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Item 7. Management’s Discussion and Analysis

2021-02-19 compared with 2020-02-24 · 420 added, 277 removed, 319 unchanged (69% of the section changed)

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with Part II, ITEM 6 of this Report and the audited Consolidated Financial Statements and accompanying notes thereto included elsewhere in this Report.

In addition, prior period amounts have been revised to reflect certain Latin American subsidiaries as discontinued operations.

The following discussion and analysis should be read in conjunction with the audited Consolidated Financial Statements and accompanying notes thereto included elsewhere in this Report.

Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company.

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For results of operations comparisons relating to years ending December 31, 2019 and 2018, refer to our annual report on Form 10-K, Part II, ITEM 7:

Management's Discussion and Analysis of Financial Conditions and Results of Operations filed with the Securities and Exchange Commission on February 25, 2019.

Management's Discussion and Analysis of Financial Condition and Results of Operations filed with the Securities and Exchange Commission on February 21, 2020.

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the years ended December 31, 2020 and 2019, including the following topics:

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• our use of certain non-GAAP financial measures.

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Business Overview

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

Our product brand portfolio includes many highly recognized and iconic brands in the industry, including Tempur®, Tempur-Pedic®, Sealy® featuring Posturepedic® Technology, Stearns & Foster® and Comfort Revolution®.

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 across two distribution channels in each operating business segment:

Wholesale and Direct.

Our Wholesale channel consists of third party retailers, including third party distribution, hospitality and healthcare.

Our Direct channel includes company-owned stores, e-commerce and call centers.

We continue to make strategic investments, including the introduction of new products;

investments to increase our global brand awareness;

investments in research and development and productivity initiatives;

and various other actions aimed at further strengthening our business.

In 2020, we expect to increase our investments in research and development, as well as to spend a record amount of advertising dollars to promote our worldwide brands.

Full year net income for 2019 increased 89% and full year earnings per share ("EPS") increased 88% to $3.42.

We believe investments we have made over the past four years strengthening the long-term foundation of our company investments have enhanced our competitive position.

The combination of our powerful omni-channel distribution platform coupled with our market leading brands and products continues to drive market share gains and solid financial performance.

Our results for 2019 included the following significant accomplishments:

Completed the launch of the all-new line of Tempur-Pedic products

Announced that we were expanding our distribution with new supply agreements

Executed the largest expansion of new stores in our history.

Business Segments

We are committed to improving the sleep of more people, every night, all around the world.

As a global leader in the design, manufacture and distribution of bedding products, we know how crucial a good night of sleep is to overall health and wellness.

Utilizing over a century of knowledge and industry-leading innovation, we deliver award-winning products that provide breakthrough sleep solutions to consumers in over 100 countries.

We operate in two segments:

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These segments are strategic business units that are managed separately based on geography.

Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries and licensees located in the U.S.

Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America.

In the fourth quarter of 2020, we realigned our business segment reporting to include Mexico within our North America segment, which was previously included in our International segment.

The change in segment reporting aligned with changes in how our global operations are managed.

Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S., Canada and Mexico.

In 2020, we acquired an 80% ownership interest in a newly formed limited liability company containing substantially all of the assets of the Sherwood Bedding business, which is included in the North America segment.

Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America (other than Mexico).

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

For additional information refer to Note 14, "Business Segment Information," included in Part II, ITEM 8 "Financial Statements and Supplementary Data", of this Report.

Our product brand portfolio includes many highly recognized and iconic brands in the industry, including Tempur-Pedic®, Sealy® featuring Posturepedic® Technology and Stearns & Foster® and our non-branded offerings include value-focused private label OEM products.

Our distinct brands allow for complementary merchandising strategies.

Our distribution model operates through an omni-channel strategy.

We distribute through two channels in each operating business segment:

Wholesale and Direct.

Our Wholesale channel consists of third-party retailers, including third-party distribution, hospitality and healthcare.

Our Direct channel includes company-owned stores, online and call centers.

We have a global manufacturing footprint with approximately 9,000 employees worldwide.

Full year net income for 2020 increased 84.1% and full year diluted earnings per share ("EPS") increased 90.7% to $1.64.

Our growth has been driven by strong demand during the COVID-19 global pandemic as more people are investing in their homes and overall wellness.

We also maintain a strong competitive position within the industry.

We believe the investments that we have made over the past five years have strengthened the long-term foundation of our company and enhanced our competitive position.

The combination of our product superiority, brand strength, manufacturing efficiency and quality, powerful omni-channel distribution platform and substantial cash flow and balance sheet continue to drive market share gains and solid financial performance.

General Business and Economic Conditions

We believe the bedding industry 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 online sales.

In 2020, we began rapidly expanding organically with new distribution partners through our direct channel and the initiation of our OEM business.

We experienced a reduction in total net sales at the outset of the COVID-19 global pandemic within our International business segment in the first quarter.

Order trends reached their lowest point in early April when they had declined approximately 80% as compared to the prior year.

North American order trends significantly improved beginning in late May, and this improvement continued throughout the remainder of the year.

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 industry.

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

Additionally, the U.S.

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 products in the U.S.

As a result, the sales growth of Sealy and Sherwood in the second half of 2020 was unfavorably impacted by these supply chain constraints, as we could not fulfill the entire domestic demand for these products.

We expect these supply chain constraints to mitigate significantly by early second quarter of 2021.

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

Sales trends for early 2021 indicate that growth in the U.S.

and Asia-Pacific has accelerated from the fourth quarter of 2020.

However, sales within certain of our European markets have decelerated from the fourth quarter of 2020 as a result of significant restrictions on retail activity due to renewed government restrictions related to the global COVID-19 pandemic.

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 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 I of this Report.

Product Launches

During the first half of 2019, we completed the rollout of our higher-end Tempur-Breeze, which completed the largest Tempur-Pedic rollout in our history.

Additionally, we completed the launch of our Stearns & Foster products.

In our North America segment in 2020, we will introduce the Tempur-Ergo Smart Base Collection with Sleeptracker technology and a new Sealy Posturepedic Plus line.We have successfully extended our product life cycle and therefore expect to have favorable launch costs in 2020.

Expanded Distribution Channels

In our North America segment in 2020, we introduced the Tempur-Ergo Smart Base Collection with Sleeptracker® technology.

In 2021, we are refreshing our Sealy portfolio and launching new models in our Posturepedic Plus™, Posturepedic® and Essentials product lines.

We expect to complete the launch of our Essentials and Posturepedic lines in the second quarter of 2021.

Additionally, we expect to complete the launch of the higher margin Posturepedic Plus line in the second half of the year.

Our global 2021 marketing plan is to aggressively support our innovative bedding products through investing significant marketing dollars to promote our worldwide brands.

We expect to spend a record amount of marketing dollars in 2021 for Tempur-Pedic, Sealy and Stearns & Foster.

Omni-Channel Distribution Expansion

We have a diversified group of strong retail partners and a rapidly growing direct business.

In 2019, we announced three new or expanded third-party retail relationships in the U.S.

This resulted in the largest expansion of stores in our history.

We announced that we entered into a supply agreement with Mattress Firm, the largest specialty mattress retailer in North America, to reintroduce Tempur-Pedic, Stearns & Foster and Sealy branded products into approximately 2,500 Mattress Firm stores across the U.S.

