UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2018
Commission file number 001-31922
TEMPUR SEALY INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
Delaware | 33-1022198 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
1000 Tempur Way
Lexington, Kentucky 40511
(Address of registrant’s principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (800) 878-8889
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class | Name of Each Exchange on Which Registered | |
Common Stock, $0.01 par value | New York Stock Exchange | |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§229.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer x Accelerated filer o Non-Accelerated filer o Smaller Reporting Company ¨ Emerging Growth Company ¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The aggregate market value of the common equity held by nonaffiliates of the registrant on June 30, 2018, computed by reference to the closing price for such stock on the New York Stock Exchange on such date, was approximately $2,192,144,163.
The number of shares outstanding of the registrant’s common stock as of February 18, 2019 was 54,641,297 shares.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement for the 2019 Annual Meeting of Stockholders, which is to be filed subsequent to the date hereof, are incorporated by reference into Part III of this Form 10-K.
TABLE OF CONTENTS
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Special Note Regarding Forward-Looking Statements
This Annual Report on Form 10-K (the “Report”), including the information incorporated by reference herein, contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which includes information concerning one or more of our plans; objectives; goals; strategies and other information that is not historical information. Many of these statements appear, in particular, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, ITEM 7 of this Report. When used in this Report, the words "assumes," "estimates," "expects," “guidance,” “anticipates,” “projects,” “plans,” “proposed,” “targets,” “intends,” “believes,” “will” and variations of such words or similar expressions are intended to identify forward-looking statements. These forward-looking statements are based upon our current expectations and various assumptions. There can be no assurance that we will realize our expectations or that our beliefs will prove correct.
Numerous factors, many of which are beyond the Company’s control, could cause actual results to differ materially from those expressed as forward-looking statements in this Report, including risks associated with the impact of the macroeconomic environment in both the U.S. and internationally (including the impact of our highly inflationary economies) on our business segments and expectations regarding growth of the mattress industry; uncertainties arising from global events; the effects of strategic investments on our operations, including our efforts to expand our global market share; the ability to develop and successfully launch new products; the efficiency and effectiveness of our advertising campaigns and other marketing programs; the ability to increase sales productivity within existing retail accounts and to further penetrate the retail channel, including the timing of opening or expanding within large retail accounts and the timing and success of product launches; the ability to continuously improve and expand our product line, maintain efficient, timely and cost-effective production and delivery of products, and manage growth; the effects of consolidation of retailers on revenues and costs; competition in our industry; consumer acceptance of our products; the effects of discontinued operations on our operating results and future performance; general economic, financial and industry conditions, particularly conditions relating to the financial performance and related credit issues present in the retail sector; financial distress among our business partners, customers and competitors; financial solvency and related problems experienced by other market participants; our reliance on information technology and the associated risks involving potential security lapses and/or cyber-based attacks; the outcome of pending tax audits or other tax, regulatory or investigation proceedings and pending litigation; changes in foreign tax rates and changes in tax laws generally, including the ability to utilize tax loss carryforwards; our capital structure and increased debt level, including our ability to meet financial obligations and continue to comply with the terms and financial ratio covenants of our credit facilities; changes in interest rates; effects of changes in foreign exchange rates on our reported earnings; changing commodity costs; disruptions in the supply of raw materials, or loss of suppliers; expectations regarding our target leverage and our share repurchase program; sales fluctuations due to seasonality; the effect of future legislative or regulatory changes, including changes in international trade duties, tariffs and other aspects of international trade policy; our ability to protect our intellectual property; and disruptions to the implementation of our strategic priorities and business plan caused by abrupt changes in our executive management team.
Other potential risk factors include the risk factors discussed under the heading “Risk Factors” under Part I, ITEM 1A of this Report. In addition, there may be other factors that may cause our actual results to differ materially from the forward-looking statements.
All forward-looking statements attributable to us apply only as of the date of this Report and are expressly qualified in their entirety by the cautionary statements included in this Report. Except as may be required by law, we undertake no obligation to publicly update or revise any of the forward-looking statements, whether as a result of new information, future events, or otherwise.
When used in this Report, except as specifically noted otherwise, the term “Tempur Sealy International” refers to Tempur Sealy International, Inc. only, and the terms “Company,” “we,” “our,” “ours” and “us” refer to Tempur Sealy International, Inc. and its consolidated subsidiaries. When used in this Report, the term "Tempur" may refer to Tempur-branded products and the term “Sealy” may refer to Sealy-branded products or to Sealy Corporation and its historical subsidiaries, in all cases as the context requires. In addition, when used in this Report, “2016 Credit Agreement” refers to the Company’s senior credit facility entered into in 2016; “2012 Credit Agreement” refers to the Company’s prior senior credit facility entered into in 2012; “2023 Senior Notes” refers to the 5.625% senior notes due 2023 issued in 2015; “2026 Senior Notes” refers to the 5.50% senior notes due 2026 issued in 2016; "2020 Senior Notes" refers to the 6.875% senior notes due 2020 retired in 2016; and "8.0% Sealy Notes” refers to Sealy’s 8.0% Senior Secured Third Lien Convertible Notes retired in 2016.
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PART I
ITEM 1. BUSINESS
General
We develop, manufacture and market bedding products, which we sell globally. Our brand portfolio includes many highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy® featuring Posturepedic® Technology, and Stearns & Foster®. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.
We operate in two segments: North America and International. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries and licensees located in the U.S. and Canada. Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. We recently divested certain of our manufacturing and distribution subsidiaries in Latin America.
Our primary selling channels are Wholesale and Direct. These channels align to the margin characteristics of our business and our marketplace. Wholesale includes all third party retailers, including third party distribution, hospitality and healthcare. Direct includes company-owned stores, e-commerce, and call centers.
Our long-term strategy is to drive earnings growth. Our goal is to improve the sleep of more people, every night, all around the world. In order to achieve our long-term strategy while managing the current economic and competitive environments, we will focus on developing the most innovative bedding products in all the markets we serve, making significant investments in our global brands and optimizing our worldwide distribution through all channels. We also intend to generate earnings growth through ongoing investments in research and development and productivity initiatives, which will improve our profitability and create long-term stockholder value.
Our principal executive office is located at 1000 Tempur Way, Lexington, Kentucky 40511 and our telephone number is (800) 878-8889. Tempur Sealy International, Inc. was incorporated under the laws of the State of Delaware in September 2002. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports filed with or furnished to the Securities and Exchange Commission (“SEC”) pursuant to Sections 13(a) or 15(d) of the Exchange Act, are available free of charge on our website at www.tempursealy.com as soon as reasonably practicable after such reports are electronically filed with the SEC. Our website and its contents are not deemed incorporated by reference into this Report.
The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The website of the SEC is www.sec.gov.
Our Products and Brands
We have a comprehensive offering of products that appeal to a broad range of consumers, some of which are covered by one or more patents and/or patent applications. We also routinely introduce new mattress models, launch new products and update our existing mattress products in each of our segments.
In order to achieve our goal to improve the sleep of more people, every night, all around the world, one of our strategic initiatives is to leverage and strengthen our comprehensive portfolio of iconic brands and products. Our brand portfolio includes many highly recognized brands, including TEMPUR®, Tempur-Pedic®, Sealy® featuring Posturepedic® Technology and Stearns & Foster®, which are described below:
• | Tempur-Pedic® - Founded in 1991, the Tempur brand is our specialty innovation category leader designed to provide life changing sleep for our wellness-seeking consumers. Our proprietary Tempur material precisely adapts to the shape, weight and temperature of the consumer and creates fewer pressure points, reduces motion transfer and provides personalized comfort and support. |
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• | Stearns & Foster® - The Stearns & Foster brand offers our consumers high quality mattresses built by certified craftsmen who have been specially trained. Founded in 1846, the brand is designed and built with precise engineering and relentless attention to detail and fuses new innovative technologies with time-honored techniques, creating supremely comfortable beds. |
• | Sealy® featuring Posturepedic® Technology - The Sealy brand originated in 1881 in Sealy, Texas, and for over a century has focused on offering trusted comfort, durability and excellent value while maintaining contemporary styles and great support. The Sealy Posturepedic brand, introduced in 1950, was engineered to provide all-over support and body alignment to allow full relaxation and deliver a comfortable night's sleep. In 2017, Sealy Posturepedic no longer represented its own separate brand as we united all of our Sealy products under one masterbrand, which features the Posturepedic Technology™ in the Sealy Performance™ and Sealy Premium™ collections. |
• | Cocoon by SealyTM - The Cocoon by Sealy brand, introduced in 2016, is our offering in the below $1,000 e-commerce space, made with the high quality materials that consumers expect from Sealy, sold online at www.cocoonbysealy.com and delivered in a box directly to consumers' doorsteps. |
In 2018, we launched a new line of Tempur-Pedic products and a new Sealy Hybrid line in North America. The new Tempur-Pedic line includes the Tempur-Adapt®, Tempur-ProAdapt®, and Tempur LuxeAdaptTM series which are made from a unique combination of innovative materials that adapt and respond to the body’s needs. Our AdaptTM and ProAdaptTM series feature a new advanced pressure relief TEMPUR® material called TEMPUR-APR™, while our LuxeAdaptTM series features TEMPUR-APR+TM, providing better pressure relief and higher conforming features than ever before. We also launched a new line of Tempur-Adapt pillows and a new portfolio of adjustable bases. The new Sealy Hybrid line completes the relaunch of Sealy products under one masterbrand. The Sealy Hybrid line leverages the best technologies from the Sealy Response and Conform lines and features the DuoChill™ Cooling Sleep System which offers twice the cool-to-the-touch technology, nested coil technology with 20% more coils and Duraflex™ Coil Edge technology offering better edge support compared to our existing Sealy Hybrid.
In 2019, we are launching the all-new Tempur-Breeze® products as well as a new Stearns & Foster lineup in North America. The new Breeze line includes PRObreezeTM and LUXEbreezeTM models offering the most innovative cooling system in the market, re-designed to deliver all night cooling comfort. The new Breeze products complete the largest Tempur rollout in our history. The new Stearns & Foster design utilizes the finest materials and legendary craftsmanship, featuring a premium, timeless look. Our all new IntelliCoil® HD innerspring incorporates 20% more coils, allowing sleepers to find their perfect level of support. This lineup also features for the first time, the proprietary memory foam engineered exclusively for Stearns & Foster by Tempur-Pedic.
Our Channels
Wholesale
Our Wholesale channel includes all third party retailers, including third party distribution, hospitality and healthcare, and represented 90.7% of net sales in 2018. Our top five customers accounted for approximately 22.7% of our sales for 2018.
Direct
Our Direct channel includes company-owned stores, e-commerce and call centers and represented 9.3% of net sales in 2018.
Marketing
Our overall marketing strategy is to drive consumer demand through the use of effective marketing. We invest across multiple media platforms to build brand awareness and drive consumer interest in our products. Our strategy varies by segment; however, the majority of our advertising programs are created on a centralized basis through our in-house advertising organization. We plan to drive net sales through continued investments in new products, marketing and other initiatives.
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North America
Our North America segment sells primarily through the Wholesale channel, which contributed 93.1% of North America segment sales in 2018. In North America, we advertise nationally on television, digitally and through consumer and trade print. In addition, we participate in cooperative advertising on a shared basis with some of our retail customers. Throughout the year, we invested in a series of strategic marketing initiatives, which included new product introductions, advertising and in-store marketing investments.
International
Our International segment sells primarily through the Wholesale channel, which contributed 81.7% of International segment net sales in 2018. The advertising strategy in our International segment focuses on building brand awareness, which we believe is important to increasing our overall market share. We advertise on television, digitally and through consumer and trade print, as well as cooperative advertising on a shared basis with some of our retail customers. We expect continued growth in our International segment through expanding product lines within existing channels, increasing our market share in previously under-penetrated markets and, where appropriate, entering into new markets.
Seasonality
We believe that sales of products to furniture and bedding stores are typically subject to modest seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters. We did not experience our typical seasonality in 2018 as this was impacted by our phased rollout of new Tempur products, with new product shipping in the second and fourth quarter. Sales in a particular quarter can also be impacted by competitive industry dynamics. Additionally, the U.S. bedding industry generally experiences increases in sales around holidays and promotional periods.
Operations
Manufacturing and Distribution
Our products are currently manufactured and distributed through our global network of facilities. For a list of our principal manufacturing and distribution facilities, please refer to Item 2, "Properties".
Suppliers
We obtain the raw materials used to produce our pressure-relieving TEMPUR® material and components used in the manufacture of Tempur products from outside sources. We currently acquire chemicals and proprietary additives for Tempur products as well as other components such as textiles from a number of suppliers with manufacturing locations around the world. These supplier relationships may be modified in order to maintain quality, cost, and delivery expectations. We do not consider ourselves dependent upon any single outside vendor as a source of raw materials for Tempur products and believe that sufficient alternate sources of supply for the same or similar raw materials are available. Additionally, we source the manufacturing of our adjustable bed bases and foundations from third party manufacturers. We do not consider ourselves dependent upon any single outside manufacturer as a source of these products.
Sealy product raw materials consist of polyurethane foam, polyethylene foam, textiles, and steel innerspring components that we purchase from various suppliers. In the U.S. and Canada, we source the majority of our requirements for polyurethane foam components and spring components for our Sealy and Stearns & Foster mattress units and adjustable bed bases from a key supplier for each component. We also purchase a significant portion of our Sealy foundation parts from third party sources. All components are purchased under supply agreements. We do not consider ourselves to be dependent in the long term upon any single outside vendor as a source of supply to our bedding business, and we believe over time that sufficient alternate sources of supply for the same, similar or alternate components are available. However if a key supplier for an applicable component failed to supply components in the amount we require, this could significantly interrupt production of our products and increase our production costs in the near term.
Research and Development
We have four research and development centers, three in the U.S. and one in Denmark, that conduct technology and product development. Additionally, we have a product testing facility that conducts hundreds of consumer tests annually. We believe our consumer-research driven approach to innovation results in best-in-class products that benefit the consumer.
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Industry and Competition
We compete in the global bedding industry. The bedding industry is comprised of mattresses and foundations, pillows and accessories. The mattress market category is comprised of traditional innerspring mattresses and non-innerspring mattresses, which includes visco-elastic and foam mattresses, innerspring/foam hybrid mattresses, airbeds and latex mattresses. The foundation category is comprised of traditional foundations and adjustable foundations. Additionally, the pillow market is comprised of traditional foam and feather pillows, as well as pillows made of visco-elastic, latex, foam, sponge, rubber and down. The primary distribution channels for mattresses and foundations are retail furniture and bedding stores, department stores, wholesale clubs and the internet.
