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 and six months ended June 30, 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. 24 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 has continued as the negative impacts of the COVID-19 pandemic largely subsided in the first half of 2021, as compared to the significant global disruption experienced throughout early 2020. Our consolidated net sales increased 75.8% as compared to the second quarter of 2020, which was impacted by COVID-19. Current order trends continue to indicate growth. As a result, we expect consolidated net sales growth to exceed 35% 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 has created operational challenges for U.S. production. The availability of certain commodities improved throughout the second quarter of 2021. However, availability declined for other key components as well as inbound and outbound freight. As a result, the U.S. sales growth in the first half of 2021 was unfavorably impacted as we could not fulfill the entire domestic demand for these products. We expect these constraints to continue to impact sales growth into the third quarter of 2021 and now anticipate the demand for these products will likely exceed supply into the fourth quarter of 2021. We estimate sales would have been approximately $150 million higher in the second quarter of 2021 had we not experienced supply chain constraints. We expect these supply chain constraints will be largely resolved by the end of 2021 and expect to be well-positioned to meet consumer demand heading into 2022. During the first half of 2021, commodity costs unfavorably impacted our gross margin. We implemented pricing actions in the fourth quarter of 2020 and in the second quarter of 2021 to mitigate these known commodity headwinds. Since then, we have continued to manage through a highly inflationary commodity environment and have taken additional pricing actions that will benefit the fourth quarter of 2021. Based on our current commodity outlook, we expect gross margin will be positively impacted by our pricing actions net of commodity cost inflation in the first half of 2022. 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. Acquisition of Dreams Topco Limited On May 26, 2021, we entered into a share purchase agreement with Project Dream S.à.r.l. and certain members of the management team and Dreams Topco Limited to purchase the entire issued share capital of Dreams Topco Limited and its direct and indirect subsidiaries ("Dreams"). Dreams has developed a successful multi-channel sales strategy, with over 200 brick and mortar retail locations in the United Kingdom, an industry-leading online channel, as well as manufacturing and delivery assets. Dreams generated sales of approximately $400 million and EBITDA of approximately $75 million for the year ending December 31, 2020. On August 2, 2021, we completed the acquisition of Dreams. The purchase price was approximately $475 million, less net debt and is subject to a customary working capital adjustment period. The transaction is expected to be accretive to our EPS by approximately $0.20 and generate annual sales of approximately $450 million in the first year post-acquisition. 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 began the largest rollout in Sealy North America’s history with the introduction of new Posturepedic Plus™, Posturepedic® and Essentials product lines. The rollout will be split between two phases with Posturepedic® and Essentials product lines successfully launched in the first half of 2021 and the new higher end Posturepedic Plus™ line planned for 2022. We expect to launch a new Tempur product line in our International segment in 2022. 25 Table of Contents Our global 2021 marketing plan is to aggressively support our innovative bedding products through investing significant marketing dollars to promote our worldwide brands. Results of Operations A summary of our results for the three months ended June 30, 2021 include: • Total net sales increased 75.8% to $1,169.1 million as compared to $665.2 million in the second quarter of 2020. On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 72.6%, with an increase of 73.8% in the North America business segment and an increase of 64.5% in the International business segment. • Gross margin was 44.3% as compared to 40.0% in the second quarter of 2020. Adjusted gross margin, which is a non-GAAP financial measure, was 40.6% in the second quarter of 2020. There were no adjustments to gross margin in the second quarter of 2021. • Operating income increased 318.2% to $223.3 million as compared to $53.4 million in the second quarter of 2020. Adjusted operating income, which is a non-GAAP financial measure, increased 191.7% to $227.2 million as compared to $77.9 million in the second quarter of 2020. • Net income increased 512.2% to $140.8 million as compared to $23.0 million in the second quarter of 2020. Adjusted net income, which is a non-GAAP financial measure, increased 294.9% to $161.5 million as compared to $40.9 million in the second quarter of 2020. • Earnings before interest, tax, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, increased 212.3% to $266.1 million as compared to $85.2 million in the second quarter of 2020. Adjusted EBITDA per credit facility, which is a non-GAAP financial measure, increased 146.6% to $270.3 million as compared to $109.6 million in the second quarter of 2020. • Earnings per diluted share ("EPS") increased 527.3% to $0.69 as compared to $0.11 in the second quarter of 2020. Adjusted EPS, which is a non-GAAP financial measure, increased 295.0% to $0.79 as compared to $0.20 in the second 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. 