 basis points.

The effective tax rate as compared to the U.S.

federal statutory tax rate for the three months ended June 30, 2020 included a net favorable impact of discrete items.

The effective tax rate as compared to the U.S.

federal statutory tax rate for the three months ended June 30, 2019 included the net favorable impact of discrete items primarily related to the impact of the likelihood of realization of certain deferred tax assets.

SIX MONTHS ENDED JUNE 30, 2020 COMPARED TO THE

SIX MONTHS ENDED JUNE 30, 2019

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

Six Months Ended June 30,

(in millions, except percentages and per share amounts) 2020 2019

Net sales $ 1,487.6 100.0 % $ 1,413.7 100.0 %

Cost of sales 864.6 58.1 818.5 57.9

Gross profit 623.0 41.9 595.2 42.1

Selling and marketing expenses 306.1 20.6 316.8 22.4

General, administrative and other expenses 163.0 10.9 143.4 10.1

Equity income in earnings of unconsolidated affiliates (4.8) (0.3) (6.5) (0.5)

Operating income 158.7 10.7 141.5 10.0

Other expense, net:

Interest expense, net 40.9 2.7 44.9 3.2

Other expense (income), net 0.8 0.1 (7.8) (0.6)

Total other expense, net 41.7 2.8 37.1 2.6

Income from continuing operations before income taxes 117.0 7.9 104.4 7.4

Income tax provision (32.9) (2.2) (32.7) (2.3)

Income from continuing operations 84.1 5.7 71.7 5.1

Loss from discontinued operations, net of tax (1.1) (0.1) (1.6) (0.1)

Net income before non-controlling interests 83.0 5.6 70.1 5.0

Net income attributable to non-controlling interests 0.3 — 0.1 —

Net income attributable to Tempur Sealy International, Inc.

$ 82.7 5.6 % $ 70.0 5.0 %

Earnings per common share:

Earnings per share for continuing operations $ 1.60 $ 1.31

Loss per share for discontinued operations (0.02) (0.03)

Earnings per share $ 1.58 $ 1.28

Earnings per share for continuing operations $ 1.58 $ 1.29

Loss per share for discontinued operations (0.02) (0.03)

Earnings per share $ 1.56 $ 1.26

Weighted average common shares outstanding:

Basic 52.5 54.7

Diluted 53.0 55.6

Six Months Ended June 30,

2020 2019 2020 2019 2020 2019

(in millions) Consolidated North America International

Net sales by channel

Wholesale $ 1,286.1 $ 1,248.1 $ 1,104.2 $ 1,030.3 $ 181.9 $ 217.8

Direct 201.5 165.6 143.5 101.8 58.0 63.8

Total net sales $ 1,487.6 $ 1,413.7 $ 1,247.7 $ 1,132.1 $ 239.9 $ 281.6

Net sales increased 5.2%, and on a constant currency basis increased 5.9%.

The change in net sales was driven by the following:

• North America net sales increased $115.6 million, or 10.2%.

Net sales in the Wholesale channel increased $73.9 million, or 7.2%.

Despite the impact of the global pandemic, the increase was primarily driven by the expansion of our retail distribution network.

Net sales in our Direct channel increased $41.7 million, or 41.0%, primarily driven by growth from our e-commerce business.

• International net sales decreased $41.7 million, or 14.8%.

On a constant currency basis, International net sales decreased 11.8% as a result of the global pandemic.

Net sales in the Wholesale channel decreased 13.2% on a constant currency basis.

Net sales in the Direct channel decreased 6.9% on a constant currency basis.

Six Months Ended June 30,

(in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin Margin Change

North America $ 493.4 39.5 % $ 444.4 39.3 % 0.2 %

International 129.6 54.0 % 150.8 53.6 % 0.4 %

Consolidated gross margin $ 623.0 41.9 % $ 595.2 42.1 % (0.2) %

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 the manufacturing process.

Gross margin declined 20 basis points.

The primary drivers of changes in gross margin by segment are discussed below:

• North America gross margin improved 20 basis points.

The improvement in gross margin was primarily driven by a favorable impact from fixed cost leverage on higher unit volume of 140 basis points, lower commodity costs of 120 basis points and decreased floor model expenses of 90 basis points.

Table of C o ntents

The improvement in gross margin was primarily driven by favorable impact from fixed cost leverage on higher unit volume of 110 basis points, decreased floor model expenses of 110 basis points and lower commodity costs of 90 basis points.

These improvements were partially offset by unfavorable product mix of 270 basis points.

Additionally, we incurred $4.0 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which partially offset the improvement in gross margin.

We expect product and brand mix headwinds to gross margin to lessen in the third quarter of 2020 as sales of our premium products have improved since the second quarter of 2020.

• International gross margin improved 40 basis points.

The improvement in gross margin was primarily driven by operational improvements of 100 basis points, favorable country mix of 70 basis points and lower commodity costs.

The improvement in gross margin was primarily driven by favorable country mix.

Additionally, we incurred $0.5 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which partially offset the improvement in gross margin.

OPERATING EXPENSES

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Three Months Ended March 31,

Six Months Ended June 30,

2020 2019 2020 2019 2020 2019 2020 2019

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The primary drivers of changes in operating expenses by segment are explained below:

• North America operating expenses increased $35.7 million, or 25.5%, and increased 20 basis points as a percentage of net sales.

