What changed in this filing

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Item 2. Management’s Discussion and Analysis

2020-11-05 compared with 2020-08-06 · 307 added, 288 removed, 399 unchanged (60% of the section changed)

5 unchanged sentences

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 and six months ended June 30, 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 nine months ended September 30, 2020, including the following topics:

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

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

Capital Allocation

In the fourth quarter, we announced our new long-term capital allocation strategy, which includes a quarterly cash dividend beginning in 2021, an increase to our share repurchase authorization and a four-for-one stock split.

Our complete capital allocation strategy includes the following components:

• Invest approximately $70 million annually for capital expenditures to invest in our people, products and processes.

• Initiate a quarterly cash dividend beginning in early 2021, subject to approval by the Board of Directors, targeting an annual distribution to our stockholders of approximately 15% of net income.

• Resume our share repurchase program and target to repurchase at least 3% of shares outstanding per year in the near-term, depending on market conditions.

• Evaluate acquisition opportunities with a focus on strategic acquisitions similar to those we have completed over the past few years.

• Execute a four-for-one stock split, which will be effected through a stock dividend in the fourth quarter of 2020, to make our common stock more accessible and improve trading liquidity.

Environmental, Social and Corporate Governance

We have announced multiple initiatives to further reduce our global environmental footprint.

In 2020, we began sourcing 100% renewable electricity for our U.S.

and European Tempur-Pedic and Sealy manufacturing operations.

Additionally, we remain committed to our investment in solar power technology and expect to complete the installation of the solar panel technology at our Albuquerque, New Mexico manufacturing facility in the first half of 2021.

Finally, we announced a commitment to achieving zero landfill waste for our U.S.

and European manufacturing operations by the end of 2022.

Keeping our employees safe and healthy is a top priority during this time of uncertainty caused by COVID-19.

We have implemented precautionary measures to protect our employees, including restricting travel and face-to-face meetings, allowing employees to work from home where possible and adopting all region-specific public health protocols applicable to our global operations.

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.

During the second quarter of 2020, 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.

Additionally, we worked with various government and healthcare organizations to provide products and services.

Business Update

We believe the U.S.

bedding industry has evolved to be healthy and is now structured for sustained growth.

The industry is no longer engaged in uneconomical retail store expansion, startups have shifted from uneconomical strategies to becoming profitable, and legacy retailers and manufacturers have become skilled in producing profitable internet sales.

Additionally, the U.S.

Department of Commerce recently announced its preliminary determination of tariffs on certain imports which are expected to benefit U.S.

manufacturers, including us.

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

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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.

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.

Order trends significantly improved beginning in late May, and this improvement continued throughout the second and third quarters of 2020.

This improvement was primarily due to the reopening of brick-and-mortar stores on a reduced or appointment only basis 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 continue to favorably impact 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.

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.

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

The broad-based increase in demand coupled with supply chain constraints, primarily related to an encased innerspring component, has created operational challenges in the production of Sealy and Sherwood bedding products in the U.S.

As a result, Sealy's third quarter sales growth was unfavorably impacted by these supply chain constraints, as we could not fulfill the domestic demand for Sealy mattresses.

We expect these supply chain constraints to continue for the next few quarters.

The Tempur-Pedic manufacturing process has not been as impacted by the current supply chain constraints.

Our business has a highly variable cost structure that can flex with changes in sales, as evidenced by our ability to quickly reduce costs in the second quarter of 2020 to maintain profitability when we were uncertain of the impact of COVID-19.

In the third quarter of 2020, most of these cost reductions were reversed.

This increase in spending reflects our forward-looking confidence in the business as we make the necessary investments to support long-term growth.

Certain international markets are now experiencing new restrictions related to COVID-19 that are expected to cause some headwinds for the remainder of 2020.

Additionally, in the fourth quarter of 2019, we shipped a large amount of floor models and back stock inventory as we expanded into new distribution networks, which we expect will impact comparisons with the fourth quarter of 2020.

We are targeting net sales to increase by low double digits and adjusted EBITDA per credit facility, which is a non-GAAP financial measure, to grow by high teens in the fourth quarter of 2020, as compared to the same period in 2019.

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.

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

Future changes in raw material prices could have an unfavorable impact on our gross margin.

In the nine months ended September 30, 2020, commodity costs favorably impacted our gross margin.