The reintroduction of products into Mattress Firm stores commenced in the fourth quarter of 2019 and is expected to be completed in the first quarter of 2020.

We also announced the recent expansion of our long-term supply agreement with Big Lots, a 1,400-store retailer in the U.S.

This agreement is expected to grow the sales of entry-level Sealy products and to drive unit volume, primarily in the below $1,000 retail price point.

Our launch of Sealy products with Big Lots was completed in 2019.

In 2019, we also expanded our European retail distribution network by reaching a supply agreement with Beter Bed Holding, one of Europe’s leading bedding retailers.

The launch of new products with Beter Bed Holding was completed in 2019 in over 100 stores.

As a result of these new and expanded agreements, we expect significantly higher volume in our North America segment operations in 2020.

Expanding Retail Footprint

We are focused on developing our North America distribution network by opening more Tempur-Pedic retail stores and expanding our online availability.

In 2020, we successfully completed the product rollout to our expanded distribution relationships, realizing robust wholesale channel growth as a result.

We continue to increase our network of third-party retail partners and recently added new distribution at several established retail chains.

We have been focused on building our direct channel, both online and company-owned retail stores.

The development of our online business has been particularly important as consumers have grown more comfortable shopping for bedding products online.

Online purchases accelerated during the pandemic and we expect that consumers will continue to lean into this channel in the future.

In 2020, we estimate that 20% of our U.S.

sales occurred online, either through our own website in our direct channel or through our third-party retailer websites in our wholesale channel.

The direct channel growth rate has surpassed the wholesale growth rate over the last few years, and we anticipate the direct channel to continue to grow as a percentage of net sales in future years.

Our North America distribution network expanded in 2020 as we opened 21 new Tempur-Pedic retail stores.

As of December 31, 2020, we had 76 Tempur-Pedic retail stores in operation.

We plan to open approximately 20 new retail stores in 2020.

We expect to recover our initial cash investment on each store after twelve months.

We plan to expand our network to 125 to 150 new retail stores in the long-term.

We expect these retail stores to complement our existing third-party retail partners by increasing our products' brand awareness in the local markets.

We also plan to expand our offerings in our own e-commerce platform and with third-party online retailers where our market share is still very low.

Online bedding sales have increased significantly, as a growing segment of consumers prefer to purchase bedding products in this way.

During 2019, we have experienced strong growth in both our e-commerce business and our company-owned stores.

In 2020, we expect to continue to expand our Direct channel through new stores and by capturing share online.

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In 2020, we expanded our presence into the OEM market by offering non-branded products, including mattresses, pillows, and other bedding products and components at a wide range of price points.

The addition of non-branded offerings expands our capabilities to service third-party retailers and creates opportunity to capture manufacturing profits from bedding brands outside our own.

In 2020, we sold approximately $150 million of OEM bedding products.

In 2021, we plan to grow our sales in the North American OEM business.

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

For the year ended December 31, 2020, commodity costs were flat as compared to the same period in the prior year, but were higher than expected for the second half of 2020.

We currently expect commodity costs and inflation to increase into 2021.

During the fourth quarter of 2020, we implemented pricing actions that fully mitigated the anticipated commodity costs increases expected for 2021.

In the first quarter of 2021, commodity costs have increased greater than expected and we will consider additional pricing actions as needed.

Acquisition of Sherwood Bedding

On January 31, 2020, we acquired an 80% ownership interest in a newly formed limited liability company containing substantially all of the assets of the Sherwood Bedding business for a cash purchase price of $39.1 million.

Sherwood Bedding is a major manufacturer in the U.S.

private label and OEM bedding market, and this acquisition of a majority interest marks our entrance into the private label category.

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

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

Acquisition of Innovative Mattress Solutions, LLC ("iMS")

On April 1, 2019, we acquired substantially all of the net assets of iMS in a transaction valued at approximately $24 million, including assumed liabilities of approximately $11 million as of March 31, 2019 (referred to as the "Sleep Outfitters Acquisition").

On April 1, 2019, we acquired substantially all of the net assets of iMS in a transaction valued at approximately $24.0 million, including assumed liabilities of $11.0 million as of March 31, 2019 (referred to as the "Sleep Outfitters Acquisition").

The acquisition of this regional bedding retailer furthers our North American retail strategy, which is focused on meeting customer demand through geographic representation and sales expertise.

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Sleep Outfitters' sales have been reclassified into our Direct channel beginning in the second quarter of 2019.

Acquisition of Sherwood Bedding

Sherwood Bedding is a major manufacturer in the U.S.

private label and OEM bedding market and this acquisition of a majority interest marks our entrance into the private label category.

In 2020, we expect this acquisition to contribute to our cash flow and profits.

Customer-Related Charges

The global economic environment continues to be challenging, and there have been signs of deterioration in the U.S.

retail sector.

Over the past two years, a national department store retail customer and various regional retail customers have filed for U.S.

bankruptcy protection.

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.

This customer represented less than 1% of our global net sales in 2019.

Similarly, in the fourth quarter of 2018, prior to the Sleep Outfitters Acquisition, we recorded $21.2 million of customer-related charges in connection with the bankruptcy of iMS to fully reserve trade receivables and other assets associated with this account.

2020 Results of Operations

A summary of our results for the year ended December 31, 2020 include:

Total net sales increased 14.9% to $3,106.0 million from $2,702.9 million in 2018 .

• Total net sales increased 18.4% to $3,676.9 million as compared to $3,106.0 million in 2019.

• Gross margin was 44.6% in 2020 as compared to 43.2% in 2019.

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Adjusted operating income, which is a non-GAAP financial measure, was $617.7 million, or 16.8% of net sales, as compared to $392.2 million, or 12.6% of net sales, in 2019.

Operating income and adjusted operating income, which is a non-GAAP financial measure, 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 was $348.8 million as compared to $189.5 million in 2019.

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• EBITDA, which is a non-GAAP financial measure, increased 57.5% to $737.8 million as compared to $468.4 million in 2019.

Adjusted EBITDA, which is a non-GAAP financial measure, increased 19.6% to $508.1 million as compared to $424.7 million in 2018 .

EPS was $3.42 as compared to $1.82 in 2018 .

Adjusted EPS, which is a non-GAAP financial measure, was $4.01 as compared to $2.96 in 2018 .

Adjusted EBITDA per credit facility, which is a non-GAAP financial measure, increased 53.5% to $779.9 million as compared to $508.1 million in 2019.

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• EPS increased to $1.64 as compared to $0.86 in 2019.

Adjusted EPS, which is a non-GAAP financial measure, increased 91.0% to $1.91 as compared to $1.00 in 2019.

Adjusted EPS, which is a non-GAAP financial measure, included $0.03 of COVID-19 charges.

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 II, ITEM 7A of this Report for a discussion of our foreign currency exchange rate risk.

Table of Co ntents

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

(in millions, except percentages and

Year Ended December 31,

(in millions, except percentages and Year Ended December 31,

per common share amounts) 2020 2019

Net sales $ 3,676.9 100.0 % $ 3,106.0 100.0 %

Cost of sales 2,038.5 55.4 1,763.8 56.8

Gross profit 1,638.4 44.6 1,342.2 43.2

Selling and marketing expenses 740.2 20.1 666.3 21.5

General, administrative and other expenses 382.5 10.4 345.1 11.1

Customer-related charges

Equity income in earnings of unconsolidated affiliates (16.4) (0.4) (15.9) (0.5)

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Interest expense, net 77.0 2.1 85.7 2.8

Loss on extinguishment of debt 5.1 0.1 — —

Other income, net (2.4) (0.1) (4.5) (0.1)

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Net income before non-controlling interests 349.8 9.5 189.4 6.1

Net loss attributable to non-controlling interests

Net income (loss) attributable to non-controlling interests 1.0 — (0.1) —

Net income attributable to Tempur Sealy International, Inc.

