# SOMNIGROUP INTERNATIONAL INC. (SGI) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from SOMNIGROUP INTERNATIONAL INC.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1206264/000120626423000060/tpx-20221231.htm
Accession: 0001206264-23-000060
Filing date: 2023-02-17
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/SGI/
All MD&A years: /company/SGI/mda/
Previous year: /company/SGI/mda/fy2021/ (FY 2021)
Next year: /company/SGI/mda/fy2023/ (FY 2023)

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. 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, 2021 and 2020, 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 22, 2022.

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the years ended December 31, 2022 and 2021, 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.

15

Table of Contents

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 worldwide, we know how crucial a good night of sleep is to overall health and wellness. Utilizing over a century of knowledge and industry-leading innovation, we deliver award-winning products that provide breakthrough sleep solutions to consumers in over 100 countries.

We operate in two segments: North America and International. These segments are strategic business units that are managed separately based on geography. Our North America segment consists of manufacturing and distribution subsidiaries, joint ventures and licensees located in the U.S., Canada and Mexico. Our International segment consists of manufacturing and distribution subsidiaries, joint ventures and licensees located in Europe, Asia-Pacific and Latin America (other than Mexico). On August 2, 2021, we acquired Dreams Topco Limited and its direct and indirect subsidiaries ("Dreams"). Dreams is also included in the International segment. Corporate operating expenses are not included in either of the segments and are presented separately as a reconciling item to consolidated results. We evaluate segment performance based on net sales, gross profit and operating income. For additional information refer to Note 15, "Business Segment Information," included in Part II, ITEM 8 "Financial Statements and Supplementary Data", 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 700 company-owned and joint venture operated retail stores worldwide and our e-commerce channel.

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

General Business and Economic Conditions

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

Over the last decade, consumers have made the connection between a good night's sleep and overall health and wellness. 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 near term, we continue to see impacts on global consumer behavior from macroeconomic pressures, particularly from strong inflation and a sense of economic uncertainty. While we do not have any operations in Ukraine or Russia, the geopolitical events in Ukraine have affected both international and domestic markets. These events have introduced elements of risk into the supply chain and are affecting global consumer confidence, as it compounds global macroeconomic factors and uncertainty. Furthermore, international responses to the ongoing COVID-19 pandemic, including in China, continue to contribute elements of risk into the supply chain. While we have taken actions that we believe have largely mitigated our broader supply chain risk, the decline in consumer confidence has impacted our order trends, which we expect to continue.

In 2022, we implemented our global enterprise resource planning ("ERP") system at all Sealy domestic manufacturing facilities. The implementation of our common ERP system is expected to drive long-term efficiencies for our global operations, enhance cybersecurity, facilitate customer communications regarding order status and improve our direct-to-consumer capabilities.

Our recent actions to expand capacity, diversify our supplier base, increase our safety stock and improve vendor and customer communications have strengthened our supply chain, putting us in a more favorable position to meet consumer demand. Though geopolitical and pandemic-related disruptions continue to create challenges, we believe the many actions we have taken to further insulate our supply chain have largely mitigated their impact.

16

Table of Contents

Product Launches

In 2023, we plan to complete the rollout of a complete refresh of our North American Stearns & Foster® portfolio that began in 2022. The new line is designed to further distinguish our high-end traditional innerspring brand and includes superior technologies, clear product step-up stories and a new, contemporary look.

We also expect to launch a new portfolio of Tempur-Pedic® Breeze mattresses and Tempur-Ergo® Smart Bases in 2023. The new lineup of Tempur-Pedic® Breeze products build upon our successful legacy Breeze portfolio. The updated collection features incremental innovation and technologies that were designed to be a solution to the most common causes of poor sleep, including aches and pains, sleeping hot and snoring. The upgraded Tempur-Ergo® Smart Base assortment features improved ergonomic design with new, proprietary lumbar support, upgraded Sleeptracker-AI® technology and industry-leading relaxation modes, including Wave FormTM massage.

In our International segment, we are launching an all-new line of Tempur® products in over 90 markets through our wholly-owned subsidiaries and third-party distributors in 2023. 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 expand our global addressable market.

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 more than 26,000 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 strengthened these relationships in 2022, which we expect to support our sales growth in 2023.

We have been focused on building our direct channel, both online and company-owned retail stores in recent years. The development of our online business has been particularly important as consumers have grown more comfortable shopping for bedding products online. The direct channel growth rate has surpassed the wholesale growth rate over the last few years, and we anticipate the direct channel to continue to grow as a percentage of net sales in future years.

We currently operate over 700 retail stores globally through our wholly-owned and joint venture operations, led by over 200 Tempur-Pedic and Sleep Outfitters retail stores in the U.S. and over 200 Dreams locations in the U.K. We expect these retail stores to complement our existing third-party retail partners by increasing our products' brand awareness in the local markets.