We encounter competition from a number of bedding manufacturers in both the highly concentrated domestic and highly fragmented international markets. Participants in each of these markets compete primarily on price, quality, brand name recognition, product availability and product performance. Mattress and pillow manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer, including the recent expansion in the number of U.S. and international companies pursuing online direct-to-consumer models for foam mattresses. In addition, retailers in both the U.S. and internationally are increasingly seeking to integrate vertically in the furniture and bedding industries, including by offering their own brands of mattresses and pillows.
The U.S. is the largest market in which we compete. Since 1997, U.S. wholesale bedding sales, which include mattresses and foundations, have grown at a compound annual growth rate, or "CAGR", of 5.6%, reaching $8.4 billion in 2017 according to the International Sleep Products Association (“ISPA”). According to ISPA, U.S. mattress producer shipments decreased 4.4% and the total dollar value of mattress shipments decreased 2.0% in 2017 as compared to 2016. Despite the decrease in shipments and total dollar value recognized by ISPA, average unit selling price (“AUSP”) for mattresses increased 3.3% in 2017 compared to 2016. The increases in AUSP are primarily due to consumer awareness of the ongoing new health benefits of better sleep discovered by the medical community, as well as increases in overall consumer brand awareness and consumer sentiment.
The recent trend change in industry shipments has largely been impacted by the increasing role played by imports. We believe imported units grew significantly during the period 2016 through 2018, and China accounted for the largest share of the imported units. Because of the influx of low-priced, imported mattresses, an anti-dumping duty petition was filed with the U.S. International Trade Commission and the U.S. Department of Commerce in September of 2018, by a number of domestic “Mattress Petitioners.” In November 2018, the U.S. International Trade Commission found a reasonable indication that unfairly traded imports of mattresses from China caused material injury to the U.S. mattress industry. The petition seeks the imposition of anti-dumping duties to offset the level of dumping. The U.S. Department of Commerce is currently investigating whether and to what extent mattresses imported from China and sold in the United States have been dumped. The U.S. Department of Commerce preliminary determination on this issue is expected in May 2019. If the U.S. Department of Commerce finds that dumping has occurred, anti-dumping duties on future imports of mattresses from China will be levied in an amount equal to the dumping margin.
The U.S. mattress market has experienced consolidation among manufacturers in recent years. We, together with Serta Simmons Bedding, LLC, which sells products under the Serta and Simmons brands, collectively accounted for a significant share of the wholesale bedding industry revenues in 2017 based on figures obtained from ISPA and Furniture Today industry publications. The balance of the mattress market in the U.S. is served by a large number of other manufacturers. In addition, there has been consolidation of mattress retailers in the U.S. over the last several years.
The international market is served by a large number of manufacturers, primarily operating on a regional and local basis. These manufacturers offer a broad range of mattress and pillow products.
The highly competitive nature of the mattress and pillow industries means we are continually subject to the risk of loss of market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.
Intellectual Property
Patents, Trademarks and Licensing
We hold U.S. and foreign patents and patent applications regarding certain elements of the design and function of many of our mattress and pillow products.
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As of December 31, 2018, we held trademark registrations worldwide, which we believe have significant value and are important to the marketing of our products to retailers. TEMPUR® and Tempur-Pedic® are trademarks registered with the U.S. Patent and Trademark Office. In addition, we have U.S. applications pending for additional trademarks. Several of our trademarks have been registered, or are the subject of pending applications, in various foreign countries. Each U.S. trademark registration is renewable indefinitely as long as the trademark remains in use. We also own numerous trademarks, trade names, service marks, logos and design marks, including Sealy®, Stearns & Foster® and Sealy Posturepedic®. In addition, we license the Bassett® trade name in various territories under a long-term agreement.
We derive income from royalties by licensing Sealy® brands, technology and trademarks to other manufacturers. Under the license arrangements, licensees have the right to use certain trademarks and current proprietary and/or patented technology that we utilize. We also provide our licensees with product specifications, research and development, statistical services and marketing programs. For the year ended December 31, 2018, our licensing activities as a whole generated unaffiliated net royalties of approximately $20.9 million.
Governmental Regulation
Our operations are subject to international, federal, state, and local consumer protection and other regulations, primarily relating to the mattress and pillow industry. These regulations vary among the states, countries, and localities in which we do business. The regulations generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling and sale and penalties for violations. The U.S. Consumer Product Safety Commission ("CPSC") has adopted rules relating to fire retardancy standards for the mattress industry. Many foreign jurisdictions also regulate fire retardancy standards. Future changes to these standards may require modifications to our products to comply with such changes. We are also subject to environmental and health and safety requirements with regard to the manufacture of our products and the conduct of our operations and facilities. We have made and will continue to make capital and other expenditures necessary to comply with these requirements. Currently these expenditures are immaterial to our financial results. For a discussion of the risks associated with our compliance programs in connection with these regulations, please refer to "Risk Factors" under Part I, Item 1A of this Report.
Our principal waste products are foam and fabric scraps, wood, cardboard and other non-hazardous materials derived from product component supplies and packaging. We also periodically dispose of small amounts of used machine lubricating oil and air compressor waste oil, primarily by recycling. In the U.S., we are subject to federal, state and local laws and regulations relating to environmental health and safety, including the Federal Water Pollution Control Act and the Comprehensive Environmental Response, Compensation and Liability Act. We believe that we are in compliance with all applicable international, federal, state and local environmental statutes and regulations. We do not expect that compliance with international, federal, state or local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have a material effect upon our capital expenditures, earnings or competitive position. We are not aware of any pending federal environmental legislation that would have a material impact on our operations, and have not been required to make, and do not expect to make, any material capital expenditures for environmental control facilities in the foreseeable future.
In connection with sales of our products, we often collect and process personal data from our customers. As such, we are subject to certain regulations relating to information technology security and personal data protection and privacy. For example, the European Union recently adopted the General Data Protection Regulation (“GDPR”), which took effect in May 2018. GDPR imposes a new and expanded set of ongoing compliance requirements on companies, including us, that process personal data from citizens living in the European Union. In addition, there are country-specific data privacy laws forthcoming which may or may not follow the principles laid out in GDPR. We have implemented a compliance system and have put reasonable measures in place to facilitate adherence to the continuing compliance requirements of GDPR.
Employees
As of December 31, 2018, we had approximately 6,200 Tempur Sealy employees, approximately 4,300 of which are located in North America and 1,900 in the rest of the world. Approximately 29.4% of our employees are represented by various labor unions with separate collective bargaining agreements. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We consider our overall relations with our workforce to be satisfactory. Our current collective bargaining agreements, which are typically one to three years in length, expire at various times beginning in 2019 through 2021. As of December 31, 2018, our North America segment employed approximately 500 individuals covered under collective bargaining agreements expiring in 2019 and our International segment employed approximately 400 individuals covered under collective bargaining agreements expiring in 2019.
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ITEM 1A. RISK FACTORS
The following risk factors and other information included in this Report should be carefully considered. Please also see “Special Note Regarding Forward-Looking Statements” on page 3.
Set forth below are descriptions of certain risks relating to our business.
Unfavorable economic and market conditions could reduce our sales and profitability and as a result, our operating results may be adversely affected.
Our business is affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The global economy has stabilized somewhat since the financial crisis, but we expect economic conditions specific to our markets to remain challenging. Further, economic and market conditions are inherently complex and subject to change, and any deterioration in those conditions may give households less confidence to make discretionary purchases.
There could be a number of other effects from these economic developments on our business, some of which we have already experienced, including reduced consumer demand for products; liquidity problems among our customers and related market participants; insolvency of and bankruptcy filings by our customers and related market participants resulting in increased provisions for credit losses and/or write downs of existing assets; liquidity problems and/or insolvency of our key suppliers resulting in product delays; inability of retailers and consumers to obtain credit to finance purchases of our products; decreased consumer confidence; decreased retail demand, including order delays or cancellations; counterparty failures negatively impacting our treasury operations; inability for us, our customers and our suppliers to accurately forecast future product demand trends; and adverse movements in foreign currency exchange rates. If such conditions are experienced in future periods, our industry, business and results of operations may be severely impacted.
Our sales growth is dependent upon our ability to implement strategic initiatives and actions taken to increase sales growth may not be effective.
Our ability to generate sales growth is dependent upon a number of factors, including the following:
• | our ability to continuously improve our products to offer new and enhanced consumer benefits and better quality; |
• | the ability of our current and future product launches to increase net sales; |
• | the effectiveness of our advertising campaigns and other marketing programs to build product and brand awareness, driving traffic to our distribution channels and increasing sales; |
• | our ability to continue to expand into new distribution channels and optimize our existing channels; |
• | our ability to continue to successfully execute our strategic initiatives; |
• | the level of consumer acceptance of our products at optimal price points; |
• | our ability to successfully mitigate the impact of headwinds facing our business, including increased commodity prices and the influx of low-end, imported beds that compete with certain of our products; and |
• | general economic factors that impact consumer confidence, disposable income or the availability of consumer financing. |
Our new product launches may not be successful due to development delays, failure of new products to achieve anticipated levels of market acceptance and significant costs associated with failed product introductions, which could adversely affect our revenues and profitability.
Each year we invest significant time and resources in research and development to improve our product offerings and launch new products. We began a major product launch for our Tempur products in the U.S. in 2018 that is ongoing. The launch was challenged in the short-term by certain discrete factors, including incremental product launch costs, cannibalization of higher-priced Tempur products and a temporary delay in the launch to ensure product quality. Our financial performance for 2018 was impacted by these factors and positive performance during 2019 will be substantially dependent on the tapering of those short-term factors and continued overall success of the launch. There are a number of risks that continue to be inherent in our new product line introductions, including that the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Further, introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, each of which could impact profitability.
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We operate in the highly competitive mattress and pillow industries, and if we are unable to compete successfully, we may lose customers and our sales may decline.
Participants in the mattress and pillow industries compete primarily on price, quality, brand name recognition, product availability and product performance across a range of distribution channels.
A number of our significant competitors offer mattress and pillow products that compete directly with our products. The effectiveness of our competition relative to our performance, including by established manufacturers or new entrants into the market, could have a material adverse effect on our business, financial condition and/or operating results. For example, market participants continue to improve their channels of distribution to optimize their reach to the consumer, including by pursuing online direct-to-consumer models for foam mattresses and offering their own lines of mattresses. In addition, retailers in the U.S. and internationally have integrated vertically in the furniture and bedding industries, and it is possible that such vertical integration may provide conditions that would negatively impact our net sales and results of operations. The pillow industry in particular is characterized by a large number of competitors, none of which is dominant. As such, conditions that substantially increase a single participant's market share would likely be detrimental to our financial performance. The highly competitive nature of the mattress and pillow industries means we are continually subject to the risk of loss of market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.
Because we depend on certain significant customers, a decrease or interruption in their business with us would reduce our sales and results of operations.
No customer represented 10.0% or more of our net sales for 2018. Our top five customers accounted for approximately 22.7% of our sales for 2018.
The credit environment in which our customers operate has been relatively stable over the past few years. However, there have been signs of deterioration in the U.S. retail sector. Recently, a national department store retail customer and a regional retail customer in the U.S. each filed for bankruptcy protection and the resolution of each matter is still pending. We expect that some additional retailers that carry our products may consolidate, undergo restructurings or reorganizations, experience financial difficulty, or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration in the retail industry. An increase in the concentration of our sales to large customers may negatively affect our profitability due to the impact of volume and other incentive programs related to these customers. Furthermore, if sales to our large customers grow, our credit exposure to these customers may also increase. Some of these retailers may decide to carry only a limited number of brands of mattress products, which could affect our ability to sell products to them on favorable terms, if at all. A substantial decrease or interruption in business from these significant customers could result in the loss of future business and could reduce revenue, liquidity and profitability. In addition, the timing of large purchases by these customers could have an increasingly significant impact on our quarterly net sales and earnings.
We rely significantly on information technology and any failure, inadequacy, interruption or security lapse of that technology, including cyber-based attacks, could harm our ability to effectively operate our business.
Consistent with other manufacturing and retail operations, we are increasingly dependent on information technology, including the Internet, for the storage, processing, and transmission of our electronic, business-related information assets. We leverage our internal information technology, infrastructures, and those of our service providers, to enable, sustain and support our global business interests. As such, our ability to effectively manage our business depends significantly on our information systems. The failure of our current systems, or future upgrades, to operate effectively or to integrate with other systems, or a breach in security of these systems could cause reduced efficiency of our operations, and remediation of any such failure, problem or breach could reduce our liquidity and profitability. Any disruptions caused by the failure of these systems could adversely impact our day-to-day business and decision making and could have a material adverse effect on our performance.
We are subject to laws and regulations relating to information technology security and personal data protection and privacy. For example, GDPR, which took effect in May 2018, has imposed a new and expanded set of ongoing compliance requirements on companies, including us, that process personal data from citizens living in the European Union. In addition, there are country-specific data privacy laws forthcoming which may or may not follow the principles laid out in GDPR. We are actively working to ensure ongoing compliance with GDPR, which involves substantial costs. Despite our ongoing efforts to bring our practices into compliance with GDPR, however, we may not be successful due to various factors within or outside of our control. Failure to comply with GDPR or the upcoming country-specific laws could result in costly investigations and litigation, expose us to potentially significant penalties, and result in negative publicity that could damage our reputation and credibility.
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Historically, we have successfully implemented a new enterprise resource planning, or “ERP,” system across several of our global subsidiaries. We are currently planning the ERP implementation for certain significant U.S. subsidiaries, which is expected to occur no earlier than 2020. This new system replaces a substantial portion of our legacy systems that have supported our operations in the past. If we are unable to successfully continue the implementation of the replacement system, it could lead to a disruption in our business and unanticipated additional use of capital and other resources, which may adversely impact our results of operations. In addition, if the cost of implementing this ERP system increases above our estimates, this could have a significant adverse effect on our profitability.
We rely on third party technology service providers in the ordinary course of our Direct to Consumer business. The services provided include website infrastructure and hosting services, digital advertising platforms, private label credit card financing program and credit card payment authorization and capture services in support of our business, all of which are customarily provided by third party technology service providers for similarly-situated retail business operations. Like others in the industry, we experience cyber-based attacks and incidents from time to time. In the event that we or our service providers are unable to prevent or detect and remediate cyber-based attacks or other security incidents in a timely manner, our operations could be disrupted or we may incur financial or reputational losses arising from the theft, misuse, unauthorized disclosure or destruction of our information assets.