$ 348.8 9.5 % $ 189.5 6.1 %

Earnings per common share:

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Weighted average common shares outstanding:

Basic 207.9 218.0

Diluted 212.3 221.6

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Year Ended December 31,

North America

International

Consolidated North America International

(in millions) 2020 2019 2020 2019 2020 2019

Net sales by channel

Wholesale $ 3,185.8 $ 2,717.1 $ 2,806.7 $ 2,343.5 $ 379.1 $ 373.6

Direct 491.1 388.9 352.5 260.0 138.6 128.9

Total net sales $ 3,676.9 $ 3,106.0 $ 3,159.2 $ 2,603.5 $ 517.7 $ 502.5

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• North America net sales increased $555.7 million, or 21.3%.

Net sales in the Wholesale channel increased $284.4 million , or 14.3% , primarily driven by new Tempur product introductions and the expansion of our retail distribution network.

Net sales in our Direct channel increased $112.7 million , or 76.6% , 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 17% and the Direct channel increased approximately 35% .

Net sales in the Wholesale channel increased $463.2 million, or 19.8%, primarily driven by broad-based demand across our retail partners and new distribution.

Net sales in our Direct channel increased $92.5 million, or 35.6%, primarily driven by growth from our e-commerce business.

On a constant currency basis, North America net sales increased 21.6%.

• International net sales increased $15.2 million, or 3.0%.

On a constant currency basis, our International net sales increased 5.3% , primarily driven by Direct channel growth.

Net sales in the Wholesale channel decreased 0.1% on a constant currency basis, primarily driven by country specific conditions.

Net sales in the Direct channel increased 29.5% on a constant currency basis, primarily driven by growth from company-owned stores.

On a constant currency basis, our International net sales increased 1.4%.

Net sales in the Wholesale channel were flat on a constant currency basis, which reflects the uneven re-opening of retail in many jurisdictions.

Net sales in the Direct channel increased 5.6% on a constant currency basis, driven by growth from our e-commerce business.

Year Ended December 31,

2020 2019 Margin Change

(in millions, except percentages)

(in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin 2020 vs 2019

North America $ 1,332.0 42.2 % $ 1,055.2 40.5 % 1.7 %

International 306.4 59.2 % 287.0 57.1 % 2.1 %

Consolidated gross margin $ 1,638.4 44.6 % $ 1,342.2 43.2 % 1.4 %

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.

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Future changes in raw material prices could have a significant impact on our gross margin.

In 2020, we expect a modest impact on gross margin due to lower commodity costs.

In 2021, we expect commodity cost inflation to negatively impact gross margin.

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.

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Year ended December 31, 2020 compared to year ended December 31, 2019

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• North America gross margin improved 170 basis points.

The improvement in gross margin was primarily driven by favorable pricing of 130 basis points, favorable product and brand mix of 110 basis points and lower commodity costs.

Additionally, in 2018, we also recorded $6.1 million of restructuring charges related to our acquisition of the remaining interest in a joint venture and $5.6 million of supply chain transition costs to consolidate certain manufacturing and distribution facilities, resulting in a favorable impact of 50 basis points in 2019.

These improvements were partially offset by increased floor model expenses.

The improvement in gross margin was primarily driven by improved fixed cost leverage and productivity on higher unit volumes of 160 basis points and favorable floor model costs of 90 basis points.

These improvements were partially offset by unfavorable product and brand mix of 100 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 210 basis points.

The improvement in gross margin was primarily driven by lower commodity costs and channel mix.

The improvement in gross margin was primarily driven by improved fixed cost leverage and productivity on higher unit volumes of 120 basis points and favorable mix of 80 basis points.

Additionally, we incurred $0.5 million of incremental costs related to the 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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Year Ended December 31,

(in millions)

North America

International

2020 2019 2020 2019 2020 2019 2020 2019

(in millions) Consolidated North America International Corporate

Operating expenses:

Advertising $ 332.5 $ 280.5 $ 297.7 $ 246.6 $ 34.8 $ 33.9 $ — $ —

Other selling and marketing 407.7 385.8 251.0 258.9 112.2 115.7 44.5 11.2

General, administrative and other 382.5 345.1 191.9 199.8 48.2 43.0 142.4 102.3

Customer-related charges

Total operating expense $ 1,122.7 $ 1,011.4 $ 740.6 $ 705.3 $ 195.2 $ 192.6 $ 186.9 $ 113.5

Operating expenses increased $129.4 million , or 14.7% , and were flat as a percentage of net sales.

Operating expenses increased $111.3 million, or 11.0%, and decreased 210 basis points as a percentage of net sales.

The primary drivers of changes in operating expenses by segment are discussed below.

North America operating expenses increased $117.0 million , or 20.4% , and increased 50 basis points as a percentage of net sales.

The increase in operating expenses was primarily driven by advertising and other selling and marketing investments, variable compensation expense and incremental operating expense associated with a higher number of company-owned stores.

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

Additionally, in the fourth quarter of 2019, we recorded an $8.9 million charge related to the donation of common stock at fair market value to certain public charities.

In the fourth quarter of 2018, prior to the Sleep Outfitters Acquisition, we recorded $21.2 million of customer-related charges in connection with the bankruptcy of iMS to fully reserve trade receivables and other assets associated with this account.

Additionally, in 2018, we recorded $4.1 million of restructuring charges related to our acquisition of the remaining interest in a joint venture and $7.3 million of supply chain transition costs which represent charges incurred to consolidate certain manufacturing and distribution facilities.

• North America operating expenses increased $35.3 million, or 5.0%, and decreased 370 basis points as a percentage of net sales.

The increase in operating expenses was primarily driven by higher advertising investments, partially offset by decreased customer-related charges.

In 2020, we recorded $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates, whereas in the same prior year period, we recorded $29.8 million of customer-related charges in connection with the bankruptcy of Mattress PAL and resulting liquidity issues of Mattress PAL's affiliates.

• International operating expenses increased $2.6 million and decreased 60 basis points as a percentage of net sales.

The increase in operating expenses was primarily driven by an increase in variable compensation expense, offset by $8.2 million of costs associated with our International simplification efforts, which were not repeated in 2019.

The increase in operating expenses was primarily driven by $3.8 million of restructuring costs associated with headcount reductions driven by the macro-economic environment and $2.9 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

These incremental costs were offset by decreased other selling and marketing investments.

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• Corporate operating expenses increased $73.4 million, or 64.7%.

The increase in operating expenses was primarily driven by increased variable compensation expense.

The increase in operating expenses was primarily driven by $49.4 million of non-recurring amortization for our long-term aspirational plan stock-based compensation.

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

Additionally, we reached the maximum payout for our 2020 performance-based stock compensation and annual incentive compensation plans.

Research and development expenses for the year ended December 31, 2020 were $23.1 million compared to $23.0 million for the year ended December 31, 2019, an increase of $0.1 million, or 0.4%.