However commodity costs were higher than expected for the third quarter of 2020.

We currently expect commodity cost inflation to continue into 2021.

As a result, we plan to implement a price increase in the fourth quarter of 2020 across all of our U.S.

brands, including Sealy, Stearns & Foster, and Tempur-Pedic products, which we expect to mitigate or fully offset the commodity cost inflation we anticipate in 2021.

Product Launches

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During the first quarter of 2020, we completed the integration of Sherwood Bedding into our portfolio of product brands.

We expect to leverage our overall brand portfolio to gain additional distribution for Sherwood products.

Since the acquisition, we have leveraged our overall brand portfolio to gain additional distribution for Sherwood products.

Results of Operations

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.

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

• Total net sales increased 37.9% to $1,132.3 million as compared to $821.0 million in the third quarter of 2019.

On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 37.7%, with an increase of 43.3% in the North America business segment and an increase of 10.1% in the International business segment.

• Gross margin was 46.8% as compared to 43.9% in the third quarter of 2019.

Adjusted gross margin, which is a non-GAAP financial measure, was 46.9% in the third quarter of 2020.

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

• Operating income increased 49.4% to $180.2 million as compared to $120.6 million in the third quarter of 2019.

Operating income in the third quarter of 2020 included $45.2 million of amortization for aspirational plan stock-based compensation.

Adjusted operating income, which is a non-GAAP financial measure, was $227.2 million in the third quarter of 2020.

There were no adjustments to operating income in the third quarter of 2019.

• Net income increased 65.6% to $121.4 million as compared to $73.3 million in the third quarter of 2019.

Adjusted net income, which is a non-GAAP financial measure, increased 114.3% to $155.4 million as compared to $72.5 million in the third quarter of 2019.

• Earnings before interest, tax, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, increased 85.7% to $279.9 million as compared to $150.7 million in the third quarter of 2019.

Adjusted EBITDA per credit facility, which is a non-GAAP financial measure, increased 86.3% to $279.3 million as compared to $149.9 million in the third quarter of 2019.

• Earnings per diluted share ("EPS") increased 74.8% to $2.29 as compared to $1.31 in the third quarter of 2019.

Adjusted EPS, which is a non-GAAP financial measure, increased 126.2% to $2.94 as compared to $1.30 in the third quarter of 2019.

• For the trailing twelve months ended September 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 1.92 times as compared to 3.22 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.

THREE MONTHS ENDED JUNE 30, 2020 COMPARED TO THE

THREE MONTHS ENDED JUNE 30, 2019

THREE MONTHS ENDED SEPTEMBER 30, 2020 COMPARED TO THE

THREE MONTHS ENDED SEPTEMBER 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 June 30,

Three Months Ended September 30,

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

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Interest expense, net 20.1 1.8 20.8 2.5

Other expense, net 0.3 — — —

Loss on extinguishment of debt 0.9 0.1 — —

Other (income) expense, net (0.5) — 1.3 0.2

Total other expense, net 20.5 1.8 22.1 2.7

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Income from continuing operations 119.4 10.5 72.4 8.8

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

Income from discontinued operations, net of tax 2.4 0.2 0.8 0.1

Net income before non-controlling interests 121.8 10.8 73.2 8.9

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Earnings per share for continuing operations $ 2.31 $ 1.33

Loss per share for discontinued operations — (0.02)

Earnings per share for discontinued operations 0.04 0.01

Earnings per share $ 2.35 $ 1.34

Earnings per share for continuing operations $ 2.25 $ 1.30

Loss per share for discontinued operations — (0.02)

Earnings per share for discontinued operations 0.04 0.01

Earnings per share $ 2.29 $ 1.31

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Diluted 52.9 55.8

Three Months Ended June 30,

Three Months Ended September 30,

2020 2019 2020 2019 2020 2019

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Total net sales $ 1,132.3 $ 821.0 $ 976.5 $ 682.0 $ 155.8 $ 139.0

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

Net sales increased 37.9%, and on a constant currency basis increased 37.7%.

The change in net sales was driven by the following:

• 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 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,

• North America net sales increased $294.5 million, or 43.2%.

Net sales in the Wholesale channel increased $266.9 million, or 44.3%, primarily driven by broad-based demand across both existing and new distribution networks.

