SOMNIGROUP INTERNATIONAL INC. (SGI) FY 2024 MD&A

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 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, excluding Mattress Firm unless otherwise noted. 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. For results of operations comparisons relating to years ending December 31, 2023 and 2022, refer to our annual report on Form 10-K, Part II, ITEM 7: Management's Discussion and Analysis of Financial Condition and Results of Operations filed with the Securities and Exchange Commission on February 16, 2024.

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the years ended December 31, 2024 and 2023, 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 the world's largest bedding company, dedicated to enriching people's lives through the power of a good night's sleep. With superior capabilities in design, manufacturing, distribution and retail, we deliver breakthrough sleep solutions and serve the evolving needs of consumers in more than 100 countries worldwide through our fully-owned businesses, Tempur Sealy, Mattress Firm and Dreams.

In 2024, we operated 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, distribution and retail subsidiaries and licensees located in the U.S., Canada and Mexico. Our International segment consists of manufacturing, distribution and retail subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America (other than Mexico). Corporate operating expenses are not included in any 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 15, "Business Segment Information," included in Part II, ITEM 8 "Financial Statements and Supplementary Data," of this Report. Following the acquisition of Mattress Firm and beginning in the first quarter of 2025, we will operate in three segments: Tempur Sealy North America, Tempur Sealy International and Mattress Firm.

Our portfolio includes the most highly recognized brands in the industry, including Tempur-Pedic®, Sealy® and Stearns & Foster®, and our global omni-channel platform enables us to meet consumers wherever they shop, offering a personal connection and innovation to provide a unique retail experience and tailored solutions. Our products allow for complementary merchandising strategies and are sold through third-party retailers, our company-owned and joint venture operated retail stores worldwide and our e-commerce channel.

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

General Business and Economic Conditions

We believe the bedding industry is structured for sustained growth, driven by product innovation, sleep technology advancements, consumer confidence, housing formations and population growth. The industry is no longer engaged in

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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 2025, we expect the current macroeconomic environment to stabilize throughout the year. The global bedding industry was challenged in 2024 due to certain macroeconomic pressures on the consumer. Ongoing geopolitical conflicts may introduce further uncertainty for the consumer. We expect to outperform the bedding industry as a result of our investments in new product launches and continued investments in innovation, quality, advertising and customer service.

Acquisition of Mattress Firm

On February 5, 2025, we completed the acquisition of Mattress Firm for an aggregate purchase price of approximately $5.1 billion, net of cash acquired of $0.3 billion. The aggregate purchase price consisted of $2.8 billion in cash and approximately 34.2 million shares of our common stock valued at $65.65 per share, which represents the simple average of the opening and closing price per share of our common stock on the NYSE on the trading day immediately prior to the date of acquisition, with the value of any fractional shares paid in cash.

In connection with the consummation of the merger, we borrowed $625.0 million on the Delayed Draw Term A Loan and $679.5 million of revolving commitments under our senior credit facility. In addition, approximately $1,592.0 million of proceeds in respect of the Term B Loan were released from escrow. The proceeds of this financing were collectively used to fund a portion of the cash consideration, the repayment of Mattress Firm's debt and the payment of certain fees and expenses related to the merger.

We incurred $47.8 million and $49.0 million of transaction expenses related to the acquisition in 2024 and 2023, respectively, and $9.8 million of transaction related interest expense, net of interest income, related to the Term B Loan drawn and held in escrow.

We expect to complete the previously announced divestiture of 73 Mattress Firm retail locations and our Sleep Outfitters subsidiary, which includes 103 specialty mattress retail locations and seven distribution centers, to Mattress Warehouse in the second quarter of 2025.

Product Launches

In 2025, we will launch an all-new collection of Sealy Posturepedic® products in North America. This reinvention of the Sealy Posturepedic® brand is strategically aimed at reigniting growth in the mid-to-entry level market, which has experienced outsized pressures relative to other price points in recent years. The new collection incorporates innovative technologies, including our proprietary PrecisionFit™ coils which were expertly designed to provide superior support.

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Omni-Channel Distribution Expansion

We have a diversified group of strong retail partners and a rapidly growing direct business. The largest pillar of our omni-channel distribution strategy is our wholesale distribution across tens of thousands of third-party retail doors. This broad footprint ensures that consumers can easily find and experience our products in person. While we are well represented at third-party retailers in the U.S. today, there are opportunities to both increase the presence of our brands with existing retail partners and to sell into certain key retailers that do not have our products on their floors today. We also have significant opportunity to expand our third-party retail distribution in our international business.

