Somnigroup International Inc.: Form 10-Q for the period ended Jun 30, 2024

The following discussion and analysis should be read in conjunction with the 2023 Annual Report, including "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in ITEM 7 of Part II of the 2023 Annual Report, and the accompanying Condensed Consolidated Financial Statements and notes thereto included in this Report. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are subject to numerous risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" elsewhere in this Report and in the 2023 Annual Report, the section titled "Risk Factors" contained in ITEM 1A of Part I of the 2023 Annual Report and in ITEM 1A of Part II 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 three and six months ended June 30, 2024, including the following topics:

• an overview of our business and strategy;
• 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 committed to improving the sleep of more people, every night, all around the world. As a leading designer, manufacturer, distributor and retailer of bedding products, we know how crucial a good night of sleep is to overall health and wellness. Utilizing over a century of knowledge and industry-leading innovation, we deliver award-winning products that provide breakthrough sleep solutions to consumers in over 100 countries.

We operate in two segments: North America and International. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of manufacturing and distribution subsidiaries and licensees located in the U.S., Canada and Mexico. Our International segment consists of manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America (other than Mexico). Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. We evaluate segment performance based on net sales, gross profit and operating income. For additional information refer to Note 11, "Business Segment Information," included in Part I, ITEM 1 of this Report.

Our highly recognized brands include Tempur-Pedic®, Sealy® and Stearns & Foster® and our non-branded offerings consist of value-focused private label and OEM products. Our products allow for complementary merchandising strategies and are sold through third-party retailers, our more than 750 company-owned and joint venture operated retail stores worldwide and our e-commerce channel.

Our distribution model operates through an omni-channel strategy. We distribute through two channels in each operating business segment: Wholesale and Direct. Our Wholesale channel consists of third-party retailers, including third-party distribution, hospitality and healthcare. Our Direct channel includes company-owned stores, online and call centers.

General Business and Economic Conditions

We believe the bedding industry is structured for sustained growth over the long term, driven by product innovation, sleep technology advancements, consumer confidence, housing formations and population growth. The industry is no longer engaged in uneconomical retail store expansion, startups have shifted from uneconomical strategies to becoming profitable and legacy retailers and manufacturers have become skilled in producing profitable online sales.

Over the last decade, consumers have made the connection between a good night's sleep and overall health and wellness. As consumers make this connection, they are willing to invest more in their bedding purchases, which positions us well for long-term growth.

In the second half of 2024, we expect a continuation of the current macroeconomic environment, which includes the impact of inflation and interest rate pressures on the consumer. These macroeconomic pressures on the consumer continue to challenge the global bedding industry. Ongoing geopolitical conflicts may also introduce further uncertainty for the consumer. We expect to outperform the bedding industry, amid these macroeconomic headwinds, as a result of our successful new product launches and recent distribution gains in the U.S.

Definitive Agreement with Mattress Firm.

On May 9, 2023, Tempur Sealy International and Mattress Firm entered into a definitive agreement and plan of merger (the "Merger Agreement") for a pending business acquisition in which Tempur Sealy International, through a wholly-owned subsidiary, will acquire Mattress Firm in a transaction valued at approximately $4.0 billion. The transaction is expected to be funded by approximately $2.7 billion of cash consideration and the issuance of 34.2 million shares of common stock, resulting in a total stock consideration value of $1.3 billion based on a closing share price of $37.62 as of May 8, 2023.

On July 2, 2024, the FTC filed a complaint for temporary restraining order and preliminary injunction in the United States District Court for the Southern District of Texas (the "Court") and an administrative complaint (together with the complaint filed with the Court, the "Actions") to challenge our proposed acquisition of Mattress Firm. Refer to Note 8, "Commitments and Contingencies" in the "Notes to Condensed Consolidated Financial Statements," under Part I, ITEM 1 of this Report for further details.

We believe that a successful litigation process can be completed in the coming months, which would allow the transaction to close in late 2024 or early 2025. Following the close of the transaction, Mattress Firm is expected to operate as a separate business unit.