We expanded our presence into the OEM market in 2020 by offering non-branded products, including mattresses, pillows and other bedding products and components at a wide range of price points. The addition of non-branded offerings expands our capabilities to service third-party retailers and creates opportunity to capture manufacturing profits from bedding brands outside our own. We made significant progress growing our OEM business in 2022 and continue to target obtaining a meaningful share of the OEM market in the long-term.

2022 Results of Operations

A summary of our results for the year ended December 31, 2022 include:

•Total net sales decreased 0.2% to $4,921.2 million as compared to $4,930.8 million in 2021.

•Gross margin was 41.6% as compared to 43.8% in 2021. Adjusted gross margin, which is a non-GAAP financial measure, was 42.0% in 2022. There were no adjustments to gross margin in 2021.

•Operating income was $680.6 million as compared to $912.3 million in 2021. Adjusted operating income, which is a non-GAAP financial measure, was $712.0 million as compared to $918.5 million in 2021.

•Net income was $455.7 million as compared to $624.5 million in 2021. Adjusted net income, which is a non-GAAP financial measure, was $467.9 million as compared to $651.7 million in 2021.

17

Table of Contents

•EPS decreased to $2.53 as compared to $3.06 in 2021. Adjusted EPS, which is a non-GAAP financial measure, was $2.60 as compared to $3.19 in 2021.

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

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

18

Table of Contents

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

[[GREPCENT_TABLE]]
[["(in millions, except percentages and","Year Ended December 31,"],["per common share amounts)","2022","","2021"],["Net sales","$","4,921.2","","","100.0","%","","$","4,930.8","","","100.0","%"],["Cost of sales","2,871.6","","","58.4","","","2,772.1","","","56.2"],["Gross profit","2,049.6","","","41.6","","","2,158.7","","","43.8"],["Selling and marketing expenses","992.5","","","20.2","","","923.1","","","18.7"],["General, administrative and other expenses","397.6","","","8.1","","","353.9","","","7.2"],["Equity income in earnings of unconsolidated affiliates","(21.1)","","","(0.4)","","","(30.6)","","","(0.6)"],["Operating income","680.6","","","13.8","","","912.3","","","18.5"],["Other expense, net:"],["Interest expense, net","103.0","","","2.1","","","66.3","","","1.3"],["Loss on extinguishment of debt","\u2014","","","\u2014","","","23.0","","","0.5"],["Other expense (income), net","0.4","","","\u2014","","","(1.0)","","","\u2014"],["Total other expense, net","103.4","","","2.1","","","88.3","","","1.8"],["Income from continuing operations before income taxes","577.2","","","11.7","","","824.0","","","16.7"],["Income tax provision","(119.0)","","","(2.4)","","","(198.3)","","","(4.0)"],["Income from continuing operations","458.2","","","9.3","","","625.7","","","12.7"],["Loss from discontinued operations, net of tax","(0.4)","","","\u2014","","","(0.7)","","","\u2014"],["Net income before non-controlling interest","457.8","","","9.3","","","625.0","","","12.7"],["Less: Net income attributable to non-controlling interest","2.1","","","\u2014","","","0.5","","","\u2014"],["Net income attributable to Tempur Sealy International, Inc.","$","455.7","","","9.3","%","","$","624.5","","","12.7","%"],["Earnings per common share:"],["Basic"],["Earnings per share for continuing operations","$","2.61","","","","","$","3.17"],["Loss per share for discontinued operations","\u2014","","","","","\u2014"],["Earnings per share","$","2.61","","","","","$","3.17"],["Diluted"],["Earnings per share for continuing operations","$","2.53","","","","","$","3.06"],["Loss per share for discontinued operations","\u2014","","","","","\u2014"],["Earnings per share","$","2.53","","","","","$","3.06"],["Weighted average common shares outstanding:"],["Basic","174.9","","","","","197.0"],["Diluted","180.3","","","","","204.3"]]
[[/GREPCENT_TABLE]]

19

Table of Contents

NET SALES

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","Consolidated","","North America","","International"],["(in millions)","2022","","2021","","","","2022","","2021","","","","2022","","2021"],["Net sales by channel"],["Wholesale","$","3,772.5","","","$","4,034.4","","","","","$","3,390.1","","","$","3,584.1","","","","","$","382.4","","","$","450.3"],["Direct","1,148.7","","","896.4","","","","","496.0","","","495.1","","","","","652.7","","","401.3"],["Total net sales","$","4,921.2","","","$","4,930.8","","","","","$","3,886.1","","","$","4,079.2","","","","","$","1,035.1","","","$","851.6"]]
[[/GREPCENT_TABLE]]

    Net sales decreased 0.2%, and on a constant currency basis increased 1.8%. The change in net sales was driven by the following:

•North America net sales decreased $193.1 million, or 4.7%. Net sales in the Wholesale channel decreased $194.0 million, or 5.4%, primarily driven by macroeconomic pressures impacting U.S. consumer behavior. Net sales in our Direct channel increased $0.9 million, or 0.2%.

