(EDGAR Online via COMTEX) -- ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the 2021 Annual Report, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in ITEM 7 of Part II of the 2021 Annual Report, and the accompanying Condensed Consolidated Financial Statements and notes thereto included in this Report. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are subject to numerous risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" elsewhere in this Report, in the 2021 Annual Report and the section titled "Risk Factors" contained in ITEM 1A of Part I of the 2021 Annual Report. Our actual results may differ materially from those contained in any forward-looking statements.
In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the three months ended March 31, 2022, including the following topics:
an overview of our business and strategy,
We are committed to improving the sleep of more people, every night, all around the world. As a leading designer, manufacturer, distributor and retailer of bedding products worldwide, we know how crucial a good night of sleep is to overall health and wellness. Utilizing over a century of knowledge and industry-leading innovation, we deliver award-winning products that provide breakthrough sleep solutions to consumers in over 100 countries.
We operate in two segments: North America and International. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S., Canada and Mexico. Our International segment consists of manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America (other than Mexico). On August 2, 2021, we acquired Dreams Topco Limited and its direct and indirect subsidiaries ("Dreams"). Dreams is also included in the International segment. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. We evaluate segment performance based on net sales, gross profit and operating income. For additional information refer to Note 12, "Business Segment Information," included in Part II, ITEM 1 of this Report.
Our highly recognized brands include Tempur-Pedic(R), Sealy(R) and Stearns & Foster(R) and our non-branded offerings consist of value-focused private label and OEM products. Our products allow for complementary merchandising strategies and are sold through third-party retailers, our more than 650 company-owned and joint venture operated retail stores worldwide and our e-commerce channel.
Our distribution model operates through an omni-channel strategy. We distribute through two channels in each operating business segment: Wholesale and Direct. Our Wholesale channel consists of third-party retailers, including third-party distribution, hospitality and healthcare. Our Direct channel includes company-owned stores, online and call centers.
General Business and Economic Conditions
We believe the bedding industry is structured for sustained growth, driven by product innovation, sleep technology advancements, consumer confidence, housing formations and population growth. The industry is no longer engaged in uneconomical retail store expansion, startups have shifted from uneconomical strategies to becoming profitable and legacy retailers and manufacturers have become skilled in producing profitable online sales.
Over the last decade, consumers have made the connection between a good night's sleep and overall health and wellness. In recent years, this trend accelerated during the COVID-19 global pandemic. As consumers make this connection they are willing to invest more in their bedding purchases, which positions us well for long-term growth.
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In the near term, there are various macro-economic factors impacting the business. While we do not have any operations in Ukraine or Russia, the war in Ukraine has affected both international and domestic markets. Internationally, the war has introduced elements of risk into the supply chain and is affecting consumer confidence in Europe. Also, U.S. consumer confidence has declined due to inflation and geopolitical uncertainty. While we have taken actions that have largely mitigated our broader supply chain risk, declining consumer confidence is negatively impacting our order trends, which we expect to continue.
The COVID-19 global pandemic continues to impact our global operations as variants appear in the markets in which we operate. The recent variant in China and the resulting government mandated lockdowns are negatively impacting our wholly-owned and joint-venture operations in the region.
Our recent actions to expand capacity, diversify our supplier base, increase our safety stock and improve vendor and customer communications have strengthened our supply chain, putting us in a more favorable position to meet consumer demand. Though geopolitical and pandemic-related disruptions continue to create challenges, the many actions we have taken to further insulate our supply chain have largely mitigated their impact.
During the first quarter of 2022, commodity costs unfavorably impacted our gross margin and we implemented pricing actions to mitigate the dollar impact of these known commodity headwinds. We now anticipate additional commodity cost inflation for the remainder of 2022 and expect to implement another round of pricing actions that will neutralize the effect of the incremental inflation on a full year basis.