26 Table of Contents THREE MONTHS ENDED JUNE 30, 2021 COMPARED TO THE THREE MONTHS ENDED JUNE 30, 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 June 30, (in millions, except percentages and per share amounts) 2021 2020 Net sales $ 1,169.1 100.0 % $ 665.2 100.0 % Cost of sales 650.9 55.7 399.3 60.0 Gross profit 518.2 44.3 265.9 40.0 Selling and marketing expenses 216.8 18.5 135.1 20.3 General, administrative and other expenses 85.1 7.3 82.4 12.4 Equity income in earnings of unconsolidated affiliates (7.0) (0.6) (5.0) (0.7) Operating income 223.3 19.1 53.4 8.0 Other expense, net: Interest expense, net 20.0 1.7 20.6 3.1 Loss on extinguishment of debt 18.0 1.5 — — Other (income) expense, net (0.1) — 0.3 — Total other expense, net 37.9 3.2 20.9 3.1 Income from continuing operations before income taxes 185.4 15.9 32.5 4.9 Income tax provision (44.7) (3.8) (9.4) (1.4) Income from continuing operations 140.7 12.0 23.1 3.5 (Loss) income from discontinued operations, net of tax (0.3) — 0.1 — Net income before non-controlling interests 140.4 12.0 23.2 3.5 Less: Net (loss) income attributable to non-controlling interests (0.4) — 0.2 — Net income attributable to Tempur Sealy International, Inc. $ 140.8 12.0 % $ 23.0 3.5 % Earnings per common share: Basic Earnings per share for continuing operations $ 0.72 $ 0.11 Loss per share for discontinued operations — — Earnings per share $ 0.72 $ 0.11 Diluted Earnings per share for continuing operations $ 0.69 $ 0.11 Loss per share for discontinued operations — — Earnings per share $ 0.69 $ 0.11 Weighted average common shares outstanding: Basic 197.0 206.4 Diluted 204.1 208.0 27 Table of Contents NET SALES Three Months Ended June 30, 2021 2020 2021 2020 2021 2020 (in millions) Consolidated North America International Net sales by channel Wholesale $ 1,005.4 $ 563.7 $ 890.8 $ 502.8 $ 114.6 $ 60.9 Direct 163.7 101.5 123.0 75.8 40.7 25.7 Total net sales $ 1,169.1 $ 665.2 $ 1,013.8 $ 578.6 $ 155.3 $ 86.6 Net sales increased 75.8%, and on a constant currency basis increased 72.6%. The change in net sales was driven by the following: • North America net sales increased $435.2 million, or 75.2%. On a constant currency basis, North America net sales increased 73.8%. Net sales in the Wholesale channel increased $388.0 million, or 77.2%. Net sales in the Direct channel increased $47.2 million, or 62.3%. The increase in net sales across all channels was driven by higher sales volume compared to the prior year period, which was impacted by COVID-19. • International net sales increased $68.7 million, or 79.3%. On a constant currency basis, International net sales increased 64.5%. Net sales in the Wholesale channel increased 71.8% on a constant currency basis. Net sales in the Direct channel increased 47.5% on a constant currency basis. The increase in net sales across all channels was driven by higher sales volume compared to the prior year period, which was impacted by COVID-19. GROSS PROFIT Three Months Ended June 30, 2021 2020 (in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin Margin Change North America $ 425.4 42.0 % $ 218.4 37.7 % 4.3 % International 92.8 59.8 % 47.5 54.8 % 5.0 % Consolidated gross margin $ 518.2 44.3 % $ 265.9 40.0 % 4.3 % 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. If 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 430 basis points. The primary drivers of changes in gross margin by segment are discussed below: • North America gross margin improved 430 basis points. The improvement in gross margin was driven by fixed cost leverage from higher sales volume, resulting in an increase of 410 basis points, compared to the prior year period, which was impacted by COVID-19. Additionally, in 2020, we incurred $4.0 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which was not repeated in 2021. • International gross margin improved 500 basis points. The improvement in gross margin was primarily driven by fixed cost leverage from higher sales volume resulting in an increase of 470 basis points compared to the prior year, which was impacted by COVID-19. Additionally, in 2020, we incurred $0.5 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which was not repeated in 2021. OPERATING EXPENSES Selling and marketing expenses include advertising and media production associated with the promotion of our brands, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing. General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs. Three Months Ended June 30, 2021 2020 2021 2020 2021 2020 2021 2020 (in millions) Consolidated North America International Corporate Operating expenses: Advertising expenses $ 108.0 $ 55.1 $ 97.1 $ 49.9 $ 10.9 $ 5.2 $ — $ — Other selling and marketing expenses 108.8 80.0 70.0 52.5 32.4 24.4 6.4 3.1 General, administrative and other expenses 85.1 82.4 40.9 48.3 13.1 11.6 31.1 22.5 Total operating expenses $ 301.9 $ 217.5 $ 208.0 $ 150.7 $ 56.4 $ 41.2 $ 37.5 $ 25.6 Operating expenses increased $84.4 million, or 38.8%, and decreased 690 