Product Launches

In 2024, we are launching a new portfolio of Tempur-Pedic® Adapt mattresses in our North America segment. This next-generation technology sets the standard for support, pressure relief and motion cancellation with Tempur material precisely responding to your body's weight, shape and temperature in a way no other mattress does. This collection was designed to complement the Tempur-Pedic® Breeze collection and Tempur-Ergo® Smart Bases launched in 2023 and finishes the complete reset of our core Tempur lineup.

In our International segment in 2024, we completed the rollout of the new line of Tempur® products in over 90 markets through our wholly-owned subsidiaries and third-party distributors. This new line of products will broaden Tempur®'s price range, with the super-premium price point ceiling maintained and the floor expanded into the premium category to broaden our global addressable market.

Results of Operations

A summary of our results for the three months ended June 30, 2024 include:

• Total net sales decreased 2.8% to $1,233.6 million as compared to $1,269.7 million in the second quarter of 2023, with a decrease of 3.8% in the North America business segment and consistent sales in the International business segment. On a constant currency basis, which is a non-GAAP financial measure, total net sales decreased 2.6%, with a decrease of 3.8% in the North America business segment and an increase of 1.9% in the International business segment.
• Gross margin was 44.9% as compared to 42.7% in the second quarter of 2023.
• Operating income increased 9.1% to $173.3 million as compared to $158.8 million in the second quarter of 2023. Adjusted operating income, which is a non-GAAP financial measure, increased 5.1% to $180.6 million as compared to $171.8 million in the second quarter of 2023.
• Net income increased 14.8% to $106.1 million as compared to $92.4 million in the second quarter of 2023. Adjusted net income, which is a non-GAAP financial measure, increased 9.5% to $111.7 million as compared to $102.0 million in the second quarter of 2023.
• Earnings per diluted share ("EPS") increased 15.4% to $0.60 as compared to $0.52 in the second quarter of 2023. Adjusted EPS, which is a non-GAAP financial measure, increased 8.6% to $0.63 as compared to $0.58 in the second quarter of 2023.

For a discussion and reconciliation of non-GAAP financial measures as discussed above to the corresponding GAAP financial results, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information."

We may refer to net sales, earnings or other historical financial information on a "constant currency basis," which is a non-GAAP financial measure. These references to constant currency basis do not include operational impacts that could result from fluctuations in foreign currency rates. To provide information on a constant currency basis, the applicable financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior corresponding period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Constant currency information is not recognized under GAAP, and it is not intended as an alternative to GAAP measures. Refer to Part I, ITEM 3 of this Report for a discussion of our foreign currency exchange rate risk.

THREE MONTHS ENDED JUNE 30, 2024 COMPARED TO THE

THREE MONTHS ENDED JUNE 30, 2023

The following table sets forth the various components of our Condensed Consolidated Statements of Income and expresses each component as a percentage of net sales:

(in millions, except percentages and per share amounts)

22

NET SALES

(in millions)

Net sales decreased 2.8%, and on a constant currency basis decreased 2.6%. The change in net sales was driven by the following:

• North America net sales decreased $38.4 million, or 3.8%. Net sales in the Wholesale channel decreased $41.2 million, or 4.6%, primarily driven by continued macroeconomic pressures impacting U.S. consumer behavior. Net sales in the Direct channel increased $2.8 million, or 2.3%, as compared to the second quarter of 2023.
• International net sales increased $2.3 million, or 0.9%. On a constant currency basis, International net sales increased 1.9%. Net sales in the Wholesale channel increased 4.8% on a constant currency basis. Net sales in the Direct channel increased 0.1% on a constant currency basis.

GROSS PROFIT

(in millions, except percentages)

Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in the manufacturing process.

Our gross margin is primarily impacted by the relative amount of net sales contributed by our premium or value products. Our value products have a significantly lower gross margin than our premium products. If sales of our value priced products increase relative to sales of our premium priced products, our gross margins will be negatively impacted in both our North America and International segments.

