Business context and reporting period
Tempur Sealy International, Inc. (the registrant named in this filing) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The company develops, manufactures, markets and sells bedding and related products through Tempur North America, Tempur International and Sealy segments.
Comparisons are significantly affected by the March 18, 2013 acquisition of Sealy: 2013 results include Sealy only from the acquisition date, while 2012 reported results do not. The $1,172.9 million net purchase consideration was funded with cash and financing. Sealy contributed $344.6 million of second-quarter sales and $391.3 million from acquisition through June 30.
Financial results and liquidity
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $660.6m | $329.5m | $1,050.7m | $713.9m |
| Gross profit / margin | $254.9m / 38.6% | $166.9m / 50.7% | $443.3m / 42.2% | $372.9m / 52.2% |
| Operating income | $44.0m | $47.5m | $88.5m | $133.6m |
| Net income (loss) attributable to company | $(1.6)m | $29.1m | $10.9m | $85.3m |
| Diluted EPS | $(0.03) | $0.45 | $0.18 | $1.31 |
Sales increased 100.5% in Q2 and 47.2% for the six-month period, primarily due to Sealy. In contrast, Tempur North America sales fell 4.9% in Q2 and 10.9% year to date; Tempur International sales declined 2.3% in Q2 and were nearly flat year to date. The acquired Sealy business has a lower gross margin, contributing to the consolidated margin decline.
Q2 interest expense was $35.7m versus $4.1m; six-month interest expense was $63.6m versus $8.2m, reflecting acquisition financing and higher debt, as well as transaction-related financing charges. Q2 pretax income was $6.7m and the reported tax provision was $8.8m; the effective tax rate was 131.3%. The six-month effective tax rate was 52.2%.
For the six months, operating cash flow was $(11.5)m, investing cash flow $(1,190.1)m (including the acquisition), and financing cash flow $1,124.1m. Cash declined $77.9m to $101.4m. Capital expenditures were $19.3m. At June 30, working capital was $298.1m.
Total debt was $1,942.7m, including $39.4m current debt; long-term debt was $1,903.3m. Cash was $101.4m and stockholders’ equity $26.8m. Revolver availability was $166.6m after borrowings and letters of credit. The company reported covenant compliance and a 4.6x funded-debt-less-qualified-cash to adjusted EBITDA ratio, against a 5.5x maximum through September 30, 2013.
Material changes and unusual items
- The acquisition materially expanded sales and assets, including $535.9m of preliminary Sealy goodwill and substantial acquired intangible assets. The purchase price allocation remained preliminary.
- Q2 Tempur North America pretax results shifted to a $22.9m loss from $23.0m of income a year earlier. Management cited competition, lower sales, product/channel mix and reduced advertising; TEMPUR-Choice launch delays were resolved, with rollout continuing into Q3.
- Sealy’s reported gross profit included $4.5m of inventory purchase-accounting step-up expense in Q2 ($7.7m for the acquisition-to-date period). Q2 included $5.4m of direct acquisition transaction costs; six-month costs were $17.2m. The company also cited $8.7m of Term B prepayment fees.
- On July 11, 2013, the company refinanced/repriced its Term A Facility, reducing the applicable margin by 75 basis points at the time. The company said repricings and lower-than-anticipated borrowing needs were expected to reduce annual interest expense.
- The company repatriated substantially all foreign earnings in a taxable transaction and recorded $42.6m of related tax. Management anticipated a tax rate of approximately 31.5% for the remainder of 2013.
Outlook, risks and contingencies
Management expected 2013 capital expenditures of approximately $60m and said operating cash flow and credit-facility availability should meet anticipated debt service, capital expenditure and working-capital needs for the foreseeable future, while cautioning that future cash generation and borrowing availability are not assured. Expected 2013 cash interest payments were approximately $71.9m. Management planned to increase advertising as a percentage of sales in the second half of 2013 and continue product innovation and integration efforts.
Key risks include high leverage and variable-rate exposure (management estimated a 100-basis-point rate increase would reduce next-year pretax income by approximately $12.8m), raw-material inflation, competitive pressure, advertising effectiveness, and integration and synergy execution. The Danish tax authority’s assessments for 2001–2007 totaled approximately $187.8m including interest and penalties; proceedings were expected to resume, and the company could be required to post security up to the claim amount. The company said the outcome and any required security were uncertain.
Former Sealy holders seeking appraisal had asserted rights for approximately 3.1 million shares; any fair-value award above the $2.20-per-share merger consideration, plus statutory interest, could affect liquidity. The filing also describes shareholder litigation concerning Tempur’s 2012 disclosures, which the company intended to defend, and environmental remediation reserves of $2.9m for South Brunswick and $0.1m for Oakville. The Sealy merger-related shareholder settlement was approved without additional monetary consideration to stockholders.
Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. The filing provides no formal full-year revenue or earnings guidance.
Important facts for investors to verify
- How much of reported sales growth reflects Sealy acquisition consolidation versus underlying organic performance, especially given Tempur North America’s declines.
- Whether integration synergies, product launches and the planned second-half advertising increase improve sales and margins, and how Sealy’s lower gross margin affects the combined business.
- Debt reduction, interest costs, covenant headroom and the effect of the July Term A repricing; confirm subsequent-period liquidity and cash generation.
- Progress and potential cash-security requirements in the Danish tax dispute, and the outcome of Sealy appraisal proceedings.
- Final purchase-price allocation, acquired intangible valuations and any resulting amortization or other purchase-accounting effects.