Net sales in the Direct channel increased $27.6 million, or 34.6%, primarily driven by growth from our e-commerce business, offset by slightly decreased performance at our company owned stores which were closed or operating under reduced hours or modified operations for a time during the third quarter as a result of the global pandemic.

• International net sales increased $16.8 million, or 12.1%.

On a constant currency basis, International net sales increased 10.1%.

Net sales in the Wholesale channel increased 8.2% on a constant currency basis.

Net sales in the Direct channel increased 16.7% on a constant currency basis.

Three Months Ended September 30,

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

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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 declined 340 basis points.

Gross margin improved 290 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.

• North America gross margin improved 280 basis points.

The improvement in gross margin was primarily driven by fixed cost leverage and productivity on higher unit volumes of 200 basis points, brand mix of 90 basis points and

lower commodity costs.

Additionally, we incurred $0.6 million of operational expansion costs related to the opening of a Sealy manufacturing facility, which partially offset the improvement in gross margin.

• International gross margin improved 570 basis points.

The improvement in gross margin was primarily driven by favorable mix of 220 basis points, fixed cost leverage and productivity on higher unit volumes of 170 basis points and lower commodity costs .

OPERATING EXPENSES

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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,

Three Months Ended September 30,

2020 2019 2020 2019 2020 2019 2020 2019

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Total operating expenses $ 354.8 $ 243.9 $ 207.1 $ 167.0 $ 51.6 $ 50.4 $ 96.1 $ 26.5

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

Operating expenses increased $110.9 million, or 45.5%, and increased 160 basis points 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%.

• North America operating expenses increased $40.1 million, or 24.0%, and decreased 330 basis points as a percentage of net sales.

The increase in operating expenses was primarily driven by advertising and variable compensation costs.

• International operating expenses increased $1.2 million, or 2.4%, and decreased 320 basis points as a percentage of net sales.

The increase in operating expenses was due to variable compensation costs and increased advertising investments.

• Corporate operating expenses increased $69.6 million, or 262.6%.

The increase in operating expenses was primarily driven by $45.2 million of amortization for our long-term aspirational plan stock-based compensation.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards which became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

Additionally, we expect to reach the maximum payout for our 2020 annual incentive and performance-based stock compensation plans, which increased operating expense in the third quarter of 2020.

We will record additional amortization related to these compensation plans and the aspirational plan in the fourth quarter of 2020.

For information regarding our aspirational plan refer to Note 9, "Stock-Based Compensation," of the "Notes to Condensed Consolidated Financial Statements," under Part I, ITEM 1, "Financial Statements" of this Report.

Research and development expenses for the three months ended September 30, 2020 were $6.1 million compared to $5.6 million for the three months ended September 30, 2019, a increase of $0.5 million, or 8.9%.

OPERATING INCOME

Three Months Ended June 30,

Three Months Ended September 30,

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

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Total operating income $ 180.2 15.9 % $ 120.6 14.7 % 1.2 %

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

Operating income increased $59.6 million and operating margin improved 120 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.

• North America operating income increased $111.7 million and operating margin improved 610 basis points.

The improvement in operating margin was primarily driven by improved operating expense leverage of 330 basis points and the improvement in gross margin of 280 basis points.

• International operating income increased $17.5 million and operating margin improved 920 basis points.

The improvement in operating margin was primarily driven by the improvement in gross margin of 570 basis points and improved operating expense leverage of 320 basis points.

• Corporate operating expenses increased $69.6 million, which negatively impacted our consolidated operating margin by 610 basis points.

The increase in operating expenses was primarily driven by $45.2 million of amortization for our long-term aspirational plan stock-based compensation.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards which became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

Additionally, we expect to reach the maximum payout for our 2020 annual incentive and performance-based stock compensation plans, which increased operating expense in the third quarter of 2020.

We will record additional amortization related to these compensation plans and the aspirational plan in the fourth quarter of 2020.

INTEREST EXPENSE, NET

Three Months Ended June 30,

Three Months Ended September 30,

(in millions, except percentages) 2020 2019 % Change

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Interest expense, net, decreased $0.7 million, or 3.4%.

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

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.

INCOME TAX PROVISION

Three Months Ended June 30,

Three Months Ended September 30,

(in millions, except percentages) 2020 2019 % Change

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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.

