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EX-23.1 - EXHIBIT 23.1 - TEMPUR SEALY INTERNATIONAL, INC.exhibit231-tpxx2015123110k.htm
EX-31.2 - EXHIBIT 31.2 - TEMPUR SEALY INTERNATIONAL, INC.exhibit312-tpxx2015123110k.htm
EX-31.1 - EXHIBIT 31.1 - TEMPUR SEALY INTERNATIONAL, INC.exhibit311-tpxx2015123110k.htm
EX-32.1 - EXHIBIT 32.1 - TEMPUR SEALY INTERNATIONAL, INC.exhibit321-tpxx2015123110k.htm
EX-21.1 - EXHIBIT 21.1 - TEMPUR SEALY INTERNATIONAL, INC.exhibit211-tpxx2015123110k.htm

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2015
Commission file number 001-31922
 
TEMPUR SEALY INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
33-1022198
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
1000 Tempur Way
Lexington, Kentucky 40511
(Address of registrant’s principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (800) 878-8889
Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, $0.01 par value
 
New York Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act:
 None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes x No¨  
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large Accelerated filer x Accelerated filer o Non-Accelerated filer o Smaller Reporting Company ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨ No x
The aggregate market value of the common equity held by nonaffiliates of the registrant on June 30, 2015, computed by reference to the closing price for such stock on the New York Stock Exchange on such date, was approximately $3,621,804,954.
The number of shares outstanding of the registrant’s common stock as of February 9, 2016 was 62,424,870 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement for the 2016 Annual Meeting of Stockholders, which is to be filed subsequent to the date hereof, are incorporated by reference into Part III of this Form 10-K.



TABLE OF CONTENTS
 
 
 
Page
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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Special Note Regarding Forward-Looking Statements
 
This Annual Report on Form 10-K (“Report”) including the information incorporated by reference herein, contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (“Exchange Act”),which includes information concerning one or more of our plans; objectives; goals; strategies and key strategic growth initiatives; future revenues or performance; our ability to realize the anticipated benefits from our recent asset dispositions and the acquisition of brand rights in certain international markets; the impact of the macroeconomic environment in both the U.S. and internationally on our business segments and expectations regarding growth of the mattress industry; uncertainties arising from global events; general economic, financial and industry conditions, particularly in the retail sector, as well as consumer confidence and the availability of consumer financing; competition in our industry; consumer acceptance of our products; the ability to continuously improve and expand our product line, maintain efficient, timely and cost-effective production and delivery of products, and manage growth; the ability to expand brand awareness, distribution and new products; the efficiency and effectiveness of our advertising campaigns and other marketing programs; the ability to increase sales productivity within existing retail accounts and to further penetrate the retail channel, including the timing of opening or expanding within large retail accounts and the timing and success of product launches; the effects of consolidation of retailers on revenues and costs; the effects of strategic investments on our operations, including our efforts to expand our global market share; changing commodity costs; changes in product and channel mix and the impact on the Company's gross margin; initiatives to improve gross margin; our capital structure and increased debt level, including our ability to meet financial obligations and continue to comply with the terms and financial ratio covenants of our credit facilities; changes in interest rates; changes in foreign tax rates and changes in tax laws generally, including the ability to utilize tax loss carry forwards; effects of changes in foreign exchange rates on our reported earnings; the outcome of pending tax audits or other tax proceedings; the effect of future legislative or regulatory changes; litigation and similar issues; financial flexibility; our expected sources of cash flow; changes in capital expenditures; our ability to effectively manage cash; and our share repurchase program. Many of these statements appear, in particular, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, ITEM 7 of this report. When used in this report, the words "assumes," "estimates," "expects," “guidance”, “anticipates,” “proposed,” “projects,” “plans,” “intends,” “believes” and variations of such words or similar expressions are intended to identify forward-looking statements. These forward-looking statements are based upon our current expectations and various assumptions. There can be no assurance that we will realize our expectations or that our beliefs will prove correct.
    
There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this Report. There are important factors, many of which are beyond the Company’s control, that could cause our actual results to differ materially from those expressed as forward-looking statements in this Report, including under the heading “Risk Factors” under Part I, ITEM 1A of this Report. There may be other factors that may cause our actual results to differ materially from the forward-looking statements.
    
All forward-looking statements attributable to us apply only as of the date of this Report and are expressly qualified in their entirety by the cautionary statements included in this Report. Except as may be required by law, we undertake no obligation to publicly update or revise any of the forward-looking statements, whether as a result of new information, future events, or otherwise.
 
When used in this Report, except as specifically noted otherwise, the term “Tempur Sealy International” refers to Tempur Sealy International, Inc. only, and the terms “Company,” “we,” “our,” “ours” and “us” refer to Tempur Sealy International, Inc. and its consolidated subsidiaries. When used in this Report, the term “Sealy” refers to Sealy Corporation and its historical subsidiaries.

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PART I
 
ITEM 1. BUSINESS    
 
General
 
We are the world's largest bedding provider. We develop, manufacture, market, and distribute bedding products, which we sell globally in approximately 100 countries. Our brand portfolio includes many highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic®, and Stearns & Foster®. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.

Prior to January 1, 2015, the Company operated under three reportable segments: Tempur North America, Tempur International and Sealy. Effective January 1, 2015, the Company realigned its organizational structure and updated its segments in light of the progress made in 2013 and 2014 integrating Sealy into its historical business. The Company's updated reportable segments are North America and International. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S. and Canada. Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. The Company evaluates segment performance based on net sales, gross profit and operating income. Financial information about our segments and geographic areas is included in Part II, ITEM 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, and Note 18, Business Segment Information, of the Notes to Consolidated Financial Statements, included in Part II, ITEM 8, Financial Statements and Supplementary Data, of this Report.

We sell our products through two distribution channels in each segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); and Other (direct-to-consumer through e-commerce platforms; company-owned stores and call centers; third party distributors; hospitality and healthcare customers).

Our principal executive office is located at 1000 Tempur Way, Lexington, Kentucky 40511 and our telephone number is (800) 878-8889. Tempur Sealy International, Inc. was incorporated under the laws of the State of Delaware in September 2002. Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to such reports filed with or furnished to the Securities and Exchange Commission (“SEC”) pursuant to Sections 13(a) or 15(d) of the Exchange Act, are available free of charge on our website at www.tempursealy.com as soon as reasonably practicable after such reports are electronically filed with the SEC.
 
You may read and copy any materials we file with the SEC at the SEC’s public reference room at 100 F Street NE, Washington, DC 20549. The public may obtain information about the operation of the public reference room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The website of the SEC is www.sec.gov.

Strategy
 
We believe our future growth potential is significant in our existing markets and through expansion into new markets. Our goal is to improve the sleep of more people, every night, all around the world. It is our goal to become the share leader in every country we compete in.  In order to achieve our long-term growth potential while managing the current economic and competitive environment, we will focus on investing in our brands, developing consumer-preferred products, expanding distribution and striving for highest dealer advocacy and, where appropriate, making strategic acquisitions. In addition, we will focus on improving our cost competitiveness to fund our investments, expand margins and grow stockholder value.
 
Acquisition of Sealy

On March 18, 2013, we completed the acquisition of Sealy (“Sealy Acquisition”) and its subsidiaries, which manufacture and market a broad range of mattresses and foundations under the Sealy®, Sealy Posturepedic®, Optimum™ and Stearns & Foster® brands. Our acquisition of Sealy is more fully described in Note 3, “Acquisitions and Divestitures”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.
 



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Our Products and Brands

We have a comprehensive offering of products that appeal to a broad range of consumers, some of which are covered by one or more patents and/or patent applications. We also routinely introduce new mattress models, launch new products and update our existing mattress products in each of our segments. Our products are divided into two categories, as described below:

Bedding - Our bedding product category includes mattresses, foundations and adjustable foundations and represented 91.6% of our net sales in 2015.

Other - Our other products include pillows, mattress covers, sheets, cushions and various other comfort products and represented 8.4% of our net sales in 2015.

In order to achieve our goal to improve the sleep of more people, every night, all around the world, one of our strategic initiatives is to leverage and strengthen our comprehensive portfolio of iconic brands and products. We offer a complete and complementary portfolio of brands, which are described below:

Tempur-Pedic - Founded in 1991, the Tempur brand is our specialty innovation category leader designed to provide life changing sleep for our wellness seeking consumers. Our proprietary Tempur material precisely adapts to the shape, weight and temperature of the consumer and creates fewer pressure points, reduces motion transfer and provides personalized comfort and support.

Stearns & Foster - The Stearns & Foster brand offers our consumers high quality mattresses built by certified craftsmen who have been specially trained. Founded in 1846, the brand is designed and built with precise engineering and relentless attention to detail and fuses new innovative technologies with time-honored techniques, creating supremely comfortable beds.

Posturepedic - The Posturepedic brand, introduced in 1950, is engineered to provide all-over support and body alignment to allow full relaxation and deliver a comfortable night's sleep.

Sealy - The Sealy brand originated in 1881 in Sealy, Texas, and for over a century has focused on offering trusted comfort, durability and excellent value while maintaining contemporary styles and great support.

Our 2015 product introductions included the TEMPUR-Flex collection, which provides all of the famous adaptive sleep benefits of TEMPUR® material with a slightly springy feel. The TEMPUR-Flex collection uses hybrid construction to deliver a unique new TEMPUR feel with more responsive support. The TEMPUR-Flex collection also features an EasyRefresh™ removable cover and a cool-to-the-touch SmartClimate™ system. In addition, we updated our Sealy Posturepedic line in 2015, which includes the Posturepedic Series, Posturepedic Plus Series and Posturepedic Premier Hybrid Series. The new Sealy Posturepedic mattresses feature encased coils, gel memory foam and a core support center. We also introduced a limited edition collection of Stearns & Foster mattresses and, internationally, introduced Tempur North, a new bed system that will be marketed primarily in Northern European markets.

Our 2016 product introductions included the new Stearns & Foster® Reserve Collection, which offers our exclusive Hybrid Pillow Top featuring our Nano Comfort™ Quilt Layer. The innovative mattress top design delivers precise support, superior adaptability and light-as-air comfort. The specially engineered Nano Comfort™ Quilt Layer places thousands of super-small coils between layers of memory foam for durable and conforming support. In addition, we updated our existing Stearns & Foster® Estate, Lux Estate and Lux Estate Hybrid product lines, which, along with the Reserve Collection, now offer four exclusive features: IntelliCoil® Advanced coil design, PrecisionEdge™ high-density border system, PrimaCool™ performance fabric and Advanced Adapt™ memory foam. We also updated our TEMPUR-Breeze line to include a state-of-the art PureCool™ Comfort technology, an ultra breathable design and a premium cooling cover. These upgrades provide more refreshing sleep for consumers seeking a cooler sleeping environment.


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Our Channels

We sell our products through two channels: Retail and Other.

Retail

Our Retail channel sells to furniture and bedding retailers, department stores and warehouse clubs, among others and represented 91.2% of net sales in 2015. Our top five customers accounted for approximately 39.4% of our net sales for the year ended December 31, 2015. Mattress Firm Holding Corp., which is represented in the North America segment, is our largest customer. On February 5, 2016, Mattress Firm Holding Corp. acquired all of the outstanding equity interests in HMK Mattress Holdings, LLC ("Sleepy’s"). Sleepy’s was also one of our top 5 customers in 2015 and as a result of this acquisition, based on 2015 net sales, the combined companies will be our largest customer, and will represent a significant portion of our overall sales. Mattress Firm and Sleepy’s together represented approximately 25% of our overall net sales for 2015. Additionally, we have a long-term supply agreement in place with Mattress Firm, which we have recently extended. The loss of one or more of these customers could negatively impact our profitability.

Other

Our Other channel sells directly to consumers through e-commerce platforms, company owned stores and call centers, and to third party, healthcare and hospitality customers and represented 8.8% of net sales in 2015. Third party includes sales to distributors in countries where we do not sell directly through our own subsidiaries. Healthcare includes sales to hospitals, nursing homes, healthcare professionals and medical retailers. Hospitality sales include hotels.

Marketing

Our overall marketing strategy is to drive consumer demand through the use of effective marketing. We invest across multiple media platforms to build brand awareness and drive consumer interest in our products. Our strategy varies by segment; however the majority of our advertising programs are created on a centralized basis through our in-house advertising organization. In 2016 we plan to drive growth through continued investments in new products, marketing and other initiatives.

North America

Our North America segment sells primarily through the Retail channel, which contributed 95.5% of North America segment sales in 2015. In North America, we advertise nationally on television, digitally and through consumer and trade print. In addition, we participate in cooperative advertising on a shared basis with some of our retail customers. Throughout the year, we relied on a series of strategic initiatives, which included: new product introductions, advertising and in-store marketing investments.

International

Our International segment sells primarily through the Retail channel, which contributed 72.0% of International segment net sales in 2015. Our advertising strategy in our International segment focuses on building brand awareness, which we believe is important to increasing our overall market share. We advertise on television, digitally and through consumer and trade print, as well as cooperative advertising on a shared basis with some of our retail customers. We believe there is significant opportunity to drive sales growth in our International segment through the expansion of product lines within existing channels, increasing our market share in previously underpenetrated markets and, where appropriate, entering into new markets.
    
Seasonality
 
We believe that our sales of products to furniture and bedding stores are typically subject to modest seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters and higher in the first and third quarters. Internationally, we are subject to seasonality with European net sales lower in the third quarter as compared to the other quarters during the year. Typical seasonality patterns may be affected by significant new product launches, which also generate an increase in floor model discounts as we deploy new products to our customers. In 2015 and 2014, we experienced stronger sales in the third and fourth quarters due to product launches in the first half of the year.




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Operations
 
Manufacturing and Distribution. Our products are currently manufactured and distributed through our global network of facilities.
    
Suppliers. We obtain the raw materials used to produce our pressure-relieving TEMPUR® material from outside sources. We currently acquire chemicals and proprietary additives for Tempur products from a number of suppliers with manufacturing locations around the world. These supplier relationships may be revised in order to maintain quality, cost, and delivery expectations. We do not consider ourselves dependent upon any single outside vendor as a source of raw materials for Tempur products and believe that sufficient alternative sources of supply for the same or similar raw materials are available. Additionally, we source a portion of the manufacturing of our adjustable bed bases and foundations from third party manufacturers. We do not consider ourselves dependent upon any single outside manufacturer as a source of these products.

In our Sealy products, our raw materials consist of polyurethane foam, polyester, polyethylene foam and steel innerspring components that we purchase from various suppliers. In the U.S. and Canada, we source the majority of our requirements for polyurethane foam components and spring components for our Sealy mattress units from a key supplier for each component. In the U.S. and Canada, we rely upon a single supplier for certain polyurethane foam components and spring components in our Sealy mattress units. These components are purchased under a supply agreement. We also purchase a significant portion of our Sealy foundation parts from third party sources under supply agreements, which require that we maintain certain volume allocations based on a proportional amount of material purchases. These volume allocations do not represent fixed purchase commitments. We are also dependent on a single supplier for the visco-elastic components and assembly of our Optimum™ specialty product lines. Except for our dependence regarding polyurethane foam, visco-elastic components and assembly of our Optimum™ specialty product lines, we do not consider ourselves to be dependent upon any single outside vendor as a source of supply to our bedding business, and we believe that sufficient alternative sources of supply for the same, similar or alternative components are available.
    