Our gross margin is also impacted by fixed cost leverage based on manufacturing unit volumes; the cost of raw materials; operational efficiencies due to the utilization in our manufacturing facilities; product, brand, channel and country mix; foreign exchange fluctuations; volume incentives offered to certain retail accounts; participation in our retail cooperative advertising programs; and costs associated with new product introductions. Future changes in raw material prices could have a significant impact on our gross margin. Our margins are also impacted by the growth in our Wholesale channel as sales in our Wholesale channel are at wholesale prices, whereas sales in our Direct channel are at retail prices.

Gross margin improved 220 basis points. The primary drivers of changes in gross margin by segment are discussed below:

• North America gross margin improved 220 basis points. The improvement in gross margin was primarily driven by favorable commodity costs of 130 basis points, operational efficiencies of 120 basis points and favorable product launch costs of 110 basis points. These improvements were partially offset by the mix impact of the new distribution win for our OEM business of 140 basis points.
• International gross margin improved 170 basis points. The improvement in gross margin was primarily driven by operational efficiencies of 110 basis points and favorable product launch costs of 80 basis points.

OPERATING EXPENSES

Selling and marketing expenses include advertising and media production associated with the promotion of our brands, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing.

General, administrative and other expenses include salaries and related expenses, IT, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs.

(in millions)

Operating expenses decreased $3.7 million, or 1.0%, and increased 60 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are explained below:

• North America operating expenses increased $0.1 million, consistent with prior year, and increased 80 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by investments in growth initiatives, partially offset by decreased variable compensation expense.
• International operating expenses increased $6.5 million, or 6.0%, and increased 210 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by investments in growth initiatives.
• Corporate operating expenses decreased $10.3 million, or 20.9%. The decrease in operating expenses was primarily driven by decreased variable compensation expense and transaction costs related to the pending acquisition of Mattress Firm.

Research and development expenses for the three months ended June 30, 2024 were $7.7 million compared to $7.3 million for the three months ended June 30, 2023, an increase of $0.4 million, or 5.5%.

OPERATING INCOME

(in millions, except percentages)

Operating income increased $14.5 million and operating margin improved 150 basis points. The primary drivers of changes in operating income and operating margin by segment are discussed below:

• North America operating income increased $6.3 million and operating margin improved 130 basis points. The improvement in operating margin was primarily driven by the improvement in gross margin of 220 basis points, partially offset by operating expense deleverage of 80 basis points.
• International operating income decreased $2.1 million and operating margin declined 90 basis points. The decline in operating margin was driven by operating expense deleverage of 210 basis points and Asia joint venture performance, partially offset by the improvement in gross margin of 170 basis points.
• Corporate operating expenses decreased $10.3 million, which positively impacted our consolidated operating margin.

INTEREST EXPENSE, NET

(in millions, except percentages)

Interest expense, net, decreased $0.2 million, or 0.6%. The decrease in interest expense, net, was primarily driven by reduced average levels of outstanding variable rate debt.

INCOME TAX PROVISION

(in millions, except percentages)

Our income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of net operating losses for certain of our foreign operations.

Our income tax provision increased $1.8 million due to an increase in income before income taxes. Our effective tax rate for the three months ended June 30, 2024 as compared to the prior year declined by 150 basis points. The effective tax rates as compared to the U.S. federal statutory rates for the three months ended June 30, 2024 and 2023 included a net favorable impact of other discrete items.

SIX MONTHS ENDED JUNE 30, 2024 COMPARED TO THE

SIX MONTHS ENDED JUNE 30, 2023

The following table sets forth the various components of our Condensed Consolidated Statements of Income and expresses each component as a percentage of net sales:

(in millions, except percentages and per share amounts)

24

NET SALES

(in millions)

Net sales decreased 2.2%, and on a constant currency basis decreased 2.4%. The change in net sales was driven by the following:

• North America net sales decreased $56.9 million, or 2.9%. Net sales in the Wholesale channel decreased $68.6 million, or 4.0%, primarily driven by continued macroeconomic pressures impacting U.S. consumer behavior. Net sales in the Direct channel increased $11.7 million, or 5.0%, primarily driven by strength in our e-commerce business.
• International net sales increased $2.1 million, or 0.4%. On a constant currency basis, International net sales were consistent with the prior year. Net sales in the Wholesale channel increased 2.7% on a constant currency basis. Net sales in the Direct channel decreased 1.6% on a constant currency basis.

