SOMNIGROUP INTERNATIONAL INC. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with the 2020 Annual Report, including "Management’s Discussion and Analysis of Financial Condition and Results of Operations" included in ITEM 7 of Part II of the 2020 Annual Report, and the accompanying Condensed Consolidated Financial Statements and notes thereto included in this Report. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are subject to numerous risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" elsewhere in this Report, in the 2020 Annual Report and the section titled "Risk Factors" contained in ITEM 1A of Part I of the 2020 Annual Report. Our actual results may differ materially from those contained in any forward-looking statements. In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the three months ended March 31, 2021, including the following topics: • an overview of our business and strategy, • results of operations, including our net sales and costs in the periods presented as well as changes between periods; • expected sources of liquidity for future operations; and • our use of certain non-GAAP financial measures. Business Overview General 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: North America and International. 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, 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 manufacturing and distribution subsidiaries, Sealy distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America (other than Mexico). Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. We evaluate segment performance based on net sales, gross profit and operating income. For additional information refer to Note 13, "Business Segment Information," included in Part I, ITEM 1 of this Report. Our product brand portfolio includes many highly recognized and iconic brands in the industry, including Tempur®, 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. General Business and Economic Conditions We believe the bedding industry is structured for sustained growth driven by product innovation, consumer confidence, housing formations and population 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. 22 Table of Contents At the outset of the COVID-19 global pandemic we experienced a reduction in total net sales across both of our business segments in the first quarter of 2020. Our North America business began experiencing sharp declines in total net sales and orders in mid-March. Order trends reached their lowest point in early April 2020 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 2020. This momentum continued in the first quarter of 2021, with consolidated net sales increasing 26.9% as compared to the first quarter of 2020, as the negative impacts of the global COVID-19 pandemic have largely subsided as compared to the significant global disruption experienced throughout early 2020. Order trends within our International markets are experiencing volatility due to restrictions on retail activity related to the COVID-19 global pandemic, however we are confident in our ability to operate in this retail environment. Current order trends continue to indicate growth in the U.S. As a result, we expect consolidated net sales growth to exceed 20% for the full year 2021. Over the past several years and accelerating during the COVID-19 global pandemic, consumers have shifted their 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. The rapid increase in demand for bedding products has challenged the entire bedding industry and supply chain, including our business. In the U.S., the broad-based increase in demand coupled with supply chain constraints, primarily related to an encased innerspring component and chemicals, has created operational challenges in the production of Sealy and Sherwood products. As a result, the sales growth of Sealy and Sherwood in the first quarter of 2021 was unfavorably impacted as we could not fulfill the entire domestic demand for these products. For the second quarter of 2021, we expect the innerspring supply chain to be largely unconstrained and the constraints in the chemical supply chain to mitigate significantly by the end of the quarter. During the first quarter of 2021, commodity costs unfavorably impacted our gross margin as they were higher than expected. We implemented pricing actions in the fourth quarter of 2020 and in early April 2021 to mitigate these known commodity headwinds. Since then, commodity costs have continued to rise due to the winter storm in the Gulf of Mexico, which caused a temporary industry-wide reduction in chemical availability. We believe this commodity cost inflation to be temporary and do not expect to take additional pricing actions at this time. We anticipate the chemical constraints will largely be resolved by the end of the second quarter. Based on our current commodity outlook, we expect commodity cost inflation to negatively impact gross margin by approximately $25 million, predominantly occurring in the second quarter of 2021, which will not be offset by price. While we are unable to determine or predict the nature, duration or scope of the overall impact the COVID-19 pandemic will have on our business, results of operations, liquidity or capital resources, we believe that it is important to share where our Company stands today, how our response to COVID-19 is progressing and how our operations and financial condition may change as the fight against COVID-19 progresses. 