The increase in operating expenses was primarily driven by advertising and other selling and marketing investments.

Additionally, we recorded $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account.

We have adapted our marketing in response to the current market created by COVID-19 to help ensure we can maximize the effectiveness of our marketing investments during this time.

We have adjusted our media mix to focus on digital channels to reach consumers shopping online.

• International operating expenses decreased $2.0 million, or 3.6%, and decreased 90 basis points as a percentage of net sales.

The decrease in operating expenses was primarily driven by decreases in advertising and other selling and marketing investments.

• North America operating expenses increased $22.6 million, or 7.5%, and decreased 60 basis points as a percentage of net sales.

The increase in operating expenses was primarily driven by $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account, as well as incremental bad debt expense primarily related to the bankruptcy of one department store in the U.S.

Additionally, we recognized $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment.

These increases were offset by lower operating expenses as a result of cost actions in the quarter.

• International operating expenses decreased $6.5 million, or 6.2% and increased 370 basis points as a percentage of net sales.

The decrease in operating expenses was primarily driven by decreases in advertising and other selling and marketing investments, partially offset by increased bad debt expense.

• Corporate operating expenses decreased $7.2 million, or 13.0%.

In the first quarter of 2019, we recorded $3.0 million of professional fees related to the acquisition of Sleep Outfitters, which were not repeated in 2020.

Additionally, the decrease in operating expenses was primarily driven by a decrease in variable compensation expense.

Research and development expenses for the three months ended March 31, 2020 were $5.8 million compared to $5.2 million for the three months ended March 31, 2019, an increase of $0.6 million, or 11.5%.

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In the first half of 2019, we recorded $4.1 million of professional fees related to the acquisition of Sleep Outfitters, which were not repeated in 2020.

Research and development expenses were $11.0 million for the six months ended June 30, 2020 as compared to $11.2 million for the six months ended June 30, 2019.

OPERATING INCOME

Three Months Ended March 31,

Six Months Ended June 30,

(in millions, except percentages) Operating Income Operating Margin Operating Income Operating Margin Margin Change

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• North America operating income increased $26.4 million and operating margin improved 90 basis points.

The improvement in operating margin was primarily driven by the improvement in gross margin of 330 basis points and improved operating expense leverage.

These improvements were offset by $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account.

• International operating income increased $1.4 million and operating margin improved 110 basis points.

The improvement in operating margin was primarily driven by the improvement in gross margin and improved operating expense leverage, partially offset by the performance of the Asia-Pacific joint venture as a result of the reduction in contributions from its operations in China.

The improvement in operating margin was primarily driven by favorable operating expense leverage of 280 basis points and the improvement in gross margin of 20 basis points.

These improvements were offset by $11.7 million of

customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account.

Additionally, we recorded $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment and incurred $4.1 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

• International operating income decreased $16.4 million and operating margin declined 360 basis points.

The decline in operating margin was primarily driven by the fixed cost deleverage on operating expenses of 110 basis points and increased bad debt expense.

These declines were partially offset by the improvement in gross margin of 40 basis points.

• Corporate operating expenses decreased $7.2 million, which positively impacted our consolidated operating margin by 50 basis points.

In the first quarter of 2019, we recorded $3.0 million of professional fees related to the acquisition of Sleep Outfitters, which were not repeated in 2020.

Additionally, the decrease in operating expenses was primarily driven by a decrease in variable compensation expense.

In the first half of 2019, we recorded $4.1 million of professional fees related to the Sleep Outfitters Acquisition, which were not repeated in 2020.

INTEREST EXPENSE, NET

Three Months Ended March 31,

Six Months Ended June 30,

(in millions, except percentages) 2020 2019 % Change

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Interest expense, net, decreased $4.0 million, or 8.9%.

The decrease in interest expense, net, was primarily driven by reduced average levels of outstanding debt and lower interest rates on our variable rate debt.

The decrease in interest expense, net, was primarily driven by lower interest rates on our variable rate debt.

INCOME TAX PROVISION

Three Months Ended March 31,

Six Months Ended June 30,

(in millions, except percentages) 2020 2019 % Change

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Effective tax rate 28.1 % 31.3 %

Income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of net operating losses for certain of our foreign operations.

Table of C o ntents

Our income tax provision increased $0.2 million due to an increase in income before income taxes.

Our effective tax rate for the three months ended March 31, 2020 as compared to the same prior year period decreased by 900 basis points.

Our effective tax rate for the six months ended June 30, 2020 as compared to the same prior year period decreased 320 basis points.

The effective tax rate as compared to the U.S.

federal statutory tax rate for the three months ended March 31, 2020 included a net unfavorable impact of discrete items primarily related to the impact of the likelihood of realization of certain deferred tax assets and certain stock compensation.

federal statutory rate for the six months ended June 30, 2020 included a net unfavorable impact of discrete items, primarily related to the impact of the likelihood of realization of certain deferred tax assets.

The effective tax rate as compared to the U.S.

federal statutory tax rate for the three months ended March 31, 2019 included the net unfavorable impact of discrete items primarily related to the sale of a certain interest in our Asia-Pacific joint venture and the impact of certain stock compensation.

federal statutory rate for the for the six months ended June 30, 2019 included a net unfavorable impact of discrete items primarily related to the sale of a certain interest in our Asia-Pacific joint venture and the impact of certain stock compensation.