•International net sales increased $183.5 million, or 21.5%. On a constant currency basis, our International net sales increased 32.4%. Net sales in the Wholesale channel decreased 5.6% on a constant currency basis. Net sales in the Direct channel increased 74.9% on a constant currency basis, driven by the acquisition of Dreams in August of 2021.

GROSS PROFIT

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","","","Margin Change"],["(in millions, except percentages)","Gross Profit","","Gross Margin","","Gross Profit","","Gross Margin","","","","","","2022 vs 2021"],["North America","$","1,487.3","","","38.3","%","","$","1,678.0","","","41.1","%","","","","","","(2.8)","%"],["International","562.3","","","54.3","%","","480.7","","","56.4","%","","","","","","(2.1)","%"],["Consolidated gross margin","$","2,049.6","","","41.6","%","","$","2,158.7","","","43.8","%","","","","","","(2.2)","%"]]
[[/GREPCENT_TABLE]]

    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 declined 220 basis points. The principal factors impacting gross margin for each segment are discussed below.

20

Table of Contents

•North America gross margin declined 280 basis points. The decline in gross margin was primarily driven by operational headwinds of 170 basis points and expense deleverage of 90 basis points. Additionally, we incurred $11.1 million of manufacturing ERP system transition costs, including labor, logistics, training and travel, and $5.8 million of operational start-up costs related to capacity expansion of our manufacturing and distribution facilities in the U.S., which contributed to the decline in gross margin.

•International gross margin declined 210 basis points. The decline in gross margin was primarily driven by unfavorable mix of 120 basis points, price increases to customers without a margin benefit of 80 basis points, and the acquisition of Dreams in August 2021. Dreams' margin profile is lower than our historical international margins as they sell a variety of products across a range of price points. The declines were partially offset by increased royalties of 70 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.

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","2022","","2021","","2022","","2021","","2022","","2021"],["(in millions)","Consolidated","","North America","","International","","Corporate"],["Operating expenses:"],["Advertising","$","448.0","","","$","432.8","","","$","375.1","","","$","368.6","","","$","72.9","","","$","64.2","","","$","\u2014","","","$","\u2014"],["Other selling and marketing","544.5","","","490.3","","","288.6","","","289.6","","","234.8","","","174.8","","","21.1","","","25.9"],["General, administrative and other","397.6","","","353.9","","","181.2","","","163.1","","","88.5","","","72.3","","","127.9","","","118.5"],["Total operating expense","$","1,390.1","","","$","1,277.0","","","$","844.9","","","$","821.3","","","$","396.2","","","$","311.3","","","$","149.0","","","$","144.4"]]
[[/GREPCENT_TABLE]]

    Operating expenses increased $113.1 million, or 8.9%, and increased 230 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 $23.6 million, or 2.9%, and increased 160 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by advertising investments and expansion of our company-owned store and e-commerce strategies. Additionally, we incurred $3.2 million of professional fees related to our manufacturing facility ERP system transition and $1.8 million of restructuring costs associated with headcount reductions. These investments were partially offset by decreased variable compensation expense.

•International operating expenses increased $84.9 million, or 27.3% and increased 170 basis points as a percentage of net sales. The increase in operating expenses was primarily driven by the acquisition of Dreams in August 2021. Additionally, we incurred $1.3 million of restructuring costs associated with headcount reductions.

•Corporate operating expenses increased $4.6 million, or 3.2%. The increase in operating expenses was primarily driven by $6.7 million of restructuring costs associated with professional fees and headcount reductions related to organizational changes. Additionally, we incurred $1.2 million of expenses related to our manufacturing facility ERP system transition. These expenses were partially offset by decreased variable compensation expense.

    Research and development expenses for the year ended December 31, 2022 were $29.2 million compared to $27.3 million for the year ended December 31, 2021, an increase of $1.9 million, or 7.0%.

21

Table of Contents

OPERATING INCOME

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["","2022","","2021","","","","Margin Change"],["(in millions, except percentages)","Operating Income","","Operating Margin","","Operating Income","","Operating Margin","","","","","","2022 vs 2021"],["North America","$","642.4","","","16.5","%","","$","856.7","","","21.0","%","","","","","","(4.5)","%"],["International","187.2","","","18.1","%","","200.0","","","23.5","%","","","","","","(5.4)","%"],["","829.6","","","","","1,056.7"],["Corporate expenses","(149.0)","","","","","(144.4)"],["Total operating income","$","680.6","","","13.8","%","","$","912.3","","","18.5","%","","","","","","(4.7)","%"]]
[[/GREPCENT_TABLE]]

    Operating income decreased $231.7 million and operating margin declined 470 basis points. The decrease was driven by the following:

•North America operating income decreased $214.3 million and operating margin declined 450 basis points. The decline in operating margin was primarily driven by the decline in gross margin of 280 basis points and operating expense deleverage of 140 basis points.