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 $57.3 million, or 38.0%, and decreased 550 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising investments and increased variable compensation expense as compared to the prior year period, when the full-year outlook included worldwide shutdowns and significant retailer door closures due to COVID-19. Additionally, in 2020, we recognized $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the macro-economic environment, which were not repeated in 2021. • International operating expenses increased $15.2 million, or 36.9%, and decreased 1,130 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising and other selling and marketing investments as compared to the prior year period, when cost reduction actions were taken due to COVID-19. These increases were partially offset by decreased restructuring costs. In 2020, we recorded $3.4 million of restructuring costs associated with headcount reductions driven by the macro-economic environment, which were not repeated in 2021. • Corporate operating expenses increased $11.9 million, or 46.5%. The increase in operating expenses was primarily driven by the low level of variable compensation expense in prior year when the full-year outlook included worldwide shutdowns and significant retailer door closures due to COVID-19. Additionally, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. Research and development expenses for the three months ended June 30, 2021 were $6.7 million compared to $5.2 million for the three months ended June 30, 2020, an increase of $1.5 million, or 28.8%. 28 Table of Contents OPERATING INCOME Three Months Ended June 30, 2021 2020 (in millions, except percentages) Operating Income Operating Margin Operating Income Operating Margin Margin Change North America $ 217.4 21.4 % $ 67.7 11.7 % 9.7 % International 43.4 27.9 % 11.3 13.0 % 14.9 % 260.8 79.0 Corporate expenses (37.5) (25.6) Total operating income $ 223.3 19.1 % $ 53.4 8.0 % 11.1 % Operating income increased $169.9 million and operating margin improved 1,110 basis points. The primary drivers of changes in operating income and operating margin by segment are discussed below: • North America operating income increased $149.7 million and operating margin improved 970 basis points. The improvement in operating margin was primarily driven by improvement in gross margin of 430 basis points and favorable operating expense leverage of 280 basis points. Additionally, in 2020, we recognized $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the macro-economic environment and incurred $4.3 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which were not repeated in 2021. • International operating income increased $32.1 million and operating margin improved 1,490 basis points. The improvement in operating margin was primarily driven by favorable operating expense leverage of 560 basis points and the improvement in gross margin of 500 basis points. Additionally, in 2020, we recorded $3.4 million of restructuring costs associated with headcount reductions driven by the macro-economic environment and $0.6 million of incremental costs related to the global pandemic, which were not repeated in 2021. • Corporate operating expenses increased $11.9 million, which negatively impacted our consolidated operating margin by 100 basis points. The increase in operating expenses was primarily driven by the low level of variable compensation expense in prior year when the full-year outlook included worldwide shutdowns and significant retailer door closures due to COVID-19. Additionally, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. INTEREST EXPENSE, NET Three Months Ended June 30, (in millions, except percentages) 2021 2020 % Change Interest expense, net $ 20.0 $ 20.6 (2.9) % Interest expense, net, decreased $0.6 million, or 2.9%. The decrease in interest expense, net, was primarily driven by lower interest rates on our variable rate debt, partially offset by $5.2 million of overlapping interest expense during the period between the issuance of the 2029 Senior Notes and the redemption of the 2026 Senior Notes. LOSS ON EXTINGUISHMENT OF DEBT On March 25, 2021, we issued our 2029 Senior Notes. During the second quarter of 2021, we used the net proceeds from the 2029 Senior Notes to primarily redeem in full our $600.0 million 2026 Senior Notes. As a result of the redemption, we recognized $18.0 million of loss on extinguishment of debt, which includes a prepayment premium of $16.5 million and the write-off of $1.5 million of deferred financing costs. Refer to Note 5, "Debt," in our Notes to Condensed Consolidated Financial Statements included in ITEM 1 under Part I for additional information. 29 Table of Contents INCOME TAX PROVISION Three Months Ended June 30, (in millions, except percentages) 2021 2020 % Change Income tax provision $ 44.7 $ 9.4 375.5 % Effective tax rate 24.1 % 28.9 % 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 $35.3 million due to an increase in income before income taxes. Our effective tax rate for the three months ended June 30, 2021 as compared to the same prior year period decreased by 480 basis points. The effective tax rate as compared to the U.S. federal statutory rate for the three months ended June 30, 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 June 30, 2020 also included a net favorable impact of discrete items. 