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2020 2019 Margin Change

(in millions, except percentages)

Operating Income

Operating Margin

Operating Income

Operating Margin

(in millions, except percentages) Operating Income Operating Margin Operating Income Operating Margin 2020 vs 2019

North America $ 591.4 18.7 % $ 349.9 13.4 % 5.3 %

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The increase was driven by the following:

North America operating income increased $94.8 million and operating margin improved 190 basis points, primarily driven by the improvement in gross margin of 240 basis points.

In 2018, we recorded $10.2 million of restructuring charges related to our acquisition of the remaining interest in a joint venture, as well as incremental bad debt expense related to the bankruptcy of a department store retailer, which were not repeated in 2019.

These improvements were offset by increased advertising and other selling and marketing investments and variable compensation expense.

Additionally, we recorded an $8.9 million charge related to the donation of common stock at fair market value to certain public charities.

• North America operating income increased $241.5 million and operating margin improved 530 basis points.

The improvement in operating margin was primarily driven by improved operating expense leverage of 310 basis points, the improvement in gross margin of 170 basis points and lower customer-related charges.

• International operating income increased $17.3 million and operating margin improved 260 basis points.

The improvement in operating margin was driven by the improvement in gross margin of 110 basis points.

In 2018, we recorded $8.5 million of costs associated with our International simplification efforts, including headcount reduction, professional fees and store closures, which were not repeated in 2019.

These improvements were offset by an increase in variable compensation expense.

The improvement in operating margin was primarily driven by the improvement in gross margin of 210 basis points and improved operating expense leverage of 180 basis points.

These improvements were offset by $3.8 million of restructuring costs associated with headcount reductions driven by the macro-economic environment and $2.9 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items.

• Corporate operating expenses increased $73.4 million, which negatively impacted our consolidated operating margin by 200 basis points.

The increase in operating expenses was primarily driven by an increase in variable compensation expense.

The increase in operating expenses was primarily driven by $49.4 million of non-recurring amortization for our long-term aspirational plan stock-based compensation.

Additionally, we reached the maximum payout for our 2020 performance-based stock compensation and annual incentive compensation plans.

INTEREST EXPENSE, NET

Year Ended December 31,

Percent change

(in millions, except percentages)

Year Ended December 31, Percent change

(in millions, except percentages) 2020 2019 2020 vs 2019

Interest expense, net $ 77.0 $ 85.7 (10.2) %

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Interest expense, net, decreased $8.7 million, or 10.2%.

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

Year Ended December 31,

Percent change

(in millions, except percentages)

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.

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INCOME TAX PROVISION

Year Ended December 31, Percent change

(in millions, except percentages) 2020 2019 2020 vs 2019

Income tax provision $ 102.6 $ 74.7 37.3 %

Effective tax rate 22.7 % 28.1 % (5.4) %

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Year ended December 31, 2020 compared to year ended December 31, 2019

Our income tax provision increased $25.1 million due to an increase in income before income taxes and as the result of discrete items.

Our income tax provision increased $27.9 million due to an increase in income before income taxes, net of the favorable impact of discrete items.

Our 2020 effective tax rate decreased as compared to 2019 by 540 basis points.

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

federal statutory tax rate for the year ending December 31, 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 tax rate for the year ending December 31, 2020 included a net favorable impact of discrete items, primarily related to the implementation of income tax regulations in 2020 that favorably impacted our taxable global intangible low-taxed income ("GILTI") starting from the year ending December 31, 2018 onward and the vesting of certain stock compensation under our incentive stock compensation plan.

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

federal statutory tax rate for the year ended December 31, 2018 included a net favorable impact of the settlement of the previously-disclosed Danish Tax Matter for the years 2001 - 2011, the favorable impact of the U.S.

Tax Reform Act as reflected on our 2017 U.S.

income tax return filed in 2018 and the unfavorable impact of an increase in our uncertain tax position related to the Danish Tax Matter for years after 2011.

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

Refer to Note 12, “Income Taxes,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information.

Liquidity and Capital Resources

Our principal sources of funds are cash flows from operations, borrowings made pursuant to our credit facilities and cash and cash equivalents on hand.

Our principal sources of funds are cash flows from operations, supplemented with borrowings made pursuant to our credit facilities and cash and cash equivalents on hand.

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

At December 31, 2019 , we had working capital of $126.9 million , including cash and cash equivalents of $64.9 million , as compared to working capital of $136.4 million including $45.8 million in cash and cash equivalents as of December 31, 2018 .

At December 31, 2020, total cash and cash equivalents were $65.0 million, of which $32.1 million was held in the U.S.

and $32.9 million was held by subsidiaries outside of the U.S.

The amount of cash and cash equivalents held by subsidiaries outside of the U.S.

and not readily convertible into the U.S.

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

Cash Provided by (Used in) Continuing Operations

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Cash provided by operating activities from continuing operations increased $339.9 million in 2020 as compared to 2019.

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

Accounts receivable and inventory were principal uses of cash, which reflect higher sales levels and volumes, the impact of the new and expanded retail relationships, and new product introductions.

Accrued expenses and other liabilities were a source of cash in 2019 as a result of increased accruals for variable compensation and other expenses such as advertising given higher revenues and earnings.

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 $56.4 million in 2020 as compared to 2019.

The increase in cash used in investing activities was primarily due to cash used for the Sleep Outfitters Acquisition and planned capital expenditures.

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

Table of Co ntents

Cash used in financing activities from continuing operations increased $319.4 million in 2020 as compared to 2019.

In 2020, we repurchased $331.8 million of our common stock, which included repurchases of $285.9 million under our share repurchase program and $45.9 million which was withheld to satisfy tax withholding obligations related to stock compensation.

In 2018, we repurchased $4.6 million of our common stock which was withheld to satisfy tax withholding obligations related to stock compensation.

We did not repurchase any shares under our share repurchase program during 2018.

Proceeds from exercise of stock options increased $13.2 million as compared to the same period in 2018.

In 2019, we repurchased $105.7 million of our common stock, which included repurchases of $102.3 million under our share repurchase program and $3.4 million which was withheld to satisfy tax withholding obligations related to stock compensation.

In 2020, we had net repayments of $184.5 million on our credit facilities, as compared to net repayments of $104.3 million in 2019.

Cash Used in Discontinued Operations

The table below presents net cash used in operating, investing and financing activities from discontinued operations for the years ended December 31, 2019 and 2018 :

Year Ended December 31,

(in millions)

Net cash (used in) provided by discontinued operations:

Operating activities

Investing activities

Financing activities

Cash used in discontinued operations decreased $22.4 million in 2019 as compared to 2018, primarily due to the payment of non-income tax obligations and related interest expense in 2018.

Net cash provided by (used in) operating, investing and financing activities from discontinued operations for the years ended December 31, 2020 and 2019 was not material.

Capital Expenditures

Capital expenditures totaled $88.2 million for the year ended December 31, 2019 and $73.6 million for the year ended December 31, 2018 .

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

ERP projects, domestic manufacturing facilities and our Tempur-Pedic retail stores.

Capital expenditures totaled $111.3 million and $88.2 million for the year ended December 31, 2020 and 2019, respectively.

We currently expect our 2021 capital expenditures to be approximately $125 million to $140 million, which includes investments in our OEM business and other growth initiatives and maintenance capital expenditures of $75 million.