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. For further information regarding the impact of COVID-19 on the Company, please refer to "Risk Factors" in ITEM 1A of Part I of the 2020 Annual Report. Product Launches During the first quarter of 2021, we completed the launch of our Tempur-Ergo Smart Base Collection with Sleeptracker® technology in North America. In 2021, we are refreshing our Sealy portfolio in our North America segment and launching new models in our Posturepedic Plus™, Posturepedic® and Essentials product lines. We plan to launch the refresh in two phases. In the first quarter of 2021, we began rolling out our 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 end Posturepedic Plus™ line in the second half of 2021, which will complete the largest rollout in Sealy's history. In 2022, we expect to launch a new Tempur product line in our International segment. Our global 2021 marketing plan is to aggressively support our innovative bedding products through investing significant marketing dollars to promote our worldwide brands. 23 Table of Contents Results of Operations A summary of our results for the three months ended March 31, 2021 include: • Total net sales increased 26.9% to $1,043.8 million as compared to $822.4 million in the first quarter of 2020. On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 25.1%, with an increase of 27.3% in the North America business segment and an increase of 13.8% in the International business segment. • Gross margin was 44.0% as compared to 43.4% in the first quarter of 2020. • Operating income increased 78.9% to $188.4 million as compared to $105.3 million in the first quarter of 2020. Adjusted operating income, which is a non-GAAP financial measure, was $120.8 million in the first quarter of 2020. There were no adjustments to operating income in the first quarter of 2021. • Net income increased 118.6% to $130.5 million as compared to $59.7 million in the first quarter of 2020. Adjusted net income, which is a non-GAAP financial measure, increased 85.7% to $134.6 million as compared to $72.5 million in the first quarter of 2020. • Earnings before interest, tax, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, increased 71.1% to $230.1 million as compared to $134.5 million in the first quarter of 2020. Adjusted EBITDA per credit facility, which is a non-GAAP financial measure, increased 52.3% to $230.3 million as compared to $151.2 million in the first quarter of 2020. • Earnings per diluted share ("EPS") increased 121.4% to $0.62 as compared to $0.28 in the first quarter of 2020. Adjusted EPS, which is a non-GAAP financial measure, increased 88.2% to $0.64 as compared to $0.34 in the first quarter of 2020. 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." We may refer to net sales or earnings or other historical financial information on a "constant currency basis," which is a non-GAAP financial measure. These references to constant currency basis do not include operational impacts that could result from fluctuations in foreign currency rates. To provide information on a constant currency basis, the applicable financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior corresponding period’s currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Constant currency information is not recognized under GAAP, and it is not intended as an alternative to GAAP measures. Refer to Part I, ITEM 3 of this Report for a discussion of our foreign currency exchange rate risk. 24 Table of Contents THREE MONTHS ENDED MARCH 31, 2021 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2020 The following table sets forth the various components of our Condensed Consolidated Statements of Income and expresses each component as a percentage of net sales: Three Months Ended March 31, (in millions, except percentages and per share amounts) 2021 2020 Net sales $ 1,043.8 100.0 % $ 822.4 100.0 % Cost of sales 584.9 56.0 465.3 56.6 Gross profit 458.9 44.0 357.1 43.4 Selling and marketing expenses 197.7 18.9 171.0 20.8 General, administrative and other expenses 79.5 7.6 80.6 9.8 Equity (income) loss in earnings of unconsolidated affiliates (6.7) (0.6) 0.2 — Operating income 188.4 18.0 105.3 12.8 Other expense, net: Interest expense, net 12.3 1.2 20.3 2.5 Loss on extinguishment of debt 5.0 0.5 — — Other (income) expense, net (0.3) — 0.5 0.1 Total other expense, net 17.0 1.6 20.8 2.6 Income from continuing operations before income taxes 171.4 16.4 84.5 10.3 Income tax provision (40.5) (3.9) (23.5) (2.9) Income from continuing operations 130.9 12.5 61.0 7.4 Loss from discontinued operations, net of tax (0.2) — (1.2) (0.1) Net income before non-controlling interests 130.7 12.5 59.8 7.3 Less: Net income attributable to non-controlling interests 0.2 — 0.1 — Net income attributable to Tempur Sealy International, Inc. $ 130.5 12.5 % $ 59.7 7.3 % Earnings per common share: Basic Earnings per share for continuing operations $ 0.64 $ 0.28 Loss per share for discontinued operations — — Earnings per share $ 0.64 $ 0.28 Diluted Earnings per share for continuing operations $ 0.62 $ 0.28 Loss per share for discontinued operations — — Earnings