In 2022, we plan to complete the rollout of a complete refresh of our North American Sealy portfolio that began in 2021. The updated Sealy portfolio features new models in our Posturepedic PlusTM, Posturepedic(R) and Essentials product lines. We also expect to launch a complete refresh of our North American Stearns & Foster portfolio in 2022. In the U.S., we plan to launch a Sealy-branded, eco-friendly mattress collection, as well as a Sealy mattress with a best-in-class pressure-relieving gel grid layer at a consumer-appealing, mid-market price point, in 2022.
In our International segment, we expect to launch an all-new line of Tempur(R) products in Europe and Asia-Pacific with the objective of reaching a new segment of international consumers. This new line of products will broaden Tempur(R)'s price range with the super-premium average selling price ceiling maintained and the floor expanded into the premium category. In response to the current geopolitical uncertainty permeating the European market, we have elected to postpone the launch of the new international line of Tempur(R) products that was planned for 2022 to the first quarter of 2023.
Our global 2022 marketing plan is to aggressively support our innovative bedding products through investing significant marketing dollars to promote our worldwide brands and product launches.
Acquisition of Dreams
On August 2, 2021, we completed the acquisition of Dreams, for a cash purchase price of $476.7 million, which included $49.5 million of cash acquired. The transaction was funded using cash on hand and bank financing. As a multi-branded retailer, Dreams sells a variety of products across a range of price points with a margin profile lower than our historical International segment margins.
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A summary of our results for the three months ended March 31, 2022 include:
Total net sales increased 18.7% to $1,239.5 million as compared to $1,043.8 million in the first quarter of 2021. On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 19.8%, with an increase of 5.5% in the North America business segment and an increase of 98.6% in the International business segment, primarily driven by the acquisition of Dreams in August 2021.
For a discussion and reconciliation of non-GAAP financial measures as discussed above to the corresponding GAAP financial results, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information."
We may refer to net sales or earnings or other historical financial information on a "constant currency basis," which is a non-GAAP financial measure. These references to constant currency basis do not include operational impacts that could result from fluctuations in foreign currency rates. To provide information on a constant currency basis, the applicable financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior corresponding period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Constant currency information is not recognized under GAAP, and it is not intended as an alternative to GAAP measures. Refer to Part I, ITEM 3 of this Report for a discussion of our foreign currency exchange rate risk.
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THREE MONTHS ENDED MARCH 31, 2022 COMPARED TO THE THREE MONTHS ENDED MARCH 31, 2021 The following table sets forth the various components of our Condensed Consolidated Statements of Income and expresses each component as a percentage of net sales: Three Months Ended March 31, (in millions, except percentages and per share amounts) 2022 2021 Net sales $ 1,239.5 100.0 % $ 1,043.8 100.0 % Cost of sales 716.7 57.8 584.9 56.0 Gross profit 522.8 42.2 458.9 44.0 Selling and marketing expenses 243.5 19.6 197.7 18.9 General, administrative and other expenses 97.6 7.9 79.5 7.6 Equity income in earnings of unconsolidated affiliates (6.9) (0.6) (6.7) (0.6) Operating income 188.6 15.2 188.4 18.0 Other expense, net: Interest expense, net 20.9 1.7 12.3 1.2 Loss on extinguishment of debt - - 5.0 0.5 Other income, net (1.3) (0.1) (0.3) - Total other expense, net 19.6 1.6 17.0 1.6 Income from continuing operations before income taxes 169.0 13.6 171.4 16.4 Income tax provision (38.1) (3.1) (40.5) (3.9) Income from continuing operations 130.9 10.5 130.9 12.5 Loss from discontinued operations, net of tax - - (0.2) - Net income before non-controlling interests 130.9 10.5 130.7 12.5 Less: Net income attributable to non-controlling interests 0.2 - 0.2 - Net income attributable to Tempur Sealy International, Inc. $ 130.7 10.5 % $ 130.5 12.5 % Earnings per common share: Basic Earnings per share for continuing operations $ 0.72 $ 0.64 Loss per share for discontinued operations - - Earnings per share $ 0.72 $ 0.64 Diluted Earnings per share for continuing operations $ 0.69 $ 0.62 Loss per share for discontinued operations - - Earnings per share $ 0.69 $ 0.62 Weighted average common shares outstanding: Basic 182.6 203.7 Diluted 188.5 210.1
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NET SALES Three Months Ended March 31, 2022 2021 2022 2021 2022 2021 (in millions) Consolidated North America International Net sales by channel Wholesale $ 924.1 $ 881.4 $ 811.3 $ 765.5 $ 112.8 $ 115.9 Direct 315.4 162.4 120.1 117.8 195.3 44.6 Total net sales $ 1,239.5 $ 1,043.8 $ 931.4 $ 883.3 $ 308.1 $ 160.5
Net sales increased 18.7%, and on a constant currency basis increased 19.8%. The change in net sales was driven by the following:
North America net sales increased $48.1 million, or 5.4%. On a constant currency basis, North America net sales increased 5.5%. Net sales in the Wholesale channel increased $45.8 million, or 6.0%, to $811.3 million, as compared to first quarter of 2021. Net sales in the Direct channel increased $2.3 million, or 2.0% to $120.1 million, as compared to the first quarter of 2021.