Liquidity and Capital Resources

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Principal uses of funds consist of payments of principal and interest on our debt facilities, share repurchases, capital expenditures and working capital needs.

As of March 31, 2020, we had working capital of $296.0 million, including cash and cash equivalents of $197.0 million, as compared to working capital of $126.9 million including cash and cash equivalents of $64.9 million as of December 31, 2019.

At March 31, 2020, total cash and cash equivalents were $197.0 million, of which $171.6 million was held in the U.S.

As of June 30, 2020, we had a working capital deficit of $56.2 million due to the 364-Day Loan of $200 million, which is classified as a current liability.

It is our intent to repay that loan with current cash and funds generated from operations no later than its May 2021 maturity date.

We maintain the financial flexibility to finance this loan on a long-term basis under our revolving senior secured credit facility if needed.

Total availability under our revolving senior secured credit facility, which matures in 2024, was $423.9 million as of June 30, 2020.

At June 30, 2020, total cash and cash equivalents were $146.8 million, of which $122.6 million was held in the U.S.

and $24.2 million was held by subsidiaries outside of the U.S.

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Dollar or other major foreign currencies is not material to our overall liquidity or financial position.

The significant increase in our cash holdings since December 31, 2019 reflects our decision to maintain on-hand liquidity to provide greater flexibility in response to the continued impact of COVID-19.

Cash Provided by (Used in) Continuing Operations

The table below presents net cash provided by (used in) operating, investing and financing activities from continuing operations for the periods indicated below:

Three Months Ended March 31,

Six Months Ended June 30,

(in millions) 2020 2019

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Financing activities 1.4 (4.0)

Cash provided by operating activities from continuing operations increased $10.4 million in the three months ended March 31, 2020, as compared to the same period in 2019.

The increase in cash provided by operating activities was primarily driven by the increase in cash earnings offset in part by a increase in working capital.

Accrued expenses and other liabilities were a use of cash in 2020 due to the payout of variable compensation and other expenses such as advertising given higher revenues and earnings in 2019.

Cash used in investing activities from continuing operations increased $43.7 million in the three months ended March 31, 2020 as compared to the same period in 2019.

Cash provided by operating activities from continuing operations increased $124.5 million in the six months ended June 30, 2020, as compared to the same period in 2019.

The increase in cash provided by operating activities was driven by strong operational performance in the period.

Cash used in investing activities from continuing operations increased $40.5 million in the six months ended June 30, 2020 as compared to the same period in 2019.

The increase in cash used in investing activities was primarily due to cash used to acquire the Sherwood Bedding business and planned capital expenditures.

Cash provided by financing activities from continuing operations increased $177.1 million in the three months ended March 31, 2020 as compared to the same period in 2019.

For the three months ended March 31, 2020, we had net borrowings of $380.1 million on our credit facilities, as compared to net borrowings of $13.9 million in 2019.

During the three months ended March 31, 2020, we repurchased $199.3 million of our common stock, which included repurchases of $187.5 million under our share repurchase program and $11.8 million which was withheld to satisfy tax withholding obligations related to stock compensation.

During the three months ended March 31, 2019, we repurchased 15,731 shares for $0.8 million under our share repurchase program and $2.9 million which was withheld to satisfy tax withholding obligations related to stock compensation.

To provide greater financial flexibility in response to the continued impact of COVID-19, we elected to hold approximately $200 million of cash by borrowing on our revolving senior secured credit facility.

Table of C o ntents

Cash provided by financing activities from continuing operations increased $5.4 million in the six months ended June 30, 2020 as compared to the same period in 2019.

For the six months ended June 30, 2020, we had net borrowings of $207.0 million on our credit facilities, including $200 million in additional financing provided under the new 364-Day Loan, as compared to net repayments of $0.6 million in 2019.

During the six months ended June 30, 2020 and 2019, respectively, we repurchased $187.5 million and $2.3 million of our common stock under our share repurchase program.

In 2020, these repurchases were largely made in the first quarter prior to the impact of COVID-19 on our business.

Additionally, we repurchased $12.0 million and $3.2 million of our common stock which was withheld to satisfy tax withholding obligations related to stock compensation during the six months ended June 30, 2020 and 2019, respectively.

Cash Used in Discontinued Operations

Net cash used in operating, investing and financing activities from discontinued operations for the periods ended March 31, 2020 and 2019 was not material.

Net cash used in operating, investing and financing activities from discontinued operations for the periods ended June 30, 2020 and 2019 was not material.

Capital Expenditures

Capital expenditures totaled $26.2 million and $19.1 million for the three months ended March 31, 2020 and 2019, respectively.

Given the current global COVID-19 health crisis and resulting business impacts, we have delayed certain capital projects and cancelled or suspended non-critical projects.

Capital expenditures totaled $49.4 million and $39.9 million for the six months ended June 30, 2020 and 2019, respectively.

We currently expect our 2020 capital expenditures to be approximately $100 to $110 million, which includes investments in our U.S.

enterprise resource planning projects and domestic manufacturing facility.

Our total debt increased to $1,941.9 million as of March 31, 2020 from $1,547.0 million as of December 31, 2019.

Total remaining availability under our revolving senior secured credit facility is $101.9 million.

We have no major debt maturities until 2023, and our senior secured credit facility matures in 2024.

