10-K 1 tpx-20161231x10k.htm FORM 10-K Document

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, 2016
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. ¨
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 30, 2016, computed by reference to the closing price for such stock on the New York Stock Exchange on such date, was approximately $2,845,571,126.
The number of shares outstanding of the registrant’s common stock as of February 21, 2017 was 53,798,212 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for the 2017 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
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


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 (the “Exchange Act”), which includes information concerning one or more of our plans; objectives; goals; strategies and key strategic growth initiatives; future revenues or performance; the anticipated impact on our business and financial performance resulting from the termination of our relationship with Mattress Firm, Inc.; the impact of the macroeconomic environment in both the U.S. and internationally on our business segments and expectations regarding growth of the mattress industry; uncertainties arising from global events; general economic, financial and industry conditions, particularly in the retail sector, as well as consumer confidence and the availability of consumer financing; competition in our industry; consumer acceptance of our products; the ability to continuously improve and expand our product line, maintain efficient, timely and cost-effective production and delivery of products, and manage growth; the ability to expand brand awareness, distribution and new products; the efficiency and effectiveness of our advertising campaigns and other marketing programs; the ability to increase sales productivity within existing retail accounts and to further penetrate the retail channel, including the timing of opening or expanding within large retail accounts and the timing and success of product launches; the effects of consolidation of retailers on revenues and costs; the effects of strategic investments on our operations, including our efforts to expand our global market share; changing commodity costs; changes in product and channel mix and the impact on the Company's gross margin; initiatives to improve gross margin; our capital structure and increased debt level, including our ability to meet financial obligations and continue to comply with the terms and financial ratio covenants of our credit facilities; changes in interest rates; changes in foreign tax rates and changes in tax laws generally, including the ability to utilize tax loss carry forwards; effects of changes in foreign exchange rates on our reported earnings; the outcome of pending tax audits or other tax proceedings; the effect of future legislative or regulatory changes; litigation and similar issues; financial flexibility; our expected sources of cash flow; changes in capital expenditures; our ability to effectively manage cash; and expectations regarding our target leverage and our share repurchase program. Many of these statements appear, in particular, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, ITEM 7 of this Report. When used in this Report, the words "assumes," "estimates," "expects," “guidance,” “anticipates,” “proposed,” “projects,” “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 Part I, ITEM 1A 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. In addition, when used in this Report “2016 Credit Agreement” refers to the Company’s senior credit facility entered into in the first quarter of 2016; “2012 Credit Agreement” refers to the Company’s prior senior credit  facility entered into in 2012; “2026 Senior Notes” refers to the 5.50% senior notes due 2026 issued in 2016; “2023 Senior Notes” refers to the 5.625% senior notes due 2023 issued in 2015; ”2020 Senior Notes” refers to the 6.875% senior notes due 2020 retired in 2016; and "8.0% Sealy Notes” refers to Sealy’s 8.0% Senior Secured Third Lien Convertible Notes retired in 2016.

3


PART I
 
ITEM 1. BUSINESS    
 
General
 
We are the world's largest bedding manufacturer. We develop, manufacture, market, and distribute bedding products, which we sell globally in approximately 100 countries. Our brand portfolio includes many highly recognized brands in the industry, including our Tempur products sold under the TEMPUR® and Tempur-Pedic® brands, and our Sealy products sold under the Sealy®, Sealy Posturepedic®, and Stearns & Foster® brands. In 2017, the Sealy® brand will also feature Posturepedic Technology™ in the Sealy Performance™ and Sealy Premium™ collections. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.

We operate in two segments: North America and International. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S. and Canada. Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. We evaluate segment performance based on net sales, gross profit and operating income. Financial information about our segments and geographic areas is included elsewhere in this Report in Part II, ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Note 16, "Business Segment Information," of the Notes to the Consolidated Financial Statements, included in Part II, ITEM 8, "Financial Statements and Supplementary Data."

We sell our products through two distribution channels in each segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); and Other (direct-to-consumer through e-commerce platforms; company-owned stores and call centers; 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 we file 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.

Strategy
 
Our long-term strategy is to drive earnings growth. Our goal is to improve the sleep of more people, every night, all around the world. In order to achieve our long-term strategy while managing the current economic and competitive environments, we will focus on developing the best bedding products, investing in our brands, expanding our North America margins while maintaining market share, growing our market share in International and optimizing our worldwide distribution. Through our strategy, we will generate earnings growth and strong cash flow that will be used to reduce debt to the extent appropriate and return value to stockholders.

Our Products and Brands

We have a comprehensive offering of products that appeal to a broad range of consumers, some of which are covered by one or more patents and/or patent applications. We also routinely introduce new mattress models, launch new products and update our existing mattress products in each of our segments. Our products are divided into two categories, as described below:

Bedding - Our bedding product category includes mattresses, foundations and adjustable foundations and represented 92.5% of our net sales in 2016.


4


Other - Our other product category includes pillows, mattress covers, sheets, cushions and various other comfort products and represented 7.5% of our net sales in 2016.

In order to achieve our goal to improve the sleep of more people, every night, all around the world, one of our strategic initiatives is to leverage and strengthen our comprehensive portfolio of iconic brands and products. Our brand portfolio includes many highly recognized brands, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic® and Stearns & Foster®, which are described below:

Tempur-Pedic - Founded in 1991, the Tempur brand is our specialty innovation category leader designed to provide life changing sleep for our wellness seeking consumers. Our proprietary Tempur material precisely adapts to the shape, weight and temperature of the consumer and creates fewer pressure points, reduces motion transfer and provides personalized comfort and support.

Stearns & Foster - The Stearns & Foster brand offers our consumers high quality mattresses built by certified craftsmen who have been specially trained. Founded in 1846, the brand is designed and built with precise engineering and relentless attention to detail and fuses new innovative technologies with time-honored techniques, creating supremely comfortable beds.

Sealy - The Sealy brand originated in 1881 in Sealy, Texas, and for over a century has focused on offering trusted comfort, durability and excellent value while maintaining contemporary styles and great support. In 2017, we are uniting all of our Sealy products under one masterbrand, which will include the Posturepedic Technology™ as described below.

Sealy Posturepedic - The Sealy Posturepedic brand, introduced in 1950, is engineered to provide all-over support and body alignment to allow full relaxation and deliver a comfortable night's sleep. In 2017, Sealy Posturepedic will no longer represent its own separate brand, but will be featured as Posturepedic Technology™ in the Sealy Performance™ and Sealy Premium™ collections.

Cocoon by Sealy - The Cocoon by Sealy brand, introduced in 2016, is our new offering in the below $1,000 e-commerce space, made with the high quality materials that consumers expect from Sealy, sold online at www.cocoonbysealy.com and delivered in a box directly to consumers' doorsteps.

Our 2016 product introductions included the new line of Stearns & Foster® products. The new Reserve Collection offers our exclusive Hybrid Pillowtop featuring our Nano Comfort™ Quilt Layer. The innovative mattress top design delivers precise support and superior adaptiveness. In addition, we updated our existing Stearns & Foster® Estate, Lux Estate and Lux Estate Hybrid product lines, which, along with the Reserve Collection, now offer four exclusive features: IntelliCoil® Advanced coil design, PrecisionEdge™ edge system, PrimaCool™ performance fabric and Advanced Adapt™ foam. We also updated our TEMPUR-Breeze line to include state-of-the-art PureCool™ Comfort technology, an ultra breathable design and a premium cooling cover. These upgrades provide more refreshing sleep for consumers seeking a cooler sleeping environment.

In 2017, we are planning significant new product introductions in our North America and International segments. In North America, we are uniting all of our Sealy products under one masterbrand. Product introductions will include new Sealy products in two distinct lines: Response and Conform. The new Sealy Essentials™, Sealy Performance™, and Sealy Premium™ Collections combine smart innovation, precise engineering and industry-leading testing to ensure quality and durability. Sealy's exclusive Posturepedic Technology™ will be featured in the Performance and Premium Collections, offering the highest quality materials to target the right level of support for each area of the body. In addition, we are introducing the new Tempur-Pedic Anniversary collection to celebrate the 25th anniversary of the Company’s founding and relaunching our flagship line of Tempur mattresses in International to feature the iconic aesthetics similar to Tempur-Pedic mattresses that you see in North America.

Our Channels

We sell our products through two channels: Retail and Other.


5


Retail

Our Retail channel sells to furniture and bedding retailers, department stores and warehouse clubs, among others and represented 89.8% of net sales in 2016. Our top five customers accounted for approximately 38.7% of our net sales for the year ended December 31, 2016. Mattress Firm Inc. (“Mattress Firm”), which was acquired by Steinhoff International Holdings N.V. ("Steinhoff") in September 2016 and is a customer within the North America segment, was our largest customer for 2016. In February 2016, Mattress Firm acquired all of the outstanding equity interests in HMK Mattress Holdings, LLC ("Sleepy’s"). Sleepy’s has historically been one of the Company's top five customers and, as a result of this acquisition, the combined companies represented 21.4%and 23.7% of the Company's sales for the year ended December 31, 2016, and 2015 respectively. In January 2017, we terminated our contracts with Mattress Firm and we expect to wind down our relationship with Mattress Firm over the first quarter of 2017. See ITEM 1A, "Risk Factors," and ITEM 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Factors That Could Impact Results of Operations" for a discussion of the anticipated impact of this termination and the Company's strategy moving forward.

Other

Our Other channel sells directly to consumers through e-commerce platforms, company-owned stores and call centers, and to third party, healthcare and hospitality customers and represented 10.2% of net sales in 2016. 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

Our overall marketing strategy is to drive consumer demand through the use of effective marketing. We invest across multiple media platforms to build brand awareness and drive consumer interest in our products. Our strategy varies by segment; however, the majority of our advertising programs are created on a centralized basis through our in-house advertising organization. In 2017, we plan to drive net sales through continued investments in new products, marketing and other initiatives.

North America

Our North America segment sells primarily through the Retail channel, which contributed 94.1% of North America segment sales in 2016. In North America, we advertise nationally on television, digitally and through consumer and trade print. In addition, we participate in cooperative advertising on a shared basis with some of our retail customers. Throughout the year, we relied on a series of strategic initiatives, which included: new product introductions, advertising and in-store marketing investments.

International

Our International segment sells primarily through the Retail channel, which contributed 69.8% of International segment net sales in 2016. Our advertising strategy in our International segment focuses on building brand awareness, which we believe is important to increasing our overall market share. We advertise on television, digitally and through consumer and trade print, as well as cooperative advertising on a shared basis with some of our retail customers. We believe there is significant opportunity to drive sales growth in our International segment through the expansion of product lines within existing channels, increasing our market share in previously underpenetrated markets and, where appropriate, entering into new markets.
    
Seasonality
 
We believe that sales of products to furniture and bedding stores are typically subject to modest seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters. We may not experience our typical seasonality in 2017 as we pursue our strategy to recapture market share in the U.S. Our sales in a particular quarter can also be impacted by new product launches. Additionally, the U.S. bedding industry generally experiences increases in sales around holidays and promotional periods.

Operations
 
Manufacturing and Distribution

Our products are currently manufactured and distributed through our global network of facilities.

6


    
Suppliers

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. These supplier relationships may be revised in order to maintain quality, cost, and delivery expectations. We do not consider ourselves dependent upon any single outside vendor as a source of raw materials for Tempur products and believe that sufficient 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 connection with the general supply chain risks described above, with respect to our Sealy products 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 source the majority of our requirements for polyurethane foam components and spring components for our Sealy and Stearns & Foster mattress units from a key supplier for each component.  These components are purchased under supply agreements. We also purchase a significant portion of our Sealy foundation parts from third party sources under supply agreements. We do not consider ourselves to be dependent in the long term upon any single outside vendor as a source of supply to our bedding business, and we believe over time that sufficient alternative sources of supply for the same, similar or alternative components are available. However, for many of these components if our key supplier for the applicable component failed to supply components in the amount we require this could significantly interrupt production of our products and increase our production costs.
    
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 $26.7 million, $28.7 million and $21.6 million in 2016, 2015 and 2014, respectively.

Industry and Competition

We compete in the global bedding industry, where we are the only truly global participant. The bedding industry is comprised of mattresses and foundations, pillows and accessories. The mattress market category is comprised of traditional innerspring mattresses and non-innerspring mattresses, which includes visco-elastic and foam mattresses, innerspring/foam hybrid mattresses, airbeds and latex mattresses. The foundation category is comprised of traditional foundations and adjustable foundations. Additionally, the pillow market is comprised of traditional foam and feather pillows, as well as pillows made of visco-elastic, latex, foam, sponge, rubber and down. The primary distribution channels for mattresses and foundations are retail furniture and bedding stores, department stores and warehouse clubs.

We encounter competition from a number of bedding manufacturers in both the highly concentrated domestic and highly fragmented international markets. Participants in each of these markets compete primarily on price, quality, brand name recognition, product availability and product performance. In addition, mattress and pillow manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer, including the recent expansion in the number of companies pursuing online direct-to-consumer models for foam mattresses.