GROSS PROFIT

(in millions, except percentages)

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.

Gross margin improved 190 basis points. The primary drivers of changes in gross margin by segment are discussed below:

• North America gross margin improved 200 basis points. The improvement in gross margin was primarily driven by favorable commodity costs of 150 basis points, operational efficiencies of 70 basis points and favorable product launch costs. These improvements were partially offset by the mix impact of the new distribution win for our OEM business of 70 basis points.
• International gross margin improved 150 basis points. The improvement in gross margin was primarily driven by operational efficiencies of 90 basis points and favorable commodity costs.

OPERATING EXPENSES

Selling and marketing expenses include advertising and media production associated with the promotion of our brands, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing.

General, administrative and other expenses include salaries and related expenses, IT, professional fees, depreciation and amortization of long-lived assets not used in the manufacturing process, expenses for administrative functions and research and development costs.

(in millions)

Operating expenses increased $21.1 million, or 2.8%, and increased 160 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are explained below:

• North America operating expenses increased $10.5 million, or 2.4%, and increased 120 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by investments in growth initiatives.
• International operating expenses increased $10.1 million, or 4.5%, and increased 160 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by investments in growth initiatives.
• Corporate operating expenses increased $0.5 million, or 0.6%. The increase in operating expenses was primarily driven by transaction costs related to the pending acquisition of Mattress Firm, partially offset by decreased variable compensation expense.

Research and development expenses were $15.8 million for the six months ended June 30, 2024 as compared to $14.8 million for the six months ended June 30, 2023, an increase of $1.0 million, or 6.8%.

OPERATING INCOME

(in millions, except percentages)

Operating income increased $2.7 million and operating margin improved 40 basis points. The primary drivers of changes in operating income and operating margin by segment are discussed below:

• North America operating income increased $4.7 million and operating margin improved 70 basis points. The improvement in operating margin was primarily driven by the improvement in gross margin of 200 basis points, partially offset by operating expense deleverage of 120 basis points.
• International operating income decreased $1.5 million and operating margin declined 30 basis points. The decline in operating margin was primarily driven by operating expense deleverage of 160 basis points, partially offset by the improvement in gross margin of 150 basis points.
• Corporate operating expenses increased $0.5 million, which negatively impacted our consolidated operating margin.

INTEREST EXPENSE, NET

(in millions, except percentages)

Interest expense, net, increased $1.3 million, or 2.0%. The increase in interest expense, net, was primarily driven by higher interest rates on our variable rate debt.

INCOME TAX PROVISION

(in millions, except percentages)

Our income tax provision decreased $2.0 million. Our effective tax rate for the six months ended June 30, 2024 as compared to the prior year declined 110 basis points. The effective tax rates as compared to the U.S. federal statutory rates for the six months ended June 30, 2024 and 2023 included the net favorable impact of the deductibility of stock compensation in the U.S., which was offset by the unfavorable impact of discrete items.

Liquidity and Capital Resources

Liquidity

Our principal sources of funds are cash flows from operations, supplemented with borrowings in the capital markets and made pursuant to our credit facilities and cash and cash equivalents on hand. Principal uses of funds consist of payments of principal and interest on our debt facilities, acquisitions, payments of dividends to our shareholders, capital expenditures and working capital needs.

As of June 30, 2024, we had net working capital of $203.9 million, including cash and cash equivalents of $95.8 million, as compared to a working capital of $195.0 million, including cash and cash equivalents of $74.9 million, as of December 31, 2023. The amount of cash and cash equivalents held by subsidiaries outside of the U.S. and not readily convertible into the U.S. Dollar or other major foreign currencies is not material to our overall liquidity or financial position.

Cash Provided by (Used in) Operations

The table below presents net cash provided by (used in) operating, investing and financing activities from operations for the periods indicated below:

(in millions)

Cash provided by operating activities increased $30.3 million in the six months ended June 30, 2024 as compared to the same period in 2023. The increase in cash provided by operating activities was primarily driven by a $14.1 million increase in cash provided by changes in operating assets and liabilities and a $13.3 million increase in depreciation expense associated with our new Tempur manufacturing facility.