As of March 31, 2020, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, in accordance with our 2019 Credit Agreement was 3.03 times.

Our total debt increased to $1,760.8 million as of June 30, 2020 from $1,547.0 million as of December 31, 2019.

During the first quarter of 2020, we took initial actions to mitigate the impact of the material slowdown in business activity resulting from COVID-19 and to provide greater financial flexibility, which included a decision to borrow $300 million on our revolving senior secured credit facility.

During the three months ended June 30, 2020, we entered into a new $200 million 364-Day Loan.

We used the proceeds from this new facility and cash on-hand to repay amounts previously drawn on our revolving senior secured credit facility.

Total availability under our revolving senior secured credit facility was $423.9 million as of June 30, 2020, which matures in 2024.

As of June 30, 2020, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, in accordance with our 2019 Credit Agreement was 2.83 times.

Our leverage ratio as of June 30, 2020 was the lowest in our history.

This ratio is within the terms of the financial covenants for the maximum consolidated total net leverage ratio as set forth in the 2019 Credit Agreement, which limits this ratio to 5.00 times.

As of March 31, 2020, we were in compliance with all of the financial covenants in our debt agreements, and we do not anticipate material issues under any debt agreements based on current facts and circumstances.

As of June 30, 2020, we were in compliance with all of the financial covenants in our debt agreements, and we do not anticipate material issues under any debt agreements based on current facts and circumstances.

Our debt agreements contain certain covenants that limit restricted payments, including share repurchases and dividends.

The 364-Day Loan did not amend financial covenants under the 2019 Credit Agreement.

Under the amendment we agreed to certain restrictive provisions, including limitations on our ability to repurchase shares and make certain investments for the duration of the 364-Day Loan.

The 2019 Credit Agreement, 2023 Senior Notes and 2026 Senior Notes contain similar limitations which, subject to other conditions, allow unlimited restricted payments at times when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, remains below 3.5 times.

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The foreign subsidiaries represent the foreign operations of the Company and do not guarantee the Senior Notes.

The Senior Notes rank equally with or senior to all debt of Tempur Sealy International and the Obligor Group, but are effectively junior to all secured debt, including obligations under the 2019 Credit Agreement, to the extent of the value of the assets securing such debt.

The Senior Notes rank equally with or senior to all debt of Tempur Sealy International and the Obligor Group, but are effectively junior to all secured debt, including obligations under the 2019 Credit Agreement and the 364-Day Loan, to the extent of the value of the assets securing such debt.

Subject to certain restrictions, Tempur Sealy International and the restricted subsidiaries under the applicable indenture may incur additional secured debt.

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The Senior Notes and each guarantee are therefore effectively subordinated to creditors (including trade creditors) and preferred stockholders (if any) of non-guarantor subsidiaries.

Table of C o ntents

Under the applicable indenture, each guarantee is limited to the maximum amount that would not render the subsidiary guarantor's obligations subject to avoidance under the applicable fraudulent conveyance provisions of the United States Bankruptcy Code or any comparable provision of state law.

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however, earlier compliance is permitted.

The Company elected to early comply with this rule in this Report.

We elected to early comply with this rule.

The summarized financial information for the Obligor Group follows.

Three Months Ended March 31, 2020

Six Months Ended

June 30, 2020

Obligor Group

(in millions) (Unaudited)

(in millions)

Net sales to unrelated parties $ 1,180.6

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Net income attributable to Tempur Sealy International, Inc.

Table of C o ntents

Obligor Group Obligor Group

March 31, 2020 December 31, 2019

(in millions) (Unaudited)

June 30, 2020 December 31, 2019

(in millions)

Receivables due from non-obligor subsidiaries $ 6.8 $ 9.6

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Our Board of Directors authorized a share repurchase program in 2016 pursuant to which we were authorized to repurchase shares of our common stock for a total repurchase price of not more than $800.0 million.

During the three months ended March 31, 2020, we repurchased 2.6 million shares for approximately $187.5 million.

As of March 31, 2020, we had approximately $131.3 million remaining under our existing share repurchase authorization.

During the six months ended June 30, 2020, we repurchased 2.6 million shares for approximately $187.5 million.

As of June 30, 2020, we had approximately $131.3 million remaining under our existing share repurchase authorization.

In February 2020, the Board of Directors authorized an increase, of $194.2 million, to our share repurchase authorization of Tempur Sealy International's common stock to $300.0 million.

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We ceased all share repurchase activity in March 2020.

We will manage our share repurchase program based on current and expected cash flows, share price and alternative investment opportunities.

We will manage our share repurchase program based on current and expected cash flows, share price and alternative investment opportunities, though in connection with the 364-Day Loan, we agreed to certain limitations on our ability to repurchase shares and make investments while the 364-Day Loan is outstanding.

For a complete description of our share repurchase program, please refer to ITEM 5 under Part II, "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities," in the 2019 Annual Report.

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Future Liquidity Sources and Uses

We have taken actions and may continue to take actions intended to increase our cash position and preserve financial flexibility in light of current uncertainty in the global markets.

These actions include:

• Elected to hold approximately $200 million of cash by borrowing on our revolving senior secured credit facility during the first quarter of 2020.

Total remaining availability under our facility is $101.9 million.

We have no major debt maturities until 2023, and our senior secured credit facility matures in 2024.