The U.S. is the largest market in which we compete. Since 1996, U.S. wholesale bedding sales, which include mattresses and foundations, have grown at a compound annual growth rate, or "CAGR", of 4.7%, reaching approximately $8.0 billion in 2015 according to the International Sleep Products Association (“ISPA”). According to ISPA, U.S. mattress producer shipments increased 4.5% in 2015 as compared to 2014, making 2015 the sixth consecutive yearly unit increase since 2010. Additionally, the value of mattress shipments increased 6.8% in 2015, also the sixth consecutive yearly increase in dollar value since 2010. The value of mattress shipments set a new high in 2015. Unit shipments in 2015 set a new post-recession high, but are still below historical records, according to ISPA. Assuming the health of the overall economy continues to improve, we believe the mattress industry is well positioned for future growth.


7


Industry growth has been driven by increases in average unit selling price (“AUSP”) primarily due to consumer awareness of the ongoing new health benefits of better sleep discovered by the medical community. Additionally, industry growth over the past several years has been driven by an increase in overall consumer brand awareness, the highly profitable nature of the mattress industry for manufacturers and retailers, an overall increase in adjustable foundation attachment rates, innovative technology and consumer demographics.

The U.S. mattress market has experienced consolidation among manufacturers in recent years. We, together with Serta Simmons Bedding, LLC, which sells products under the Serta and Simmons brands, collectively accounted for a significant share of the wholesale bedding industry revenues in 2015 based on figures obtained from ISPA and Furniture/Today industry publications. The balance of the mattress market in the U.S. is served by a large number of other manufacturers. In addition, there has been consolidation of mattress retailers in the U.S. over the last several years, driven principally by Mattress Firm.

The international market is served by a large number of manufacturers, primarily operating on a regional and local basis. These manufacturers offer a broad range of mattress and pillow products.
The highly competitive nature of the mattress and pillow industries means we are continually subject to the risk of loss of market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.

Intellectual Property

Patents, Trademarks and Licensing
 
We hold 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.
 
As of December 31, 2016, we held trademark registrations worldwide, which we believe have significant value and are important to the marketing of our products to retailers. TEMPUR® and Tempur-Pedic® are trademarks registered with the U.S. Patent and Trademark Office. In addition, we have U.S. applications pending for additional trademarks. Several of our trademarks have been registered, or are the subject of pending applications, in various foreign countries. Each U.S. trademark registration is renewable indefinitely as long as the trademark remains in use. We also own numerous trademarks, trade names, service marks, logos and design marks, including Sealy®, Stearns & Foster® and Sealy Posturepedic®. We also license the Bassett® trade name in various territories under a long-term agreement.
    
We derive income from royalties by licensing Sealy® brands, technology and trademarks to other manufacturers. 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, research and development, statistical services and marketing programs. For the year ended December 31, 2016, our licensing activities as a whole generated unaffiliated net royalties of approximately $19.5 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 these requirements. Currently these expenditures are immaterial to our financial results.


8


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 U.S., we are subject to federal, state and local laws and regulations relating to environmental health and safety, including the Federal Water Pollution Control Act and the Comprehensive Environmental Response, Compensation and Liability Act. We believe that we are in compliance with all applicable international, federal, state and local environmental statutes and regulations. We do not expect that compliance with international, federal, state or local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, will have a material effect upon our capital expenditures, earnings or competitive position. We are not aware of any pending federal environmental legislation which would have a material impact on our operations, and have not been required to make and do not expect to make any material capital expenditures for environmental control facilities in the foreseeable future.

Employees
 
As of December 31, 2016, we had approximately 7,300 Tempur Sealy employees, approximately 4,900 of which are located in North America and 2,400 in the rest of the world. Approximately 34.2% of our employees are represented by various labor unions with separate collective bargaining agreements. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We consider our overall relations with our workforce to be satisfactory. Our current collective bargaining agreements, which are typically one to three years in length, expire at various times beginning in 2017 through 2019. As of December 31, 2016, our North America segment employed approximately 600 individuals covered under collective bargaining agreements expiring in 2017 and our International segment employed approximately 1,000 individuals covered under collective bargaining agreements expiring in 2017.

Executive Officers of the Registrant
 
This information is incorporated herein by reference from our definitive proxy statement for the 2017 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 global economy remains unstable, and we expect the economic environment to continue to be challenging. Economic uncertainty may give households less confidence to make discretionary purchases.

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; counterparty failures negatively impacting our treasury operations; inability for us, our customers and our suppliers to accurately forecast future product demand trends; and adverse movements in foreign currency exchange rates. If such conditions are experienced in future periods, our industry, business and results of operations may be severely impacted.

We recently terminated our contracts with Mattress Firm, our largest customer, and this will have a significant negative impact on our sales and profitability in the short term, and if we are unable to recapture these lost sales through other retailers and other channels, over the longer term.

Mattress Firm, which was acquired by Steinhoff in September 2016 and is a customer within the North America segment, was our largest customer in 2016. In February 2016, Mattress Firm acquired Sleepy’s, another large customer. As a result of this acquisition, Mattress Firm and Sleepy's combined represented 21.4% and 23.7% of our sales for the year ended December 31, 2016 and 2015, respectively.

9



During the week of January 23, 2017, we were unexpectedly notified by the senior management of Mattress Firm and representatives of its parent, Steinhoff, of Mattress Firm’s intent to terminate all of Mattress Firm’s contracts with us in the U.S. if we did not agree to considerable changes to its agreements, including significant economic concessions. We engaged in discussions to facilitate a mutually agreeable supply arrangement with Mattress Firm. However, the parties were unable to reach an agreement, and we issued formal termination notices for all of our brands to Mattress Firm as of January 27, 2017. We expect we will wind down our business with Mattress Firm during the first quarter of 2017.

We expect that the termination of our relationship with Mattress Firm will have a significant negative impact on our financial performance in the short-term, but that this termination is in the long term interests of our stockholders. In the short term, we expect that the wind-down of our relationship with Mattress Firm may disrupt the retail mattress market as Mattress Firm closes out its inventory of Tempur and Sealy products. In addition, we expect that the loss of Mattress Firm as a customer will cause a decrease in our market share in the U.S. in 2017 and will cause our net sales in 2017 to decline from our net sales in 2016, and as a result we expect to be less profitable in 2017 as compared to 2016. If we are unable to recapture this market share and net sales or manage our cost structure in light of the decreased volume of sales, this will have a significant negative impact on our net sales and profitability. In the first quarter of 2017 we expect to incur restructuring charges and non-cash write offs related to certain prepaid items and intangibles associated with the Mattress Firm relationship. In addition, as a result of the Mattress Firm termination, indicators of impairment with respect to intangible assets may exist that will require further analysis in the first quarter of 2017. For more information about the anticipated impacts of the Mattress Firm termination and our plans going forward to address the anticipated impacts, please see “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Factors That Could Impact Results of Operations” included in Part II, ITEM 7 of this Report.

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

Our top five customers, collectively, accounted for approximately 38.7% of our sales for 2016. Sales to Mattress Firm represented approximately 21.4% of our sales for 2016. Excluding Mattress Firm, our revised top five customers (the second to sixth largest customers in 2016) represented approximately 19.5% of our sales. The credit environment in which our customers operate has been relatively stable over the past few years. We expect that some of the retailers that carry our products may consolidate, undergo restructurings or reorganizations, experience financial difficulty, or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration in the retail industry. An increase in the concentration of our sales to large customers may negatively affect our profitability due to the impact of volume and other incentive programs related to these customers. Furthermore, as sales to our large customers grow, our credit exposure to these customers may also increase. Some of these retailers may decide to carry only a limited number of brands of mattress products, which could affect our ability to sell products to them on favorable terms, if at all. A substantial decrease or interruption in business from these significant customers could result in the loss of future business and could reduce liquidity and profitability. In addition, the timing of large purchases by these customers could have an increasingly significant impact on our quarterly net sales and earnings. In addition, if Steinhoff or Mattress Firm acquired one or more significant retailers in the U.S. and these retailers thereafter chose not to do business with us, that could adversely impact our net sales and profitability.

Our sales growth is dependent upon our ability to implement strategic initiatives and actions taken to increase sales growth may not be effective.

Our ability to generate sales growth is dependent upon a number of factors, including the following:

our ability to continuously improve our products to offer new and enhanced consumer benefits and better quality;
the ability of our 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 expand into new distribution channels and grow our existing channels, including our current roll-out of Sealy mattress products in various international markets;
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.


10


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 and compete across a range of distribution channels.

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. In addition, mattress and pillow manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer, including the recent expansion in the number of companies pursuing online direct-to-consumer models for foam mattresses. In addition, retailers outside the U.S. have integrated vertically in the furniture and bedding industries, and it is possible that Mattress Firm, Steinhoff and others may acquire other retailers and/or may seek to vertically integrate in the U.S. by acquiring a mattress manufacturer. The pillow industry is characterized by a large number of competitors, none of which are dominant. 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.

We are subject to a pending tax proceeding in Denmark, and an adverse decision or a negotiated settlement could adversely impact our results of operations and cash flows.

We have received income tax assessments from the Danish Tax Authority (“SKAT”). We believe the process to reach a final resolution of this matter could potentially extend over a number of 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. In addition, we are pursuing a settlement with SKAT, which could also require us to pay a significant amount to SKAT in excess of any related reserve. Each of these outcomes could have a material adverse impact on our results of operations and cash flows. In addition, prior to any ultimate resolution of this issue before the Danish National Tax Tribunal ("Tribunal"), the appeals division within SKAT, or the Danish courts, or a settlement of the matter with SKAT, based on a change in facts and circumstances, we may be required to further increase our uncertain tax liability associated with this matter, which could have a material impact on our reported earnings. 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 12, “Income Taxes,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report, and "Management's Discussion and Analysis" included in Part II, ITEM 7 of this Report.

Changes in tax laws and regulations or other factors could cause our income tax rate to increase, potentially reducing net income and adversely affecting cash flows, and fluctuations in our tax obligations and effective tax rate may result in volatility of our financial results and stock price.

We are subject to taxation in various jurisdictions around the world and at any one time multiple tax years are subject to audit by various taxing jurisdictions. In preparing financial statements, we calculate our annual effective income tax rate based on current tax laws and regulations and the estimated taxable income within each of these jurisdictions. Our effective income tax rate, however, may be higher due to numerous factors, including, but not limited to, changes in accounting methods or policies, tax laws or regulations, the tax litigation environment in each such jurisdiction, and the outcome of pending or future audits, whether the result of litigation or negotiations with taxing authorities. Each such item may result in a tax liability that differs from our original estimate. An effective income tax rate that is significantly higher than currently anticipated could have an adverse effect on our net income and cash flows. In addition, there could be ongoing variability in our quarterly tax rates as events occur and exposures are evaluated, which could adversely affect our quarterly results of operations and stock price.

Officials in some of the jurisdictions in which we do business, including the U.S., have proposed or announced that they are considering changes in tax laws and/or other revenue raising laws and regulations, including how U.S. multi-national corporations are taxed on earnings. Additionally, the global tax environment is becoming more complex, with government tax authorities becoming increasingly more aggressive in asserting claims for taxes. Any resulting changes in tax laws or regulations could increase our effective income tax rate or impose new restrictions, costs or prohibitions on our current practices and reduce our net income and adversely affect our cash flows.


11


In addition to the increased activity of taxing authorities with respect to income tax, taxing authorities are also becoming more aggressive in asserting claims for indirect taxes such as import duties and value added tax. These types of claims present risks and uncertainties similar to those discussed above. We believe we are in compliance with all tax laws and regulations that govern such indirect taxes in each of the jurisdictions in which we do business. However, because the claims taxing authorities assert often involve the question of internal product pricing, which is inherently subjective in nature, any such claim may require us to litigate the matter to defend our position or to negotiate a settlement on the matter with the taxing authorities that differs from the amount of potential exposure recorded in the financial statements.

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. Any disruptions caused by the failure of these systems could adversely impact our day-to-day business and decision making and could have a material adverse effect on our performance.

We have successfully implemented a new enterprise resource planning, or “ERP,” system across several of our global subsidiaries. We are continuing this implementation and expanding into our North America segment. This new system will continue to replace a substantial portion of our legacy systems currently supporting our operations. If we are unable to successfully implement the replacement of the legacy systems, it could lead to a disruption in our business and unanticipated additional use of capital and other resources, which may adversely impact our results of operations. In addition, if the cost of implementing this ERP system increases above our estimates, this could have a significant adverse effect on our profitability.

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

As a result of our acquisition of Sealy in 2013 and the implementation of our share repurchase program in 2016, our long-term debt 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 6, “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, thereby reducing our ability to use our cash flow to fund our operations, capital expenditures and other business opportunities;
making it more difficult for us to satisfy 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;
exposing us to variability in interest rates, as a substantial portion of our indebtedness is and will be at variable rates; and
limiting our ability to return capital to our stockholders, including through share repurchases.

In addition, the instruments governing our debt contain 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 6, “Debt,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.


12


We may be unable to sustain our profitability, which could impair our ability to service our indebtedness and make investments in our business and could adversely affect the market price for our stock and increase our leverage.