Research and Development. We have four research and development centers, three in the U.S. and one in Denmark, which conduct technology and product development. Additionally, we have a product testing facility that conducts hundreds of consumer tests annually. We believe our consumer-research driven approach to innovation results in best-in-class products that benefit the consumer. Research and development expenses were $28.7 million, $21.6 million and $21.0 million in 2015, 2014 and 2013, respectively.

Industry

We compete in the global bedding industry, comprised of mattresses and foundations, pillows and accessories. The mattress market category is comprised of traditional innerspring mattresses, as well as non-innerspring mattresses that include visco-elastic and foam mattresses, innerspring/foam hybrid mattresses, airbeds and latex mattresses. The foundation category is comprised of traditional foundations and adjustable foundations. The primary distribution channels for mattresses and foundations are retail furniture and bedding stores, department stores and warehouse clubs. Additionally, the pillow market is comprised of traditional foam and feather pillows, as well as pillows made of visco-elastic, latex, foam, sponge, rubber and down.

The U.S. is the largest market in which we compete. Since 1995, U.S. wholesale bedding sales, which include mattresses and foundations, have grown at a compound annual growth rate, or CAGR, of 4.9%, reaching approximately $7,524.0 million in 2014 according to the International Sleep Products Association (“ISPA”). This growth has been driven by the increase in the U.S. population, natural replacement cycle of mattresses and an increase in the average unit selling prices (“AUSPs”).

The U.S. mattress industry has benefited from a steady increase in AUSP over the past three decades, due in particular to the growth in premium priced non-innerspring mattresses but also due to various other factors, including an increase in the percentage of larger sized mattresses sold. As consumers have become increasingly aware of the health benefits of a good night’s sleep, which is often associated with the quality of their mattress, consumers have demonstrated a growing willingness to increase spending for higher quality mattresses and related bedding products. This trend has been further supported by the demographic shift in the population to consumers who are 45-64 years old and typically have a higher level of disposable income. The U.S. mattress industry has responded with the development of new, innovative technologies. Mattresses with enhanced features are typically sold at higher prices than traditional innerspring mattresses.

The traditional mattress innerspring category continues to account for the majority of industry mattress revenues; however the market for non-innerspring mattresses continues to grow. In 2014, traditional innerspring mattresses, excluding foundations, represented approximately $4,400.0 million of the bedding industry, and non-innerspring mattresses, excluding foundations, represented approximately $1,900.0 million of the industry, according to ISPA. The market for non-innerspring mattresses was

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30.0% of the overall U.S. mattress industry in 2014, according to ISPA.

The U.S. mattress industry has historically been correlated with the health of the overall economy and a significant portion of new mattress purchases are typically driven by the replacement cycle. Factors that have shown some level of association with industry sales include overall GDP, housing turnover, personal disposable income, consumer confidence, interest rates and employment levels. As such, during recessionary periods, demand for mattresses declines as consumers reduce spending and delay discretionary purchases. During the most recent recession in 2008 and 2009, wholesale bedding sales experienced the greatest year-over-year decline in the past 20 years. Although demand improved in subsequent years, the increase in units sold was slower than in years following prior recessionary periods. Assuming the health of the overall economy continues to improve, we believe the mattress industry is well positioned for future growth.

Competition

The global bedding industry is highly competitive. We encounter competition from a number of mattress and foundation manufacturers in both domestic and international markets, as well as competition from a number of pillow and other bedding accessories manufacturers. Participants in each of these markets compete primarily on price, quality, brand name recognition, product availability and product performance.

We have a portfolio of brands and a complementary product offering, addressing most price points, consumer preferences and points of distribution. Our mattress products compete with a number of different types of mattresses, including innerspring mattresses, visco-elastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These competing products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, Internet, telemarketing programs, television infomercials and catalogs. The U.S. pillow industry is characterized by a large number of competitors, none of which are dominant.

The U.S. mattress market has experienced consolidation in recent years. We, together with Serta Simmons, collectively accounted for a significant share of the wholesale bedding industry revenues in 2014 based on figures obtained from ISPA and Furniture/Today industry publications. The balance of the mattress market in the U.S. is served by a large number of other manufacturers, including Select Comfort Corporation, which focuses on air beds and other air-supported mattresses, and many others operating on a regional basis.

The international market for mattresses and pillows is generally served by a large number of manufacturers, primarily operating on a regional and local basis. These manufacturers offer a broad range of mattress and pillow products.
The highly competitive nature of the mattress and pillow industries means we are continually subject to the risk of loss of market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.

Intellectual Property

Patents, Trademarks and Licensing
 
We hold various U.S. and foreign patents and patent applications regarding certain elements of the design and function of many of our mattress and pillow products.
 
As of December 31, 2015, we held trademark registrations worldwide, which we believe have significant value and are important to the marketing of our products to retailers. TEMPUR® and Tempur-Pedic® are trademarks registered with the United States Patent and Trademark Office. In addition, we have U.S. applications pending for additional trademarks. Several of our trademarks have been registered, or are the subject of pending applications, in various foreign countries. Each U.S. trademark registration is renewable indefinitely as long as the trademark remains in use. We also own numerous of trademarks, trade names, service marks, logos and design marks, including Sealy®, Stearns & Foster® and Sealy Posturepedic®. We also license the Bassett® trade name in various territories under a long term agreement.
    
We derive income from royalties by licensing Sealy® brands, technology and trademarks to other manufacturers. Our licenses include rights for the licensees to use trademarks as well as current proprietary or patented technology utilized by us. We also provide our licensees with product specifications, research and development, statistical services and marketing programs. For the year ended December 31, 2015, the licensing group as a whole generated unaffiliated net royalties of approximately $18.3 million.



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Governmental Regulation
 
Our operations are subject to state, local and foreign consumer protection and other regulations relating to the mattress and pillow industry. These regulations vary among the states and countries in which we do business. The regulations generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling and sale and penalties for violations. The U.S. Consumer Product Safety Commission has adopted rules relating to fire retardancy standards for the mattress industry. Many foreign jurisdictions also regulate fire retardancy standards. Future changes to these standards may require modifications to our products to comply with these additional standards. We are also subject to environmental and health and safety requirements with regard to the manufacture of our products and conduct of our operations and facilities. We have made and will continue to make capital and other expenditures necessary to comply with these requirements. Currently these expenditures are immaterial to our financial results.

Our principal waste products are foam and fabric scraps, wood, cardboard and other non-hazardous materials derived from product component supplies and packaging. We also periodically dispose of (primarily by recycling) small amounts of used machine lubricating oil and air compressor waste oil. In the United States, we are subject to federal, state and local laws and regulations relating to environmental health and safety, including the Federal Water Pollution Control Act and the Comprehensive Environmental Response, Compensation and Liability Act. We believe that we are in compliance with all applicable international, federal, state and local environmental statutes and regulations. Except as set forth in “Legal Proceedings”, included in Part I, ITEM 3 of this Report, compliance with international, federal, state or local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, should not have any material effect upon our capital expenditures, earnings or competitive position. We are not aware of any pending federal environmental legislation which would have a material impact on our operations. Except as set forth in “Legal Proceedings”, included in Part I, ITEM 3 of this Report, we have not been required to make and do not expect to make any material capital expenditures for environmental control facilities in the foreseeable future.

Employees
 
As of December 31, 2015 we had approximately 7,200 Tempur Sealy employees, approximately 4,700 of which are located in North America and 2,500 in the rest of world. Approximately 40.0% of our employees are represented by various labor unions with separate collective bargaining agreements. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We consider our overall relations with our workforce to be satisfactory. Our current collective bargaining agreements, which are typically three years in length, expire at various times beginning in 2016 through 2019. As of December 31, 2015, our domestic operations employed approximately 770 individuals covered under collective bargaining agreements expiring in 2016. Our international operations employed approximately 400 individuals covered under collective bargaining agreements expiring in 2016.

Executive Officers of the Registrant
 
This information is incorporated herein by reference from our definitive proxy statement for the 2016 Annual Meeting of Stockholders (the “Proxy Statement”) under the section entitled “Proposal One—Election of Directors—Executive Officers.”

ITEM 1A. RISK FACTORS
 
The following risk factors and other information included in this Report should be carefully considered. Please also see “Special Note Regarding Forward-Looking Statements” on page 3.

Set forth below are descriptions of certain risks relating to our business.

Unfavorable economic and market conditions could reduce our sales and profitability and as a result, our operating results may be adversely affected.

Our business has been affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The global economy remains unstable, and we expect the economic environment to continue to be challenging. Economic uncertainty may give households less confidence to make discretionary purchases.


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There could be a number of other effects from these economic developments on our business, including reduced consumer demand for products; insolvency of our customers, resulting in increased provisions for credit losses; insolvency of our key suppliers resulting in product delays; inability of retailers and consumers to obtain credit to finance purchases of our products; decreased consumer confidence; decreased retail demand, including order delays or cancellations; counterparty failures negatively impacting our treasury operations; inability for us, our customers and our suppliers to accurately forecast future product demand trends; and adverse movements in foreign currency exchange rates. If such conditions are experienced in future periods, our industry, business and results of operations may be severely impacted.

Because we depend on our significant customers, a decrease or interruption in their business with us would reduce our sales and results of operations.

Our top five customers, collectively, account for approximately 39.4% of our net sales for 2015. The credit environment in which our customers operate has been relatively stable over the past few years. We expect that some of the retailers that carry our products may consolidate, undergo restructurings or reorganizations, experience financial difficulty, or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration in the retail industry. An increase in the concentration of our sales to large customers may negatively affect our profitability due to the impact of volume and other incentive programs related to these customers. Furthermore, as sales to our large customers grow, our credit exposure to these customers may also increase. Some of these retailers may decide to carry only a limited number of brands of mattress products, which could affect our ability to sell products to them on favorable terms, if at all. A substantial decrease or interruption in business from these significant customers could result in the loss of future business and could reduce liquidity and profitability. In addition, the timing of large purchases by these customers could have an increasingly significant impact on our quarterly net sales and earnings.

Mattress Firm Holding Corp., which is represented in the North America segment, is our largest customer. On February 5, 2016, Mattress Firm Holding Corp. acquired all of the outstanding equity interests in HMK Mattress Holdings, LLC ("Sleepy’s"). Sleepy’s operates approximately 1,500 specialty mattress retail stores located in 17 states and the combined company will operate approximately 3,500 stores in 48 states. Sleepy’s was also one of our top 5 customers in 2015 and as a result of this acquisition, based on 2015 net sales, the combined company will be our largest customer, and will represent a significant portion of our overall sales. Mattress Firm and Sleepy’s together represented approximately 25% of our overall net sales for 2015. This higher customer concentration will increase the risks associated with large customers described above.

Our sales growth is dependent upon our ability to implement strategic initiatives and actions taken to increase sales growth may not be effective.

Our ability to generate sales growth is dependent upon a number of factors, including the following:

our ability to continuously improve our products to offer new and enhanced consumer benefits and better quality;
ability of our future product launches to increase net sales;
the effectiveness of our advertising campaigns and other marketing programs in building product and brand awareness, driving traffic to our distribution channels and increasing sales;
our ability to expand into new distribution channels and grow our existing channels, including our current roll-out of Sealy mattress products in various international markets;
our ability to continue to successfully execute our strategic initiatives;
the level of consumer acceptance of our products; and
general economic factors that negatively impact consumer confidence, disposable income or the availability of consumer financing.


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We may be adversely affected by fluctuations in exchange rates, which could affect our results of operations, the costs of our products and our ability to sell our products in foreign markets.

Approximately 25% of our net sales were generated outside of the United States in 2015. As a multinational company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign exchange rates. If the U.S. dollar strengthened relative to the euro or other foreign currencies where we have operations, there would be a negative impact on our operating results upon translation of those foreign operating results into the U.S. dollar. In 2015, foreign currency exchange rate changes negatively impacted our adjusted EBITDA, which is a non-U.S generally accepted accounting principle ("U.S. GAAP") financial measure, by approximately 6.4%. In 2016, we expect foreign exchange could continue to negatively impact our results of operations. Changes in foreign currency exchange rates could have an adverse impact on our financial condition, results of operations and cash flows. We do not hedge the translation of foreign currency operating results into the U.S. dollar.

We use foreign exchange forward contracts to manage a portion of the exposure to the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as among certain subsidiaries. These hedging transactions may not succeed in managing our foreign currency exchange rate risk.

Refer to “Management's Discussion and Analysis” included in Part II, ITEM 7 of this Report and “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report for further discussion on the impact of foreign exchange rates on our operations.

We are subject to a pending tax proceeding in Denmark, and an adverse decision or a negotiated settlement could adversely impact our results of operations and cash flows.

We have received income tax assessments from the Danish Tax Authority (“SKAT”). We believe the process to reach a final resolution of this matter could potentially extend over a number of years. If we are not successful in defending our position that we owe no additional taxes, we could be required to pay a significant amount to SKAT. In addition, the Company could choose to pursue a settlement with SKAT, which could also require the Company to pay significant amounts to SKAT in excess of any related reserve.  Each of these outcomes could have a material adverse impact on our results of operations and cash flows. In addition, prior to any ultimate resolution of this issue before the Tribunal or the Danish courts, or a settlement of the matter with SKAT, based on a change in facts and circumstances, the Company may be required to further increase its uncertain tax liability associated with this matter, which could have a material impact on the Company's reported earnings. For a description of these assessments and additional information with respect to these assessments and the various related legal proceedings, see “Legal Proceedings” included in Part I, ITEM 3 of this Report and Note 14, “Income Taxes”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report, and "Management's Discussion and Analysis" included in Part II, ITEM 7 of this Report.

We operate in the highly competitive mattress and pillow industries, and if we are unable to compete successfully, we may lose customers and our sales may decline.

Participants in the mattress and pillow industries compete primarily on price, quality, brand name recognition, product availability and product performance and compete across a range of distribution channels.

A number of our significant competitors offer mattress and pillow products that compete directly with our products. Any such competition by established manufacturers or new entrants into the market could have a material adverse effect on our business, financial condition and operating results. In addition, mattress and pillow manufacturers and retailers are seeking to increase their channels of distribution and looking for new ways to reach the consumer, including the recent expansion in the number of companies pursuing online direct-to-consumer models for foam mattresses. The pillow industry is characterized by a large number of competitors, none of which are dominant. The highly competitive nature of the mattress and pillow industries means we are continually subject to the risk of loss of market share, loss of significant customers, reductions in margins, and the inability to acquire new customers.

We rely significantly on information technology and any failure, inadequacy, interruption or security lapse of that technology could harm our ability to effectively operate our business.

Our ability to effectively manage our business depends significantly on our information systems. The failure of our current systems, or future upgrades, to operate effectively or to integrate with other systems, or a breach in security of these systems could cause reduced efficiency of our operations, and remediation of any such failure, problem or breach could reduce our liquidity and

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profitability. Any disruptions caused by the failure of these systems could adversely impact our day-to-day business and decision making and could have a material adverse effect on its performance.

We have successfully implemented a new enterprise resource planning, or “ERP,” system across several of our global subsidiaries. We are continuing this implementation and expanding into our North America segment. This new system will continue to replace a substantial portion of our legacy systems currently supporting our operations. If we are unable to successfully implement the replacement of the legacy systems, it could lead to a disruption in our business and unanticipated additional use of capital and other resources, which may adversely impact our results of operations.

Changes in tax laws and regulations or other factors could cause our income tax rate to increase, potentially reducing net income and adversely affecting cash flows, and fluctuations in our tax obligations and effective tax rate may result in volatility of our financial results and stock price.