•International operating income decreased $12.8 million and operating margin declined 540 basis points. The decline in operating margin was primarily driven by the decline in gross margin of 210 basis points, operating expense deleverage of 190 basis points and the decline in Asia joint venture performance due to COVID-19 of 160 basis points.

•Corporate operating expenses increased $4.6 million, which negatively impacted our consolidated operating margin.

INTEREST EXPENSE, NET

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","","","Percent change"],["(in millions, except percentages)","2022","","2021","","","","2022 vs 2021"],["Interest expense, net","$","103.0","","","$","66.3","","","","","55.4","%"]]
[[/GREPCENT_TABLE]]

Interest expense, net, increased $36.7 million, or 55.4%. The increase in interest expense, net, was primarily driven by increased average levels of outstanding debt and higher interest rates on our variable rate debt.

LOSS ON EXTINGUISHMENT OF DEBT

In the first half of 2021, we issued our 2029 Senior Notes and we redeemed our 2023 Senior Notes and our 2026 Senior Notes. Accordingly, we incurred $23.0 million of loss on extinguishment of debt in 2021.

INCOME TAX PROVISION

[[GREPCENT_TABLE]]
[["","Year Ended December 31,","","Percent change"],["(in millions, except percentages)","2022","","2021","","2022 vs 2021"],["Income tax provision","$","119.0","","","$","198.3","","","(40.0)","%"],["Effective tax rate","20.6","%","","24.1","%","","(3.5)","%"]]
[[/GREPCENT_TABLE]]

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.

22

Table of Contents

Our income tax provision decreased $79.3 million due to a decrease in income before income taxes and the favorable impact of discrete items. Our 2022 effective tax rate decreased as compared to 2021 by 350 basis points. The effective tax rate as compared to the U.S. federal statutory tax rate for 2022 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 release of reserves for uncertain tax positions related to a tax matter in Denmark. The effective tax rate as compared to the U.S. federal statutory tax rate for 2021 included the impact of net favorable discrete items primarily related to excess tax benefits from the vesting of certain stock awards under our incentive stock compensation plan.

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, 2022, we had net working capital of $214.0 million, including cash and cash equivalents of $69.4 million, as compared to working capital of $222.2 million, including cash and cash equivalents of $300.7 million, as of December 31, 2021.

At December 31, 2022, total cash and cash equivalents were $69.4 million, of which $37.3 million was held in the U.S. and $32.1 million was held by subsidiaries outside of the U.S. The amount of cash and cash equivalents held by subsidiaries outside of the U.S. and not readily convertible into the U.S. Dollar or other major foreign currencies is not material to our overall liquidity or financial position.

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, 2022 and 2021.

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["(in millions)","","2022","","2021"],["Net cash provided by (used in) continuing operations:"],["Operating activities","","$","378.8","","","$","723.1"],["Investing activities","","(315.3)","","","(554.8)"],["Financing activities","","(279.1)","","","76.5"]]
[[/GREPCENT_TABLE]]

Cash provided by operating activities from continuing operations decreased $344.3 million in 2022 as compared to 2021. The decrease in cash provided by operating activities was driven by increased inventory investments, as well as the reduction of net income. Our inventory increased significantly during the year ended 2022 as we increased our safety stock of Tempur-Pedic® finished goods, adjustable bases and raw materials to better support our customers.

Cash used in investing activities from continuing operations decreased $239.5 million in 2022 as compared to 2021. The decrease in cash used in investing activities was driven by the acquisition of Dreams in August 2021, which was partially offset by increased capital expenditures in 2022.

Cash used in financing activities from continuing operations increased $355.6 million in 2022 as compared to 2021. In 2022, we had net funding of $474.5 million as compared to net funding of $979.3 million in 2021 from our credit facilities. This decrease was driven by proceeds of $1.6 billion from the issuance of our 2029 and 2031 Senior Notes, offset by repayments of $250.0 million of our 2023 Senior Notes and $600.0 million of our 2026 Senior Notes in 2021. In 2022, we repurchased shares of our common stock for $667.4 million as compared to $816.3 million in 2021.

23

Table of Contents

Cash (Used in) Provided by Discontinued Operations

Net cash (used in) provided by operating, investing and financing activities from discontinued operations for the years ended December 31, 2022 and 2021 was not material.

Capital Expenditures

Capital expenditures totaled $306.5 million and $123.3 million for the year ended December 31, 2022 and 2021, respectively. We currently expect our 2023 capital expenditures to decrease significantly to approximately $200 million, which includes investments to complete our manufacturing capacity expansion.