Our total debt decreased to $1,370.3 million as of December 31, 2020 from $1,547.0 million as of December 31, 2019.

In the first half of 2019, we prepaid $75.0 million on the Term A facility under the 2016 Credit Agreement.

Total availability under our revolving senior secured credit facility was $424.9 million as of December 31, 2020, which matures in 2024.

Refer to Note 5, “Debt,” in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.

On October 16, 2019, we entered into the 2019 Credit Agreement, which provides for a $425.0 million revolving credit facility, a $425.0 million term loan facility and an accordion feature for additional borrowings.

Refer to Note 8 , "Debt," in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of the accordion feature of the 2019 Credit Agreement.

We used the proceeds under the term loan facility to refinance outstanding borrowings under the 2016 Credit Agreement and terminated the existing revolving credit commitments.

As of October 16, 2019, the terms of the 2019 Credit Agreement replaced the terms of the 2016 Credit Agreement.

As of December 31, 2019 , 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 2.92 times , 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 December 31, 2019 , we were in compliance with all of the financial covenants in our debt agreements.

As of December 31, 2020, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure defined in the 2019 Credit Agreement was 1.68 times.

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 December 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.

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

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 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.

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.

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Both consolidated indebtedness and adjusted EBITDA as used in discussion of the 2019 Credit Agreement are terms that are not recognized under GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt.

Debt Securities Guaranteed by Subsidiaries

The $450.0 million and $600.0 million aggregate principal amount of 2023 Senior Notes and 2026 Senior Notes (collectively the "Senior Notes"), respectively, are general unsecured senior obligations of Tempur Sealy International and are fully and unconditionally guaranteed on a senior unsecured basis, jointly and severally, by all of Tempur Sealy International’s 100% directly or indirectly owned domestic subsidiaries (together, the "Obligor Group").

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

Table of Co ntents

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.

Claims of creditors of non-guarantor subsidiaries, including trade creditors, and creditors holding debt and guarantees issued by those subsidiaries, and claims of preferred stockholders (if any) of those subsidiaries generally will have priority with respect to the assets and earnings of those subsidiaries over the claims of creditors of the holders of the Senior Notes.

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

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.

By virtue of this limitation, a subsidiary guarantor's obligation under its guarantee could be significantly less than amounts payable with respect to the Senior Notes, or could be reduced to zero, depending upon the amount of other obligations of such guarantor.

A subsidiary guarantor will be released from its obligations under the applicable indenture governing the Senior Notes when:

(a) the subsidiary guarantor is sold or sells all or substantially all of its assets;

(b) the subsidiary is declared "unrestricted" under the applicable indenture;

(c) the subsidiary’s guarantee of indebtedness under the 2019 Credit Agreement (as it may be amended, refinanced or replaced) is released (other than a discharge through repayment);

(d) the requirements for legal or covenant defeasance or discharge of the applicable indenture have been satisfied;

(e) the subsidiary is liquidated or dissolved in accordance with the applicable indenture;

or (f) the occurrence of any covenant suspension.

The Company has accounted for its investments in its subsidiaries under the equity method.

The summarized financial information for the Obligor Group follows.

December 31, 2020

Obligor Group

(in millions)

Net sales to unrelated parties $ 2,902.6

Net sales to non-obligor subsidiaries 67.0

Gross profit 1,274.4

Income from continuing operations 253.6

Net income attributable to Tempur Sealy International, Inc.

Table of Co ntents

Obligor Group

December 31, 2020

(in millions)

Receivables due from non-obligor subsidiaries $ 13.8

Other current assets 418.4

Total current assets 432.2

Loan receivable from non-obligor subsidiaries 184.8

Goodwill and other intangible assets, net 1,092.5

Other non-current assets 741.5

Total non-current assets 2,018.8

Payables due to non-obligor subsidiaries 15.2

Other current liabilities 618.5

Total current liabilities 633.7

Loan payable to non-obligor subsidiaries 14.5

Other non-current liabilities 1,689.2

Total non-current liabilities $ 1,703.7

Share Repurchase Program

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.

We did not repurchase any shares under our share repurchase program during 2018.

For the year ended 2019 , we repurchased 1.3 million shares under our share repurchase program for approximately $102.3 million .

As of December 31, 2019 , we had approximately $124.6 million remaining under our share repurchase program.

In February 2020, the Board of Directors authorized an increase, of over $190.0 million , to our share repurchase authorization of Tempur Sealy International's common stock to $300.0 million .

Our Board of Directors authorized a share repurchase program in 2016 pursuant to which we were authorized to repurchase shares of our common stock.

The Board of Directors authorized increases to our share repurchase authorization of $194.2 million and $168.7 million during February and October 2020, respectively.

For the year ended December 31, 2020, we had repurchased 6.5 million shares under our share repurchase program for approximately $285.9 million and had approximately $201.6 million remaining under our share repurchase program.

In February 2021, the Board of Directors authorized an increase to our share repurchase authorization to bring the total authorization to $400.0 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.

In 2021, subject to market conditions, we expect to repurchase 6.0% of common shares outstanding.

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," of this Report.

Future Liquidity Sources and Uses

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 December 31, 2019 , we had $1,547.0 million in total debt outstanding, and our adjusted EBITDA, which is a non-GAAP financial measure, was $508.1 million for the year ended December 31, 2019 .

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

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

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

As of December 31, 2020, we had $519.2 million of liquidity, including $65.0 million of cash on hand and $424.9 million available under our revolving senior secured credit facility.

We also had availability of $29.3 million under our securitization facility.

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.

Table of Co ntents

Our capital allocation plan is focused on the following to drive shareholder value:

• Invest an incremental $150 million of capital expenditures by 2023 to support our OEM business;

• Initiate a quarterly cash dividend beginning in early 2021, subject to approval by the Board of Directors.

For the first quarter of 2021, the Board of Directors has declared a dividend of $0.07 per share.

The dividend is payable on March 12, 2021 to shareholders of record as of February 25, 2021;

• Repurchase 6.0% of our common stock 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.

As of December 31, 2020, we had $1,370.3 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $1,306.7 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 1.68 times for the year ended December 31, 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 between approximately $55 million to $60 million in 2021.

On November 9, 2020, we redeemed $200.0 million of our $450.0 million issued and outstanding 2023 Senior Notes at 101.406% of their principal amount, plus the accrued and unpaid interest.

Additionally, we redeemed the remaining $250.0 million at 101.406% of their principal amount, plus the accrued and unpaid interest in the first quarter of 2021.

The 2019 Credit Agreement provides for a $425.0 million revolving credit facility, a $425.0 million term loan facility, and an incremental facility in an aggregate amount of up to $550.0 million plus the amount of certain prepayments plus an additional unlimited amount subject to compliance with a maximum consolidated secured leverage ratio test.

The 2019 Credit Agreement has a $60.0 million sub-facility for the issuance of letters of credit.

On February 2, 2021 we entered into an amendment to our 2019 Credit Agreement, which provides for an increase in the aggregate commitments under our revolving credit facility from $425.0 million to $725.0 million.

We expect to use the revolving credit facility from time to time to finance working capital needs and for general corporate purposes.

Our business continues to generate significant cash flows from operations.