We are subject to taxation in various jurisdictions around the world and at any one time multiple tax years are subject to audit by various taxing jurisdictions. In preparing financial statements, we calculate our annual effective income tax rate based on current tax laws and regulations and the estimated taxable income within each of these jurisdictions. Our effective income tax rate, however, may be higher due to numerous factors, including, but not limited to, changes in accounting methods or policies, tax laws or regulations, the tax litigation environment in each such jurisdiction, and the outcome of pending or future audits, whether the result of litigation or negotiations with taxing authorities. Each such item may result in a tax liability that differs from our original estimate. An effective income tax rate that is significantly higher than currently anticipated could have an adverse effect on our net income and cash flows. In addition, there could be ongoing variability in our quarterly tax rates as events occur and exposures are evaluated, which could adversely affect our quarterly results of operations and stock price.

Officials in some of the jurisdictions in which we do business, including the United States, have proposed or announced that they are considering tax increases and other revenue raising laws and regulations. Additionally, the global tax environment is becoming more complex, with government tax authorities becoming increasingly more aggressive in asserting claims for taxes. Any resulting changes in tax laws or regulations could increase our effective income tax rate or impose new restrictions, costs or prohibitions on our current practices and reduce our net income and adversely affect our cash flows.

In addition to the increased activity of taxing authorities with respect to income tax, taxing authorities are also becoming more aggressive in asserting claims for indirect taxes such as import duties and value added tax. These types of claims present similar risks and uncertainties as those discussed above. We believe we are in compliance with all tax laws and regulations that govern such indirect taxes in each of the jurisdictions we do business in. However, because claims taxing authorities assert often involve the question of internal product pricing, which is inherently subjective in nature, any such claim may require us to litigate the matter to defend our position or to negotiate a settlement on the matter with the taxing authorities that differs from the amount of potential exposure recorded in the financial statements.

Our leverage may limit our flexibility and increase our risk of default.

As a result of our acquisition of Sealy, our long-term debt has increased substantially, which, in turn, has increased our leverage (for information regarding these topics, see “Management’s Discussion and Analysis” included in Part II, ITEM 7 of this Report and Note 6, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

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Our degree of leverage could have important consequences to our investors, such as:

increasing our vulnerability to adverse economic, industry or competitive developments;
requiring a substantial portion of our cash flow from operations to be dedicated to the payment of principal and interest on our indebtedness, therefore reducing our ability to use our cash flow to fund our operations, capital expenditures and other business opportunities;
making it more difficult for us to satisfy our obligations with respect to our indebtedness;
restricting us from making strategic acquisitions or investments or causing us to make non-strategic divestitures;
limiting our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, acquisitions and general corporate or other purposes;
limiting our flexibility in planning for, or reacting to, changes in our business or the industry in which we operate, placing us at a competitive disadvantage compared to our competitors who are less highly leveraged and who therefore, may be able to take advantage of opportunities that our leverage prevents us from exploiting;
exposing us to variability in interest rates, as a substantial portion of our indebtedness is and will be at variable rates; and
limiting our ability to return capital to our stockholders, including through share repurchases.

In addition, the instruments governing our debt contain financial and other restrictive covenants, which limit our operating flexibility and could prevent us from taking advantage of business opportunities and reduce our flexibility to respond to changing business and economic conditions, which could put us at a competitive disadvantage. Our failure to comply with these covenants may result in an event of default. If such event of default is not cured or waived, we may suffer adverse effects on our operations, business or financial condition, including acceleration of our debt. For further discussion regarding our debt covenants and compliance, refer to “Management’s Discussion and Analysis” included in Part II, ITEM 7 of this Report and Note 6, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

We are subject to fluctuations in the cost of raw materials, and increases in these costs would reduce our liquidity and profitability.

The bedding industry has been challenged by volatility in the price of petroleum-based and steel products, which affects the cost of polyurethane foam, polyester, polyethylene foam and steel innerspring component parts. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Given the significance of the cost of these materials to our products, volatility in the prices of the underlying commodities can significantly affect profitability. To the extent we are unable to absorb higher costs, or pass any such higher costs to our customers, our gross margin could be negatively affected, which could result in a decrease in our liquidity and profitability.

If we, or our service providers, are unable to adequately protect our information assets from cyber-based attacks or other security incidents, our operations could be disrupted and our reputation could be damaged.

We are increasingly dependent on information technology, including the Internet, for the storage, processing, and transmission of our electronic, business-related information assets. We leverage our internal information technology infrastructures, and those of our service providers, to enable, sustain and support our global business interests. In the event that we or our service providers are unable to prevent, detect and remediate cyber-based attacks or other security incidents in a timely manner, our operations could be disrupted or we may incur financial or reputational losses arising from the theft, alteration, misuse, unauthorized disclosure or destruction of its information assets.

We cannot guarantee that we will repurchase our common stock pursuant to our recently announced stock repurchase program or that our stock repurchase program will enhance long-term stockholder value. Stock repurchases could also increase the volatility of the price of our common stock and could diminish our cash reserves.

In February 2016, our board of directors authorized a stock repurchase program. Under the program, we are authorized to repurchase shares of our common stock for an aggregate purchase price not to exceed $200 million. Although our board of directors has authorized the stock repurchase program, the stock repurchase program does not obligate us to repurchase any specific dollar amount or to acquire any specific number of shares and may be suspended or terminated at any time. Stock may be purchased from time to time, in the open market or through private transactions, subject to market condition, in compliance with applicable state and federal securities laws. The timing and amount of repurchases, if any, will depend upon several factors, including market and business conditions, the trading price of our common stock and the nature of other investment opportunities. In addition, repurchases of our common stock pursuant to our stock repurchase program could affect the market price of our common stock or increase its volatility. For example, the existence of a stock repurchase program could cause our stock price to be higher than

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it would be in the absence of such a program and could potentially reduce the market liquidity for our stock. Additionally, our stock repurchase program could diminish our cash reserves, which may impact our ability to finance future growth and to pursue possible future strategic opportunities and acquisitions. There can be no assurance that any stock repurchases will enhance stockholder value because the market price of our common stock may decline below the levels at which we determine to repurchase our stock. Although our stock repurchase program is intended to enhance long-term stockholder value, there is no assurance that it will do so and short-term stock price fluctuations could reduce the program’s effectiveness.

We may be unable to sustain our profitability, which could impair our ability to service our indebtedness and make investments in our business and could adversely affect the market price for our stock.

Our ability to service our indebtedness depends on our ability to maintain our profitability. We may not be able to maintain our profitability on a quarterly or annual basis in future periods. Further, our profitability will depend upon a number of factors, including without limitation:

general economic conditions in the markets in which we sell our products and the impact on consumers and retailers;
the level of competition in the mattress and pillow industry;
our ability to successfully identify and respond to emerging trends in the mattress and pillow industry;
our ability to successfully launch new products;
our ability to effectively sell our products through our distribution channels in volumes sufficient to drive growth and leverage our cost structure and advertising spending;
our ability to reduce costs, including our ability to align our cost structure with sales in the existing economic environment;
our ability to successfully manage our relationships with our major customers;
our ability to absorb fluctuations in commodity costs;
our ability to maintain efficient, timely and cost-effective production and utilization of our manufacturing capacity; and
our ability to maintain efficient, timely and cost-effective delivery of our products, and our ability to maintain public recognition of our brands.

Our new product launches may not be successful due to development delays, failure of new products to achieve anticipated levels of market acceptance and significant costs associated with failed product introductions, which could adversely affect our revenues and profitability.

Each year we invest significant time and resources in research and development to improve our product offerings and launch new products. There are a number of risks inherent in our new product line introductions, including that the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, which could impact profitability.

Our advertising expenditures and customer incentives may not result in increased sales or generate the levels of product and brand name awareness we desire and we may not be able to manage our advertising expenditures on a cost-effective basis.

A significant component of our marketing strategy involves the use of direct marketing to generate brand awareness and sales. Future growth and profitability will depend in part on the cost and efficiency of our advertising expenditures, including our ability to create greater awareness of our products and brand names and determine the appropriate creative message and media mix for future advertising expenditures and to incent the promotion of our products.

Our operating results are subject to fluctuations, including as a result of seasonality, which could make sequential quarter to quarter comparisons an unreliable indication of our performance and adversely affect the market price of our common stock.

A significant portion of our net sales are attributable to our Retail channel, particularly net sales to furniture and bedding stores. We believe that our sales of bedding and other products to furniture and bedding stores are subject to seasonality inherent in the bedding industry, with sales expected to be generally lower in the second and fourth quarters and higher in the first and third quarters, and in Europe, lower in the third quarter as compared to the other quarters during the year. Additionally, typical seasonality patterns may be affected by significant new product launches. In 2015 and 2014, we experienced stronger sales in the third and fourth quarters due to product launches in the first half of the year. This seasonality means that a sequential quarter to quarter comparison may not be a good indication of our performance or of how we will perform in the future.


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We are subject to risks from our international operations, such as complying with U.S. and foreign laws, foreign exchange exposure, tariffs, increased costs, political risks and our ability to expand in certain international markets, which could impair our ability to compete and our profitability.

We are a global company, selling our products in approximately 100 countries worldwide. We generated approximately 25% of our net sales outside of the United States in 2015, and we continue to pursue additional international opportunities. We also participate in international license and joint venture arrangements with independent third parties. Our international operations are subject to the customary risks of operating in an international environment, including complying with U.S. laws affecting operations outside of the United States such as the Foreign Corrupt Practices Act; complying with foreign laws and regulations, including disparate anti-corruption laws and regulations; risks associated with varying local business customs; and the potential imposition of trade or foreign exchange restrictions, tariffs and other tax increases, fluctuations in exchange rates, inflation and unstable political situations and labor issues. We are also limited in our ability to independently expand in certain international markets where we have granted licenses to manufacture and sell Sealy® bedding products. Fluctuations in the rate of exchange between currencies in which we do business may affect our financial condition or results of operations.

If we are not able to protect our trade secrets or maintain our trademarks, patents and other intellectual property, we may not be able to prevent competitors from developing similar products or from marketing in a manner that capitalizes on our trademarks, and this loss of a competitive advantage could decrease our profitability and liquidity.

We rely on trade secrets to protect the design, technology and function of our products. To date, we have not sought U.S. or international patent protection for our principal product formula for TEMPUR® material and manufacturing processes. Accordingly, we may not be able to prevent others from developing viscoelastic material and products that are similar to or competitive with our products. Our ability to compete effectively with other companies also depends, to a significant extent, on our ability to maintain the proprietary nature of our owned and licensed intellectual property. We own a significant number of patents on aspects of our products and have patent applications pending on aspects of our products and manufacturing processes. However, the principal product formula and manufacturing processes for our TEMPUR® material and our products are not patented and we must maintain these as trade secrets in order to protect this intellectual property. We own U.S. and foreign registered trade names and service marks and have applications for the registration of trade names and service marks pending domestically and abroad. We also license certain intellectual property rights from third parties.

Our trademarks are currently registered in the U.S. and registered or pending in foreign jurisdictions. However, those rights could be circumvented, or violate the proprietary rights of others, or we could be prevented from using them if challenged. A challenge to our use of our trademarks could result in a negative ruling regarding our use of our trademarks, their validity or their enforceability, or could prove expensive and time consuming in terms of legal costs and time spent defending against such a challenge. Any loss of trademark protection could result in a decrease in sales or cause us to spend additional amounts on marketing, either of which could decrease our liquidity and profitability. In addition, if we incur significant costs defending our trademarks, that could also decrease our liquidity and profitability. In addition, we may not have the financial resources necessary to enforce or defend our trademarks. Furthermore, our patents may not provide meaningful protection and patents may never issue from pending applications. It is also possible that others could bring claims of infringement against us, as our principal product formula and manufacturing processes are not patented, and that any licenses protecting our intellectual property could be terminated. If we were unable to maintain the proprietary nature of our intellectual property and our significant current or proposed products, this loss of a competitive advantage could result in decreased sales or increased operating costs, either of which would decrease our liquidity and profitability.

In addition, the laws of certain foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the U.S. or the European Union. Third parties, including competitors, may assert intellectual property infringement or invalidity claims against us that could be upheld. Intellectual property litigation, which could result in substantial cost to and diversion of effort by us, may be necessary to protect our trade secrets or proprietary technology, or for us to defend against claimed infringement of the rights of others and to determine the scope and validity of others’ proprietary rights. We may not prevail in any such litigation, and if we are unsuccessful, we may not be able to obtain any necessary licenses on reasonable terms or at all.

A material increase in our product return rates or an inadequacy in our warranty reserves could reduce our liquidity and profitability.

We allow consumers to return certain products for comfort reasons. As we expand our sales, our return rates may not remain within our historical levels. A downturn in general economic conditions may also increase our product return rates. A material increase in return rates could significantly impair our liquidity and profitability.

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We provide our consumers warranties on our products ranging from 3 to 25 years. Due to the increase in new product introductions in recent years, we may still see significant warranty claims on products under warranty which are early in their product life cycles. As of March 1, 2014, we shortened the warranty of Tempur mattresses sold in our North America segment from 25 years to 10 years to align with the industry standard. Also, in line with our strategy, as we continue to innovate to provide new products to our customers, we could be susceptible to unanticipated risks with our warranty claims, which could impair our liquidity and profitability.

Because some of our products have been in use by our customers for the full warranty period, we rely on the combination of historical experience and product testing for the development of our estimate for warranty claims. However, our actual level of warranty claims could prove to be greater than the level of warranty claims we estimated based on our products’ performance during product testing. If our warranty reserves are not adequate to cover future warranty claims, their inadequacy could have a material adverse effect on our liquidity and profitability.

We are vulnerable to interest rate risk with respect to our debt, which could lead to an increase in interest expense.

We are subject to interest rate risk in connection with the variable rate debt under our debt agreements. Interest rate changes could increase the amount of our interest payments and thus, negatively impact our future earnings and cash flows. Although we refinanced a significant portion of our variable rate debt in 2015 with fixed rate debt, we still have a significant amount of variable rate debt outstanding. For information regarding our sensitivity to changes in interest rates, refer to “Quantitative and Qualitative Disclosures About Market Risk” included in Part II, ITEM 7A of this Report.

Loss of suppliers and disruptions in the supply of our raw materials could increase our costs of sales and reduce our ability to compete effectively.

We acquire raw materials and certain components from a number of suppliers with manufacturing locations around the world. If we were unable to obtain raw materials and certain components from these suppliers for any reason, we would have to find replacement suppliers. Any substitute arrangements for raw materials and certain components might not be on terms as favorable to us. In addition, we outsource the procurement of certain goods and services from suppliers in foreign countries. If we were no longer able to outsource through these suppliers, we could source it elsewhere, perhaps at a higher cost. We maintain relatively small supplies of our raw materials and outsourced goods at our manufacturing facilities, and any disruption in the on-going shipment of supplies to us could interrupt production of our products, which could result in a decrease of our sales or could cause an increase in our cost of sales, either of which could decrease our liquidity and profitability.

In connection with the general supply chain risks described above, we are dependent upon single source suppliers for certain structural components or assembly of specific product lines within the Sealy brand portfolio. These products are purchased under a supply agreement and are manufactured in accordance with proprietary designs jointly owned by us and the supplier.

Unexpected equipment failures, delays in deliveries or catastrophic loss delays may lead to production curtailments or shutdowns.