In addition to the sale of our branded products through third-party retailers, we also offer non-branded products through our OEM business, including mattresses, pillows and other bedding products and components, at a wide range of price points. Our non-branded offerings complement our suite of branded products, expanding our capability to service third-party retailers and creating opportunity to capture manufacturing profits from bedding brands outside our own. In the fourth quarter of 2024, we lost a significant portion of our OEM business as a result of a customer's acquisition which foreclosed on our OEM product sales to this customer. In 2025, we expect this distribution loss to have an unfavorable impact on our results. We continue to target obtaining a meaningful share of the OEM market in the long-term.

We have been focused on building our direct channel, both online and company-owned retail stores. The development of our online business has been particularly important as consumers have grown more comfortable shopping for bedding products online. Following the acquisition of Mattress Firm, we expect over 60% of our global sales will be direct-to-consumer and no customer will represent more than 5% of global sales. Our expanded direct channel distribution complements our wholesale business, and we believe this balanced approach enhances the overall global sales potential and profitability of Somnigroup.

We currently operate over 2,800 retail stores globally through our wholly-owned and joint venture operations, led by over 2,200 Mattress Firm and retail stores in the U.S. and over 200 Dreams locations in the U.K. We believe these retail stores complement our existing third-party retail partners by increasing our products' brand awareness in the local markets.

2024 Results of Operations

A summary of our results for the year ended December 31, 2024 include:

•Total net sales increased 0.1% to $4,930.9 million as compared to $4,925.4 million in 2023, with a decrease of 1.7% in the North America business segment and an increase of 6.7% in the International business segment. On a constant currency basis, which is a non-GAAP financial measure, total net sales increased 0.1%, with a decrease of 1.5% in the North America business segment and an increase of 5.8% in the International business segment.

•Gross margin was 44.2% as compared to 43.2% in 2023. Adjusted gross margin, which is a non-GAAP financial measure, was 45.0% as compared to 43.7% in 2023.

•Operating income increased 4.4% to $634.2 million as compared to $607.2 million in 2023. Adjusted operating income, which is a non-GAAP financial measure, increased 3.8% to $721.3 million as compared to $695.1 million in 2023.

•Net income increased 4.4% to $384.3 million as compared to $368.1 million in 2023. Adjusted net income, which is a non-GAAP financial measure, increased 6.9% to $455.1 million as compared to $425.6 million in 2023.

•Earnings per diluted share ("EPS") increased 3.8% to $2.16 as compared to $2.08 in 2023. Adjusted EPS, which is a non-GAAP financial measure, increased 6.3% to $2.55 as compared to $2.40 in 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."

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We may refer to net sales or earnings or other historical financial information on a "constant currency basis," which is a non-GAAP financial measure. These references to constant currency basis do not include operational impacts that could result from fluctuations in foreign currency rates. To provide information on a constant currency basis, the applicable financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior corresponding period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Constant currency information is not recognized under GAAP, and it is not intended as an alternative to GAAP measures. Refer to Part II, ITEM 7A of this Report for a discussion of our foreign currency exchange rate risk.

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

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NET SALES

Net sales increased 0.1% (including on a constant currency basis). The change in net sales was driven by the following:

•North America net sales decreased $66.6 million, or 1.7%. Net sales in the Wholesale channel decreased $73.0 million, or 2.2%, primarily driven by continued macroeconomic pressures impacting U.S. consumer behavior. Net sales in our Direct channel increased $6.4 million, or 1.3%.

•International net sales increased $72.1 million, or 6.7%, primarily driven by the success of new product launches. On a constant currency basis, our International net sales increased 5.8%. Net sales in the Wholesale channel increased 7.8% on a constant currency basis. Net sales in the Direct channel increased 4.6% on a constant currency basis.

GROSS PROFIT

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 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 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 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 100 basis points. The principal factors impacting gross margin for each segment are discussed below:

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•North America gross margin improved 50 basis points. The improvement in gross margin was primarily driven by favorable commodity costs of 100 basis points and operational efficiencies. These improvements were offset by the unfavorable mix of new OEM distribution of 50 basis points.