International net sales increased $147.6 million, or 92.0%. On a constant currency basis, International net sales increased 98.6%. Net sales in the Wholesale channel increased 3.7% on a constant currency basis. Net sales in the Direct channel increased 345.3% on a constant currency basis, primarily driven by the acquisition of Dreams in August 2021.
GROSS PROFIT Three Months Ended March 31, 2022 2021 (in millions, except percentages) Gross Profit Gross Margin Gross Profit Gross Margin Margin Change North America $ 352.4 37.8 % $ 363.9 41.2 % (3.4) % International 170.4 55.3 % 95.0 59.2 % (3.9) % Consolidated gross margin $ 522.8 42.2 % $ 458.9 44.0 % (1.8) %
Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in the manufacturing process.
Our gross margin is primarily impacted by the relative amount of net sales contributed by our premium or value products. Our value products have a significantly lower gross margin than our premium products. If sales of our value priced products increase relative to sales of our premium priced products, our gross margins will be negatively impacted in both our North America and International segments.
Our gross margin is also impacted by fixed cost leverage based on manufacturing unit volumes; the cost of raw materials; operational efficiencies due to the utilization in our manufacturing facilities; product, brand, channel and country mix; foreign exchange fluctuations; volume incentives offered to certain retail accounts; participation in our retail cooperative advertising programs; and costs associated with new product introductions. Future changes in raw material prices could have a significant impact on our gross margin. Our margins are also impacted by the growth in our Wholesale channel as sales in our Wholesale channel are at wholesale prices whereas sales in our Direct channel are at retail prices.
Gross margin declined 180 basis points. The primary drivers of changes in gross margin by segment are discussed below:
North America gross margin declined 340 basis points. The decline in gross margin was driven by price increases to customers without a margin benefit of 280 basis points and operational inefficiencies related to supply chain constraints of 120 basis points. Our gross margin was impacted as sales increased with no change in gross profit dollars, as our pricing actions have been neutralizing the dollar impact of commodities. These declines were partially offset by favorable mix.
International gross margin declined 390 basis points. The decline in gross margin was primarily driven by the acquisition of Dreams of 200 basis points and price increases to customers without a margin benefit of 160 basis points. Dreams' margin profile is lower than our historical international margins as they sell a variety of products across a range of price points.
Selling and marketing expenses include advertising and media production associated with the promotion of our brands, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing.
General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs.
Three Months Ended March 31, 2022 2021 2022 2021 2022 2021 2022 2021 (in millions) Consolidated North America International Corporate Operating expenses: Advertising expenses $ 103.2 $ 90.9 $ 80.9 $ 79.4 $ 22.3 $ 11.5 $ - $ - Other selling and marketing expenses 140.3 106.8 72.4 68.8 63.0 31.6 4.9 6.4 General, administrative and other expenses 97.6 79.5 43.7 42.3 25.2 12.4 28.7 24.8 Total operating expenses $ 341.1 $ 277.2 $ 197.0 $ 190.5 $ 110.5 $ 55.5 $ 33.6 $ 31.2
Operating expenses increased $63.9 million, or 23.1%, and increased 90 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are explained below:
North America operating expenses increased $6.5 million, or 3.4%, and decreased 40 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising and other selling and marketing investments.