We manufacture and distribute products to our customers from our network of manufacturing facilities located around the world. An interruption in production capabilities at any of these manufacturing facilities could result in our inability to produce our products, which would reduce our net sales and earnings for the affected period. In addition, we generally deliver our products only after receiving the order from the customer or the retailer, and in certain facilities, on a just-in-time basis, and thus do not hold significant levels of inventories. Any significant delay in deliveries to our customers could lead to increased returns or cancellations and cause us to lose future sales. Any increase in freight charges could increase our costs of doing business and affect our profitability. We have introduced new distribution programs to increase our ability to deliver products on a timely basis, but if we fail to deliver products on a timely basis, we may lose sales which could decrease our liquidity and profitability. Our manufacturing facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. Despite the fact that we maintain insurance covering the majority of these risks, we may in the future experience material plant shutdowns or periods of reduced production as a result of equipment failure, delays in deliveries or catastrophic loss.





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The loss of the services of any members of our executive management team could impair our ability to execute our business strategy and as a result, reduce our sales and profitability.

We depend on the continued services of our executive management team. The loss of key personnel could have a material adverse effect on our ability to execute our business strategy and on our financial condition and results of operations. We do not maintain key-person insurance for members of our executive management team.

We could face adverse consequences as a result of stockholder actions or abrupt changes in our management or Board of Directors.

As previously disclosed, H Partners Management LLC, together with certain of its affiliates (collectively, "H Partners"), has publicly criticized our operation of our business, our business strategy, corporate governance considerations and other matters and demanded immediate changes in our management and Board of Directors. Although as described in the Form 8-K filed May 13, 2015, the Company entered into an agreement with H Partners on May 11, 2015 that includes a standstill that limits H Partners’ ability to take certain actions, this standstill provision expires after the 2016 Annual Meeting of Stockholders and there can be no assurance that H Partners or another stockholder will not make additional demands in the future.

As described in the Form 8-K Current Reports filed on May 11, 2015, June 1, 2015, July 30, 2015, September 8, 2015 and February 2, 2016, the Company announced a number of significant changes in its senior management and Board of Directors. Abrupt changes in our senior management or Board of Directors could adversely impact our ability to manage our business and implement our key strategic priorities. In addition, perceived uncertainties as to our future direction, or any abrupt changes in our management or Board of Directors, may lead to concerns regarding the direction or stability of our business, which may be exploited by our competitors, result in the loss of business opportunities, cause concern to our current or potential customers or suppliers, or make it more difficult to retain existing personnel or attract and retain new personnel. Considering and responding to future demands by stockholders, or abrupt changes in management or the Board, could be time-consuming and result in significant additional costs to us and could be disruptive of our operations and divert the time and attention of management and our employees away from our business operations and executing on our strategic plan. These actions could also cause our stock price to experience periods of volatility.

Deterioration in labor relations could disrupt our business operations and increase our costs, which could decrease our liquidity and profitability.

As of December 31, 2015, we had approximately 7,200 full-time employees. Approximately 40.0% of our employees are represented by various labor unions with separate collective bargaining agreements or government labor union contracts for certain international locations. Our North American collective bargaining agreements, which are typically three years in length, expire at various times during any given three year period. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We may at some point be subject to work stoppages by some of our employees and, if such events were to occur, there may be a material adverse effect on our operations and profitability. Further, we may not be able to renew our various collective bargaining agreements on a timely basis or on favorable terms, or at all. Any significant increase in our labor costs could decrease our liquidity and profitability and any deterioration of employee relations, slowdowns or work stoppages at any of our locations, whether due to union activities, employee turnover or otherwise, could result in a decrease in our net sales or an increase in our costs, either of which could decrease our liquidity and profitability.

We may face exposure to product liability claims, which could reduce our liquidity and profitability and reduce consumer confidence in our products.

We face an inherent business risk of exposure to product liability claims if the use of any of our products results in personal injury or property damage. In the event that any of our products prove to be defective, we may be required to recall, redesign or even discontinue those products. We maintain insurance against product liability claims, but such coverage may not continue to be available on terms acceptable to us or be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage could impair our liquidity and profitability, and any claim or product recall that results in significant adverse publicity against us could result in consumers purchasing fewer of our products, which would also impair our liquidity and profitability.


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Regulatory requirements, including, but not limited to, trade, environmental, health and safety requirements, may require costly expenditures and expose us to liability.

Our products and our marketing and advertising programs are subject to regulation in the U.S. by various federal, state and local regulatory authorities, including the Federal Trade Commission and the U.S. Food and Drug Administration. In addition, other governments and agencies in other jurisdictions regulate the sale and distribution of our products. These rules and regulations may change from time to time, or may conflict. There may be continuing costs of regulatory compliance including continuous testing, additional quality control processes and appropriate auditing of design and process compliance. For example, the U.S. Consumer Product Safety Commission (“CPSC”) and many foreign jurisdictions have adopted rules relating to fire retardancy standards for the mattress industry. Further, some states and the U.S. Congress continue to consider fire retardancy regulations that may be different or more stringent than the CPSC standard. Adoption of multi-layered regulatory regimes, particularly if they conflict with each other, could increase our costs, alter our manufacturing processes and impair the performance of our products which may have an adverse effect on our business. We are also subject to various health and environmental provisions, such as California Proposition 65 (the Safe Drinking Water and Toxic Enforcement Act of 1986) and 16 CFR Part 1633 (Standard for the Flammability (Open Flame) of Mattress Sets).

Our marketing and advertising practices could also become the subject of proceedings before regulatory authorities or the subject of claims by other parties and could require us to alter or end these practices or adopt new practices that are not as effective or are more expensive.

In addition, we are subject to federal, state and local laws and regulations relating to pollution, environmental protection and occupational health and safety. We may not be in complete compliance with all such requirements at all times. We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. If a release of hazardous substances occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of our properties, we may be held liable and the amount of such liability could be material. As a manufacturer of bedding and related products, we use and dispose of a number of substances, such as glue, lubricating oil, solvents and other petroleum products, as well as certain foam ingredients, that may subject us to regulation under numerous foreign, federal and state laws and regulations governing the environment. Among other laws and regulations, we are subject in the United States to the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act, the Clean Air Act and related state and local statutes and regulations.

Our operations could also be impacted by a number of pending legislative and regulatory proposals to address greenhouse gas emissions in the U.S. and other countries. Certain countries have adopted the Kyoto Protocol. New greenhouse gas reduction targets have been established under the Kyoto Protocol, as amended, and certain countries, including Denmark, have adopted the new reduction targets. This and other international initiatives under consideration could affect our International operations. These actions could increase costs associated with our operations, including costs for raw materials, pollution control equipment and transportation. Because it is uncertain what laws will be enacted, we cannot predict the potential impact of such laws on our future consolidated financial condition, results of operations, or cash flows.

We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. With respect to the acquisition of Sealy, we could incur costs related to certain remediation activities. In particular, Sealy is currently addressing the clean-up of environmental contamination at certain of its former facilities. For additional information regarding these remediation activities, Refer to Note 13, “Commitments and Contingencies”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for a discussion of Commitments and Contingencies. In the event of an adverse development or decision by one or more of the governing environmental authorities, additional contamination being discovered with respect to these or other properties or any third parties bringing claims related to these or other properties, these or other matters could have a material effect on our profitability.

Our pension plans are currently underfunded and we may be required to make cash payments to the plans, reducing our available cash.

We maintain certain defined benefit pension plans. In addition, hourly employees working at certain of Sealy’s domestic manufacturing facilities are covered by union sponsored retirement and health and welfare plans. These plans cover both active employees and retirees. The plans are currently underfunded, and under certain circumstances we could be required to pay amounts with respect to this underfunding. Such events may significantly impair our profitability and liquidity. For more information, refer to Note 9, “Retirement Plans”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.



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Challenges to our pricing policies could adversely affect our operations.

Certain of our retail pricing policies are subject to antitrust regulations in the U.S. and abroad. If antitrust regulators in any jurisdiction in which we do business initiate investigations into or challenge our pricing or advertising policies, our efforts to respond could force us to divert management resources and we could incur significant unanticipated costs. If such an investigation were to result in a charge that our practices or policies were in violation of applicable antitrust or other laws or regulations, we could be subject to significant additional costs of defending such charges in a variety of venues and, ultimately, if there were a finding that we were in violation of antitrust or other laws or regulations, there could be an imposition of fines, and damages for persons injured, as well as injunctive or other relief. Any requirement that we pay fines or damages could decrease our liquidity and profitability, and any investigation or claim that requires significant management attention or causes us to change our business practices could disrupt our operations or increase our costs, also resulting in a decrease in our liquidity and profitability. An antitrust class action suit against us could result in potential liabilities, substantial costs and the diversion of our management’s attention and resources, regardless of the outcome.

Our stock price is likely to continue to be volatile, your investment could decline in value, and we may incur significant costs from class action litigation.

The trading price of our common stock is likely to continue to be volatile and subject to wide price fluctuations. The trading price of our common stock may fluctuate significantly in response to various factors, including but not limited to:

actual or anticipated variations in our quarterly and annual operating results, including those resulting from seasonal variations in our business;
general economic conditions, such as unemployment, changes in short-term and long-term interest rates and fluctuations in both debt and equity capital markets;
introductions or announcements of technological innovations or new products by us or our competitors;
disputes or other developments relating to proprietary rights, including patents, litigation matters, and our ability to patent, or otherwise protect, our products and technologies;
changes in estimates by securities analysts of our financial performance or the financial performance of our competitors or major customers or statements by others in the investment community relating to such performance;
stock repurchase programs;
bankruptcies of any of our major customers;
conditions or trends in the mattress industry generally;
additions or departures of key personnel;
announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;
announcements by our competitors or our major customers of their quarterly operating results or announcements by our competitors or our major customers of their views on trends in the bedding industry;
regulatory developments in the U.S. and abroad;
economic and political factors;
public announcements or filings with the SEC indicating that significant stockholders, directors or officers are buying or selling shares of our common stock; and
the declaration or suspension of a cash dividend.

In addition, the stock market in general has experienced significant price and volume fluctuations that have often been unrelated or disproportionate to operating performance. These broad market factors may seriously harm the market price of our common stock, regardless of our operating performance.

In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in potential liabilities, substantial costs, and the diversion of our management’s attention and resources, regardless of the outcome. See “Legal Proceedings” included in Part I, ITEM 3 of this Report.

 Future sales of our common stock may depress our stock price.

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. All shares of our common stock are freely transferable without restriction

19


or further registration under the Securities Act, except for certain shares of our common stock which were purchased by our executive officers, directors, principal stockholders, and some related parties.

We have stockholders who presently beneficially own more than 5.0% of our outstanding capital stock. Sales or other dispositions of our shares by these major stockholders may depress our stock price.

Provisions of Delaware law and our charter documents could delay or prevent an acquisition of us, even if the acquisition would be beneficial to you.

Provisions of Delaware law and our certificate of incorporation and by-laws could hamper a third party’s acquisition of us, or discourage a third party from attempting to acquire control of us. You may not have the opportunity to participate in these transactions. These provisions could also limit the price that investors might be willing to pay in the future for shares of our common stock.

These provisions include:

our ability to issue preferred stock with rights senior to those of the common stock without any further vote or action by the holders of our common stock;
the requirements that our stockholders provide advance notice when nominating our directors; and
the inability of our stockholders to convene a stockholders’ meeting without the chairperson of the board, the president, or a majority of the board of directors first calling the meeting.

ITEM 1B. UNRESOLVED STAFF COMMENTS
 
None.


20


ITEM 2. PROPERTIES

The following table sets forth certain information regarding our principal facilities at December 31, 2015.
Name
 
Location
 
Approximate Square Footage
 


Title
 


Type of Facility
North America
 
 
 
 
 
 
 
 
Tempur Production USA, LLC
 
Albuquerque, New Mexico
 
800,000
 
Leased
 
Manufacturing
Sealy of Maryland and Virginia, LLC
 
Hagerstown, MD
 
615,600
 
Leased
 
Manufacturing
Sealy Corporation
 
Plainfield, Indiana
 
614,000
 
Leased
 
Manufacturing
Tempur Production USA, LLC
 
Duffield, Virginia
 
581,000
 
Owned
 
Manufacturing
Ohio-Sealy Mattress Manufacturing Co.
 
Conyers, Georgia
 
300,000
 
Owned
 
Manufacturing
Sealy Mattress Co. of Albany, Inc.
 
Green Island, New York
 
257,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Richmond, California
 
241,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Orlando, Florida
 
225,050
 
Leased
 
Manufacturing
Sealy Texas Management, Inc.
 
Brenham, Texas
 
220,500
 
Owned (a)
 
Manufacturing
Sealy Mattress Company of Illinois
 
Batavia, Illinois
 
210,000
 
Leased
 
Manufacturing
The Ohio Mattress Company Licensing & Components Group, Inc.
 
Mountain Top, Pennsylvania
 
210,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Trinity, North Carolina
 
180,000
 
Owned
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
South Gate, California
 
172,000
 
Leased
 
Manufacturing
Sealy Canada, Ltd
 
Alberta, Canada
 
144,500
 
Owned (a)
 
Manufacturing
Sealy Mattress Company
 
Medina, Ohio
 
140,000
 
Owned (a)
 
Manufacturing
Sealy of Maryland and Virginia, Inc.
 
Williamsport, Maryland
 
134,500
 
Leased
 
Manufacturing
Sealy Mattress Co. of Kansas City, Inc.
 
Kansas City, Kansas
 
122,000
 
Leased
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Phoenix, Arizona
 
120,000
 
Leased
 
Manufacturing
Sealy Canada, Ltd
 
Toronto, Canada
 
120,000
 
Leased
 
Manufacturing
Sealy, Inc.
 
Trinity, NC
 
105,500
 
Owned
 
Office
Sealy of Minnesota, Inc.
 
St Paul, Minnesota
 
93,600
 
Owned (a)
 
Manufacturing
Sealy Canada, Ltd
 
Quebec, Canada
 
88,000
 
Owned (a)
 
Manufacturing
Sealy Mattress Manufacturing Co. Inc.
 
Denver, Colorado
 
82,000
 
Owned (a)
 
Manufacturing
Tempur-Pedic Management, LLC
 
Lexington, Kentucky
 
77,400
 
Owned
 
Office
Sealy Mattress Company of Puerto Rico
 
Carolina, Puerto Rico
 
44,000
 
Owned (a)
 
Manufacturing
 
 
 
 
 
 
 
 
 
International
 
 
 
 
 
 
 
 
Dan-Foam ApS
 
Aarup, Denmark
 
523,000
 
Owned
 
Manufacturing
Sealy Argentina SRL
 
Buenos Aires, Argentina
 
144,000
 
Owned
 
Manufacturing
Tempur Deutschland GmbH
 
Steinhagen, German
 
143,500
 
Owned
 
Warehouse
Sealy Mattress Company Mexico, S. de R.L. de C.V.
 
Toluca, Mexico
 
130,500
 
Owned
 
Manufacturing
Tempur UK Ltd
 
Middlesex, UK
 
61,000
 
Leased
 
Warehouse
Tempur France
 
Ile de France, France
 
53,800
 
Leased
 
Warehouse
(a)
 
We have granted a mortgage or otherwise encumbered our interest in this facility as collateral for secured indebtedness.

 In addition to the properties listed above, we have other facilities in other countries, the majority under leases with one to ten year terms. The manufacturing facility in Albuquerque, New Mexico is leased as part of the related industrial revenue bond financing. We have an option to repurchase the property for one dollar upon termination of the lease.

We believe that our existing properties are suitable for the conduct of our business, are adequate for our present needs and will be adequate to meet our future needs.