Cash used in investing activities decreased $52.6 million in the six months ended June 30, 2024 as compared to the same period in 2023. The decrease in cash used in investing activities was primarily driven by decreased capital expenditures related to our manufacturing capacity expansion projects in 2023.

Cash used in financing activities increased $83.6 million in the six months ended June 30, 2024 as compared to the same period in 2023. For the six months ended June 30, 2024, we had net repayments of $93.7 million on our credit facilities as compared to $27.6 million in the same period in 2023. We repurchased $43.8 million and $35.9 million of our common stock to satisfy tax withholding obligations upon the vesting of our long-term incentive plans during the six months ended June 30, 2024 and 2023, respectively. Additionally, we paid dividends to shareholders of $47.5 million and $39.8 million, during the six months ended June 30, 2024 and 2023, respectively.

Capital Expenditures

Capital expenditures totaled $60.0 million and $112.7 million for the six months ended June 30, 2024 and 2023, respectively. We currently expect our 2024 capital expenditures to be approximately $140 million, which includes maintenance capital expenditures of $110 million.

Indebtedness

Our total debt decreased to $2,505.8 million as of June 30, 2024 from $2,593.6 million as of December 31, 2023. Total availability under our revolving senior secured credit facility was $1,112.9 million as of June 30, 2024. Refer to Note 4, "Debt" in the "Notes to Condensed Consolidated Financial Statements," under Part I, ITEM 1 for further discussion of our debt.

On February 6, 2024, we entered into an amendment to the 2023 Credit Agreement which provides for a $625.0 million delayed draw term loan and a $40.0 million increase in availability on the existing revolving loan. Once drawn, the instruments will have the same terms and conditions as the Company's existing term loans and revolving loans, respectively, under the 2023 Credit Agreement. This amendment was executed in connection with the Company's financing strategy for the pending acquisition of Mattress Firm.

As of June 30, 2024, our ratio of consolidated indebtedness less netted cash to adjusted earnings before interest, taxes, depreciation and amortization ("EBITDA"), which is a non-GAAP financial measure, in accordance with our 2023 Credit Agreement was 2.70 times. This ratio is within the terms of the financial covenants for the maximum consolidated total net leverage ratio as set forth in the 2023 Credit Agreement, which limits this ratio to 5.00 times. As of June 30, 2024, we were in compliance with all of the financial covenants in our debt agreements, and we do not anticipate material issues under any debt agreements based on current facts and circumstances.

Our debt agreements contain certain covenants that limit restricted payments, including share repurchases and dividends. The 2023 Credit Agreement, 2029 Senior Notes and 2031 Senior Notes contain similar limitations which, subject to certain conditions, allow unlimited restricted payments at times when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, remains below 3.75 times in the case of the 2023 Credit Agreement and remains below 3.50 times in the cases of the 2029 Senior Notes and 2031 Senior Notes. In addition, these agreements permit limited restricted payments under certain conditions when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA is above 3.75 times in the case of the 2023 Credit Agreement and above 3.50 times in the cases of the 2029 Senior Notes and 2031 Senior Notes. The limit on restricted payments under the 2023 Credit Agreement, 2029 Senior Notes and 2031 Senior Notes is in part determined by a basket that grows at 50% of adjusted net income each quarter, reduced by restricted payments that are not otherwise permitted.

For additional information, refer to "Non-GAAP Financial Information" below for the calculation of the ratio of consolidated indebtedness less netted cash to adjusted EBITDA calculated in accordance with the 2023 Credit Agreement. Both consolidated indebtedness and adjusted EBITDA as used in discussion of the 2023 Credit Agreement are non-GAAP financial measures and do not purport to be alternatives to net income as a measure of operating performance or total debt.

Share Repurchase Program

Our Board of Directors authorized a share repurchase program in 2016 pursuant to which we were authorized to repurchase shares of our common stock, and the Board of Directors has authorized increases to this authorization from time to time. During the six months ended June 30, 2024, we did not repurchase shares under our share repurchase program. As of June 30, 2024, we had $774.5 million remaining under our share repurchase authorization.