Our income tax provision increased $14.2 million due to an increase in income before income taxes.

Our effective tax rate for the three months ended September 30, 2020 as compared to the same prior year period decreased by 130 basis points.

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

federal statutory tax rate for the three months ended September 30, 2020 and 2019 included a net favorable impact of discrete items.

NINE MONTHS ENDED SEPTEMBER 30, 2020 COMPARED TO THE

NINE MONTHS ENDED SEPTEMBER 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,

Nine Months Ended September 30,

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

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Interest expense, net 61.0 2.3 65.7 2.9

Loss on extinguishment of debt 0.9 — — —

Other expense (income), net 0.3 — (6.5) (0.3)

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Income from continuing operations 203.5 7.8 144.1 6.4

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

Income (loss) from discontinued operations, net of tax 1.3 — (0.8) —

Net income before non-controlling interests 204.8 7.8 143.3 6.4

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Earnings per share for continuing operations $ 3.89 $ 2.63

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

Earnings (loss) per share for discontinued operations 0.02 (0.01)

Earnings per share $ 3.91 $ 2.62

Earnings per share for continuing operations $ 3.83 $ 2.57

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

Earnings (loss) per share for discontinued operations 0.03 (0.01)

Earnings per share $ 3.86 $ 2.56

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Diluted 52.9 56.0

Six Months Ended June 30,

Nine Months Ended September 30,

2020 2019 2020 2019 2020 2019

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• North America net sales increased $410.1 million, or 22.6%.

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.

Net sales in the Wholesale channel increased $340.8 million, or 20.9%, primarily driven by broad-based demand across both existing and new distribution.

Net sales in the Direct channel increased $69.3 million, or 38.2%, primarily driven by growth from our e-commerce business.

• International net sales decreased $24.9 million, or 5.9%.

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Net sales in the Wholesale channel decreased 6.1% on a constant currency basis.

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

Six Months Ended June 30,

Net sales in the Direct channel increased 0.7% on a constant currency basis.

Nine Months Ended September 30,

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

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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.

Gross margin improved 120 basis points.

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

• North America gross margin improved 160 basis points.

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.

The improvement in gross margin was primarily driven by fixed cost leverage and productivity on higher unit volume of 190 basis points, decreased floor model expenses of 70 basis points and lower commodity costs of 70 basis points.

These improvements were partially offset by unfavorable product and brand mix of 170 basis points.

Additionally, we incurred $4.0 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items and $0.6 million of operational expansion costs related to the opening of a Sealy manufacturing facility, which partially offset the improvement in gross margin.

• International gross margin improved 250 basis points.

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

The improvement in gross margin was primarily driven by favorable mix of 110 basis points, fixed cost leverage and productivity on higher unit volumes of 60 basis points and lower commodity costs .

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.

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Six Months Ended June 30,

Nine Months Ended September 30,

2020 2019 2020 2019 2020 2019 2020 2019

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• North America operating expenses increased $62.7 million, or 13.4%, and decreased 190 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.

The increase in operating expenses was primarily driven by advertising and incremental bad debt expense primarily related to the bankruptcy of one department store in the U.S.

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

• International operating expenses decreased $5.3 million, or 3.4%, and increased 100 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 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.

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

Additionally, we incurred $3.8 million of restructuring costs associated with headcount reductions driven by the macro-economic environment and $2.6 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

• Corporate operating expenses increased $62.4 million, or 76.1%.

The increase in operating expenses was primarily driven by $45.2 million of amortization for our long-term aspirational plan stock-based compensation.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards which became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

Additionally, we expect to reach the maximum payout for our 2020 annual incentive and performance-based stock compensation plans, which increased operating expense in the third quarter of 2020.

We will record additional amortization related to these compensation plans and the aspirational plan in the fourth quarter of 2020.

This increase was partially offset by $4.1 million of professional fees recorded in the first half of 2019 related to the acquisition of Sleep Outfitters, which were not repeated in 2020.

Research and development expenses were $17.1 million for the nine months ended September 30, 2020 as compared to $16.8 million for the nine months ended September 30, 2019.

OPERATING INCOME

Six Months Ended June 30,

Nine Months Ended September 30,

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

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• North America operating income increased $138.1 million and operating margin improved 350 basis points.

