Business context and reporting period
Tempur-Pedic International Inc. filed this unaudited Form 10-Q for the quarter ended March 31, 2013. The filing is by Tempur-Pedic International Inc., not Somnigroup International Inc. Sealy Corporation was acquired on March 18, 2013, so reported results include only Sealy’s operations from March 18–31. The company now reports Tempur North America, Tempur International and Sealy segments.
Key financial results
Amounts are in millions of dollars except per-share data. Comparisons are with the three months ended March 31, 2012 unless otherwise stated.
| Metric | Q1 2013 | Q1 2012 |
|---|---|---|
| Net sales | $390.1 | $384.4 |
| Gross profit / margin | $188.4 / 48.3% | $206.0 / 53.6% |
| Operating income / margin | $44.3 / 11.4% | $86.1 / 22.4% |
| Net income | $12.5 | $56.2 |
| Diluted EPS | $0.20 | $0.86 |
| Operating cash flow | $5.2 | $44.6 |
| Cash and equivalents at period end | $91.5 | $134.0 |
- Sales rose 1.5%, but the increase included $46.7 million from Sealy’s partial-period contribution. Tempur North America sales fell 16.0% to $225.9 million; Tempur International sales rose 1.8% to $117.5 million. Sealy reported $46.7 million of sales and a $2.9 million operating loss during its included period.
- Gross margin contracted 5.3 percentage points. Tempur North America sales weakness and unfavorable mix, lower production-volume absorption and new-product floor-model discounts weighed on results. Sealy’s margin was 22.9%, including a $3.1 million inventory fair-value step-up charge.
- Interest expense increased to $27.9 million from $4.1 million. The company attributed $19.9 million of Q1 interest expense to acquisition-related financing costs, commitment fees and the write-off of old financing costs.
- Investing cash outflow was $1,271.0 million, principally the Sealy acquisition; financing provided $1,180.8 million. Capital expenditures were $5.6 million, versus $6.6 million.
Balance sheet, debt and liquidity
- At March 31, 2013, total debt was $1,997.9 million, comprising $1,961.7 million long-term debt and $36.2 million current portion; cash was $91.5 million. Debt increased from $1,025.0 million at December 31, 2012, primarily to finance the Sealy acquisition.
- Working capital was $347.4 million, down from $611.9 million at year-end. The prior-year-end amount included a $375.0 million escrow receivable related to acquisition financing; that escrow was released at closing. The company reported $241.6 million of revolver availability after borrowings and letters of credit.
- The company reported compliance with its debt covenants. Its covenant leverage measure was 4.4x at March 31, against a maximum of 5.5x through September 30, 2013 and 5.25x from October 1 through year-end.
- Cash interest payments for 2013 were expected to be approximately $77.7 million. A $250 million interest-rate swap fixes the LIBOR component at 1.25% on the hedged balance; management estimated that a 1-percentage-point rate increase would reduce annual pretax income by about $12.5 million.
Material changes, outlook and risks
- Management cited stronger competition as the main factor behind the 16.0% decline in Tempur North America sales. It said sales there were relatively stable sequentially versus Q4 2012. International sales benefited from broader distribution and brand investment, while management expected economic uncertainty to continue into Q2.
- Management expected to launch several products in Q2 2013 and warned that new-product floor models and Sealy’s historically lower margin could continue to pressure consolidated gross margin. It forecast approximately $60 million of 2013 capital expenditures and an approximately 32.5% tax rate for the remainder of 2013.
- The company planned to reprice and reduce the Term B facility, with the stated aim of lowering debt and annual interest expense; completion was not assured. It targeted more than $40 million of cost synergies by the third year after the acquisition, with approximately 45% expected from distribution, 30% from purchasing/supply chain/manufacturing and 25% from corporate costs. These were targets, not guaranteed outcomes.
- The Sealy acquisition cost $1,265.5 million net of cash acquired. The preliminary purchase-price allocation included $549.3 million of goodwill and substantial intangible assets and remained subject to valuation finalization. Sealy’s post-acquisition net sales were $46.7 million and pretax loss was $3.6 million. Unaudited pro forma combined results, which are not fully adjusted and are not necessarily indicative, showed Q1 2013 sales of $683.0 million and net income of $15.6 million, versus $696.7 million and $29.0 million in Q1 2012.
- A Danish tax assessment covering 2001–2007 totaled approximately $185.9 million including interest and penalties. A bilateral tax agreement process ended without resolution; proceedings were expected to resume, and the authority could require cash or other security, potentially up to the claim amount. The company disputed the assessments.
- Merger-related shareholder lawsuits were subject to a proposed settlement without additional monetary consideration, pending court approval. Holders of about 3.1 million Sealy shares had asserted appraisal rights; an appraisal above the $2.20-per-share merger price could require additional payment. The company also disclosed securities litigation, whose outcome and potential loss were not estimable.
- Other disclosed risks include high leverage and variable-rate exposure, integration and synergy execution, competitive pressure, raw-material inflation, customer concentration, foreign-exchange risk, underfunded pension obligations and environmental remediation at former Sealy facilities. The top five customers represented 25.3% of sales; one customer exceeded 10%.
- Management said disclosure controls were effective at March 31, 2013 and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of the reported sales and earnings trend reflects the acquired Sealy business, given its inclusion for only 14 days, and how do subsequent full-quarter segment results compare?
- Whether Sealy integration delivers the targeted synergies and whether the planned Term B repricing and debt reduction occur on the expected terms.
- Progress on the $185.9 million Danish tax dispute, any security or deposit requirement, and developments in the Sealy appraisal and litigation matters.
- Whether margins stabilize amid competition, new-product launch costs, commodity inflation and the expected greater contribution from lower-margin Sealy operations.
- The final acquisition purchase-price allocation, ongoing cash generation, covenant headroom and ability to meet debt service and planned capital expenditures.
- The filing’s MD&A describes general, administrative and other expenses as $53.9 million, while the consolidated income statement reports $58.7 million. Verify the correct reported amount and reconciliation in the filed statements.