per share $ 0.62 $ 0.28 Weighted average common shares outstanding: Basic 203.7 213.6 Diluted 210.1 216.0 25 Table of Contents NET SALES Three Months Ended March 31, 2021 2020 2021 2020 2021 2020 (in millions) Consolidated North America International Net sales by channel Wholesale $ 881.4 $ 722.4 $ 765.5 $ 624.7 $ 115.9 $ 97.7 Direct 162.4 100.0 117.8 67.6 44.6 32.4 Total net sales $ 1,043.8 $ 822.4 $ 883.3 $ 692.3 $ 160.5 $ 130.1 Net sales increased 26.9%, and on a constant currency basis increased 25.1%. The change in net sales was driven by the following: • North America net sales increased $191.0 million, or 27.6%. Net sales in the Wholesale channel increased $140.8 million, or 22.5%, primarily driven by broad-based demand across our retail partners. Net sales in the Direct channel increased $50.2 million, or 74.3%, primarily driven by growth from our e-commerce business. On a constant currency basis, North America net sales increased 27.3%. • International net sales increased $30.4 million, or 23.4%. On a constant currency basis, International net sales increased 13.8%. Net sales in the Wholesale channel increased 9.1% on a constant currency basis. Net sales in the Direct channel increased 28.1% on a constant currency basis. GROSS PROFIT Three Months Ended March 31, 2021 2020 (in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin Margin Change North America $ 363.9 41.2 % $ 281.2 40.6 % 0.6 % International 95.0 59.2 % 75.9 58.3 % 0.9 % Consolidated gross margin $ 458.9 44.0 % $ 357.1 43.4 % 0.6 % 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. Our gross margin is primarily impacted by the relative amount of net sales contributed by our Tempur and Sealy products. Our Sealy products have a significantly lower gross margin than our Tempur products. Our Sealy mattress products range from value to premium priced offerings, and gross margins are typically higher on premium products compared to value priced offerings. Our Tempur products are exclusively premium priced products. As sales of our value priced products increase relative to sales of our premium priced products, our gross margins will be negatively impacted in both our North America and International segments. Our gross margin is also impacted by fixed cost leverage based on manufacturing unit volumes; the cost of raw materials; operational efficiencies due to the utilization in our manufacturing facilities; product, brand, channel and country mix; foreign exchange fluctuations; volume incentives offered to certain retail accounts; participation in our retail cooperative advertising programs; and costs associated with new product introductions. Future changes in raw material prices could have a significant impact on our 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. Gross margin improved 60 basis points. The primary drivers of changes in gross margin by segment are discussed below: • North America gross margin improved 60 basis points. The improvement in gross margin was primarily driven by brand and channel mix of 140 basis points, partially offset by operational inefficiencies related to supply chain constraints of 100 basis points. • International gross margin improved 90 basis points. The improvement in gross margin was primarily driven by favorable mix of 160 basis points as well as operational efficiencies of 150 basis points, partially offset by increased commodity costs of 220 basis points . OPERATING EXPENSES Selling and marketing expenses include advertising and media production associated with the promotion of our brands, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing. General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs. Three Months Ended March 31, 2021 2020 2021 2020 2021 2020 2021 2020 (in millions) Consolidated North America International Corporate Operating expenses: Advertising expenses $ 90.9 $ 73.5 $ 79.4 $ 63.9 $ 11.5 $ 9.6 $ — $ — Other selling and marketing expenses 106.8 97.5 68.8 66.2 31.6 28.3 6.4 3.0 General, administrative and other expenses 79.5 80.6 42.3 49.5 12.4 11.4 24.8 19.7 Total operating expenses $ 277.2 $ 251.6 $ 190.5 $ 179.6 $ 55.5 $ 49.3 $ 31.2 $ 22.7 Operating expenses increased $25.6 million, or 10.2%, and decreased 400 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are explained below: • North America operating expenses increased $10.9 million, or 6.1%, and decreased 430 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by 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, which was not repeated in the same period in 2021. • International operating expenses increased $6.2 million, or 12.6%, and decreased 330 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising and other selling and marketing investments. • Corporate operating expenses increased $8.5 million, or 37.4%. The increase in operating expenses was primarily driven by variable compensation due to a reduction in prior year when the full year outlook included worldwide shutdowns and significant retailer door closures. Research and development expenses for the three months ended March 31, 2021 were $6.5 million compared to $5.8 million for the three months ended March 31, 2020, an increase of $0.7 million, or 12.1%. OPERATING INCOME Three Months Ended March 31, 2021 2020 (in millions, except percentages) Operating Income Operating