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

The improvement in operating margin was primarily driven by improved operating expense leverage of 310 basis points and the improvement in gross margin of 160 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 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 increased $1.1 million and operating margin improved 150 basis points.

The improvement in operating margin was primarily driven by the improvement in gross margin of 250 basis points and improved operating expense leverage.

These improvements were offset by $3.8 million of restructuring costs associated with headcount reductions driven by the macro-economic environment and $3.1 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

• Corporate operating expenses increased $62.4 million, which negatively impacted our consolidated operating margin by 240 basis points.

The increase in operating expenses was primarily driven by $45.2 million of amortization for our long-term aspirational plan stock-based compensation.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards which became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

Additionally, we expect to reach the maximum payout for our 2020 annual incentive and performance-based stock compensation plans, which increased operating expense in the third quarter of 2020.

We will record additional amortization related to these compensation plans and the aspirational plan in the fourth quarter of 2020.

This increase was partially offset by $4.1 million of professional fees recorded in the first half of 2019 related to the acquisition of Sleep Outfitters, which were not repeated in 2020.

INTEREST EXPENSE, NET

Six Months Ended June 30,

Nine Months Ended September 30,

(in millions, except percentages) 2020 2019 % Change

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Interest expense, net, decreased $4.7 million, or 7.2%.

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

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.

INCOME TAX PROVISION

Six Months Ended June 30,

Nine Months Ended September 30,

(in millions, except percentages) 2020 2019 % Change

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Our income tax provision increased $14.4 million due to an increase in income before income taxes.

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

Our effective tax rate for the nine months ended September 30, 2020 as compared to the same prior year period decreased 250 basis points.

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

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.

federal statutory rate for the nine months ended September 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 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.

federal statutory rate for the for the nine months ended September 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 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.

As of September 30, 2020, we had net working capital of $121.4 million, including cash and cash equivalents of $229.2 million, as compared to $126.9 million, including cash and cash equivalents of $64.9 million, as of December 31, 2019.

At September 30, 2020, total cash and cash equivalents were $229.2 million, of which $186.3 million was held in the U.S.

and $42.9 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:

Six Months Ended June 30,

Nine Months Ended September 30,

(in millions) 2020 2019

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Financing activities (228.5) (124.8)

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.

Cash provided by operating activities from continuing operations increased $296.2 million in the nine months ended September 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.

Cash used in investing activities from continuing operations increased $47.4 million in the nine months ended September 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 $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.

Cash used in financing activities from continuing operations increased $103.7 million in the nine months ended September 30, 2020 as compared to the same period in 2019.

For the nine months ended September 30, 2020, we had net repayments of $21.0 million on our credit facilities, as compared to net repayments of $76.0 million in 2019.

During the nine months ended September 30, 2020 and 2019, respectively, we repurchased $187.5 million and $52.3 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 June 30, 2020 and 2019 was not material.

Additionally, we repurchased $12.1 million and $3.2 million of our common stock which was withheld to satisfy tax withholding obligations related to stock compensation during the nine months ended September 30, 2020 and 2019, respectively.

Cash Provided by (Used in) Discontinued Operations

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

Capital Expenditures

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

Capital expenditures totaled $73.6 million and $61.9 million for the nine months ended September 30, 2020 and 2019, respectively.

We currently expect our 2020 capital expenditures to be approximately $110 to $115 million, which includes investments in our U.S.

enterprise resource planning projects and domestic manufacturing facility.

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.

enterprise resource planning projects and domestic manufacturing facilities.

Our total debt decreased to $1,535.3 million as of September 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.

As a result, we entered into a new $200.0 million 364-day term loan (the "364-Day Loan") in the second quarter of 2020.

As industry trends improved in the third quarter of 2020, we generated record operating cash flow which allowed us to repay the 364-Day Loan referred to below.

Total availability under our revolving senior secured credit facility was $424.9 million as of September 30, 2020, which matures in 2024.

As of September 30, 2020, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure, in accordance with our 2019 Credit Agreement was 1.92 times.

Our leverage ratio as of September 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 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.

As of September 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.

In addition, these agreements permit limited restricted payments under certain conditions when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA is above 3.5 times.

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 per credit facility, which is a non-GAAP financial measure, remains below 3.5 times.

In addition, these agreements permit limited restricted payments under certain conditions when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility is above 3.5 times.