21


ITEM 3. LEGAL PROCEEDINGS

(a) Norfolk County Retirement System, Individually and on behalf of all others similarly situated, Plaintiff v. Tempur-Pedic International Inc., Mark A. Sarvary and Dale E. Williams; filed June 20, 2012

Arthur Benning, Jr., Individually and on behalf of all others similarly situated, Plaintiff v. Tempur-Pedic International Inc., Mark A. Sarvary and Dale E. Williams; filed June 25, 2012

On June 20 and 25, 2012, the above suits were filed against the Company and two named executive officers in the United States District Court for the Eastern District of Kentucky, purportedly on behalf of a proposed class of stockholders who purchased the Company’s stock between January 25, 2012 and June 5, 2012. The complaints asserted claims under Sections 10(b) and 20(a) of the Exchange Act, alleging, among other things, false and misleading statements and concealment of material information concerning the Company’s competitive position, projected net sales, earnings per diluted share and related financial performance for the Company’s 2012 fiscal year. The plaintiffs sought damages, interest, costs, attorney’s fees, expert fees and unspecified equitable/injunctive relief. On November 2, 2012, the Court consolidated the two lawsuits and on March 6, 2013, plaintiffs filed a consolidated complaint. On March 31, 2014, the Court issued an Order granting the Company’s motion to dismiss with prejudice the consolidated complaint. The Court issued its memorandum of opinion and entered final judgment on May 23, 2014. On June 6, 2014, the plaintiffs filed a notice of appeal in the U.S. Court of Appeals for the Sixth Circuit ("Appeals Court"). Following oral argument, the Appeals Court issued an order on June 4, 2015, ruling in favor of the Company. The Plaintiff had until September 2, 2015 to file a petition seeking review by the United States Supreme Court. The Plaintiff did not file for review, therefore this matter has now been resolved in the Company's favor. 

(b) Sealy Mattress Company of NJ, Inc., David Hertz, individually, as trustee of, respectively, the Allison Lindsay Hertz Trust, the Samuel Douglas Hertz Trust, the Sydney Lauren Hertz Trust, the U/A DTD 08/21/97 Andrew Michael Marcus Trust, the U/A DTD 08/21/97 Julia Robyn Marcus Trust, and the U/A DTD 08/21/97 James Daniel Marcus Trust, and as executor of the Estate of Walter Hertz, Lisa Marcus, Rose Naiman, Michael Shoobs, and Diane Shoobs, individually and as custodian of the Robert S. Shoobs UTMA NJ v. Sealy Corporation, filed June 27, 2013.  With respect to the Sealy Acquisition, holders of approximately 3.1 million shares of Sealy common stock sent notices to Sealy purporting to exercise their appraisal rights in accordance with the Merger Agreement executed on September 26, 2012. On June 27, 2013, an appraisal proceeding was commenced in the Delaware Court of Chancery (the “Appraisal Action”). This matter was settled on March 13, 2015. Sealy paid $2.20 per share for the Sealy common stock formerly held by the former Sealy stockholders seeking the appraisal, plus interest at the statutory rate, less $0.6 million already received in 2013 by one of the petitioners in connection with the closing of the Sealy Acquisition. The agreed upon per share value of $2.20 is equal to the amount paid to non-dissenting stockholders at the time of the closing of the Sealy Acquisition.

(c) Alvin Todd, and Henry and Mary Thompson, individually and on behalf of all others similarly situated, Plaintiffs v. Tempur Sealy International, Inc., formerly known as Tempur-Pedic International, Inc. and Tempur-Pedic North America, LLC, Defendants; filed October 25, 2013

On October 25, 2013, a suit was filed against Tempur Sealy International and one of its domestic subsidiaries in the United States District Court for the Northern District of California, purportedly on behalf of a proposed class of “consumers” as defined by Cal. Civ. Code § 1761(d) who purchased, not for resale, a Tempur-Pedic mattress or pillow in the State of California. On November 19, 2013, the Company was served for the first time in the case but with an amended petition adding additional class representatives for additional states. The purported classes seek certification of claims under applicable state laws.

The complaint alleges that the Company engaged in unfair business practices, false advertising, and misrepresentations or omissions related to the sale of certain products. The plaintiffs seek restitution, injunctive relief and all other relief allowed under applicable state laws, interest, attorneys’ fees and costs. The purported classes do not seek damages for physical injuries. The Company believes the case lacks merit and intends to defend against the claims vigorously. The Court was scheduled to consider class certification motions in the fourth quarter of 2015; however, the Plaintiff’s filed a Motion to Amend the Complaint, at which time the Company filed a Motion to Dismiss the Amended Complaint. A hearing on the Motion to Dismiss was held January 28, 2016 and the Court denied in part and granted in part the Company’s Motion to Dismiss allowing certain claims to proceed. The outcome of this case remains uncertain. As a result, the Company is unable to reasonably estimate the possible loss or range of losses, if any, arising from this litigation, or whether the Company’s applicable insurance policies will provide sufficient coverage for these claims. Accordingly, the Company can give no assurance that this matter will not have a material adverse effect on the Company’s financial position or results of operations.

(d) German Regulatory Investigation. The German Federal Cartel Office ("FCO") conducted unannounced inspections of the premises of several mattress wholesaler/manufacturers including the Company's German subsidiary. The order permitting

22


the inspection and collection of records alleged “vertical price fixing”. The parties met during 2015 and negotiated a final settlement in October 2015. Under the terms of the settlement, in 2015 the Company paid approximately €15.5 million (approximately $17.4 million) to fully resolve this matter. The Company recognized expense of $17.4 million (€15.5 million), which is presented within other expense (income), net in the accompanying Consolidated Statements of Income for the year ended December 31, 2015.

(e) Environmental. The Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. Sealy and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, Sealy and its subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the property in 1997. The Company retained primary responsibility for the required remediation. Previously, the Company removed and disposed of contaminated soil from the site with the New Jersey Department of Environmental Protection approval, and the Company has installed a groundwater remediation system on the site. During 2005, with the approval of the New Jersey Department of Environmental Protection, the Company removed and disposed of sediment in Oakeys Brook adjoining the site. The Company continues to monitor ground water at the site. During 2012, with the approval of the New Jersey Department of Environmental Protection, the Company commenced the removal and disposal of additional contaminated soil from the site. The Company does not believe this matter is material to the Company's financial statements.
 
The Company has also undertaken a remediation of soil and groundwater contamination at an inactive facility located in Oakville, Connecticut. Although the Company is conducting the remediation voluntarily, it obtained Connecticut Department of Energy and Environmental Protection (“DEEP”) approval of the remediation plan. In 2012, the Company submitted separate closure reports to the Connecticut DEEP for the lower portion of the site and the upper portion of the site.  The Connecticut DEEP approved the Company’s closure report for the upper portion of the site and also gave conditional approval to the Company’s closure report for the lower portion of the site.  The Company is continuing to work with the Connecticut DEEP and is performing additional testing to obtain closure for the lower portion of the site. The Company does not believe the contamination on this site is attributable to the Company’s operations, nor will have a material effect on the Company's financial statements.

In 1998, the Company sold an inactive facility located in Putnam, Connecticut. In 2012, the Company received a letter from the attorney for the current owner of that property claiming that the Company may have some responsibility for an environmental condition on the property. The Company continues to investigate this matter, but intends to vigorously defend the claim of the current owner against the Company.
 
The Company cannot predict the ultimate timing or costs of the South Brunswick, Oakville and Putnam environmental matters. Based on facts currently known, the Company believes that the accruals recorded are adequate and does not believe the resolution of these matters will have a material effect on the financial position or future operations of the Company. However, in the event of an adverse decision by the agencies involved, or an unfavorable result in the New Jersey natural resources damages matter, these matters could have a material effect on the Company’s financial position or results of operations.

(f) Income tax assessments. The Company has received income tax assessments from SKAT. The Company believes the process to reach a final resolution of this matter could potentially extend over a number of years. If the Company is not successful in defending its position that the Company owes no additional taxes, the Company could be required to pay a significant amount to SKAT. In addition, the Company could choose to pursue a settlement with SKAT, which could also require the Company to pay significant amounts to SKAT in excess of any related reserve.  Each of these outcomes could have a material adverse impact on the Company's results of operations and cash flows. In addition, prior to any ultimate resolution of this issue before the Tribunal or the Danish courts, or a settlement of the matter with SKAT, based on a change in facts and circumstances, the Company may be required to further increase its uncertain tax liability associated with this matter, which could have a material impact on the Company's reported earnings. For a description of these assessments and additional information with respect to these assessments and the various related legal proceedings, see Note 14, “Income Taxes” in the Company's Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

(g) Other. The Company is involved in various other legal proceedings incidental to the operations of its business. The Company believes that the outcome of all such pending legal proceedings in the aggregate will not have a material adverse effect on its business, financial condition, liquidity, or operating results.

ITEM 4. MINE SAFETY DISCLOSURES
 
None.


23


PART II
 
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market for Registrant’s Common Equity

Our sole class of common equity is our $0.01 par value common stock, which trades on the New York Stock Exchange (NYSE) under the symbol “TPX.” Trading of our common stock commenced on the NYSE on December 18, 2003. Prior to that time, there was no public trading market for our common stock.
 
The following table sets forth the high and low sales prices per common share, at closing, of our common stock as reported by the NYSE.
 
Price Range
 
High
 
Low
Fiscal 2015
 
 
 
First Quarter
$
59.14

 
$
49.17

Second Quarter
67.18

 
56.35

Third Quarter
78.64

 
67.50

Fourth Quarter
81.89

 
70.46

 
 
 
 
Fiscal 2014
 
 
 
First Quarter
$
54.39

 
$
45.64

Second Quarter
59.70

 
46.79

Third Quarter
61.34

 
54.28

Fourth Quarter
58.71

 
49.95


As of February 9, 2016, we had approximately 91 stockholders of record of our common stock.

Dividends

The Company does not pay a dividend. The decision to pay a dividend in future periods is reviewed by our Board of Directors on a periodic basis. Further, the Company is subject to certain customary restrictions on dividends under its 2012 Credit Agreement and Indentures. See Note 6, "Debt", in our Consolidated Financial Statements, included in Part II, Item 8 of this Report, for a discussion of the 2012 Credit Agreement and Indentures.

Recent Sales of Unregistered Securities

The Company sold 69,686 shares of Common Stock pursuant to a subscription agreement entered into with the Company's CEO on September 4, 2015, in connection with his hiring by the Company. These shares were issued from treasury stock at a price per share equal to $71.75, the closing price of the Common Stock on the NYSE on the date of the subscription agreement (September 4, 2015), in a transaction exempt under Section 4(2) of the Securities Act. The Company received $4,999,970.50 in cash proceeds from the CEO upon closing of the transaction, which proceeds were used for general corporate purposes.

Issuer Purchases of Equity Securities

There were no repurchases of our common stock for the three months ended December 31, 2015.

On February 1, 2016, our Board of Directors authorized a new share repurchase authorization of up to $200.0 million of our common stock. Stock repurchases under this program may be made through open market transactions, negotiated purchases or otherwise, at times and in such amounts as management deems appropriate. The timing and actual number of shares repurchased will depend on a variety of factors including price, financing, regulatory requirements and other market conditions. The program does not require the repurchase of any minimum number of shares and may be suspended, modified or discontinued at any time without prior notice. Repurchases may be made under a Rule 10b5-1 plan, which would permit shares to be repurchased when we might otherwise be precluded from doing so under federal securities laws.


24


Equity Compensation Plan Information

Equity Compensation Plan Information required by this Item is incorporated by reference from Part III, ITEM 12 of this Report.

Performance Graph

The following Performance Graph and related information shall not be deemed to be “soliciting material” or to be “filed” with the Securities and Exchange Commission, nor shall such information be incorporated by reference into any future filing under the Securities Act or Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.

The following table compares cumulative stockholder returns for the Company over the last five years to the Standard & Poor’s ("S&P") 500 Stock Composite Index, and a peer group. The S&P 500 Composite Index is a capitalization weighted index of 500 stocks intended to be a representative sample of leading companies in leading industries within the U.S. economy, and are chosen for market size, liquidity and industry group representation. We believe the peer group closely reflects our business and, as a result, provides meaningful comparison of stock performance.
 
The peer issuers included in this graph are set forth below:

Peer Group
Brunswick Corp.
Harman International Industries, Inc.
Newell Rubbermaid Inc.
Carter's, Inc.
Hasbro, Inc.
Polaris Industries Inc.
Columbia Sportswear Co.
Jarden Corp.
Select Comfort Corp.
Deckers Outdoor Corp.
Leggett & Platt, Inc.
Steelcase Inc.
Dorel Industries Inc.
Lexmark International, Inc.
Tupperware Brands Corp.
Fossil Group, Inc.
Mattress Firm Holding Corp.
Under Armour, Inc.
Gildan Activewear Inc.
Herman Miller, Inc.
Williams-Sonoma, Inc.
HanesBrands Inc.
Mohawk Industries, Inc.
Wolverine World Wide, Inc.

25


 
 
12/31/2010
 
12/31/2011
 
12/31/2012
 
12/31/2013
 
12/31/2014
 
12/31/2015
Tempur Sealy International, Inc.
 
$
100.00

 
$
131.13

 
$
78.61

 
$
134.70

 
$
137.07

 
$
175.89

S&P 500
 
100.00

 
102.11

 
118.45

 
156.82

 
178.29

 
180.75

Peer Group
 
100.00

 
98.55

 
127.95

 
198.60

 
231.57

 
225.37


ITEM 6. SELECTED FINANCIAL DATA
 
The following table sets forth our selected historical consolidated financial and operating data for the periods indicated. We have derived our statements of income and balance sheet data as of and for the years ended December 31, 2015, 2014, 2013, 2012 and 2011 from our audited financial statements. Our Consolidated Financial Statements as of December 31, 2015 and 2014 and for each of the three years in the period ended December 31, 2015 are included in Part II, ITEM 8 of this Report.
(in millions, except per common share amounts)
 
 
 
 
 
 
 
 
 
Statement of Income Data:
2015
 
2014
 
2013 (1)
 
2012
 
2011
Net sales
$
3,151.2

 
$
2,989.8

 
$
2,464.3

 
$
1,402.9

 
$
1,417.9

Cost of sales
1,902.3

 
1,839.4

 
1,449.4

 
688.3

 
674.8

Gross profit
1,248.9

 
1,150.4

 
1,014.9

 
714.6

 
743.1

Operating expense, net
939.8

 
874.1

 
771.1

 
466.3

 
402.6

Operating income
309.1

 
276.3

 
243.8

 
248.3

 
340.5

Interest expense, net
96.1

 
91.9

 
110.8

 
18.8

 
11.9

Loss on disposal, net

 
23.2

 

 

 

Other expense (income), net
12.9

 
(13.7
)
 
5.0

 
0.3

 
0.2

Income before income taxes
200.1

 
174.9

 
128.0

 
229.2

 
328.4

Income tax provision(2)
(125.4
)
 
(64.9
)
 
(49.1
)
 
(122.4
)
 
(108.8
)
Net income before non-controlling interest
74.7

 
110.0

 
78.9

 
106.8

 
219.6

Less: income attributable to non-controlling interest
1.2

 
1.1

 
0.3

 

 

Net income attributable to Tempur Sealy International, Inc.
$
73.5

 
$
108.9

 
$
78.6

 
$
106.8

 
$
219.6

 
 
 
 
 
 
 
 
 
 
Balance Sheet Data (at end of period):
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
153.9