Margin Operating Income Operating Margin Margin Change North America $ 173.4 19.6 % $ 101.6 14.7 % 4.9 % International 46.2 28.8 % 26.4 20.3 % 8.5 % 219.6 128.0 Corporate expenses (31.2) (22.7) Total operating income $ 188.4 18.0 % $ 105.3 12.8 % 5.2 % 26 Table of Contents Operating income increased $83.1 million and operating margin improved 520 basis points. The primary drivers of changes in operating income and operating margin by segment are discussed below: • North America operating income increased $71.8 million and operating margin improved 490 basis points. The improvement in operating margin was primarily driven by favorable operating expense leverage of 240 basis points, improvement in gross margin of 60 basis points and 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, which was not repeated in the same period in 2021. • International operating income increased $19.8 million and operating margin improved 850 basis points. The improvement in operating margin was primarily driven by improved performance of the Asia-Pacific joint ventures of 340 basis points, favorable operating expense leverage of 240 basis points and the improvement in gross margin of 90 basis points. Additionally, in 2020, we recorded $2.3 million of charges associated with the global pandemic, which were not repeated in 2021. • Corporate operating expenses increased $8.5 million, which negatively impacted our consolidated operating margin by 80 basis points. The increase in operating expenses was primarily driven by variable compensation due to a reduction in prior year when the full year outlook included worldwide shutdowns and significant retailer door closures. INTEREST EXPENSE, NET Three Months Ended March 31, (in millions, except percentages) 2021 2020 % Change Interest expense, net $ 12.3 $ 20.3 (39.4) % Interest expense, net, decreased $8.0 million, or 39.4%. The decrease in interest expense, net, was primarily driven by reduced average levels of outstanding debt and lower interest rates on our variable rate debt. INCOME TAX PROVISION Three Months Ended March 31, (in millions, except percentages) 2021 2020 % Change Income tax provision $ 40.5 $ 23.5 72.3 % Effective tax rate 23.6 % 27.8 % Our income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of net operating losses for certain of our foreign operations. Our income tax provision increased $17.0 million due to an increase in income before income taxes. Our effective tax rate for the three months ended March 31, 2021 as compared to the same prior year period decreased by 420 basis points. The effective tax rate as compared to the U.S. federal statutory rate for the three months ended March 31, 2021 included the favorable impact of the elimination of global intangible low-taxed income ("GILTI") from U.S. taxable income, the favorable impact of the deductibility of stock compensation in the U.S. and included a net unfavorable impact of other discrete items. The effective tax rate as compared to the U.S. federal statutory tax rate for the three months ended March 31, 2020 included a net unfavorable impact of discrete items primarily related to the likelihood of the realization of certain deferred tax assets, i.e., the future deductibility of such items for income tax purposes, and certain stock compensation. Liquidity and Capital Resources Liquidity Our principal sources of funds are cash flows from operations, supplemented with borrowings in the capital markets and 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, payments of dividends to our shareholders, capital expenditures and working capital needs. 27 Table of Contents As of March 31, 2021, we had net working capital of $318.6 million, including cash and cash equivalents of $290.5 million, as compared to a working capital deficit of $6.4 million, including cash and cash equivalents of $65.0 million, as of December 31, 2020. At March 31, 2021, total cash and cash equivalents were $290.5 million, of which $264.6 million was held in the U.S. and $25.9 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 The table below presents net cash provided by (used in) operating, investing and financing activities from continuing operations for the periods indicated below: Three Months Ended March 31, (in millions) 2021 2020 Net cash provided by (used in) continuing operations: Operating activities $ 86.3 $ 15.0 Investing activities (24.4) (64.0) Financing activities 168.9 188.1 Cash provided by operating activities from continuing operations increased $71.3 million in the three months ended March 31, 2021 as compared to the same period in 2020. 