Our ability to service our indebtedness depends on our ability to maintain our profitability. We may not be able to maintain our profitability on a quarterly or annual basis in future periods. Further, our profitability will depend upon a number of factors, including without limitation:

general economic conditions in the markets in which we sell our products and the 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 successfully manage our relationships with our major customers;
our ability to absorb fluctuations in commodity costs;
our ability to maintain efficient, timely and cost-effective production and utilization of our manufacturing capacity; and
our ability to maintain efficient, timely and cost-effective delivery of our products, and our ability to maintain public recognition of our brands.

We are vulnerable to interest rate risk with respect to our debt, which could lead to an increase in interest expense.

We are subject to interest rate risk in connection with the variable rate debt under our debt agreements. Interest rate changes could increase the amount of our interest payments and thus, negatively impact our future earnings and cash flows. Although we refinanced a significant portion of our variable rate debt in 2016 and 2015 with fixed rate debt, we still have a significant amount of variable rate debt outstanding. For information regarding our sensitivity to changes in interest rates, refer to “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report.

We may be adversely affected by fluctuations in exchange rates, which could affect our results of operations, the costs of our products and our ability to sell our products in foreign markets.

Approximately 24% of our net sales were generated outside of the U.S. in 2016. 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. If the U.S. dollar strengthened relative to the Euro or other foreign currencies where we have operations, there would be a negative impact on our operating results upon translation of those foreign operating results into the U.S. dollar. In 2016, foreign currency exchange rate changes negatively impacted our net income by approximately 3.4% and adjusted EBITDA, which is a non-U.S. generally accepted accounting principle ("GAAP") financial measure, by approximately 2.0%. In 2017, we expect foreign exchange could continue to negatively impact our results of operations. Changes in foreign currency exchange rates could have an adverse impact on our financial condition, results of operations and cash flows. We do not hedge the translation of foreign currency operating results into the U.S. dollar.

We use foreign exchange forward contracts to manage a portion of the exposure to the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as among certain subsidiaries. These foreign exchange forward contracts have maturities ranging from January 2017 to September 2017. These hedging transactions may not succeed in managing our foreign currency exchange rate risk.

Refer to “Management's Discussion and Analysis” included in Part II, ITEM 7 of this Report and “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report for further discussion on the impact of foreign exchange rates on our operations.


13


We are subject to fluctuations in the cost of raw materials, and increases in these costs would reduce our liquidity and profitability.

The bedding industry has been challenged by volatility in the price of petroleum-based and steel products, which affects the cost of polyurethane foam, polyester, polyethylene foam and steel innerspring component parts. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Given the significance of the cost of these materials to our products, volatility in the prices of the underlying commodities can significantly affect profitability. 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.

If we, or our service providers, are unable to adequately protect our information assets from cyber-based attacks or other security incidents, our operations could be disrupted and our reputation could be damaged.

We are increasingly dependent on information technology, including the Internet, for the storage, processing, and transmission of our electronic, business-related information assets. We leverage our internal information technology infrastructures, and those of our service providers, to enable, sustain and support our global business interests. In the event that we or our service providers are unable to prevent, detect and remediate cyber-based attacks or other security incidents in a timely manner, our operations could be disrupted or we may incur financial or reputational losses arising from the theft, alteration, misuse, unauthorized disclosure or destruction of our information assets.

We cannot guarantee that we will repurchase our common stock pursuant to our stock repurchase program or that our stock repurchase program will enhance long-term stockholder value. Stock repurchases could also increase the volatility of the price of our common stock and could diminish our cash reserves.

On February 1, 2016, our Board of Directors authorized a stock repurchase program pursuant to which the Company was authorized to repurchase shares of our common stock for a total repurchase price of not more than $200.0 million. During 2016 our Board of Directors increased the total authorization to $600.0 million. As of December 31, 2016, the Company had repurchased 8.7 million shares for approximately $533.0 million under the share repurchase authorization and had approximately $67.0 million remaining under the existing share repurchase authorization. In February 2017 our Board of Directors increased this share repurchase authorization by $200 million, and at February 16, 2017 we had available approximately $227 million under this amended share repurchase authorization. Although our Board of Directors has authorized the stock repurchase program, the stock repurchase program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares and may be suspended or terminated at any time. Stock may be purchased from time to time, in the open market or through private transactions, subject to market conditions, in compliance with applicable state and federal securities laws. The timing and amount of repurchases, if any, will depend upon several factors, including market and business conditions, restrictions in our debt agreements, the trading price of our common stock and the nature of other investment opportunities. In addition, repurchases of our common stock pursuant to our stock repurchase program could affect the market price of our common stock or increase its volatility. For example, the existence of a stock repurchase program could cause our stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. Additionally, our stock repurchase program could diminish our cash reserves, which may impact our ability to finance future growth and to pursue possible future strategic opportunities and acquisitions. There can be no assurance that any stock repurchases will enhance stockholder value because the market price of our common stock may decline below the levels at which we determine to repurchase our stock. Although our stock repurchase program is intended to enhance long-term stockholder value, there is no assurance that it will do so and short-term stock price fluctuations could reduce the program’s effectiveness.

Our new product launches may not be successful due to development delays, failure of new products to achieve anticipated levels of market acceptance and significant costs associated with failed product introductions, which could adversely affect our revenues and profitability.

Each year we invest significant time and resources in research and development to improve our product offerings and launch new products. 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.


14


Our operating results are subject to fluctuations, including as a result of seasonality, which could make sequential quarter to quarter comparisons an unreliable indication of our performance and adversely affect the market price of our common stock.

A significant portion of our net sales are attributable to our Retail channel, particularly net sales to furniture and bedding stores. We believe that our sales of products to furniture and bedding stores are typically subject to modest seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters. Our sales in a particular quarter can be impacted by new product launches. Additionally, the U.S. bedding industry generally experiences increases in sales around holidays and promotional periods.This seasonality means that a sequential quarter to quarter comparison may not be a good indication of our performance or of how we will perform in the future. We may not experience our typical seasonality in 2017 as we pursue our strategy to recapture market share in the U.S.

We are subject to risks from our international operations, such as complying with U.S. and foreign laws, foreign exchange exposure, tariffs, increased costs, political risks and our ability to expand in certain international markets, which could impair our ability to compete and our profitability.

We are a global company, selling our products in approximately 100 countries worldwide. We generated approximately 24% of our net sales outside of the U.S. in 2016, 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 U.S. laws affecting operations outside of the U.S. such as the Foreign Corrupt Practices Act; complying with foreign laws and regulations, including disparate anti-corruption laws and regulations; risks associated with varying local business customs; and the potential imposition of trade or foreign exchange restrictions, tariffs and other tax increases, fluctuations in exchange rates, inflation and unstable political situations and labor issues. We are also limited in our ability to independently expand in certain international markets where we have granted licenses to manufacture and sell Sealy® bedding products. Fluctuations in the rate of exchange between currencies in which we do business may affect our financial condition or results of operations.

If we are not able to protect our trade secrets or maintain our trademarks, patents and other intellectual property, we may not be able to prevent competitors from developing similar products or from marketing in a manner that capitalizes on our trademarks, and this loss of a competitive advantage could decrease our profitability and liquidity.

We rely on patents and trade secrets to protect the design, technology and function of our products. To date, we have not sought U.S. or international patent protection for our principal product formula for TEMPUR® material and certain of our manufacturing processes. Accordingly, we may not be able to prevent others from developing certain visco-elastic material and products that are similar to or competitive with our products. Our ability to compete effectively with other companies also depends, to a significant extent, on our ability to maintain the proprietary nature of our owned and licensed intellectual property. We own a significant number of patents or have patent applications pending on some aspects of our products and certain manufacturing processes. However, the principal product formula and manufacturing processes for our TEMPUR® material are not patented and we must maintain these as trade secrets in order to protect this intellectual property. We own U.S. and foreign registered trademarks and service marks and have applications for the registration of trademarks and service marks pending domestically and abroad. We also license certain intellectual property rights from third parties.

Certain of our trademarks are currently registered in the U.S. and are registered or pending in foreign jurisdictions. Certain other trademarks are the subject of protection under common law. However, those rights could be circumvented, or violate the proprietary rights of others, or we could be prevented from using them if challenged. A challenge to our use of our trademarks could result in a negative ruling regarding our use of our trademarks, their validity or their enforceability, or could prove expensive and time consuming in terms of legal costs and time spent defending against such a challenge. Any loss of trademark protection could result in a decrease in sales or cause us to spend additional amounts on marketing, either of which could decrease our liquidity and profitability. In addition, if we incur significant costs defending our trademarks, that could also decrease our liquidity and profitability. In addition, we may not have the financial resources necessary to enforce or defend our trademarks. Furthermore, our patents may not provide meaningful protection and patents may never issue from pending applications. It is also possible that others could bring claims of infringement against us, as our principal product formula and manufacturing processes are not patented, and that any licenses protecting our intellectual property could be terminated. If we were unable to maintain the proprietary nature of our intellectual property and our significant current or proposed products, this loss of a competitive advantage could result in decreased sales or increased operating costs, either of which would decrease our liquidity and profitability.

15



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.

Loss of suppliers and disruptions in the supply of our raw materials could increase our costs of sales and reduce our ability to compete effectively.

We acquire raw materials and certain components from a number of suppliers with manufacturing locations around the world. If we were unable to obtain raw materials and certain components from these suppliers for any reason, we would have to find replacement suppliers. Any substitute arrangements for raw materials and certain components might not be on terms as favorable to us. In addition, we outsource the procurement of certain goods and services from suppliers in foreign countries. If we were no longer able to outsource through these suppliers, we could source them elsewhere, perhaps at a higher cost. We maintain relatively small supplies of our raw materials and outsourced goods at our manufacturing facilities, and any disruption in the on-going shipment of supplies to us could interrupt production of our products, which could result in a decrease of our sales or could cause an increase in our cost of sales, either of which could decrease our liquidity and profitability.

In our Sealy products, raw materials consist of polyurethane foam, polyester, polyethylene foam and steel innerspring components that we purchase from various suppliers. In the U.S. and Canada, we source the majority of our requirements for polyurethane foam components and spring components for our Sealy and Stearns & Foster mattress units from a key supplier for each component.  These components are purchased under supply agreements. We also purchase a significant portion of our Sealy foundation parts from third party sources under supply agreements. We do not consider ourselves to be dependent in the long term upon any single outside vendor as a source of supply to our bedding business, and we believe over time that sufficient alternative sources of supply for the same, similar or alternative components are available. However, for many of these components if our key supplier for the applicable component failed to supply components in the amount we require this could significantly interrupt production of our products and increase our production costs.   

The loss of the services of any members of our executive management team could impair our ability to execute our business strategy and as a result, reduce our sales and profitability.

We depend on the continued services of our executive management team. The loss of key personnel could have a material adverse effect on our ability to execute our business strategy and on our financial condition and results of operations. We do not maintain key-person insurance for members of our executive management team.

Deterioration in labor relations could disrupt our business operations and increase our costs, which could decrease our liquidity and profitability.

As of December 31, 2016, we had approximately 7,300 full-time employees. Approximately 34.2% 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.


16


We may face exposure to product liability claims, which could reduce our liquidity and profitability and reduce consumer confidence in our products.

We face an inherent business risk of exposure to product liability claims if the use of any of our products results in personal injury or property damage. In the event that any of our products prove to be defective, we may be required to recall, redesign or even discontinue those products. We maintain insurance against product liability claims, but such coverage may not continue to be available on terms acceptable to us or be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage could impair our liquidity and profitability, and any claim or product recall that results in significant adverse publicity against us could result in consumers purchasing fewer of our products, which would also impair our liquidity and profitability.

Regulatory requirements, including, but not limited to, trade, environmental, health and safety requirements, may require costly expenditures and expose us to liability.

Our products and our marketing and advertising programs are subject to regulation in the U.S. by various federal, state and local regulatory authorities, including the Federal Trade Commission and the U.S. Food and Drug Administration. In addition, other governments and agencies in other jurisdictions regulate the sale and distribution of our products. These rules and regulations may change from time to time, or may conflict. There may be continuing costs of regulatory compliance including continuous testing, additional quality control processes and appropriate auditing of design and process compliance. For example, the U.S. Consumer Product Safety Commission (“CPSC”) and many foreign jurisdictions have adopted rules relating to fire retardancy standards for the mattress industry. Further, some states and the U.S. Congress continue to consider fire retardancy regulations that may be different or more stringent than the CPSC standard. Adoption of multi-layered regulatory regimes, particularly if they conflict with each other, could increase our costs, alter our manufacturing processes and impair the performance of our products which may have an adverse effect on our business. We are also subject to various health and environmental provisions, such as California Proposition 65 (the Safe Drinking Water and Toxic Enforcement Act of 1986) and 16 CFR Part 1633 (Standard for the Flammability (Open Flame) of Mattress Sets).

Our marketing and advertising practices could also become the subject of proceedings before regulatory authorities or the subject of claims by other parties and could require us to alter or end these practices or adopt new practices that are not as effective or are more expensive.

In addition, we are subject to federal, state and local laws and regulations relating to pollution, environmental protection and occupational health and safety. We may not be in complete compliance with all such requirements at all times. We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. If a release of hazardous substances occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of our properties, we may be held liable and the amount of such liability could be material. As a manufacturer of bedding and related products, we use and dispose of a number of substances, such as glue, lubricating oil, solvents and other petroleum products, as well as certain foam ingredients, that may subject us to regulation under numerous foreign, federal and state laws and regulations governing the environment. Among other laws and regulations, we are subject in the U.S. to the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act, the Clean Air Act and related state and local statutes and regulations.