 
$
62.5

 
$
81.0

 
$
179.3

 
$
111.4

Total assets (3)
2,655.5

 
2,582.7

 
2,729.9

 
1,319.5

 
838.2

Total debt (3)
1,420.8

 
1,537.0

 
1,808.9

 
1,025.0

 
585.0

Capital leases and other debt
34.0

 
27.7

 
27.6

 

 

Redeemable non-controlling interest
12.4

 
12.6

 
11.5

 

 

Total stockholders' equity
290.2

 
202.7

 
118.6

 
22.3

 
30.8

 
 
 
 
 
 
 
 
 
 
Other Financial and Operating Data:
 
 
 
 
 
 
 
 
 
Dividends per common share
$

 
$

 
$

 
$

 
$

Depreciation and amortization (4)
93.9

 
89.7

 
91.5

 
42.0

 
51.0

Net cash provided by operating activities
234.2

 
225.2

 
98.5

 
189.9

 
248.7

Net cash used in investing activities
(59.7
)
 
(10.4
)
 
(1,213.0
)
 
(55.0
)
 
(36.1
)
Net cash (used in) provided by financing activities
(90.7
)
 
(238.1
)
 
1,013.4

 
(70.8
)
 
(148.9
)
Basic earnings per common share
1.19

 
1.79

 
1.30

 
1.74

 
3.27

Diluted earnings per common share
1.17

 
1.75

 
1.28

 
1.70

 
3.18

Capital expenditures
65.9

 
47.5

 
40.0

 
50.5

 
29.5


(1)
Includes Sealy results of operations from March 18, 2013 through December 31, 2013. Information presented for periods prior to March 18, 2013 do not include Sealy and as a result, the information may not be comparable. Refer to Note 3, “Acquisitions and Divestitures” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for additional information regarding the Sealy Acquisition.
(2)
Income tax provision for 2015 includes approximately $60.7 million related to changes in estimates related to uncertain tax position regarding the Danish tax matter. 
(3)
Includes issuance of $375.0 million of Senior Notes in December 2012 ("2020 Senior Notes"), with cash proceeds held in escrow at December 31, 2012. The net proceeds from the 2020 Senior Notes were used as part of the financing for the Sealy Acquisition. Refer

26


to Note 6, “Debt” in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for additional information regarding the 2020 Senior Notes.
(4)
Includes $22.5 million, $13.4 million, $16.9 million, $5.7 million, and $16.7 million in non-cash stock-based compensation expense related to restricted stock units, performance restricted stock units, deferred stock units and stock options in 2015, 2014, 2013, 2012, and 2011, respectively.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with Part II, ITEM 6 of this Report and the audited consolidated financial statements and accompanying notes thereto included elsewhere 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” and Part I, ITEM 1A of this 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 years ended December 31, 2015, 2014 and 2013, including the following topics:

an overview of our business and strategy;
factors impacting results of operations;
results of operations including our net sales and costs in the periods presented as well as changes between periods;
expected sources of liquidity for future operations; and
our use of certain non-GAAP financial measures

Business Overview

General

We are the world's largest bedding provider. We develop, manufacture, market, and distribute bedding products, which we sell globally. Our brand portfolio includes many highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic®, and Stearns & Foster®. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.

We sell our products through two distribution channels in each operating business segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); and Other (directly to consumers through e-commerce platforms, company owned stores and call centers, and to third party, healthcare and hospitality and customers).

Business Segments

Prior to January 1, 2015, the Company operated under three reportable segments: Tempur North America, Tempur International and Sealy. Effective January 1, 2015, the Company realigned its organizational structure and updated its segments in light of the progress made in 2013 and 2014 integrating Sealy into its historical business. The Company's updated reportable segments are North America and International. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S. and Canada. Our International segment consists of Tempur and Sealy manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America. The Company evaluates segment performance based on net sales, gross profit and operating income.

Strategy
 
We are the world’s largest bedding provider and the only provider with global scale. For a complete overview of our business, including a description of our business segments, see "Business" under Part I, ITEM 1 of this Report. We believe our future growth potential is significant in our existing markets and through expansion into new markets. Our goal is to improve the sleep of more people, every night, all around the world. It is our goal to become the market leader in every country we compete in.  In order to achieve our long-term growth potential while managing the current economic and competitive environment, our strategy will focus on the following key strategic priorities: leveraging and strengthening our comprehensive portfolio of iconic brands and

27


products; expanding global distribution and seeking highest dealer advocacy; expanding margins with a focus on driving significant cost improvement; leveraging our global scale for competitive advantage; and, where appropriate, making accretive acquisitions of licensees and joint ventures. Successful execution of these strategic priorities is expected to result in above-industry sales and earnings growth and strong cash flow that will be used to reduce debt to the extent appropriate and return value to stockholders.

Factors That Could Impact Results of Operations

The factors outlined below could impact our future results of operations. For more extensive discussion of these and other risk factors, please refer to "Risk Factors", under Part I, ITEM 1A in this Report.

General Business and Economic Conditions

Our business has been affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The global economic environment continues to be challenging, and we expect the uncertainty to continue. We continue to make strategic investments, including: introducing new products; investing in increasing our global brand awareness; extending our presence and improving our Retail account productivity and distribution; investing in our operating infrastructure to meet the requirements of our business; and taking other actions to further strengthen our business.

Customer Concentration

Our top five customers, collectively, account for approximately 39.4% of our net sales for 2015. Mattress Firm Holding Corp., which is represented in the North America segment, is our largest customer. On February 5, 2016, Mattress Firm Holding Corp. acquired all of the outstanding equity interests in HMK Mattress Holdings, LLC (Sleepy’s). Sleepy’s operates approximately 1,500 specialty mattress retail stores located in 17 states in the Northeast, New England, the Mid-Atlantic and Illinois and the combined company will operate approximately 3,500 stores in 48 states. Sleepy’s was also one of our top 5 customers in 2015 and as a result of this acquisition, based on 2015 net sales, the combined companies will be our largest customer, and will represent a significant portion of our overall sales. Mattress Firm and Sleepy’s together represented approximately 25% of our overall net sales for 2015. This higher customer concentration will increase the risks associated with large customers as described in "Risk Factors" under Part I, ITEM 1A in this Report.

Exchange Rates

As a multinational company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign currency exchange rates. Foreign currency exchange rate movements also create a degree of risk by affecting the U.S. dollar value of sales made and costs incurred in foreign currencies. We use foreign exchange forward contracts to manage a portion of the exposure to the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as among certain subsidiaries. These hedging transactions may not succeed in managing our foreign currency exchange rate risk. Consequently, our reported earnings and financial position could fluctuate materially as a result of foreign exchange gains or losses. Additionally, the operations of our foreign currency denominated subsidiaries result in foreign currency translation fluctuations in our consolidated operating results. These operations do not constitute transactions which qualify for hedge accounting treatment. Therefore, we do not hedge the translation of foreign currency operating results into the U.S. dollar. Should currency rates change sharply, our results could be negatively impacted. In 2015, foreign currency exchange rate changes negatively impacted our adjusted EBITDA, which is a non-GAAP financial measure by approximately 6.4%. In 2016, we expect foreign exchange could continue to negatively impact our results of operations.

Competition

Participants in the bedding industry compete primarily on price, quality, brand name recognition, product availability, and product performance. We compete with a number of different types of mattress alternatives, including standard innerspring mattresses, viscoelastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These alternative products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, internet, telemarketing programs, television infomercials, television advertising and catalogs.

Our North America segment competes in various mattress categories, and contributed 81.8% of our net sales for the year ended December 31, 2015. These mattress categories are highly competitive, with many competitor products supported by aggressive marketing campaigns and promotions. The international market for mattresses and pillows is generally served by a large number

28


of manufacturers, primarily operating on a regional and local basis. These manufacturers offer a broad range of mattress and pillow products. As a result of this or increased competition, our results could be negatively impacted.

Gross Margins

Our gross margin is primarily impacted by the relative amount of net sales contributed by our Tempur and Sealy products. Our Sealy products have a significantly lower gross margin than our Tempur products. Our Sealy mattress products range from value to premium priced offerings, and gross margins are typically higher on premium products compared to value priced offerings. Our Tempur products are exclusively premium priced products. As sales of our Sealy products increase relative to sales of our Tempur products, our gross margins will be negatively impacted in both our North America and International segments. Due to the anticipated growth of Sealy products sold through our International segment, this change in product mix has unfavorably impacted our gross margin in 2015 as compared to prior years. Additionally, sales of our Tempur products in our International segment have historically had higher gross margins than the Tempur products sold in our North America segment.

Our gross margin is also impacted by fixed cost leverage; the cost of raw materials; operational efficiencies due to the utilization in our manufacturing facilities; product, channel and geographic 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 Retail channel as sales in our Retail channel are at wholesale prices whereas sales in our Direct channel are at retail prices.
    
In 2016, we expect gross margin to benefit from improvement in our North America segment gross margin, primarily driven by sourcing improvements, operational efficiencies and pricing actions. We expect this improvement to be partially offset by a decrease in the gross margin in our International segment, which we expect will decrease as a result of increased sales of Sealy products and unfavorable foreign exchange rate. In addition, our ability to increase the profitability of our Sealy operations will depend on our ability to improve the efficiency of our manufacturing of Sealy products and improve the overall gross margins for these products. If we are unable to improve these gross margins this may have a material adverse impact on our overall profitability.

New Product Development and Introduction

Each year we invest significant time and resources in research and development to improve our product offerings. There are a number of risks inherent in our new product line introductions, including that the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, product introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, which could impact profitability. In 2016, we expect to incur significant costs associated with new product introductions.
    
Financial Leverage and Liquidity

As of December 31, 2015, we had $1,479.6 million of debt outstanding, and our adjusted EBITDA, which is a non-GAAP financial measure, was $455.8 million. Higher financial leverage makes us more vulnerable to general adverse competitive, economic and industry conditions. There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowing will be available. As of December 31, 2015, our ratio of funded debt less qualified cash to EBITDA in accordance with our 2012 Credit Agreement was 3.21 times, within the covenant in our debt agreements which limits this ratio to 4.50 times for the year ended December 31, 2015. For more information on this non-GAAP measure and compliance with our 2012 Credit Agreement, please refer to the section set forth below “Non-GAAP Financial Measures”. The Company expects that it will seek to refinance its senior credit facility in the first half of 2016 to take advantage of the favorable interest rate environment and to obtain some favorable adjustments to certain of the restrictions currently contained in the 2012 Credit Agreement.  

Danish Tax Proceeding
As described in Note 14 of the Notes to Consolidated Financial Statements included in Part II, ITEM 8 of this Report, the Company is the subject of significant outstanding tax assessments asserted by SKAT. Any decision by the Company to achieve a negotiated settlement of this matter, or if the Company does not enter into a negotiated settlement of this matter, a negative outcome in the related legal proceedings, could require the Company to make significant payments, which could have a material adverse effect on the Company’s results of operations and liquidity. In addition, if the Company is required to further increase its uncertain tax liability for this matter, based on a changes in facts and circumstances, this could have a material impact on the Company's reported earnings.

29



Integration

The operational integration of the legacy Tempur and Sealy businesses is substantially complete in our North America and International segments. In 2015, we continued to focus on consolidating our distribution network, transforming our Sealy domestic manufacturing facilities and introducing Sealy products in Europe and Japan. We currently expect integration activities to continue through the first half of 2016, and we expect the level of integration expense to significantly decrease over this period as compared to prior years.

Results of Operations
 
A summary of our results for the year ended December 31, 2015 include:

Total net sales increased 5.4% to $3,151.2 million from $2,989.8 million in 2014. On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 9.4%, with growth in both the North America and International business segments.

Gross margin was 39.6% as compared to 38.5% in 2014. Adjusted gross margin, which is a non-GAAP financial measure, was 40.1% as compared to 38.9% in 2014.

Earnings before interest, taxes, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, increased 9.4% to $388.9 million as compared to $355.4 million in 2014. Adjusted EBITDA, which is a non-GAAP financial measure, increased 12.7% to $455.8 million as compared to $404.6 million in 2014.

Operating income was $309.1 million as compared to $276.3 million in 2014. Adjusted operating income, which is a non-GAAP financial measure, was $373.8 million, or 11.9% of net sales, as compared to $320.1 million, or 10.7% of net sales in 2014.

Net income was $73.5 million as compared to net income of $108.9 million in 2014. During the fourth quarter of 2015, the Company reevaluated its uncertain tax position regarding the previously disclosed Danish tax matter. As a result of the re-evaluation, including consideration of certain events that occurred during the fourth quarter of 2015, the Company recorded a change in estimate of its uncertain tax positions related to this matter of approximately $60.7 million. Adjusted net income, which is a non-GAAP financial measure, increased 21.4% to $199.9 million as compared to $164.6 million in 2014.

EPS was $1.17 as compared to $1.75 in 2014. Adjusted EPS, which is a non-GAAP financial measure, increased 20.4% to $3.19 as compared to adjusted EPS of $2.65 in 2014. On a constant currency basis, adjusted EPS increased 31.7%.

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 year 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 U.S. GAAP, and it is not intended as an alternative to U.S. GAAP measures. Refer to Part II, ITEM 7A of this Report.

For additional information regarding adjusted gross margin, EBITDA, adjusted EBITDA, adjusted operating income, adjusted net income and adjusted EPS, all of which are non-GAAP financial measures, please refer to the Non-GAAP Financial Information section below.




30


The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales:
(in millions, except percentages and
Year Ended December 31,
per common share amounts)
2015
 
2014
 
2013
Net sales
$
3,151.2

 
100.0
 %
 
$
2,989.8

 
100.0
 %
 
$
2,464.3

 
100.0
 %
Cost of sales
1,902.3

 
60.4

 
1,839.4

 
61.5

 
1,449.4

 
58.8

Gross profit
1,248.9

 
39.6

 
1,150.4

 
38.5

 
1,014.9

 
41.2

Selling and marketing expenses
648.0

 
20.6

 
619.9

 
20.7

 
522.9

 
21.2

General, administrative and other
322.0

 
10.2

 
280.6

 
9.4

 
266.3

 
10.8

Equity income in earnings of unconsolidated affiliates
(11.9
)
 
(0.4
)
 
(8.3
)
 
(0.3
)
 
(4.4
)
 
(0.2
)
Royalty income, net of royalty expense
(18.3
)
 
(0.6
)
 
(18.1
)
 
(0.6
)
 
(13.7
)
 
(0.6
)
Operating income
309.1

 
9.8

 
276.3

 
9.3

 
243.8

 
10.0

 
 
 
 
 
 
 
 
 
 
 
 
Other expense, net:
 
 
 
 
 
 
 
 
 
 
 
Interest expense, net
96.1

 
3.0

 
91.9

 
3.1

 
110.8

 
4.5

Loss on disposal, net

 

 
23.2

 
0.8

 

 

Other expense (income), net
12.9

 
0.5

 
(13.7
)
 
(0.4
)
 
5.0

 
0.2

Total other expense
109.0

 
3.5

 
101.4

 
3.5

 
115.8

 
4.7

 
 
 
 
 
 
 
 
 
 
 
 
Income before income taxes
200.1

 
6.3

 
174.9

 
5.8

 
128.0

 
5.3

Income tax provision
(125.4
)
 
(4.0
)
 
(64.9
)
 
(2.2
)
 
(49.1
)
 
(2.0
)
Net income before non-controlling interest
74.7

 
2.3

 
110.0

 
3.6

 
78.9

 
3.3

Less: Net income attributable to non-controlling interest
1.2

 

 
1.1

 

 
0.3

 

Net income attributable to Tempur Sealy International, Inc.
$
73.5

 
2.3
 %
 
$
108.9

 
3.6
 %
 
$
78.6

 
3.3
 %
 
 
 
 
 
 
 
 
 
 
 
 
Earnings per common share:
 
 
 
 
 
 
 
 
 
 
 
Diluted
$
1.17

 
 
 
$
1.75

 
 
 
$
1.28

 
 
Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
Diluted
62.6

 
 
 
62.1

 
 
 
61.6

 
 


31


CONSOLIDATED SUMMARY

Net sales and gross profit
(in millions, except percentages)
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Net sales
 
$
3,151.2

 
$
2,989.8

 
$
2,464.3

 
5.4
 %
 
21.3
 %
 
 
 
 
 
 
 
 
 
 
 
Net sales by segment:
 
 
 
 
 
 
 
 
 
 
North America
 
2,577.2

 
2,404.9

 
1,927.0

 
7.2
 %
 
24.8
 %
International
 
574.0

 
584.9

 
537.3

 
(1.9
)%
 
8.9
 %
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
1,248.9

 
1,150.4

 
1,014.9

 
8.6
 %
 
13.4
 %
Gross margin
 
39.6
%
 
38.5
%
 
41.2
%
 
1.1
 %
 
(2.7
)%

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. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.