Based upon the current level of operations, we believe that cash generated from operations and amounts available under our credit facilities will be adequate to meet our anticipated debt service requirements, capital expenditures and working capital needs for the foreseeable future.

There can be no assurance, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available under our debt facilities or otherwise enable us to service our indebtedness or to make anticipated capital expenditures.

In 2020, we expect to be within our target range for our ratio of consolidated indebtedness less netted cash of 2.5 times to 3.5 times.

We expect to continue to use excess cash flows from operations for share repurchases and debt repayment.

We may also consider other capital allocations, such as acquisitions or other investments.

At December 31, 2019 , total cash and cash equivalents were $64.9 million , of which $28.9 million was held in the U.S.

and $36.0 million was held by subsidiaries outside of the U.S.

The amount of cash and cash equivalents held by subsidiaries outside of the U.S.

and not readily convertible into the U.S.

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

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 I of this Report.

Contractual Obligations

Our contractual obligations and other commercial commitments as of December 31, 2020 are summarized below:

(in millions)

Payment Due By Period

Contractual Obligations

(in millions) Payment Due By Period

Contractual Obligations 2021 2022 2023 2024 2025 Thereafter Total

$ 66.4 $ 21.3 $ 31.9 $ 579.3 $ — $ 600.0 $ 1,298.9

Letters of credit 23.4 — — — — — 23.4

Interest payments (2)

Operating leases

42.4 40.0 39.1 38.0 31.6 15.1 206.2

Operating lease obligations 74.1 67.9 55.5 46.0 39.3 112.3 395.1

Finance lease obligations (3)

11.4 10.2 8.1 6.4 5.8 29.5 71.4

Pension obligations 1.0 1.1 1.2 1.2 1.3 36.7 42.5

$ 218.7 $ 140.5 $ 135.8 $ 670.9 $ 78.0 $ 793.6 $ 2,037.5

(1) Debt excludes finance lease obligations and deferred financing costs.

In the first quarter of 2021, we redeemed the remaining $250.0 million of the 2023 Notes, principally funded by our revolving credit facility.

Accordingly, we have re-characterized the outstanding balance of the 2023 Notes as maturing in 2024, consistent with the maturity date of our revolving credit facility.

(2) Interest payments represent obligations under our debt outstanding as of December 31, 2020, applying December 31, 2020 interest rates and assuming scheduled payments are paid as contractually required through maturity.

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(4) Uncertain tax positions are excluded from this table given the timing of payments cannot be reasonably estimated.

Table of Co ntents

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Non-GAAP Financial Information

We provide information regarding adjusted net income, adjusted EPS, adjusted operating income (expense), adjusted operating margin, EBITDA, adjusted EBITDA, free cash flow, 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 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) and operating margin as a measure of operating performance 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.

We believe that exclusion of these items assists in providing a more complete understanding of our underlying results from continuing operations and trends, and we use these measures along with the corresponding GAAP financial measures to manage our business, to evaluate our consolidated and business segment performance compared to prior periods and the marketplace, to establish operational goals and to provide continuity to investors for comparability purposes.

Limitations associated with the use of these non-GAAP measures include that these measures do not present all of the amounts associated with our results as determined in accordance with GAAP.

Limitations associated with the use of these non-GAAP financial measures include that these measures do not present all of the amounts associated with our results as determined in accordance with GAAP.

These non-GAAP financial measures should be considered supplemental in nature and should not be construed as more significant than comparable financial measures defined by GAAP.

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Year Ended December 31,

(in millions, except percentages)

% Change Constant Currency (1)

Adjusted EBITDA (1)

(in millions, except percentages and per common share amounts) 2020 2019 % Change % Change Constant Currency (1)

Net sales $ 3,676.9 $ 3,106.0 18.4 % 18.3 %

Net income $ 348.8 $ 189.5 84.1 % 83.5 %

Adjusted EBITDA per credit facility (1)

$ 779.9 $ 508.1 53.5 % 53.2 %

EPS $ 1.64 $ 0.86 90.7 % 90.7 %

Adjusted EPS (1)

$ 1.91 $ 1.00 91.0 % 91.0 %

(1) Non-GAAP financial measure.

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The following table sets forth the reconciliation of our reported net income to adjusted net income and the calculation of adjusted EPS for the years ended December 31, 2020 and 2019.

Table of Co ntents

Year Ended December 31,

(in millions, except per common share amounts) 2020 2019

Net income $ 348.8 $ 189.5

Loss from discontinued operations, net of tax (1)

Aspirational plan amortization (2)

Customer-related charges (3)

Incremental operating costs (4)

Asset impairments (5)

Loss on extinguishment of debt (6)

Restructuring costs (7)

Accounting standard adoption (8)

Aspirational plan employer costs (9)

Facility expansion costs (10)

Charitable stock donation (11)

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Other income (14)

Restructuring costs (7)

Supply chain transition costs (8)

Tax adjustments (15)

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Diluted shares outstanding 212.3 221.6

Adjusted net income included COVID-19 charges of $5.8 million, net of tax, and adjusted earnings per share of $0.03.

Table of Co ntents

(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.

In the fourth quarter of 2018, we recorded $21.2 million of customer-related charges in connection with the bankruptcy of iMS to fully reserve trade receivables and other assets associated with this account.

(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.

We recognized an additional $4.2 million in the fourth quarter commensurate with the remaining requisite service period.

(3) 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.

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

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

(5) 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.

(6) In the fourth quarter of 2020, we recognized $4.2 million of loss on extinguishment of debt associated with the redemption of the 2023 senior notes.

In the third quarter of 2020, we recognized $0.9 million of loss on extinguishment of debt associated with the early repayment of the 364-day term loan.

(7) We incurred $0.4 million and $3.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment, in the third and second quarter of 2020, respectively.

(8) In 2020, we recorded $3.6 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.

(9) In the fourth quarter of 2020, we recognized $2.3 million of employer-related tax costs related to the aspirational plan compensation.

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

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

(12) In the first half of 2019, we recorded $6.1 million of acquisition-related and other costs, primarily related to post acquisition restructuring charges and professional fees incurred in connection with the acquisition of substantially all of the net assets of iMS by an affiliate of ours.

In the fourth quarter of 2019, we incurred $0.7 million of professional fees in connection with the amendment of the senior secured credit facility.

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

(14) In the fourth quarter of 2020, we recorded $2.3 million of other income related to the sale of a manufacturing facility.

In the first quarter of 2019, we recorded $7.2 million of other income related to the sale of our interest in a subsidiary of the Asia-Pacific joint venture.

In 2018, we recorded $24.9 million of restructuring costs, which included $1.3 million of other expense, net.

These costs included $11.5 million of charges related to the operational alignment of a joint venture that was wholly owned in the North America business segment, which included $6.1 million in cost of sales and $1.3 million of other expense, net.

Restructuring costs also included $8.5 million of expenses in the International business segment related to International simplification efforts, which included $0.3 million in cost of sales.

Corporate recorded $4.9 million of professional fees related to restructuring activities.

In 2018, we recorded $7.3 million of supply chain transition costs which represent charges incurred to consolidate certain manufacturing and distribution facilities, including $5.6 million in cost of sales and $0.8 million of other expense.

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

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

In 2020, we recorded a $9.5 million discrete income tax benefit upon the vesting of our long-term aspirational plan awards.

Adjusted Gross Profit and Gross Margin and Adjusted 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 gross profit and operating income (expense) to the calculation of adjusted operating income (expense) for the year ended December 31, 2019 .