Our operations could also be impacted by a number of pending legislative and regulatory proposals to address greenhouse gas emissions in the U.S. and other countries. Certain countries have adopted the Kyoto Protocol. New greenhouse gas reduction targets have been established under the Kyoto Protocol, as amended, and certain countries, including Denmark, have adopted the new reduction targets. This and other international initiatives under consideration could affect our International operations. These actions could increase costs associated with our operations, including costs for raw materials, pollution control equipment and transportation. Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future consolidated financial condition, results of operations, or cash flows.

We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. In the event contamination is discovered with respect to one or more of our current or former properties, government authorities or third parties may bring claims related to these properties, which could have a material effect on our profitability.

17



Our pension plans are currently underfunded and we may be required to make cash payments to the plans, reducing our available cash.

We maintain certain defined benefit pension plans. In addition, hourly employees working at certain of Sealy’s domestic manufacturing facilities are covered by union sponsored retirement and health and welfare plans. These plans cover both active employees and retirees. The plans are currently underfunded, and under certain circumstances, including the decision to close or sell a facility, we could be required to pay amounts with respect to this underfunding. Such events may significantly impair our profitability and liquidity and the possibility of having to make these payments could affect our decision on whether to close or sell a particular facility. For more information, refer to Note 7, “Retirement Plans,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

Challenges to our pricing or promotional allowance policies or practices could adversely affect our operations.

Certain of our retail pricing and promotional allowance policies or practices are subject to antitrust regulations in the U.S. and abroad. If antitrust regulators or private parties in any jurisdiction in which we do business initiate investigations or claims that challenge our pricing or promotional allowance policies or practices, our efforts to respond could force us to divert management resources and we could incur significant unanticipated costs. If such an investigation or claim were to result in a charge that our practices or policies were in violation of applicable antitrust or other laws or regulations, we could be subject to significant additional costs of defending such charges in a variety of venues and, ultimately, if there were a finding that we were in violation of antitrust or other laws or regulations, there could be an imposition of fines, and damages for persons injured, as well as injunctive or other relief. Any requirement that we pay fines or damages (which, under the laws of certain jurisdictions, may be trebled) could decrease our liquidity and profitability, and any investigation or claim that requires significant management attention or causes us to change our business practices could disrupt our operations or increase our costs, also resulting in a decrease in our liquidity and profitability. An antitrust class action or individual suit against us could result in potential liabilities, substantial costs, treble damages, and the diversion of our management’s attention and resources, regardless of the outcome.

Our stock price is likely to continue to be volatile, your investment could decline in value, and we may incur significant costs from class action litigation.

The trading price of our common stock is likely to continue to be volatile and subject to wide price fluctuations. The trading price of our common stock may fluctuate significantly in response to various factors, including but not limited to:

actual or anticipated variations in our quarterly and annual operating results, including those resulting from seasonal variations in our business;
general economic conditions, such as unemployment, changes in short-term and long-term interest rates and fluctuations in both debt and equity capital markets;
introductions or announcements of technological innovations or new products by us or our competitors;
disputes or other developments relating to proprietary rights, including patents, litigation matters, and our ability to patent, or otherwise protect, our products and technologies;
changes in estimates by securities analysts of our financial performance or the financial performance of our competitors or major customers or statements by others in the investment community relating to such performance;
stock repurchase programs;
bankruptcies of any of our major customers;
loss 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 or significant retailer customers of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
announcements by our competitors or our major customers of their quarterly operating results or announcements by our competitors or our major customers of their views on trends in the bedding industry;
regulatory developments in the U.S. and abroad;
economic and political factors;
public announcements or filings with the SEC indicating that significant stockholders, directors or officers are buying or selling shares of our common stock; and
the declaration or suspension of a cash dividend.


18


In addition, the stock market in general has experienced significant price and volume fluctuations that have often been unrelated or disproportionate to operating performance. These broad market factors may seriously harm the market price of our common stock, regardless of our operating performance.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in potential liabilities, substantial costs, and the diversion of our management’s attention and resources, regardless of the outcome. See “Legal Proceedings” included in Part I, ITEM 3 of this Report.

Future sales of our common stock may depress our stock price.

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. All shares of our common stock are freely transferable without restriction or further registration under the Securities Act, except for certain shares of our common stock which were purchased by our executive officers, directors, principal stockholders, and some related parties.

We have stockholders who presently beneficially own more than 5.0% of our outstanding capital stock. Sales or other dispositions of our shares by these major stockholders may depress our stock price.

Delaware law and our certificate of incorporation and bylaws contain anti-takeover provisions, and our Board of Directors has adopted a limited duration stockholder rights agreement, any of which could delay or discourage a merger, tender offer, or assumption of control of the Company not approved by our Board of Directors that some stockholders may consider favorable.

Provisions of Delaware law and our certificate of incorporation and by-laws could hamper a third party’s acquisition of us, or discourage a third party from attempting to acquire control of us. You may not have the opportunity to participate in these transactions. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions include:

our ability to issue preferred stock with rights senior to those of the common stock without any further vote or action by the holders of our common stock;
the requirements that our stockholders provide advance notice when nominating our directors; and
the inability of our stockholders to convene a stockholders’ meeting without the chairperson of the Board of Directors, the president, or a majority of the Board of Directors first calling the meeting.

In addition, our Board of Directors recently adopted a short-term stockholder rights agreement with an expiration date of February 7, 2018 and an ownership trigger threshold of 20%. This stockholder rights agreement could render more difficult, or discourage a merger, tender offer, or assumption of control of the Company that is not approved by our Board of Directors. The rights agreement, however, should not interfere with any merger, tender or exchange offer or other business combination approved by our Board of Directors. In addition, the rights agreement does not prevent our Board of Directors from considering any offer that it considers to be in the best interest of the Company’s stockholders.


ITEM 1B. UNRESOLVED STAFF COMMENTS
 
None.


19


ITEM 2. PROPERTIES

The following table sets forth certain information regarding our principal facilities at December 31, 2016.
Name
 
Location
 
Approximate Square Footage
 


Title
 


Type of Facility
North America
 
 
 
 
 
 
 
 
Tempur Production USA, LLC
 
Albuquerque, New Mexico
 
800,000
 
Leased (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Hagerstown, Maryland
 
615,600
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Plainfield, Indiana
 
614,000
 
Leased
 
Manufacturing
Tempur Production USA, LLC
 
Duffield, Virginia
 
581,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Conyers, Georgia
 
300,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Green Island, New York
 
257,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Richmond, California
 
241,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Orlando, Florida
 
225,050
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Brenham, Texas
 
220,500
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Batavia, Illinois
 
210,000
 
Leased
 
Manufacturing
Tempur Production USA, LLC
 
Mountain Top, Pennsylvania
 
210,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Trinity, North Carolina
 
180,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
South Gate, California
 
172,000
 
Leased
 
Manufacturing
Sealy Canada, Ltd
 
Alberta, Canada
 
144,500
 
Owned
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Medina, Ohio
 
140,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Williamsport, Maryland
 
134,500
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Lacey, Washington
 
134,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Kansas City, Kansas
 
122,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Phoenix, Arizona
 
120,000
 
Leased
 
Manufacturing
Sealy Canada, Ltd
 
Toronto, Canada
 
120,000
 
Leased
 
Manufacturing
Sealy, Inc.
 
Trinity, North Carolina
 
105,500
 
Owned (a)
 
Office
Sealy Mattress Manufacturing Co., LLC
 
St. Paul, Minnesota
 
93,600
 
Owned (a)
 
Manufacturing
Sealy Canada, Ltd
 
Quebec, Canada
 
88,000
 
Owned
 
Manufacturing
Sealy Mattress Manufacturing Co., LLC
 
Denver, Colorado
 
82,000
 
Owned (a)
 
Manufacturing
Tempur-Pedic Management, LLC
 
Lexington, Kentucky
 
77,400
 
Owned (a)
 
Office
Sealy Mattress Company of Puerto Rico
 
Carolina, Puerto Rico
 
44,000
 
Owned
 
Manufacturing
 
 
 
 
 
 
 
 
 
International
 
 
 
 
 
 
 
 
Dan-Foam ApS
 
Aarup, Denmark
 
523,000
 
Owned
 
Manufacturing
Sealy Argentina SRL
 
Buenos Aires, Argentina
 
144,000
 
Owned
 
Manufacturing
Tempur Deutschland GmbH
 
Steinhagen, Germany
 
143,500
 
Owned
 
Warehouse
Sealy Mattress Company Mexico, S. de R.L. de C.V.
 
Toluca, Mexico
 
130,500
 
Owned
 
Manufacturing
Tempur UK Ltd
 
Middlesex, United Kingdom
 
61,000
 
Leased
 
Warehouse
Tempur France
 
Ile de France, France
 
53,800
 
Leased
 
Warehouse
(a)
 
We have granted a mortgage or otherwise encumbered our interest in this facility as collateral for secured indebtedness.

 In addition to the properties listed above, we have other facilities in other countries, the majority under leases with one to ten year terms. The manufacturing facility in Albuquerque, New Mexico is leased as part of the related industrial revenue bond financing. We have an option to repurchase the property for one dollar upon termination of the lease.

We believe that our existing properties are suitable for the conduct of our business, are adequate for our present needs and will be adequate to meet our future needs.


20


ITEM 3. LEGAL PROCEEDINGS

(a) 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 U.S. 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.

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. The Court was scheduled to consider class certification motions in the fourth quarter of 2015; however, the plaintiffs filed a Motion to Amend the Complaint, at which time the Company filed a Motion to Dismiss the Amended Complaint. A hearing on the Motion to Dismiss was held January 28, 2016 and the Court denied in part and granted in part the Company’s Motion to Dismiss allowing certain claims to proceed. The Court considered class certification motions in August 2016, and in September 2016, denied the Plaintiffs’ motion for class certification. In December 2016, the Ninth Circuit Court of Appeals affirmed the lower court’s decision. It is unclear what additional actions the plaintiffs may take in light of the denial of class certification. As a result, the outcome of the case remains unclear, and 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.

(b) Income tax assessments. The Company has received income tax assessments from SKAT. The Company believes the process to reach a final resolution of this matter could potentially extend over a number of years. If the Company is not successful in defending its position that the Company owes no additional taxes, the Company could be required to pay a significant amount to SKAT. In addition, the Company is pursuing a settlement with SKAT, which could also require the Company to pay a significant amount to SKAT in excess of any related reserve.  Each of these outcomes could have a material adverse impact on the Company's results of operations and cash flows. In addition, prior to any ultimate resolution of this issue before the Tribunal or the Danish courts, or a settlement of the matter with SKAT, based on a change in facts and circumstances, the Company may be required to further increase its uncertain tax liability associated with this matter, which could have a material impact on the Company's reported earnings. For a description of these assessments and additional information with respect to these assessments and the various related legal proceedings, see Note 12, “Income Taxes,” in the Company's Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

(c) 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.

ITEM 4. MINE SAFETY DISCLOSURES
 
None.

PART II
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market for Registrant’s Common Equity

Our sole class of common equity is our $0.01 par value common stock, which trades on the New York Stock Exchange (NYSE) under the symbol “TPX.” Trading of our common stock commenced on the NYSE on December 18, 2003. Prior to that time, there was no public trading market for our common stock.
 

21


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.
 
Price Range
 
High
 
Low
Fiscal 2016
 
 
 
First Quarter
$
69.32

 
$
52.51

Second Quarter
62.76

 
53.95

Third Quarter
82.04

 
53.95

Fourth Quarter
68.99

 
50.94

 
 
 
 
Fiscal 2015
 
 
 
First Quarter
$
59.14

 
$
49.17

Second Quarter
67.18

 
56.35

Third Quarter
78.64

 
67.50

Fourth Quarter
81.89

 
70.46


As of February 21, 2017, we had approximately 90 stockholders of record of our common stock.

Dividends

We do not pay a dividend. The decision to pay a dividend in future periods is reviewed by our Board of Directors on a periodic basis. Further, we are subject to certain customary restrictions on dividends under our 2016 Credit Agreement and Indentures. See Note 6, "Debt," in our Consolidated Financial Statements, included in Part II, ITEM 8 of this Report, for a discussion of the 2016 Credit Agreement and Indentures.

Issuer Purchases of Equity Securities

On February 1, 2016, our Board of Directors authorized a stock repurchase program pursuant to which we were authorized to repurchase shares of our common stock for a total repurchase price of not more than $200.0 million. During 2016 our Board of Directors increased the total authorization to $600.0 million. As of December 31, 2016, we had repurchased 8.7 million shares for approximately $533.0 million under the share repurchase authorization and had approximately $67.0 million remaining under the existing share repurchase authorization. In February 2017, our Board of Directors increased this share repurchase authorization by $200 million, and at February 16, 2017 we had available approximately $227 million under this amended share repurchase authorization.

Stock repurchases under this program may be made through open market transactions, negotiated purchases or otherwise, at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, financing, regulatory requirements and other market conditions. The program does not require the repurchase of any minimum number of shares and may be suspended, modified or discontinued at any time without prior notice. Repurchases may be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under federal securities laws.