Indebtedness

Our total debt increased to $2,830.8 million as of December 31, 2022 from $2,353.2 million as of December 31, 2021. Total availability under our revolving senior secured credit facility was $387.4 million as of December 31, 2022, which matures in 2024.

As of December 31, 2022, our ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure defined in the 2019 Credit Agreement, was 3.10 times. This ratio is within the terms of the financial covenants for the maximum consolidated total net leverage ratio as set forth in the 2019 Credit Agreement, which limits this ratio to 5.00 times. As of December 31, 2022, 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 2019 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 3.5 times. 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 3.5 times. The limit on restricted payments under the 2019 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 2019 Credit Agreement. Both consolidated indebtedness and adjusted EBITDA as used in discussion of the 2019 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, 2022, we repurchased 18.6 million shares under our share repurchase program for approximately $621.2 million and had approximately $779.5 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.    

In 2023, subject to market conditions, we expect to repurchase at least 5.0% of common shares outstanding. We will manage our share repurchase program based on current and expected cash flows, share price and alternative investment opportunities. 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.

24

Table of Contents

Future Liquidity Sources and Uses

As of December 31, 2022, we had $464.8 million of liquidity, including $69.4 million of cash on hand and $387.4 million available under our revolving senior secured credit facility and $8.0 million available under our securitization 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, share repurchases and debt service obligations.

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

The Board of Directors declared a dividend of $0.11 per share for the first quarter of 2023. The dividend is payable on March 9, 2023 to shareholders of record as of February 23, 2023.

As of December 31, 2022, we had $2,830.8 million in total debt outstanding and consolidated indebtedness less netted cash, which is a non-GAAP financial measure, of $2,762.6 million. Leverage based on the ratio of consolidated indebtedness less netted cash to adjusted EBITDA, which is a non-GAAP financial measure, was 3.10 times for the year ended December 31, 2022. We expect our leverage ratio to return to our target range of 2.0 to 3.0 times in 2023.

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. For information regarding the impact of COVID-19 on our business, including our liquidity and capital resources, please refer to "Risk Factors" in ITEM 1A of Part I of this Report.

Material Cash Requirements

Our material cash requirements as of December 31, 2022 are summarized below:

[[GREPCENT_TABLE]]
[["(in millions)","","Payment Due By Period"],["Contractual Obligations","","2023","","2024","","2025","","2026","","2027","","Thereafter","","Total Obligations"],["Debt (1)","","$","196.5","","","$","921.4","","","$","\u2014","","","$","\u2014","","","$","\u2014","","","$","1,634.1","","","$","2,752.0"],["Letters of credit","","27.4","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","\u2014","","","27.4"],["Interest payments (2)","","102.9","","","96.5","","","64.7","","","64.7","","","64.7","","","160.6","","","554.1"],["Operating lease obligations","","123.7","","","109.5","","","94.2","","","79.3","","","67.3","","","165.6","","","639.6"],["Finance lease obligations (3)","","13.2","","","11.0","","","9.6","","","9.9","","","8.9","","","26.1","","","78.7"],["Pension obligations","","1.1","","","1.2","","","1.3","","","1.3","","","1.5","","","23.7","","","30.1"],["Total (4)","","$","464.8","","","$","1,139.6","","","$","169.8","","","$","155.2","","","$","142.4","","","$","2,010.1","","","$","4,081.9"]]
[[/GREPCENT_TABLE]]

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

(2)Interest payments represent obligations under our debt outstanding as of December 31, 2022, applying December 31, 2022 interest rates and assuming scheduled payments are paid as contractually required through maturity.

(3)The payments due for finance lease obligations excludes $15.2 million in future payments for interest.

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

25

Table of Contents

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.

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

[[GREPCENT_TABLE]]
[["","","","Year Ended December 31,"],["(in millions, except percentages and per common share amounts)","","","","","","","","","2022","","2021","","% Change"],["Net sales","","","","","","","","","$","4,921.2","","","$","4,930.8","","","(0.2)","%"],["Net income","","","","","","","","","$","455.7","","","$","624.5","","","(27.0)","%"],["Adjusted net income (1)","","","","","","","","","$","467.9","","","$","651.7","","","(28.2)","%"],["EPS","","","","","","","","","$","2.53","","","$","3.06","","","(17.3)","%"],["Adjusted EPS (1)","","","","","","","","","$","2.60","","","$","3.19","","","(18.5)","%"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","","Non-GAAP financial measure. Please refer to the reconciliations in the following tables."]]
[[/GREPCENT_TABLE]]

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, 2022 and 2021.