•International gross margin improved 160 basis points. The improvement in gross margin was primarily driven by operational efficiencies of 80 basis points and favorable commodity costs of 30 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, 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.

Operating expenses increased $20.3 million, or 1.3%, and increased 30 basis points as a percentage of net sales. The primary drivers of changes in operating expenses by segment are discussed below:

•North America operating expenses increased $24.3 million, or 2.7%, and increased 100 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by incremental bad debt expense related to retailer bankruptcies and investments in growth initiatives, partially offset by decreases in advertising.

•International operating expenses increased $30.0 million, or 6.8%, and was flat as a percentage of net sales. The increase in operating expenses was primarily driven by investments in growth initiatives.

•Corporate operating expenses decreased $34.0 million, or 16.4%. The decrease in operating expenses was primarily driven by decreased variable compensation expense and a one-time fair value remeasurement of $11.0 million related to a strategic investment in a product innovation initiative which was recorded in the prior year.

Research and development expenses for the year ended December 31, 2024 were $30.8 million as compared to $30.6 million for the year ended December 31, 2023, an increase of $0.2 million, or 0.7%.

OPERATING INCOME

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Operating income increased $27.0 million and operating margin improved 60 basis points. The increase was driven by the following:

•North America operating income decreased $31.0 million and operating margin declined 50 basis points. The decline in operating margin was primarily driven by operating expense deleverage of 100 basis points, partially offset by the improvement in gross margin of 50 basis points.

•International operating income increased $24.0 million and operating margin improved 110 basis points. The improvement in operating margin was primarily driven by the improvement in gross margin of 160 basis points, partially offset by Asia joint venture performance of 50 basis points and operating expense deleverage.

•Corporate operating expenses decreased $34.0 million, which positively impacted our consolidated operating margin.

INTEREST EXPENSE, NET

Interest expense, net, increased $4.9 million, or 3.8%. The increase in interest expense, net, was primarily driven by the incremental Term B Loan interest expense, net of $8.4 million, partially offset by reduced average levels of outstanding variable rate debt.

INCOME TAX PROVISION

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 $15.2 million due to an increase in income before income taxes. Our 2024 effective tax rate increased 170 basis points as compared to 2023. The 2024 effective tax rate as compared to the U.S. federal statutory tax rate included a net favorable impact of discrete items, primarily related to excess tax benefits from the vesting of certain stock awards under our incentive stock compensation plan and other discrete items. The 2023 effective tax rate, as compared to the U.S. federal statutory tax rate, also included a net favorable impact of discrete items, primarily related to excess tax benefits from the vesting of certain stock awards under our incentive stock compensation plan and a benefit related to the settlement of the Danish Tax Matter.

Refer to Note 13, "Income Taxes," in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for further information.

Liquidity and Capital Resources

Liquidity

Our principal sources of funds are cash flows from operations, supplemented with 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, share repurchases, capital expenditures and working capital needs.

As of December 31, 2024, we had net working capital of $105.1 million, including cash and cash equivalents of $117.4 million, as compared to 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.

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Cash Provided by (Used in) Continuing Operations

The table below presents net cash provided by (used in) operating, investing and financing activities from continuing operations for the years ended December 31, 2024 and 2023.

Cash provided by operating activities increased $96.2 million in 2024 as compared to 2023. The increase in cash provided by operating activities was driven by a $66.3 million increase in cash provided by changes in operating assets and liabilities, primarily due to increases in cash provided by accounts payable and income taxes receivable and payable, which were offset by decreases in cash provided by inventory and prepaid expenses and other assets. Cash provided by operating activities also increased as a result of additional non-cash depreciation and amortization of $29.8 million, primarily associated with our new Tempur manufacturing facility.

Cash used in investing activities decreased $91.1 million in 2024 as compared to 2023. The decrease in cash used in investing activities was driven by decreased capital expenditures related to our manufacturing capacity expansion projects in 2023.

Cash provided by financing activities increased $1,461.7 million in 2024 as compared to 2023. In 2024, we had net borrowings of $1,246.4 million as compared to net repayments of $250.8 million in 2023 from our credit facilities, including $1,592.0 million of proceeds from the Term B Loan. The proceeds from the Term B Loan were funded into escrow and were released upon the closing of the Mattress Firm acquisition. Additionally, we repurchased shares of our common stock to satisfy tax withholding obligations upon the vesting of our long-term incentive plans for $43.8 million in 2024 as compared to $36.0 million in 2023.