Equity Compensation Plan Information

Equity compensation plan information required by this Item is incorporated by reference from Part III, ITEM 12 of this Report.

Performance Graph

The following Performance Graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act or Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.


22


The following table compares cumulative stockholder returns for us over the last five years to the Standard & Poor’s ("S&P") 500 Stock Composite Index, and a peer group. The S&P 500 Composite Index is a capitalization weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the U.S. economy, 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 a meaningful comparison of stock performance.
 
The peer issuers included in this graph are set forth below in the table. In 2016 the peer group was changed to remove Mattress Firm Holding Corp., which was acquired in 2016 by Steinhoff, and to remove Newell Rubbermaid and Jarden, which combined during 2016 and no longer meet our revenue criteria. In 2016 the peer group was also changed to add La-Z-Boy and Lululemon Athletica.

2016 Peer Group
Brunswick Corp.
Harman International Industries, Inc.
Polaris Industries Inc.
Carter's, Inc.
Hasbro, Inc.
Select Comfort Corp.
Columbia Sportswear Co.
La-Z-Boy
Steelcase Inc.
Deckers Outdoor Corp.
Leggett & Platt, Inc.
Tupperware Brands Corp.
Dorel Industries Inc.
Lexmark International, Inc.
Under Armour, Inc.
Fossil Group, Inc.
Lululemon Athletica
Williams-Sonoma, Inc.
Gildan Activewear Inc.
Herman Miller, Inc.
Wolverine World Wide, Inc.
HanesBrands Inc.
Mohawk Industries, Inc.
 

2015 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.


23


    tpx-2013123_charta01.jpg
 
 
12/31/2011
 
12/31/2012
 
12/31/2013
 
12/31/2014
 
12/31/2015
 
12/31/2016
Tempur Sealy International, Inc.
 
$
100.00

 
$
59.95

 
$
102.72

 
$
104.53

 
$
134.13

 
$
129.98

S&P 500
 
100.00

 
116.00

 
153.58

 
174.60

 
177.01

 
198.18

2015 Peer Group
 
100.00

 
130.36

 
198.15

 
224.53

 
210.83

 
217.07

2016 Peer Group
 
100.00

 
132.43

 
190.64

 
211.58

 
193.81

 
202.99



24


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, 2016, 2015, 2014, 2013 and 2012 from our audited financial statements. Our Consolidated Financial Statements as of December 31, 2016 and 2015 and for each of the three years in the period ended December 31, 2016 are included in Part II, ITEM 8 of this Report.
(in millions, except per common share amounts)
 
 
 
 
 
 
 
 
 
Statement of Income Data:
2016
 
2015
 
2014
 
2013 (1)
 
2012
Net sales
$
3,127.3

 
$
3,151.2

 
$
2,989.8

 
$
2,464.3

 
$
1,402.9

Cost of sales
1,817.9

 
1,902.3

 
1,839.4

 
1,449.4

 
688.3

Gross profit
1,309.4

 
1,248.9

 
1,150.4

 
1,014.9

 
714.6

Operating expense, net
893.9

 
939.8

 
874.1

 
771.1

 
466.3

Operating income
415.5

 
309.1

 
276.3

 
243.8

 
248.3

Interest expense, net
85.2

 
96.1

 
91.9

 
110.8

 
18.8

Loss on extinguishment of debt
47.2

 

 

 

 

Loss on disposal, net

 

 
23.2

 

 

Other (income) expense, net
(0.2
)
 
12.9

 
(13.7
)
 
5.0

 
0.3

Income before income taxes
283.3

 
200.1

 
174.9

 
128.0

 
229.2

Income tax provision (2)
(86.8
)
 
(125.4
)
 
(64.9
)
 
(49.1
)
 
(122.4
)
Net income before non-controlling interests
196.5

 
74.7

 
110.0

 
78.9

 
106.8

Less: net (loss) income attributable to non-controlling interests
(5.6
)
 
1.2

 
1.1

 
0.3

 

Net income attributable to Tempur Sealy International, Inc.
$
202.1

 
$
73.5

 
$
108.9

 
$
78.6

 
$
106.8

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data (at end of period):
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
65.7

 
$
153.9

 
$
62.5

 
$
81.0

 
$
179.3

Total assets (3)
2,702.6

 
2,655.5

 
2,582.7

 
2,729.9

 
1,319.5

Total debt (3)
1,779.0

 
1,420.8

 
1,537.0

 
1,808.9

 
1,025.0

Capital leases and other debt
109.1

 
34.0

 
27.7

 
27.6

 

Redeemable non-controlling interest
7.6

 
12.4

 
12.6

 
11.5

 

Total stockholders' (deficit) equity
(12.2
)
 
290.2

 
202.7

 
118.6

 
22.3

 
 
 
 
 
 
 
 
 
 
Other Financial and Operating Data:
 
 
 
 
 
 
 
 
 
Dividends per common share
$

 
$

 
$

 
$

 
$

Depreciation and amortization (4)
89.5

 
93.9

 
89.7

 
91.5

 
42.0

Net cash provided by operating activities
165.5

 
234.2

 
225.2

 
98.5

 
189.9

Net cash used in investing activities
(62.4
)
 
(59.7
)
 
(10.4
)
 
(1,213.0
)
 
(55.0
)
Net cash (used in) provided by financing activities
(185.1
)
 
(90.7
)
 
(238.1
)
 
(1,013.4
)
 
70.8

Basic earnings per common share
3.43

 
1.19

 
1.79

 
1.30

 
1.74

Diluted earnings per common share
3.38

 
1.17

 
1.75

 
1.28

 
1.70

Capital expenditures
62.4

 
65.9

 
47.5

 
40.0

 
50.5


(1)
Includes Sealy results of operations from March 18, 2013 through December 31, 2013. Information presented for periods prior to March 18, 2013 do not include Sealy and as a result, the information may not be comparable.
(2)
Income tax provision for 2015 includes approximately $60.7 million related to changes in estimate related to the uncertain tax position regarding the Danish Tax Matter, as defined in Note 12, "Income Taxes," in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report. 
(3)
Includes issuance of $375.0 million of 2020 Senior Notes in December 2012, with cash proceeds held in escrow at December 31, 2012. The net proceeds from the 2020 Senior Notes were used as part of the financing for the 2013 acquisition of Sealy Corporation and its subsidiaries. Refer to Note 6, “Debt,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for additional information regarding the 2020 Senior Notes.
(4)
Includes $16.2 million, $22.5 million, $13.4 million, $16.9 million, $5.7 million in non-cash, stock-based compensation expense related to restricted stock units, performance restricted stock units, deferred stock units and stock options in 2016, 2015, 2014, 2013, and 2012, respectively.


25


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with Part II, ITEM 6 of this Report and the audited Consolidated Financial Statements and accompanying notes thereto included elsewhere in this Report. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are subject to numerous risks and uncertainties. See “Special Note Regarding Forward-Looking Statements” and Part I, ITEM 1A of this Report. Our actual results may differ materially from those contained in any forward-looking statements.

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the years ended December 31, 2016, 2015 and 2014, including the following topics:

an overview of our business and strategy;
factors impacting results of operations;
results of operations including our net sales and costs in the periods presented as well as changes between periods;
expected sources of liquidity for future operations; and
our use of certain non-GAAP financial measures.

Business Overview

General

We are the world's largest bedding manufacturer. We develop, manufacture, market, and distribute bedding products, which we sell globally. Our brand portfolio includes many highly recognized brands in the industry, including our Tempur products sold under the TEMPUR® and Tempur-Pedic® brands, and our Sealy products sold under the Sealy®, Sealy Posturepedic®, and Stearns & Foster® brands. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.

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

Business Segments

We operate under two reportable segments: North America and International. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S. and Canada. Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. We evaluate segment performance based on net sales, gross profit and operating income.

Strategy
 
We are the world’s largest bedding manufacturer and the only manufacturer with global scale. Our long-term strategy is to drive earnings growth. Our goal is to improve the sleep of more people, every night, all around the world. In order to achieve our long-term strategy while managing the current economic and competitive environments, we will focus on developing the best bedding products, investing in our brands, expanding our North America margins while maintaining market share, growing our market share in International and optimizing our worldwide distribution. Through our strategy, we will generate earnings growth and strong cash flow that will be used to reduce debt to the extent appropriate and return value to stockholders. For a complete overview of our business, including a description of our business segments, see "Business" under Part I, ITEM 1 of this Report.

Factors That Could Impact Results of Operations

The factors outlined below could impact our future results of operations. For more extensive discussion of these and other risk factors, please refer to "Risk Factors" under Part I, ITEM 1A in this Report.


26


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. We continue 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 other actions to further strengthen our business.

Termination of Mattress Firm Relationship

Mattress Firm, which was acquired by Steinhoff in September 2016 and is a customer within the North America segment, is our largest customer. In February 2016, Mattress Firm acquired Sleepy’s, another large customer. As a result of this acquisition, Mattress Firm and Sleepy's combined represented 21.4% and 23.7% of our sales for the year ended December 31, 2016 and 2015, respectively. Our net sales to Mattress Firm declined 10.6% in 2016 as compared to 2015, including sales to Sleepy’s in both years. Excluding net sales to Mattress Firm, our net sales increased 2.3% in 2016 as compared to 2015.

During the week of January 23, 2017, we were unexpectedly notified by the senior management of Mattress Firm and representatives of Steinhoff of Mattress Firm's intent to terminate all of Mattress Firm's contracts with us in the U.S. if we did not agree to considerable changes to our agreements with Mattress Firm, including significant economic concessions. We engaged in discussions to facilitate a mutually agreeable supply arrangement with Mattress Firm. However, the parties were unable to reach an agreement, and we issued formal termination notices for all of our brands to Mattress Firm as of January 27, 2017. We agreed to continue supplying Mattress Firm for an additional two months. We expect that the termination of our relationship with Mattress Firm will have a significant negative impact on our financial performance in the short-term, but that this termination is in the long-term interests of our stockholders.

In the short-term, we expect that the wind down of our relationship with Mattress Firm may disrupt the retail mattress market as Mattress Firm closes out its inventory of Tempur and Sealy products. In addition, we expect that the loss of Mattress Firm as a customer will cause a decrease in our market share in the U.S. in 2017 and will cause our net sales in 2017 to decline from our net sales in 2016, and as a result we expect to be less profitable in 2017 as compared to 2016. In order to address this issue and recapture market share and lost sales, we will work with our existing retailers to expand their offerings of our products and expand our distribution with new retailers and other distribution channels. Our ability to improve our net sales performance in 2017 as compared to current expectations will be driven primarily by how quickly we can recapture market share and net sales.

With respect to our cost structure, we expect to take steps in the first quarter of 2017 to manage our cost structure, primarily in areas of our operations that are most significantly dependent on the level of our sales. In the first quarter of 2017, due to the termination of the contract with Mattress Firm, we expect there will be some restructuring charges and non-cash write offs. In managing our business and our costs going forward, we intend to manage our business with the primary goal of recapturing market share and net sales, and accordingly our expense reductions in the areas of manufacturing and marketing are not expected to be significant. On the manufacturing side of our operations, we will accept some lower operating efficiencies in the short term to retain our high quality manufacturing capabilities, which we expect the market will need over time. On the marketing side, we expect to increase our investment on an absolute dollar basis and as a percentage of sales consistent with our long-term strategy of building and maintaining our brands to drive sales, and this may have an incremental negative impact on our profitability in the short-term.

With respect to our cash flow and liquidity, we expect that over the first half of 2017 the impact of the Mattress Firm termination will be unfavorable as compared to the first half of 2016. In the first quarter of 2017, we expect to incur some restructuring charges and non-cash write offs related to certain prepaid items and intangible assets associated with the Mattress Firm relationship. In addition, as a result of the Mattress Firm termination, indicators of impairment may exist with respect to our intangible assets that will require further analysis in the first quarter of 2017.

With respect to the financial covenants in our debt facilities, we expect to remain in compliance with our financial covenants through the end of 2017 and beyond, notwithstanding the decrease in net sales and other impacts referred to above.

For further discussion of the risks associated with large customers, refer to our "Risk Factors" under Part I, ITEM 1A in this Report.


27


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 currency exchange rates. Foreign currency exchange rate movements also create a degree of risk by affecting the U.S. dollar value of sales made and costs incurred in foreign currencies. We use foreign exchange forward contracts to manage a portion of the exposure to the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as among certain subsidiaries. These hedging transactions may not succeed in managing our foreign currency exchange rate risk. Consequently, our reported earnings and financial position could fluctuate materially as a result of foreign exchange gains or losses. Additionally, the operations of our foreign currency denominated subsidiaries result in foreign currency translation fluctuations in our consolidated operating results. These operations do not constitute transactions which qualify for hedge accounting treatment. Therefore, we do not hedge the translation of foreign currency operating results into the U.S. dollar. Should currency rates change sharply, our results could be negatively impacted. In 2016, foreign currency exchange rate changes negatively impacted our net income by 3.4% and our adjusted EBITDA, which is a non-GAAP financial measure, by approximately 2.0%. In 2017, we expect foreign exchange rate fluctuations could continue to negatively impact our results of operations.