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 decreased $39.6 million in the three months ended March 31, 2021 as compared to the same period in 2020. The decrease in cash used in investing activities was due to the acquisition of the Sherwood Bedding business, which occurred in the first quarter of 2020. Cash provided by financing activities from continuing operations decreased $19.2 million in the three months ended March 31, 2021 as compared to the same period in 2020. For the three months ended March 31, 2021, we had net funding of $504.8 million, which included proceeds of $800.0 million from the issuance of our 2029 Senior Notes partially offset by net repayments under our credit facilities and 2023 Senior Notes, as compared to net borrowings of $380.1 million in 2020 on our credit facilities. During the three months ended March 31, 2021 and 2020, we repurchased $313.1 million and $199.3 million, respectively, of our common stock. Cash provided by financing activities also decreased due to dividends paid to shareholders of $14.3 million and payment of deferred financing costs of $12.7 million during the three months ended March 31, 2021. Cash Provided by (Used in) Discontinued Operations Net cash provided by (used in) operating, investing and financing activities from discontinued operations for the periods ended March 31, 2021 and 2020 was not material. Capital Expenditures Capital expenditures totaled $23.5 million and $26.2 million for the three months ended March 31, 2021 and 2020, respectively. We currently expect our 2021 capital expenditures to be approximately $125 million to $140 million, which includes investments in growth initiatives and maintenance capital expenditures of $75 million. Indebtedness Our total debt increased to $1,873.1 million as of March 31, 2021 from $1,370.3 million as of December 31, 2020. On November 9, 2020, we redeemed $200.0 million of our issued and outstanding 2023 Senior Notes at 101.406% of their principal amount, plus the accrued and unpaid interest. During the first quarter of 2021, we redeemed the remaining $250.0 million of our 2023 Senior Notes, principally funded by our revolving credit facility, at 101.406% of the principal amount, plus the accrued and unpaid interest. 28 Table of Contents On February 2, 2021 we entered into an amendment to our 2019 Credit Agreement, which increased our revolving credit facility from $425.0 million to $725.0 million. Total availability under our revolving senior secured credit facility was $724.9 million as of March 31, 2021, which matures in 2024. On March 25, 2021, we issued the 2029 Senior Notes. The 2029 Senior Notes mature on April 15, 2029 and 4.00% interest is payable semi-annually in arrears on each April 15 and October 15, beginning on October 15, 2021. Refer to Note 5, "Debt" in our of the "Notes to Condensed Consolidated Financial Statements," under Part I, ITEM 1 for further discussion of our debt. As of March 31, 2021, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure, in accordance with our 2019 Credit Agreement was 1.95 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 March 31, 2021, 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, 2026 Senior Notes and 2029 Senior Notes contain similar limitations which, subject to other conditions, allow unlimited restricted payments at times when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure, remains below 3.50 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 3.50 times. The limit on restricted payments under the 2019 Credit Agreement, 2026 Senior Notes and 2029 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. For additional information, refer to "Non-GAAP Financial Information" below for the calculation of the ratio of consolidated indebtedness less netted cash to adjusted EBITDA calculated in accordance with the 2019 Credit Agreement. Both consolidated indebtedness and adjusted EBITDA as used in discussion of the 2019 Credit Agreement are non-GAAP financial measures 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 $600.0 million aggregate principal amount of 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 guaranteeing Tempur Sealy International's obligations under the 2019 Credit Agreement (together, the "Obligor Group"). The $450.0 million aggregate principal amount of 2023 Senior Notes were general unsecured senior obligations at December 31, 2020. The foreign subsidiaries represent the foreign operations of the Company and do not guarantee the Senior Notes. The Senior Notes rank equally with or senior to all debt of Tempur Sealy International and the Obligor Group, but are effectively junior to all secured debt, including obligations under the 2019 Credit Agreement, to the extent of the value of the assets securing such debt. 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. 29 Table of Contents 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 principal elimination entries relate to investments in subsidiaries and intercompany balances and transactions, including transactions with the Company’s wholly-owned subsidiary guarantors and non-guarantor subsidiaries. The Company has accounted for its investments in its subsidiaries under the equity method. In March 2020, the SEC adopted final rules that amend the financial disclosure requirements for subsidiary issuers and guarantors of registered debt securities under Rule 3-10 of Regulation S-X, permitting registrants to disclose summarized financial information for such subsidiary issuers and guarantors. The rule was effective January 4, 2021. The summarized financial information for the Obligor Group follows: Three Months Ended March 31, 2021 Obligor Group (in millions) Net sales to unrelated parties $ 823.0 Net sales to non-obligor subsidiaries $ 16.7 Gross profit $ 348.2 Income from continuing operations $ 89.7 Net income attributable to Tempur Sealy International, Inc. $ 89.7 Obligor Group Obligor Group March 31, 2021 December 31, 2020 (in millions) ASSETS Receivables due from