We had no adjustments to gross profit for the year ended December 31, 2019 .

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 year ended December 31, 2020.

Table of Co ntents

FULL YEAR 2020

(in millions, except percentages)

North America

International

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

Net sales $ 3,676.9 $ 3,159.2 $ 517.7 $ —

Gross profit $ 1,638.4 44.6 % $ 1,332.0 42.2 % $ 306.4 59.2 % $ —

Incremental operating costs (1)

4.5 4.0 0.5 —

Facility expansion costs (2)

Total adjustments 5.1 4.6 0.5 —

Adjusted gross profit $ 1,643.5 44.7 % $ 1,336.6 42.3 % $ 306.9 59.3 % $ —

Operating income (expense) $ 532.1 14.5 % $ 591.4 18.7 % $ 127.6 24.6 % $ (186.9)

Aspirational plan amortization (3)

49.4 — — 49.4

Customer-related charges (4)

11.7 11.7 — —

Incremental operating costs (1)

7.2 4.3 2.9 —

Asset impairments (5)

Restructuring costs (6)

Accounting standard adoption (7)

Aspirational plan employer costs (8)

Facility expansion costs (2)

Total adjustments 85.6 27.2 6.7 51.7

Adjusted operating income (expense) $ 617.7 16.8 % $ 618.6 19.6 % $ 134.3 25.9 % $ (135.2)

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

The North America and International business segments included $6.3 million and $1.6 million of these charges, respectively.

(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.

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

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

(3) 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.

We recognized an additional $4.2 million in the fourth quarter commensurate with the remaining requisite service period.

(4) 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.

(5) 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.

(6) In 2020, we incurred $3.8 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment.

(7) In 2020, we recorded $3.6 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.

(8) In the fourth quarter of 2020, we recognized $2.3 million of employer-related tax costs related to the aspirational plan compensation.

Table of Co ntents

The following table sets forth the reconciliation of our operating income (expense) and operating margin to the calculation of adjusted operating income (expense) and adjusted operating margin for the year ended December 31, 2019:

FULL YEAR 2019

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

Net sales $ 3,106.0 $ 2,603.5 $ 502.5 $ —

Gross profit $ 1,342.2 43.2 % $ 1,055.2 40.5 % $ 287.0 57.1 % $ —

Operating income (expense) $ 346.7 11.2 % $ 349.9 13.4 % $ 110.3 22.0 % $ (113.5)

Customer-related charges (1)

29.8 29.8 — —

Charitable stock donation (2)

Acquisition-related costs and other (3)

6.1 1.7 0.3 4.1

Credit facility amendment (4)

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Adjusted operating income (expense) $ 392.2 12.6 % $ 390.3 15.0 % $ 110.6 22.0 % $ (108.7)

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

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

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(4) In the fourth quarter of 2019, we incurred $0.7 million of professional fees in connection with the amendment of the senior secured credit facility.

FULL YEAR 2018

(in millions, except percentages)

North America

International

Restructuring costs (1)

Supply chain transition costs (2)

Total adjustments

Adjusted gross profit

Operating income (expense)

Restructuring costs (1)

Customer-related charges (3)

Supply chain transition costs (2)

Total adjustments

Adjusted operating income (expense)

In 2018, we recorded $24.9 million of restructuring costs, which included $1.3 million of other expense, net.

Restructuring costs also included $8.5 million of expenses in the International business segment related to International simplification efforts, which included $0.3 million in cost of sales.

Corporate recorded $4.9 million of professional fees related to restructuring activities.

EBITDA, Adjusted EBITDA, Consolidated Indebtedness Less Netted Cash and Free Cash Flow

EBITDA, 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 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

Net cash provided by operating activities to free cash flow

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 years ended December 31, 2019 and 2018 :

(in millions)

December 31, 2019

December 31, 2018

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

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 per credit facility for the years ended December 31, 2020 and 2019:

Table of Co ntents

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

Net income $ 348.8 $ 189.5

Interest expense, net 77.0 85.7

Loss on extinguishment of debt (1)

Income tax provision 102.6 74.7

Depreciation and amortization 154.9 118.5

Aspirational plan amortization (2)

EBITDA $ 737.8 $ 468.4

Loss from discontinued operations, net of tax (3)

Customer-related charges (4)

COVID-19 charges (5)

Incremental operating costs (6)

Asset impairments (7)

Restructuring costs (8)

Accounting standard adoption (9)

Aspirational plan employer costs (10)

Facility expansion costs (11)

Earnings from Sherwood prior to acquisition (12)

Charitable stock donation (13)

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Other income (16)

Restructuring costs (7)

Supply chain transition costs (8)

Adjusted EBITDA

Adjusted EBITDA per credit facility $ 779.9 $ 508.1

Consolidated indebtedness less netted cash $ 1,306.7 $ 1,483.6

Ratio of consolidated indebtedness less netted cash to adjusted EBITDA

Ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility 1.68 times 2.92 times

Table of Co ntents

(1) In the fourth quarter of 2020, we recognized $4.2 million of loss on extinguishment of debt associated with the redemption of the 2023 senior notes.

In the third quarter of 2020, we recognized $0.9 million of loss on extinguishment of debt associated with the early repayment of the 364-day term 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.

We recognized an additional $4.2 million in the fourth quarter commensurate with the remaining requisite service period.

(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.

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

In the fourth quarter of 2019, we recorded $29.8 million of customer-related charges in connection with the bankruptcy of Mattress PAL and resulting liquidity issues with Mattress PAL's affiliates.

(5) In the second quarter of 2020, 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.

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

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

(7) 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.

(8) In 2020, we incurred $3.8 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment.

(9) In 2020, we recorded $3.6 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.

(10) In the fourth quarter of 2020, we recognized $2.3 million of employer-related tax costs related to the aspirational plan compensation.

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

(12) 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, the Company included $0.3 million of EBITDA from this subsidiary for the one month prior to acquisition in our calculation of adjusted EBITDA per credit facility for the trailing twelve months ended December 31, 2020.

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

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(15) In the fourth quarter of 2019, we incurred $0.7 million of professional fees in connection with the amendment of the senior secured credit facility.

(16) In the fourth quarter of 2020, we recorded $2.3 million of other income related to the sale of a manufacturing facility.

In the first quarter of 2019, we recorded $7.2 million of other income related to the sale of our interest in a subsidiary of the Asia-Pacific joint venture.

In 2018, we recorded $24.9 million of restructuring costs, including $2.6 million of depreciation expense and $1.3 million of other expense, net.

Restructuring costs also included $8.5 million of expenses in the International business segment related to International simplification efforts, which included $0.3 million in cost of sales.

Corporate recorded $4.9 million of professional fees related to restructuring activities.

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.

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 year ended December 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 2.92 times for the trailing twelve months ended December 31, 2019 .

The ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility was 1.68 times for the trailing twelve months ended December 31, 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.

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

(in millions)

December 31, 2019

December 31, 2018

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

Total debt, net $ 1,366.9 $ 1,540.0

3 unchanged sentences

Consolidated indebtedness less netted cash $ 1,306.7 $ 1,483.6

Table of Co ntents

(1) We present deferred financing costs as a direct reduction from the carrying amount of the related debt in the Consolidated Balance Sheets.