We are subject to a pending tax proceeding in Denmark, and an adverse decision or a negotiated settlement could adversely impact our results of operations and cash flows.
During the third quarter of 2018, we reached agreements with both the Danish Tax Authority ("SKAT") and the U.S. Internal Revenue Service ("IRS") to settle the previously-disclosed Danish Tax Matter relating to the appropriate royalty rate to be paid to the Company’s Danish subsidiary for the right to utilize certain intangible assets owned by such subsidiary for the disputed tax years 2001 to 2011. As we have previously disclosed, we received significant income tax assessments from SKAT for prior tax years, which we disputed. We resolved this matter in a way that did not have a material impact on our financial position or liquidity as we maintain funds equal to the estimated Danish tax liability on deposit with SKAT. We have entered into an advanced pricing agreement program for the tax years 2012 through 2022 in which the IRS, on our behalf, will negotiate directly with SKAT the royalty to be paid by the U.S. subsidiary to the Danish subsidiary to reach a mutual agreement for such years. We have accrued Danish tax and interest for this matter as an uncertain income tax position in an amount that we think is appropriate. However, if this matter is not resolved successfully or there is a change in facts or circumstances, we may be required to further increase our uncertain income tax provision or to decrease our deferred tax asset related to this matter, which could have a material impact on the Company’s reported earnings. For a description of these matters and additional information please refer to Note 14, "Income Taxes," to the accompanying Consolidated Financial Statements.
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Changes in tax laws and regulations or other factors could cause our income tax rate to increase, potentially reducing net income and adversely affecting cash flows, and fluctuations in our tax obligations and effective tax rate may result in volatility of our financial results and stock price.
We are subject to taxation in various jurisdictions around the world and at any one time multiple tax years are subject to audit by various taxing jurisdictions. In preparing financial statements, we calculate our annual effective income tax rate based on current tax laws and regulations and the estimated taxable income within each of these jurisdictions. Our effective income tax rate, however, may be higher due to numerous factors, including, but not limited to, changes in accounting methods or policies, tax laws or regulations, the tax litigation environment in each such jurisdiction, and the outcome of pending or future audits, whether the result of litigation or negotiations with taxing authorities. Each such item may result in a tax liability that differs from our original estimate. An effective income tax rate that is significantly higher than currently anticipated could have an adverse effect on our net income and cash flows. In addition, there could be ongoing variability in our quarterly tax rates as events occur and exposures are evaluated, which could adversely affect our quarterly results of operations and stock price.
Additionally, the global tax environment is becoming more complex, with government tax authorities becoming increasingly more aggressive in asserting claims for taxes. Any resulting changes in tax laws or regulations could increase our effective income tax rate or impose new restrictions, costs or prohibitions on our current practices and reduce our net income and adversely affect our cash flows.
In addition to the increased activity of taxing authorities with respect to income tax, taxing authorities are also becoming more aggressive in asserting claims for indirect taxes such as import duties and value added tax. These types of claims present risks and uncertainties similar to those discussed above. We believe we are in compliance with all tax laws and regulations that govern such indirect taxes in each of the jurisdictions in which we do business. However, because the claims taxing authorities assert often involve the question of internal product pricing, which is inherently subjective in nature, any such claim may require us to litigate the matter to defend our position or to negotiate a settlement on the matter with the taxing authorities that differs from the amount of potential exposure recorded in the financial statements.
Our leverage may limit our flexibility and increase our risk of default.
We operate in the ordinary course of our business with a certain amount of leverage. Our degree of leverage could have important consequences to our investors, such as:
• | increasing our vulnerability to adverse economic, industry or competitive developments; |
• | requiring a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and other business opportunities; |
• | making it more difficult for us to satisfy the obligations related to our indebtedness; |
• | restricting us from making strategic acquisitions or investments or causing us to make non-strategic divestitures; |
• | limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes; |
• | limiting our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate, placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who, therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting; |
• | exposing us to variability in interest rates, as a substantial portion of our indebtedness is and will be at variable rates; and |
• | limiting our ability to return capital to our stockholders, including through share repurchases. |
In addition, the instruments governing our debt contain customary financial and other restrictive covenants, which limit our operating flexibility and could prevent us from taking advantage of business opportunities and reduce our flexibility to respond to changing business and economic conditions. These covenants could put us at a competitive disadvantage. Failure to comply with our debt covenants may result in a default or event of default under the related credit document. If such default or event of default is not cured or waived, as applicable. We may suffer adverse effects on our operations, business or financial condition, including acceleration of the maturity date of all amounts outstanding under our debt facilities. For further discussion regarding our debt covenants and compliance, refer to “Management’s Discussion and Analysis” included in Part II, ITEM 7 of this Report and Note 8, “Debt,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
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We may be unable to sustain our profitability, which could impair our ability to service our indebtedness and make investments in our business and could adversely affect the market price for our stock and increase our leverage.
Our ability to service our indebtedness depends on our ability to maintain our profitability. We may not be able to maintain our profitability on a quarterly or annual basis in future periods. Further, our profitability will depend upon a number of factors, including without limitation:
• | general economic conditions in the markets in which we sell our products and the related impacts on consumers and retailers; |
• | the level of competition in the mattress and pillow industry; |
• | our ability to successfully identify and respond to emerging trends in the mattress and pillow industry; |
• | our ability to successfully launch new products; |
• | our ability to effectively sell our products through our distribution channels, including our new distribution channels, in volumes sufficient to drive growth and leverage our cost structure and advertising spending; |
• | our ability to reduce costs, including our ability to align our cost structure with sales in the existing economic environment; |
• | our ability to successfully manage our relationships with our major customers and navigate any financial difficulties those customers may experience from time to time; |
• | our ability to absorb fluctuations in commodity costs; |
• | our ability to maintain efficient, timely and cost-effective production and utilization of our manufacturing capacity; |
• | our ability to maintain efficient, timely and cost-effective delivery of our products; and |
• | our ability to maintain public recognition of our brands. |
We are vulnerable to interest rate risk with respect to our debt, which could lead to an increase in interest expense.
We are subject to interest rate risk in connection with the variable rate debt under our debt agreements. Interest rate changes could increase the amount of our interest payments and thus, negatively impact our future earnings and cash flows. Although we refinanced a significant portion of our variable rate debt with fixed rate debt in 2016 and 2015, we still have a significant amount of variable rate debt outstanding. For information regarding our sensitivity to changes in interest rates, refer to “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report.
We may be adversely affected by fluctuations in exchange rates, which could affect our results of operations, the costs of our products and our ability to sell our products in foreign markets.
Approximately 29% of our net sales were generated outside of the U.S. in 2018. As a multi-national company, we conduct our business in a wide variety of currencies and are therefore subject to market risk relating to changes in foreign exchange rates. If the U.S. dollar strengthens relative to the Euro or other foreign currencies where we have operations, for example, there will be a negative impact on our operating results upon translation of those foreign operating results into the U.S. dollar. In 2018, foreign currency exchange rate changes positively impacted our net income by approximately 1.4% and negatively impacted adjusted EBITDA, which is a non-U.S. GAAP financial measure, by approximately 0.4%. In 2019, we expect that foreign exchange translation may negatively impact our results of operations. Changes in foreign currency exchange rates could have an adverse impact on our financial condition, results of operations and cash flows. Except for the use of foreign exchange forwards contracts described immediately below, we do not hedge the translation of foreign currency operating results into the U.S. dollar.
We use foreign exchange forward contracts to manage a portion of the exposure to the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions among certain subsidiaries. These hedging transactions may not succeed or may be only partially successful in managing our foreign currency exchange rate risk.
Refer to “Management's Discussion and Analysis” included in Part II, ITEM 7 of this Report and “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report for further discussion on the impact of foreign exchange rates on our operations.
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We are subject to fluctuations in the cost of raw materials, and increases in these costs would reduce our liquidity and profitability.
The bedding industry has been challenged by volatility in the price of petroleum-based and steel products, which affects the cost of polyurethane foam, polyester, polyethylene foam and steel innerspring component parts. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Given the significance of the cost of these materials to our products, volatility in the prices of the underlying commodities can significantly affect profitability. While we currently expect the negative impact on profitability associated with commodities costs to abate somewhat in 2019 compared to prior years, the markets for these materials are fluid and always subject to change. To the extent we are unable to absorb higher costs, or pass any such higher costs to our customers, our gross margin could be negatively affected, which could result in a decrease in our liquidity and profitability.
Loss of suppliers and disruptions in the supply of our raw materials could increase our costs of sales and reduce our ability to compete effectively.
We acquire raw materials and certain components from a number of suppliers with manufacturing locations around the world. If we were unable to obtain raw materials and certain components from these suppliers for any reason, we would have to find replacement suppliers. Any substitute arrangements for raw materials and certain components might not be on terms as favorable to us. In addition, we outsource the procurement of certain goods and services from suppliers in foreign countries. If we were no longer able to outsource through these suppliers, we could source them elsewhere, which may be at a higher cost. We maintain relatively small supplies of our raw materials and outsourced goods at our manufacturing facilities, and any disruption in the on-going shipment of supplies to us could interrupt production of our products, which could result in a decrease of our sales or could cause an increase in our cost of sales, either of which could decrease our liquidity and profitability.
Sealy product raw materials consist of polyurethane foam, polyester, polyethylene foam and steel innerspring components that we purchase from various suppliers. In the U.S. and Canada, we source the majority of our requirements for polyurethane foam components and spring components for our Sealy and Stearns & Foster mattress units from a key supplier for each component. These components are purchased under supply agreements. We also purchase a significant portion of our Sealy foundation parts from third party sources under supply agreements. We do not consider ourselves to be dependent in the long term upon any single outside vendor as a source of supply to our bedding business, and we believe over time that sufficient alternative sources of supply for the same, similar or alternative components are available. However, if a key supplier for an applicable component failed to supply components in the amount we require this could significantly interrupt production of our products and increase our production costs in the near term. Such a disruption could occur for a variety of reasons, including changes in international trade duties and other aspects of international trade policy, both in the U.S. and abroad. For further information relating to this risk in particular, please refer to the discussion under the heading “We are subject to risks from our international operations, such as complying with U.S. and foreign laws, foreign exchange exposure, tariffs, increased costs, political risks and our ability to expand in certain international markets, which could impair our ability to compete and our profitability.”
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We cannot guarantee that we will repurchase our common stock pursuant to our share repurchase program or that our share repurchase program will enhance long-term stockholder value. Share repurchases could also increase the volatility of the price of our common stock and could diminish our cash reserves.
On February 1, 2016, our Board of Directors authorized a share repurchase program pursuant to which the Company was authorized to repurchase shares of our common stock. During 2016 and 2017, our Board of Directors increased the total authorization to $800.0 million. We made no share repurchases during the year ended December 31, 2018. As of December 31, 2018, the Company had repurchased an aggregate of 9.3 million shares for approximately $573.1 million under the share repurchase program and had approximately $226.9 million remaining under the existing share repurchase program. Although our Board of Directors has authorized the share repurchase program, the share repurchase program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares and may be suspended or terminated at any time. Shares may be repurchased from time to time, in the open market or through private transactions, subject to market conditions, in compliance with applicable state and federal securities laws. The timing and amount of repurchases, if any, will depend upon several factors, including market and business conditions, restrictions in our debt agreements, the trading price of our common stock and the nature of other investment opportunities. In addition, repurchases of our common stock pursuant to our share repurchase program could affect the market price of our common stock or increase its volatility. For example, the existence of a share repurchase program could cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. Additionally, our share repurchase program could diminish our cash reserves, which may impact our ability to finance future growth and to pursue possible future strategic opportunities and acquisitions. There can be no assurance that any share repurchases will enhance stockholder value because the market price of our common stock may decline below the levels at which we determine to repurchase our stock. Although our share repurchase program is intended to enhance long-term stockholder value, there is no assurance that it will do so and short-term stock price fluctuations could reduce the program’s effectiveness.
Our operating results are subject to fluctuations, including as a result of seasonality, which could make sequential quarter-to-quarter comparisons an unreliable indication of our performance and adversely affect the market price of our common stock.
A significant portion of our net sales are attributable to our Wholesale channel, particularly net sales to furniture and bedding stores. We believe that our sales of products to furniture and bedding stores are typically subject to modest seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters. Our sales in a particular quarter can be impacted by new product launches. Additionally, the U.S. bedding industry generally experiences increases in sales around holidays and promotional periods. This seasonality means that a sequential quarter-to-quarter comparison may not be a good indication of our performance or of how we will perform in the future.
We are subject to risks from our international operations, such as complying with U.S. and foreign laws, foreign exchange exposure, tariffs, increased costs, political risks and our ability to expand in certain international markets, which could impair our ability to compete and our profitability.
We are a global company, selling our products in approximately 100 countries worldwide. We generated approximately 29% of our net sales outside of the U.S. in the year ended December 31, 2018, including in geographic areas where corruption has historically been a problem, and we continue to pursue additional international opportunities. In connection with these activities, we completed an evaluation of our International operations and identified certain Latin American subsidiaries with higher operational risk and volatility. As a result, we decided to divest of the net assets of certain of these subsidiaries in the Latin American region and enter into licensee relationships in these markets. Please refer to "Factors That Could Impact Results of Operations" under "Management’s Discussion and Analysis of Financial Condition and Results of Operations" in Item 7, Part II of this Report for further discussion of this matter. We also participate in international license and joint venture arrangements with independent third parties. Our international operations are subject to the customary risks of operating in an international environment, including complying with U.S. laws affecting operations outside of the U.S. such as the Foreign Corrupt Practices Act; complying with foreign laws and regulations, including disparate anti-corruption laws and regulations; risks associated with varying local business customs; and the potential imposition of trade or foreign exchange restrictions, tariffs and other tax increases, fluctuations in exchange rates, inflation and unstable political situations and labor issues. We are also limited in our ability to independently expand in certain international markets where we have granted licenses to manufacture and sell Sealy® bedding products. Fluctuations in the rate of exchange between currencies in which we do business may affect our financial condition or results of operations. Additionally, changes in international trade duties and other aspects of international trade policy, both in the U.S. and abroad, could materially impact our business. For example, in 2018, the U.S. implemented tariffs on thousands of categories of goods. These tariffs caused us to alter our behavior, which included raising prices and purchasing products in amounts and at times that we otherwise may not have. These behaviors likely negatively impacted our operating results and could lead to the loss of customers. Given the uncertainty regarding the scope and duration of these trade actions, the continuing impact on our operations and/or results is difficult to predict.