non-obligor subsidiaries $ 13.9 $ 13.8 Other current assets 642.5 418.4 Total current assets 656.4 432.2 Loan receivable from non-obligor subsidiaries 162.2 184.8 Goodwill and other intangible assets, net 1,089.2 1,092.5 Other non-current assets 740.0 741.5 Total non-current assets 1,991.4 2,018.8 LIABILITIES Payables due to non-obligor subsidiaries 13.7 15.2 Other current liabilities 646.8 618.5 Total current liabilities 660.5 633.7 Loan payable to non-obligor subsidiaries 0.1 14.5 Other non-current liabilities 2,223.9 1,689.2 Total non-current liabilities $ 2,224.0 $ 1,703.7 30 Table of Contents 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. On February 11, 2021, the Board of Directors authorized an increase of $211.4 million, to the existing share repurchase authorization of Tempur Sealy International's common stock. During the three months ended March 31, 2021, we repurchased 8.4 million shares under our share repurchase program for $299.8 million. As of March 31, 2021, we had $113.2 million remaining under our share repurchase authorization. On April 29, 2021, the Board of Directors authorized an additional increase to the share repurchase authorization bringing 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. These repurchases may be funded by operating cash flows and/or borrowings under our debt arrangements. The timing and actual number of shares repurchased will depend on a variety of factors including price, financing and regulatory requirements and other market conditions. The program is subject to certain limitations under our debt agreements. The program does not require the purchase of any minimum number of shares and may be suspended, modified or discontinued at any time without prior notice. Repurchases may be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under federal securities laws. We will manage our share repurchase program based on current and expected cash flows, share price and alternative investment opportunities. For a complete description of our share repurchase program, please refer to ITEM 5 under Part II, "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities," in the 2020 Annual Report. Please also refer to "Issuer Purchases of Equity Securities" in ITEM 2(c) of Part II of this Report. Future Liquidity Sources and Uses As of March 31, 2021, we had $1,102.6 million of liquidity, including $290.5 million of cash on hand and $724.9 million available under our revolving senior secured credit facility. We also had availability of $87.2 million under our securitization facility. In addition, we expect to generate significant cash flow from operations in the full year 2021. We believe that cash flow from operations, availability under our existing credit facilities and arrangements, current cash balances and the ability to obtain other financing, if necessary, will provide adequate cash funds for our foreseeable working capital needs, necessary capital expenditures and debt service obligations. Our capital allocation strategy follows a balanced approach focused on supporting the business, returning shareholder value through share repurchases and quarterly dividends as well as opportunistic and strategic acquisition opportunities that enhance our global competitiveness. Additionally, we have taken capital structure actions to optimize our balance sheet, through extending the maturities of our long-term debt and lowering our annualized interest expense by approximately $23 million. We plan to take the following additional actions in 2021: • For the second quarter of 2021, the Board of Directors has declared a dividend of $0.07 per share. The dividend is payable on May 27, 2021 to shareholders of record as of May 13, 2021. • Repurchase at least 6% of shares outstanding over the course of 2021, subject to market conditions. • We intend to use the net proceeds from the 2029 Senior Notes to redeem in full the $600.0 million 2026 Senior Notes. The remaining funds will be used for general corporate purposes. As of March 31, 2021, we had $1,873.1 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $1,673.1 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 1.95 times for the trailing twelve months ended March 31, 2021. Our target range for our ratio of consolidated indebtedness less netted cash, which is a non-GAAP financial measure, is 2.0 to 3.0 times. Total cash interest payments related to our borrowings are expected to be approximately $50 million to $55 million in 2021. On April 6, 2021, we entered into a new amendment to our Accounts Receivable Securitization that, among other things, extended its maturity date to April 6, 2023 and increased the overall limit from $120.0 million to $200.0 million. 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" contained in ITEM 1A of Part I of the 2020 Annual Report. 31 Table of Contents Non-GAAP Financial Information We provide information regarding adjusted net income, adjusted EPS, 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, operating income (expense), operating margin or an alternative to total debt as a measure of liquidity. We believe these non-GAAP financial measures provide investors with performance measures that better reflect our underlying operations and trends, providing a perspective not immediately apparent from net income, operating income (expense) and operating margin. 