26

Table of Contents

[[GREPCENT_TABLE]]
[["","Year Ended December 31,"],["(in millions, except per common share amounts)","2022","","2021"],["Net income","$","455.7","","","$","624.5"],["Loss from discontinued operations, net of tax (1)","0.4","","","0.7"],["ERP system transition (2)","15.5","","","\u2014"],["Restructuring costs (3)","10.0","","","\u2014"],["Operational start-up costs (4)","6.5","","","\u2014"],["Loss on extinguishment of debt (5)","\u2014","","","23.0"],["Acquisition-related costs (6)","\u2014","","","6.2"],["Overlapping interest expense (7)","\u2014","","","5.2"],["Danish tax matter(8)","(12.3)","","","\u2014"],["Adjusted income tax provision (9)","(7.9)","","","(7.9)"],["Adjusted net income","$","467.9","","","$","651.7"],["Adjusted earnings per share, diluted","$","2.60","","","$","3.19"],["Diluted shares outstanding","180.3","","","204.3"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","Certain subsidiaries in the International business segment are accounted for as discontinued operations and have been designated as unrestricted subsidiaries in the 2019 Credit Agreement. Therefore, these subsidiaries are excluded from our adjusted financial measures for covenant compliance purposes."],["(2)","We recorded $15.5 million of charges related to the transition of our ERP system in the year ended 2022. Cost of sales included $11.1 million of manufacturing facility ERP system transition costs, including labor, logistics, training and travel. Operating expenses included $4.4 million, primarily related to professional fees."],["(3)","We recorded $10.0 million of restructuring costs primarily associated with professional fees and headcount reductions related to organizational changes in the year ended 2022, including $0.2 million of other expense."],["(4)","We recorded $6.5 million of operational start-up costs related to the capacity expansion of our manufacturing and distribution facilities in the U.S. in the year ended 2022, including $0.4 million of other expense. Cost of sales and operating expenses included personnel and facility related costs of $5.8 million and $0.3 million, respectively."],["(5)","In the year ended December 31, 2021, we recognized $23.0 million of loss on extinguishment of debt associated with the redemption of the 2026 and 2023 senior notes."],["(6)","In the year ended December 31, 2021, we recognized $6.2 million of acquisition-related costs, primarily related to legal and professional fees and stamp taxes associated with the acquisition of Dreams."],["(7)","In the year ended December 31, 2021, we incurred $5.2 million of overlapping interest expense during the period between the issuance of the 2029 Senior Notes and the redemption of the 2026 Senior Notes."],["(8)","The Company recorded an income tax benefit, on a net basis, of $12.3 million related to its Danish tax matter in the fourth quarter of 2022. In December 2022, the Danish tax authority and the IRS agreed on a preliminary framework to conclude the Company's Danish tax matter for the years 2012 through 2024."],["(9)","Adjusted income tax provision represents the tax effects associated with the aforementioned items, excluding the income tax benefit for the Danish tax matter."]]
[[/GREPCENT_TABLE]]

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, 2022.

27

Table of Contents

[[GREPCENT_TABLE]]
[["","FULL YEAR 2022"],["(in millions, except percentages)","Consolidated","","Margin","","North America","","Margin","","International","","Margin","","Corporate"],["Net sales","$","4,921.2","","","","","$","3,886.1","","","","","$","1,035.1","","","","","$","\u2014"],["Gross profit","$","2,049.6","","","41.6","%","","$","1,487.3","","","38.3","%","","$","562.3","","","54.3","%","","$","\u2014"],["Adjustments:"],["ERP system transition (1)","11.1","","","","","11.1","","","","","\u2014","","","","","\u2014"],["Operational start-up costs (2)","5.8","","","","","5.8","","","","","\u2014","","","","","\u2014"],["Total adjustments","16.9","","","","","16.9","","","","","\u2014","","","","","\u2014"],["Adjusted gross profit","$","2,066.5","","","42.0","%","","$","1,504.2","","","38.7","%","","$","562.3","","","54.3","%","","$","\u2014"],["Operating income (expense)","$","680.6","","","13.8","%","","$","642.4","","","16.5","%","","$","187.2","","","18.1","%","","$","(149.0)"],["Adjustments:"],["ERP system transition (1)","15.5","","","","","14.3","","","","","\u2014","","","","","1.2"],["Restructuring costs (3)","9.8","","","","","1.8","","","","","1.3","","","","","6.7"],["Operational start-up costs (2)","6.1","","","","","6.1","","","","","\u2014","","","","","\u2014"],["Total adjustments","31.4","","","","","22.2","","","","","1.3","","","","","7.9"],["Adjusted operating income (expense)","$","712.0","","","14.5","%","","$","664.6","","","17.1","%","","$","188.5","","","18.2","%","","$","(141.1)"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","We recorded $15.5 million of charges related to the transition of our ERP system in the year ended 2022. Cost of sales included $11.1 million of manufacturing facility ERP system transition costs, including labor, logistics, training and travel. Operating expenses included $4.4 million, primarily related to professional fees."],["(2)","We recorded $6.5 million of operational start-up costs related to the capacity expansion of our manufacturing and distribution facilities in the U.S. in the year ended 2022, including $0.4 million of other expense. Cost of sales and operating expenses included personnel and facility related costs of $5.8 million and $0.3 million, respectively."],["(3)","We recorded $10.0 million of restructuring costs in the year ended 2022. These costs were primarily associated with professional fees and headcount reductions related to organizational changes, including $0.2 million of other expense."]]
[[/GREPCENT_TABLE]]

The following table sets forth our reported gross profit and the reconciliation of our operating income (expense) to the calculation of adjusted operating income (expense) for the year ended December 31, 2021. We had no adjustments to gross profit for the year ended December 31, 2021.