Capital Expenditures

Capital expenditures were $97.3 million and $185.4 million for the year ended December 31, 2024 and 2023, respectively. We currently expect our 2025 capital expenditures to be approximately $250 million, including $50 million of investments to refresh Mattress Firm stores.

Indebtedness

Our total debt increased to $3,844.5 million as of December 31, 2024 from $2,593.6 million as of December 31, 2023. Total availability under our revolving senior secured credit facility was $1,189.2 million as of December 31, 2024.

On February 6, 2024, we entered into an Amendment No. 1 ("Amendment No. 1") to the 2023 Credit Agreement which provided for a $625.0 million Delayed Draw Term A Loan commitment and a $40.0 million increase in availability on the existing revolving loan. This amendment was executed in connection with the Company's financing strategy for the Mattress Firm acquisition.

On October 24, 2024, we entered into an Amendment No. 2 ("Amendment No. 2") and an Amendment No. 3 ("Amendment No. 3") to the 2023 Credit Agreement. Amendment No. 2 extended the termination date for $605 million of the Delayed Draw Term A Loan commitments until October 24, 2025, among other changes. Amendment No. 3 provided for an incremental Term B Loan in the aggregate principal amount of $1.6 billion which will mature on October 24, 2031. The proceeds of the Term B Loan were funded into escrow on the closing of Amendment No. 3 and will mature on October 24, 2031. The proceeds of the Term B Loan were used to pay fees and expenses in connection with Amendment No. 3 and were released for the closing of the Mattress Firm acquisition.

On February 5, 2025, upon the consummation of the Mattress Firm acquisition, we borrowed $625.0 million of our Delayed Draw Term A Loan commitments and $679.5 million of revolving commitments under the 2023 Credit Agreement. In addition, approximately $1,592.0 million of proceeds in respect of the Term B Loan were released from escrow. The proceeds

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of this financing were collectively used to fund a portion of the cash consideration for the acquisition, the repayment of Mattress Firm's debt and the payment of certain fees and expenses related to the acquisition.

As of December 31, 2024, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure defined in the 2023 Credit Agreement, was 2.31 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 December 31, 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 other conditions, allow unlimited restricted payments at times when the ratio of consolidated indebtedness less netted cash to adjusted EBITDA 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 our 2023 Credit Agreement. Both consolidated indebtedness and adjusted EBITDA as used in discussion of the 2023 Credit Agreement are terms that are not recognized under GAAP 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. For the year ended December 31, 2024, we did not repurchase shares under our share repurchase program and had approximately $774.5 million remaining under our share repurchase program.

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 manage our share repurchase program based on current and expected cash flows, share price and alternative investment opportunities. While the Mattress Firm acquisition was pending, we temporarily suspended our repurchase of shares. In 2025, we expect minimal share repurchases as we focus on debt repayment to reduce leverage to our target ratio of 2.0 to 3.0 times. 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," of this Report.

Future Liquidity Sources and Uses

As of December 31, 2024, we had $1,306.6 million of liquidity, including $117.4 million of cash on hand and $1,189.2 million available under our revolving senior secured credit facility. To fund the Mattress Firm acquisition on February 5, 2025, we subsequently borrowed $679.5 million on our revolving senior secured credit facility. 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.

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Our capital allocation strategy follows a balanced approach focused on supporting the business and 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 $0.15 per share for the first quarter of 2025. The dividend is payable on March 20, 2025 to shareholders of record as of March 6, 2025.

As of December 31, 2024, we had $3,844.5 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $2,134.8 million. Leverage based on the ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, was 2.31 times for the year ended December 31, 2024. Following the close of the Mattress Firm acquisition in 2025, our leverage ratio was approximately 3.5 times. We currently expect our target leverage ratio to return to 2.0 to 3.0 times in the first twelve months following the close of the transaction. Total cash interest payments related to our borrowings are expected to be between approximately $265 million to $275 million in 2025.

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.

Material Cash Requirements

Our material cash requirements as of December 31, 2024 are summarized below:

(1)Debt excludes finance lease obligations and deferred financing costs.

(2)Interest payments represent obligations under our debt outstanding as of December 31, 2024, applying December 31, 2024 interest rates and assuming scheduled payments are paid as contractually required through maturity.