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. 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. Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies. For more information about these non-GAAP financial measures and a reconciliation to the nearest GAAP financial measure, please refer to the reconciliations on the following pages. Adjusted Net Income and Adjusted EPS A reconciliation of reported net income to adjusted net income and the calculation of adjusted EPS is provided below. We believe that the use of these non-GAAP financial measures provides investors with additional useful information with respect to the impact of various adjustments as described in the footnotes below. The following table sets forth the reconciliation of our reported net income to adjusted net income and the calculation of adjusted EPS for the three months ended March 31, 2021 and 2020: Three Months Ended (in millions, except per share amounts) March 31, 2021 March 31, 2020 Net income $ 130.5 $ 59.7 Loss from discontinued operations, net of tax (1) 0.2 1.2 Loss on extinguishment of debt (2) 5.0 — Customer-related charges (3) — 11.7 Incremental operating costs (4) — 2.3 Accounting standard adoption (5) — 1.5 Tax adjustments (6) (1.1) (3.9) Adjusted net income $ 134.6 $ 72.5 Adjusted earnings per share, diluted $ 0.64 $ 0.34 Diluted shares outstanding 210.1 216.0 32 Table of Contents (1) Certain subsidiaries in the International business segment are accounted for as discontinued operations and have been designated as unrestricted subsidiaries in the 2019 Credit Agreement. Therefore, these subsidiaries are excluded from our adjusted financial measures for covenant compliance purposes. (2) In the first quarter of 2021, we recognized $5.0 million of loss on extinguishment of debt associated with the redemption of the remaining amount outstanding on the 2023 senior notes. (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 first quarter of 2020, we recorded $2.3 million of charges related to the global pandemic. (5) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326)". As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation. (6) Adjusted income tax provision represents the tax effects associated with the aforementioned items. Adjusted Operating Income (Expense) and Operating Margin A reconciliation of operating income (expense) and operating margin to adjusted operating income (expense) and adjusted operating margin, respectively, are provided below. 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 our reported gross profit and operating income (expense) for the three months ended March 31, 2021. We had no adjustments to gross profit and operating income (expense) for the three months ended March 31, 2021. Three Months Ended March 31, 2021 (in millions, except percentages) Consolidated Margin North America Margin International Margin Corporate Net sales $ 1,043.8 $ 883.3 $ 160.5 $ — Gross profit $ 458.9 44.0 % $ 363.9 41.2 % $ 95.0 59.2 % $ — Operating income (expense) $ 188.4 18.0 % $ 173.4 19.6 % $ 46.2 28.8 % $ (31.2) The following table sets forth our reported gross profit and the reconciliation of our operating income (expense) and operating margin to the calculation of adjusted operating income (expense) and adjusted operating margin for the three months ended March 31, 2020. We had no adjustments to gross profit for the three months ended March 31, 2020. Three Months Ended March 31, 2020 (in millions, except percentages) Consolidated Margin North America Margin International Margin Corporate Net sales $ 822.4 $ 692.3 $ 130.1 $ — Gross profit $ 357.1 43.4 % $ 281.2 40.6 % $ 75.9 58.3 % $ — Operating income (expense) $ 105.3 12.8 % $ 101.6 14.7 % $ 26.4 20.3 % $ (22.7) Adjustments: Customer-related charges (1) 11.7 11.7 — — Incremental operating costs (2) 2.3 — 2.3 — Accounting standard adoption (3) 1.5 1.5 — — Total adjustments 15.5 13.2 2.3 — Adjusted operating income (expense) $ 120.8 14.7 % $ 114.8 16.6 % $ 28.7 22.1 % $ (22.7) 33 Table of Contents (1) In the first quarter of 2020, we recorded $11.7 million of customer-related charges in connection with the bankruptcy of Art Van Furniture, LLC and affiliates to fully reserve trade receivables and other assets associated with this account. (2) In the first quarter of 2020, we recorded $2.3 million of charges related to the global pandemic. (3) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326)". As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation. 