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Our business operations and financial results may be impacted by the United Kingdom’s (“UK”) planned departure from the European Union (“EU”), commonly referred to as Brexit. The UK’s deadline to reach an agreement with the EU is March 29, 2019 and it is unclear whether the parties will agree to terms before then. As such, and even if a deal is reached, Brexit may, among other things, result in adverse tax consequences for us relating to the movement of products and related matters between the UK and EU.
If we are not able to protect our trade secrets or maintain our trademarks, patents and other intellectual property, we may not be able to prevent competitors from developing similar products or from marketing in a manner that capitalizes on our trademarks, and this loss of a competitive advantage could decrease our profitability and liquidity.
We rely on patents and trade secrets to protect the design, technology and function of our products. To date, we have not sought U.S. or international patent protection for our principal product formula for TEMPUR® material and certain of our manufacturing processes. Accordingly, we may not be able to prevent others from developing certain visco-elastic material and products that are similar to or competitive with our products. Our ability to compete effectively with other companies also depends, to a significant extent, on our ability to maintain the proprietary nature of our owned and licensed intellectual property. We own a significant number of patents or have patent applications pending on some aspects of our products and certain manufacturing processes. However, the principal product formula and manufacturing processes for our TEMPUR® material are not patented and we must maintain these as trade secrets in order to protect this intellectual property. We own U.S. and foreign registered trademarks and service marks and have applications for the registration of trademarks and service marks pending domestically and abroad. We also license certain intellectual property rights from third parties.
Certain of our trademarks are currently registered in the U.S. and are registered or pending in foreign jurisdictions. Certain other trademarks are the subject of protection under common law. However, those rights could be circumvented, or violate the proprietary rights of others, or we could be prevented from using them if challenged. A challenge to our use of our trademarks could result in a negative ruling regarding our use of our trademarks, their validity or their enforceability, or could prove expensive and time consuming in terms of legal costs and time spent defending against such a challenge. Any loss of trademark protection could result in a decrease in sales or cause us to spend additional amounts on marketing, either of which could decrease our liquidity and profitability. In addition, if we incur significant costs defending our trademarks, that could also decrease our liquidity and profitability. In addition, we may not have the financial resources necessary to enforce or defend our trademarks. Furthermore, our patents may not provide meaningful protection and patents may never issue from pending applications. It is also possible that others could bring claims of infringement against us, as our principal product formula and manufacturing processes are not patented, and that any licenses protecting our intellectual property could be terminated. If we were unable to maintain the proprietary nature of our intellectual property and our significant current or proposed products, this loss of a competitive advantage could result in decreased sales or increased operating costs, either of which would decrease our liquidity and profitability.
In addition, the laws of certain foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the U.S. or the European Union. Third parties, including competitors, may assert intellectual property infringement or invalidity claims against us that could be upheld. Intellectual property litigation, which could result in substantial cost to and diversion of effort by us, may be necessary to protect our trade secrets or proprietary technology, or for us to defend against claimed infringement of the rights of others and to determine the scope and validity of others’ proprietary rights. We may not prevail in any such litigation, and if we are unsuccessful, we may not be able to obtain any necessary licenses on reasonable terms or at all.
The loss of the services of any members of our executive management team could impair our ability to execute our business strategy and as a result, reduce our sales and profitability.
We depend on the continued services of our executive management team. The loss of key personnel could have a material adverse effect on our ability to execute our business strategy and on our financial condition and results of operations. We do not maintain key-person insurance for members of our executive management team.
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Deterioration in labor relations could disrupt our business operations and increase our costs, which could decrease our liquidity and profitability.
As of December 31, 2018, we had approximately 6,200 full-time employees. Approximately 29.4% of our employees are represented by various labor unions with separate collective bargaining agreements or government labor union contracts for certain international locations. Our North American collective bargaining agreements, which are typically three years in length, expire at various times during any given three year period. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We may at some point be subject to work stoppages by some of our employees and, if such events were to occur, there may be a material adverse effect on our operations and profitability. Further, we may not be able to renew our various collective bargaining agreements on a timely basis or on favorable terms, or at all. Any significant increase in our labor costs could decrease our liquidity and profitability and any deterioration of employee relations, slowdowns or work stoppages at any of our locations, whether due to union activities, employee turnover or otherwise, could result in a decrease in our net sales or an increase in our costs, either of which could decrease our liquidity and profitability.
We may face exposure to product liability claims, which could reduce our liquidity and profitability and reduce consumer confidence in our products.
We face an inherent business risk of exposure to product liability claims if the use of any of our products results in personal injury or property damage. In the event that any of our products prove to be defective, we may be required to recall, redesign or even discontinue those products. We maintain insurance against product liability claims, but such coverage may not continue to be available on terms acceptable to us or be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage could impair our liquidity and profitability, and any claim or product recall that results in significant adverse publicity against us could result in consumers purchasing fewer of our products, which would also impair our liquidity and profitability.
Regulatory requirements, including, but not limited to, trade, environmental, health and safety requirements, may require costly expenditures and expose us to liability.
Our products and our marketing and advertising programs are subject to regulation in the U.S. by various federal, state and local regulatory authorities, including the Federal Trade Commission and the U.S. Food and Drug Administration. In addition, other governments and agencies in other jurisdictions regulate the sale and distribution of our products. These rules and regulations may change from time to time, or may conflict. There may be continuing costs of regulatory compliance including continuous testing, additional quality control processes and appropriate auditing of design and process compliance. For example, the CPSC and many foreign jurisdictions have adopted rules relating to fire retardancy standards for the mattress industry. Further, some states and the U.S. Congress continue to consider fire retardancy regulations that may be different or more stringent than the CPSC standard. Adoption of multi-layered regulatory regimes, particularly if they conflict with each other, could increase our costs, alter our manufacturing processes and impair the performance of our products which may have an adverse effect on our business. We are also subject to various health and environmental provisions, such as California Proposition 65 (the Safe Drinking Water and Toxic Enforcement Act of 1986) and 16 CFR Part 1633 (Standard for the Flammability (Open Flame) of Mattress Sets).
Our marketing and advertising practices could also become the subject of proceedings before regulatory authorities or the subject of claims by other parties and could require us to alter or end these practices or adopt new practices that are not as effective or are more expensive.
In addition, we are subject to federal, state and local laws and regulations relating to pollution, environmental protection and occupational health and safety. We may not be in complete compliance with all such requirements at all times. We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. If a release of hazardous substances occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of our properties, we may be held liable and the amount of such liability could be material. As a manufacturer of bedding and related products, we use and dispose of a number of substances, such as glue, lubricating oil, solvents and other petroleum products, as well as certain foam ingredients, that may subject us to regulation under numerous foreign, federal and state laws and regulations governing the environment. Among other laws and regulations, we are subject in the U.S. to the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act, the Clean Air Act and related state and local statutes and regulations.
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Our operations could also be impacted by a number of pending legislative and regulatory proposals to address greenhouse gas emissions in the U.S. and other countries. Certain countries have adopted the Kyoto Protocol. New greenhouse gas reduction targets have been established under the Kyoto Protocol, as amended, and certain countries, including Denmark, have adopted the new reduction targets. This and other international initiatives under consideration could affect our International operations. These actions could increase costs associated with our operations, including costs for raw materials, pollution control equipment and transportation. Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future consolidated financial condition, results of operations, or cash flows.
We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. In the event contamination is discovered with respect to one or more of our current or former properties, government authorities or third parties may bring claims related to these properties, which could have a material effect on our profitability.
Our pension plans are currently underfunded and we may be required to make cash payments to the plans, reducing our available cash.
We maintain certain defined benefit pension plans. In addition, hourly employees working at certain of Sealy’s domestic manufacturing facilities are covered by union sponsored retirement and health and welfare plans. These plans cover both active employees and retirees. The plans are currently underfunded, and under certain circumstances, including the decision to close or sell a facility, we could be required to pay amounts with respect to this underfunding. Such events may significantly impair our profitability and liquidity and the possibility of having to make these payments could affect our decision on whether to close or sell a particular facility. For more information, refer to Note 9, “Retirement Plans,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
Challenges to our pricing or promotional allowance policies or practices could adversely affect our operations.
Certain of our retail pricing and promotional allowance policies or practices are subject to antitrust regulations in the U.S. and abroad. If antitrust regulators or private parties in any jurisdiction in which we do business initiate investigations or claims that challenge our pricing or promotional allowance policies or practices, our efforts to respond could force us to divert management resources and we could incur significant unanticipated costs. If such an investigation or claim were to result in a charge that our practices or policies were in violation of applicable antitrust or other laws or regulations, we could be subject to significant additional costs of defending such charges in a variety of venues and, ultimately, if there were a finding that we were in violation of antitrust or other laws or regulations, there could be an imposition of fines, and damages for persons injured, as well as injunctive or other relief. Any requirement that we pay fines or damages (which, under the laws of certain jurisdictions, may be trebled) could decrease our liquidity and profitability, and any investigation or claim that requires significant management attention or causes us to change our business practices could disrupt our operations or increase our costs, also resulting in a decrease in our liquidity and profitability. An antitrust class action or individual suit against us could result in potential liabilities, substantial costs, treble damages, and the diversion of our management’s attention and resources, regardless of the outcome.
Our stock price is likely to continue to be volatile, your investment could decline in value, and we may incur significant costs from class action litigation.
The trading price of our common stock is likely to continue to be volatile and subject to wide price fluctuations. The trading price of our common stock may fluctuate significantly in response to various factors, including but not limited to:
• | actual or anticipated variations in our quarterly and annual operating results, including those resulting from seasonal variations in our business; |
• | general economic conditions, such as unemployment, changes in short-term and long-term interest rates and fluctuations in both debt and equity capital markets; |
• | introductions or announcements of technological innovations or new products by us or our competitors; |
• | disputes or other developments relating to proprietary rights, including patents, litigation matters, and our ability to patent, or otherwise protect, our products and technologies; |
• | changes in estimates by securities analysts of our financial performance or the financial performance of our competitors or major customers or statements by others in the investment community relating to such performance; |
• | the use or non-use of our share repurchase program; |
• | bankruptcies of any of our nationally or regionally-significant customers; |
• | loss of any of our major customers; |
• | conditions or trends in the mattress industry generally; |
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• | additions or departures of key personnel; |
• | announcements by us or our competitors or significant retailer customers of significant acquisitions, strategic partnerships, joint ventures or capital commitments; |
• | announcements by our competitors or our major customers of their quarterly operating results or announcements by our competitors or our major customers of their views on trends in the bedding industry; |
• | regulatory developments in the U.S. and abroad; |
• | economic and political factors; |
• | public announcements or filings with the SEC indicating that significant stockholders, directors or officers are buying or selling shares of our common stock; and |
• | the declaration or suspension of a cash dividend. |
In addition, the stock market in general has experienced significant price and volume fluctuations that have often been unrelated or disproportionate to operating performance. These broad market factors may seriously harm the market price of our common stock, regardless of our operating performance.
In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in potential liabilities, substantial costs, and the diversion of our management’s attention and resources, regardless of the outcome. See “Legal Proceedings” included in Part I, ITEM 3 of this Report.
Future sales of our common stock may depress our stock price.
The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. All shares of our common stock are freely transferable without restriction or further registration under the Securities Act, except for certain shares of our common stock which were purchased by our executive officers, directors, principal stockholders, and some related parties.
We have stockholders who presently beneficially own more than 5.0% of our outstanding capital stock. Sales or other dispositions of our shares by these major stockholders may depress our stock price.
Delaware law and our certificate of incorporation and bylaws contain anti-takeover provisions, any of which could delay or discourage a merger, tender offer, or assumption of control of the Company not approved by our Board of Directors that some stockholders may consider favorable.
Provisions of Delaware law and our certificate of incorporation and by-laws could hamper a third party’s acquisition of us, or discourage a third party from attempting to acquire control of us. You may not have the opportunity to participate in these transactions. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions include:
• | our ability to issue preferred stock with rights senior to those of the common stock without any further vote or action by the holders of our common stock; |
• | the requirements that our stockholders provide advance notice and certain disclosures when nominating our directors; and |
• | the inability of our stockholders to convene a stockholders’ meeting without the chairperson of the Board of Directors, the president, or a majority of the Board of Directors first calling the meeting. |
In addition, our Board of Directors adopted a short-term stockholder rights agreement in February 2017 with an expiration date of February 7, 2018 and an ownership trigger threshold of 20%. This stockholder rights agreement was approved by the stockholders in May 2017, but expired pursuant to its terms in February 2018. However, our Board of Directors could determine in the future that adoption of a similar stockholder rights agreement is in the best interest of our stockholders and any such stockholder rights agreement, if adopted, could render more difficult, or discourage, a merger, tender offer, or assumption of control of the Company that is not approved by our Board of Directors.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
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ITEM 2. PROPERTIES
The following table sets forth certain information regarding our principal facilities at December 31, 2018.
Name | Location | Approximate Square Footage | Title | Type of Facility | ||||
North America | ||||||||
Tempur Production USA, LLC | Albuquerque, New Mexico | 800,000 | Leased (a) | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Hagerstown, Maryland | 615,600 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Plainfield, Indiana | 614,000 | Leased | Manufacturing | ||||
Tempur Production USA, LLC | Duffield, Virginia | 581,000 | Owned (a) | Manufacturing | ||||
Comfort Revolution, LLC | Belmont, MS | 432,000 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | City of Industry, California | 430,000 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Conyers, Georgia | 300,000 | Owned (a) | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Green Island, New York | 257,000 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Richmond, California | 241,000 | Owned (a) | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Orlando, Florida | 225,050 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Brenham, Texas | 220,500 | Owned (a) | Manufacturing | ||||
Tempur Production USA, LLC | Mountain Top, Pennsylvania | 210,000 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Trinity, North Carolina | 180,000 | Owned (a) | Manufacturing | ||||
Sealy Canada, Ltd | Alberta, Canada | 144,500 | Owned | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Medina, Ohio | 140,000 | Owned (a) | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Lacey, Washington | 134,000 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Kansas City, Kansas | 122,000 | Leased | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Phoenix, Arizona | 120,000 | Leased | Manufacturing | ||||
Sealy Canada, Ltd | Toronto, Canada | 120,000 | Leased | Manufacturing | ||||
Sealy, Inc. | Trinity, North Carolina | 105,500 | Owned (a) | Office | ||||
Sealy Canada, Ltd | Quebec, Canada | 88,000 | Owned | Manufacturing | ||||
Sealy Mattress Manufacturing Co., LLC | Denver, Colorado | 82,000 | Owned (a) | Manufacturing | ||||
Tempur-Pedic Management, LLC | Lexington, Kentucky | 77,400 | Owned (a) | Office | ||||
Sealy Mattress Company of Puerto Rico | Carolina, Puerto Rico | 44,000 | Owned | Manufacturing | ||||
Tempur Retail Stores, LLC | Irving, Texas | 10,225 | Leased | Office | ||||
International | ||||||||
Dan-Foam ApS | Aarup, Denmark | 523,000 | Owned | Manufacturing | ||||
Tempur Deutschland GmbH | Steinhagen, Germany | 143,500 | Owned | Warehouse | ||||
Sealy Mattress Company Mexico, S. de R.L. de C.V. | Toluca, Mexico | 130,500 | Owned | Manufacturing | ||||
Tempur UK Ltd | Middlesex, United Kingdom | 61,000 | Leased | Warehouse | ||||
Tempur France | Ile de France, France | 53,800 | Leased | Warehouse | ||||
(a) | We have granted a mortgage or otherwise encumbered our interest in this facility as collateral for secured indebtedness. | |
In addition to the properties listed above, we have other facilities in the U.S. and other countries, the majority under leases with one to ten year terms. The manufacturing facility in Albuquerque, New Mexico is leased as part of the related industrial revenue bond financing. We have an option to repurchase the property for one dollar upon termination of the lease.