• Suspended our share repurchase program.

• Delayed certain capital projects and canceled or suspended non-critical projects.

Table of C o ntents

• Evaluated and took actions to reduce costs and spending across our organization, which included reductions in advertising, personnel, including a furlough of 35% of U.S.

salaried employees, other staffing related expenses and variable compensation.

• Worked closely with our customers, especially third-party retailers, to support their operations and ensure timely collection of amounts owed.

• Closely managed working capital.

• Advanced discussions with commercial banks to obtain additional incremental liquidity in the form of a variable rate term loan.

As of June 30, 2020, we had $611.5 million of liquidity, including $146.8 million of cash on hand and $423.9 million available under our revolving senior secured credit facility.

We also had availability of $40.8 million under our securitization facility.

In addition, we expect to generate significant cash flow from operations in the full year of 2020.

We believe that cash flow from operations, availability under our existing credit facilities and arrangements, current cash balances and the ability to obtain other financing, if necessary, will provide adequate cash funds for our foreseeable working capital needs, necessary capital expenditures, and debt service obligations.

Our cash requirements are subject to change as business conditions warrant and opportunities arise.

The timing and size of any new business ventures or acquisitions that we may complete may also impact our cash requirements.

For information regarding the impact of COVID-19 on our business, including our liquidity and capital resources, please refer to "Risk Factors" in ITEM 1A of Part II of this Report.

Our primary sources of liquidity are cash flows from operations and borrowings, as needed, under our debt facilities.

We expect that ongoing requirements for debt service and capital expenditures will be funded from these sources.

As of March 31, 2020, we had $1,941.9 million in total debt outstanding and our adjusted EBITDA, which is a non-GAAP financial measure, was $151.2 million for the three months ended March 31, 2020.

Our debt service obligations could, under certain circumstances, have material consequences to our stockholders.

We continue to take actions intended to increase our cash position and preserve financial flexibility in light of current uncertainty in the global markets.

In addition to actions taken in the first quarter, additional actions taken in the second quarter of 2020 include:

• Entered into a new $200 million 364-Day Loan to enhance liquidity.

We used the proceeds from this new facility and cash on-hand to repay amounts previously drawn on our revolving senior secured credit facility.

Total availability on our revolving senior secured credit facility, which matures in 2024, is $423.9 million as of June 30, 2020.

• Continued the suspension of our share repurchase program.

Our 364-Day Loan contains a restriction on share repurchases while the loan is outstanding.

As of June 30, 2020, we had $1,760.8 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $1,614.9 million.

Leverage based on the ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure, was 2.83 times for the trailing twelve months ended June 30, 2020, the lowest in our history.

We lowered our target leverage ratio for the second time in the last 12 months.

Our new revised target range is 2.0 to 3.0 times.

The reduction in our leverage target is not due to any market concerns;

it is a strategic move to provide flexibility.

As highlighted through the current environment, we have always seen our financial strength as a competitive advantage and part of our long-term strategy.

Total cash interest payments related to our borrowings are expected to be approximately $80 to $85 million in 2020.

Our target range for our ratio of consolidated indebtedness less netted cash, which is a non-GAAP financial measure, is 2.5 to 3.5 times.

As a result of the current environment, we anticipate our ratio of consolidated indebtedness less netted cash to temporarily increase above our target range in 2020.

Our debt service obligations could, under certain circumstances, have material consequences to our stockholders.

Similarly, our cash requirements are subject to change as business conditions warrant and opportunities arise.

The timing and size of any new business ventures or acquisitions that we may complete may also impact our cash requirements and debt service obligations.

For information regarding the impact of COVID-19 on our business, including our liquidity and capital resources, please refer to "Risk Factors" in ITEM 1A of Part II of this Report.

Non-GAAP Financial Information

We provide information regarding adjusted net income, adjusted EPS, adjusted operating income (expense), adjusted operating margin, EBITDA, adjusted EBITDA, consolidated indebtedness and consolidated indebtedness less netted cash, which are not recognized terms under GAAP and do not purport to be alternatives to net income, earnings per share, operating income (expense), operating margin and net cash provided by operating activities as a measure of operating performance or an alternative to total debt as a measure of liquidity.

We believe these non-GAAP financial measures provide investors with performance measures that better reflect our underlying operations and trends, providing a perspective not immediately apparent from net income, operating income (expense) and operating margin.

We provide information regarding adjusted net income, adjusted EPS, adjusted gross profit, adjusted gross margin, adjusted operating income (expense), adjusted operating margin, EBITDA, adjusted EBITDA (including COVID-19 charges), adjusted EBITDA per credit facility, consolidated indebtedness and consolidated indebtedness less netted cash, which are not recognized terms under GAAP and do not purport to be alternatives to net income, earnings per share, gross profit, gross margin, operating income (expense), operating margin or an alternative to total debt as a measure of liquidity.

The adjustments we make to derive the non-GAAP financial measures include adjustments to exclude items that may cause short-term fluctuations in the nearest GAAP financial measure, but which we do not consider to be the fundamental attributes or primary drivers of our business.

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We believe that the use of these non-GAAP financial measures provides investors with additional useful information with respect to the impact of various adjustments as described in the footnotes below.