International operating expenses increased $55.0 million, or 99.1%, and increased 130 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising and other selling and marketing investments, as well as the acquisition of Dreams.
Corporate operating expenses increased $2.4 million, or 7.7%, primarily driven by ERP implementation costs.
Research and development expenses for the three months ended March 31, 2022 were $7.8 million compared to $6.5 million for the three months ended March 31, 2021, an increase of $1.3 million, or 20.0%.
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OPERATING INCOME Three Months Ended March 31, 2022 2021 Operating (in millions, except percentages) Operating Income Operating Margin Income Operating Margin Margin Change North America $ 155.4 16.7 % $ 173.4 19.6 % (2.9) % International 66.8 21.7 % 46.2 28.8 % (7.1) % 222.2 219.6 Corporate expenses (33.6) (31.2) Total operating income $ 188.6 15.2 % $ 188.4 18.0 % (2.8) %
Operating income increased $0.2 million and operating margin declined 280 basis points. The primary drivers of changes in operating income and operating margin by segment are discussed below:
North America operating income decreased $18.0 million and operating margin declined 290 basis points. The decline in operating margin was primarily driven by the decline in gross margin of 340 basis points, partially offset by favorable operating expense leverage.
International operating income increased $20.6 million and operating margin declined 710 basis points. The decline in operating margin was primarily driven by the decline in gross margin of 390 basis points and unfavorable operating expense leverage of 120 basis points.
Corporate operating expenses increased $2.4 million, which negatively impacted our consolidated operating margin by 20 basis points, primarily driven by ERP implementation costs.
INTEREST EXPENSE, NET Three Months Ended March 31, (in millions, except percentages) 2022 2021 % Change Interest expense, net $ 20.9 $ 12.3 69.9 %
Interest expense, net, increased $8.6 million, or 69.9%. The increase in interest expense, net, was primarily driven by increased average levels of outstanding debt.
INCOME TAX PROVISION Three Months Ended March 31, (in millions, except percentages) 2022 2021 % Change Income tax provision $ 38.1 $ 40.5 (5.9) % Effective tax rate 22.5 % 23.6 %
Our income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of net operating losses for certain of our foreign operations.
Our income tax provision decreased $2.4 million due to a decrease in income before income taxes. Our effective tax rate for the three months ended March 31, 2022 as compared to the same prior year period decreased by 110 basis points. The effective tax rate as compared to the U.S. federal statutory rate for the three months ended March 31, 2022 included the favorable impact of the deductibility of stock compensation in the U.S. and included a net unfavorable impact of other discrete items. The effective tax rate as compared to the U.S. federal statutory tax rate for the three months ended March 31, 2021 included the favorable impact of the deductibility of stock compensation in the U.S. and included a net unfavorable impact of discrete items.
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Our principal sources of funds are cash flows from operations, supplemented with borrowings in the capital markets and made pursuant to our credit facilities and cash and cash equivalents on hand. Principal uses of funds consist of payments of principal and interest on our debt facilities, share repurchases, acquisitions, payments of dividends to our shareholders, capital expenditures and working capital needs.
As of March 31, 2022, we had net working capital of $117.7 million, including cash and cash equivalents of $116.3 million, as compared to a working capital of $222.2 million, including cash and cash equivalents of $300.7 million, as of December 31, 2021.
At March 31, 2022, total cash and cash equivalents were $116.3 million, of which $29.9 million was held in the U.S. and $86.4 million was held by subsidiaries outside of the U.S. The amount of cash and cash equivalents held by subsidiaries outside of the U.S. and not readily convertible into the U.S. Dollar or other . . .
May 05, 2022
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