(3)The payments due for finance lease obligations excludes $14.0 million in future payments for interest.

(4)Uncertain tax positions are excluded from this table given the timing of payments cannot be reasonably estimated.

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, adjusted EBITDA, 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.

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We believe that exclusion of these items assists in providing a more complete understanding of our underlying results from continuing 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 financial 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.

Key Highlights

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 years ended December 31, 2024 and 2023.

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

A reconciliation of gross profit and gross margin to adjusted gross profit and adjusted gross margin, respectively, and operating income (expense) and operating margin to adjusted operating income (expense) and adjusted operating margin, respectively, are 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 gross profit and operating income (expense) to the calculation of adjusted gross profit and adjusted operating income (expense) for the year ended December 31, 2024.

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The following table sets forth the reconciliation of our reported gross profit and operating income (expense) to the calculation of adjusted gross profit and adjusted operating income (expense) for the year ended December 31, 2023.

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 progress in reducing our leverage.

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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 years ended December 31, 2024 and 2023:

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Under the 2023 Credit Agreement, the definition of adjusted EBITDA contains certain restrictions that limit adjustments to net income when calculating adjusted EBITDA. For the year ended December 31, 2024, our adjustments to net income when calculating adjusted EBITDA did not exceed the allowable amount under the 2023 Credit Agreement.

The ratio of consolidated indebtedness less netted cash to adjusted EBITDA was 2.31 times for the trailing twelve months ended December 31, 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 December 31, 2024 and 2023. "Consolidated Indebtedness" and "Netted Cash" are terms used in the 2023 Credit Agreement for purposes of certain financial covenants.

Critical Accounting Estimates

Our management is responsible for our financial statements and has evaluated the accounting policies to be used in their preparation. Our management believes these policies are reasonable and appropriate. The following discussion identifies those accounting policies that we believe are critical in the preparation of our financial statements, the judgments and uncertainties affecting the application of those policies and the possibility that materially different amounts will be reported under different conditions or using different assumptions.

The preparation of financial statements in conformity with GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our actual results could differ from those estimates.

Revenue Recognition. Sales of product are recognized when the performance obligations under the terms of the contract with the customer are satisfied, which is generally when control of the product has transferred to the customer. Transferring control of each product sold is considered a separate performance obligation. We transfer control and recognize a sale when the product ships to the customer or when the customer receives the product based upon agreed shipping terms. Each unit sold is considered an independent, unbundled performance obligation. We do not have any additional performance obligations other than product sales that are material in the context of the contract. We extend volume discounts to certain customers and reflect these amounts as a reduction of net sales as variable consideration.

We allow product returns through certain sales channels and on certain products. The accrued sales returns in the accompanying Consolidated Balance Sheet, which include a current balance in accrued expenses and other current liabilities and a non-current balance in other non-current liabilities, was $44.2 million and $43.7 million as of December 31, 2024 and 2023, respectively. Estimated sales returns are provided at the time of sale based on historical sales channel return rates. Estimated future obligations related to these products are provided by a reduction of sales in the period in which the revenue is recognized. We considered the impact of recoverable salvage value on sales returns by product in determining its estimate of future sales returns. We recognized a return asset for the right to recover the goods returned by the customer. The right of return asset is recognized on a gross basis outside of the accrued sales returns and is not material to our Consolidated Balance Sheets. Our level of sales returns differs by channel, with our Direct channel typically experiencing a higher rate of returns. In the event future sales returns claims are higher than our historical experiences, such as a 50 basis point increase, the impact would not be material to the Consolidated Financial Statements.

The allowance for credit losses is our best estimate of the amount of estimated lifetime credit losses in our accounts receivable. The allowance for credit losses included in accounts receivable, net in the accompanying Consolidated Balance Sheets, was $80.4 million and $66.9 million as of December 31, 2024 and 2023, respectively. We regularly review the adequacy of our allowance for credit losses. We estimate losses over the contractual life using assumptions to capture the risk of loss, even if remote, based principally on how long a receivable has been outstanding. Account balances are charged off against the allowance for credit losses after all reasonable means of collection have been exhausted and the potential for recovery is considered remote. As of December 31, 2024, our accounts receivable were substantially current. Other factors considered include historical write-off experience, current economic conditions and also factors such as customer credit, past transaction history with the customer and changes in customer payment terms.