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, visco-elastic 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 North America segment competes in various mattress categories, and contributed 82.2% of our net sales for the year ended December 31, 2016. These mattress categories are highly competitive, with many competitor products supported by aggressive marketing campaigns and promotions. The international market for mattresses and pillows is generally served by a large number of manufacturers, primarily operating on a regional and local basis. These manufacturers offer a broad range of mattress and pillow products. In addition, mattress and pillow manufacturers and retailers are seeking to increase their channels of distribution and are looking for new ways to reach the consumer, including the recent expansion in the number of companies pursuing online direct-to-consumer models for foam mattresses. As a result of this or increased competition, our results could be negatively impacted.

Gross Margins

Our gross margin is primarily impacted by the relative amount of net sales contributed by our Tempur and Sealy products. Our Sealy products have a significantly lower gross margin than our Tempur products. Our Sealy mattress products range from value to premium priced offerings, and gross margins are typically higher on premium products compared to value priced offerings. Our Tempur products are exclusively premium priced products. As sales of our Sealy products increase relative to sales of our Tempur products, our gross margins will be negatively impacted in both our North America and International segments.

Our gross margin is also impacted by fixed cost leverage based on manufacturing unit volumes; the cost of raw materials; operational efficiencies due to the utilization in our manufacturing facilities; product, channel and geographic mix; foreign exchange fluctuations; volume incentives offered to certain retail accounts; participation in our retail cooperative advertising programs; and costs associated with new product introductions. Future changes in raw material prices could have a significant impact on our gross margin, and we expect commodity inflation of approximately $15 million in 2017. 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.
    
New Product Development and Introduction

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


28


In 2017, we are planning significant new product introductions in our North America and International segments. In North America, we are uniting all of our Sealy products under one masterbrand. We expect to incur lower costs associated with new product introductions in North America as compared to 2016, given we only introduced premium products in 2016. In our International segment, we are relaunching our flagship line of Tempur mattresses to feature the iconic aesthetics similar to Tempur-Pedic mattresses that we currently sell in North America.

Financial Leverage and Liquidity

As of December 31, 2016, we had $1,901.0 million of debt outstanding, and our adjusted EBITDA, which is a non-GAAP financial measure, was $521.6 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, 2016, our ratio of funded debt less qualified cash to EBITDA in accordance with our 2016 Credit Agreement was 3.60 times, within the covenant in our debt agreements which limits this ratio to 5.00 times for the year ended December 31, 2016. For more information on this non-GAAP measure and compliance with our 2016 Credit Agreement, please refer to “Non-GAAP Financial Information” below.

Danish Tax Proceeding

As described in Note 12, "Income Taxes," of the Notes to the Consolidated Financial Statements included in Part II, ITEM 8 of this Report, the Company is the subject of significant outstanding tax assessments asserted by SKAT. Any decision by the Company to achieve a negotiated settlement of this matter, or if the Company does not enter into a negotiated settlement of this matter, a negative outcome in the related legal proceedings, could require the Company to make a significant payment, which could have a material adverse effect on the Company’s results of operations and liquidity. In addition, if the Company is required to further increase its uncertain tax liability for this matter, based on a change in facts and circumstances, this could have a material impact on the Company's reported earnings.

Integration

In 2016, we completed the operational integration of the legacy Tempur and Sealy businesses in our North America and International segments. Integration expenses were $2.0 million in the current year as compared to $28.6 million in the prior year.

Results of Operations
 
A summary of our results for the year ended December 31, 2016 include:

Total net sales decreased 0.8% to $3,127.3 million from $3,151.2 million in 2015. On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 0.7%, with growth in both the North America and International business segments.

Gross margin was 41.9% as compared to 39.6% in 2015. Adjusted gross margin, which is a non-GAAP financial measure, was 41.9% as compared to 40.1% in 2015.

Net income was $202.1 million as compared to $73.5 million in 2015. During the fourth quarter of 2015, we re-evaluated our uncertain tax position regarding the Danish Tax Matter. As a result of the re-evaluation, including consideration of certain events that occurred during the fourth quarter of 2015, we recorded a change in estimate of its uncertain tax positions related to this matter of approximately $60.7 million. Adjusted net income, which is a non-GAAP financial measure, increased 21.3% to $242.4 million as compared to $199.9 million in 2015.

Earnings before interest, taxes, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, increased 31.3% to $510.8 million as compared to $388.9 million in 2015. Adjusted EBITDA, which is a non-GAAP financial measure, increased 14.4% to $521.6 million as compared to $455.8 million in 2015.

Operating income increased 34.4% to $415.5 million, as compared to $309.1 million in 2015. Adjusted operating income, which is a non-GAAP financial measure, was $425.0 million, or 13.6% of net sales, as compared to $373.8 million, or 11.9% of net sales, in 2015.

Earnings per share ("EPS") was $3.38 as compared to $1.17 in 2015. Adjusted EPS, which is a non-GAAP financial measure, increased 27.0% to $4.05 as compared to adjusted EPS of $3.19 in 2015. On a constant currency basis, which is a non-GAAP financial measure, adjusted EPS increased 30.7%.

29



For a discussion and reconciliation of non-GAAP financial measures as discussed above to the corresponding GAAP financial results, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information."

We may refer to net sales or earnings or other historical financial information on a “constant currency basis,” which is a non-GAAP financial measure. These references to constant currency basis do not include operational impacts that could result from fluctuations in foreign currency rates. To provide information on a constant currency basis, the applicable financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior year period’s currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Constant currency information is not recognized under GAAP, and it is not intended as an alternative to GAAP measures. Refer to Part II, ITEM 7A of this Report for a discussion of our foreign currency exchange rate risk.



30


The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales:
(in millions, except percentages and
Year Ended December 31,
per common share amounts)
2016
 
2015
 
2014
Net sales
$
3,127.3

 
100.0
 %
 
$
3,151.2

 
100.0
 %
 
$
2,989.8

 
100.0
 %
Cost of sales
1,817.9

 
58.1

 
1,902.3

 
60.4

 
1,839.4

 
61.5

Gross profit
1,309.4

 
41.9

 
1,248.9

 
39.6

 
1,150.4

 
38.5

Selling and marketing expenses
648.5

 
20.7

 
648.0

 
20.6

 
619.9

 
20.7

General, administrative and other expenses
278.2

 
8.9

 
322.0

 
10.2

 
280.6

 
9.4

Equity income in earnings of unconsolidated affiliates
(13.3
)
 
(0.4
)
 
(11.9
)
 
(0.4
)
 
(8.3
)
 
(0.3
)
Royalty income, net of royalty expense
(19.5
)
 
(0.6
)
 
(18.3
)
 
(0.6
)
 
(18.1
)
 
(0.6
)
Operating income
415.5

 
13.3

 
309.1

 
9.8

 
276.3

 
9.3

 
 
 
 
 
 
 
 
 
 
 
 
Other expense, net:
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
85.2

 
2.7

 
96.1

 
3.0

 
91.9

 
3.1

Loss on extinguishment of debt
47.2

 
1.5

 

 

 

 

Loss on disposal, net

 

 

 

 
23.2

 
0.8

Other (income) expense, net
(0.2
)
 
(0.1
)
 
12.9

 
0.5

 
(13.7
)
 
(0.4
)
Total other expense
132.2

 
4.1

 
109.0

 
3.5

 
101.4

 
3.5

 
 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
283.3

 
9.1

 
200.1

 
6.3

 
174.9

 
5.8

Income tax provision
(86.8
)
 
(2.8
)
 
(125.4
)
 
(4.0
)
 
(64.9
)
 
(2.2
)
Net income before non-controlling interests
196.5

 
6.3

 
74.7

 
2.3

 
110.0

 
3.6

Less: Net (loss) income attributable to non-controlling interests
(5.6
)
 
(0.2
)
 
1.2

 

 
1.1

 

Net income attributable to Tempur Sealy International, Inc.
$
202.1

 
6.5
 %
 
$
73.5

 
2.3
 %
 
$
108.9

 
3.6
 %
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
Diluted
$
3.38

 
 
 
$
1.17

 
 
 
$
1.75

 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
Diluted
59.8

 
 
 
62.6

 
 
 
62.1

 
 

NET SALES
 
Year Ended December 31,
 
Consolidated
 
North America
 
International
(in millions)
2016
 
2015
 
2014
 
2016
 
2015
 
2014
 
2016
 
2015
 
2014
Net sales by channel
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Retail channel
$
2,808.4

 
$
2,874.5

 
$
2,750.2

 
$
2,419.4

 
$
2,461.5

 
$
2,308.6

 
$
389.0

 
$
413.0

 
$
441.6

Other channel
318.9

 
276.7

 
239.6

 
150.7

 
115.7

 
96.3

 
168.2

 
161.0

 
143.3

Total net sales
$
3,127.3

 
$
3,151.2

 
$
2,989.8

 
$
2,570.1

 
$
2,577.2

 
$
2,404.9

 
$
557.2

 
$
574.0

 
$
584.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net sales by product
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Bedding
$
2,891.5

 
$
2,887.2

 
$
2,726.5

 
$
2,447.8

 
$
2,428.9

 
$
2,261.9

 
$
443.7

 
$
458.3

 
$
464.6

Other products
235.8

 
264.0

 
263.3

 
122.3

 
148.3

 
143.0

 
113.5

 
115.7

 
120.3

Total net sales
$
3,127.3

 
$
3,151.2

 
$
2,989.8

 
$
2,570.1

 
$
2,577.2

 
$
2,404.9

 
$
557.2

 
$
574.0

 
$
584.9


31



Year ended December 31, 2016 compared to year ended December 31, 2015

Net sales decreased 0.8%, and on a constant currency basis increased 0.7%. The decrease in net sales was driven by:

North America net sales decreased 0.3%. Net sales of Bedding products were relatively flat. Our sales to Mattress Firm decreased approximately $80 million as compared to 2015. Excluding Mattress Firm, our sales increased 4%. Net sales of Other products decreased $26.0 million, or 17.5%, primarily as a result of a decline in net sales of pillows and other accessories. Canada net sales increased 2.9%, and, on a constant currency basis, increased 6.2%.

International net sales decreased 2.9% due to unfavorable foreign exchange rates. On a constant currency basis, our International net sales increased 3.9%, primarily driven by the success of new product introductions, an increase in direct sales of our Tempur products in Asia-Pacific and an increase in net sales of our Sealy products in Latin America.

Year ended December 31, 2015 compared to year ended December 31, 2014

Net sales increased 5.4%, and on a constant currency basis increased 9.4%. The increase in net sales was driven by:

North America net sales increased $172.3 million, or 7.2%. On a constant currency basis, our North America net sales increased approximately 8.5%. The increase was primarily due to a $167.0 million increase in net sales of Bedding products, driven primarily by strong U.S. net sales growth across both the Tempur and Sealy brands, which benefited from new product introductions and 2015 pricing actions. This increase was offset by a 6.3% decrease in Canada net sales due to unfavorable foreign exchange rates. On a constant currency basis, Canada net sales grew 8.6%.

International net sales decreased $10.9 million, or 1.9%. On a constant currency basis, our International net sales increased approximately 13.2%, primarily due to strong sales growth of our Sealy products in Asia-Pacific and Latin America. Net sales growth was also driven by an increase in sales of Tempur products through Company-owned stores.

GROSS PROFIT
 
Year Ended December 31,
 
 
 
 
 
2016
 
2015
 
2014
 
Margin Change
(in millions, except percentages)
Gross Profit
 
Gross Margin
 
Gross Profit
 
Gross Margin
 
Gross Profit
 
Gross Margin
 
2016 vs 2015
 
2015 vs 2014
North America
$
1,017.4

 
39.6
%
 
$
954.6

 
37.0
%
 
$
834.8

 
34.7
%
 
2.6
%
 
2.3
 %
International
292.0

 
52.4
%
 
294.3

 
51.3
%
 
315.6

 
54.0
%
 
1.1
%
 
(2.7
)%
Consolidated
$
1,309.4

 
41.9
%
 
$
1,248.9

 
39.6
%
 
$
1,150.4

 
38.5
%
 
2.3
%
 
1.1
 %

Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in the manufacturing process. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.

Year ended December 31, 2016 compared to year ended December 31, 2015

Gross margin increased 230 basis points. The increase was primarily driven by 160 basis points of operational improvements, including sourcing improvements, 40 basis points due to pricing actions, and 20 basis points from favorable product mix.

North America gross margin increased 260 basis points. The increase was driven primarily by 180 basis points of operational improvements, including sourcing improvements, 50 basis points due to pricing actions, and 30 basis points from favorable product mix.

International gross margin increased 110 basis points. The increase was driven by 80 basis points of operational improvements and 50 basis points of favorable channel mix, as we expand distribution through more profitable direct-to-consumer channels.


32



Year ended December 31, 2015 compared to year ended December 31, 2014

Gross margin increased 110 basis points. The increase in gross margin was primarily due to supply chain and sourcing improvements of 170 basis points, a favorable decrease in discounts of 50 basis points and 2015 pricing actions which increased gross margin 40 basis points in 2015 as compared to 2014. These factors were primarily offset by unfavorable product mix of 130 basis points.