Share 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. These repurchases may be funded by operating cash flows and/or borrowings under our debt arrangements. The timing and actual number of shares repurchased will depend on a variety of factors including price, financing and regulatory requirements and other market conditions. The program is subject to certain limitations under our debt agreements. The program does not require the purchase 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.

We will manage our share repurchase program based on current and expected cash flows, share price and alternative investment opportunities. As a result of the pending Mattress Firm acquisition, we have temporarily suspended our repurchase of shares in advance of closing the transaction. For a complete description of our share repurchase program, please refer to ITEM 5 under Part II, "Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities," in the 2023 Annual Report. Please also refer to "Issuer Purchases of Equity Securities" in ITEM 2(c) of Part II of this Report.

Future Liquidity Sources and Uses

As of June 30, 2024, we had $1,208.7 million of liquidity, including $95.8 million of cash on hand and $1,112.9 million available under our 2023 Credit Agreement. In addition, we expect to generate cash flow from operations in the full year 2024. We believe that cash flow from operations, availability under our existing credit facilities and arrangements, current cash balances and the ability to obtain other financing, if necessary, will provide adequate cash funds for our foreseeable working capital needs, necessary capital expenditures, debt service obligations and dividend payments.

Our capital allocation strategy follows a balanced approach focused on supporting the business, returning shareholder value through strategic acquisition opportunities that enhance our global competitiveness, as well as quarterly dividends and opportunistic share repurchases.

The Board of Directors declared a dividend of $0.13 per share for the third quarter of 2024. The dividend is payable on August 29, 2024 to shareholders of record as of August 15, 2024.

As of June 30, 2024, we had $2,505.8 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $2,410.0 million. Leverage based on the ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, was 2.70 times for the trailing twelve months ended June 30, 2024.

Our debt service obligations could, under certain circumstances, have material consequences to our stockholders. Similarly, our cash requirements are subject to change as business conditions warrant and opportunities arise. The timing and size of any new business ventures or acquisitions that we may complete may also impact our cash requirements and debt service obligations.

Non-GAAP Financial Information

We provide information regarding adjusted net income, EBITDA, adjusted EBITDA, adjusted EPS, adjusted gross profit, adjusted gross margin, adjusted operating income (expense), adjusted operating margin, consolidated indebtedness and consolidated indebtedness less netted cash, which are not recognized terms under GAAP and do not purport to be alternatives to net income, earnings per share, gross profit, gross margin, operating income (expense) and operating margin as a measure of operating performance, or an alternative to total debt as a measure of liquidity. We believe these non-GAAP financial measures provide investors with performance measures that better reflect our underlying operations and trends, providing a perspective not immediately apparent from net income, gross profit, gross margin, operating income (expense) and operating margin. The adjustments we make to derive the non-GAAP financial measures include adjustments to exclude items that may cause short-term fluctuations in the nearest GAAP financial measure, but which we do not consider to be the fundamental attributes or primary drivers of our business.

We believe that exclusion of these items assists in providing a more complete understanding of our underlying results from operations and trends, and we use these measures along with the corresponding GAAP financial measures to manage our business, to evaluate our consolidated and business segment performance compared to prior periods and the marketplace, to establish operational goals and to provide continuity to investors for comparability purposes. Limitations associated with the use of these non-GAAP measures include that these measures do not present all of the amounts associated with our results as determined in accordance with GAAP. These non-GAAP financial measures should be considered supplemental in nature and should not be construed as more significant than comparable financial measures defined by GAAP. 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 financial measures and a reconciliation to the nearest GAAP financial measure, please refer to the reconciliations on the following pages.

Adjusted Net Income and Adjusted EPS

A reconciliation of reported net income to adjusted net income and the calculation of 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 adjusted net income and the calculation of adjusted EPS for the three months ended June 30, 2024 and 2023:

(in millions, except per share amounts)

(1) In the second quarter of 2024, we recorded $7.3 million of transaction costs, primarily related to legal and professional fees associated with the pending acquisition of Mattress Firm. In the second quarter of 2023, we recorded $10.6 million of transaction costs primarily associated with the pending acquisition of Mattress Firm.