30 Table of Contents SIX MONTHS ENDED JUNE 30, 2021 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 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: Six Months Ended June 30, (in millions, except percentages and per share amounts) 2021 2020 Net sales $ 2,212.9 100.0 % $ 1,487.6 100.0 % Cost of sales 1,235.8 55.8 864.6 58.1 Gross profit 977.1 44.2 623.0 41.9 Selling and marketing expenses 414.5 18.7 306.1 20.6 General, administrative and other expenses 164.6 7.4 163.0 10.9 Equity income in earnings of unconsolidated affiliates (13.7) (0.6) (4.8) (0.3) Operating income 411.7 18.6 158.7 10.7 Other expense, net: Interest expense, net 32.3 1.5 40.9 2.7 Loss on extinguishment of debt 23.0 1.0 — — Other (income) expense, net (0.4) — 0.8 0.1 Total other expense, net 54.9 2.5 41.7 2.8 Income from continuing operations before income taxes 356.8 16.1 117.0 7.9 Income tax provision (85.2) (3.9) (32.9) (2.2) Income from continuing operations 271.6 12.3 84.1 5.7 Loss from discontinued operations, net of tax (0.5) — (1.1) (0.1) Net income before non-controlling interests 271.1 12.3 83.0 5.6 Less: Net (loss) income attributable to non-controlling interests (0.2) — 0.3 — Net income attributable to Tempur Sealy International, Inc. $ 271.3 12.3 % $ 82.7 5.6 % Earnings per common share: Basic Earnings per share for continuing operations $ 1.36 $ 0.39 Loss per share for discontinued operations — — Earnings per share $ 1.36 $ 0.39 Diluted Earnings per share for continuing operations $ 1.32 $ 0.40 Loss per share for discontinued operations — (0.01) Earnings per share $ 1.32 $ 0.39 Weighted average common shares outstanding: Basic 200.4 210.0 Diluted 204.9 212.0 31 Table of Contents NET SALES Six Months Ended June 30, 2021 2020 2021 2020 2021 2020 (in millions) Consolidated North America International Net sales by channel Wholesale $ 1,886.8 $ 1,286.1 $ 1,656.3 $ 1,127.5 $ 230.5 $ 158.6 Direct 326.1 201.5 240.8 143.4 85.3 58.1 Total net sales $ 2,212.9 $ 1,487.6 $ 1,897.1 $ 1,270.9 $ 315.8 $ 216.7 Net sales increased 48.8%, and on a constant currency basis increased 46.4%. The change in net sales was driven by the following: • North America net sales increased $626.2 million, or 49.3%. Net sales in the Wholesale channel increased $528.8 million, or 46.9%, primarily driven by broad-based demand across our retail partners and higher sales volume compared to the prior year period, which was impacted by COVID-19. Net sales in the Direct channel increased $97.4 million, or 67.9%, primarily driven by growth from web sales and higher retail sales volume compared to the prior year period, which was impacted by COVID-19. • International net sales increased $99.1 million, or 45.7%. On a constant currency basis, International net sales increased 34.1%. Net sales in the Wholesale channel increased 33.1% on a constant currency basis. Net sales in the Direct channel increased 36.7% on a constant currency basis. The increase in net sales across all channels was driven by higher sales volume compared to the prior year period, which was impacted by COVID-19. GROSS PROFIT Six Months Ended June 30, 2021 2020 (in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin Margin Change North America $ 789.3 41.6 % $ 499.6 39.3 % 2.3 % International 187.8 59.5 % 123.4 56.9 % 2.6 % Consolidated gross margin $ 977.1 44.2 % $ 623.0 41.9 % 2.3 % Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in the manufacturing process. Gross margin improved 230 basis points. The primary drivers of changes in gross margin by segment are discussed below: • North America gross margin improved 230 basis points. The improvement in gross margin was primarily driven by fixed cost leverage on higher sales volume of 220 basis points, compared to the prior year period which was impacted by COVID-19. Additionally, in 2020, we incurred $4.0 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which was not repeated in 2021. • International gross margin improved 260 basis points. The improvement in gross margin was primarily driven by favorable mix of 120 basis points and fixed cost leverage on higher unit volumes of 110 basis points. Additionally, in 2020, we incurred $0.5 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which was not repeated in 2021. 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. 32 Table of Contents 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. Six Months Ended June 30, 2021 2020 2021 2020 2021 2020 2021 2020 (in millions) Consolidated North America International Corporate Operating expenses: Advertising expenses $ 198.9 $ 128.6 $ 176.5 $ 113.8 $ 22.4 $ 14.8 $ — $ — Other selling and marketing expenses 215.6 177.5 138.8 118.7 64.0 52.7 12.8 6.1 General, administrative and other expenses 164.6 163.0 83.2 97.8 25.5 23.0 55.9 42.2 Total operating expenses $ 579.1 $ 469.1 $ 398.5 $ 330.3 $ 111.9 $ 90.5 $ 68.7 $ 48.3 Operating expenses increased $110.0 million, or 23.4%, and decreased 530 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 $68.2 million, or 20.6%, and decreased 500 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising investments and increased variable compensation expense as compared to the prior year period, when the full-year outlook included worldwide shutdowns and significant retailer door closures due to COVID-19. Additionally, in 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 and $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the macro-economic environment, which were not repeated in 2021. • International operating expenses increased $21.4 million, or 23.6%, and decreased 640 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by other selling and marketing investments and increased advertising as compared to the prior year period, when cost reduction actions were taken due to COVID-19. Additionally, in 2020, we incurred $3.4 million of restructuring costs associated with headcount reductions driven by the macro-economic environment and $2.4 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which were not repeated in 2021. • Corporate operating expenses increased $20.4 million, or 42.2%. The increase in operating expenses was primarily driven by amortization of our performance-based stock compensation plans. Additionally, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. Research and development expenses were $13.2 million for the six months ended June 30, 2021 as compared to $11.0 million for the six months ended June 30, 2020. OPERATING INCOME Six Months Ended June 30, 2021 2020 (in millions, except percentages) Operating Income Operating Margin Operating Income Operating Margin Margin Change North America $ 390.8 20.6 % $ 169.3 13.3 % 7.3 % International 89.6 28.4 % 37.7 17.4 % 11.0 % 480.4 207.0 Corporate expenses (68.7) (48.3) Total operating income $ 411.7 18.6 % $ 158.7 10.7 % 7.9 % Operating income increased $253.0 million and operating margin improved 790 basis points. The primary drivers of changes in operating income and operating margin by segment are discussed below: 33 Table of Contents • North America operating income increased $221.5 million and operating margin improved 730 basis points. The improvement in operating margin was primarily driven by improved operating expense leverage of 270 basis points, improvement in gross margin of 230 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. Additionally, in 2020, we recorded $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets driven by the macro-economic environment and incurred $4.3 million of incremental costs related to global pandemic relief efforts, sanitation supplies and services and other items, which were not repeated in 2021. • International operating income increased $51.9 million and operating margin improved 1,100 basis points. The improvement in operating margin was primarily driven by improved operating expense leverage of 360 basis points, improvement in gross margin of 260 basis points and improved performance of the Asia-Pacific joint ventures of 160 basis points. Additionally, in 2020, we incurred $3.4 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, which were not repeated in 2021. • Corporate operating expenses increased $20.4 million, which negatively impacted our consolidated operating margin by 90 basis points. The increase in operating expenses was primarily driven by amortization of our performance-based stock compensation plans. Additionally, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. INTEREST EXPENSE, NET Six Months Ended June 30, (in millions, except percentages) 2021 2020 % Change Interest expense, net $ 32.3 $ 40.9 (21.0) % Interest expense, net, decreased $8.6 million, or 21.0%. 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, partially offset by $5.2 million of overlapping interest expense for the period between the issuance of the 2029 Senior Notes and redemption of the 2026 Senior Notes. LOSS ON EXTINGUISHMENT OF DEBT On March 25, 2021, we issued our 2029 Senior Notes. During the second quarter of 2021, we used the net proceeds from the 2029 Senior Notes primarily to redeem in full our $600.0 million 2026 Senior Notes, at 102.75% of their principal amount, plus the accrued and unpaid interest. As a result of the redemption, we recognized $18.0 million of loss on extinguishment of debt, which included a prepayment premium of $ 16.5 million and the write-off of $ 1.5 million of deferred financing costs. Additionally, in the first quarter of 2021, we recognized $ 5.0 million of loss on extinguishment of debt, which includes a prepayment premium of $ 3.5 million and the write-off of $ 1.5 million of deferred financing costs, associated with the redemption of the remaining amount outstanding of the 2023 Senior Notes. Refer to Note 5, "Debt," in our Notes to Condensed Consolidated Financial Statements included in ITEM 1 under Part I for additional information. INCOME TAX PROVISION Six Months Ended June 30, (in millions, except percentages) 2021 2020 % Change Income tax provision $ 85.2 $ 32.9 159.0 % Effective tax rate 23.9 % 28.1 % Our income tax provision increased $52.3 million due to an increase in income before income taxes. Our effective tax rate for the six months ended June 30, 2021 as compared to the same prior year period decreased 420 basis points. The effective tax rate as compared to the U.S. federal statutory rate for the six months ended June 30, 2021 included the favorable impact of the elimination of 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 rate for the for the six months ended June 30, 2020 included a net unfavorable impact of discrete items primarily related to the impact of the likelihood of realization of certain deferred tax assets. 