North America gross margin increased 230 basis points. The increase in gross margin was primarily due to supply chain and sourcing improvements of 210 basis points, a favorable decrease in discounts of 70 basis points driven by fewer floor model discounts and improved participation in our retail cooperative advertising programs and favorable 2015 pricing actions of 50 basis points in 2015 as compared to 2014. These factors were partially offset by unfavorable product mix of 140 basis points, primarily due to the introduction of new products.

International gross margin declined 270 basis points. The decline in gross margin was driven by unfavorable product mix and manufacturing costs of 160 basis points due to the increase in sales of our Sealy products relative to sales of our Tempur products. The decrease in gross margin was also due to unfavorable channel mix of 110 basis points.

OPERATING EXPENSES

Selling and marketing expenses include advertising and media production associated with the promotion of our brands, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials, and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing.

General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs.

Year ended December 31, 2016 compared to year ended December 31, 2015
 
Year Ended December 31,
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
 
2016
 
2015
(in millions)
Consolidated
 
North America
 
International
 
Corporate
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Advertising
$
352.7

 
$
360.5

 
$
316.5

 
$
323.0

 
$
36.2

 
$
37.5

 
$

 
$

Other selling and marketing
295.8

 
287.5

 
169.5

 
161.1

 
123.4

 
122.3

 
2.9

 
4.1

General, administrative and other
278.2

 
322.0

 
127.3

 
143.6

 
54.6

 
57.0

 
96.3

 
121.4

Total operating expense
$
926.7

 
$
970.0

 
$
613.3

 
$
627.7

 
$
214.2

 
$
216.8

 
$
99.2

 
$
125.5


Operating expenses decreased $43.3 million or 4.5%, and decreased 120 basis points as a percentage of net sales. During 2015 and 2016, we took actions to reduce our overall operating expenses, including headcount reductions and international store closings and we expect to take actions to reduce our overall operating expenses in 2017. The primary drivers of changes in operating expenses by segment are explained below.

North America operating expenses decreased $14.4 million and decreased 50 basis points as a percentage of net sales. The decrease was primarily driven by decreased incentive compensation expenses, as well as lower overall operating expenses in selling and marketing expenses and general, administrative and other expenses.

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

Corporate operating expenses decreased $26.3 million, or 21.0%. Executive management transition and retention compensation decreased $11.6 million and integration costs decreased $4.6 million, and additional costs related to our 2015 Annual Meeting which were not incurred in 2016 were $6.3 million. We also recorded a stock compensation benefit of $3.8 million, representing the fourth quarter change in estimate to reduce accumulated performance based stock compensation amortization to actual cost based on financial results for the year ended December 31, 2016.


33


Research and development expenses for the year ended December 31, 2016 were $26.7 million compared to $28.7 million for the year ended December 31, 2015, a decrease of $2.0 million, or 7.0%.
    
Year ended December 31, 2015 compared to year ended December 31, 2014
 
Year Ended December 31,
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
 
2015
 
2014
(in millions)
Consolidated
 
North America
 
International
 
Corporate
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Advertising
$
360.5

 
$
326.7

 
$
323.0

 
$
282.3

 
$
37.5

 
$
44.4

 
$

 
$

Other selling and marketing
287.5

 
293.2

 
161.1

 
172.5

 
122.3

 
117.8

 
4.1

 
2.9

General and administrative
322.0

 
280.6

 
143.6

 
131.0

 
57.0

 
54.9

 
121.4

 
94.7

Total operating expense
$
970.0

 
$
900.5

 
$
627.7

 
$
585.8

 
$
216.8

 
$
217.1

 
$
125.5

 
$
97.6


Operating expenses increased $69.5 million or 7.7%, and increased 70 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are explained below.

North America operating expenses increased $41.9 million but remained flat as a percentage of net sales. This increase was primarily driven by a $40.7 million increase in advertising expense, driven primarily by improved participation in our retail cooperative advertising programs.

International operating expenses remained relatively flat and increased 70 basis points as a percentage of net sales.

Corporate operating expenses increased $27.9 million, or 28.6%. The increase was primarily driven by a $26.7 million increase in general, administrative and other expenses, including $14.5 million of executive transition and related retention expenses and $3.2 million of restructuring costs related to headcount reductions. We also incurred $6.3 million in 2015 of additional costs related to our 2015 Annual Meeting and related issues.

Research and development expenses for the year ended December 31, 2015 were $28.7 million compared to $21.6 million for the year ended December 31, 2014, an increase of $7.1 million, or 32.9%.
 
OPERATING INCOME
 
Year Ended December 31,
 
 
 
 
 
2016
 
2015
 
2014
 
Margin Change
(in millions, except percentages)
Operating Income
 
Operating Margin
 
Operating Income
 
Operating Margin
 
Operating Income
 
Operating Margin
 
2016 vs 2015
 
2015 vs 2014
North America
$
411.8

 
16.0
%
 
$
335.6

 
13.0
%
 
$
255.0

 
10.6
%
 
3.0
%
 
2.4
 %
International
102.7

 
18.4
%
 
98.9

 
17.2
%
 
118.8

 
20.3
%
 
1.2
%
 
(3.1
)%
 
514.5

 
 
 
434.5

 
 
 
373.8

 
 
 
 
 
 
Corporate expenses
(99.0
)
 
 
 
(125.4
)
 
 
 
(97.5
)
 
 
 
 
 
 
Total operating income
$
415.5

 
13.3
%
 
$
309.1

 
9.8
%
 
$
276.3

 
9.2
%
 
3.5
%
 
0.6
 %

Year ended December 31, 2016 compared to year ended December 31, 2015

Operating income increased $106.4 million and operating margin improved 350 basis points. The increase was driven by:

North America operating income increased $76.2 million and operating margin improved 300 basis points. The improvement in operating margin was primarily driven by improved gross margin of 230 basis points and an improvement in operating expense leverage of 50 basis points.

International operating income increased $3.8 million and operating margin improved 120 basis points. The improvement in operating margin was primarily driven by improved gross margin of 110 basis points.

Corporate operating expenses decreased $26.4 million, as discussed above, which improved our consolidated operating margin by 80 basis points.


34


Year ended December 31, 2015 compared to year ended December 31, 2014

Operating income increased $32.8 million and operating margin improved 60 basis points. The increase was driven by:

North America operating income increased $80.6 million and operating margin improved 240 basis points. The improvement in operating margin was primarily driven by improved gross margin of 230 basis points.

International operating income decreased $19.9 million and operating margin decreased 310 basis points. The decrease in operating margin was primarily driven by a decrease in gross margin of 270 basis points and a decrease in operating expense leverage of 50 basis points.

Corporate operating expenses increased $27.9 million, as discussed above, which reduced our consolidated operating margin by 90 basis points.

INTEREST EXPENSE, NET
 
Year Ended December 31,
 
Percent change
(in millions, except percentages)
2016
 
2015
 
2014
 
2016 vs 2015
 
2015 vs 2014
Interest expense, net
$
85.2

 
$
96.1

 
$
91.9

 
(11.3
)%
 
4.6
%

Year ended December 31, 2016 compared to the year ended December 31, 2015

Interest expense, net, decreased $10.9 million, or 11.3%. During 2015, we recorded $12.0 million of accelerated amortization of deferred financing costs associated with the $493.8 million voluntary prepayments on our 2012 Credit Agreement, subsequent to the issuance of $450 million aggregate principal amount of 2023 Senior Notes. During 2016, in connection with the overlapping period between the issuance of the 2026 Senior Notes on May 24, 2016 and redemption of the 2020 Senior Notes on June 23, 2016, we incurred an additional $2.1 million of interest as compared to 2015. Refer to Note 6, "Debt," in our Consolidated Financial Statements included in Part II, ITEM 8 for additional information.

Year ended December 31, 2015 compared to the year ended December 31, 2014

Interest expense, net, increased $4.2 million, or 4.6%. During 2015, we recorded $12.0 million of accelerated amortization of deferred financing costs associated with the $493.8 million voluntary prepayments on our Term A Facility and Term B Facility, subsequent to the issuance of the 2023 Senior Notes. Excluding this accelerated amortization, interest expense decreased due to lower average debt levels throughout 2015 as compared to 2014.

LOSS ON EXTINGUISHMENT OF DEBT

In the second quarter of 2016, we issued our 2026 Senior Notes and entered into our 2016 Credit Agreement. The net proceeds of the 2026 Senior Notes offering were used in part to redeem the 2020 Senior Notes. The net proceeds from the 2016 Credit Agreement were used to repay in full the 2012 Credit Agreement and to pay certain transaction fees and expenses incurred in connection with the 2016 Credit Agreement. In association with these transactions, we recorded a $47.2 million loss on extinguishment of debt. The $47.2 million loss includes a $23.6 million premium on the prepayment of our 2020 Senior Notes, $11.0 million and $4.8 million of deferred financing costs write-offs for the 2012 Credit Agreement and 2020 Senior Notes, respectively, and $1.9 million and $5.9 million of lender expenses for the 2016 Credit Agreement and 2026 Senior Notes, respectively. Refer to Note 6, "Debt," in our Consolidated Financial Statements included in ITEM 8 under Part II for additional information.

LOSS ON DISPOSAL OF BUSINESS

Effective June 30, 2014, we completed the sale of our three U.S. innerspring component production facilities and equipment, along with associated working capital, to Leggett and Platt ("L&P") for total consideration of approximately $47.8 million.  The working capital adjustment resulted in a cash payment to L&P of $2.8 million, which reduced the total consideration received to $45.0 million. The carrying amount of the net assets sold in this transaction, including an allocation of reporting unit goodwill determined using the relative fair value method, was approximately $66.8 million.  As a result, a loss on disposal of business was recorded for $23.2 million during 2014, which included $1.4 million of transaction costs and the $2.8 million working capital adjustment.


35


OTHER (INCOME) EXPENSE, NET
 
Year Ended December 31,
 
Percent change
(in millions, except percentages)
2016
 
2015
 
2014
 
2016 vs 2015
 
2015 vs 2014
Other (income) expense, net
$
(0.2
)
 
$
12.9

 
$
(13.7
)
 
(101.6
)%
 
194.2
%

Year ended December 31, 2016 compared to year ended December 31, 2015

During 2015, we reached a settlement related to an antitrust investigation by the German Federal Cartel Office ("FCO"). Under the terms of the settlement, we paid approximately €15.5 million (approximately $17.4 million) to fully resolve this matter. The payment is not tax deductible. In addition, during 2015 we recorded $9.5 million of other income from a partial settlement of a legal dispute. Refer to Note 11, "Commitments and Contingencies," in our Consolidated Financial Statements included in Part II, ITEM 8 for additional information.

Year ended December 31, 2015 compared to year ended December 31, 2014

During 2015, we reached a settlement with the FCO, as described above. Refer to Note 11, "Commitments and Contingencies," in our Consolidated Financial Statements included in Part II, ITEM 8 for additional information. In addition, we recorded $9.5 million and $15.6 million of other income from a partial settlement of a legal dispute in 2015 and 2014, respectively.

INCOME TAXES
 
Year Ended December 31,
 
Percent change
(in millions, except percentages)
2016
 
2015
 
2014
 
2016 vs 2015
 
2015 vs 2014
Income tax
$
86.8

 
$
125.4

 
$
64.9

 
(30.8
)%
 
93.2
%
Effective tax rate
30.6
%
 
62.7
%
 
37.1
%
 
(32.1
)%
 
25.6
%

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, 2016 compared to year ended December 31, 2015

Our income tax provision decreased $38.6 million and our effective tax rate decreased 32.1 percentage points. During 2015, we increased our uncertain tax liability associated with the Danish Tax Matter through a charge to income tax expense of $60.7 million. Refer to Note 12, “Income Taxes,” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information.

Year ended December 31, 2015 compared to year ended December 31, 2014

Our income tax provision increased $60.5 million and our effective tax rate increased 25.6 percentage points. In 2014, upon the filing of our various 2013 U.S. federal and state income tax returns, we finalized the calculation of the tax on the repatriation of earnings and we recognized an incremental $12.2 million current income tax expense for the repatriation so described to reflect tax positions taken on the various income tax returns when filed. During 2015, we increased our uncertain tax liability associated with the Danish Tax Matter through a charge to income tax expense of $60.7 million. Refer to Note 12, “Income Taxes," in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information associated with this tax assessment.

Liquidity and Capital Resources
 
Liquidity

Our principal sources of funds are cash flows from operations, borrowings made pursuant to our credit facilities and cash and cash equivalents on hand. Principal uses of funds consist of payments of principal and interest on our debt facilities, share repurchases, capital expenditures and working capital needs. At December 31, 2016, we had working capital of $126.0 million, including cash and cash equivalents of $65.7 million as compared to working capital of $96.1 million including $153.9 million in cash and cash equivalents as of December 31, 2015.


36


The increase in working capital was primarily driven by decreases in accounts payable and the current portion of long-term debt. This was partially offset by decreases in cash and cash equivalents, as we funded our share repurchase program and other capital requirements, decrease in accounts receivable, prepaid expenses and other current assets. Accounts payable decreases are driven primarily by the timing of payments to vendors. The current portion of long-term debt decreased primarily due to the repayment of our 8.0% Sealy Notes. Accounts receivable decreases are driven primarily by net sales, in addition to timing of customer collections. Prepaid expenses and other current assets decreases are driven primarily by decreases in our foreign exchange forward contracts.