[[GREPCENT_TABLE]]
[["","FULL YEAR 2021"],["(in millions, except percentages)","Consolidated","","Margin","","North America","","Margin","","International","","Margin","","Corporate"],["Net sales","$","4,930.8","","","","","$","4,079.2","","","","","$","851.6","","","","","$","\u2014"],["Gross profit","$","2,158.7","","","43.8","%","","$","1,678.0","","","41.1","%","","$","480.7","","","56.4","%","","$","\u2014"],["Operating income (expense)","$","912.3","","","18.5","%","","$","856.7","","","21.0","%","","$","200.0","","","23.5","%","","$","(144.4)"],["Adjustments:"],["Acquisition-related costs (1)","6.2","","","","","\u2014","","","","","2.3","","","","","3.9"],["Adjusted operating income (expense)","$","918.5","","","18.6","%","","$","856.7","","","21.0","%","","$","202.3","","","23.8","%","","$","(140.5)"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","In the year ended December 31, 2021, we recognized $6.2 million of acquisition-related costs, primarily related to legal and professional fees and stamp taxes associated with the acquisition of Dreams."]]
[[/GREPCENT_TABLE]]

28

Table of Contents

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.

The 2019 Credit Agreement provides the definition of adjusted EBITDA. Accordingly, we present adjusted EBITDA to provide information regarding our compliance with requirements under the 2019 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, 2022 and 2021:

[[GREPCENT_TABLE]]
[["","Year Ended"],["(in millions)","December 31, 2022","","December 31, 2021"],["Net income","$","455.7","","$","624.5"],["Interest expense, net","103.0","","61.1"],["Income tax provision","119.0","","198.3"],["Depreciation and amortization","182.0","","176.6"],["Overlapping interest expense (1)","\u2014","","5.2"],["Loss on extinguishment of debt (2)","\u2014","","23.0"],["EBITDA","$","859.7","","$","1,088.7"],["Adjustments:"],["Loss from discontinued operations, net of tax (3)","0.4","","0.7"],["ERP system transition (4)","15.5","","\u2014"],["Restructuring costs (5)","10.0","","\u2014"],["Operational start-up costs (6)","6.5","","\u2014"],["Acquisition-related costs (7)","\u2014","","6.2"],["Earnings from Dreams prior to acquisition (8)","\u2014","","40.3"],["Adjusted EBITDA","$","892.1","","$","1,135.9"],["Consolidated indebtedness less netted cash","$","2,762.6","","$","2,053.7"],["Ratio of consolidated indebtedness less netted cash to adjusted EBITDA","3.10","times","","1.81","times"]]
[[/GREPCENT_TABLE]]

29

Table of Contents

[[GREPCENT_TABLE]]
[["(1)","In the year ended December 31, 2021, we incurred $5.2 million of overlapping interest expense during the period between the issuance of the 2029 Senior Notes and the redemption of the 2026 Senior Notes."],["(2)","In the year ended December 31, 2021, we recognized $23.0 million of loss on extinguishment of debt associated with the redemption of the 2026 and 2023 senior notes."],["(3)","Certain subsidiaries in the International business segment are accounted for as discontinued operations and have been designated as unrestricted subsidiaries in the 2019 Credit Agreement. Therefore, these subsidiaries are excluded from our adjusted financial measures for covenant compliance purposes."],["(4)","We recorded $15.5 million of charges related to the transition of our ERP system in the year ended 2022."],["(5)","We recorded $10.0 million of restructuring costs primarily associated with professional fees and headcount reductions related to organization changes in the year ended 2022."],["(6)","We recorded $6.5 million of operational start-up costs related to the capacity expansion of our manufacturing and distribution facilities in the U.S in the year ended 2022."],["(7)","In the year ended December 31, 2021, we recognized $6.2 million of acquisition-related costs, primarily related to legal and professional fees and stamp taxes associated with the acquisition of Dreams."],["(8)","We completed the acquisition of Dreams on August 2, 2021 and designated this subsidiary as restricted under the 2019 Credit Agreement. For covenant compliance purposes, we included $40.3 million of EBITDA from this subsidiary for the seven months prior to acquisition in our calculation of adjusted EBITDA for the year ended December 31, 2021."]]
[[/GREPCENT_TABLE]]

Under the 2019 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, 2022, our adjustments to net income when calculating adjusted EBITDA did not exceed the allowable amount under the 2019 Credit Agreement.

