Business context and reporting period
Tempur Sealy International, Inc. (NYSE: TPX) filed this Form 10-K for the fiscal year ended December 31, 2016. It develops, manufactures and sells bedding and related products globally, primarily under the Tempur-Pedic, Sealy and Stearns & Foster brands. The business operates through North America and International segments. Figures below are in U.S. dollars; non-GAAP measures are identified as such.
Financial performance and position
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Net sales | $3,127.3 million | $3,151.2 million |
| Gross profit / margin | $1,309.4 million / 41.9% | $1,248.9 million / 39.6% |
| Operating income / margin | $415.5 million / 13.3% | $309.1 million / 9.8% |
| Net income attributable to Tempur Sealy | $202.1 million | $73.5 million |
| Diluted EPS | $3.38 | $1.17 |
| Operating cash flow | $165.5 million | $234.2 million |
| Capital expenditures | $62.4 million | $65.9 million |
Adjusted net income (non-GAAP) was $242.4 million versus $199.9 million; adjusted EBITDA (non-GAAP) was $521.6 million versus $455.8 million. The reported earnings comparison was affected by the $60.7 million Danish tax-position estimate charge in 2015 and a $47.2 million debt-extinguishment loss in 2016.
North America sales were $2,570.1 million, down 0.3%; International sales were $557.2 million, down 2.9% reported but up 3.9% on a constant-currency basis. The company attributed the consolidated gross-margin improvement primarily to operational and sourcing improvements, pricing and product mix.
At year-end, cash and cash equivalents were $65.7 million, working capital was $126.0 million, and current assets were $671.5 million against current liabilities of $545.5 million. Total debt was $1,901.0 million, including capital leases and other debt; the balance-sheet carrying amount, net of deferred financing costs, was $1,888.1 million. Revolver borrowings were $156.9 million, with $321.1 million of availability after outstanding letters of credit. Net leverage under the credit agreement was 3.60x versus a 5.00x maximum; the company reported covenant compliance. Stockholders’ equity was a deficit of $12.2 million.
Cash provided by operating activities fell from $234.2 million to $165.5 million, primarily reflecting cash used by operating assets and liabilities, including the Danish tax deposit. Investing activities used $62.4 million; financing activities used $185.1 million, including $535.0 million of share repurchases, partly offset by borrowing proceeds. The company paid no dividend.
Fourth-quarter snapshot
Fourth-quarter 2016 sales were $769.5 million versus $767.3 million a year earlier; operating income was $107.5 million versus $91.8 million, and net income was $63.4 million versus a net loss of $11.3 million. The prior-year quarter included the Danish tax-position charge.
Material changes versus the prior year
- Sales declined 0.8% reported, while increasing 0.7% on a constant-currency basis. Mattress Firm and Sleepy’s together represented 21.4% of 2016 sales, down from 23.7% in 2015; sales to Mattress Firm declined approximately $80 million. Excluding Mattress Firm, sales rose 2.3%.
- Gross margin rose 230 basis points and operating margin rose 350 basis points. Operating income increased 34.4%; adjusted EBITDA increased 14.4%.
- Operating cash flow decreased $68.7 million. Debt increased from $1,479.6 million to $1,901.0 million, while cash declined from $153.9 million to $65.7 million.
- The company refinanced debt, issued $600 million of 5.50% senior notes due 2026, redeemed $375 million of 6.875% notes due 2020, replaced its prior credit agreement and retired Sealy’s 8.0% notes. It recorded a $47.2 million loss on extinguishment.
- The company repurchased 8.7 million shares for approximately $533 million. The share-repurchase authorization was increased by $200 million in February 2017.
Outlook, commentary and key risks
- Mattress Firm termination: Following unsuccessful negotiations over proposed contract changes, the company issued termination notices on January 27, 2017 and expected to wind down the relationship during the first quarter. Management expected 2017 sales to decline from 2016 and profitability to be lower, with a U.S. market-share decline in the near term. It plans to pursue other retailers and channels, manage costs, and increase marketing investment; restructuring charges and non-cash write-offs were expected in Q1 2017. Potential intangible-asset impairment required further analysis.
- Costs and investment: Management expected approximately $15 million of commodity inflation in 2017 and capital expenditures of $60–70 million. Expected 2017 cash interest was approximately $85 million. Management stated it expected to remain within financial covenants and targeted net leverage of 3.5x, generally ranging from 3.0x to 4.0x.
- Danish tax matter: SKAT assessments for 2001–2008 totaled approximately $219.3 million including interest and penalties. The company accrued approximately $120.6 million at year-end and disclosed that assessments for 2009–2016, if issued, could exceed the earlier assessments. A negotiated resolution or adverse decision could require substantial additional payment. The company had placed a tax deposit with SKAT and applied VAT refunds toward the matter.
- Other risks: High customer concentration, retail consolidation, competition including online direct-to-consumer entrants, foreign-exchange exposure, variable-rate debt, raw-material price volatility, supplier continuity, pension underfunding, litigation, and execution of product launches and ERP implementation. Foreign-exchange movements negatively affected 2016 net income by approximately 3.4% and adjusted EBITDA by approximately 2.0%.
- The consumer class-action plaintiffs’ class-certification motion was denied and the Ninth Circuit affirmed; the company said the case outcome and possible losses remained unclear. The auditor issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- How much Mattress Firm-related volume and profit can be replaced, and the actual effects on 2017 sales, margins, restructuring costs and asset impairments.
- Whether operating cash flow recovers after the Danish tax-related cash outflows and whether the company reduces debt while continuing buybacks.
- The final Danish tax resolution, including amounts payable beyond the $120.6 million reserve and the treatment of deposits and VAT refunds.
- Debt covenant headroom, variable-rate exposure and the company’s ability to meet debt service if earnings decline.
- Whether margin gains are sustainable amid anticipated commodity inflation, product-mix changes and higher marketing spending.