The limit on restricted payments under the 2019 Credit Agreement, 2023 Senior Notes and 2026 Senior Notes is in part determined by a basket that grows at 50% of adjusted net income each quarter, reduced by restricted payments that are not otherwise permitted.

On May 13, 2020, we entered into an amendment to the existing 2019 Credit Agreement, which provided for the $200.0 million 364-Day Loan.

We used the proceeds of the 364-Day Loan to repay borrowings under the existing $425.0 million revolving credit facility and to pay fees and expenses in connection with the amendment.

On September 14, 2020, we repaid the 364-Day Loan.

Repayment of the 364-Day Loan lifted certain restrictions on dividends, share repurchases and our ability to make certain investments.

For additional information, refer to "Non-GAAP Financial Information" below for the calculation of the ratio of consolidated indebtedness less netted cash to adjusted EBITDA calculated in accordance with the 2019 Credit Agreement.

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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 and the 364-Day Loan, 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, 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 summarized financial information for the Obligor Group follows.

Six Months Ended

June 30, 2020

Nine Months Ended

September 30, 2020

Obligor Group

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Obligor Group Obligor Group

June 30, 2020 December 31, 2019

September 30, 2020 December 31, 2019

(in millions)

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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 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.

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

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

In October 2020, the Board of Directors authorized an additional increase, of $168.7 million, to the existing share repurchase authorization of Tempur Sealy International's common stock to $300.0 million.

Share repurchases under this program may be made through open market transactions, negotiated purchases or otherwise, at times and in such amounts as management deems appropriate.

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Repurchases may be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under federal securities laws.

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, 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.

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 was outstanding.

These limitations were lifted upon repayment of the 364-Day Loan in the third quarter of 2020.

In the near term, subject to market conditions, we expect to repurchase at least 3% of shares outstanding per year.

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

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

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.

As of September 30, 2020, we had $737.7 million of liquidity, including $229.2 million of cash on hand and $424.9 million available under our revolving senior secured credit facility.

We also had availability of $83.6 million under our securitization facility.

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

In addition, we expect to generate additional cash flow from operations in the fourth quarter 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.

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.

Operating cash flow and liquidity exceeded our expectations in 2020.

As a result, we have developed a new capital allocation plan to drive shareholder value over time.

Our plan is focused on the following:

• Invest approximately $70 million annually for capital expenditures to invest in our people, products and processes.

• Initiate a quarterly cash dividend beginning in early 2021, subject to approval by the Board of Directors, targeting an annual distribution to our stockholders of approximately 15% of net income.

• Resume our share repurchase program and target to repurchase at least 3% of shares outstanding per year in the near-term, depending on market conditions.

• Evaluate acquisition opportunities with a focus on strategic acquisitions similar to those we have completed over the past few years.

• Execute a four-for-one stock split, which will be effected through a stock dividend in the fourth quarter of 2020, to make our common stock more accessible and improve trading liquidity.

As of September 30, 2020, we had $1,535.3 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $1,335.3 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 1.92 times for the trailing twelve months ended September 30, 2020, the lowest in our history.

Our target range for our ratio of consolidated indebtedness less netted cash, which is a non-GAAP financial measure, is 2.0 to 3.0 times.

Total cash interest payments related to our borrowings are expected to be approximately $75 to $80 million in 2020.

On October 8, 2020, we announced our election to conditionally redeem $200.0 million of our $450.0 million of our issued and outstanding 2023 Senior Notes on November 9, 2020 (the "Redemption Date").

The 2023 Senior Notes selected for redemption will be redeemed at 101.406% of their principal amount, plus the accrued and unpaid interest.

The redemption is conditioned on the determination by our Chief Financial Officer, in his sole discretion, as of the second business day before the Redemption Date, that the redemption continues to be reasonably prudent and consistent with our objectives concerning liquidity, financing needs and funding costs.

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

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Non-GAAP Financial Information

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.

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 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.

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, gross profit, gross margin, operating income (expense) and operating margin.

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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.

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:

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 September 30, 2020 and 2019:

Three Months Ended

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

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

Net income $ 121.4 $ 73.3

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

Incremental operating costs (2)

Asset impairments (3)

Restructuring costs (4)

Income from discontinued operations, net of tax (1)

Aspirational plan amortization (2)

Loss on extinguishment of debt (3)

Accounting standard adoption (4)

Acquisition-related costs and other (6)

Facility expansion costs (5)

Restructuring costs (6)

Tax adjustments (7)

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Diluted shares outstanding 52.9 55.8

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 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.