Year ended December 31, 2015 compared to year ended December 31, 2014

Net sales increased $161.4 million, or 5.4%. On a constant currency basis, net sales increased approximately 9.4%, primarily due to growth in our North America segment. North America segment net sales grew at 7.2%, driven primarily by U.S. net sales growth across both the Tempur and Sealy brands. International net sales decreased by 1.9%, driven primarily by unfavorable foreign exchange rates. On a constant currency basis, International net sales increased approximately13.2%, due to continued growth in Asia-Pacific and Latin America. Additionally, net sales in our Other distribution channels increased double digits in each of our North America and International segments, primarily driven by our direct business.

Gross profit increased $98.5 million, and gross margin increased 110 basis points. The increase in gross margin was primarily due to supply chain and sourcing improvements of 170 basis points, a favorable decrease in discounts of 50 basis points and 2015 pricing actions which increased gross margin 40 basis points in 2015 as compared to 2014. These factors were primarily offset by unfavorable product mix of 130 basis points. The principal factors that impacted gross margin by segment are discussed below in their respective segment discussions.

Year ended December 31, 2014 compared to year ended December 31, 2013

Net sales increased $525.5 million, or 21.3%. The increase was primarily due to the results of our Sealy business being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013, as well as increased net sales of our Tempur products in both the North America and International segments.

Gross profit increased $135.5 million, or 13.4%. Gross margin declined 270 basis points. The gross margin decrease was primarily due to Sealy's results being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013. As sales of our Sealy products increased relative to sales of our Tempur products, our gross margins were negatively impacted.


32


OPERATING EXPENSES

Selling and Marketing Expenses
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Total selling and marketing
 
$
648.0

 
$
619.9

 
$
522.9

 
4.5
 %
 
18.6
 %
As a percent of net sales
 
20.6
%
 
20.7
%
 
21.2
%
 
(0.1
)%
 
(0.5
)%
Advertising expenses
 
360.5

 
326.7

 
274.2

 
10.3
 %
 
19.1
 %
As a percent of net sales
 
11.4
%
 
10.9
%
 
11.1
%
 
0.5
 %
 
(0.2
)%
Selling and marketing other
 
287.5

 
293.2

 
248.7

 
(1.9
)%
 
17.9
 %
As a percent of net sales
 
9.2
%
 
9.8
%
 
10.1
%
 
(0.6
)%
 
(0.3
)%

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.

Year ended December 31, 2015 compared to year ended December 31, 2014
    
Selling and marketing expenses increased $28.1 million, or 4.5%, and decreased slightly as a percentage of net sales.

Our advertising expenses increased $33.8 million, or 10.3%, and increased slightly as a percentage of net sales. The increase in advertising expenses was primarily due to a $40.7 million increase in our North America segment, which was primarily driven by improved participation in our retail cooperative advertising programs. This increase was offset by a $6.9 million decrease in our International segment.

All other selling and marketing expenses decreased $5.7 million, or 1.9%, and decreased slightly as a percentage of net sales. The decrease to other selling and marketing expenses is primarily due to an $11.4 million decrease in the North America segment driven by fewer in-store marketing investments in 2015 as compared to 2014. This was partially offset by a $4.5 million increase in our International segment, driven primarily by additional company-owned stores and costs associated with marketing and distributing Sealy products in Europe and Japan in 2015 as compared to 2014. In 2015, we took actions to begin reducing our overhead expenses. In the second half of 2015, we incurred $5.1 million related to this restructuring in other selling and marketing expenses, which included headcount reductions and international store closures.

Year ended December 31, 2014 compared to year ended December 31, 2013

Selling and marketing expenses increased $97.0 million, or 18.6%, and decreased 0.5% as a percentage of net sales.

Our advertising expenses increased $52.5 million, or 19.1%, and remained relatively flat as a percentage of net sales. The increase in advertising expenses was primarily driven by the Sealy results being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013.

All other selling and marketing expenses increased $44.5 million, or 17.9%, and decreased slightly as a percentage of net sales. The increase to other selling and marketing expenses was primarily due to the $24.7 million increase in the International segment, driven primarily by additional openings of company-owned stores and integration costs associated with marketing and distributing Sealy products in certain international markets. Additionally, the North America segment other selling and marketing expenses increased $19.2 million, primarily driven by the Sealy results being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013.



33


General, Administrative and Other Expenses
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
General, administrative and other expenses
 
$
322.0

 
$
280.6

 
$
266.3

 
14.8
%
 
5.4
 %
As a percent of net sales
 
10.2
%
 
9.4
%
 
10.8
%
 
0.8
%
 
(1.4
)%
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.
Year ended December 31, 2015 compared to year ended December 31, 2014

General, administrative and other expenses increased $41.4 million, or 14.8%. The increase in general, administrative and other expenses is due to a $26.7 million increase in Corporate expenses, as discussed below, and a $12.6 million increase in North America segment expenses. The increase in our North America segment's general, administrative and other expenses was primarily driven by a $6.8 million increase in research and development expenses. Additionally, in 2015, we took actions to begin reducing our overhead expenses. In the second half of 2015, we incurred $6.3 million related to this restructuring in general, administrative and other expenses, primarily related to headcount reductions and international store closures.

Corporate general, administrative and other expenses were $121.4 million in 2015 as compared to $94.7 million in 2014, an increase of $26.7 million or 28.2%. This increase was driven primarily by $14.5 million of executive transition and related retention expenses and $3.2 million of restructuring costs related to headcount reductions. We also incurred $6.3 million of additional costs related to our 2015 Annual Meeting and related issues.

Research and development expenses for 2015 were $28.7 million compared to $21.6 million for 2014, an increase of $7.1 million, or 32.9%, as a result of continued new product investment. We plan to continue to invest in research and development to leverage the combined technologies of our portfolio to deliver innovative products.

Year ended December 31, 2014 compared to year ended December 31, 2013

General, administrative and other expenses increased $14.3 million, or 5.4%. The increase was primarily due to a $27.8 million increase in our North America segment, which was driven by the Sealy results being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013. This increase was offset by a $12.9 million decrease in Corporate expenses, driven by a decrease in transaction expenses associated with the Sealy Acquisition which were not incurred in 2014.

Research and development expenses for 2014 were $21.6 million compared to $21.0 million for 2013, an increase of $0.6 million, or 2.9%.
 
OPERATING INCOME
(in millions, except percentages)
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Operating income
 
$
309.1

 
$
276.3

 
$
243.8

 
11.9
%
 
13.3
 %
Operating margin
 
9.8
%
 
9.2
%
 
9.9
%
 
0.6
%
 
(0.7
)%

Year ended December 31, 2015 compared to year ended December 31, 2014

Operating income increased $32.8 million, or 11.9%, and was primarily impacted by the factors discussed above. During 2015, equity income in earnings of unconsolidated affiliates and royalty income, net of royalty expense increased $3.6 million and $0.2 million, respectively. Our royalty income is based on sales of Sealy® and Stearns & Foster® branded products by various licensees and is offset by royalty expenses we pay to other entities for the use of their names on our Sealy branded products. Our equity income in earnings of unconsolidated affiliates represents our 50.0% interest in the earnings of our Asia-Pacific joint ventures whose purpose is to develop markets for Sealy branded products.
 

34


During 2015 and 2014, we incurred $27.9 million and $42.5 million of integration costs, respectively, related to the continued alignment of our business in connection with the Sealy Acquisition, as well as costs related to introducing Sealy products in our International segment. In addition, 2015 operating income included $16.2 million of executive transition and related retention expense and $13.0 million of restructuring costs. We also incurred $6.3 million of additional costs related to our 2015 Annual Meeting and related issues in the first half of 2015. We currently expect to incur approximately $3.0 million of integration expenses in 2016. The principal factors that impacted integration costs by segment are discussed below in their respective segment discussions.

Year ended December 31, 2014 compared to year ended December 31, 2013

Operating income increased $32.5 million, or 13.3%, and was primarily impacted by the factors discussed above. During the full year 2014, equity income in earnings of unconsolidated affiliates and royalty income, net of royalty expense increased $3.9 million and $4.4 million, respectively as a result of the 2013 results only including the post-acquisition period of March 13, 2013 through December 31, 2013.

               During the full year 2014, we incurred $43.8 million of integration and financing costs in connection with the Sealy Acquisition. During the full year 2013, we incurred $18.7 million of transaction expenses and $25.9 million of integration expenses in connection with the Sealy Acquisition.

INTEREST EXPENSE, NET
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Interest expense, net
 
$
96.1

 
$
91.9

 
$
110.8

 
4.6
%
 
(17.1
)%

Year ended December 31, 2015 compared to the year ended December 31, 2014

Interest expense, net, increased $4.2 million, or 4.6%. During 2015, we recorded $12.0 million of accelerated amortization of deferred financing costs associated with the $493.8 million voluntary prepayments on our Term A Facility and Term B Facility, subsequent to the issuance of our $450 million aggregate principal amount of 5.625% senior notes due 2023 ("2023 Senior Notes"). Excluding this accelerated amortization, interest expense decreased due to lower average debt levels throughout 2015 as compared to 2014. Refer to Note 6, "Debt", in our Consolidated Financial Statements included in Part II, ITEM 8 for additional information.

Year ended December 31, 2014 compared to the year ended December 31, 2013

Interest expense, net, decreased $18.9 million, due to lower average debt levels and interest rates in effect during 2014 as compared to 2013. This was offset by $3.3 million in accelerated amortization of deferred financing costs after a voluntary prepayment of the Term A and Term B loans under our 2012 Credit Agreement.

LOSS ON DISPOSAL OF BUSINESS

Year ended December 31, 2015 compared to year ended December 31, 2014

Effective June 30, 2014, we completed the sale of our three U.S. innerspring component production facilities and equipment, along with associated working capital, to Leggett and Platt ("L&P") for total consideration of approximately $47.8 million.  The working capital adjustment period ended in the quarter ended September 30, 2014, which resulted in a cash payment to L&P of $2.8 million, reduced the total consideration received to $45.0 million. The carrying amount of the net assets sold in this transaction, including an allocation of reporting unit goodwill determined using the relative fair value method, was approximately $66.8 million.  As a result, a loss on disposal of business was recorded for $23.2 million for the year ended December 31, 2014, which included $1.4 million of transaction costs and the $2.8 million working capital adjustment.

OTHER EXPENSE (INCOME), NET
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Other expense (income), net
 
$
12.9

 
$
(13.7
)
 
$
5.0

 
(194.2
)%
 
(374.0
)%


35


Year ended December 31, 2015 compared to year ended December 31, 2014

Other expense, net was $12.9 million in 2015 as compared to other income, net of $(13.7) million in 2014. During 2015, we reached a settlement of the previously disclosed antitrust investigation by the German Federal Cartel Office ("FCO") regarding alleged vertical price fixing. Our German subsidiary was one of several mattress wholesaler/manufacturers that have reached a settlement with the FCO. Under the terms of the settlement, we paid approximately €15.5 million (approximately $17.4 million) to fully resolve this matter. The payment is not tax deductible. Refer to Note 13, "Commitments and Contingencies," in our Consolidated Financial Statements included in Part II, ITEM 8 for additional information. In addition, we recorded $9.5 million and $15.6 million of other income from a partial settlement of a legal dispute in 2015 and 2014, respectively.

Year ended December 31, 2014 compared to year ended December 31, 2013

Other expense, net decreased $14.4 million, or 12.4%. In 2014, we recorded $15.6 million of other income from a partial settlement of a legal dispute.

INCOME BEFORE INCOME TAXES
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Income before income taxes
 
$
200.1

 
$
174.9

 
$
128.0

 
14.4
%
 
36.6
%

Year ended December 31, 2015 compared to year ended December 31, 2014

Income before income taxes increased $25.2 million, or 14.4%. This increase was a result of the factors discussed above.

Year ended December 31, 2014 compared to year ended December 31, 2013

Income before income taxes increased $46.9 million, or 36.6%. This increase was a result of the factors discussed above.

INCOME TAXES
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Income tax
 
$
125.4

 
$
64.9

 
$
49.1

 
93.2
%
 
32.2
 %
Effective tax rate
 
62.7
%
 
37.1
%
 
38.4
%
 
25.6
%
 
(1.3
)%

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.

Year ended December 31, 2015 compared to year ended December 31, 2014

Our income tax provision increased $60.5 million and our effective tax rate increased 25.6 percentage points. In 2014, upon the filing of our various 2013 U.S. federal and state income tax returns, we finalized the calculation of the tax on the repatriation of earnings described in Note 14, "Income Taxes" and we recognized an incremental $12.2 million current income tax expense for the repatriation so described to reflect tax positions taken on the various income tax returns when filed. During 2015 the Company increased its uncertain tax liability associated with the Danish tax matter via a charge to income tax expense by $60.7 million. Refer to Note 14, “Income Taxes”, in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information associated with this tax assessment.

Year ended December 31, 2014 compared to year ended December 31, 2013

Our income tax provision increased $15.8 million and our effective tax rate decreased 1.3 percentage points. During 2013, we undertook a taxable transaction as part of the Sealy Acquisition in which we recognized current taxable income based on the earnings of certain of our foreign subsidiaries and increased the tax previously accrued associated with this transaction. In 2014, upon the filing of our various 2013 U.S. federal and state income tax returns, we finalized the calculation of the tax on this transaction

36


and we recognized an incremental $12.2 million current income tax expense for this transaction to reflect tax positions taken on the various income tax returns when filed.