34 Table of Contents 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. As of June 30, 2021, we had net working capital of $67.4 million, including cash and cash equivalents of $58.1 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 June 30, 2021, total cash and cash equivalents were $58.1 million, of which $25.5 million was held in the U.S. and $32.6 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: Six Months Ended June 30, (in millions) 2021 2020 Net cash provided by (used in) continuing operations: Operating activities $ 313.0 $ 170.4 Investing activities (57.9) (87.2) Financing activities (260.5) 1.4 Cash provided by operating activities from continuing operations increased $142.6 million in the six months ended June 30, 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 $29.3 million in the six months ended June 30, 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 used in financing activities from continuing operations increased $261.9 million in the six months ended June 30, 2021 as compared to the same period in 2020. For the six months ended June 30, 2021, we had net funding of $153.8 million, which included proceeds of $800.0 million from the issuance of our 2029 Senior Notes, offset by repayments of $250.0 million of our 2023 Senior Notes and $600.0 million of our 2026 Senior Notes and net borrowings of $203.8 million on our credit facilities, as compared to net borrowings of $207.0 million in 2020 on our credit facilities. During the six months ended June 30, 2021 and 2020, we repurchased $374.4 million and $199.5 million, respectively, of our common stock. Cash used in financing activities also decreased due to dividends paid to shareholders of $28.1 million and payment of deferred financing costs of $14.2 million during the six months ended June 30, 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 June 30, 2021 and 2020 was not material. Capital Expenditures Capital expenditures totaled $52.6 million and $49.4 million for the six months ended June 30, 2021 and 2020, respectively. We currently expect our 2021 capital expenditures to be approximately $150 million to $165 million, which includes investments in growth initiatives. 35 Table of Contents Indebtedness Our total debt increased to $1,523.6 million as of June 30, 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. 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 $629.3 million as of June 30, 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. On June 15, 2021, we redeemed our $600.0 million 2026 Senior Notes, in full, using net proceeds from our 2029 Senior Notes. Additionally, on May 26, 2021, we entered into an amendment to our 2019 Credit Agreement. The amendment provides for a $300.0 million delayed draw term loan. On July 30, 2021 we drew down the full $300.0 million available under the delayed draw term loan to fund, in part, the Dreams acquisition. Refer to Note 5, "Debt" in our "Notes to Condensed Consolidated Financial Statements," under Part I, ITEM 1 for further discussion of our debt. As of June 30, 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 1.44 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 June 30, 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 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 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. 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. On April 29, 2021, the Board of Directors authorized an additional increase, of $325.3 million, to the share repurchase authorization. During the six months ended June 30, 2021, we repurchased 10.0 million shares under our share repurchase program for $361.4 million. As of June 30, 2021, we had $376.8 million remaining under our share repurchase authorization. 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. 36 Table of Contents 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 June 30, 2021, we had $987.4 million of liquidity, including $58.1 million of cash on hand, $629.3 million available under our revolving senior secured credit facility and $300.0 million available under our delayed draw term loan. 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. We plan to take the following additional actions in 2021: • For the third quarter of 2021, the Board of Directors has declared a dividend of $0.09 per share. The dividend is payable on August 26, 2021 to shareholders of record as of August 12, 2021. This represents a 29% increase over our previous quarterly dividend of $0.07 per share. • Repurchase at least 6% of shares outstanding over the course of 2021, subject to market conditions. • On July 30, 2021, we drew down the full $300.0 million available under the delayed draw term loan to fund, in part, the Dreams acquisition. As of June 30, 2021, we had $1,523.6 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $1,466.6 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 1.44 times for the trailing twelve months ended June 30, 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. We expect our ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility, which is a non-GAAP financial measure, will be approximately 1.80 times after the acquisition of Dreams. Total cash interest payments related to our borrowings are expected to be approximately $55 million in 2021. 