(2) In the third quarter of 2020, we recognized $45.2 million of performance-based stock compensation amortization related to our long-term aspirational awards.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards that became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

(3) In the third quarter of 2020, loss on extinguishment of debt represents costs associated with the early repayment of the 364-Day Loan.

(4) In the third quarter of 2020, we recorded $0.8 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 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.

(5) In the third quarter of 2020, we recorded $0.6 million of costs related to the opening of a Sealy manufacturing facility.

(6) We incurred $0.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment, in the third quarter of 2020.

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

2 unchanged sentences

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

Three Months Ended September 30, 2020

(in millions, except percentages) Consolidated

2 unchanged sentences

Gross profit $ 530.2 46.8 % $ 438.6 44.9 % $ 91.6 58.8 % $ —

Incremental operating costs (1)

4.5 4.0 0.5 —

Facility expansion costs (1)

Adjusted gross profit $ 530.8 46.9 % $ 439.2 45.0 % $ 91.6 58.8 % $ —

Operating income (expense) $ 180.2 15.9 % $ 231.5 23.7 % $ 44.8 28.8 % $ (96.1)

Incremental operating costs (1)

Aspirational plan amortization (2)

45.2 — — 45.2

Asset impairments (2)

Restructuring costs (3)

Accounting standard adoption (3)

Facility expansion costs (1)

Restructuring costs (4)

Total adjustments 47.0 1.4 0.4 45.2

Adjusted operating income (expense) $ 227.2 20.1 % $ 232.9 23.9 % $ 45.2 29.0 % $ (50.9)

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.

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 June 30, 2019.

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

Three Months Ended June 30, 2019

The following table sets forth our reported gross profit and operating income (expense) for the three months ended September 30, 2019.

We had no adjustments to gross profit and operating income (expense) for the three months ended September 30, 2019.

Three Months Ended September 30, 2019

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

2 unchanged sentences

Operating income (expense) $ 120.6 14.7 % $ 119.8 17.6 % $ 27.3 19.6 % $ (26.5)

Acquisition-related costs and other (5)

2.8 1.7 — 1.1

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

(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.

(1) In the third quarter of 2020, we recorded $0.6 million of costs related to the opening of a Sealy manufacturing facility.

(2) In the third quarter of 2020, we recognized $45.2 million of performance-based stock compensation amortization related to our long-term aspirational awards.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards that became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

(3) In the third quarter of 2020, we recorded $0.8 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 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

(4) We incurred $0.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment, in the third quarter of 2020.

EBITDA, Adjusted EBITDA per Credit Facility and Consolidated Indebtedness less Netted Cash

The following reconciliations are provided below:

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

• Net income to EBITDA and adjusted EBITDA per credit facility

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

2 unchanged sentences

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:

The following table sets forth the reconciliation of our reported net income to the calculations of EBITDA and adjusted EBITDA per credit facility for the three months ended September 30, 2020 and 2019:

Three Months Ended

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

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

Net income $ 121.4 $ 73.3

Interest expense, net 20.1 20.8

Loss on extinguishment of debt (1)

Income taxes 40.3 26.1

Depreciation and amortization 52.0 30.5

Aspirational plan amortization (2)

EBITDA $ 279.9 $ 150.7

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

Incremental operating costs (2)

Asset impairments (3)

Restructuring costs (4)

Income from discontinued operations, net of tax (3)

Accounting standard adoption (4)

Acquisition-related costs and other (6)

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

COVID-19 charges (7)

Facility expansion costs (5)

Restructuring costs (6)

Adjusted EBITDA per credit facility $ 279.3 $ 149.9

(1) In the third quarter of 2020, loss on extinguishment of debt represents costs associated with the early repayment of the 364-Day Loan.

(2) In the third quarter of 2020, we recognized $45.2 million of performance-based stock compensation amortization related to our long-term aspirational awards.

The amount recognized represents the cumulative catch-up adjustment for the long-term aspirational awards that became probable of vesting during the third quarter of 2020.

The awards are subject to a remaining service vesting condition which will lapse in December 2020.

(3) 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.