We believe that our existing properties are suitable for the conduct of our business, are adequate for our present needs and will be adequate to meet our future needs.
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ITEM 3. LEGAL PROCEEDINGS
Information regarding legal proceedings can be found in Note 13, “Commitments and Contingencies,” of the Notes to the Consolidated Financial Statements, included in Part II, ITEM 8, “Financial Statements and Supplementary Data,” and is incorporated herein by reference.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for Registrant’s Common Equity
Our sole class of common equity is our $0.01 par value common stock, which trades on the New York Stock Exchange ("NYSE") under the symbol “TPX.” Trading of our common stock commenced on the NYSE on December 18, 2003. Prior to that time, there was no public trading market for our common stock.
As of February 18, 2019, we had approximately 76 stockholders of record of our common stock.
Dividends
We do not pay a dividend. The decision to pay a dividend in future periods is reviewed by our Board of Directors on a periodic basis. Further, we are subject to certain customary restrictions on dividends under our 2016 Credit Agreement and Indentures. See Note 8, "Debt," in our Consolidated Financial Statements, included in Part II, ITEM 8 of this Report, for a discussion of the 2016 Credit Agreement and Indentures.
Issuer Purchases of Equity Securities
In 2016, our Board of Directors authorized a share repurchase program pursuant to which we were authorized to repurchase shares of our common stock for a total repurchase price of not more than $600.0 million. In February 2017, the Board authorized an increase of $200.0 million to its existing share repurchase program for repurchases of Tempur Sealy International's common stock. The Company did not repurchase any shares during the year ended December 31, 2018 under the existing share repurchase program. As of December 31, 2018, the Company had approximately $226.9 million remaining under the existing share repurchase program for repurchases of Tempur Sealy International's common stock.
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. The timing and actual number of shares repurchased will depend on a variety of factors including price, financing, regulatory requirements and other market conditions. The program does not require the repurchase 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.
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The following table sets forth purchases of our common stock for the three months ended December 31, 2018:
Period | (a) Total number of shares purchased | (b) Average price paid per share | (c) Total number of shares purchased as part of publicly announced plans or programs | (d) Maximum number of shares (or approximate dollar value of shares) that may yet be purchased under the plans or programs (in millions) | ||||
October 1, 2018 - October 31, 2018 | — | (1) | $— | — | $226.9 | |||
November 1, 2018 - November 30, 2018 | 32 | (1) | $49.11 | — | $226.9 | |||
December 1, 2018 - December 31, 2018 | 25,085 | (1) | $42.45 | — | $226.9 | |||
Total | 25,117 | — | ||||||
(1) | Includes shares withheld upon the vesting of certain equity awards to satisfy tax withholding obligations. The shares withheld were valued at the closing price of the common stock on the New York Stock Exchange on the vesting date or prior business day. |
Equity Compensation Plan Information
Equity compensation plan information required by this Item is incorporated by reference from Part III, ITEM 12 of this Report.
Performance Graph
The following Performance Graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act or Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.
The following table compares cumulative stockholder returns for us over the last five years to the Standard & Poor’s ("S&P") 500 Stock Composite Index, and a peer group. The S&P 500 Composite Index is a capitalization weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the U.S. economy. We selected these stocks based on market size, liquidity and industry group representation. We believe the peer group discussed below closely reflects our business and, as a result, provides a meaningful comparison of stock performance.
The peer issuers included in this graph are set forth below in the table. In 2018, HNI Corporation was added to the peer group.
2018 Peer Group
Brunswick Corporation (BC) | HNI Corporation (HNI) | Sleep Number Corporation (SNBR) |
Carter's, Inc. (CRI) | La-Z-Boy Incorporated (LZB) | Steelcase Inc. (SCS) |
Columbia Sportswear Company (COLM) | Leggett & Platt, Incorporated (LEG) | Tupperware Brands Corporation (TUP) |
Deckers Outdoor Corporation (DECK) | lululemon athletica inc. (LULU) | Under Armour, Inc. (UA) |
Gildan Activewear Inc. (GIL) | Herman Miller, Inc. (MLHR) | Williams-Sonoma, Inc. (WSM) |
Hanesbrands Inc. (HBI) | Polaris Industries Inc. (PII) | Wolverine World Wide, Inc. (WWW) |
Hasbro, Inc. (HAS) | RH (RH) | |
2017 Peer Group
Brunswick Corporation (BC) | La-Z-Boy Incorporated (LZB) | Steelcase Inc. (SCS) |
Carter's, Inc. (CRI) | Leggett & Platt, Incorporated (LEG) | Tupperware Brands Corporation (TUP) |
Columbia Sportswear Company (COLM) | lululemon athletica inc. (LULU) | Under Armour, Inc. (UA) |
Deckers Outdoor Corporation (DECK) | Herman Miller, Inc. (MLHR) | Williams-Sonoma, Inc. (WSM) |
Gildan Activewear Inc. (GIL) | Polaris Industries Inc. (PII) | Wolverine World Wide, Inc. (WWW) |
Hanesbrands Inc. (HBI) | RH (RH) | |
Hasbro, Inc. (HAS) | Sleep Number Corporation (SNBR) | |
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12/31/2013 | 12/31/2014 | 12/31/2015 | 12/31/2016 | 12/31/2017 | 12/31/2018 | |||||||||||||||||||
Tempur Sealy International, Inc. | $ | 100.00 | $ | 101.76 | $ | 130.58 | $ | 126.54 | $ | 116.18 | $ | 76.72 | ||||||||||||
S&P 500 | 100.00 | 113.69 | 115.26 | 129.05 | 157.22 | 150.33 | ||||||||||||||||||
2017 Peer Group | 100.00 | 113.30 | 103.71 | 104.82 | 123.56 | 118.23 | ||||||||||||||||||
2018 Peer Group | 100.00 | 113.78 | 103.59 | 105.90 | 123.36 | 118.01 | ||||||||||||||||||
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ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected historical consolidated financial and operating data for the periods indicated. Our Consolidated Financial Statements as of December 31, 2018 and 2017 and for each of the three years in the period ended December 31, 2018 are included in Part II, ITEM 8 of this Report. The table has been adjusted to reflect certain Latin American subsidiaries as discontinued operations for all periods presented.
(in millions, except per common share amounts) | |||||||||||||||||||
Statement of Income Data: | 2018 | 2017 | 2016 | 2015 | 2014 | ||||||||||||||
Net sales | $ | 2,702.9 | $ | 2,700.6 | $ | 3,079.7 | $ | 3,089.3 | $ | 2,936.3 | |||||||||
Cost of sales | 1,582.2 | 1,579.6 | 1,790.2 | 1,864.4 | 1,808.6 | ||||||||||||||
Gross profit | 1,120.7 | 1,121.0 | 1,289.5 | 1,224.9 | 1,127.7 | ||||||||||||||
Operating expense, net (1) | 864.4 | 825.5 | 876.1 | 918.3 | 854.0 | ||||||||||||||
Operating income | 256.3 | 295.5 | 413.4 | 306.6 | 273.7 | ||||||||||||||
Interest expense, net | 92.3 | 87.3 | 82.9 | 94.0 | 90.1 | ||||||||||||||
Loss on extinguishment of debt | — | — | 47.2 | — | — | ||||||||||||||
Loss on disposal, net | — | — | — | — | 23.2 | ||||||||||||||
Other (income) expense, net | (1.0 | ) | (7.2 | ) | (0.3 | ) | 9.7 | (14.6 | ) | ||||||||||
Income before income taxes from continuing operations | 165.0 | 215.4 | 283.6 | 202.9 | 175.0 | ||||||||||||||
Income tax provision (2) | (49.6 | ) | (43.8 | ) | (86.3 | ) | (125.2 | ) | (65.1 | ) | |||||||||
Income from continuing operations | 115.4 | 171.6 | 197.3 | 77.7 | 109.9 | ||||||||||||||
Loss from discontinued operations, net of tax | (17.8 | ) | (30.9 | ) | (12.3 | ) | (12.0 | ) | (7.0 | ) | |||||||||
Net income before non-controlling interests | 97.6 | 140.7 | 185.0 | 65.7 | 102.9 | ||||||||||||||
Less: net (loss) income attributable to non-controlling interests | (2.9 | ) | (10.7 | ) | (5.6 | ) | 1.2 | 1.1 | |||||||||||
Net income attributable to Tempur Sealy International, Inc. | $ | 100.5 | $ | 151.4 | $ | 190.6 | $ | 64.5 | $ | 101.8 | |||||||||
Balance Sheet Data (at end of period): | |||||||||||||||||||
Cash and cash equivalents | $ | 45.8 | $ | 41.1 | $ | 64.6 | $ | 153.0 | $ | 61.8 | |||||||||
Total assets | 2,715.4 | 2,694.0 | 2,698.8 | 2,652.0 | 2,573.2 | ||||||||||||||
Total debt, net | 1,576.5 | 1,644.6 | 1,779.0 | 1,420.8 | 1,537.0 | ||||||||||||||
Capital leases and other debt | 69.7 | 108.5 | 109.1 | 34.0 | 27.7 | ||||||||||||||
Redeemable non-controlling interest | — | 2.2 | 7.6 | 12.4 | 12.6 | ||||||||||||||
Total stockholders' equity (deficit) | 217.5 | 112.5 | (41.9 | ) | 267.8 | 180.6 | |||||||||||||
Other Financial and Operating Data: | |||||||||||||||||||
Dividends per common share | $ | — | $ | — | $ | — | $ | — | $ | — | |||||||||
Depreciation and amortization (3) | 111.9 | 94.0 | 88.6 | 92.6 | 88.2 | ||||||||||||||
Net cash provided by operating activities from continuing operations | 207.5 | 256.5 | 168.1 | 231.6 | 233.1 | ||||||||||||||
Net cash used in investing activities from continuing operations | (71.2 | ) | (65.7 | ) | (61.9 | ) | (58.9 | ) | (9.5 | ) | |||||||||
Net cash used in financing activities from continuing operations | (107.0 | ) | (175.2 | ) | (185.1 | ) | (90.7 | ) | (238.1 | ) | |||||||||
Basic earnings per common share for continuing operations | 2.17 | 3.37 | 3.44 | 1.24 | 1.79 | ||||||||||||||
Diluted earnings per common share for continuing operations | 2.15 | 3.33 | 3.39 | 1.22 | 1.75 | ||||||||||||||
Capital expenditures | 73.6 | 66.6 | 61.9 | 65.1 | 46.5 | ||||||||||||||
(1) | Operating expense, net for 2018 includes $31.3 million of bad debt expense, which includes the impact of certain customer bankruptcies. |
(2) | Income tax provision for 2015 includes approximately $60.7 million related to changes in estimate related to the uncertain tax position regarding the Danish Tax Matter, as defined in Note 14, "Income Taxes," in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report. The income tax provision for 2017 includes the provisional impact of the U.S. Tax Reform Act. |
(3) | Includes $24.8 million, $13.3 million, $16.2 million, $22.5 million, $13.4 million in non-cash, stock-based compensation expense related to restricted stock units, performance restricted stock units, deferred stock units and stock options in 2018, 2017, 2016, 2015, and 2014, respectively. |
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with Part II, ITEM 6 of this Report and the audited Consolidated Financial Statements and accompanying notes thereto included elsewhere in this Report. In addition, prior period amounts have been revised to reflect certain Latin American subsidiaries as discontinued operations. 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” and Part I, ITEM 1A of this 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 years ended December 31, 2018, 2017 and 2016, including the following topics:
• | an overview of our business and strategy; |
• | factors impacting results of operations; |
• | 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 develop, manufacture and market bedding products, which we sell globally. Our brand portfolio includes many highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy® featuring Posturepedic® Technology, and Stearns & Foster®. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.
We sell our products through two distribution channels in each operating business segment: Wholesale (third party retailers, including third party distribution, hospitality and healthcare); and Direct (company-owned stores, e-commerce, and call centers).
Business Segments
We operate under two reportable segments: North America and International. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries and licensees located in the U.S. and Canada. Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. We evaluate segment performance based on net sales, gross profit and operating income.
Customer Bankruptcies
We have experienced a decline in certain North America traditional bedding and department store retailers. In 2018, we recorded $31.3 million of bad debt expense, which includes the impact of certain customer bankruptcies.
On January 11, 2019, a customer in our North America business segment, Innovative Mattress Solutions, LLC ("iMS"), filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Eastern District of Kentucky (the "Bankruptcy Court"). In connection with the bankruptcy filing, we agreed to provide debtor-in-possession financing (the “DIP Financing”) to iMS, which was subsequently approved by the Bankruptcy Court. For the year ended December 31, 2018, iMS represented less than 2% of our global net sales. In 2018, we recorded charges of $21.2 million associated with certain iMS-related assets, primarily made up of trade and other receivables, to fully reserve this account.