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. Non-GAAP Financial Information We provide information regarding adjusted net income, adjusted EPS, adjusted gross profit, adjusted gross margin, adjusted operating income (expense), adjusted operating margin, EBITDA, adjusted EBITDA per credit facility, consolidated indebtedness and consolidated indebtedness less netted cash, which are not recognized terms under GAAP and do not purport to be alternatives to net income, earnings per share, gross profit, gross margin, operating income (expense), operating margin or an alternative to total debt as a measure of liquidity. We believe these non-GAAP financial measures provide investors with performance measures that better reflect our underlying operations and trends, providing a perspective not immediately apparent from net income, gross profit, gross margin, operating income (expense) and operating margin. 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. 37 Table of Contents 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 June 30, 2021 and 2020: Three Months Ended (in millions, except per share amounts) June 30, 2021 June 30, 2020 Net income $ 140.8 $ 23.0 Loss (income) from discontinued operations, net of tax (1) 0.3 (0.1) Loss on extinguishment of debt (2) 18.0 — Overlapping interest expense (3) 5.2 — Acquisition-related costs (4) 3.9 — COVID-19 charges (5) — 7.9 Asset impairments (6) — 7.0 Incremental operating costs (7) — 4.9 Restructuring costs (8) — 3.4 Accounting standard adoption (9) — 1.3 Tax adjustments (10) (6.7) (6.5) Adjusted net income $ 161.5 $ 40.9 Adjusted earnings per share, diluted $ 0.79 $ 0.20 Diluted shares outstanding 204.1 208.0 38 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 second quarter of 2021, we recognized $18.0 million of loss on extinguishment of debt associated with the redemption of the 2026 Senior Notes. (3) In the second quarter of 2021, we incurred $5.2 million of overlapping interest expense during the period between the issuance of the 2029 Senior Notes and the redemption of the 2026 Senior Notes. (4) In the second quarter of 2021, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. (5) In the second quarter of 2020, we recorded $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 $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets. (7) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic. (8) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment. (9) In the second quarter of 2020, we recorded $1.3 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) Adjusted income tax provision represents the tax effects associated with the aforementioned items. Adjusted Gross Profit, Adjusted Gross Margin, Adjusted Operating Income (Expense) and Adjusted Operating Margin A reconciliation of gross profit and gross margin to adjusted gross profit and adjusted gross margin, respectively, and operating income (expense) and operating margin to adjusted operating income (expense) and adjusted operating margin, respectively, are provided below. 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 the reconciliation of the Company's operating income (expense) to the calculation of adjusted operating (income) expense for the three months ended June 30, 2021. We had no adjustments to gross profit for the three months ended June 30, 2021. Three Months Ended June 30, 2021 (in millions, except percentages) Consolidated Margin North America Margin International Margin Corporate Net sales $ 1,169.1 $ 1,013.8 $ 155.3 $ — Gross profit $ 518.2 44.3 % $ 425.4 42.0 % $ 92.8 59.8 % $ — Operating income (expense) $ 223.3 19.1 % $ 217.4 21.4 % $ 43.4 27.9 % $ (37.5) Adjustments: Acquisition-related costs (1) 3.9 — — 3.9 Adjusted operating income (expense) $ 227.2 19.4 % $ 217.4 21.4 % $ 43.4 27.9 % $ (33.6) 39 Table of Contents The following table sets forth the reconciliation of our reported gross profit and operating income (expense) to the calculation of adjusted gross profit and adjusted operating income (expense) for the three months ended June 30, 2020. Three Months Ended June 30, 2020 (in millions, except percentages) Consolidated Margin North America Margin International Margin Corporate Net sales $ 665.2 $ 578.6 $ 86.6 $ — Gross profit $ 265.9 40.0 % $ 218.4 37.7 % $ 47.5 54.8 % $ — Adjustments: Incremental operating costs (2) 4.5 4.0 0.5 — Adjusted gross profit $ 270.4 40.6 % $ 222.4 38.4 % $ 48.0 55.4 % $ — Operating income (expense) $ 53.4 8.0 % $ 67.7 11.7 % $ 11.3 13.0 % $ (25.6) Adjustments: COVID-19 charges (3) 7.9 6.3 1.6 — Asset impairments (4) 7.0 7.0 — — Incremental operating costs (2) 4.9 4.3 0.6 — Restructuring costs (5) 3.4 — 3.4 — Accounting standard adoption (6) 1.3 1.3 — — Total adjustments 24.5 18.9 5.6 — Adjusted operating income (expense) $ 77.9 11.7 % $ 86.6 15.0 % $ 16.9 19.5 % $ (25.6) (1) In the second quarter of 2021, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. (2) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic. Cost of sales included $4.5 million of costs for relief efforts, increased sanitation supplies and services and other items. Operating expenses included $0.4 million of charges related to increased sanitation supplies and services. (3) In the second quarter of 2020, we recorded $7.9 million of COVID-19 charges associated with temporarily closed company-owned retail stores and sales force retention costs. (4) 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. (5) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment. (6) In the second quarter of 2020, we recorded $1.3 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. 