Tempur Sealy International, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. The supplied filing is for Tempur Sealy International, Inc.; it does not identify Somnigroup International Inc. as the registrant. Figures are in U.S. dollars; financial amounts are in millions unless stated otherwise.
Business context
The company develops, manufactures, markets and sells bedding products through North America and International segments, using Wholesale and Direct channels. Its brands include Tempur, Tempur-Pedic, Sealy and Stearns & Foster.
Financial performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Net sales | $648.0 | $722.1 |
| Gross profit / margin | $267.9 / 41.3% | $286.6 / 39.7% |
| Operating income / margin | $53.9 / 8.3% | $59.5 / 8.2% |
| Net income attributable to Tempur Sealy | $23.1 | $33.9 |
| Diluted EPS | $0.42 | $0.62 |
| Net cash from (used in) operating activities | $(9.7) | $67.2 |
| Capital expenditures | $21.8 | $12.9 |
Net sales fell 10.3% reported and 12.2% on a constant-currency basis. North America sales declined 16.7%; excluding the prior-year Mattress Firm sales, the decline was 0.6%. International sales rose 16.6% reported and 8.2% constant currency. Direct sales increased to $59.8 from $49.8; Wholesale sales declined to $588.2 from $672.3.
Gross margin improved 160 basis points, but Q1 2017 included $11.5 of Mattress Firm-related cost-of-sales charges; on the company’s adjusted comparison, gross margin was 41.3% in both periods. Operating income and net income were below prior-year adjusted measures of $85.4 and $52.2, respectively. Q1 2018 EBITDA was $83.2 versus $86.8 reported and $121.1 adjusted in Q1 2017; these are non-GAAP measures. Interest expense increased to $22.9 from $22.1. The effective tax rate was 30.5%, versus 31.3%.
Liquidity, debt and cash flow
At March 31, 2018, cash was $34.5, working capital was $90.3, and total debt was $1,783.8, up from $1,762.5 at year-end 2017. The balance sheet reported $1,707.6 of long-term debt, net, and $65.6 current debt. Revolver availability was $476.4 after letters of credit. The company reported compliance with its debt covenants; leverage under the credit agreement was 4.34x against a 5.00x maximum. Its stated target leverage was 3.5x, with an expected typical range of 3.0x–4.0x.
Operating cash flow was negative, principally reflecting working-capital changes, including inventory buildup for new product launches and collection timing. Investing cash outflow was $17.6; financing provided $19.5, including net borrowings. Free cash flow, a non-GAAP measure, was negative $31.5. Cash interest payments for 2018 were expected to total approximately $85–$90.
Material changes and management commentary
- The loss of Mattress Firm, whose Q1 2017 purchases were $94.5, weighed on the year-over-year North America comparison. Management also said Mattress Firm’s discounting practices adversely affected North America sales trends. Q1 2017 included $25.9 of net termination charges and $9.3 of transition-agreement payments recorded as other income.
- Commodity inflation reduced Q1 2018 gross margin by approximately $12; management expected approximately $45 of commodity cost inflation for full-year 2018.
- Significant North America product launches were planned for 2018 and early 2019. Management expected higher North America launch costs and retailer inventory reductions ahead of new floor-model shipments; it expected lower International launch costs than in 2017.
- 2018 capital expenditures were expected to be approximately $65–$75, including Canadian ERP, manufacturing, IT and company-owned retail investments. Management expected operating cash flow and available credit to cover anticipated debt service, capital expenditures and working capital, while cautioning that cash generation and future borrowing are not assured. Excess cash was expected to support debt repayment; share repurchases could resume subject to market conditions.
- Revenue standard Topic 606 was adopted January 1, 2018. Adoption had no material overall impact, but moved royalty income into net sales; comparative figures were not restated. Reported Q1 2018 sales were $5.3 higher than they would have been without this classification change.
Risks, contingencies and unusual items
- The Danish tax matter involved assessments of approximately $274.6, including interest and penalties, for 2001–2008; potential assessments for 2009–2017 could exceed that amount. The company had accrued approximately $142.2 and stated that an unfavorable outcome could require payments above the reserve and materially affect earnings and liquidity. SKAT had withheld VAT refunds; withheld refunds were approximately $59.1 at quarter-end.
- Pending matters include shareholder securities and derivative litigation and lawsuits between the company’s subsidiaries and Mattress Firm. Outcomes and possible losses were not estimable; the company intends to defend the claims.
- Variable-rate debt was approximately $662.8; a 100-basis-point rate increase was estimated to reduce pretax income by approximately $6.6. A hypothetical 10% adverse currency move implied a $2.6 loss in the fair value of outstanding currency forwards, expected to be largely offset by underlying exposures.
- Management identified economic and retail-sector uncertainty, department-store account declines, foreign competition, customer concentration and demand, product-launch execution, commodity costs, leverage and interest rates, foreign exchange, and tax and regulatory developments as risks. The 2019 lease standard was expected to materially increase recognized assets and liabilities.
Important facts for investors to verify
- Reconcile the sales decline with the Mattress Firm comparison, discounting effects, segment trends, and the Topic 606 royalty reclassification.
- Assess whether planned product launches, inventory levels and the expected $45 commodity headwind affect margins and operating cash flow.
- Monitor leverage against the 5.00x covenant and 3.5x target, debt availability, interest costs and the negative quarterly free cash flow.
- Track developments in the Danish tax matter, including potential additional assessments and withheld VAT refunds, and in the Mattress Firm and shareholder litigation.
- Compare actual 2018 capital expenditures, cash interest, commodity costs and operating performance with management’s stated expectations; the filing provides no formal revenue or earnings guidance.