Table of C o ntents

The following table sets forth the reconciliation of our reported net income to adjusted net income and the calculation of adjusted EPS for the three months ended March 31, 2020 and 2019:

The following table sets forth the reconciliation of our reported net income to adjusted net income and the calculation of adjusted EPS for the three months ended June 30, 2020 and 2019:

Three Months Ended

(in millions, except per share amounts) March 31, 2020 March 31, 2019

(in millions, except per share amounts) June 30, 2020 June 30, 2019

Net income $ 23.0 $ 41.6

Loss from discontinued operations, net of tax (1)

Customer-related charges (2)

Operational disruptions (3)

(Income) loss from discontinued operations, net of tax (1)

Incremental operating costs (2)

Asset impairments (3)

Restructuring costs (4)

Accounting standard adoption (5)

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Diluted shares outstanding 52.0 56.0

Adjusted net income included COVID-19 charges of $5.8 million, net of tax, and adjusted earnings per share of $0.11.

(1) Certain subsidiaries in the International business segment are accounted for as discontinued operations and have been designated as unrestricted subsidiaries in the 2019 Credit Agreement.

Therefore, these subsidiaries are excluded from our adjusted financial measures for covenant compliance purposes.

(2) In the first quarter of 2020, we recorded $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account.

(3) In the first quarter of 2020, in applying contractual definitions under the 2019 Credit Agreement, we recorded $2.3 million of certain direct charges related to operational disruptions caused by the government shutdowns as a result of COVID-19.

(4) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)".

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within the covenant compliance calculation.

(5) In the first quarter of 2019, we recorded $3.3 million of acquisition-related and other costs in operating expenses, primarily related to professional fees for the acquisition of Sleep Outfitters.

These costs were offset by $7.2 million of other income related to the sale of our interest in a subsidiary of the Asia-Pacific joint venture.

(2) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic.

Cost of sales included $4.5 million of costs for relief efforts, increased sanitation supplies and services and other items.

Operating expenses included $0.4 million of charges related to increased sanitation supplies and services.

(3) In the second quarter of 2020, we recorded $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment.

(4) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the current macro-economic environment.

(5) We recorded $1.3 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)", in the second quarter of 2020.

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation.

(6) In the second quarter of 2019, we recorded $2.8 million of acquisition-related and other costs in operating expenses, primarily related to post acquisition restructuring charges and professional fees for the acquisition of Sleep Outfitters.

(7) Adjusted income tax provision represents the tax effects associated with the aforementioned items and other discrete income tax events.

Adjusted Operating Income (Expense) and Adjusted Operating Margin

A reconciliation of operating income (expense) and operating margin to adjusted operating income (expense) and adjusted operating margin, respectively, are provided below.

Adjusted Gross Profit and Gross Margin and Adjusted Operating Income (Expense) and Operating Margin

A reconciliation of gross profit and gross margin to adjusted gross profit and adjusted gross margin, respectively, and operating income (expense) and operating margin to adjusted operating income (expense) and adjusted operating margin, respectively, are provided below.

Table of C o ntents

The following table sets forth our reported gross profit and the reconciliation of our operating income (expense) and operating margin to the calculation of adjusted operating income (expense) and adjusted operating margin for the three months ended March 31, 2020.

We had no adjustments to gross profit for the three months ended March 31, 2020.

Three Months Ended March 31, 2020

The following table sets forth the reconciliation of our reported gross profit and operating income (expense) to the calculation of adjusted gross profit and adjusted operating income (expense) for the three months ended June 30, 2020.

Three Months Ended June 30, 2020

(in millions, except percentages) Consolidated

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Gross profit $ 265.9 40.0 % $ 216.2 37.9 % $ 49.7 52.5 % $ —

Incremental operating costs (1)

4.5 4.0 0.5 —

Adjusted gross profit $ 270.4 40.6 % $ 220.2 38.6 % $ 50.2 53.0 % $ —

Operating income (expense) $ 53.4 8.0 % $ 69.4 12.2 % $ 9.6 10.1 % $ (25.6)

Customer-related charges (1)

Incremental operating costs (1)

4.9 4.1 0.8 —

Operational disruptions (2)

Asset impairments (2)

Restructuring costs (3)

Accounting standard adoption (4)

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Adjusted operating income (expense) $ 70.0 10.5 % $ 81.8 14.3 % $ 13.8 14.6 % $ (25.6)

We had no adjustments to gross profit for the three months ended March 31, 2019.

Three Months Ended March 31, 2019

Operating income and adjusted operating income included $7.9 million of COVID-19 charges.

The North America and International business segments included $6.0 million and $1.9 million of these charges, respectively.

We had no adjustments to gross profit for the three months ended June 30, 2019.

Three Months Ended June 30, 2019

(in millions, except percentages) Consolidated Margin North America Margin International Margin Corporate

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2.8 1.7 — 1.1

Total adjustments 3.3 — 0.3 3.0

Adjusted operating income (expense) $ 83.8 11.6 % $ 81.8 13.9 % $ 27.4 20.3 % $ (25.4)

(1) In the first quarter of 2020, we recorded $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account.

(2) In the first quarter of 2020, in applying contractual definitions under the 2019 Credit Agreement, we recorded $2.3 million of certain direct charges related to operational disruptions caused by the government shutdowns as a result of COVID-19.

(3) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)".

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within the covenant compliance calculation.