The table below presents net cash provided by (used in) operating, investing and financing activities for the years ended December 31, 2016, 2015 and 2014.
(in millions)
 
2016
 
2015
 
2014
Net cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
165.5

 
$
234.2

 
$
225.2

Investing activities
 
(62.4
)
 
(59.7
)
 
(10.4
)
Financing activities
 
(185.1
)
 
(90.7
)
 
(238.1
)
 
Cash provided by operating activities decreased $68.7 million in 2016 as compared to 2015. The decrease in cash provided by operating activities was primarily the result of an increase in cash used by operating assets and liabilities, which was primarily due to the $92.0 million payment on deposit with SKAT. This decrease was offset by an increase in net income before non-controlling interest, as well as excluding the impact of the loss on extinguishment of debt of $47.2 million. The loss on extinguishment of debt was composed of a non-cash write-off of $15.8 million in deferred financing costs associated with the 2012 Credit Agreement and 2020 Senior Notes, $7.8 million of fees and underwriting discounts paid to lenders associated with the 2016 Credit Agreement and 2026 Senior Notes, and $23.6 million of a call premium paid with respect to our 2020 Senior Notes. The lender fees and call premium are presented as uses of cash in financing activities.

Cash used in investing activities increased $2.7 million in 2016 as compared to 2015. The increase in cash used in investing activities is due to a decrease in capital expenditures, which is primarily due to the phasing of planned capital projects.

Cash used in financing activities increased $94.4 million in 2016 as compared to 2015. In the year ended December 31, 2016, we repurchased 8.8 million shares of treasury stock for $535.0 million. Our other primary sources and uses of cash for financing activities relate to the repayment of our 2012 Credit Agreement using proceeds from our 2016 Credit Agreement, as well as the repayment of our 2020 Senior Notes using proceeds from our 2026 Senior Notes. In April 2016, we received proceeds of $524.5 million under our 2016 Credit Agreement and repaid $521.4 million outstanding under our 2012 Credit Agreement. In May 2016, we received gross proceeds of $600.0 million prior to the underwriting discount, from the issuance of our 2026 Senior Notes and, in June 2016, redeemed the 2020 Senior Notes for $375.0 million plus a call premium of $23.6 million. In connection with the 2016 Credit Agreement and 2026 Senior Notes, we paid $6.9 million in deferred financing costs and $7.8 million in fees and underwriting discounts to lenders. Additional borrowings to fund share repurchases and other financing and operating activities during the year ended December 31, 2016 were $1,108.8 million, offset by repayments of $971.3 million. Refer to Note 6, "Debt," in our Condensed Consolidated Financial Statements included in Part II, ITEM 8 for additional information.

Capital Expenditures

Capital expenditures totaled $62.4 million for the year ended December 31, 2016 and $65.9 million for the year ended December 31, 2015. We currently expect our 2017 capital expenditures to be approximately $60 to 70 million, which primarily relate to investments in our domestic manufacturing facilities and information technology.

Debt Service

On April 6, 2016, we entered into our 2016 Credit Agreement, which provides for (i) a $500.0 million revolving credit facility, (ii) a $500.0 million term loan facility and (iii) a $100.0 million delayed draw term loan facility. The Company used $500.0 million of the proceeds under the term loan facility and approximately $27.8 million of the proceeds under the revolving credit facility to repay in full the 2012 Credit Agreement and to pay certain transaction fees and expenses incurred in connection with the 2016 Credit Agreement. As of April 6, 2016, the 2016 Credit Agreement replaced the 2012 Credit Agreement.


37


In July 2016, the Company paid a total of approximately $115.0 million in cash to holders of the 8.0% Sealy Notes who properly converted their 8.0% Sealy Notes in advance of the maturity date, pursuant to the terms of the 8.0% Sealy Notes. In connection with the making of conversion payments with respect to, and the repayment of, the 8.0% Sealy Notes, on July 14, 2016, the Company also borrowed $100.0 million using the delayed draw term loan facility under the Company's 2016 Credit Agreement. The commitment to provide the delayed draw term loan facility terminated with its funding.
    
Our total debt increased to $1,901.0 million as of December 31, 2016 from $1,479.6 million as of December 31, 2015. As of December 31, 2016, we had a balance of $156.9 million under our revolving credit facility, and total availability under the revolver was $321.1 million after giving effect to letters of credit outstanding of $22.0 million. Refer to Note 6, “Debt,” in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.

As of December 31, 2016, our ratio of consolidated funded debt less qualified cash to EBITDA, which is a non-GAAP financial measure, in accordance with the Company's 2016 Credit Agreement was 3.60 times, within the terms of the financial covenants for the maximum consolidated total net leverage ratio as set forth in the 2016 Credit Agreement, which limits this ratio to 5.00 times. As of December 31, 2016, we were in compliance with all of the financial covenants in our debt agreements.

Our debt agreements contain certain covenants that limit restricted payments, including share repurchases and dividends.  The 2016 Credit Agreement, 2026 Senior Notes and 2023 Senior Notes contain similar limitations which, subject to other conditions, allow unlimited restricted payments at times when the ratio of consolidated funded debt less qualified cash to adjusted EBITDA remains below 3.5 times. In addition, both agreements permit limited restricted payments under certain conditions when the ratio of consolidated funded debt less qualified cash to adjusted EBITDA is above 3.5 times. The limit on restricted payments under the 2016 Credit Agreement, 2023 Senior Notes and 2026 Senior Notes is in part determined by a basket that grows at 50% of adjusted net income each quarter, reduced by restricted payments that are not otherwise permitted. 

Our business continues to generate significant cash flows from operations. In the near term, we expect to use our cash flows from operations primarily for debt repayment. Our target ratio of consolidated funded debt less qualified cash to adjusted EBITDA is 3.5 times, but we expect that this ratio could typically range from 3.0 times to 4.0 times. Subject to market conditions, we also expect to continue repurchasing shares. On February 16, 2017, our Board of Directors increased our share repurchase authorization by $200 million. As of that date, we had approximately $227 million available under this amended share repurchase authorization.

For additional information, refer to "Non-GAAP Financial Information" below for the calculation of the ratio of consolidated funded debt less qualified cash to EBITDA in accordance with the Company's 2016 Credit Agreement. Both consolidated funded debt and EBITDA in accordance with the Company's 2016 Credit Agreement are terms that are not recognized under GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt.

Non-GAAP Financial Information

We provide information regarding adjusted net income, adjusted EPS, adjusted gross profit, adjusted gross margin, adjusted operating income (expense), adjusted operating margin, EBITDA, adjusted EBITDA, consolidated funded debt and consolidated funded debt less qualified cash, which are not recognized terms under GAAP and do not purport to be alternatives to net income and earnings per share as a measure of operating performance or total debt. We believe these non-GAAP measures provide investors with performance measures that better reflect our underlying operations and trends, including trends in changes in margin and operating expenses, providing a perspective not immediately apparent from net income and operating income. The adjustments we make to derive the non-GAAP measures include adjustments to exclude items that may cause short-term fluctuations in the nearest GAAP measure, but which we do not consider to be the fundamental attributes or primary drivers of its business, including restructuring costs associated with headcount reductions and store closures, stock compensation benefits representing changes in estimate to reduce accumulated performance based stock compensation amortization, costs associated with the completion of the 2016 Credit Agreement and 2026 Senior Notes offering in the second quarter of 2016, costs associated with our 2013 acquisition of Sealy Corporation and its subsidiaries ("Sealy Acquisition") and the exclusion of other costs associated with the 2015 Annual Meeting (including executive management transition and retention compensation), legal settlements, and other costs.


38


We believe that exclusion of these items assists in providing a more complete understanding of our underlying results from continuing operations and trends, and management uses these measures along with the corresponding GAAP financial measures to manage our business, to evaluate the Company's consolidated and segment performance compared to prior periods and the marketplace, to establish operational goals and to provide continuity to investors for comparability purposes. These non-GAAP measures should be considered supplemental in nature and should not be construed as more significant than comparable measures defined by GAAP. Limitations associated with the use of these non-GAAP measures include that these measures do not present all of the amounts associated with our results as determined in accordance with GAAP. Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies. For more information about these non-GAAP measures and a reconciliation to the nearest GAAP measure, please refer to the reconciliations on the following pages.

Key Highlights

 
Year Ended December 31,
(in millions, except percentages and per common share amounts)
2016
 
2015
 
% Change
 
% Change Constant Currency (1)
Net sales
$
3,127.3

 
$
3,151.2

 
(0.8
)%
 
0.7
%
Net income
202.1

 
73.5

 
175.0
 %
 
184.4
%
EPS
3.38

 
1.17

 
188.9
 %
 
199.1
%
Adjusted EPS (1)
4.05

 
3.19

 
27.0
 %
 
30.7
%
EBITDA (1)
510.8

 
388.9

 
31.3
 %
 
34.1
%
Adjusted EBITDA (1)
521.6

 
455.8

 
14.4
 %
 
16.8
%
(1)
 
Non-GAAP financial measure. Please refer to the reconciliations in the following tables.

Adjusted Net Income and Adjusted EPS

A reconciliation of net income to adjusted net income and a calculation of adjusted EPS is provided below. We believe that the use of these non-GAAP financial measures provides investors with additional useful information with respect to the impact of various adjustments as described in the footnotes below. The following table sets forth the reconciliation of our reported net income to the calculation of adjusted net income for the year ended December 31, 2016 and 2015, respectively.

 
Year Ended
(in millions, except per share amounts)
December 31, 2016
 
December 31, 2015
GAAP net income
$
202.1

 
$
73.5

Integration costs (1)
2.0

 
28.7

German legal settlement (2)

 
17.6

Executive management transition and retention compensation (3)
3.0

 
16.2

Restructuring costs (4)
8.3

 
13.5

Stock compensation benefit (5)
(3.8
)
 

Interest expense and financing costs (6)
2.1

 
12.0

Other income (7)

 
(9.5
)
2015 Annual Meeting costs (8)

 
6.3

Pension settlement (9)

 
1.3

Loss on extinguishment of debt (10)
47.2

 

Tax adjustments (11)
(18.5
)
 
40.3

Adjusted net income
$
242.4

 
$
199.9

 
 
 
 
Adjusted earnings per share, diluted
$
4.05

 
$
3.19

 
 
 
 
Diluted shares outstanding
59.8

 
62.6


39


(1)
Integration costs represents costs, including legal fees, professional fees, compensation costs and other charges related to the transition of manufacturing facilities, and other costs related to the continued alignment of the North America business segment related to the Sealy Acquisition.
(2)
German legal settlement represents the previously announced €15.5 million ($17.6 million) settlement we reached in 2015 with the FCO to fully resolve the FCO's antitrust investigation, and related legal fees.
(3)
Executive management transition and retention compensation represents certain costs associated with the transition of certain of the Company's executive officers following the 2015 Annual Meeting.
(4)
Restructuring costs represent costs associated with headcount reduction and store closures.
(5)
Stock compensation benefit represents the fourth quarter change in estimate to reduce accumulated performance based stock compensation amortization to actual cost based on financial results for the year ended December 31, 2016.
(6)
Interest expense and financing costs in 2015 represents non-cash interest costs related to the accelerated amortization of deferred financing costs associated with the $493.8 million voluntary prepayment of our term loans, subsequent to our issuance of $450 million aggregate principal amount of 2023 Senior Notes. Interest expense in 2016 represents incremental interest incurred with respect to the 2026 Senior Notes sold in the second quarter of 2016 and 2020 Senior Notes, which were repaid with the proceeds of the new 2026 Senior Notes.
(7)
Other income includes income from a partial settlement of a legal dispute.
(8)
2015 Annual Meeting costs represent additional costs related to our 2015 Annual Meeting and related issues.
(9)
Pension settlement represents pension expense recorded in conjunction with a settlement offered to terminated, vested participants in a defined benefit pension plan.
(10)
Loss on extinguishment of debt represents costs associated with the completion of the 2016 Credit Agreement and 2026 Senior Notes offering in the second quarter of 2016.
(11)
Tax adjustments represent adjustments associated with the aforementioned items and other discrete income tax events.

Adjusted Gross Profit and Gross Margin and Adjusted Operating Income (Expense) and Operating Margin

Reconciliations of GAAP gross profit and gross margin to adjusted gross profit and gross margin, respectively, and GAAP operating income (expense) and operating margin to adjusted operating income (expense) and operating margin, respectively, are provided below. We believe that the use of these non-GAAP financial measures provides investors with additional useful information with respect to the impact of various adjustments as described in the footnotes below. The following table sets forth the reconciliation of the Company's reported GAAP gross profit and operating income (expense) to the calculation of adjusted gross profit and operating income (expense) for the year ended December 31, 2016:

 
FULL YEAR 2016
(in millions, except percentages)
 Consolidated
 
 Margin
 
 North America
(1)
 
 Margin
 
 International
(2)
 
 Margin
 
 Corporate
(3)
Net sales
$
3,127.3

 
 
 
$
2,570.1

 
 
 
$
557.2

 
 
 
$

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gross profit
$
1,309.4

 
41.9
%