Business context and reporting period
This is Tempur Sealy International, Inc.’s unaudited Form 10-Q for the quarter and nine months ended September 30, 2013; the filing is not for SomniGroup International Inc. The company develops, manufactures and sells bedding products through Tempur North America, Tempur International and Sealy segments. Sealy was acquired on March 18, 2013, so 2013 results include Sealy only from that date; comparisons with 2012 are therefore not like-for-like.
Key financial metrics
| Metric | Three months ended September 30, 2013 | Nine months ended September 30, 2013 |
|---|---|---|
| Net sales | $735.5 million | $1,786.2 million |
| Gross profit / margin | $298.7 million / 40.6% | $742.0 million / 41.5% |
| Operating income / margin | $81.2 million / 11.0% | $169.7 million / 9.5% |
| Net income attributable to the company | $40.2 million | $51.1 million |
| Diluted EPS | $0.65 | $0.83 |
| Operating cash flow | Not separately stated | $104.8 million |
| Capital expenditures | Not separately stated | $28.4 million |
For the third quarter of 2012, sales were $347.9 million, gross margin 49.2%, operating income $63.4 million, net loss $2.0 million and diluted EPS a loss of $0.03. For the first nine months of 2012, sales were $1,061.8 million, gross margin 51.2%, operating income $197.0 million, net income $83.3 million and diluted EPS $1.31. The large reported sales increases—111.4% for the quarter and 68.2% for the nine-month period—primarily reflect Sealy’s inclusion, not comparable underlying growth.
At September 30, 2013, cash was $126.6 million, current assets $750.6 million and current liabilities $475.3 million (working capital $275.3 million). Total debt was $1,860.1 million, versus $1,025.0 million at December 31, 2012; cash-adjusted debt was approximately $1,733.5 million. The company reported $237.6 million of revolving-credit availability after borrowings and letters of credit. Its reported covenant leverage ratio was 4.3 times adjusted EBITDA, within the applicable 5.5-times limit at September 30.
Material changes versus prior periods
- Sealy contributed $389.9 million of third-quarter sales and $781.2 million from acquisition through September 30. Its lower gross margins reduced consolidated gross margin; Sealy’s third-quarter margin was 34.5% and its post-acquisition nine-month margin was 31.9%.
- Despite higher quarterly operating income, nine-month operating income fell to $169.7 million from $197.0 million and net income fell to $51.1 million from $83.3 million. Higher interest expense ($88.2 million versus $13.0 million) and Tempur North America weakness contributed. Tempur North America’s nine-month sales declined 7.2%; its nine-month pretax result was a $37.9 million loss.
- Operating cash flow declined to $104.8 million from $153.6 million. Investing cash outflow was $1,200.4 million, chiefly reflecting the $1,172.9 million net Sealy acquisition payment.
- The company refinanced and repriced credit facilities, made a $125 million voluntary Term B prepayment, and reduced Term A and Term B borrowing margins. Sealy acquisition financing and assumed debt drove the increase in total debt.
Outlook, commentary, risks and unusual items
- Management expected 2013 capital expenditures of approximately $50 million and a tax rate of approximately 31.5% for the remainder of 2013. It expected about $92.3 million of cash interest payments for 2013, plus fourth-quarter U.S. tax payments of approximately $35 million related to repatriation and foreign tax payments of approximately $25 million.
- Management said operating cash flow and available credit were expected to cover debt service, capital expenditures, share repurchases and working capital for the foreseeable future, while cautioning that future cash generation and borrowing availability were not assured. It planned continued investment in product innovation, advertising, international expansion and supply-chain efficiency; advertising was expected to rise as a percentage of sales in the fourth quarter.
- Sealy integration and transaction costs affected results: nine-month general and administrative expense included $14.0 million of acquisition/integration-related professional fees, and the company reported $18.4 million of direct transaction costs. Nine-month interest expense included $8.7 million of prepayment fees and a $4.7 million write-off of deferred financing costs. Sealy purchase accounting also added $7.7 million to cost of sales for acquired inventory revaluation.
- A Danish tax assessment covering 2001–2007 totaled approximately $200.3 million, including interest and penalties. The company contests it; the requirement to post security was deferred to 2017. A further adverse outcome could materially affect liquidity and profitability.
- Other disclosed exposures include Sealy shareholder appraisal litigation relating to the $2.20-per-share merger consideration, shareholder securities litigation, a newly filed California consumer class action, and environmental remediation. The company stated it could not estimate losses for certain litigation matters. It recorded $2.9 million for South Brunswick remediation and approximately $0.1 million for Oakville.
- Top five customers represented 33.9% of third-quarter sales; Mattress Firm accounted for more than 10% of third-quarter and nine-month sales. The company stated disclosure controls were effective and it was in compliance with debt covenants at quarter-end.
Important facts for investors to verify
- How much reported revenue and earnings growth is attributable to Sealy versus comparable organic performance; consider the filing’s unaudited pro forma figures and their stated limitations.
- Whether Tempur North America’s sales and profitability recover, and whether the lower consolidated gross margin and integration costs improve as expected.
- Debt repayment capacity, variable-rate exposure, covenant headroom and the potential cash impact if holders convert the remaining 8.0% Sealy Notes.
- Developments in the Danish tax dispute, Sealy appraisal action, securities and consumer litigation, and environmental matters.
- Customer concentration and whether management’s capital expenditure, tax, interest and liquidity expectations are met.