(4) In the first quarter of 2019, we recorded $3.3 million of acquisition-related and other costs in operating expenses, primarily related to professional fees for the acquisition of Sleep Outfitters.

Table of C o ntents

EBITDA, Adjusted EBITDA, Consolidated Indebtedness Less Netted Cash

(1) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic.

Cost of sales included $4.5 million of costs for relief efforts, increased sanitation supplies and services and other items.

Operating expenses included $0.4 million of charges related to increased sanitation supplies and services.

(2) In the second quarter of 2020, we recorded $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment.

(3) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the current macro-economic environment.

(4) We recorded $1.3 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)", in the second quarter of 2020.

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation.

(5) In the second quarter of 2019, we recorded $2.8 million of acquisition-related and other costs in operating expenses, primarily related to post acquisition restructuring charges and professional fees for the acquisition of Sleep Outfitters.

EBITDA, Adjusted EBITDA (including COVID-19 charges), Adjusted EBITDA per Credit Facility and Consolidated Indebtedness Less Netted Cash

The following reconciliations are provided below:

• Net income to EBITDA and adjusted EBITDA

• Ratio of consolidated indebtedness less netted cash to adjusted EBITDA

• Net income to EBITDA, adjusted EBITDA (including COVID-19 charges) and adjusted EBITDA per credit facility

• Ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility

• Total debt, net to consolidated indebtedness less netted cash

We believe that presenting these non-GAAP measures provides investors with useful information with respect to our operating performance, cash flow generation and comparisons from period to period, as well as general information about our progress in reducing our leverage.

The following table sets forth the reconciliation of our reported net income to the calculations of EBITDA and adjusted EBITDA for the three months ended March 31, 2020 and 2019:

The 2019 Credit Agreement provides the definition of adjusted EBITDA (“adjusted EBITDA per credit facility”).

In the second quarter of 2020, in determining adjusted EBITDA per credit facility, we made an adjustment for COVID-19 charges that was not made to adjusted EBITDA (including COVID-19 charges).

Accordingly, we present adjusted EBITDA per credit facility to provide information regarding our compliance with requirements under the 2019 Credit Agreement.

The following table sets forth the reconciliation of our reported net income to the calculations of EBITDA and adjusted EBITDA (including COVID-19 charges) and adjusted EBITDA per credit facility for the three months ended June 30, 2020 and 2019:

Three Months Ended

(in millions) March 31, 2020 March 31, 2019

(in millions) June 30, 2020 June 30, 2019

Net income $ 23.0 $ 41.6

3 unchanged sentences

EBITDA $ 85.2 $ 109.0

Loss from discontinued operations, net of tax (1)

Customer-related charges (2)

Operational disruptions (3)

(Income) loss from discontinued operations, net of tax (1)

Incremental operating costs (2)

Asset impairments (3)

Restructuring costs (4)

Accounting standard adoption (5)

Acquisition-related costs and other (6)

Adjusted EBITDA $ 151.2 $ 92.8

Adjusted EBITDA (including COVID-19 charges) $ 101.7 $ 113.0

COVID-19 charges (7)

Adjusted EBITDA per credit facility $ 109.6 113.0

(1) Certain subsidiaries in the International business segment are accounted for as discontinued operations and have been designated as unrestricted subsidiaries in the 2019 Credit Agreement.

Therefore, these subsidiaries are excluded from our adjusted financial measures for covenant compliance purposes.

(4) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)".

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within the covenant compliance calculation.

These costs were offset by $7.2 million of other income related to the sale of our interest in a subsidiary of the Asia-Pacific joint venture.

Table of C o ntents

The following table sets forth the reconciliation of our net income to the calculations of EBITDA and adjusted EBITDA for the trailing twelve months ended March 31, 2020:

(2) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic.

Cost of sales included $4.5 million of costs for relief efforts, increased sanitation supplies and services and other items.

Operating expenses included $0.4 million of charges related to increased sanitation supplies and services.

(4) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the current macro-economic environment.

(5) We recorded $1.3 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)", in the second quarter of 2020.

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation.

(7) Adjusted EBITDA per credit facility excluded $7.9 million of COVID-19 charges associated with temporarily closed company-owned retail stores and sales force retention costs.

The following table sets forth the reconciliation of our net income to the calculations of EBITDA and adjusted EBITDA per credit facility for the trailing twelve months ended June 30, 2020:

Trailing Twelve Months Ended

(in millions) March 31, 2020

(in millions) June 30, 2020

Net income $ 202.2

Interest expense, net 81.7

Income taxes 81.3

Income tax provision 74.9

Depreciation and amortization 124.0

2 unchanged sentences

Customer-related charges (2)

Earnings from Sherwood prior to acquisition (3)

Charitable stock donation (3)

Acquisition-related costs and other (5)

Operational disruptions (6)

COVID-19 charges (4)

Incremental operating costs (5)

Asset impairments (6)

Earnings from Sherwood prior to acquisition (7)

Restructuring costs (8)

Accounting standard adoption (9)

Adjusted EBITDA $ 576.3

Credit facility amendment (10)

Adjusted EBITDA per credit facility $ 569.8

Consolidated indebtedness less netted cash $ 1,614.9

Ratio of consolidated indebtedness less netted cash to adjusted EBITDA 3.03 times

Ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility 2.83 times

(1) Certain subsidiaries in the International business segment are accounted for as discontinued operations and have been designated as unrestricted subsidiaries in the 2019 Credit Agreement.