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On February 12, 2019, in connection with our review of strategic alternatives related to iMS during the iMS bankruptcy proceedings, we submitted a stalking horse bid in the form of an asset purchase agreement (the "Asset Purchase Agreement") pursuant to which we agreed to purchase certain assets of iMS. Under the terms of the Asset Purchase Agreement, upon consummation of the transactions contemplated thereby, iMS will assign all of its rights, title and interest in and to substantially all assets and related contractual rights, other than certain specified excluded assets and contractual rights (the "Assets"), to us in exchange for consideration consisting of (i) a credit bid of amounts outstanding as of the closing date under the DIP Financing and pre-petition obligations, (ii) assumption of certain liabilities; and (iii) cash consisting of cure costs, a wind down payment and certain unpaid professional fees as of the closing date, all of which is subject to the approval of the Bankruptcy Court. The purchase price is expected to be up to $26 million based on the aggregate value of clauses (i)-(iii), but will depend on the timing of the Section 363 auction to be supervised by the Bankruptcy Court (the “Section 363 Auction”) and closing. The transaction contemplated by the Asset Purchase Agreement (the "Transaction") is expected to close during the second quarter of 2019. The Assets will not be fully determined until just before closing, which is currently anticipated to be around April 1, 2019, and will likely include inventory, receivables, leases, intellectual property, contractual rights, personal property and goodwill. The closing is subject to a number of customary conditions, including being selected as the winning bidder after the Section 363 Auction and the Bankruptcy Court’s approval of the Asset Purchase Agreement. The Transaction may be terminated by either party, subject to conditions including a drop-dead date of May 1, 2019, and the Asset Purchase Agreement includes customary conditions, representations and warranties and covenants. We can provide no assurance that we will be selected as the winning bidder in the Section 363 Auction or that the Bankruptcy Court will approve the Asset Purchase Agreement.
Discontinued Operations
During 2018, we completed an evaluation of our International operations and identified certain Latin American subsidiaries with low profitability and difficult operating environments with higher operational risk and volatility. As a result, we decided to divest of the net assets of certain of these subsidiaries in the Latin American region and enter into licensee relationships in these markets. These actions were completed in 2018 with the sale of certain subsidiaries, including our largest subsidiary in the region which was sold to an unrelated third party on December 28, 2018. The decision to convert certain subsidiaries of the Latin American region to a licensee model represents a strategic shift in our business. Accordingly, we classified the results of operations and cash flows of certain of these subsidiaries in the Latin American region as discontinued operations in our Consolidated Statements of Income and Consolidated Statements of Cash Flows for all periods presented. The net assets of these Latin American subsidiaries have been retrospectively reflected as held for sale at December 31, 2017.
Termination of Mattress Firm Relationship
Mattress Firm, Inc. ("Mattress Firm") was a customer within the North America segment and was our largest customer in 2016, but only represented 3.5% of net sales in 2017. In January 2017, Tempur-Pedic North America, LLC. ("Tempur-Pedic") and Sealy Mattress Company ("Sealy Mattress") entered into transition agreements with Mattress Firm in which they agreed, among other things, to continue supplying Mattress Firm until April 3, 2017, at which time the parties' business relationships ended. The parties have been subject to ongoing litigation since 2017. Effective February 11, 2019, the parties agreed to settle all such litigation, in consideration of full mutual releases of all claims.
Factors That Could Impact Results of Operations
The factors outlined below could impact our future results of operations. For more extensive discussion of these and other risk factors, please refer to "Risk Factors" under Part I, ITEM 1A in this Report.
General Business and Economic Conditions
Our business is affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The global economic environment continues to be challenging, and we expect the uncertainty to continue. Low end bedding imports from China significantly increased during 2018 and are competing against our value priced Sealy products in the U.S. market. These imports may be sold below cost. In September 2018, we and other industry participants filed petitions with the U.S. International Trade Commission and the U.S. Department of Commerce, alleging that many of these Chinese imports are being dumped into the U.S. market at prices below cost. As a result of this petition, the U.S. International Trade Commission and the U.S. Department of Commerce have commenced investigations which are expected to take fifteen months to complete. A final determination of their investigations are expected in late 2019.
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We are focused on developing our North America distribution network by opening more company-owned stores and expanding our online availability. We currently expect to have at least 60 company-owned retail stores in operation by the end of 2019. We expect these company-owned stores to complement our existing third-party retail partners by increasing our product's brand awareness in the local markets. We also plan to expand our offerings in our own e-commerce platform and with third-party online retailers where our market share is still very low. Bedding sales have increased significantly online, as a growing segment of consumers prefer to purchase bedding products through this channel.
We continue to make strategic investments, including: introducing new products; investing in increasing our global brand awareness; investing in research and development and productivity initiatives; and taking other actions to further strengthen our business. In 2019, we also expect to pay incentive compensation of approximately $20 million at target, which was not earned in 2018.
Exchange Rates
As a multi-national company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign currency exchange rates. Foreign currency exchange rate movements also create a degree of risk by affecting the U.S. dollar value of sales made and costs incurred in foreign currencies. We use foreign exchange forward contracts to manage a portion of the exposure to the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions among certain subsidiaries. These hedging transactions may not succeed in managing our foreign currency exchange rate risk. Consequently, our reported earnings and financial position could fluctuate materially as a result of foreign exchange gains or losses. Additionally, the operations of our foreign currency denominated subsidiaries result in foreign currency translation fluctuations in our consolidated operating results. These operations do not constitute transactions which qualify for hedge accounting treatment. Therefore, we do not hedge the translation of foreign currency operating results into the U.S. dollar. Should currency rates change sharply, our results could be negatively impacted.
In 2018, foreign currency exchange rate changes positively impacted our net income by 1.4% and positively impacted our adjusted EBITDA, which is a non-GAAP financial measure, by approximately 0.4%. In the first half of 2019, we expect foreign exchange rate fluctuations will negatively impact our results of operations as the U.S. Dollar is projected to strengthen relative to all major foreign currencies. As a result, we expect net sales will be unfavorably impacted by approximately $30 million as compared to 2018. We also expect net income and EBITDA, which is a non-GAAP financial measure, will be unfavorably impacted by approximately $3 million and $5 million, respectively.
Competition
We compete in the global bedding industry. Participants in the bedding industry compete primarily on price, quality, brand name recognition, product availability, and product performance. We compete with a number of different types of mattress alternatives, including standard innerspring mattresses, visco-elastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These alternative products are primarily sold through a variety of channels, including retail furniture and bedding stores, department stores, wholesale clubs and the internet.
Our North America segment competes in various mattress categories, and contributed 79.0% of our net sales for the year ended December 31, 2018. These mattress categories are highly competitive, with many competitor products supported by aggressive marketing campaigns and promotions. The North American bedding market is also changing rapidly, becoming more focused on the consumer, rationalizing store count, evolving media spend and investing in online direct-to-consumer models. Our International segment competes in a highly fragmented market, which is generally served by a large number of manufacturers operating primarily on a regional and local basis. These manufacturers offer a broad range of mattress and pillow products. In addition, mattress and pillow manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer, including the recent expansion in the number of companies pursuing online direct-to-consumer models for foam mattresses. Additionally, retailers in both the U.S. and international markets are seeking to integrate vertically in the furniture and bedding industries, including offering their own brands of mattresses and pillows. These factors, along with increased competition, may negatively impact our results.
Gross Margins
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 Sealy products increase relative to sales of our Tempur products, our gross margins will be negatively impacted in both our North America and International segments.
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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, channel and geographic 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.
In 2019, we expect gross margin to be favorably impacted by several factors: sales growth of Tempur products in North America, 2018 and 2019 pricing actions of approximately $30 million, improved merchandising mix as we complete the launch of new products and expansion of our Direct channel. We expect these factors may be offset by a slight decline in Sealy product sales in North America.
We do not expect significant commodity inflation in 2019. As a result of significant commodity cost increases in 2018, we implemented price increases on our products three times. In 2019, we also plan to implement certain price increases on our adjustable bases imported from China as a result of import tariffs in 2018, as there is generally a lag to fully offset these inflationary pressures. Our gross margins may be unfavorably impacted if import tariffs increase in 2019.
New Product Development and Introduction
Each year we invest significant time and resources in research and development to improve our product offerings. There are a number of risks inherent in our new product line introductions, including that the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, product introduction costs, the speed and order of the product rollout and manufacturing inefficiencies may unfavorably impact our profitability.
In our North America segment in 2019, we will introduce our higher-end Tempur Breeze products to complete the largest Tempur rollout in our history, and we will introduce our new Stearns & Foster lineup. In 2018, we launched entry-level Tempur mattresses, Tempur pillows, Sealy Hybrid mattresses and adjustable bases. Our profitability in North America was unfavorably impacted, as some consumers purchased our new entry-level mattresses instead of our existing higher-end mattresses. We expect this trend to continue in the first half of 2019, when our higher-end Tempur mattresses are fully floored with our retailers. We expect to incur launch costs for the Tempur Breeze and Stearns & Foster product introductions comparable to the launch costs incurred in 2018. Sales in our Wholesale and Direct channels will also be unfavorably impacted as retailers discount and sell their existing inventory of our products in anticipation of the release of our new products.
The U.S. Tax Reform Act
On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the “U.S. Tax Reform Act”) was signed into law making significant changes to U.S. tax law. Changes include, but are not limited to, a corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S. international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017 (the "Transition Tax"). In accordance with the U.S. Tax Reform Act, we recorded an income tax benefit of $23.8 million in the fourth quarter of 2017, the period in which the legislation was enacted. The total benefit included a tax benefit of $69.7 million related to the remeasurement of certain deferred tax assets and liabilities net of $45.9 million in additional income tax expense related to the Transition Tax. During 2018, we completed our analysis based on subsequent guidance issued with respect to the U.S. Tax Reform Act currently available which resulted in an additional tax benefit of $6.8 million related to the finalization of the Transition Tax obligation. The overall net impact of the U.S. Tax Reform Act on future periods is expected to result in a net decrease in our overall effective tax rates as compared to periods prior to enactment, driven by the reduction in the U.S. federal tax rate. The impact of the rate reduction will be partially offset in future periods by changing or limiting certain tax deductions and certain international provisions of the U.S. Tax Reform Act. The impact of the U.S. Tax Reform Act on future periods may differ due to changes in tax law interpretations, issuance of additional guidance, and other changes in facts and circumstances. We expect our effective tax rate to range from 26% to 28% in 2019.
For more extensive discussion of the U.S. Tax Reform Act, please refer to Note 14, "Income Taxes," of the Notes to the Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
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Danish Tax Proceeding
Since 2001, we have been involved in a dispute with SKAT regarding the royalty paid by a U.S. subsidiary of Tempur Sealy International to a Danish subsidiary (the "Danish Tax Matter") for the right to utilize certain intangible assets. During 2018, we negotiated a settlement with SKAT for the tax years 2001 through 2011 (the “Settlement Years”). In addition, we have entered into an Advance Pricing Agreement program (the “APA Program”) for the tax years 2012 through 2022 in which the IRS, on our behalf, will negotiate directly with SKAT the royalty to be paid by the U.S. subsidiary to the Danish Subsidiary. We maintain an uncertain income tax liability for both the Settlement Years and for the tax years 2012 through 2018 that are included in the APA Program. If we are required to further increase the uncertain tax liability for either or both periods based on a change in facts and circumstances, it could have a material impact on our reported earnings. Further, if the IRS and SKAT are unable to reach a mutually acceptable agreement with respect to the tax years included in the APA Program, we could be required to make a significant payment to SKAT for Danish tax related to such years, which could have a material adverse effect on our results of operations and liquidity.
For more extensive discussion of the Danish Tax Proceeding, please refer to Note 14, "Income Taxes," of the Notes to the Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
Financial Leverage
As of December 31, 2018, we had $1,653.8 million of debt outstanding, and our adjusted EBITDA, which is a non-GAAP financial measure, was $424.7 million for 2018. Higher financial leverage makes us more vulnerable to general adverse competitive, economic and industry conditions. There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available. As of December 31, 2018, our ratio of funded debt less qualified cash to Adjusted EBITDA in accordance with our 2016 Credit Agreement was 3.87 times, within the covenant in our debt agreements which limits this ratio to 5.00 times for the year ended December 31, 2018. For more information on this non-GAAP measure and compliance with our 2016 Credit Agreement, please refer to “Non-GAAP Financial Information” below.
2018 Results of Operations
A summary of our results for the year ended December 31, 2018 include:
• | Total net sales increased 0.1% to $2,702.9 million from $2,700.6 million in 2017. |
• | Gross margin was 41.5% in both 2018 and 2017. Adjusted gross margin, which is a non-GAAP financial measure, was 41.9% as compared to 42.0% in 2017. |
• | GAAP operating income was $256.3 million, or 9.5% of net sales, as compared to $295.5 million, or 10.9% of net sales, in 2017. Adjusted operating income, which is a non-GAAP financial measure was $307.6 million, or 11.4% of net sales, as compared to $325.3 million, or 12.0% of net sales, in 2017. |
• | GAAP net income was $100.5 million as compared to $151.4 million in 2017. Adjusted net income, which is a non-GAAP financial measure, was $163.0 million as compared to $179.2 million in 2017. |
• | GAAP earnings per diluted share ("EPS") was $1.82 as compared to $2.77 in 2017. Adjusted EPS, which is a non-GAAP financial measure, was $2.96 as compared to $3.28 in 2017. |
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 year 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 II, ITEM 7A of this Report for a discussion of our foreign currency exchange rate risk.