The credit environment in which our customers operate has been relatively stable over the past few years. Historically, less than 1.0% of net sales ultimately prove to be uncollectible. Total bad debt expense was $22.5 million in 2024, $8.2 million in 2023 and $6.7 million in 2022. If circumstances change, for example, due to the occurrence of higher-than-expected defaults or a significant adverse change in a major customer's ability to meet our financial obligations such as bankruptcies, estimates of the recoverability of receivable amounts due could be reduced.

We have not made any material changes in the accounting methodology we use to measure the estimated liability for sales returns or allowance for credit losses during the past three fiscal years.

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to establish the liability for sales returns and credit losses. However, if actual results are not consistent with our estimates or assumptions which are based on our historical experiences, we may be exposed to losses or gains that could be material.

Income Taxes. Accounting for income taxes requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities.

We recognize deferred tax assets in our Consolidated Balance Sheets, and these deferred tax assets typically represent items deducted currently from operating income in the financial statements that will be deducted in future periods in tax returns. A valuation allowance is recorded against certain deferred tax assets to reduce the consolidated deferred tax asset to an amount that will, more likely than not, be realized in future periods. At December 31, 2024, the valuation allowance of $48.1 million was primarily related to certain tax attributes both domestically and in various foreign jurisdictions. The valuation allowance is based, in part, on our estimate of future taxable income, the expected utilization of foreign and state tax loss carryforwards and credits and the expiration dates of such tax loss carryforwards.

We did not recognize tax benefits from uncertain tax positions within the provision for income taxes. We may recognize a tax benefit only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such positions are then measured based on the largest benefit that has a greater than 50% likelihood of being realized upon settlement. At December 31, 2024, our estimated gross unrecognized tax benefits were $2.1 million which, if recognized, would favorably impact our future earnings. Due to uncertainties in any tax audit outcome, our estimates of the ultimate settlement of our unrecognized tax positions may change and the actual tax benefits may differ significantly from the estimates.

We had previously been involved in a dispute with SKAT regarding the Danish Tax Matter for tax years 2012 through 2022. The matter was formally resolved in the three months ended December 31, 2023 with terms of the final resolution substantially identical as those preliminarily agreed to in the three months ended December 31, 2022. As a result of the resolution of the matter, there is no uncertain tax position reflected in our Consolidated Balance Sheet at either December 31, 2024 or 2023 related to the Danish Tax Matter. The resolution of this matter is discussed in Note 13, "Income Taxes," in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report.

Goodwill and Indefinite-Lived Intangible Assets. Goodwill and indefinite-lived intangible assets are evaluated for impairment annually as of October 1 and whenever events or circumstances make it more likely than not that impairment may have occurred or when required by accounting standards.

We test goodwill for impairment at the reporting unit level. Our reporting units are our North America segment, our International segment (excluding Dreams) and Dreams. We test individual indefinite-lived intangible assets at the brand level. These assessments may be performed quantitatively or qualitatively.

Using the quantitative approach, we make various estimates and assumptions in determining the estimated fair value of each reporting unit using a combination of discounted cash flow models and valuations based on earnings multiples for guideline public companies in each reporting unit's industry peer group, when externally quoted market prices are not readily available. Discounted cash flow models are reliant on various assumptions, including projected business results, long-term growth factors and weighted-average cost of capital. Management judgement is involved in estimating these variables, and they include inherent uncertainties as they are forecasting future events. We perform sensitivity analyses by using a range of inputs to confirm the reasonableness of the long-term growth rate and weighted average cost of capital. Additionally, we compare the indicated equity value to our market capitalization and evaluate the resulting implied control premium/discount to determine if the estimated enterprise value is reasonable compared to external market indicators.

Under the qualitative approach, we review macroeconomic conditions, industry and market conditions and entity specific factors, including strategies and financial performance for potential indicators of impairment.

In 2024, we did not make any changes to our reporting units or the accounting methodology we use to assess impairment loss on goodwill and indefinite-lived intangible assets, which included an assessment of the impairment of goodwill for our reporting units and indefinite-lived intangible assets using a quantitative approach. The results indicated that the fair values of each of our reporting units and indefinite-lived intangible assets were substantially in excess of their carrying values. Subsequent to our October 1, 2024 annual impairment test, no indications of impairment were identified.

We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to test for impairment losses on goodwill and indefinite-lived intangible assets. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to an impairment charge that could be material.