(2) In the second quarter of 2023, we recorded $2.4 million of operational start-up costs related to the capacity expansion of our manufacturing and distribution facilities in the U.S., including personnel and facility related costs.

(3) Adjusted income tax provision represents the tax effects associated with the aforementioned items.

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Adjusted Gross Profit, Adjusted Gross Margin, Adjusted Operating Income (Expense) and Adjusted Operating Margin

The following table sets forth the reconciliation of our reported gross profit and operating income (expense) to the calculation of adjusted operating income (expense) for the three months ended June 30, 2024.

(in millions, except percentages)

(1) In the second quarter of 2024, we recorded $7.3 million of transaction costs, primarily related to legal and professional fees associated with the pending acquisition of Mattress Firm.

The following table sets forth our reported gross profit and operating income (expense) to the calculation of adjusted gross profit and adjusted operating income (expense) for the three months ended June 30, 2023.

(in millions, except percentages)

(1) In the second quarter of 2023, we recorded $2.4 million of operational start-up costs related to the capacity expansion of our manufacturing and distribution facilities in the U.S., including personnel and facility related costs.

(2) In the second quarter of 2023, we recorded $10.6 million of transaction costs primarily associated with the pending acquisition of Mattress Firm.

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EBITDA, Adjusted EBITDA and Consolidated Indebtedness less Netted Cash

The following reconciliations are provided below:

• Net income to EBITDA and adjusted EBITDA
• Ratio of consolidated indebtedness less netted cash to adjusted EBITDA
• Total debt, net to consolidated indebtedness less netted cash

We believe that presenting these non-GAAP measures provides investors with useful information with respect to our operating performance, cash flow generation and comparisons from period to period, as well as general information about our leverage.

The 2023 Credit Agreement provides the definition of adjusted EBITDA. Accordingly, we present adjusted EBITDA to provide information regarding our compliance with requirements under the 2023 Credit Agreement.

The following table sets forth the reconciliation of our reported net income to the calculations of EBITDA and adjusted EBITDA for the three months ended June 30, 2024 and 2023:

(in millions)

(1) In the second quarter of 2024, we recorded $7.3 million of transaction costs, primarily related to legal and professional fees associated with the pending acquisition of Mattress Firm. In the second quarter of 2023, we recorded $10.6 million of transaction costs primarily associated with the pending acquisition of Mattress Firm.

(2) In the second quarter of 2023, we recorded $2.4 million of operational start-up costs related to the capacity expansion of our manufacturing and distribution facilities in the U.S., including personnel and facility related costs.

30

The following table sets forth the reconciliation of our net income to the calculations of EBITDA and adjusted EBITDA for the trailing twelve months ended June 30, 2024:

(in millions)

(1) In the trailing twelve months ended June 30, 2024, we recognized $3.2 million of loss on extinguishment of debt associated with the refinancing of our senior secured credit facilities.

(2) In the trailing twelve months ended June 30, 2024, we recognized $55.3 million of transaction costs associated with the pending acquisition of Mattress Firm.

(3) In the trailing twelve months ended June 30, 2024, we recorded $14.3 million of costs associated with the cybersecurity event identified on July 23, 2023.

(4) In the trailing twelve months ended June 30, 2024, we recorded a fair value remeasurement of $11.0 million related to a strategic investment in a product innovation initiative.

(5) In the trailing twelve months ended June 30, 2024, we recognized $9.4 million of operational start-up costs.

Under the 2023 Credit Agreement, the ratio of adjusted EBITDA to consolidated indebtedness less netted cash was 2.70 times for the trailing twelve months ended June 30, 2024. The 2023 Credit Agreement requires us to maintain a ratio of consolidated indebtedness less netted cash to adjusted EBITDA of less than 5.00 times.

The following table sets forth the reconciliation of our reported total debt to the calculation of consolidated indebtedness less netted cash as of June 30, 2024. "Consolidated Indebtedness" and "Netted Cash" are terms used in the 2023 Credit Agreement for purposes of certain financial covenants.