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The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales:
(in millions, except percentages and | Year Ended December 31, | |||||||||||||||||||
per common share amounts) | 2018 | 2017 | 2016 | |||||||||||||||||
Net sales | $ | 2,702.9 | 100.0 | % | $ | 2,700.6 | 100.0 | % | $ | 3,079.7 | 100.0 | % | ||||||||
Cost of sales | 1,582.2 | 58.5 | 1,579.6 | 58.5 | 1,790.2 | 58.1 | ||||||||||||||
Gross profit | 1,120.7 | 41.5 | 1,121.0 | 41.5 | 1,289.5 | 41.9 | ||||||||||||||
Selling and marketing expenses | 587.8 | 21.7 | 586.1 | 21.7 | 635.5 | 20.6 | ||||||||||||||
General, administrative and other expenses | 294.2 | 10.9 | 261.4 | 9.7 | 273.4 | 8.9 | ||||||||||||||
Customer termination charges, net | — | — | 14.4 | 0.5 | — | — | ||||||||||||||
Equity income in earnings of unconsolidated affiliates | (17.6 | ) | (0.7 | ) | (15.6 | ) | (0.6 | ) | (13.3 | ) | (0.4 | ) | ||||||||
Royalty income, net of royalty expense | — | — | (20.8 | ) | (0.8 | ) | (19.5 | ) | (0.6 | ) | ||||||||||
Operating income | 256.3 | 9.5 | 295.5 | 10.9 | 413.4 | 13.4 | ||||||||||||||
Other expense, net: | ||||||||||||||||||||
Interest expense, net | 92.3 | 3.4 | 87.3 | 3.2 | 82.9 | 2.7 | ||||||||||||||
Loss on extinguishment of debt | — | — | — | — | 47.2 | 1.5 | ||||||||||||||
Other income, net | (1.0 | ) | — | (7.2 | ) | (0.3 | ) | (0.3 | ) | — | ||||||||||
Total other expense. net | 91.3 | 3.4 | 80.1 | 3.0 | 129.8 | 4.2 | ||||||||||||||
Income from continuing operations before income taxes | 165.0 | 6.1 | 215.4 | 8.0 | 283.6 | 9.2 | ||||||||||||||
Income tax provision | (49.6 | ) | (1.8 | ) | (43.8 | ) | (1.6 | ) | (86.3 | ) | (2.8 | ) | ||||||||
Income from continuing operations | 115.4 | 4.3 | 171.6 | 6.4 | 197.3 | 6.4 | ||||||||||||||
Loss from discontinued operations, net of tax | (17.8 | ) | (0.6 | ) | (30.9 | ) | (1.1 | ) | (12.3 | ) | (0.4 | ) | ||||||||
Net income before non-controlling interests | 97.6 | 3.6 | 140.7 | 5.2 | 185.0 | 6.0 | ||||||||||||||
Less: Net loss attributable to non-controlling interests | (2.9 | ) | (0.1 | ) | (10.7 | ) | (0.4 | ) | (5.6 | ) | (0.2 | ) | ||||||||
Net income attributable to Tempur Sealy International, Inc. | $ | 100.5 | 3.7 | % | $ | 151.4 | 5.6 | % | $ | 190.6 | 6.2 | % | ||||||||
Earnings per common share: | ||||||||||||||||||||
Basic | ||||||||||||||||||||
Earnings per share for continuing operations | $ | 2.17 | $ | 3.37 | $ | 3.44 | ||||||||||||||
Loss per share for discontinued operations | (0.32 | ) | (0.57 | ) | (0.21 | ) | ||||||||||||||
Earnings per share | $ | 1.85 | $ | 2.80 | $ | 3.23 | ||||||||||||||
Diluted | ||||||||||||||||||||
Earnings per share for continuing operations | $ | 2.15 | $ | 3.33 | $ | 3.39 | ||||||||||||||
Loss per share for discontinued operations | (0.33 | ) | (0.56 | ) | (0.20 | ) | ||||||||||||||
Earnings per share | $ | 1.82 | $ | 2.77 | $ | 3.19 | ||||||||||||||
Weighted average common shares outstanding: | ||||||||||||||||||||
Basic | 54.4 | 54.0 | 59.0 | |||||||||||||||||
Diluted | 55.1 | 54.7 | 59.8 | |||||||||||||||||
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NET SALES
Year Ended December 31, | |||||||||||||||||||||||||||||||||||
Consolidated | North America | International | |||||||||||||||||||||||||||||||||
(in millions) | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | 2018 | 2017 | 2016 | ||||||||||||||||||||||||||
Net sales by channel | |||||||||||||||||||||||||||||||||||
Wholesale | $ | 2,452.1 | $ | 2,499.9 | $ | 2,949.0 | $ | 1,989.1 | $ | 2,052.6 | $ | 2,511.7 | $ | 463.0 | $ | 447.3 | $ | 437.3 | |||||||||||||||||
Direct | 250.8 | 200.7 | 130.7 | 147.1 | 121.2 | 58.4 | 103.7 | 79.5 | 72.3 | ||||||||||||||||||||||||||
Total net sales | $ | 2,702.9 | $ | 2,700.6 | $ | 3,079.7 | $ | 2,136.2 | $ | 2,173.8 | $ | 2,570.1 | $ | 566.7 | $ | 526.8 | $ | 509.6 | |||||||||||||||||
Year ended December 31, 2018 compared to year ended December 31, 2017
Net sales increased 0.1%, and on a constant currency basis decreased 0.3%. The change in net sales was driven by the following:
• | North America net sales decreased $37.6 million, or 1.7%. Excluding Mattress Firm, North America net sales increased 2.8%. In 2017, net sales to Mattress Firm were $95.7 million prior to the termination of our contract on April 3, 2017. Net sales in the Wholesale channel decreased $63.5 million, or 3.1%, driven primarily by the termination of our contract with Mattress Firm. Additionally, we experienced a decline in certain traditional bedding and department store retailers in 2018. Net sales in our Direct channel increased $25.9 million, or 21.4%, driven primarily by expanded retail stores. On a constant currency basis, North America net sales decreased 1.7%. |
• | International net sales increased $39.9 million, or 7.6%. On a constant currency basis, our International net sales increased 5.6%, driven primarily by growth across all regions and the change in classification of royalty income due to the adoption of new revenue recognition guidance. Net sales in the Wholesale channel increased 1.3% on a constant currency basis. Net sales in the Direct channel increased 29.6% on a constant currency basis, primarily driven by growth from company-owned stores. |
Year ended December 31, 2017 compared to year ended December 31, 2016
Net sales decreased 12.3%, and on a constant currency basis decreased 12.5%. The change in net sales was driven by the following:
• | North America net sales decreased $396.3 million or 15.4%. Net sales to Mattress Firm were $95.7 million prior to the termination of our contract on April 3, 2017, as compared to $668.6 million for 2016, which resulted in a net sales decrease of $572.9 million. Excluding Mattress Firm, North America net sales increased $176.6 million or 9.3%, driven by growth across all of our brands. Net sales in the Wholesale channel decreased $459.1 million, or 18.3%, driven primarily by the termination of our contract with Mattress Firm. Excluding sales to Mattress Firm, Wholesale net sales increased 6.2%. Additionally, sales to a national department store retailer in the Wholesale channel significantly declined in 2017 as compared to 2016. Net sales in our Direct channel increased $62.8 million or 107.5%, driven primarily by growth in e-commerce. |
• | International net sales increased $17.2 million, or 3.4%. On a constant currency basis, our International net sales increased 3.2%, driven primarily by growth in Asia-Pacific and Latin America. Net sales in the Wholesale channel increased 1.8% on a constant currency basis. Net sales in the Direct channel increased 11.3% on a constant currency basis. |
GROSS PROFIT
Year Ended December 31, | ||||||||||||||||||||||||||
2018 | 2017 | 2016 | Margin Change | |||||||||||||||||||||||
(in millions, except percentages) | Gross Profit | Gross Margin | Gross Profit | Gross Margin | Gross Profit | Gross Margin | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||||||||
North America | $ | 823.4 | 38.5 | % | $ | 844.7 | 38.9 | % | $ | 1,017.4 | 39.6 | % | (0.4 | )% | (0.7 | )% | ||||||||||
International | 297.3 | 52.5 | % | 276.3 | 52.4 | % | 272.1 | 53.4 | % | 0.1 | % | (1.0 | )% | |||||||||||||
Consolidated | $ | 1,120.7 | 41.5 | % | $ | 1,121.0 | 41.5 | % | $ | 1,289.5 | 41.9 | % | — | % | (0.4 | )% | ||||||||||
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Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in the manufacturing process.
Year ended December 31, 2018 compared to year ended December 31, 2017
Gross margin was flat. The principal factors impacting gross margin for each segment are discussed below.
• | North America gross margin declined 40 basis points. The decline in gross margin was primarily driven by commodity cost inflation of 220 basis points and unfavorable merchandising mix of 90 basis points. We also recorded $6.1 million of restructuring charges related to our acquisition of the remaining interest in a joint venture and $5.6 million of supply chain transition costs to consolidate certain manufacturing and distribution facilities. The decline in gross margin was offset by operational improvements of 80 basis points, favorable brand mix of 70 basis points and favorable pricing of 70 basis points. In the first quarter of 2017, we also recorded costs associated with a $5.4 million write-off of customer-unique inventory and $6.1 million of increased product obligations as a result of the termination of the Mattress Firm relationship. |
• | International gross margin improved 10 basis points. The change in gross margin was primarily driven by operational improvements of 80 basis points, the change in classification of royalty income due to the adoption of the new revenue recognition accounting standard of 70 basis points and favorable product launch costs. These were partially offset by unfavorable mix of 130 basis points and unfavorable commodity cost inflation. |
Year ended December 31, 2017 compared to year ended December 31, 2016
Gross margin declined 40 basis points. The principal factors impacting gross margin for each segment are discussed below.
• | North America gross margin declined 70 basis points. The decline was driven primarily by the termination of the Mattress Firm relationship, which resulted in fixed cost deleverage of 120 basis points and unfavorable brand mix of 90 basis points. In 2017, we also recorded charges associated with the Mattress Firm termination for an unfavorable impact of 60 basis points. These charges included a $5.4 million write-off of customer-unique inventory and $6.1 million of increased product obligations. The decline in gross margin was also due to unfavorable commodity costs of 100 basis points, offset by favorable channel mix of 130 basis points, operational productivity of 100 basis points and lower floor model discounts of 60 basis points. |
• | International gross margin declined 100 basis points. The decline was driven primarily by new product launch costs and mix. |
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.
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Year ended December 31, 2018 compared to year ended December 31, 2017
Year Ended December 31, | |||||||||||||||||||||||||||||||
2018 | 2017 | 2018 | 2017 | 2018 | 2017 | 2018 | 2017 | ||||||||||||||||||||||||
(in millions) | Consolidated | North America | International | Corporate | |||||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||
Advertising | $ | 259.3 | $ | 283.4 | $ | 220.5 | $ | 248.7 | $ | 38.8 | $ | 34.7 | $ | — | $ | — | |||||||||||||||
Other selling and marketing | 328.5 | 302.7 | 194.4 | 186.7 | 125.7 | 110.3 | 8.4 | 5.7 | |||||||||||||||||||||||
General, administrative and other | 294.2 | 261.4 | 158.5 | 124.0 | 42.9 | 46.1 | 92.8 | 91.3 | |||||||||||||||||||||||
Customer termination charges, net | — | 14.4 | — | 20.9 | — | 0.8 | — | (7.3 | ) | ||||||||||||||||||||||
Total operating expense | $ | 882.0 | $ | 861.9 | $ | 573.4 | $ | 580.3 | $ | 207.4 | $ | 191.9 | $ | 101.2 | $ | 89.7 | |||||||||||||||
Operating expenses increased $20.1 million, and increased 70 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are discussed below.
• | North America operating expenses decreased $6.9 million and increased 10 basis points as a percentage of net sales. The decrease was driven by decreased participation in our wholesale cooperative advertising programs and decreased investments in our advertising programs, which was partially offset by investments in our retail store expansion. In 2018, we also recorded $20.9 million of charges associated with a Wholesale customer bankruptcy, primarily made up of the write-off of trade and other receivables. Additionally, in 2018, we recorded $4.1 million of restructuring charges related to our acquisition of the remaining interest in a joint venture and bad debt expenses of $3.5 million, primarily driven by the bankruptcy of a department store retailer. In 2017, we recorded $20.9 million of charges related to the Mattress Firm termination. |
• | International operating expenses increased $15.5 million and increased 20 basis points as a percentage of net sales. In 2018, we recorded $8.2 million of costs associated with our International simplification efforts, including headcount reduction, professional fees and store closures. The remaining increase in operating expenses was primarily driven by increased other selling and marketing expenses for certain retail store expansions. |
• | Corporate operating expenses increased $11.5 million, or 12.8%. The increase in operating expenses was primarily driven by a $9.3 million benefit recorded in the first quarter of 2017 for the change in estimate associated with performance-based stock compensation that was no longer probable of payout following the Mattress Firm termination, offset by $0.9 million of accelerated stock-based compensation and $1.1 million of other employee-related expenses and professional fees. In 2018, we also recorded $4.9 million of professional fees related to restructuring activities. |
Research and development expenses for the year ended December 31, 2018 were $21.9 million compared to $21.7 million for the year ended December 31, 2017, a decrease of $0.2 million, or 0.9%.
Year ended December 31, 2017 compared to year ended December 31, 2016
Year Ended December 31, | |||||||||||||||||||||||||||||||
2017 | 2016 | 2017 | 2016 | 2017 | 2016 | 2017 | 2016 | ||||||||||||||||||||||||
(in millions) | Consolidated | North America | International | Corporate | |||||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||
Advertising | $ | 283.4 | $ | 352.3 | $ | 248.7 | $ | 316.5 | $ | 34.7 | $ | 35.8 | $ | — | $ | — | |||||||||||||||
Other selling and marketing | 302.7 | 283.2 | 186.7 | 169.5 | 110.3 | 110.8 | 5.7 | 2.9 | |||||||||||||||||||||||
General, administrative and other | 261.4 | 273.4 | 124.0 | 127.3 | 46.1 | 49.8 | 91.3 | 96.3 | |||||||||||||||||||||||
Customer termination charges, net | $ | 14.4 | $ | — | $ | 20.9 | $ | — | $ | 0.8 | $ | — | $ | (7.3 | ) | $ | — | ||||||||||||||
Total operating expense | $ | 861.9 | $ | 908.9 | $ | 580.3 | $ | 613.3 | $ | 191.9 | $ | 196.4 | $ | 89.7 | $ | 99.2 | |||||||||||||||
Operating expenses decreased $47.0 million and increased 240 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are discussed below.
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• | North America operating expenses decreased $33.0 million and increased 280 basis points as a percentage of net sales. In the first quarter of 2017, we recorded $20.9 million of charges related to the Mattress Firm termination, which included a $17.2 million write-off of customer incentives and marketing assets and $3.7 million of employee-related and professional fees. Additionally, we had unfavorable operating expense leverage, including investments in marketing. These were offset by decreased participation in our wholesale cooperative advertising programs. |
• | International operating expenses decreased $4.5 million and decreased 210 basis points as a percentage of net sales, primarily driven by improved operating expense leverage. In 2017, we recognized $2.7 million of charges for a European customer's bankruptcy and other employee-related expenses. |
• | Corporate operating expenses decreased $9.5 million, or 9.6%. The decrease in operating expenses was primarily driven by a $9.3 million benefit recorded in the first quarter of 2017 for the change in estimate associated with performance-based stock compensation that was no longer probable of payout following the Mattress Firm termination. |
Research and development expenses for the year ended December 31, 2017 were $21.7 million compared to $26.7 million for the year ended December 31, 2016, a decrease of $5.0 million, or 18.7%.
OPERATING INCOME
Year Ended December 31, | ||||||||||||||||||||||||||
2018 | 2017 | 2016 | Margin Change | |||||||||||||||||||||||
(in millions, except percentages) | Operating Income | Operating Margin | Operating Income | Operating Margin | Operating Income | Operating Margin | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||||||||
North America | $ | 250.0 | 11.7 | % | $ | 273.2 | 12.6 | % | $ | 411.8 | 16.0 | % | (0.9 | )% | (3.4 | )% | ||||||||||
International | 107.5 | 19.0 | % | 112.0 | 21.3 | % | 100.6 | 19.7 | % | (2.3 | )% | 1.6 | % | |||||||||||||
357.5 | 385.2 | 512.4 | ||||||||||||||||||||||||
Corporate expenses | (101.2 | ) | (89.7 | ) | (99.0 | ) | ||||||||||||||||||||
Total operating income | $ | 256.3 | 9.5 | % | $ | 295.5 | 10.9 | % | $ | 413.4 | 13.4 | % | (1.4 | )% | (2.5 | )% | ||||||||||
Year ended December 31, 2018 compared to year ended December 31, 2017
Operating income decreased $39.2 million and operating margin declined 140 basis points. The decrease was driven by the following:
• | North America operating income decreased $23.2 million and operating margin declined 90 basis points, primarily driven by the decline in gross margin. In 2018, we recorded $20.9 million of charges associated with a Wholesale customer bankruptcy, primarily made up of the write-off of trade and other receivables. Additionally, in 2018, we recorded $4.1 million of restructuring charges related to our acquisition of the remaining interest in a joint venture and bad debt expenses of $3.5 million, primarily driven by the bankruptcy of a department store retailer. In 2017, we recorded $20.9 million of charges related to the Mattress Firm termination. |
• | International operating income decreased $4.5 million and operating margin declined 230 basis points. In 2018, we recorded $8.5 million of costs associated with our International simplification efforts, including headcount reduction, professional fees and store closures. In 2017, we recognized $1.9 million of customer-related charges. The decline in operating margin was driven by the change in classification of royalty income due to the adoption of the new revenue recognition accounting standard. |
• | Corporate operating expenses increased $11.5 million, which negatively impacted our consolidated operating margin by 40 basis points. In the first quarter of 2017, we recorded $8.4 million of net stock-based compensation benefit. In 2018, we recorded $4.9 million of professional fees related to restructuring activities. |
Year ended December 31, 2017 compared to year ended December 31, 2016
Operating income decreased $117.9 million and operating margin declined 250 basis points. The decrease was driven by the following:
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• | North America operating income decreased $138.6 million and operating margin declined 340 basis points. The decline in operating margin was primarily driven by the termination of our contracts with Mattress Firm at the beginning of the second quarter, which resulted in gross margin decline and unfavorable operating expense leverage. The decline in operating margin was also driven by charges of $32.4 million recorded in the first quarter of 2017 associated with the Mattress Firm termination. Cost of sales included $11.5 million of charges related to the write-off of customer-unique inventory and increased product obligations. Operating expenses included $20.9 million of charges related to the write-off of customer incentives and marketing assets, as well as employee-related expenses. |
• | International operating income increased $11.4 million and operating margin improved 160 basis points, primarily driven by improved operating expense leverage. |
• | Corporate operating expenses decreased $9.3 million, as discussed above, which improved our consolidated operating margin by 40 basis points. |
INTEREST EXPENSE, NET
Year Ended December 31, | Percent change | ||||||||||||||||
(in millions, except percentages) | 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||
Interest expense, net | $ | 92.3 | $ | 87.3 | $ | 82.9 | 5.7 | % | 5.3 | % | |||||||
Year ended December 31, 2018 compared to year ended December 31, 2017
Interest expense, net, increased $5.0 million, or 5.7%. The increase in interest expense, net, was driven by higher interest rates on our variable rate debt, offset in part by reduced levels of outstanding debt.
Year ended December 31, 2017 compared to year ended December 31, 2016
Interest expense, net, increased $4.4 million, or 5.3%. The increase in interest expense, net, was driven by higher interest rates on our variable rate debt, offset in part by reduced levels of outstanding debt.
LOSS ON EXTINGUISHMENT OF DEBT
In 2016, we issued our 2026 Senior Notes and entered into our 2016 Credit Agreement. The net proceeds of the 2026 Senior Notes offering were used in part to redeem the 2020 Senior Notes. The net proceeds from the 2016 Credit Agreement were also used to repay in full the 2012 Credit Agreement and to pay certain transaction fees and expenses incurred in connection with the 2016 Credit Agreement. In association with these transactions, we recorded a $47.2 million loss on extinguishment of debt. The $47.2 million loss includes a $23.6 million premium on the prepayment of our 2020 Senior Notes, $11.0 million and $4.8 million of deferred financing costs write-offs for the 2012 Credit Agreement and 2020 Senior Notes, respectively, and $1.9 million and $5.9 million of lender expenses for the 2016 Credit Agreement and 2026 Senior Notes, respectively.
OTHER INCOME, NET
Year Ended December 31, | Percent change | ||||||||||||||||
(in millions, except percentages) | 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||
Other income, net | $ | (1.0 | ) | $ | (7.2 | ) | $ | (0.3 | ) | (86.1 | )% | 2,300.0 | % | ||||
Year ended December 31, 2018 compared to year ended December 31, 2017
In 2017, we recognized other income of $9.3 million for payments received pursuant to the transition agreements with Mattress Firm, which did not recur in 2018.
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Year ended December 31, 2017 compared to year ended December 31, 2016
In the first quarter of 2017, we recognized other income of $9.3 million for payments received pursuant to the transition agreements with Mattress Firm. In the fourth quarter of 2016, we spent approximately $13 million to support Mattress Firm with store transitions and product launches. The $9.3 million of payments from Mattress Firm were intended to partially reimburse that prior investment.
INCOME TAXES
Year Ended December 31, | Percent change | ||||||||||||||||
(in millions, except percentages) | 2018 | 2017 | 2016 | 2018 vs 2017 | 2017 vs 2016 | ||||||||||||
Income tax | $ | 49.6 | $ | 43.8 | $ | 86.3 | 13.2 | % | (49.2 | )% | |||||||
Effective tax rate | 30.1 | % | 20.3 | % | 30.4 | % | 9.8 | % | (10.1 | )% | |||||||
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.
Year ended December 31, 2018 compared to year ended December 31, 2017
Our income tax provision increased $5.8 million and our effective tax rate increased 980 basis points, primarily due to discrete, one-time tax matters impacting 2018 and 2017. During 2018, we recorded income tax expense of $12.8 million, net, related to the Danish Tax Matter and a tax benefit of $6.8 million related to the finalization of our Transition Tax obligation. The 2017 income tax provision includes $23.8 million, net, favorable impact of U.S. Tax Reform, which included the initial estimate of the Transition Tax. The 2018 income tax provision includes the benefit of lower U.S. federal corporate tax rates offset in part by the international provisions and other changes to various deductions resulting from U.S. Tax Reform. Refer to Note 14, “Income Taxes,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information.
Year ended December 31, 2017 compared to year ended December 31, 2016
Our income tax provision decreased $42.5 million and our effective tax rate decreased 1,010 basis points. The decrease in effective tax rate is primarily the result of the net favorable effect of the revaluation of deferred income tax assets and liabilities required as a result of the U.S. Tax Reform Act, net of the unfavorable impact of the Transition Tax. Refer to Note 14, “Income Taxes,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information.
Liquidity and Capital Resources
Liquidity
Our principal sources of funds are cash flows from operations, borrowings made pursuant to our credit facilities and cash and cash equivalents on hand. Principal uses of funds consist of payments of principal and interest on our debt facilities, share repurchases, capital expenditures and working capital needs. At December 31, 2018, we had working capital of $136.4 million, including cash and cash equivalents of $45.8 million, as compared to working capital of $30.5 million including $41.1 million in cash and cash equivalents as of December 31, 2017.
The increase in working capital was primarily driven by increases in prepaid expenses and other current assets and inventories, as well as decreases in current liabilities from discontinued operations, current portion of long-term debt and income taxes payable. These changes were offset by increases in accrued expenses and other current liabilities and accounts payable. During 2018, we reached an agreement with SKAT and the IRS regarding the previously-disclosed Danish Tax Matter. As a result, the $130.0 million liability owed to SKAT was reclassified from other non-current liabilities to accrued expenses and other current liabilities. We also reclassified $130.0 million from other non-current assets to prepaid expenses and other current assets for amounts on deposit with SKAT. These changes offset each other in working capital. The increase in inventories was primarily due to new product introductions in 2018 and the first quarter of 2019. The decrease in current liabilities from discontinued operations was primarily due to the payment of non-income tax obligations and related interest expense. The decrease in current portion of long-term debt was primarily driven by repayments of International segment debt obligations. The decrease in income taxes payable was primarily due to the payment of our one-time transition tax liability. Accounts payable changes are primarily driven by the timing of payments to vendors.
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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 years ended December 31, 2018, 2017 and 2016.
Year Ended December 31, | ||||||||||||
(in millions) | 2018 | 2017 | 2016 | |||||||||
Net cash provided by (used in) continuing operations: | ||||||||||||
Operating activities | $ | 207.5 | $ | 256.5 | $ | 168.1 | ||||||
Investing activities | (71.2 | ) | (65.7 | ) | (61.9 | ) | ||||||
Financing activities | (107.0 | ) | (175.2 | ) | (185.1 | ) | ||||||
Cash provided by operating activities from continuing operations decreased $49.0 million in 2018 as compared to 2017. The decrease in cash provided by operating activities was primarily driven by changes in accounts receivable, inventories and income taxes payable. These were primarily offset by changes in accrued expenses and other current liabilities, accounts payable and deferred income taxes.
Cash used in investing activities from continuing operations increased $5.5 million in 2018 as compared to 2017. The increase in cash used in investing activities was due primarily to an increase in capital expenditures, which was primarily due to the phasing of planned capital projects.
Cash used in financing activities from continuing operations decreased $68.2 million in 2018 as compared to 2017. In 2018, we had net repayments of $100.9 million on our credit facilities, as compared to net repayments of $138.6 million in 2017. In 2018, share repurchases decreased $40.3 million and proceeds from exercise of stock options decreased $8.2 million as compared to the same period in 2017.
Cash Used in Discontinued Operations
The table below presents net cash used in operating, investing and financing activities from discontinued operations for the years ended December 31, 2018, 2017 and 2016:
Year Ended December 31, | ||||||||||||
(in millions) | 2018 | 2017 | 2016 | |||||||||
Net cash used in discontinued operations: | ||||||||||||
Operating activities | $ | (24.4 | ) | $ | (33.6 | ) | $ | (2.6 | ) | |||
Investing activities | 2.1 | 3.6 | (0.5 | ) | ||||||||
Financing activities | — | — | — | |||||||||
Cash used in discontinued operations decreased $7.7 million in 2018 as compared to 2017, primarily due to the payment of non-income tax obligations and related interest expense.
Capital Expenditures
Capital expenditures totaled $73.6 million for the year ended December 31, 2018 and $66.6 million for the year ended December 31, 2017. We currently expect our 2019 capital expenditures to be approximately $70 to $75 million, which includes investments in our U.S. enterprise resource planning projects, domestic manufacturing facilities, other information technology and our company-owned retail stores.
Debt Service
Our total debt decreased to $1,653.8 million as of December 31, 2018 from $1,762.5 million as of December 31, 2017. As of December 31, 2018, we had no borrowings outstanding under our revolving credit facility, and total availability under the revolver was $476.8 million after giving effect to letters of credit outstanding of $22.7 million. Refer to Note 8, “Debt,” in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.
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As of December 31, 2018, our ratio of consolidated funded debt less qualified cash to EBITDA, which is a non-GAAP financial measure, in accordance with our 2016 Credit Agreement was 3.87 times, within the terms of the financial covenants for the maximum consolidated total net leverage ratio as set forth in the 2016 Credit Agreement, which limits this ratio to 5.00 times. As of December 31, 2018, we were in compliance with all of the financial covenants in our debt agreements.
Our debt agreements contain certain covenants that limit restricted payments, including share repurchases and dividends. The 2016 Credit Agreement, 2026 Senior Notes and 2023 Senior Notes contain similar limitations which, subject to other conditions, allow unlimited restricted payments at times when the ratio of consolidated funded debt less qualified cash to adjusted EBITDA remains below 3.5 times. In addition, these agreements permit limited restricted payments under certain conditions when the ratio of consolidated funded debt less qualified cash to adjusted EBITDA is above 3.5 times. The limit on restricted payments under the 2016 Credit Agreement, 2023 Senior Notes and 2026 Senior Notes is in part determined by a basket that grows at 50% of adjusted net income each quarter, reduced by restricted payments that are not otherwise permitted.
Our business continues to generate significant cash flows from operations. Our target ratio of consolidated funded debt less qualified cash to Adjusted EBITDA is 3.5 times, and we expect that this ratio could typically range from 3.0 times to 4.0 times. We expect to continue to use excess cash flows from operations for debt repayment. We may also consider other allocations of our capital.
For additional information, refer to "Non-GAAP Financial Information" below for the calculation of the ratio of consolidated funded debt less qualified cash to adjusted EBITDA calculated in accordance with our 2016 Credit Agreement. Both consolidated funded debt and adjusted EBITDA as used in discussion of the 2016 Credit Agreement are terms that are not recognized under GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt.
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, consolidated funded debt and consolidated funded debt less qualified cash, which are not recognized terms under GAAP and do not purport to be alternatives to net income, earnings per share, gross profit, gross margin, operating income (expense) and operating margin as a measure of operating performance or an alternative to total debt as a measure of liquidity. 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, and operating income. 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 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 and these non-GAAP measures should be considered supplemental in nature and should not be construed as more significant than comparable 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 measures and a reconciliation to the nearest GAAP financial measure, please refer to the reconciliations on the following pages.
Key Highlights
Year Ended December 31, | |||||||||||||
(in millions, except percentages) | 2018 | 2017 | % Change | % Change Constant Currency (1) | |||||||||
Net sales | $ | 2,702.9 | $ | 2,700.6 | 0.1 | % | (0.3 | )% | |||||
Net income | 100.5 | 151.4 | (33.6 | )% | (32.7 | )% | |||||||
Adjusted net income(1) | 163.0 | 179.2 | (9.0 | )% | (8.3 | )% | |||||||
EBITDA (1) | 356.1 | 376.5 | (5.4 | )% | (5.0 | )% | |||||||
Adjusted EBITDA (1) | 424.7 | 445.6 | (4.7 | )% | (4.4 | )% | |||||||
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(1) | ||