40 Table of Contents 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 June 30, 2021 and 2020: Three Months Ended (in millions) June 30, 2021 June 30, 2020 Net income $ 140.8 $ 23.0 Interest expense, net 14.8 20.6 Overlapping interest expense (1) 5.2 — Loss on extinguishment of debt (2) 18.0 — Income taxes 44.7 9.4 Depreciation and amortization 42.6 32.2 EBITDA $ 266.1 $ 85.2 Adjustments: Loss (income) from discontinued operations, net of tax (3) 0.3 (0.1) Acquisition-related costs (4) 3.9 — COVID-19 charges (5) — 7.9 Asset impairments (6) — 7.0 Incremental operating costs (7) — 4.9 Restructuring costs (8) — 3.4 Accounting standard adoption (9) — 1.3 Adjusted EBITDA per credit facility $ 270.3 $ 109.6 (1) In the second quarter of 2021, we incurred $5.2 million of overlapping interest expense during the period between the issuance of the 2029 Senior Notes and the redemption of the 2026 Senior Notes. (2) In the second quarter of 2021, we recognized $18.0 million of loss on extinguishment of debt associated with the redemption of the 2026 Senior Notes. (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 the second quarter of 2021, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. (5) In the second quarter of 2020, we recorded $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 $7.0 million of asset impairment charges related to the write-off of certain sales and marketing assets. (7) In the second quarter of 2020, we recorded $4.9 million of incremental operating costs associated with the global pandemic. (8) In the second quarter of 2020, we incurred $3.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment. (9) In the second quarter of 2020, we recorded $1.3 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. 41 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 June 30, 2021: Trailing Twelve Months Ended (in millions) June 30, 2021 Net income $ 537.4 Interest expense, net 63.2 Overlapping interest expense (1) 5.2 Loss on extinguishment of debt (2) 28.1 Income tax provision 154.9 Depreciation and amortization 176.1 Aspirational plan amortization (3) 49.4 EBITDA $ 1,014.3 Adjustments: Income from discontinued operations, net of tax (4) (0.6) Acquisition-related costs (5) 3.9 Aspirational plan employer costs (6) 2.3 Accounting standard adoption (7) 0.8 Facility expansion costs (8) 0.6 Restructuring costs (9) 0.4 Other income (10) (2.3) Adjusted EBITDA per credit facility $ 1,019.4 Consolidated indebtedness less netted cash $ 1,466.6 Ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility 1.44 times (1) In the second quarter of 2021, we incurred $5.2 million of overlapping interest expense during the period between the issuance of the 2029 Senior Notes and the redemption of the 2026 Senior Notes. (2) We recognized $28.1 million of loss on extinguishment of debt of which $18.0 million is associated with the redemption of the 2026 Senior Notes and $10.1 million is associated with the redemption of the 2023 Senior Notes and early repayment of the 364-day term loan. (3) In 2020, we recognized $49.4 million of performance-based stock compensation amortization related to our long-term aspirational awards. (4) 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. (5) In the second quarter of 2021, we recorded $3.9 million of acquisition-related costs, primarily related to legal and professional fees associated with the acquisition of Dreams. (6) In 2020, we recognized $2.3 million of employer-related tax costs related to the aspirational plan compensation. (7) During 2020, we recorded $0.8 million of charges related to the adoption of ASU No. 2016-13, "Financial Instruments - Credit Losses (Topic 326)". As permitted by the 2019 Credit Agreement, we elected to eliminate the effect of this accounting change within our covenant compliance calculation. (8) In 2020, we recorded $0.6 million of costs related to the opening of a Sealy manufacturing facility. (9) In 2020, we incurred $0.4 million of restructuring costs associated with International headcount reductions driven by the macro-economic environment. (10) In 2020, we recorded $2.3 million of other income related to the sale of a manufacturing facility. Under the 2019 Credit Agreement, the definition of adjusted EBITDA (which we refer to as "adjusted EBITDA per credit facility") contains certain restrictions that limit adjustments to net income when calculating adjusted EBITDA. For the trailing twelve months ended June 30, 2021, our adjustments to net income when calculating adjusted EBITDA did not exceed the allowable amount under the 2019 Credit Agreement. 42 Table of Contents The ratio of consolidated indebtedness less netted cash to adjusted EBITDA per credit facility is 1.44 times for the trailing twelve months ended June 30, 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 June 30, 2021. "Consolidated Indebtedness" and "Netted Cash" are terms used in the 2019 Credit Agreement for purposes of certain financial covenants. (in millions) June 30, 2021 Total debt, net $ 1,509.6 Plus: Deferred financing costs (1) 14.0 Consolidated indebtedness 1,523.6 Less: Netted cash (2) 57.0 Consolidated indebtedness less netted cash $ 1,466.6 (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. 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.