(in millions)

(1) We present deferred financing costs as a direct reduction from the carrying amount of the related debt in the Condensed Consolidated Balance Sheets. For purposes of determining total debt for financial covenant purposes, we have added these costs back to total debt, net as calculated per the Condensed Consolidated Balance Sheets.

(2) Netted cash includes cash and cash equivalents for domestic and foreign subsidiaries designated as restricted subsidiaries in the 2023 Credit Agreement.

31

Critical Accounting Policies and Estimates

For a discussion of our critical accounting policies and estimates, please refer to ITEM 7 under Part II, "Management’s Discussion and Analysis of Financial Condition and Results of Operations," in the 2023 Annual Report. There have been no material changes to our critical accounting policies and estimates in 2024.

The Company's market risks are discussed in detail in ITEM 7A of Part II of our 2023 Annual Report. Management has reassessed the quantitative and qualitative market risk disclosures described in our 2023 Annual Report and determined there were no material changes to market risks for the six months ended June 30, 2024.

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), of the effectiveness of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, as of the end of the period covered by this Report. Based on that evaluation, our management, including our Chief Executive Officer and Chief Financial Officer, concluded that our disclosure controls and procedures were effective as of June 30, 2024, and were designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission's rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting:

There were no changes in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Exchange Act Rules 13a-15 or 15d-15 that was conducted during the last fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In order to consummate the previously disclosed, pending merger with Mattress Firm, we and Mattress Firm must obtain certain governmental approvals, and if such approvals are not granted or are granted with conditions, consummation of the merger may be jeopardized, may not occur, or may be delayed, or the anticipated benefits of the merger may not be achieved.

On May 9, 2023, we entered into the Merger Agreement to acquire Mattress Firm. On July 2, 2024, the FTC filed the Actions. The FTC alleges in the Actions that, if consummated, the pending acquisition of Mattress Firm may substantially lessen competition and would be an unfair method of competition. In each of the Company's and Mattress Firm's respective answers to the Actions, the Company and Mattress Firm each denied the FTC's substantive allegations; asserted numerous defenses; described the pro-competitive aspects and significant consumer benefits relating to the merger; and denied that the combination of their respective businesses would violate any law. The failure to satisfy all of the required closing conditions, including as a result of the Actions, could delay the merger for a significant period of time (including beyond the termination date of February 9, 2025) or prevent it from occurring.

The FTC and the federal courts have broad discretion in administering the governing laws and regulations, and may take into account various facts and circumstances in their consideration of the merger. The failure to satisfy all of the required closing conditions, including as a result of the antitrust actions by the FTC, could delay the completion of the merger for a significant period of time (including beyond the termination date of February 9, 2025) or prevent it from occurring. The FTC or a federal court may also impose conditions, terms, obligations or restrictions, or require divestitures as a condition of permitting the merger. As further described in the Merger Agreement, we have agreed to take certain divestiture actions and agree to certain other obligations or commitments in connection with the consummation of the merger if reasonably likely to permit consummation of the merger, provided that we are not required to take any divestiture actions in excess of an agreed amount specified in the Merger Agreement or if such actions, commitments and divestitures individually or in the aggregate would or would reasonably be expected to have a material and adverse impact on our business or the business of Mattress Firm or the anticipated benefits to the Company of the merger. While we are pursuing the divestiture of certain of our and Mattress Firm's stores, the progress of such process may change and there can be no assurance that we will successfully complete this process on the expected timing or at all.

There can be no assurance that the FTC or a federal court will not impose the aforementioned divestiture obligations, conditions, terms, obligations or restrictions and that such divestiture obligations, conditions, terms, obligations or restrictions will not have the effect of delaying or preventing consummation of the merger or imposing additional material costs on or limiting the benefits of the merger to the Company, or otherwise adversely affecting, including to a material extent, our business, results of operations and financial condition after consummation of the merger. If we are required to divest assets or businesses, there can be no assurance that we will be able to negotiate such divestitures expeditiously or on favorable terms or that the FTC or a federal court will approve the terms of such divestitures. We can provide no assurance that these divestiture obligations, conditions, terms, obligations or restrictions will not result in the abandonment of the merger and termination of the Merger Agreement.