2 unchanged sentences

In the fourth quarter of 2019, we recorded $29.8 million of customer-related charges in connection with the bankruptcy of Mattress PAL Holding, LLC ("Mattress PAL") and resulting significant liquidity issues of Mattress PAL's affiliates to fully reserve trade receivables and other assets associated with this account.

(3) We completed the acquisition of Sherwood Bedding on January 31, 2020 and designated this subsidiary as restricted under the 2019 Credit Agreement.

For covenant compliance purposes, we included $9.8 million of EBITDA from this subsidiary for the ten months prior to acquisition in our calculation of adjusted EBITDA for the trailing twelve months ended March 31, 2020.

(3) In 2019, we recorded an $8.9 million charge related to the donation of common stock at fair market value to certain public charities.

(5) In 2019, we recorded $3.5 million of acquisition-related and other costs.

These costs included $2.8 million of post-acquisition restructuring charges and professional fees incurred in the acquisition of Sleep Outfitters and $0.7 million of professional fees in connection with the amendment of the senior secured credit facility.

(6) In the first quarter of 2020, in applying contractual definitions under the 2019 Credit Agreement, we recorded $2.3 million of certain direct charges related to operational disruptions caused by the government shutdowns as a result of COVID-19.

(7) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)".

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within the covenant compliance calculation.

On October 16, 2019, we entered into the 2019 Credit Agreement with a syndicate of banks.

Under the 2019 Credit Agreement, the definition of adjusted EBITDA contains certain restrictions that limit adjustments to net income when calculating adjusted EBITDA.

For the trailing twelve months ended March 31, 2020, our adjustments to net income when calculating adjusted EBITDA did not exceed the allowable amount under the 2019 Credit Agreement.

The ratio of adjusted EBITDA under the 2019 Credit Agreement to consolidated indebtedness less netted cash was 3.03 times for the trailing twelve months ended March 31, 2020.

(4) Adjusted EBITDA per credit facility excluded $7.9 million of COVID-19 charges associated with temporarily closed company-owned retail stores and sales force retention costs.

(5) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic.

Cost of sales included $4.5 million of costs for relief efforts, increased sanitation supplies and services and other items.

Operating expenses included $0.4 million of charges related to increased sanitation supplies and services.

In the first quarter of 2020, we recorded $2.3 million of charges related to the global pandemic.

(6) In the second quarter of 2020, we recorded $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the current macro-economic environment.

(7) We completed the acquisition of Sherwood Bedding on January 31, 2020 and designated this subsidiary as restricted under the 2019 Credit Agreement.

For covenant compliance purposes, we included $6.7 million of EBITDA from this subsidiary for the seven months prior to acquisition in our calculation of adjusted EBITDA per credit facility for the trailing twelve months ended June 30, 2020.

(8) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the current macro-economic environment.

(9) We recorded $1.3 million and $1.5 million of charges related to the adoption of ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)", in the second and first quarters of 2020, respectively.

As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation.

(10) In 2019, we recorded $0.7 million of professional fees in connection with the amendment of the 2019 Credit Agreement.

Under the 2019 Credit Agreement, the definition of adjusted EBITDA (which we refer to as "adjusted EBITDA per credit facility") contains certain restrictions that limit adjustments to net income when calculating adjusted EBITDA.

For the trailing twelve months ended June 30, 2020, our adjustments to net income when calculating adjusted EBITDA did not exceed the allowable amount under the 2019 Credit Agreement.

The ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility is 2.83 times for the trailing twelve months ended June 30, 2020.

The 2019 Credit Agreement requires us to maintain a ratio of consolidated indebtedness less netted cash to adjusted EBITDA of less than 5.00:1.00 times.

Table of C o ntents

The following table sets forth the reconciliation of our reported total debt to the calculation of consolidated indebtedness less netted cash as of March 31, 2020.

The following table sets forth the reconciliation of our reported total debt to the calculation of consolidated indebtedness less netted cash as of June 30, 2020.

"Consolidated Indebtedness" and "Netted Cash" are terms used in the 2019 Credit Agreement for purposes of certain financial covenants.

(in millions) March 31, 2020

(in millions) June 30, 2020

Total debt, net $ 1,753.6

9 unchanged sentences

There have been no material changes to our critical accounting policies and estimates in 2020.

Goodwill and indefinite-lived intangible assets are evaluated for impairment annually as of October 1 and whenever events or circumstances make it more likely than not that impairment may have occurred.

The most recent annual impairment tests performed as of October 1, 2019 indicated that the fair values of each of our reporting units and indefinite-lived intangible assets were substantially in excess of their carrying values.

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

Our assessment of an impairment on any of these assets could change in future periods if significant events happen and/or circumstances change that effect the previously mentioned assumptions included in our 2019 Annual Report, which could result in an impairment charge in future periods.

Significant assumptions inherent in the valuation methodologies include, but are not limited to, such estimates as future projected business results, growth rates, the weighted average cost of capital, and royalty and discount rates.

While we are unable to currently determine or predict the nature, duration or scope of the overall impact the COVID-19 pandemic will have on our business, a substantial decline in our operating performance over an extended period of time could cause us to recognize an impairment of some or all of our tangible and intangible assets.

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis