10-K 1 tpx-20131231x10k.htm 10-K TPX-2013.12.31-10K
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, 2013
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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post 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. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting 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 ¨
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 28, 2013, computed by reference to the closing price for such stock on the New York Stock Exchange on such date, was approximately $2,620,902,918.
The number of shares outstanding of the registrant’s common stock as of February 21, 2014 was 60,640,581 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for the 2014 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
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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Special Note Regarding Forward-Looking Statements
 
This Annual Report on Form 10-K, (“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 (“Exchange Act”), which includes information concerning our plans; objectives; goals; strategies; future events; future revenues or performance; the impact of the macroeconomic environment in both the U.S. and internationally on sales and our business segments; strategic long-term investments; changes in capital expenditures; consumer confidence and the availability of consumer financing; changes in interest rates; litigation and similar issues; changes in foreign tax rates and changes in tax laws generally, including the ability to utilize tax loss carry forwards; the outcome of pending tax audits or other tax proceedings; financial flexibility; the impact of initiatives to respond to increased levels of competition in our industry; the impact of initiatives to accelerate growth, expand market share and attract sales; efforts to expand business within established accounts, improve account productivity, reduce costs and operating expenses and improve manufacturing productivity; changing commodity costs; initiatives to improve gross margin; the vertical integration of our business; the development, rollout and market acceptance of new products; the efficiency and effectiveness of our advertising campaigns and other marketing programs; our ability to further invest in the business and in brand awareness; our ability to meet financial obligations and continue to comply with the terms of our credit facilities, including financial ratio covenants; effects of changes in foreign exchange rates on our reported earnings; our expected sources of cash flow; our ability to effectively manage cash; our ability to align costs with sales expectations; and  our ability to successfully integrate Sealy Corporation (“Sealy”) into the Company’s operations and realize cost and revenue synergies and other benefits from the transaction, including expectations regarding product offerings, growth opportunities, value creation, and financial strength. Many of these statements appear, in particular, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in ITEM 7 of Part II of this Report. When used in this Report, the words “estimates,” “expects,” “anticipates,” “projects,” “proposed,” “plans,” “intends,” “believes” 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.
    
There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this Report. There are important factors, many of which are beyond the Company’s control, that could cause our actual results to differ materially from those expressed as forward-looking statements in this Report, including under the heading “Risk Factors” under ITEM 1A of Part 1 of this Report. 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 “Sealy” refers to Sealy Corporation and its historical subsidiaries.

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PART I
 
ITEM 1. BUSINESS    
 
General
 
We are the world's largest bedding provider. We develop, manufacture, market, and distribute bedding products, which we sell globally in approximately 100 countries. Our brand portfolio includes many of the most highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic®, Optimum™, 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 three business segments: Tempur North America, Tempur International and Sealy. Our Tempur North America segment consists of two U.S. manufacturing facilities in Virginia and New Mexico and our Tempur North America distribution subsidiaries. Our Tempur International segment consists of our manufacturing facility in Denmark, whose customers include all of our distribution subsidiaries and third party distributors outside our Tempur North America and Sealy segments. Our Sealy segment consists of company-owned and operated bedding and component manufacturing facilities located around the world, along with distribution subsidiaries, joint ventures, and licensees.

We sell our products through three distribution channels in each segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); Direct (e-commerce platforms, company-owned stores, and call centers); and Other (third party distributors, hospitality and healthcare customers).

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.
 
You may read and copy any materials the Company files with the SEC at the SEC’s public reference room at 100 F Street NE, Washington, DC 20549. The public may obtain information about the operation of the public reference room by calling the SEC at 1-800-SEC-0330. 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.

Acquisition of Sealy

On March 18, 2013, we completed the acquisition of Sealy and its subsidiaries, which manufacture and market a broad range of mattresses and foundations under the Sealy®, Sealy Posturepedic®, Optimum™ and Stearns & Foster® brands. Our acquisition of Sealy (“Sealy Acquisition”) is more fully described in Note 2, “Business Combination”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report. In connection with the Sealy Acquisition, the Company borrowed $1,900.0 million in aggregate principal to fund the purchase price, to repay Sealy's outstanding convertible and non-convertible debt and to repay all outstanding borrowings under the 2011 Credit Facility, which is more fully described in Note 5, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
 
Our Products

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. Our 2014 product introductions include the updated TEMPUR-Cloud® and TEMPUR-Contour™ collections, which feature more TEMPUR® material, an EasyRefresh™ removable cover and a cool-to-the-touch SmartClimate™ system. In addition, our new Stearns & Foster® mattresses will incorporate hybrid and cooling technologies. The updated Optimum® line features gel foam from the top to bottom of each mattress. We also introduced several products in our international markets, including six new Tempur mattresses featuring TEMPUR-BreezeTM technology. Additionally, we offer a range of comfort products which include pillows and other accessories.

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Bedding

Our bedding product category includes mattresses, foundations and adjustable foundations and represented 89.2% of our net sales in 2013. Our Tempur North America and Tempur International mattresses are composed of proprietary multi-layer, temperature sensitive, pressure-relieving TEMPUR® material that continuously conforms to the body. Additionally, our Tempur North America and Tempur International segments also offer several foundations and adjustable foundations. Our Sealy segment produces mattresses and foundations across a range of technologies, including innerspring, latex foam, innerspring/foam hybrid and visco-elastic “memory foam” and sells them directly to customers in North and South America. In addition, Sealy brands are represented by joint ventures and licensees throughout the world.

Other

Our other products include pillows, comfort products and components and represented 10.8% of our net sales in 2013.
    
Our Channels

We sell our products through three channels: Retail, Direct and Other.

Retail

Our Retail channel sells to furniture and bedding retailers, department stores and warehouse clubs, among others and represented 90.5% of net sales in 2013. Our top five customers accounted for approximately 27.5% of our net sales for the year ended December 31, 2013, with one customer in our Tempur North America and Sealy segment (Mattress Firm) accounting for more than 10.0% of our consolidated net sales. The loss of one or more of these customers could negatively impact our profitability.

Direct

Our Direct channel sells directly to consumers through our e-commerce platforms, company-owned stores, and our call centers and represented 4.8% of net sales in 2013.
 
Other

The Other channel sells to third party, health care and hospitality and represented 4.6% of net sales in 2013. Third party includes sales to distributors in countries where we do not sell directly through our own subsidiaries. Healthcare includes sales to hospitals, nursing homes, healthcare professionals and medical retailers. Hospitality sales include hotels.

Marketing and Sales

Our overall marketing strategy is to drive consumer demand through the use of effective marketing, which varies by segment.

Tempur North America

Our Tempur North America segment sells primarily through the Retail channel, which contributed 92.9% of Tempur North America segment net sales in 2013.Throughout the year, we relied on a series of strategic initiatives, which included: advertising investments, new product introductions and improvements in how we serve our Retail customers to stabilize our Tempur North America Retail channel. During 2013, we reintroduced our highly successful “Ask Me” advertising campaign. In 2014, we plan to drive growth in our Tempur North America segment through investments in new products, marketing and other initiatives.

Tempur International

Our Tempur International segment sells primarily through the Retail channel, which contributed 78.3% of Tempur International segment net sales in 2013. Additionally, our Tempur International net sales are impacted by the number of company-owned stores within the segment. We believe there is significant opportunity to drive sales growth in our Tempur International segment through the expansion of company-owned stores. Our advertising strategy in our Tempur International segment focuses on building brand awareness, which we believe is important to increasing our overall market share.

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Sealy

Our Sealy segment sells primarily through the Retail channel, which contributed 93.4% of Sealy segment net sales in 2013. Our Sealy segment focuses on providing quality products with widely-recognized brand names at competitive prices. The advertising strategy for our Sealy segment is largely based on cooperative advertising with our retailers. However, we have also increased national consumer advertising in recent years.
    
Seasonality
 
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 and higher in the first and third quarters. Internationally, we are subject to seasonality with European net sales lower in the third quarter as compared to the other quarters during the year.

Operations
 
Manufacturing and Distribution. Our products are currently manufactured and distributed through our global network of facilities.
 
Suppliers. In our Tempur North America and Tempur International segments we obtain the raw materials used to produce our pressure-relieving TEMPUR® material from outside sources. We currently acquire chemicals and proprietary additives for Tempur products from a number of suppliers with manufacturing locations around the world. We expect to continue these supplier relationships for the foreseeable future. We do not consider ourselves dependent upon any single outside vendor as a source of raw materials for Tempur products and believe that sufficient alternative sources of supply for the same or similar raw materials are available. Additionally, we source a portion of 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.

In our Sealy segment our 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 rely upon a single supplier for certain polyurethane foam components in our Sealy mattress units. These components are purchased under a supply agreement. We also purchase a significant portion of our Sealy foundation parts from third party sources under supply agreements, which require that we maintain certain volume allocations based on a proportional amount of material purchases. These volume allocations do not represent fixed purchase commitments. We are also dependent on a single supplier for the visco-elastic components and assembly of our Optimum™ specialty product lines. Except for our dependence regarding polyurethane foam, visco-elastic components and assembly of our Optimum™ specialty product lines, we do not consider ourselves to be dependent upon any single outside vendor as a source of supply to our bedding business, and we believe that sufficient alternative sources of supply for the same, similar or alternative components are available.

Research and Development. We have four research and development centers, three in the U.S. and one in Denmark, which 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. Research and development expenses were $21.0 million, $15.6 million and $9.9 million in 2013, 2012 and 2011, respectively.

Industry

We compete in the global bedding industry comprised of mattresses and foundations, pillows and accessories. The mattress market category is comprised of traditional innerspring mattresses, as well as non-innerspring mattresses that include visco-elastic and foam mattresses, innerspring/foam hybrid mattresses, airbeds and latex mattresses. The foundation category is comprised primarily of traditional foundations, but also includes adjustable foundations. The primary distribution channels for mattresses and foundations are retail furniture and bedding stores, as well as department stores, and warehouse clubs. 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 U.S. is the largest market in which we compete. Since 1992, U.S. wholesale bedding sales, which include mattresses and foundations, have grown at a compound annual growth rate, or CAGR, of 5.0%, reaching approximately $6,800.0 million in 2012 according to the International Sleep Products Association (“ISPA”). This growth has been driven by the increase in the U.S. population, natural replacement cycle of mattresses and an increase in the average unit selling prices (“AUSPs”).

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The U.S. mattress industry has benefited from a steady increase in AUSP over the past three decades, due in particular to the growth in premium priced non-innerspring mattresses but also due to various other factors including increasing mix of larger sized mattresses sold. As consumers have become increasingly aware of the health benefits of a good night’s sleep, which is often associated with the quality of their mattress, consumers have demonstrated a growing willingness to increase spending for higher quality mattresses and related bedding products. This trend has been further supported by the demographic shift in the population to consumers who are 45-64 years old and typically have a higher level of disposable income. The U.S. mattress industry has responded with the development of new, innovative technologies. Mattresses with enhanced features are typically sold at higher prices than traditional innerspring mattresses.

The traditional mattress innerspring category continues to account for the majority of industry mattress revenues; however the market for non-innerspring mattresses continues to grow. In 2012, traditional innerspring mattresses, excluding foundations, represented approximately $3,700.0 million of the bedding industry, and non-innerspring mattresses, excluding foundations, represented approximately $1,800.0 million of the industry, according to ISPA. The market for non-innerspring mattresses has grown from 22.0% in 2008 to 32.0% in 2012 of the overall U.S. mattress industry, according to ISPA.

The U.S. mattress industry has historically been correlated with the health of the overall economy and approximately 70% of new mattress purchases are typically driven by the replacement cycle. Factors that have shown some level of association with industry sales include overall GDP, housing turnover, personal disposable income, consumer confidence, interest rates and employment levels. As such, during recessionary periods, demand for mattresses declines as consumers reduce spending and delay discretionary purchases. During the most recent recession in 2008 and 2009, wholesale bedding sales experienced the greatest year-over-year decline in the past 20 years. Although demand improved in subsequent years, the increase in units sold was slower than in years following prior recessionary periods. Assuming the health of the overall economy continues to improve, we believe the mattress industry is well positioned for future growth.

Competition

The global bedding industry is highly competitive. We encounter competition from a number of mattress and foundation manufacturers in both domestic and international markets, as well as competition from a number of pillow and other bedding accessories manufacturers. Participants in each of these markets compete primarily on price, quality, brand name recognition, product availability and product performance.

We have a portfolio of brands and a complementary product offering, addressing most all price points, consumer preferences and points of distribution. Our mattress products compete with a number of different types of mattresses, including innerspring mattresses, visco-elastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These competing products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, Internet, telemarketing programs, television infomercials and catalogs. The U.S. pillow industry is characterized by a large number of competitors, none of which are dominant, but many of which have greater resources than us.

The U.S. mattress market has experienced consolidation in recent years. We, together with Serta Simmons, collectively accounted for a significant share of the wholesale bedding industry revenues in 2012 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, including Select Comfort Corporation, which competes in the non-innerspring mattress market and focuses on the air mattress market segment, and many others operating on a regional basis.

The international market for mattresses and pillows is generally served by a large number of manufacturers, primarily operating on a regional 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 and Trademarks
 
We hold various 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, 2013, 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 United States Patent and Trademark Office. In addition, we have U.S. applications pending for additional marks. 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 mark remains in use.

We own thousands of trademarks, tradenames, service marks, logos and design marks, including Sealy®, Stearns & Foster® and Sealy Posturepedic®. We also license the Bassett® tradename in various territories under a long term agreement.
    
Our licenses include rights for the licensees to use trademarks as well as current proprietary or patented technology utilized by us. We also provide our licensees with product specifications, quality control inspections, research and development, statistical services and marketing programs. Only the New Jersey, Australia, United Kingdom and Jamaica licenses are of perpetual duration (with some rights of termination), while the other licenses are for a set duration or are indeterminate in length and subject to reasonable notice provisions. All licenses have provisions for termination for cause (such as bankruptcy, misuse of the mark or violation of standards), approval of marketing materials, audit rights and confidentiality of proprietary data. With the exception of the Sealy New Jersey license discussed below, the domestic licenses are predominantly trademark licenses. Also, with the exception of the Sealy New Jersey license (which is of perpetual duration), each domestic license is limited by a period of years, all of which are for a length of five years or less.

Licensing

Our Sealy business segment derives income from royalties by licensing Sealy® brands, technology and trademarks to other manufacturers. At December 31, 2013, there were 23 separate license agreements in effect with 8 domestic and 15 foreign independent licensees. Sealy New Jersey (a bedding manufacturer), Rooms To Go (a furniture retailer), Kolcraft Enterprises, Inc. (a crib mattress manufacturer), Dog Pacer (a dog bed manufacturer), and Mantua Manufacturing Co. (a bed frame manufacturer), Chairworks (a chair manufacturer), Downlite (a pillow manufacturer) and American Textile Company (a comforter and mattress pad manufacturer) are the only domestic manufacturers that are licensed to use the Sealy trademark, subject to the terms of license agreements. Under license agreements between Sealy New Jersey and us, Sealy New Jersey has the perpetual right to use certain of our trademarks in the manufacture and sale of Sealy® brand and Stearns & Foster® brand products in selected markets in the United States. In addition, we have a joint venture with Comfort Revolution.
    
Our foreign license agreements provide exclusive rights to market the Sealy brand in Australia, Thailand, Japan, the United Kingdom, continental Europe, Brazil, Columbia, Paraguay, South Africa, Israel, Saudi Arabia, Jamaica, Venezuela, Honduras and the Dominican Republic. Additionally, we have license agreements in place with our joint ventures including those in Asia, New Zealand and India. These licensing agreements allow us to reduce our exposure to political and economic risk abroad by minimizing investments in those markets.

Our licensing group generates royalties by licensing Sealy® brand technology and trademarks to manufacturers located throughout the world. We also provide our licensees with product specifications, research and development, statistical services and marketing programs. For the period ended March 18, 2013 through December 31, 2013, the licensing group as a whole generated unaffiliated gross royalties of approximately $13.7 million.

Governmental Regulation
 
Our operations are subject to state, local and foreign consumer protection and other regulations relating to the mattress and pillow industry. These regulations vary among the states and countries 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 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 these additional standards. We are also subject to environmental and health and safety requirements with regard to the manufacture of our products and conduct of our operations and facilities. We have made and will continue to make capital and other expenditures necessary to comply with all these requirements. Currently these expenditures are immaterial to our financial results.


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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 (primarily by recycling) small amounts of used machine lubricating oil and air compressor waste oil. In the United States, 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. Except as set forth in “Legal Proceedings”, included in Part I, ITEM 3 of this Report, 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, should not have any material effect upon our capital expenditures, earnings or competitive position. We are not aware of any pending federal environmental legislation which would have a material impact on our operations. Except as set forth in “Legal Proceedings”, included in Part I, ITEM 3 of this Report, we have not been required to make and do not expect to make any material capital expenditures for environmental control facilities in the foreseeable future.

Employees
 
As of December 31, 2013, we had approximately 6,700 Tempur Sealy employees, with approximately 4,100 in North America, approximately 300 in Denmark and approximately 2,300 in the rest of the world. Approximately 35.0% 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 three years in length, expire at various times beginning in 2014 through 2016. As of December 31, 2013, our domestic operations employed approximately 400 individuals covered under collective bargaining agreements expiring in 2014. Our international operations employed approximately 300 individuals covered under collective bargaining agreements expiring in 2014.

Executive Officers of the Registrant
 
This information is incorporated herein by reference from our definitive proxy statement for the 2014 Annual Meeting of Stockholders (the “Proxy Statement”) under the section entitled “Proposal One—Election of Directors—Executive Officers.”

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 has been affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The U.S. macroeconomic environment remains uncertain and was the primary factor in a slowdown in the mattress industry starting in 2008. In addition, our International segment experienced weakening as a result of general business and economic conditions beginning in 2012. The global economy remains unstable, and we expect the economic environment to continue to be challenging as continued economic uncertainty has generally given households less confidence to make discretionary purchases.

In particular, the financial crisis that affected the banking system and financial markets and the current uncertainty in global economic conditions have resulted in a tightening in the credit markets, a low level of liquidity in many financial markets and volatility in credit, equity and fixed income markets. There could be a number of other effects from these economic developments on our business, including reduced consumer demand for products; insolvency of our customers, resulting in increased provisions for credit losses; 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; and counterparty failures negatively impacting our treasury operations. If such conditions are experienced in future periods, our industry, business and results of operations may be severely impacted.


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In addition, the negative worldwide economic conditions and market instability makes it increasingly difficult for us, our customers and our suppliers to accurately forecast future product demand trends, which could cause us to produce excess products that can increase our inventory carrying costs. Alternatively, this forecasting difficulty could cause a shortage of products, or materials used in our products, that could result in an inability to satisfy demand for our products and a loss of market share.

Our leverage may limit our flexibility and increase our risk of default.

As a result of our acquisition of Sealy, our long-term debt outstanding has increased substantially, which, in turn, has increased our leverage (for information regarding these topics, see “Management’s Discussion and Analysis” included in Part II, ITEM 7 of this Report and Note 5, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report. 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, therefore 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 our obligations with respect 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; and
exposing us to variability in interest rates, as a substantial portion of our indebtedness are and will be variable rate.

In addition, the instruments governing our debt contain 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, which could put us at a competitive disadvantage. Our failure to comply with these covenants may result in an event of default. If such event of default is not cured or waived, we may suffer adverse effects on our operations, business or financial condition, including acceleration of our debt. 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 5, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

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;
ability of our future product launches to increase net sales;
the effectiveness of our advertising campaigns and other marketing programs in building product and brand awareness, driving traffic to our distribution channels and increasing sales;
our ability to continue to successfully execute our strategic initiatives;
the level of consumer acceptance of our products; and
general economic factors that negatively impact consumer confidence, disposable income or the availability of consumer financing.

Over the last few years, we have had to manage our business both through periods of rapid growth and the uncertain economic environment. A source of our growth within this time frame has been through expanding distribution of our products into new stores, principally furniture and bedding retail stores in the U.S. Some of these retail stores may undergo restructurings, experience financial difficulty or realign their affiliations, which could decrease the number of stores that carry our products. Our future sales growth will increasingly depend on our ability to generate additional sales in our existing accounts in the Retail channel. If we are unable to increase product sales in our existing retail accounts at a sufficient rate overall, our net sales growth could slow or decline.

We may seek to acquire an additional business or businesses in order to increase sales growth, and any acquisition could be disruptive to our ongoing business, create integration issues, require additional borrowings or share issuances, or create other risks for our business.

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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. Our mattresses compete with a number of different types of mattress alternatives in all price categories, including standard innerspring mattresses, viscoelastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These alternative products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, Internet, telemarketing programs, television infomercials and catalogs.
 
A number of our significant competitors offer mattress and pillow products that compete directly with our products. Any such competition by established manufacturers or new entrants into the market could have a material adverse effect on our business, financial condition and operating results. The pillow industry is characterized by a large number of competitors, none of which are dominant, but many of which have greater resources than us. The highly competitive nature of the mattress and pillow industries means we are continually subject to the risk of loss of significant new product launches by our competitors, market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.

Over the last several years, the mattress market has been more competitive than at any time in our experience, which has adversely affected our results. In particular, competitors have expanded into the non-innerspring segments, which has adversely impacted our Tempur North America segment’s market share and margins. In addition, hybrid mattresses sold by competitors can adversely impact sales of our non-innerspring mattresses. The acquisition of Sealy has provided us additional tools allowing us to compete more effectively across the industry, but if this environment continues and our response is not successful, our results would continue to be adversely affected.

Because we depend on our significant customers, a decrease or interruption in their business with us would reduce our sales and profitability.

Our top five customers, collectively, account for more than 25% of our net sales for 2013, with one customer, whose net sales are included in both the Tempur North America and Sealy segments, accounting for more than 10% of our net sales. The credit environment in which our customers operate has been relatively stable over the past few years. However, the continued management of credit risk by financial institutions has caused a decrease in the availability of credit for mattress retailers. In certain instances, this has caused mattress retailers to exit the market or be forced into bankruptcy. Furthermore, many of our customers rely in part on consumers’ ability to finance their mattress purchases with credit from third parties. If customers are unable to obtain financing, they may defer their purchases. We expect that some of the retailers that carry our products may consolidate, undergo restructurings or reorganizations, experience financial difficult, 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. 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 liquidity and profitability.

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. Domestic supplies of these raw materials are being limited by supplier consolidation, the impact on the cost of these products as a result of changes in the strength of the dollar compared to other currencies and other forces beyond our control. Certain raw materials that we purchase for production are chemicals and proprietary additives, which are influenced by oil prices. 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. 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.
 

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We are subject to a pending tax proceeding in Denmark, and an adverse decision would reduce our liquidity and profitability.

We have received income tax assessments from the Danish Tax Authority (“SKAT”). We believe we have meritorious defenses to the proposed adjustments and will oppose the assessments, as necessary in the appropriate Danish venue. We believe the litigation process to reach a final resolution of this matter could potentially extend over the next five years. If we are not successful in defending our position that we owe no additional taxes, we could be required to pay a significant amount to SKAT, which could impair or reduce our liquidity and profitability. For a description of these assessments and additional information with respect to these assessments and the various related legal proceedings, see “Legal Proceedings” included in Part I, ITEM 3 of this Report and Note 13, “Income Taxes”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

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.

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 impact 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 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 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;
our ability to maintain public association of our brands, including overcoming any impact on our brand caused by some of our customers seeking to sell our products at a discount to our recommended price; and
our ability to successfully integrate after the Sealy Acquisition.
 
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. In 2013 we had a large number of new product launches, and we expect that trend to continue in 2014 and subsequent years. 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, introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, which could impact profitability.

We may not be able to successfully integrate and combine Sealy with our business, which could cause our business to suffer.

Our acquisition of Sealy is significant, and we may not be able to successfully integrate and combine the operations, personnel and technology of Sealy with our operations. Because of the size and complexity of Sealy’s business, if we do not successfully manage the integration, we may experience interruptions in our business activities, a deterioration in our employee and customer relationships, increased costs of integration and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations. We may also experience difficulties in combining corporate cultures, maintaining employee morale and retaining key employees. The integration may also impose substantial demands on our management. There is no assurance that improved operating results will be achieved as a result of the Sealy Acquisition or that the businesses of Sealy and Tempur-Pedic will be successfully integrated in a timely manner.
 

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Our advertising expenditures and customer subsidies may not result in increased sales or generate the levels of product and brand name awareness we desire and we may not be able to manage our advertising expenditures on a cost-effective basis.

A significant component of our marketing strategy involves the use of direct marketing to generate brand awareness and sales. Future growth and profitability will depend in part on the cost and efficiency of our advertising expenditures, including our ability to create greater awareness of our products and brand names and determine the appropriate creative message and media mix for future advertising expenditures and to incent the promotion of our products.

Our operating results are increasingly 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 Retail channel, particularly net sales to furniture and bedding stores. We believe that our sales of bedding and other products to furniture and bedding stores are subject to seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters and higher in the first and third quarters, and in Europe, lower in the third quarter. Our net sales may be affected increasingly by this seasonality, particularly as our Retail sales channel continues to grow as a percentage of our overall net sales and, to a lesser extent, by seasonality in our international markets. Our third quarter sales are typically higher than other quarters. 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.

In addition to seasonal fluctuations, the demand for our products can fluctuate significantly based on a number of other factors, including general economic conditions, consumer confidence, the timing of new product introductions or price increases announced by us or our competitors and promotions we offer or offered by our competitors.

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.

Over one fourth of our net sales were generated outside of the United States in 2013. As a multinational company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign exchange rates. 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 between our subsidiaries and their customers and suppliers, as well as among certain subsidiaries. The hedging transactions may not succeed in managing our foreign currency exchange rate risk. Refer to “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report.
 
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. Except as noted above, we do not enter into hedging transactions to hedge this risk. Consequently, our reported earnings and financial position could fluctuate materially as a result of foreign exchange gains or losses. Should currency rates change sharply, our results could be negatively impacted. Refer to “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report.

We are subject to risks from our international operations, such as foreign exchange, 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 over one fourth of our net sales outside of the United States in 2013, and we continue to pursue additional international opportunities. 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 foreign laws and regulations 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.


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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 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 manufacturing processes. Accordingly, we may not be able to prevent others from developing viscoelastic 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 on aspects of our products and have patent applications pending on aspects of our products and manufacturing processes. However, the principal product formula and manufacturing processes for our TEMPUR® material and our products 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 trade names and service marks and have applications for the registration of trade names and service marks pending domestically and abroad. We also license certain intellectual property rights from third parties.

Our trademarks are currently registered in the U.S. and registered or pending in foreign jurisdictions. 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.
 
An increase in our product return rates or an inadequacy in our warranty reserves could reduce our liquidity and profitability.
 
We allow consumers to return certain products for comfort reasons. As we expand our sales, our return rates may not remain within our historical levels. A downturn in general economic conditions may also increase our product return rates. An increase in return rates could significantly impair our liquidity and profitability.

We also provide our consumers warranties on our products ranging from 3 to 25 years. However, as we have released new products in recent years, many of which are fairly early in their product life cycles, we may still see significant warranty claims on products still under warranty. Also, in line with our strategy, as we continue to innovate to provide new products to our customers, we could be susceptible to unanticipated risks with our warranty claims, which could impair our liquidity and profitability.

Because not all of our products have been in use by our customers for the full warranty period, we rely on the combination of historical experience and product testing for the development of our estimate for warranty claims. However, our actual level of warranty claims could prove to be greater than the level of warranty claims we estimated based on our products’ performance during product testing. If our warranty reserves are not adequate to cover future warranty claims, their inadequacy could have a material adverse effect on our liquidity and profitability.


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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. 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.

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, 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 it elsewhere, perhaps at a higher cost. In addition, if one of our major suppliers, or several of our suppliers, declare bankruptcy or otherwise cease operations, our supply chain could be materially disrupted. 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.

We are dependent upon a single supplier for certain structural components and assembly of our specialty product lines within the Sealy brand portfolio. These products are purchased under a supply agreement and are manufactured in accordance with proprietary designs jointly owned by us and the supplier. If we experience a loss or disruption in its supply of these products, we may have difficulty sourcing substitute components on favorable terms. In addition, any alternative source may impair product performance or require Sealy to alter the manufacturing process relating to these products, which could have an adverse effect on profitability.
 
We rely significantly on information technology and any failure, inadequacy, interruption or security lapse of that technology could harm our ability to effectively operate our business.
 
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.

Certain of Sealy’s systems are dated and require significant upgrades. Sealy depends on accurate and timely information and numerical data from key software applications to aid its day-to-day business, financial reporting and decision making and, in many cases, aged and custom designed software is necessary to operate its bedding plants. Sealy has put in place disaster recovery plans for its critical systems. Sealy is, however, dependent on certain key personnel and consultants as these applications are no longer supported by the vendor. Any disruptions caused by the failure of these systems could adversely impact Sealy’s day-to-day business and decision making and could have a material adverse effect on its performance. We plan to integrate Sealy into our information systems but could suffer disruptions during such process.
 

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Unexpected equipment failures, delays in deliveries or catastrophic loss delays may lead to production curtailments or shutdowns.

We manufacture and distribute products to our customers from our network of manufacturing facilities located around the world. An interruption in production capabilities at any of these manufacturing facilities could result in our inability to produce our products, which would reduce our net sales and earnings for the affected period. In addition, we generally deliver our products only after receiving the order from the customer or the retailer, and in certain facilities, on a just-in-time basis, and thus do not hold significant levels of inventories. In the event of a disruption in production at any of our manufacturing facilities, even if only temporary, or if we experience delays as a result of events that are beyond our control, delivery times could be severely affected. For example, a third party carrier could potentially be unable to deliver our products within acceptable time periods due to a labor strike or other disturbance in its business. Any significant delay in deliveries to our customers could lead to increased returns or cancellations and cause us to lose future sales. Any increase in freight charges could increase our costs of doing business and affect our profitability. We have introduced new distribution programs to increase our ability to deliver products on a timely basis, but if we fail to deliver products on a timely basis, we may lose sales which could decrease our liquidity and profitability. Our manufacturing facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. Despite the fact that we maintain insurance covering the majority of these risks, we may in the future experience material plant shutdowns or periods of reduced production as a result of equipment failure, delays in deliveries or catastrophic loss.

We may not realize the growth opportunities that are anticipated from our acquisition of Sealy.

The benefits we expect to achieve as a result of the Sealy Acquisition will depend, in part, on our ability to realize anticipated growth opportunities. Our success in realizing these growth opportunities, and the timing of this realization, depends on the successful integration of Sealy’s business and operations with our business and operations. Even if we are able to integrate our business with Sealy’s business successfully, this integration may not result in the realization of the full benefits of the growth opportunities we currently expect from this integration within the anticipated time frame or at all. While we anticipate that certain expenses will be incurred, such expenses are difficult to estimate accurately, and may exceed current estimates. In addition, certain retail customers of our combined company could determine that the combined company's business has too much exposure to that retail customer, and reduce focus on our products or otherwise promote competitors’ products more aggressively, which could have a material adverse effect on the combined company's sales and offset the synergies expected from the Sealy Acquisition. Accordingly, the benefits from the Acquisition may be offset by costs incurred or delays in integrating the companies, which could cause our revenue assumptions to be inaccurate.
 
We may not be able to achieve the full amount of cost synergies that are anticipated, or achieve the cost synergies on the schedule anticipated, from the Sealy Acquisition.
 
Although we currently expect to achieve in excess of $70.0 million of cumulative cost synergies by 2016, inclusion of the projected cost synergies in this Report should not be viewed as a representation that we in fact will achieve these cost synergies by 2016 or at all.

We currently expect cost synergies to be realized in three primary areas: sourcing and manufacturing, warehouse and distribution, and corporate and other SG&A expenses. Sourcing and manufacturing cost synergies are expected to result from increased purchasing, supply chain and manufacturing efficiencies, principally focused on duplicative efforts, such as lower cost sourcing and combined manufacturing costs as we seek to leverage our combined capabilities and consolidation of purchasing across products. Warehouse and distribution cost synergies are expected to result from consolidation of our and Sealy’s product warehouses and distribution routes resulting in improved route efficiency and distribution integration. Corporate and other SG&A cost synergies are expected to be realized through consolidation of various corporate expenses, including elimination of duplicative services and streamlining of corporate administration.

In order to identify areas for potential synergies, we have undertaken the following efforts:

senior management and functional area leaders have reviewed and continue to review functional areas across both our operations, on a standalone basis and on a combined basis;
senior management team members, together with outside consultants, conducted an analysis assessing areas of duplication and projected growth, determining projected synergy levels from the perspective of both senior management and functional area leaders; and

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senior management teams conducted analyses to assess the cost savings opportunities related to distribution, supply chain, sourcing, manufacturing efficiencies and corporate expenses. For example, in the areas of distribution, each company assessed their respective costs to deliver mattresses and foundations on a per piece basis throughout their U.S. operations and the opportunity to leverage transportation capacity and improve service levels resulting in an anticipated substantial savings on a per piece delivery basis.

Through this process, we have identified targeted cost synergies in various operating functions including manufacturing and distribution. We continue to evaluate our estimates of cost synergies to be realized and refine them, so that our actual cost synergies could differ materially from our current estimates. Actual cost synergies, the expenses required to realize the cost synergies and the sources of the cost synergies could differ materially from these estimates, and we cannot assure you that we will achieve the full amount of cost synergies on the schedule anticipated or at all or that these cost synergy programs will not have other adverse effects on our business.

The assumption of unknown liabilities in the Sealy Acquisition may harm our financial condition and results of operations.

As a result of the Sealy Acquisition, we acquired Sealy subject to all of its liabilities, including contingent liabilities. If there are unknown obligations, our business could be materially and adversely affected. We may learn additional information about Sealy’s business that adversely affects us, such as unknown liabilities, or issues that could affect our ability to comply with applicable laws. As a result, we cannot assure you that the acquisition of Sealy will be successful or will not, in fact, harm our business. Among other things, if Sealy’s liabilities are greater than expected, or if there are material obligations of which we do not become aware until after the acquisition, our business could be materially and adversely affected. If we become responsible for substantial uninsured liabilities, such liabilities may have a material adverse effect on our financial condition and results of operations.

We will incur significant transaction and integration costs in connection with the Sealy Acquisition.

We have incurred and expect to incur additional significant costs associated with completing the Sealy Acquisition and integrating the operations of the two companies. The substantial majority of these costs will be non-recurring expenses resulting from the Sealy Acquisition and will consist of transaction costs related to the Sealy Acquisition, facilities and systems consolidation costs and employment-related costs. Additional unanticipated costs may be incurred in the integration of our businesses. Although we expect that the elimination of duplicative costs, as well as the realization of other efficiencies related to the integration of the businesses, may offset incremental transaction and acquisition costs over time, this net benefit may not be achieved in the near term, or at all.
  
As part of the Sealy Acquisition, we assumed a portion of Sealy’s 8.0% Senior Secured Third Lien Convertible Notes due 2016 (“8.0% Sealy Notes”), which could impact our liquidity, and increases our leverage and risk of default.

A portion of the 8.0% Sealy Notes remain outstanding after completion of the Sealy Acquisition. Holders of the 8.0% Sealy Notes may choose to convert to cash the amount outstanding at their discretion prior to maturity. Upon conversion prior to maturity, we would be required to pay the holders within 3 business days after the receipt of the notice of conversion. The conversion of an unusually large number of the 8.0% Sealy Notes prior to maturity could have a significant impact on our liquidity. For additional information regarding the 8% Sealy Notes, “Management’s Discussion and Analysis” included in Part II, ITEM 7 of this Report and Note 5, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
  
The loss of the services of any members of our senior 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 senior management team. As we integrate and combine Sealy with our business, we expect that key senior management team members will leave the Company. 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 senior 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, 2013, we had approximately 6,700 full-time employees. Approximately 35.0% 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 and will continue to be 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. Compliance with these regulations may have an adverse effect on our business. 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 U.S. Consumer Product Safety Commission (“CSPC”) has adopted rules relating to fire retardancy standards for the mattress industry. We developed product modifications that allow us to meet these standards. Required product modifications have added cost to our products. Many foreign jurisdictions also regulate fire retardancy standards, and changes to these standards and changes in our products that require compliance with additional standards would raise similar risks. Further, some states and the U.S. Congress continue to consider open flame regulations for mattresses and bed sets or integral components that may be different or more stringent than the CPSC standard and we may be required to make different products for different states or change our processes or distribution practices nationwide. It is possible that some states’ more stringent standards, if adopted and enforceable, could make it difficult to manufacture a cost effective product in those jurisdictions and compliance with proposed new rules and regulations may increase our costs, alter our manufacturing processes and impair the performance of our products. As we abide by certain new open flame regulations, our products and processes may be governed more rigorously by certain state and federal environmental and health and safety standards as well as the provisions of 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.


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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 United States 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.

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.

The three legacy Tempur-Pedic manufacturing locations are certified to ISO 14001:2004. This is a voluntary standard that provides a framework for an environmental management system. Each Tempur-Pedic facility sets site-specific goals for continually improving its performance within this important area. Environmental goals may include reducing energy consumption, improving water conservation, generating less waste, and recycling. Our system is audited by an independent third party to ensure we are making progress toward our stated goals. As part of the integration efforts, is ongoing at Sealy manufacturing facilities to implement similar environmental measures.

We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. With respect to the acquisition of Sealy, we could incur costs related to certain remediation activities. In particular, Sealy is currently addressing the clean-up of environmental contamination at certain of its former facilities. For additional information regarding these remediation activities, Refer to Note 12, “Commitments and Contingencies”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for a discussion of Commitments and Contingencies. In the event of an adverse development or decision by one or more of the governing environmental authorities, additional contamination being discovered with respect to these or other properties or any third parties bringing claims related to these or other properties, these or other matters could have a material effect on our profitability.
 
Our pension plans are currently underfunded and will be required to make cash payments to the plans, reducing our available cash.

We maintain a domestic noncontributory, defined benefit pension plan covering current and former hourly employees at four of Sealy’s active plants and eight previously closed facilities as well as a Canadian noncontributory, defined benefit pension plan covering the employees of a facility of Sealy’s Canadian operations. We record a liability associated with these plans equal to the excess of the benefit obligation over the fair value of plan assets. If the performance of the assets in these pension plans does not meet our expectations, or if other actuarial assumptions are modified, our future cash payments to the plans could be higher than expected. The domestic pension plan is subject to the Employee Retirement Income Security Act of 1974 (“ERISA”). Under ERISA, the Pension Benefit Guaranty Corporation (“PBGC”) has the authority to terminate an underfunded pension plan under limited circumstances. In the event the domestic pension plan is terminated for any reason while it is underfunded, we will incur a liability to the PBGC that may be equal to the entire amount of the underfunding.

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. If a participating employer ceases its contributions to the plan, the unfunded obligations of the plan allocable to the withdrawing employer may be borne by the remaining participant employers. Further, if we withdraw from a multi-employer pension plan in which we participate, we may be required to pay those plans an amount based on our allocable share of the underfunded status of the plan. Such events may significantly impair our profitability and liquidity.


19


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.

We are subject to taxation in various jurisdictions around the world. In preparing financial statements, we calculate our respective 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 changes in accounting, tax laws or regulations. A significantly higher effective income tax rate than currently anticipated could have an adverse effect on our business, results of operations and liquidity.

Officials in some of the jurisdictions in which we do business, including the United States, have proposed or announced that they are considering tax increases and other revenue raising laws and regulations. Any resulting changes in tax laws or regulations could increase our effective tax rate or impose new restrictions, costs or prohibitions on our current practices and reduce our net income and adversely affect our cash flows.

Challenges to our pricing policies could adversely affect our operations.

Certain of our retail pricing policies are subject to antitrust regulations in the U.S. and abroad. If antitrust regulators in any jurisdiction in which we do business initiate investigations into or challenge our pricing or advertising policies, our efforts to respond could force us to divert management resources and we could incur significant unanticipated costs. If such an investigation 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 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 suit against us could result in potential liabilities, substantial costs 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 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;
stock repurchase programs;
bankruptcies of any of our major customers;
conditions or trends in the mattress industry generally;
additions or departures of key personnel;
announcements by us or our competitors 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.


20


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.

Provisions of Delaware law and our charter documents could delay or prevent an acquisition of us, even if the acquisition would be beneficial to you.

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 when nominating our directors; and
the inability of our stockholders to convene a stockholders’ meeting without the chairperson of the board, the president, or a majority of the board of directors first calling the meeting.

ITEM 1B. UNRESOLVED STAFF COMMENTS
 
None.


21


ITEM 2. PROPERTIES

The following table sets forth certain information regarding our principal Tempur Sealy facilities at December 31, 2013.
Name
 
Location
 
Approximate
Square
Footage
 


Title
 


Type of Facility
Tempur Production USA, LLC
 
Albuquerque, New Mexico
 
800,000
 
Leased
 
Manufacturing
Tempur Production USA, LLC
 
Duffield, Virginia
 
540,000
 
Owned
 
Manufacturing
Dan-Foam ApS
 
Aarup, Denmark
 
517,000
 
Owned
 
Manufacturing
Tempur-Pedic Management, LLC
 
Lexington, Kentucky
 
128,000
 
Owned
 
Office
Tempur Deutschland GmbH
 
Steinhagen, German
 
121,000
 
Owned
 
Warehouse
Sealy Mattress Co. of Albany, Inc.
 
Green Island, New York
 
257,000
 
Leased
 
Manufacturing
Ohio-Sealy Mattress Manufacturing Co.
 
Conyers, Georgia
 
278,000
 
Owned
 
Manufacturing
Sealy Mattress Company of Illinois
 
Batavia, Illinois
 
210,000
 
Leased
 
Manufacturing
Sealy Texas Management, Inc.
 
Brenham, Texas
 
220,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Denver, Colorado
 
69,000
 
Owned (a)
 
Manufacturing
Sealy Texas Management, Inc.
 
North Richland Hills, Texas
 
125,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Trinity, North Carolina
 
151,000
 
Owned
 
Manufacturing
Sealy Mattress Co. of Kansas City, Inc.
 
Kansas City, Kansas
 
122,000
 
Leased
 
Manufacturing
Sealy Mattress Company
 
Medina, Ohio
 
142,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Orlando, Florida
 
225,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Phoenix, Arizona
 
252,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Richmond, California
 
240,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
South Gate, California
 
178,000
 
Leased
 
Manufacturing
Sealy of Minnesota, Inc.
 
St Paul, Minnesota
 
89,000
 
Owned (a)
 
Manufacturing
Sealy of Maryland and Virginia, Inc.
 
Williamsport, Maryland
 
144,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Lacey, Washington
 
134,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Portland, Oregon
 
140,000
 
Owned (a)
 
Manufacturing
The Ohio Mattress Company and Licensing and Components Group, Inc.
 
Colorado Springs, Colorado
 
74,000
 
Owned (a)
 
Manufacturing
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Delano, Pennsylvania
 
151,000
 
Owned (a)
 
Manufacturing
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Mountain Top, Pennsylvania
 
210,000
 
Leased
 
Manufacturing
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Rensselaer, Indiana
 
141,000
 
Owned (a)
 
Manufacturing
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Colorado Springs, Colorado
 
87,000
 
Leased
 
Warehouse
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Rensselaer, Indiana
 
32,000
 
Owned (a)
 
Warehouse
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Hometown, Pennsylvania
 
55,000
 
Leased
 
Warehouse
Sealy Mattress Company
 
Medina, Ohio
 
15,000
 
Leased
 
Warehouse
Sealy Mattress Manufacturing Co. Inc.
 
Lacey, Washington
 
134,000
 
Leased
 
Warehouse
Sealy Canada, Ltd
 
Alberta, Canada
 
145,000
 
Owned (a)
 
Manufacturing
Sealy Canada, Ltd
 
Ontario, Canada
 
131,000
 
Leased
 
Manufacturing
Sealy Canada, Ltd
 
Quebec, Canada
 
76,000
 
Owned (a)
 
Manufacturing
Sealy Argentina SRL
 
Buenos Aires, Argentina
 
85,000
 
Owned
 
Manufacturing
Sealy Mattress Company Mexico, S. de R.L. de C.V.
 
Toluca, Mexico
 
157,000
 
Owned
 
Manufacturing
Sealy do Brasil, Limitada
 
Sorocaba, Brazil
 
92,000
 
Owned (b)
 
Manufacturing
Sealy Mattress Company of Puerto Rico
 
Carolina, Puerto Rico
 
59,000
 
Owned (a)
 
Manufacturing
Sealy Uruguay SRL
 
Montevidea, Uruguay
 
40,000
 
Leased
 
Manufacturing

(a)
We have granted a mortgage or otherwise encumbered our interest in this facility as collateral for secured indebtedness.

22


(b)
This facility represents our former manufacturing facility in Brazil which is currently being leased to a third party over a period of twelve years.

 In addition to the properties listed above, we have 80 facilities in 20 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.

ITEM 3. LEGAL PROCEEDINGS

 (a) Norfolk County Retirement System, Individually and on behalf of all others similarly situated, Plaintiff v. Tempur-Pedic International Inc., Mark A. Sarvary and Dale E. Williams; filed June 20, 2012

Arthur Benning, Jr., Individually and on behalf of all others similarly situated, Plaintiff v. Tempur-Pedic International Inc., Mark A. Sarvary and Dale E. Williams; filed June 25, 2012

On June 20 and 25, 2012, the above suits were filed against the Company and two named executive officers in the United States District Court for the Eastern District of Kentucky, purportedly on behalf of a proposed class of shareholders who purchased the Company’s stock between January 25, 2012 and June 5, 2012. The complaints assert claims under Sections 10(b) and 20(a) of the Exchange Act, alleging, among other things, false and misleading statements and concealment of material information concerning the Company’s competitive position, projected net sales, earnings per diluted share and related financial performance for the Company’s 2012 fiscal year. The plaintiffs seek damages, interest, costs, attorney’s fees, expert fees and unspecified equitable/injunctive relief. The Company strongly believes that the shareholder suits lack merit and intends to defend against the claims vigorously. The outcome of these matters is uncertain, however, and although the Company does not currently expect to incur a loss with respect to these matters, the Company cannot currently predict the manner and timing of the resolution of the suits, an estimate of a range of losses or any minimum loss that could result in the event of an adverse verdict in these suits, or whether the Company’s applicable insurance policies will provide sufficient coverage for these claims. Accordingly, the Company can give no assurance that these matters will not have a material adverse effect on the Company’s financial position or results of operations.  

(b) Sealy Mattress Company of NJ, Inc., David Hertz, individually, as trustee of, respectively, the Allison Lindsay Hertz Trust, the Samuel Douglas Hertz Trust, the Sydney Lauren Hertz Trust, the U/A DTD 08/21/97 Andrew Michael Marcus Trust, the U/A DTD 08/21/97 Julia Robyn Marcus Trust, and the U/A DTD 08/21/97 James Daniel Marcus Trust, and as executor of the Estate of Walter Hertz, Lisa Marcus, Rose Naiman, Michael Shoobs, and Diane Shoobs, individually and as custodian of the Robert S. Shoobs UTMA NJ v. Sealy Corporation, filed June 27, 2013.  With respect to the Sealy Acquisition, holders of approximately 3.1 million shares of Sealy common stock sent notices to Sealy purporting to exercise their appraisal rights in accordance with the Merger Agreement executed on September 26, 2012. In order to preserve these appraisal rights, any such former stockholder was required to commence an appraisal proceeding in the Delaware courts within 120 days after March 18, 2013. Sealy has expressly reserved its rights to contest that any or all of such notices were not delivered timely or otherwise not in the form required under Delaware law. On June 27, 2013, an appraisal proceeding was commenced in the Delaware Court of Chancery (the “Appraisal Action”).  If the fair value of the Sealy common stock formerly held by the former Sealy stockholders seeking the appraisal is determined to be greater than the $2.20 per share paid pursuant to the Merger Agreement, Sealy would be required to pay such difference, plus interest at the statutory rate, which could impact the Company’s financial condition and  liquidity.

(c) Michael Dodson, Alvin Todd, and Henry and Mary Thompson, individually and on behalf of all others similarly situated, Plaintiffs v. Tempur Sealy International, Inc., formerly known as Tempur-Pedic International, Inc. and Tempur-Pedic North America, LLC, Defendants; filed October 25, 2013

On October 25, 2013, a suit was filed against Tempur Sealy International and one of its domestic subsidiaries in the United States District Court for the Northern District of California, purportedly on behalf of a proposed class of “consumers” as defined by Cal. Civ. Code § 1761(d) who purchased, not for resale, a Tempur-Pedic mattress or pillow in the State of California. On November 19, 2013, the Company was served for the first time in the case but with an amended petition adding additional class representatives for additional states. The purported classes seek certification of claims under applicable state laws.

23


The complaint alleges that the Company engaged in unfair business practices, false advertising, and misrepresentations or omissions related to the sale of certain products. The plaintiffs seek restitution, injunctive relief and all other relief allowed under applicable state laws, interest, attorneys’ fees and costs. The purported classes do not seek damages for physical injuries. The Company believes the case lacks merit and intends to defend against the claims vigorously. This matter is at a very preliminary stage, and the outcome is uncertain. As a result, the Company is unable to reasonably estimate the possible loss or range of losses, if any, arising from this litigation, or whether the Company’s applicable insurance policies will provide sufficient coverage for these claims. Accordingly, the Company can give no assurance that this matter will not have a material adverse effect on the Company’s financial position or results of operations.

(d) Environmental. The Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. Sealy and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, Sealy and its subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the property in 1997. The Company retained primary responsibility for the required remediation. Previously, the Company removed and disposed of contaminated soil from the site with the New Jersey Department of Environmental Protection approval, and the Company has installed a groundwater remediation system on the site. During 2005, with the approval of the New Jersey Department of Environmental Protection, the Company removed and disposed of sediment in Oakeys Brook adjoining the site. The Company continues to monitor ground water at the site. During 2012, with the approval of the New Jersey Department of Environmental Protection, the Company commenced the removal and disposal of additional contaminated soil from the site. The Company has recorded a reserve as a component of other accrued expenses and other noncurrent liabilities in the accompanying Consolidated Balance Sheets as of December 31, 2013 for $2.7 million associated with this remediation project.
 
The Company has also undertaken a remediation of soil and groundwater contamination at an inactive facility located in Oakville, Connecticut. Although the Company is conducting the remediation voluntarily, it obtained Connecticut Department of Energy and Environmental Protection (“DEEP”) approval of the remediation plan. The Company believes that it has essentially completed its remediation of the site. In 2012, the Company submitted separate closure reports to the Connecticut DEEP for the lower portion of the site and the upper portion of the site.  The Connecticut DEEP approved the Company’s closure report for the upper portion of the site and also gave conditional approval to the Company’s closure report for the lower portion of the site.  The conditional approval for the lower portion closure requires the Company to perform additional water monitoring on the lower portion of the site to demonstrate compliance with applicable standards.  The Company has performed that monitoring and submitted a closure report for the lower parcel to the Connecticut DEEP. The Company has recorded a liability of approximately $0.1 million associated with the completion of the closure of its remediation efforts at the site. The Company believes the contamination is attributable to the manufacturing operations of previous, unrelated, unaffiliated occupants of the facility.
 
The Company cannot predict the ultimate timing or costs of the South Brunswick and Oakville environmental matters. Based on facts currently known, the Company believes that the accruals recorded are adequate and does not believe the resolution of these matters will have a material effect on the financial position or future operations of the Company. However, in the event of an adverse decision by the agencies involved, or an unfavorable result in the New Jersey natural resources damages matter, these matters could have a material effect on the Company’s financial position or results of operations.
 
In 1998, the Company sold an inactive facility located in Putnam, Connecticut. In 2012, the Company received a letter from the attorney for the current owner of that property claiming that the Company may have some responsibility for an environmental condition on the property. The Company continues to investigate the factual background on this matter, but intends to vigorously defend the claim of the current owner against the Company.

(e) Income tax assessments. The Company has received income tax assessments from the Danish Tax Authority (“SKAT”). The Company believes we have meritorious defenses to the proposed adjustments and will oppose the assessments, as necessary in the appropriate Danish venue. The Company believes the litigation process to reach a final resolution of this matter could potentially extend over the next five years. If the Company is not successful in defending our position that the Company owes no additional taxes, the Company could be required to pay a significant amount to SKAT, which could impair or reduce our liquidity and profitability. For a description of these assessments and additional information with respect to these assessments and the various related legal proceedings, see Note 13, “Income Taxes”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

(f) Other. The Company is involved in various other legal proceedings incidental to the operations of its business. The Company believes that the outcome of all such pending legal proceedings in the aggregate will not have a material adverse effect on its business, financial condition, liquidity, or operating results.

24


ITEM 4. MINE SAFETY DISCLOSURES
 
None.

25


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.
 
The following table sets forth the high and low sales prices per common share, at closing, of our common stock as reported by the NYSE and cash dividends paid per common share for the fiscal periods indicated.
 
Price Range
 
High
 
Low
Fiscal 2012
 
 
 
First Quarter
$
84.43

 
$
55.18

Second Quarter
87.26

 
21.02

Third Quarter
34.95

 
22.35

Fourth Quarter
34.11

 
24.54

 
 
 
 
Fiscal 2013
 
 
 
First Quarter
$
51.02

 
$
32.11

Second Quarter
50.49

 
39.44

Third Quarter
47.80

 
36.12

Fourth Quarter
54.38

 
37.28


As of February 20, 2014, we had approximately 108 stockholders of record of our common stock.

Dividends

The Company did not pay any dividends in 2013 or 2012. The decision to pay a dividend in future periods is reviewed by our Board of Directors on a periodic basis.


26


Equity Compensation Plan Information

The following table sets forth equity compensation plan information as of December 31, 2013:
Plan category
 
Number of securities to be issued upon exercise of outstanding options, warrants and rights
 
Weighted-average exercise price of outstanding options, warrants and rights
 
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
 
 
(a)
 
(b)
 
(c)
Equity compensation plans approved by security holders:
 
 
 
 
 
 
  2003 Stock Option Plan (1)
 
3,195,333

 
$
21.48

 

  2013 Equity Incentive Plan (2)
 
53,944

 
44.04

 
4,677,737

Equity compensation plans not approved by security holders
 

 

 

Total
 
3,249,277

 
$
21.86

 
4,677,737


(1)
In May 2013, our Board of Directors adopted a resolution that prohibited further grants under the 2003 Stock Option Plan. The number of securities to be issued upon exercise of outstanding stock options, warrants and rights issued under the 2003 Equity Incentive Plan includes 180,013 of restricted stock units and deferred stock units. Additionally, this number includes 519,313 performance restricted stock units which reflects a maximum payout of the awards granted. These restricted, deferred and performance restricted stock units are excluded from the weighted average exercise price calculation above.
(2)
The number of securities to be issued upon exercise of outstanding stock options, warrants and rights issued under the 2013 Equity Incentive Plan includes 19,905 of restricted stock units and deferred stock units. Additionally, this number includes 2,430 performance restricted stock units which reflects a maximum payout of the awards granted. These restricted, deferred and performance restricted stock units are excluded from the weighted average exercise price calculation above.

For information regarding the material features of each of the above plans see Note 11, “Stock-based compensation”, in our Consolidated Financial Statements included in Part II, ITEM 8 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 shareholder returns for the Company 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, and are chosen for market size, liquidity and industry group representation. We believe the peer group closely reflects our business and, as a result, provides meaningful comparison of stock performance.
 
The peer issuers included in this graph are set forth below:

New Peer Group
Brunswick Corp.
Harman International Industries, Inc.
Newell Rubbermaid Inc.
Carter's, Inc.
Hasbro, Inc.
Polaris Industries Inc.
Columbia Sportswear Co.
Jarden Corp.
Select Comfort Corp.
Deckers Outdoor Corp.
Leggett & Platt, Inc.
Steelcase Inc.
Dorel Industries Inc.
Lexmark International, Inc.
Tupperware Brands Corp.
Fossil Group, Inc.
Mattress Firm Holding Corp.
Under Armour, Inc.
Gildan Activewear Inc.
Herman Miller, Inc.
Williams-Sonoma, Inc.
Hanesbrands Inc.
Mohawk Industries, Inc.
Wolverine World Wide, Inc.




27


Old Peer Group
Callaway Golf Company
Herman Miller, Inc.
Steelcase Inc.
Coach, Inc.
Krispy Kreme Doughnuts, Inc.
Tempur-Pedic International Inc.
Columbia Sportswear Company
Nautilus, Inc.
Tiffany & Co.
Ethan Allen Interiors Inc.
Ralph Lauren Corp.
Tupperware Brands Corp.
Fossil, Inc.
Quiksilver, Inc.
 
Harman International Industries Inc.
Select Comfort Corp.
 

We decided to use a new peer group for the year ended December 31, 2013. We believe the new peer group more closely reflects our business following the Sealy Acquisition and, as a result, provides a more meaningful comparison of stock performance. In accordance with Securities and Exchange Commission rules, the graph includes both the old peer group and the new peer group. The comparison for each of the periods assumes that $100 was invested on December 31, 2008 in our common stock, the stocks included in the S & P 500 Composite Index and the stocks included in each peer group index and that all dividends were reinvested. The stock performance shown on the graph below is not necessarily indicative of future price performance.


 
 
12/31/2008
 
12/31/2009
 
12/31/2010
 
12/31/2011
 
12/31/2012
 
12/31/2013
Tempur Sealy International, Inc.
 
$
100.00

 
$
333.29

 
$
565.02

 
$
740.90

 
$
444.15

 
$
761.07

S&P 500
 
100.00

 
126.00

 
146.00

 
149.00

 
172.00

 
228.00

Peer Group - New
 
100.00

 
263.80

 
362.72

 
574.77

 
708.22

 
735.85

Peer Group - Old
 
100.00

 
323.05

 
462.71

 
787.62

 
941.48

 
932.72



28


ITEM 6. SELECTED FINANCIAL DATA
 
The following table sets forth our selected historical consolidated financial and operating data for the periods indicated. We have derived our statements of income and balance sheet data as of and for the years ended December 31, 2013, 2012, 2011, 2010 and 2009 from our audited financial statements. Our financial statements as of December 31, 2013 and 2012 and for each of the three years in the period ended December 31, 2013 are included in ITEM 15, under Part IV of this Report.
(in millions, except per common share amounts)
 
 
 
 
 
 
 
 
 
Statement of Income Data:
2013 (1)
 
2012
 
2011
 
2010
 
2009
Net sales
$
2,464.3

 
$
1,402.9

 
$
1,417.9

 
$
1,105.4

 
$
831.2

Cost of sales
1,449.4

 
688.3

 
674.8

 
550.0

 
437.5

Gross profit
1,014.9

 
714.6

 
743.1

 
555.4

 
393.7

Operating expense
771.1

 
466.3

 
402.6

 
309.5

 
248.8

Operating income
243.8

 
248.3

 
340.5

 
245.9

 
144.9

Interest expense, net
110.8

 
18.8

 
11.9

 
14.5

 
17.3

Other expense (income), net
5.0

 
0.3

 
0.2

 
0.5

 
(0.4
)
Income before income taxes
128.0

 
229.2

 
328.4

 
230.9

 
128.0

Income tax provision
(49.1
)
 
(122.4
)
 
(108.8
)
 
(73.7
)
 
(43.0
)
Net income before non-controlling interest
78.9

 

 

 

 

Less: income attributable to non-controlling interest
0.3

 

 

 

 

Net income attributable to Tempur Sealy International, Inc.
$
78.6

 
$
106.8

 
$
219.6

 
$
157.2

 
$
85.0

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data (at end of period):
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
81.0

 
$
179.3

 
$
111.4

 
$
53.6

 
$
14.0

Total assets (2)
2,729.9

 
1,319.5

 
838.2

 
716.0

 
643.4

Total debt (2)
1,836.5

 
1,025.0

 
585.0

 
407.0

 
297.5

Redeemable non-controlling interest
11.5

 

 

 

 

Total stockholders' equity
118.6

 
22.3

 
30.8

 
126.0

 
172.3

 
 
 
 
 
 
 
 
 
 
Other Financial and Operating Data:
 
 
 
 
 
 
 
 
 
Dividends per common share
$

 
$

 
$

 
$

 
$

Depreciation and amortization (3)
91.5

 
42.0

 
51.0

 
44.0

 
40.2

Net cash provided by operating activities
98.5

 
189.9

 
248.7

 
184.1

 
135.0

Net cash used in investing activities
(1,213.0
)
 
(55.0
)
 
(36.1
)
 
(37.5
)
 
(14.3
)
Net cash provided by (used in) financing activities
1,013.4

 
(70.8
)
 
(148.9
)
 
(106.4
)
 
(118.7
)
Basic earnings per common share
1.30

 
1.74

 
3.27

 
2.23

 
1.13

Diluted earnings per common share
1.28

 
1.70

 
3.18

 
2.16

 
1.12

Capital expenditures
40.0

 
50.5

 
29.5

 
18.1

 
14.3


(1)
Includes Sealy results of operations from March 18, 2013 through December 31, 2013. Historical periods presented do not include Sealy and as a result, the information may not be comparable. Refer to Note 2, “Business Combination” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for additional information regarding the Sealy Acquisition.
(2)
Includes issuance of $375.0 million of Senior Notes held in escrow at December 31, 2012. The net proceeds from the Senior Notes were used as part of the financing for the Sealy Acquisition. Refer to Note 5, “Debt” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for additional information regarding the Senior Notes.
(3)
Includes $16.9 million, $5.7 million, $16.7 million, $11.6 million, and $8.8 million in non-cash stock-based compensation expense related to restricted stock units, performance restricted stock units, deferred stock units and stock options in 2013, 2012, 2011, 2010, and 2009, respectively.



29



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 ITEM 6 under Part II of this Report and the audited consolidated financial statements and accompanying notes thereto included elsewhere in this Report. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. 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 ITEM 1A under Part I 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, 2013, 2012 and 2011, including the following topics:

an overview of our business, including the acquisition of Sealy Corporation and its subsidiaries (“Sealy”) that closed on March 18, 2013;
the effect of the foregoing on our overall financial performance and condition;
our net sales and costs in the periods presented as well as changes between periods; and
expected sources of liquidity for future operations.

Business Overview

General

We are the world's largest bedding provider. We develop, manufacture, market, and distribute bedding products, which we sell globally. Our brand portfolio includes many of the most highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic®, Optimum™, 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 three distribution channels in each operating business segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); Direct (e-commerce platforms, company-owned stores, and call centers); and Other (third party distributors, hospitality and healthcare customers).

Business Segments

We have three reportable business segments: Tempur North America, Tempur International, and Sealy. These reportable segments are strategic business units that are managed separately based on the fundamental differences in their operations. Our Tempur North America segment consists of two U.S. manufacturing facilities and our Tempur North America distribution subsidiaries. Our Tempur International segment consists of our manufacturing facility in Denmark, whose customers include all of our distribution subsidiaries and third party distributors outside our Tempur North America and Sealy segments. Our Sealy segment consists of company-owned and operated bedding and component manufacturing facilities located around the world, along with distribution subsidiaries, joint ventures, and licensees. We evaluate segment performance based on net sales and operating income.

Strategy
 
We are the world’s largest bedding provider and the only provider with global scale. We believe our future growth potential is significant in our existing markets and through expansion into new markets. In order to achieve our long-term growth potential while managing the current economic and competitive environment, we will focus on the key strategic growth initiatives discussed below:
 
Product Innovation

We will continue to invest in research and development to leverage the combined technologies of our comprehensive portfolio of products to deliver a stream of innovative products. Our goal is to provide consumers the best bed and best sleep of their life and to provide our retailers a complete and optimal offering across brands, products, and prices to drive growth. We will also pursue opportunities to enter or develop new product categories.

30



Marketing

We will increase our investment in advertising to increase consumer awareness, preference and loyalty for each of our key brands. We will also invest in in-store marketing and direct sales to maximize our sales opportunity driven from national brand and retailer advertising.

New Market Expansion

We will pursue opportunities to expand into new international markets and over time into non-consolidated markets where our brands are currently represented under licensee, joint venture or third party distributor agreements.

Supply Chain (“Easier To Do Business With”)

We are committed to building a world-class supply chain that is “easier to do business with.” Our goal is to improve efficiencies related to purchasing and delivery, as well as inventory management to drive sales growth.

Our strategic growth initiatives will be supported by cost synergies realized from the acquisition of Sealy as well as through our ongoing cost productivity initiatives.

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, ITEM1A in this Report.

General Business and Economic Conditions

Our business has been 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. In light of the macroeconomic environment, we continue to take steps to further align our cost structure with our anticipated level of net sales. We continued to make strategic investments, including: introducing new products; investing in increasing our global brand awareness; extending our presence and improving our Retail account productivity and distribution; investing in our operating infrastructure to meet the requirements of our business; and taking actions to further strengthen our business.

Competition

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, viscoelastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These alternative products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, Internet, telemarketing programs, television infomercials, television advertising and catalogs.

Our Tempur North America segment competes in the non-innerspring mattress category and contributes 36.9% of our net sales. Beginning in the second half of 2012, a significant number of new non-innerspring mattress products were introduced in this category and changed the competitive environment of the U.S. bedding industry. Many of these new non-innerspring mattress products have been supported by aggressive marketing campaigns and promotions. As a result of this change, our results have been negatively impacted and we modified our business strategy to compete and expand our market share. Our results could continue to be challenged.


31


Financial Leverage

As of December 31, 2013, we had $1,836.5 million of debt outstanding, and our stockholders’ equity was $114.0 million. 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 borrowing will be available. As of December 31, 2013, our ratio of funded debt less qualified cash to EBITDA was 4.4 times, within the covenant in our debt agreements which limits this ratio to 5.25 times for the year ended December 31, 2013. For more information on this non-GAAP measure, please refer to the section set forth below “Non-GAAP Financial Measures”.

Sealy Integration

Our Sealy Acquisition is significant, and we may not be able to successfully integrate and combine the operations, personnel and technology of Sealy with our operations. Because of the size and complexity of Sealy’s business, if we do not successfully manage integration, we may experience interruptions in our business activities, a deterioration in our employee and customer relationships, increased costs of integration and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations. We may also experience difficulties in combining corporate cultures, maintaining employee morale and retaining key employees. The integration may also impose substantial demands on our management. There is no assurance that improved operating results will be achieved as a result of the Sealy Acquisition or that the businesses of Sealy and Tempur-Pedic will be successfully integrated in a timely manner.

Gross Margins

Our gross margin is primarily impacted by the relative amount of net sales between our business segments. The Sealy segment operates at a significantly lower gross margin than the Tempur North America and Tempur International segments. If Sealy's net sales increase as a percentage of net sales, our gross margin will be negatively impacted. Additionally, our Tempur North America gross margin has historically been lower than that of our Tempur International segment. Our gross margin is also impacted by fixed cost leverage; the cost of raw materials; operational efficiency; product, channel and geographic mix; volume incentives offered to certain retail accounts; and costs associated with new product introductions. Future increases in raw material prices could have a negative impact on our gross margin if we do not raise prices to cover increased cost.
    
Our gross margin can also be impacted by our operational efficiencies, including the particular levels of utilization in our manufacturing facilities. If we increase our net sales significantly the effect of this operating leverage could have a significant positive impact on our gross margin. Conversely, if we experience significant decreases in our net sales, the effect of this operating deleverage could have a significant negative impact on our gross margin. Our margins are also impacted by the growth in our Retail channel as sales in our Retail channel are at wholesale prices whereas sales in our Direct channel are at retail prices.

In 2014, we expect gross margin to benefit from cost synergies and leverage, offset by investments in new products and foreign exchange. Floor model shipments will be elevated in the first half of 2014 as we complete our new product roll-outs. However, we expect floor model shipments will be much lower in the second half of 2014. Foreign exchange is also expected to negatively impact gross margin due to our Canadian subsidiaries where a significant portion of their material costs are denominated in U.S. dollars.

New Product Development and Introduction

Each year we invest significant time and resources in research and development to improve our respective product offerings. There are a number of risks inherent in our new product line introductions, including the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, which could impact profitability.

Exchange Rates

As a multinational company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign exchange rates. We use foreign exchange forward contracts to manage a portion of the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as between our subsidiaries themselves. These hedging transactions may not succeed in effectively managing our foreign currency exchange rate risk.


32


Sealy Acquisition

On March 18, 2013, we completed the Sealy Acquisition. Refer to Note 2, “Business Combination”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for a discussion of the Sealy Acquisition. Pursuant to the merger agreement, each share of common stock of Sealy issued and outstanding immediately prior to the effective time of the Sealy Acquisition was cancelled and (other than shares held by Sealy or Tempur-Pedic or their subsidiaries or Sealy stockholders who properly exercised their appraisal rights) converted into the right to receive $2.20 in cash. The total purchase price was $1,172.9 million, which was funded using available cash and financing consisting of our 2012 Credit Agreement and Senior Notes. Refer to Note 5, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for the definition of these terms and further discussion. The purchase price of Sealy, including debt assumed, consisted of the following items:

(in millions)
 
 
Cash consideration for stock
$
231.2

(1) 
Cash consideration for share-based awards
14.2

(2) 
Cash consideration for 8.0% Sealy Notes
442.1

(3) 
Cash consideration for repayment of Sealy Senior Notes
260.7

(4) 
Cash consideration for repayment of Sealy 2014 Notes
276.9

(5) 
Total consideration
1,225.1

 
Cash acquired
(52.2
)
(6) 
Net consideration transferred
$
1,172.9

 

(1)
The cash consideration for outstanding shares of Sealy common stock is the product of the agreed-upon cash per share price of $2.20 and total Sealy shares of 105.1 million.
(2)
The cash consideration for share-based awards is the product of the agreed-upon cash per share price of $2.20 and the total number of restricted stock units (“RSUs”) and deferred stock units (“DSUs”) outstanding and the “in the money” stock options net of the weighted average exercise price.
(3)
The cash consideration for 8.0% Sealy Notes is the result of applying the adjusted equity conversion rate to the 8.0% Sealy Notes tendered for conversion and multiplying the result by the agreed-upon cash per share price of $2.20. The 8.0% Sealy Notes that were converted represented the right to receive the same merger consideration that would have been payable to a holder of 201.0 million shares of Sealy common stock, subject to adjustment in accordance with the terms of the supplemental indenture governing the 8.0% Sealy Notes. 
(4)
The cash consideration for Sealy’s 10.875% Senior Notes due 2016 (“Sealy Senior Notes”) reflects the repayment of the outstanding obligation.
(5)
The cash consideration for Sealy’s 8.25% Senior Subordinated Notes due 2014 (“Sealy 2014 Notes”) reflects the repayment of the outstanding obligation.
(6)
Represents the Sealy cash balance acquired at acquisition.

Our Sealy segment manufactures and markets a complete line of bedding products under the Sealy®, Sealy Posturepedic®, Optimum™, and Stearns & Foster® brands. Sealy’s results of operations are reported within our Sealy reportable segment. The combination brings together two highly complementary companies with iconic brands and significant opportunities for global innovation and growth. We will have products for almost every consumer preference and price point, distribution through all key channels, in-house expertise on most key bedding technologies, and a world-class research and development team.


33


Results of Operations
 
A summary of our results for the year ended December 31, 2013 include:

Earnings per diluted common share (“EPS”) were $1.28 for the full year 2013 compared to $1.70 per diluted share for the full year 2012. The 2013 results include Sealy results for the post-acquisition period from March 18, 2013 to December 31, 2013 and also reflect transaction and integration costs related to the Sealy Acquisition, interest and fees related to our refinancing of our Term A Facility and Term B loans under our senior secured credit facility, as well as tax provision adjustments related to the repatriation of foreign earnings utilized in connection with the Sealy Acquisition. 2012 EPS reflects the tax expense recorded in connection with the anticipated repatriation of foreign earnings together with certain transaction and integration costs related to the Sealy Acquisition, and other restructuring costs.
Adjusted EPS were $2.38 for the full year 2013 compared to adjusted EPS $2.61 for the full year 2012. For a discussion and reconciliation of EPS to adjusted EPS, refer to the non-GAAP financial information set forth below under the heading “Non-GAAP Financial Information”.
Net income for the full year 2013 was $78.6 million as compared to net income of $106.8 million for the full year 2012. Adjusted net income was $146.4 million for the full year 2013 as compared to adjusted net income of $164.1 million for the full year 2012. For a discussion and reconciliation of net income to adjusted net income, refer to the non-GAAP financial information set forth below under the heading “Non-GAAP Financial Information”.
Net sales increased 75.7% to $2,464.3 million for the full year 2013 compared to $1,402.9 million for the full year 2012. The net sales increase was due to the inclusion of $1,114.7 million of Sealy net sales for the post-acquisition period from March 18, 2013 to December 31, 2013.
Gross margin was 41.2% for the full year 2013 compared to 50.9% for the full year 2012. The gross margin decreased primarily as a result of the inclusion of Sealy, which has lower margins than the Tempur North America and Tempur International segments, and changes in product mix, offset partially by lower sourcing costs.
Operating income was $243.8 million for the full year 2013 as compared to $248.3 million for the full year 2012. Operating income for the full year 2013 included $44.6 million of transaction and integration costs related to the Sealy Acquisition. Excluding these costs, the higher operating income reflects the inclusion of Sealy.




34


The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales:
 
Year Ended December 31,
(in millions, except per common share amounts)
2013
 
2012
 
2011
Net sales
$
2,464.3

 
100.0
 %
 
$
1,402.9

 
100.0
 %
 
$
1,417.9

 
100.0
 %
Cost of sales
1,449.4

 
58.8

 
688.3

 
49.1

 
674.8

 
47.6

Gross profit
1,014.9

 
41.2

 
714.6

 
50.9

 
743.1

 
52.4

Selling and marketing expenses
522.9

 
21.2

 
319.1

 
22.7

 
276.9

 
19.5

General, administrative and other
266.3

 
10.8

 
147.2

 
10.5

 
125.7

 
8.9

Equity income in earnings of unconsolidated affiliates
(4.4
)
 
(0.2
)
 

 

 

 

Royalty income, net of royalty expense
(13.7
)
 
(0.6
)
 

 

 

 

Operating income
243.8

 
10.0

 
248.3

 
17.7

 
340.5

 
24.0

 
 
 
 
 
 
 
 
 
 
 
 
Other expense, net:
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
110.8

 
4.5

 
18.8

 
1.3

 
11.9

 
0.8

Other expense, net
5.0

 
0.2

 
0.3

 

 
0.2

 

Total other expense
115.8

 
4.7

 
19.1

 
1.3

 
12.1

 
0.8

 
 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
128.0

 
5.3

 
229.2

 
16.4

 
328.4

 
23.2

Income tax provision
(49.1
)
 
(2.0
)
 
(122.4
)
 
(8.7
)
 
(108.8
)
 
(7.7
)
Net income before non-controlling interest
78.9

 
3.3

 
106.8

 
7.7

 
219.6

 
15.5

Less: Net income attributable to non-controlling interest
0.3

 

 

 

 

 

Net income attributable to Tempur Sealy International, Inc.
$
78.6

 
3.3
 %
 
$
106.8

 
7.7
 %
 
$
219.6

 
15.5
 %
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
Diluted
$
1.28

 
 
 
$
1.70

 
 
 
$
3.18

 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
Diluted
61.6

 
 
 
62.9

 
 
 
69.1

 
 


35


CONSOLIDATED SUMMARY

Net sales and gross profit
(in millions, except percentages)
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Net sales
 
$
2,464.3

 
$
1,402.9

 
$
1,417.9

 
75.7
 %
 
(1.1
)%
 
 
 
 
 
 
 
 
 
 
 
Net sales by segment:
 
 
 
 
 
 
 
 
 
 
Tempur North America
 
910.0

 
964.3

 
1,004.7

 
(5.6
)%
 
(4.0
)%
Tempur International
 
439.6

 
438.6

 
413.2

 
0.2
 %
 
6.1
 %
Sealy
 
1,114.7

 

 

 
 %
 
 %
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
1,014.9

 
714.6

 
743.1

 
42.0
 %
 
(3.8
)%
Gross margin
 
41.2
%
 
50.9
%
 
52.4
%
 
(9.7
)%
 
(1.5
)%

Year ended December 31, 2013 compared to year ended December 31, 2012


36


Net sales increased $1,061.4 million, or 75.7%. The increase was due to the inclusion of Sealy’s net sales of $1,114.7 million for the post-acquisition period from March 18, 2013 to December 31, 2013. The increase in net sales was partially offset by decreases in our Tempur North America segment in bedding net sales, driven by decreases in our Retail and Direct channels.

Gross profit increased $300.3 million, or 42.0%. Gross margin decreased 9.7%. The increase in gross profit was due to the inclusion of Sealy’s gross profit of $352.4 million at a gross margin of 31.6% for the post-acquisition period from March 18, 2013 through December 31, 2013. Sealy’s gross profit also included an incremental cost of $7.7 million associated with the revaluation of finished goods inventory related to the purchase price allocation of the Sealy Acquisition. The increase in gross profit was also offset by Tempur North America’s gross profit decrease of $56.6 million and gross margin decline of 3.4%. Our gross margin was impacted by the relative amount of net sales between our business segments. The Sealy segment operates at a lower gross margin than the Tempur North America and Tempur International segments. Our gross margin has been negatively impacted as Sealy’s net sales have increased as a percentage of our consolidated net sales. 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 this process. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.

Year ended December 31, 2012 compared to year ended December 31, 2011
   
Net sales decreased $15.0 million, or 1.1%. The decrease was due to a $40.4 million decrease in Tempur North America’s net sales, which was partially offset by a $25.4 million increase in Tempur International’s net sales. Tempur North America’s net sales decline was attributed to increased competition in the non-innerspring mattress category and led to several initiatives designed to stabilize Tempur North America’s net sales. Tempur International net sales increased primarily in the Retail channel as a result of expanding points of distribution and investments in our brand awareness.    

Gross profit decreased $28.5 million, or 3.8%. Gross margin decreased 1.5%. Tempur North America’s gross profit decreased $50.5 million and gross margin declined 3.1%. Tempur International’s gross profit increased $22.0 million and gross margin increased 1.6%. Our gross margin was impacted by the relative amount of net sales between our business segments. Historically, our Tempur North America gross margin has been lower than that of our Tempur International segment, due in part to the royalty paid by the Tempur North America segment. This intercompany royalty expense was $12.7 million and $12.3 million for the years ended 2012 and 2011, respectively. 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 this process. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.
  
OPERATING EXPENSES

Selling and Marketing Expenses
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Total selling and marketing
 
$
522.9

 
$
319.1

 
$
276.9

 
63.9
 %
 
15.2
%
As a percent of net sales
 
21.2
%
 
22.7
%
 
19.5
%
 
(1.5
)%
 
3.2
%
Advertising expenses
 
274.2

 
164.5

 
148.8

 
66.7
 %
 
10.6
%
As a percent of net sales
 
11.1
%
 
11.7
%
 
10.5
%
 
(0.6
)%
 
1.2
%
Selling and marketing other
 
248.7

 
154.6

 
128.1

 
60.9
 %
 
20.7
%
As a percent of net sales
 
10.1
%
 
11.0
%
 
9.0
%
 
(0.9
)%
 
2.0
%

Selling and marketing expenses include advertising and media production associated with our Direct channel, 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.


37


Year ended December 31, 2013 compared to year ended December 31, 2012
    
Selling and marketing expenses increased $203.8 million, or 63.9%, and decreased 1.5% as a percentage of net sales. Our advertising expenses increased $109.7 million, or 66.7%, and remained relatively flat as a percentage of net sales. Sealy’s selling and marketing expenses were $204.5 million, including advertising expenses of $124.8 million, for the post-acquisition period from March 18, 2013 through December 31, 2013. The increase due to Sealy was offset by decreased advertising expenses in our Tempur North America and Tempur International segments. During the first half of 2013, we reduced our Tempur North America advertising expense to align with Tempur North America’s lower net sales. Throughout the second half of 2013 we increased Tempur North America advertising expenses and reintroduced the “Ask Me” campaign as part of our strategic initiatives.

All other selling and marketing expenses increased $94.1 million, or 60.9%, and decreased 0.9% as a percentage of net sales. Sealy’s other selling and marketing expenses was $79.6 million for the post-acquisition period from March 18, 2013 through December 31, 2013. In the current year, we also incurred $3.4 million of other selling and marketing expenses related to the integration of Sealy. The additional increase was due to costs associated with the growth in Tempur International company-owned stores and e-commerce.

Year ended December 31, 2012 compared to year ended December 31, 2011

Selling and marketing expenses increased $42.2 million, or 15.2%, and increased 3.2% as a percentage of net sales. Our advertising expenses increased $15.7 million, or 10.6%, and increased 1.2% as a percentage of net sales. During 2012, consistent with our strategy to align advertising expenses with net sales, we made additional investments in advertising to increase brand awareness to drive future growth in certain key Tempur North America and Tempur International markets.

All other selling and marketing expenses increased $26.5 million, or 20.7%, and increased 2.0% as a percentage of net sales. The increase was due to increases in promotional related expenses of $11.8 million, costs associated with opening additional company-owned stores of $5.0 million, salaries and associated expense of $4.5 million related to additional headcount, and $1.1 million of restructuring charges related to severance. This was offset by a benefit recorded for our performance restricted share units (“PRSUs”) of $2.3 million following our re-evaluation of the probability of meeting certain required financial metrics related to the grants.    

General, Administrative and Other Expenses
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
General, administrative and other expenses
 
$
266.3

 
$
147.2

 
$
125.7

 
80.9
%
 
17.1
%
As a percent of net sales
 
10.8
%
 
10.5
%
 
8.9
%
 
0.3
%
 
1.6
%
General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation of buildings, furniture and fixtures, machinery, leasehold improvements and computer equipment, expenses for administrative functions and research and development costs.
Year ended December 31, 2013 compared to year ended December 31, 2012

General, administrative and other expenses increased $119.1 million, or 80.9%. The increase was primarily due to the inclusion of Sealy’s $97.3 million of general, administrative and other expenses for the post-acquisition period from March 18, 2013 through December 31, 2013. We also recorded additional expenses of $10.8 million in professional fees related to the Sealy Acquisition and integration of the business. Additionally, salaries and related expenses increased $14.5 million, with the majority of the increase driven by increased stock-based compensation expense. In 2012, we recorded a benefit of $8.0 million for the PRSUs granted in 2011 and 2012 following the re-evaluation of the probability of meeting certain required financial metrics related to the grants.

Research and development expenses for 2013 were $21.0 million compared to $15.6 million for 2012, an increase of $5.4 million, or 34.6%. We plan to continue to invest in research and development to leverage the combined technologies of our portfolio to deliver innovative products.


38


Year ended December 31, 2012 compared to year ended December 31, 2011

General, administrative and other expenses increased $21.5 million, or 17.1%. The increase was primarily a result of increased legal and professional fees of $16.1 million, driven by transaction costs related to the Sealy Acquisition of $8.9 million and integration costs of $2.2 million, along with an increase of $5.0 million related to increased litigation costs and strategic initiatives. During 2012, we also incurred an additional $5.2 million related to incremental investments in information technology and associated depreciation expense. Also, in 2011, we recorded a benefit for favorable settlements of indirect taxes with certain regulatory authorities of $3.5 million that did not recur in 2012. These increases were offset by an $8.0 million benefit recorded for PRSUs following our re-evaluation of the probability of meeting certain required financial metrics related to the grants. We expect general, administrative and other expenses to continue to be impacted by transaction and integration costs related to the proposed Sealy Acquisition.

Research and development expenses for 2012 were $15.6 million compared to $9.9 million for 2011, an increase of $5.7 million, or 57.6%.
 
OPERATING INCOME
(in millions, except percentages)
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Operating income
 
$
243.8

 
$
248.3

 
$
340.5

 
(1.8
)%
 
(27.1
)%
Operating margin
 
9.9
%
 
17.7
%
 
24.0
%
 
(7.8
)%
 
(6.3
)%

Year ended December 31, 2013 compared to year ended December 31, 2012

Operating income decreased $4.5 million, or 1.8%, and was primarily impacted by the factors discussed above. During the full year 2013, we also recorded royalty income, net of royalty expense, of $13.7 million and equity income in earnings of unconsolidated affiliates of $4.4 million. Our royalty income is based on sales of Sealy® and Stearns & Foster® branded products by various licensees and is offset by royalty expenses we pay to other entities for the use of their names on our Sealy branded products. Our equity income in earnings of unconsolidated affiliates represents our 50.0% interest in the earnings of our Asia-Pacific joint ventures whose purpose is to develop markets for Sealy branded products.

               During the full year 2013, we incurred $18.7 million of transaction expenses and $25.9 million of integration expenses in connection with the Sealy Acquisition. During the full year 2012, we incurred $8.9 million of transaction expenses and $3.7 million of integration expenses in connection with the Sealy Acquisition.

Year ended December 31, 2012 compared to year ended December 31, 2011

Operating income decreased $92.2 million, or 27.1%, and was primarily impacted by the factors discussed above.

INTEREST EXPENSE, NET
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Interest expense, net
 
$
110.8

 
$
18.8

 
$
11.9

 
489.4
%
 
58.0
%

Year ended December 31, 2013 compared to the year ended December 31, 2012

Interest expense, net, increased $92.0 million, or 489.4%. In 2013, we incurred $19.9 million of incremental interest expense and fees on the Senior Notes and 2012 Credit Agreement for the period prior to March 18, 2013, commitment fees associated with financing for the closing of the Sealy Acquisition, and write off of deferred financing costs associated with the 2011 Credit Facility. In addition, we incurred $8.7 million in prepayment fees related to the refinancing of our Term B Facility in the second quarter of 2013. The remaining increase was due to higher debt levels as a result of the Sealy Acquisition.    


39


Year ended December 31, 2012 compared to the year ended December 31, 2011

Interest expense, net, increased $6.9 million, or 58.0%. The increase in interest expense was primarily attributable to an increase in our debt outstanding as of December 31, 2012 compared to our debt outstanding as of December 31, 2011 and an increase in our effective interest rate. Our debt levels increased in anticipation of the Sealy Acquisition, which occurred on March 18, 2013.

INCOME BEFORE INCOME TAXES
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Income before income taxes
 
$
128.0

 
$
229.2

 
$
328.4

 
(44.2
)%
 
(30.2
)%

Year ended December 31, 2013 compared to year ended December 31, 2012

Income before income taxes decreased $101.2 million, or 44.2%. This decrease was a result of the factors discussed above.

Year ended December 31, 2012 compared to year ended December 31, 2011

Income before income taxes decreased $99.2 million, or 30.2%. This decrease was a result of the factors discussed above.

INCOME TAXES
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Income tax
 
$
49.1

 
$
122.4

 
$
108.8

 
(59.9
)%
 
12.5
%
Effective tax rate
 
38.4
%
 
53.4
%
 
33.1
%
 
(15.0
)%
 
20.3
%

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, 2013 compared to year ended December 31, 2012

Our income tax provision decreased $73.3 million and our effective tax rate decreased 15.0%. During 2012, we recorded $48.1 million of additional income tax expense related to our undistributed earnings from non-U.S. operations, which increased our effective tax rate by 21.0%. This was recorded as deferred income tax expense in 2012 and a deferred tax liability at December 31, 2012. During 2013, we undertook a taxable transaction in which we recognized current taxable income based on the earnings of certain of our foreign subsidiaries. The resulting income tax payable was approximately $51.7 million. Consequently, we reclassified the $48.1 million deferred tax liability recorded at December 31, 2012 to current tax payable at December 31, 2013 and recognized an incremental $3.6 million current income tax expense in 2013.

Year ended December 31, 2012 compared to year ended December 31, 2011

Our income tax provision increased $13.6 million and our effective tax rate increased 20.3%.We had made no historical provision for U.S. federal and/or state income tax and foreign withholdings on our undistributed earnings from non-U.S. operations because we intended to reinvest such earnings indefinitely outside of the United States. During 2012, we changed the classification of our undistributed earnings to reflect a change in management’s strategic objectives that could require the repatriation of foreign earnings. As a result of this change, we recognized $48.1 million of additional income tax expense in 2012 to record the applicable U.S. deferred income tax liability. We repatriated non-U.S. cash holdings upon the closing of the proposed Sealy Acquisition.


40


TEMPUR NORTH AMERICA SEGMENT SUMMARY
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Net sales
 
$
910.0

 
$
964.3

 
$
1,004.7

 
(5.6
)%
 
(4.0
)%
 
 
 
 
 
 
 
 
 
 
 
Net sales by channel:
 
 
 
 
 
 
 
 
 
 
Retail
 
845.6

 
876.5

 
917.6

 
(3.5
)%
 
(4.5
)%
Direct
 
49.2

 
76.2

 
76.0

 
(35.4
)%
 
0.3
 %
Other
 
15.2

 
11.6

 
11.1

 
31.0
 %
 
4.5
 %
 
 
 
 
 
 
 
 
 
 
 
Net sales by product:
 
 
 
 
 
 
 
 
 
 
Bedding
 
830.4

 
882.3

 
916.7

 
(5.9
)%
 
(3.8
)%
Other products
 
79.6

 
82.0

 
88.0

 
(2.9
)%
 
(6.8
)%
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
392.7

 
449.2

 
499.8

 
(12.6
)%
 
(10.1
)%
Gross margin
 
43.2
%
 
46.6
%
 
49.7
%
 
(3.4
)%

(3.1
)%
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
67.6

 
144.4

 
236.9

 
(53.2
)%
 
(39.0
)%
Operating Margin
 
7.4
%
 
15.0
%
 
23.6
%
 
(7.6
)%
 
(8.6
)%

Year ended December 31, 2013 compared to year ended December 31, 2012
     
Tempur North America net sales decreased $54.3 million, or 5.6%. The decline was driven by a decrease in bedding net sales of $51.9 million, or 5.9%. Retail channel net sales decreased $30.9 million, or 3.5%. Direct channel net sales also decreased $27.0 million, or 35.4%. During the first half of 2013, Tempur North America decreased advertising expenses to better align with lower net sales. We believe this reduction in advertising had a negative impact on the Retail and Direct channel net sales. Retail net sales decreased in the first half of 2013 as compared to the prior year due to continued competition and decreased advertising spend, but Retail net sales stabilized in the second half of 2013 as we implemented additional strategic initiatives and increased our investments in advertising. The Direct channel performance also declined throughout 2013 due to lower direct to consumer advertising.

Operating income decreased $76.8 million, or 53.2%, and was primarily impacted by the following factors:

Gross profit decreased $56.6 million, or 12.6%. Gross margin decreased 3.4%. The decrease in gross margin was due to a 5.3% unfavorable product mix, which includes the impact of initiatives implemented to drive net sales growth. Unfavorable product mix was partially offset by a 2.2% increase as a result of lower sourcing costs and improved supply chain and manufacturing efficiencies.
Operating expenses were $325.1 million for the full year 2013, as compared to $304.8 million for the full year 2012, and increased 4.2% as a percentage of net sales due to increased selling and marketing activities, as well as professional fees and stock-based compensation expense incurred following the Sealy Acquisition.
 

41


Year ended December 31, 2012 compared to year ended December 31, 2011
     
Tempur North America net sales decreased $40.4 million, or 4.0%. The decline was driven by a decrease in bedding net sales of $34.4 million, or 3.8%. Retail channel net sales decreased $41.1 million, or 4.5%. Direct channel net sales remained flat. The net sales decline was attributed to increased competition in the non-innerspring mattress category and led to several initiatives designed to stabilize Tempur North America’s net sales. To drive growth in our Tempur North America segment, we implemented various strategic initiatives, which included new product introductions, wholesale mattress price reductions, extension of our mattress warranty to 25 years, and various other initiatives to realign dealer incentives. These initiatives were implemented during the second half of 2012.
 
Operating income decreased $92.5 million, or 39.0%, and was primarily impacted by the following factors:

Gross profit decreased $50.5 million, or 10.1%. Gross margin decreased 3.1%. The decrease in gross margin was due to a 1.7% decrease related to additional promotions and discounts and new product introductions, a 1.4% decrease related to unfavorable product mix and a 0.5% decrease due to fixed cost de-leverage related to lower production volumes. These decreases were partially offset by a 0.5% increase related to sourcing costs.
Operating expenses were $304.8 million for the full year 2012, as compared to $262.9 million for the full year 2011, and increased 5.5% as a percentage of net sales. During 2012, we made additional investments in advertising to increase brand awareness to drive growth in certain key Tempur North America markets. In addition, operating expenses increased as a result of transaction costs incurred for the Sealy Acquisition.


42


TEMPUR INTERNATIONAL SEGMENT SUMMARY
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Net sales
 
$
439.6

 
$
438.6

 
$
413.2

 
0.2
 %
 
6.1
 %
 
 
 
 
 
 
 
 
 
 
 
Net sales by channel:
 
 
 
 
 
 
 
 
 
 
Retail
 
344.3

 
351.5

 
328.0

 
(2.0
)%
 
7.2
 %
Direct
 
49.5

 
37.0

 
24.1

 
33.8
 %
 
53.5
 %
Other
 
45.8

 
50.1

 
61.1

 
(8.6
)%
 
(18.0
)%
 
 
 
 
 
 
 
 
 
 
 
Net sales by product:
 
 
 
 
 
 
 
 
 
 
Bedding
 
327.7

 
332.4

 
309.8

 
(1.4
)%
 
7.3
 %
Other products
 
111.9

 
106.2

 
103.4

 
5.4
 %
 
2.7
 %
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
269.8

 
265.2

 
243.3

 
1.7
 %
 
9.0
 %
Gross margin
 
61.4
%
 
60.5
%
 
58.9
%
 
0.9
 %
 
1.6
 %
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
107.5

 
103.9

 
103.6

 
3.5
 %
 
0.3
 %
Operating margin
 
24.5
%
 
23.7
%
 
25.1
%
 
0.8
 %
 
(1.4
)%

Year ended December 31, 2013 compared to year ended December 31, 2012
     
Tempur International net sales remained flat. On a constant currency basis (1), our Tempur International net sales increased approximately 1.0%. Retail channel net sales decreased $7.2 million, or 2.0%, primarily due to macroeconomic pressure in Europe which was partially offset by growth in our Asia-Pacific and Latin American businesses. Direct channel net sales increased $12.5 million, or 33.8%, due to expanding our points of distribution through an increase in the number of company-owned stores and e-commerce.

Operating income increased $3.6 million, or 3.5%, and was primarily impacted by the following factors:

Gross profit increased $4.6 million, or 1.7%. Gross margin increased 0.9%. The increase in gross margin was due to a 1.8% increase related to favorable product mix and a 0.9% decrease related to floor model discounts for new product introductions.
Operating expenses were $162.3 million for the full year 2013 and $161.3 million for the full year 2012, remaining flat as a percentage of net sales.

(1)
The references to “constant currency basis” in this Management Discussion & Analysis do not include operational impacts that could result from fluctuations in foreign currency rates. Certain 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. Refer to ITEM 7A under Part II of this Report.

43



Year ended December 31, 2012 compared to year ended December 31, 2011
     
Tempur International net sales increased $25.4 million, or 6.1%. On a constant currency basis (1), our Tempur International net sales increased approximately 11.3%. Retail channel net sales increased $23.5 million, or 7.2%, primarily due to expanding points of distribution and investments in our brand awareness. As a result, bedding net sales increased $22.6 million, or 7.3%.

Operating income increased $0.3 million, or 0.3%, and was primarily impacted by the following factors:
    
Gross profit increased $21.9 million, or 9.0%. Gross margin increased 1.6%. The increase in gross margin was due to a 1.3% increase driven by efficiencies in manufacturing and fixed cost leverage related to higher production volumes, as well as a 0.3% increase driven by costs associated with an information technology upgrade at our manufacturing facility in Denmark during 2011 that did not recur in 2012.
Operating expenses were $161.3 million for the full year 2012, as compared to $139.7 million for the full year 2011, and increased 3.0% as a percentage of net sales. During 2012, we made additional investments in advertising to increase brand awareness to drive growth in certain key Tempur International markets.

(1) 
The references to “constant currency basis” in this Management Discussion & Analysis do not include operational impacts that could result from fluctuations in foreign currency rates. Certain 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. Refer to ITEM 7A under Part II of this Report.

SEALY SEGMENT SUMMARY
(in millions, except percentages)
 
2013
 
2012
 
2011
 
Percentage change 2013 vs. 2012
 
Percentage change 2012 vs. 2011
Net sales
 
$
1,114.7

 
$

 
$

 
%
 
%
 
 
 
 
 
 
 
 
 
 
 
Net sales by channel:
 
 
 
 
 
 
 
 
 
 
Retail
 
1,041.4

 

 

 
%
 
%
Direct
 
20.5

 

 

 
%
 
%
Other
 
52.8

 

 

 
%
 
%
 
 
 
 
 
 
 
 
 
 
 
Net sales by product:
 
 
 
 
 
 
 
 
 
 
Bedding
 
1,040.3

 

 

 
%
 
%
Other products
 
74.4

 

 

 
%
 
%
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
352.4

 

 

 
%
 
%
Gross margin
 
31.6
%
 
%
 
%
 
%
 
%
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
68.7

 

 

 
%
 
%
Operating margin
 
6.2
%
 
%
 
%
 
%
 
%

Sealy’s results are only presented for the post-acquisition period from March 18, 2013 to December 31, 2013.
    

44


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, business combinations, capital expenditures and working capital needs. At December 31, 2013, we had working capital of $286.0 million, including cash and cash equivalents of $81.0 million as compared to working capital of $611.9 million including $179.3 million in cash and cash equivalents as of December 31, 2012. Working capital as of December 31, 2012 included a $375.0 million receivable from escrow account that was funded with the issuance of proceeds of the Senior Notes. This escrow was released at the closing of the Sealy Acquisition and was used to fund a portion of the purchase price cash consideration. This decrease was primarily offset by the assumption of working capital due to the Sealy Acquisition.

The table below presents net cash provided by (used in) operating, investing and financing activities for the full years 2013, 2012 and 2011.

(in millions)
 
2013
 
2012
 
2011
Net cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
98.5

 
$
189.9

 
$
248.7

Investing activities
 
(1,213.0
)
 
(55.0
)
 
(36.1
)
Financing activities
 
1,013.4

 
(70.8
)
 
(148.9
)
 
Cash provided by operating activities decreased $91.4 million to $98.5 million for the year ended December 31, 2013, as compared to $189.9 million for the same period in 2012. The decrease in cash provided by operating activities was due to a decrease in net income of $27.9 million, which was primarily impacted in 2013 by transaction, integration and other expenses related to the Sealy Acquisition and partially offset by Sealy net income. Our cash flow provided by operating activities was also impacted by decreases due to income tax payments associated with the repatriation of cash of our non-U.S. subsidiaries resulting from the Sealy Acquisition and other working capital changes during the year ended December 31, 2013. Inventories used cash primarily due to new product launches scheduled for 2014 in our Tempur North America and Sealy segments, which was offset by cash provided from accounts payable. Prepaid expenses and other current assets provided cash due primarily to the return of prepaid interest associated with our Senior Notes. Accounts receivable used cash due primarily to timing of payments from our customers.

Cash used by investing activities increased to $1,213.0 million for the year ended December 31, 2013 as compared to $55.0 million for the year ended December 31, 2012, an increase of $1,158.0 million. This increase is due to the Sealy Acquisition. Refer to Note 2, “Business Combination”, in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of the Sealy Acquisition.

Cash provided by financing activities was $1,013.4 million for the year ended December 31, 2013 as compared to $70.8 million for the year ended December 31, 2012. This increase is primarily due to new debt facilities put in place in December 2012 in anticipation of the Sealy Acquisition, which provided $375.0 million from our Senior Notes and $1,525.0 million from our 2012 Credit Agreement and was funded in connection with the closing of the Sealy Acquisition on March 18, 2013. Proceeds from the Senior Notes and 2012 Credit Agreement were used for the Sealy Acquisition and to repay the 2011 Credit Facility outstanding balance of $696.5 million. During 2013, we also repriced certain portions of the 2012 Credit Agreement. On May 16, 2013, we completed a repricing of our Term B Facility under the 2012 Credit Agreement, and this repricing was effected through a full repayment of $867.8 million and new borrowing of $742.8 million at the new lower interest rate. On July 11, 2013, we completed a repricing of our Term A Facility under the 2012 Credit Agreement, and this repricing was effected through a full repayment of $536.3 million and new borrowing of $536.3 million at the new lower interest rate. Additional borrowings made pursuant to the 2012 Credit Agreement in the year ended December 31, 2013 also provided $178.5 million and were used primarily to fund capital expenditures and our working capital needs. Additional repayments made pursuant to the 2012 Credit Agreement in the current period were $204.0 million and were funded by operating activities. Refer to Note 5, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.


45


Capital Expenditures

Capital expenditures totaled $40.0 million for the year ended December 31, 2013 and $50.5 million for the year ended December 31, 2012. Capital expenditures in 2013 were lower than expected due to the integration focus of our business. Capital expenditures in 2012 included the new corporate headquarters in Lexington, Kentucky. We currently expect our 2014 capital expenditures to be approximately $65.0 million, and relate to continued strategic investments which we believe will support our future plans.

Non-GAAP Financial Information

We provide information regarding earnings before interest, taxes, depreciation and amortization (“EBITDA”), adjusted EBITDA, consolidated funded debt less qualified cash, adjusted net income and adjusted earnings per share, which are not recognized terms under U.S. GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt. Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies. A reconciliation of our adjusted earnings per share is provided below. We believe that the use of this non-GAAP financial measure provides investors with additional useful information with respect to the impact of transaction and integration costs, and interest expense incurred related to the Sealy Acquisition. A reconciliation of our net income to EBITDA and adjusted EBITDA and a reconciliation of total debt to consolidated funded debt less qualified cash are also provided below. We believe the use of these non-GAAP financial measures provides investors with additional useful information with respect to our debt agreements and our compliance with the related debt covenants.
Reconciliation of net income to adjusted net income
The following table sets forth the reconciliation of our reported net income to the calculation of adjusted net income for the year ended December 31, 2013 and 2012, respectively:
(in millions, except per share amounts)
Year Ended December 31, 2013
 
Year Ended December 31, 2012
Net income
$
78.6

 
$
106.8

Plus:
 
 
 
Transaction costs, net of tax (2)
13.2
 
6.7
Integration costs, net of tax (1)
37.2
 
2.5
Long term debt refinance, net of tax (2)
6.5
 

Adjustment of taxes to normalized rate (3)
10.9
 

Tax provision related to repatriation of foreign earnings(4)

 
48.1
Adjusted net income
$
146.4

 
$
164.1

 
 
 
 
Earnings per share, diluted
$
1.28

 
$
1.70

Transaction costs, net of tax (1)
0.21

 
0.11