1 unchanged sentence

(2) Netted cash includes cash and cash equivalents for domestic and foreign subsidiaries designated as restricted subsidiaries in the 2019 Credit Agreement.

The following table sets forth the reconciliation of our net cash from operating activities to free cash flow for the years ended December 31, 2019 and 2018 :

Year Ended December 31,

(in millions)

Net cash provided by operating activities

Purchases of property, plant and equipment

Free cash flow

Critical Accounting Policies and Estimates

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Our level of sales returns differs by channel, with our Direct channel typically experiencing the higher rate of returns.

We record an allowance for doubtful accounts receivable for amounts due from third parties that we do not expect to collect.

We estimate the allowance based on historical write-off experience and current economic conditions and also consider factors such as customer credit, past transaction history with the customer and changes in customer payment terms when determining whether the collection of a receivable is reasonably assured.

We record an allowance for credit losses for amounts due from third parties that we do not expect to collect.

We estimate the losses over the contractual life using assumptions to capture the risk of loss, even if remote, based principally on how long a receivable has been outstanding.

Other factors considered included historical write-off experience, current and projected economic conditions and also factors such as customer credit, past transaction history with the customer and changes in customer payment terms.

The credit environment in which our customers operate has been relatively stable over the past few years.

1 unchanged sentence

However, there have been signs of deterioration in the U.S.

retail sector.

retail sector, with certain key retailer bankruptcies over the last few years.

Total bad debt expense was $35.8 million in 2020, $29.3 million in 2019 and $31.3 million in 2018.

We regularly review the adequacy of our allowance for doubtful accounts based on the latest information available and accrue losses from uncollectible receivables when such losses can reasonably be estimated.

The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable.

The allowance for doubtful accounts included in accounts receivable, net in the accompanying Consolidated Balance Sheets was $71.9 million and $47.6 million as of December 31, 2019 and 2018, respectively.

We regularly review the adequacy of our allowance for credit losses based on the latest information available and accrue losses from uncollectible receivables when such losses can reasonably be estimated.

The allowance for credit losses is our best estimate of the amount of probable credit losses in our existing accounts receivable.

Our accounts receivable are substantially current and there were no significant changes to the aging of receivables as a result of the impact of the global pandemic.

The allowance for credit losses included in accounts receivable, net in the accompanying Consolidated Balance Sheets was $71.6 million and $71.9 million as of December 31, 2020 and 2019, respectively.

If circumstances change, for example, due to the occurrence of higher-than-expected defaults or a significant adverse change in a major customer’s ability to meet our financial obligations, estimates of the recoverability of receivable amounts due could be reduced.

1 unchanged sentence

Our estimate of the amount and timing of sales returns and uncollectible accounts is based primarily on historical transaction experience.

We have not made any material changes in the accounting methodology we use to measure the estimated liability for sales returns and exchanges or doubtful accounts during the past three fiscal years.

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to establish the liability for sales returns and exchanges and doubtful accounts.

However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

On January 1, 2020, we adopted Accounting Standards Update ("ASU") No.

Table of Co ntents

We have not made any material changes in the accounting methodology we use to measure the estimated liability for sales returns and exchanges or credit losses during the past three fiscal years.

On January 1, 2020, we adopted ASU No.

2016-13, "Financial Instruments - Credit Losses (Topic 326)," which requires entities to estimate expected lifetime credit losses on financial assets and provide expanded disclosures.

The ASU replaced the incurred loss impairment methodology with one that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates.

The adoption of the standard did not have a significant impact on our financial statements or our critical accounting policies.

The adoption of this standard did not have a material impact on our consolidated financial statements.

However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

Income Taxes .

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production process.

During 2018, we negotiated a settlement with SKAT for the tax years 2001 through 2011 (the “Settlement Years”).

During 2018, we negotiated a settlement with SKAT (the "Settlement") for the tax years 2001 through 2011 (the "Settlement Years").

The Company and SKAT are currently discussing the appropriate administrative process required to implement the Settlement as it relates to the computation of interest.

During this process, the Company continues to maintain an uncertain income tax liability on its balance sheet for tax and interest under the terms of the Settlement.

In addition, we have entered into the APA Program for the tax years 2012 through 2022 in which the IRS, on our behalf, will negotiate directly with SKAT the royalty to be paid by the U.S.

subsidiary to the Danish Subsidiary.

We maintain an uncertain income tax liability for both the Settlement Years and for the tax years 2012 through 2019 that are included in the APA Program.

We maintain an uncertain income tax liability the tax years 2012 through 2020 that are included in the APA Program.

If we are required to further increase the uncertain tax liability for either or both periods based on a change in facts and circumstances, it could have a material impact on our reported earnings.

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Goodwill and Indefinite-Lived Intangible Assets.

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.

Table of Co ntents

We test goodwill for impairment by comparing the book values to the fair value at the reporting unit level.

Our reporting units are our North America and International segments.

Our reporting units are equivalent to our North America and International segments.

We test individual indefinite-lived intangible assets by comparing the book values of each asset to the estimated fair value.

If the fair value exceeds the carrying amount, then no impairment exists.

If the carrying amount exceeds the fair value, further analysis is performed to measure the impairment loss.

The fair value of each reporting unit is determined by using an income approach, which uses a discounted cash flow approach and a market approach.

The fair value of each indefinite-lived intangible asset is determined using an income approach.

Significant management judgment is necessary to evaluate the impact of operating and macroeconomic changes on each reporting unit.

The significant estimates and assumptions include projected sales growth, gross profit rates, selling, general and administrative rates, working capital requirements, capital expenditures and terminal growth rates, discount rates per reporting unit, and the selection of peer company multiples.

We determine discount rates separately for each reporting unit using the weighted average cost of capital, which includes a calculation of cost of equity, which is developed using the capital asset pricing model and comparable company betas (a measure of systemic risk), and cost of debt.

We also use comparable market earnings multiple data and our market capitalization to corroborate our reporting unit valuations.

We have not made any material changes in our reporting units or the accounting methodology we use to assess impairment loss on goodwill and indefinite-lived intangible assets.

Using the quantitative approach, we make various estimates and assumptions in determining the estimated fair value of each reporting unit using a combination of discounted cash flow models and valuations based on earnings multiples for guideline public companies in each reporting unit’s industry peer group, when externally quoted market prices are not readily available.

Discounted cash flow models are reliant on various assumptions, including projected business results, long-term growth factors and weighted-average cost of capital.

Management judgement is involved in estimating these variables, and they include inherent uncertainties as they are forecasting future events.

We perform sensitivity analyses by using a range of inputs to confirm the reasonableness of the long-term growth rate and weighted average cost of capital.

Additionally, we compare the indicated equity value to our market capitalization and evaluate the resulting implied control premium/discount to determine if the estimated enterprise value is reasonable compared to external market indicators.

We have not made any material changes in 2020 to our reporting units or the accounting methodology we use to assess impairment loss on goodwill and indefinite-lived intangible assets.

The most recent annual impairment tests performed as of October 1, 2020 indicated that the fair values of each of our reporting units and indefinite-lived intangible assets were substantially in excess of their carrying values.

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However, if actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.

Impact of Recently Issued Accounting Pronouncements

Refer to Note 2 , " Recently Issued Accounting Pronouncements ," in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein by reference.

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-K

Item 7. Management’s Discussion and Analysis