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 per credit facility • Ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility • Total debt, net to consolidated indebtedness less netted cash We believe that presenting these non-GAAP measures provides investors with useful information with respect to our operating performance, cash flow generation and comparisons from period to period, as well as general information about our progress in reducing our leverage. The 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 three months ended March 31, 2021 and 2020: Three Months Ended (in millions) March 31, 2021 March 31, 2020 Net income $ 130.5 $ 59.7 Interest expense, net 12.3 20.3 Loss on extinguishment of debt (1) 5.0 — Income taxes 40.5 23.5 Depreciation and amortization 41.8 31.0 EBITDA $ 230.1 $ 134.5 Adjustments: Loss from discontinued operations, net of tax (2) 0.2 1.2 Customer-related charges (3) — 11.7 Incremental operating costs (4) — 2.3 Accounting standard adoption (5) — 1.5 Adjusted EBITDA per credit facility $ 230.3 $ 151.2 (1) In the first quarter of 2021, we recognized $5.0 million of loss on extinguishment of debt associated with the redemption of the remaining amount outstanding on the 2023 senior notes. (2) 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. (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 first quarter of 2020, we recorded $2.3 million of charges related to the global pandemic. (5) In the first quarter of 2020, we recorded $1.5 million of charges related to the adoption of ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326)". As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation. 34 Table of Contents The following table sets forth the reconciliation of our net income to the calculations of EBITDA and adjusted EBITDA per credit facility for the trailing twelve months ended March 31, 2021: Trailing Twelve Months Ended (in millions) March 31, 2021 Net income $ 419.6 Interest expense, net 69.0 Loss on extinguishment of debt (1) 10.1 Income tax provision 119.6 Depreciation and amortization 165.7 Aspirational plan amortization (2) 49.4 EBITDA $ 833.4 Adjustments: Income from discontinued operations, net of tax (3) (1.0) COVID-19 charges (4) 7.9 Asset impairments (5) 7.0 Incremental operating costs (6) 4.9 Restructuring costs (7) 3.8 Aspirational plan employer costs (8) 2.3 Accounting standard adoption (9) 2.1 Facility expansion costs (10) 0.6 Other income (11) (2.3) Adjusted EBITDA per credit facility $ 858.7 Consolidated indebtedness less netted cash $ 1,673.1 Ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility 1.95 times (1) In the first quarter of 2021, we recognized $5.0 million of loss on extinguishment of debt associated with the redemption of the remaining amount outstanding on the 2023 senior notes. In the third and fourth quarter of 2020, we recognized a total of $5.1 million of loss on extinguishment of debt associated with the partial redemption of the 2023 senior notes and early repayment of the 364-day term loan. (2) In 2020, we recognized $49.4 million of performance-based stock compensation amortization related to our long-term aspirational awards. (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. (4) In 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. (5) In 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 recorded $4.9 million of incremental operating costs associated with the global pandemic. (7) In 2020, we incurred $3.8 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment. (8) In 2020, we recognized $2.3 million of employer-related tax costs related to the aspirational plan compensation. (9) During 2020, we recorded $2.1 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 2020, we recorded $0.6 million of costs related to the opening of a Sealy manufacturing facility. (11) In 2020, we recorded $2.3 million of other income related to the sale of a manufacturing facility. 35 Table of Contents Under the 2019 Credit Agreement, the definition of adjusted EBITDA (which we refer to as "adjusted EBITDA per credit facility") contains certain restrictions that limit adjustments to net income when calculating adjusted EBITDA. For the trailing twelve months ended March 31, 2021, our adjustments to net income when calculating adjusted EBITDA did not exceed the allowable amount under the 2019 Credit Agreement. The ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility is 1.95 times for the trailing twelve months ended March 31, 2021. 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. The following table sets forth the reconciliation of our reported total debt to the calculation of consolidated indebtedness less netted cash as of March 31, 2021. "Consolidated Indebtedness" and "Netted Cash" are terms used in the 2019 Credit Agreement for purposes of certain financial covenants. (in millions) March 31, 2021 Total debt, net $ 1,860.1 Plus: Deferred financing costs (1) 13.0 Consolidated indebtedness 1,873.1 Less: Netted cash (2) 200.0 Consolidated indebtedness less netted cash $ 1,673.1 (1) We present deferred financing costs as a direct reduction from the carrying amount of the related debt in the Condensed Consolidated Balance Sheets. For purposes of determining total debt for financial covenant purposes, we have added these costs back to total debt, net as calculated per the Condensed Consolidated Balance Sheets. (2) Netted cash includes cash and cash equivalents for domestic and foreign subsidiaries designated as restricted subsidiaries in the 2019 Credit Agreement. For purposes of determining netted cash for financial covenant purposes under the 2019 Credit Agreement, the aggregate amount of netted cash is not permitted to exceed $200.0 million. Critical Accounting Policies and Estimates For a discussion of our critical accounting policies and estimates, please refer to ITEM 7 under Part II, "Management’s Discussion and Analysis of Financial Condition and Results of Operations," in the 2020 Annual Report. There have been no material changes to our critical accounting policies and estimates in 2021.