NORTH AMERICA SEGMENT SUMMARY
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Net sales
 
$
2,577.2

 
$
2,404.9

 
$
1,927.0

 
7.2
%
 
24.8
 %
 
 
 
 
 
 
 
 
 
 
 
Net sales by channel:
 
 
 
 
 
 
 
 
 
 
Retail
 
2,461.5

 
2,308.6

 
1,819.2

 
6.6
%
 
26.9
 %
Other
 
115.7

 
96.3

 
107.8

 
20.1
%
 
(10.7
)%
 
 
 
 
 
 
 
 
 
 
 
Net sales by product:
 
 
 
 
 
 
 
 
 
 
Bedding
 
2,428.9

 
2,261.9

 
1,779.3

 
7.4
%
 
27.1
 %
Other products
 
148.3

 
143.0

 
147.7

 
3.7
%
 
(3.2
)%
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
954.6

 
834.8

 
710.2

 
14.4
%
 
17.5
 %
Gross margin
 
37.0
%
 
34.7
%
 
36.9
%
 
2.3
%
 
(2.2
)%
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
335.6

 
255.0

 
229.0

 
31.6
%
 
11.4
 %
Operating margin
 
13.0
%
 
10.6
%
 
11.9
%
 
2.4
%
 
(1.3
)%

Year ended December 31, 2015 compared to year ended December 31, 2014
     
North America net sales increased $172.3 million, or 7.2%. On a constant currency basis, our North America net sales increased approximately 8.5%. The increase was primarily due to a $167.0 million increase in net sales of Bedding products, driven primarily by strong U.S. net sales growth across both the Tempur and Sealy brands, which benefited from new product introductions and 2015 pricing actions. This increase was offset by a 6.3% decrease in Canada net sales due to unfavorable foreign exchange rates. On a constant currency basis, Canada net sales grew 8.6%.

Operating income increased $80.6 million, or 31.6%, and was primarily impacted by the following factors:

Gross profit increased $119.8 million, or 14.4%. Gross margin increased 230 basis points. The increase in gross margin was primarily due to supply chain and sourcing improvements of 210 basis points, a favorable decrease in discounts of 70 basis points driven by fewer floor model discounts and improved participation in our retail cooperative advertising programs and favorable 2015 pricing actions of 50 basis points in 2015 as compared to 2014. These factors were partially offset by unfavorable product mix of 140 basis points, primarily due to the introduction of new products.

Operating expenses increased $41.9 million to $627.7 million as compared to $585.8 million in 2014. This increase was primarily due to a $40.7 million increase in advertising expense, driven primarily by improved participation in our retail cooperative advertising programs. General, administrative and other expenses increased $12.6 million primarily as a result of a $6.8 million increase in research and development expenses, as well as $1.5 million in restructuring costs associated with headcount reductions. The increase in operating expense was partially offset by an $11.4 million decrease in other selling and marketing expenses, driven by fewer in-store marketing investments in 2015 as compared to 2014.

During 2015 and 2014, the North America segment incurred $19.4 million and $30.0 million, respectively, of integration costs. In addition, the North America segment also incurred $3.6 million of restructuring costs related to headcount reduction, $1.2 million of retention expense for certain members of senior management related to the executive transitions and $1.3 million of pension expense recorded in conjunction with a settlement offered to terminated, vested participants in a defined benefit pension plan. The integration costs incurred in 2015 were primarily related to the restructuring of Sealy domestic manufacturing facilities and consolidation of our distribution network. The integration costs incurred in 2014 were primarily related to severance, retention, relocation and professional fees related to the restructuring of Sealy domestic manufacturing facilities.


37


Year ended December 31, 2014 compared to year ended December 31, 2013
     
North America net sales increased $477.9 million, or 24.8%. The increase was primarily due to the results from our Sealy business being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013, as well as new product introductions and increased sales of our adjustable base products.

Operating income increased $26.0 million, or 11.4%, and was primarily impacted by the following factors:

Gross profit increased $124.6 million, or 17.5%, and gross margin declined 220 basis points. The decrease in gross margin was primarily related to an increase in sales of our adjustable base products and unfavorable channel mix, driven by the impact of higher floor model discounts and rebates.

Operating expenses were $585.8 million for the full year 2014, as compared to $486.8 million for the full year 2013, an increase of $99.0 million or 20.3%. The increase was primarily due to the results from our Sealy business being reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013, as well as increases in salaries and benefits to support the expanded business.

INTERNATIONAL SEGMENT SUMMARY
(in millions, except percentages)
 
2015
 
2014
 
2013
 
Percentage change 2015 vs. 2014
 
Percentage change 2014 vs. 2013
Net sales
 
$
574.0

 
$
584.9

 
$
537.3

 
(1.9
)%
 
8.9
 %
 
 
 
 
 
 
 
 
 
 
 
Net sales by channel:
 
 
 
 
 
 
 
 
 
 
Retail
 
413.0

 
441.6

 
406.4

 
(6.5
)%
 
8.7
 %
Other
 
161.0

 
143.3

 
130.9

 
12.4
 %
 
9.5
 %
 
 
 
 
 
 
 
 
 
 
 
Net sales by product:
 
 
 
 
 
 
 
 
 
 
Bedding
 
458.3

 
464.6

 
419.1

 
(1.4
)%
 
10.9
 %
Other products
 
115.7

 
120.3

 
118.2

 
(3.8
)%
 
1.8
 %
 
 
 
 
 
 
 
 
 
 
 
Gross profit
 
294.3

 
315.6

 
304.7

 
(6.7
)%
 
3.6
 %
Gross margin
 
51.3
%
 
54.0
%
 
56.7
%
 
(2.7
)%
 
(2.7
)%
 
 
 
 
 
 
 
 
 
 
 
Operating income
 
98.9

 
118.8

 
124.7

 
(16.8
)%
 
(4.7
)%
Operating margin
 
17.2
%
 
20.3
%
 
23.2
%
 
(3.1
)%
 
(2.9
)%

Year ended December 31, 2015 compared to year ended December 31, 2014
     
International net sales decreased $10.9 million, or 1.9%. On a constant currency basis, our International net sales increased approximately 13.2%, primarily due to strong sales growth of our Sealy products in Asia-Pacific and Latin America. Net sales growth was also driven by an increase in sales of Tempur products through Company-owned stores.

Operating income decreased $19.9 million, or 16.8%, and was primarily impacted by the following factors:

Gross profit decreased $21.3 million and gross margin declined 270 basis points. The decline in gross margin was driven by unfavorable product mix and manufacturing costs of 160 basis points due to the increase in sales of our Sealy products relative to sales of our Tempur products. The decrease in gross margin was also due to unfavorable channel mix of 110 basis points.

Operating expenses decreased $0.3 million to $216.8 million in 2015 as compared to $217.1 million in 2014.


38


During 2015 and 2014, the International segment incurred $2.3 million and $5.2 million, respectively, of integration costs in connection with the introduction of Sealy products in Europe and Japan, which include startup costs related to manufacturing, distribution and marketing of Sealy products. In addition, the International segment incurred $5.8 million of restructuring costs related to headcount reduction and store closures in 2015.

Year ended December 31, 2014 compared to year ended December 31, 2013
     
International net sales increased $47.6 million, or 8.9%. On a constant currency basis, our International net sales increased approximately 13.5%. Retail channel net sales increased $35.2 million, or 8.7%, primarily due to solid performance in Asia and Latin America. In addition, the results from our Sealy business are reflected for the full year ended December 31, 2014 as compared to the post-acquisition period March 18, 2013 through December 31, 2013.

Operating income decreased $5.9 million, or 4.7%, and was primarily impacted by the following factors:

Gross profit increased $10.9 million, or 3.6%, and gross margin declined 270 basis points. The decline in gross margin was primarily related to unfavorable product and geographic mix, driven by the introduction of Sealy products in certain international markets, as well as unfavorable foreign exchange rates.

Operating expenses were $217.1 million for the full year 2014 as compared to $192.5 million for the full year 2013. The increase in operating expenses was driven by a $24.7 million increase in other selling and marketing expenses driven primarily by additional openings of company-owned stores and integration costs associated with marketing and distributing Sealy products in certain international markets.

Liquidity and Capital Resources
 
Liquidity

Our principal sources of funds are cash flows from operations, borrowings 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, business combinations, capital expenditures and working capital needs. At December 31, 2015, we had working capital of $96.1 million, including cash and cash equivalents of $153.9 million as compared to working capital of $183.9 million including $62.5 million in cash and cash equivalents as of December 31, 2014.

The decrease in working capital was primarily driven by Sealy's 8.0% Senior Secured Third Lien Convertible Notes due 2016 ("8.0% Sealy Notes"), which mature on July 15, 2016, and are now classified as current liabilities. Additionally, the decrease is driven by increases in accounts payable and accrued expenses and other current liabilities. These factors were partially offset by increases in cash and prepaid expenses and other current assets. Accounts payable increases are driven primarily by increased costs to support the increased net sales, in addition to the timing of payments to vendors. Accrued expenses and other current liabilities increases are primarily driven by increases in our brand advertising activities, including improved participation in our retail cooperative advertising programs, increased professional fees, as well as interest accrued on our 2023 Senior Notes. Prepaid and other current asset increases are driven primarily by increases in our retail customer incentive programs and foreign exchange forward contract receivables.

The table below presents net cash provided by (used in) operating, investing and financing activities for the years ended December 31, 2015, 2014 and 2013.

(in millions)
 
2015
 
2014
 
2013
Net cash provided by (used in):
 
 
 
 
 
 
Operating activities
 
$
234.2

 
$
225.2

 
$
98.5

Investing activities
 
(59.7
)
 
(10.4
)
 
(1,213.0
)
Financing activities
 
(90.7
)
 
(238.1
)
 
1,013.4

 
Cash provided by operating activities increased $9.0 million in 2015 as compared to 2014. The increase in cash provided by operating activities was primarily driven by the $41.6 million increase in cash provided by operating assets and liabilities, as explained above, which was primarily offset by the $35.3 million decrease in net income before non-controlling interest.


39


Cash used in investing activities increased $49.3 million in 2015 as compared to 2014. In 2014, we received cash consideration of $43.5 million from L&P in connection with the sale of our three U.S. innerspring component production facilities and equipment, along with associated working capital. The increase in cash used in investing activities in 2015 as compared to 2014 is also due to an increase in capital expenditures, which was driven by planned investments in our domestic manufacturing facilities and information technology.

Cash used in financing activities decreased $147.4 million in 2015 as compared to 2014. This decrease is primarily due to the $450.0 million issuance of our 2023 Senior Notes in the third quarter of 2015. Refer to Note 6, "Debt," in our Condensed Consolidated Financial Statements included in Part II, ITEM 8 for additional information.

Capital Expenditures

Capital expenditures totaled $65.9 million for the year ended December 31, 2015 and $47.5 million for the year ended December 31, 2014. The increase was driven by investments in our domestic manufacturing facilities and information technology.
We currently expect our 2016 capital expenditures to be approximately $75.0 million, which relates primarily to our continued focus on productivity initiatives.

Debt Service
    
Our debt decreased to $1,479.6 million as of December 31, 2015 from $1,602.3 million as of December 31, 2014. As of December 31, 2015, we had no balance under our revolving credit facility, and total availability under the revolver was $330.2 million after giving effect to letters of credit outstanding of $19.8 million. The 8.0% Sealy Notes mature on July 15, 2016, at which time we will be required to pay approximately $115.2 million. Refer to Note 6, “Debt”, in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.

In the third quarter of 2015, we completed the offering of our 2023 Senior Notes, and used the $450.0 million proceeds to reduce term loan debt outstanding under our 2012 Credit Agreement. In addition, we made a $50.0 million voluntary prepayment on the Term Loan A under our 2012 Credit Agreement. These actions shifted a portion of our debt outstanding to fixed rate debt.
    
As of December 31, 2015, we were in compliance with all of the financial covenants in our debt agreements. In the first quarter of 2015, we were required to make prepayments of up to $19.5 million on our Term A Facility and Term B Facility, collectively, as a result of the excess cash flow covenant in the 2012 Credit Agreement. Our lenders have the option to decline their respective portions of the prepayment, thereby reducing the amount required per the excess cash flow covenant. In the first quarter of 2015, certain lenders elected to decline their portion of the prepayment. Accordingly, the final prepayment was $17.6 million.

As of December 31, 2015, our ratio of consolidated funded debt less qualified cash to EBITDA in accordance with the Company's 2012 Credit Agreement was 3.21 times, which is within the terms of the financial covenants by quarter for the maximum consolidated total net leverage ratio as set forth in the 2012 Credit Agreement, which limited this ratio to 4.50 times as of December 31, 2015.

The Company expects that it will seek to refinance its senior credit facility in the first half of 2016 to take advantage of the favorable interest rate environment and to obtain some favorable adjustments to certain of the restrictions currently contained in the 2012 Credit Agreement.  

The maximum consolidated total net leverage ratio under our 2012 Credit Agreement is summarized in the following table:
Fiscal Quarter
 
Maximum Consolidated Total Net Leverage Ratio
December 31, 2015 through September 30, 2016
 
4.50:1.00
October 1, 2016 through December 31, 2017
 
4.25:1.00
January 1, 2018 and thereafter
 
4.00:1.00

For additional information refer to "Non-GAAP Financial Information" below for the calculation of the ratio of consolidated funded debt less qualified cash to EBITDA in accordance with the Company's 2012 Credit Agreement. Both consolidated funded debt and EBITDA in accordance with the Company's 2012 Credit Agreement are terms that are not recognized under U.S. GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt.

40



Non-GAAP Financial Information

We provide information regarding adjusted net income, adjusted EPS, adjusted gross profit, adjusted gross margin, adjusted operating income (expense), adjusted operating margin, EBITDA, EBITDA in accordance with the Company's 2012 Credit Agreement, adjusted EBITDA, consolidated funded debt and consolidated funded debt less qualified cash, which are not recognized terms under U.S. GAAP and do not purport to be alternatives to net income and earnings per share as a measure of operating performance or total debt. Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies. For more information about these non-GAAP measures and reconciliation to the nearest GAAP measure, please refer to the reconciliations on the following pages.

Key Highlights
 
Year Ended December 31,
(in millions, except percentages and per common share amounts)
2015
 
2014
 
% Change
 
% Change Constant Currency(1) 
Net sales
$
3,151.2

 
$
2,989.8

 
5.4
%
 
9.4
%
Adjusted operating income(1)
373.8

 
320.1

 
16.8
%
 
23.8
%
Adjusted EBITDA(1)
455.8

 
404.6

 
12.7
%
 
19.8
%
Adjusted net income(1)
199.9

 
164.6

 
21.4
%
 
32.9
%
Adjusted EPS(1)
$
3.19

 
$
2.65

 
20.4
%
 
31.7
%
(1)
 
Non-GAAP financial measure. Please refer to the reconciliations on the following pages.




41


Adjusted Net Income and Adjusted EPS

A reconciliation of net income to adjusted net income and EPS to adjusted EPS is provided below. We believe that the use of these non-GAAP financial measures provides investors with additional useful information with respect to the impact of various adjustments as described in the footnotes below. The following table sets forth the reconciliation of our reported net income to the calculation of adjusted net income for the year ended December 31, 2015 and 2014, respectively:
(in millions, except per share amounts)
2015
 
2014
GAAP net income:
$
73.5

 
$
108.9

Integration costs, net of tax (1)
20.2

 
30.6

German legal settlement (2)
17.6

 

Executive management transition, and retention compensation, net of tax (3)
11.5

 

Restructuring costs, net of tax (4)
9.4

 

Interest expense and financing costs, net of tax (5)
8.3

 
3.4

Other income, net of tax (6)
(6.6
)
 
(11.3
)
2015 Annual Meeting Costs, net of tax (7)
4.4

 

Pension settlement, net of tax (8)
0.9

 

Loss on disposal of business, net of tax (9)

 
16.7

Tax adjustment (10)
60.7

 
16.3

Adjusted net income
$
199.9

 
$
164.6

 
 
 
 
GAAP earnings per share, diluted
$
1.17

 
$
1.75

Integration costs, net of tax (1)
0.33

 
0.49

German legal settlement (2)
0.28

 

Executive management transition, and retention compensation, net of tax (3)
0.18