The ratio of consolidated indebtedness less netted cash to adjusted EBITDA was 3.10 times for the trailing twelve months ended December 31, 2022. The 2019 Credit Agreement requires us to maintain a ratio of consolidated indebtedness less netted cash to adjusted EBITDA of less than 5.00:1.00 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, 2022 and 2021. "Consolidated Indebtedness" and "Netted Cash" are terms used in the 2019 Credit Agreement for purposes of certain financial covenants.

[[GREPCENT_TABLE]]
[["(in millions)","December 31, 2022","","December 31, 2021"],["Total debt, net","$","2,810.3","","","$","2,331.5"],["Plus: Deferred financing costs (1)","20.5","","","21.7"],["Consolidated indebtedness","2,830.8","","","2,353.2"],["Less: Netted cash (2)","68.2","","","299.5"],["Consolidated indebtedness less netted cash","$","2,762.6","","","$","2,053.7"]]
[[/GREPCENT_TABLE]]

[[GREPCENT_TABLE]]
[["(1)","We present deferred financing costs as a direct reduction from the carrying amount of the related debt in the Consolidated Balance Sheets. For purposes of determining total debt for financial covenant purposes, we added these costs back to total debt, net as calculated per the Consolidated Balance Sheets."],["(2)","Netted cash includes cash and cash equivalents for domestic and foreign subsidiaries designated as restricted subsidiaries in the 2019 Credit Agreement."]]
[[/GREPCENT_TABLE]]

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 $40.5 million and $49.8 million as of December 31, 2022 and 2021, 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 impacts 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 $62.4 million and $62.1 million as of December 31, 2022 and 2021, 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, 2022, 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. However, there have been signs of deterioration in the U.S. retail sector, with certain key retailer bankruptcies over the last few years. Total bad debt expense was $6.7 million in 2022, $2.7 million in 2021 and $35.8 million in 2020 which were predominantly related to customer bankruptcies which were current on payments at the time proceedings began. 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, 2022 the valuation allowance of $42.3 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, 2022, our estimated gross unrecognized tax benefits were $39.0 million of which $17.6 million, 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 have been involved in a dispute with SKAT regarding the Danish Tax Matter for tax years 2001 through current. The royalty is paid by the U.S. subsidiary for the right to utilize certain intangible assets owned by the Danish subsidiary in the U.S. production process.

We have entered into the Advance Pricing Agreement ("APA") Program for the tax years 2012 to 2024 in which the IRS, on our behalf, has been negotiating directly with SKAT with respect to the royalty to be paid by the U.S. subsidiary to the Danish subsidiary. We maintain an uncertain income tax liability for the 2012 to 2022 tax years that are included in the APA Program. If we are required to further increase the uncertain tax liability for any year after the 2012 to 2022 tax years based on a change in facts and circumstances, it could have a material impact on our reported earnings.

During the quarter ended December 31, 2022, pursuant to the negotiations described above with respect to the APA Program, SKAT and the IRS preliminarily concluded on a mutually acceptable framework ("Preliminary Framework") to resolve the Danish Tax Matter for the 2012 to 2022 tax years. It is expected the Preliminary Framework will be formally agreed upon in the next twelve months. If ultimately agreed upon by the two tax authorities, the terms of the Preliminary Framework would extend to the years 2023 and 2024, as well. The Preliminary Framework is not a definitive agreement, but its terms provide updated definitive data for the Company to determine the potential Danish income tax exposure for the 2012 to 2022 tax years as well as the associated deferred tax asset for the U.S. correlative benefit for such period. Further, if the IRS and SKAT are unable to reach a definitive agreement with respect to the tax years included in the APA Program, we could be required to make a significant payment to SKAT for Danish tax, interest and penalties related to such years, which could have a material adverse effect on our results of operations and liquidity.

Our liability for the Danish Tax Matter uncertain tax position is derived using a cumulative probability analysis with possible outcomes based on an evaluation of the facts and circumstances and applying the technical requirements applicable to U.S., Danish and the international transfer pricing standards, taking into account both the U.S. and Danish income tax implications of such outcomes. The key assumption in these outcomes is that the IRS and SKAT ultimately finalize the APA within the parameters of the Preliminary Framework discussed in Note 13, "Income Taxes" of the Consolidated Financial Statements.

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. Dreams was added as a separate reporting unit upon acquisition of the business on August 2, 2021. 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.

We have not made any changes in 2022 to our reporting units or the accounting methodology we use to assess impairment loss on goodwill and indefinite-lived intangible assets. Prior to 2021, Management performed an assessment of the impairment of goodwill for our reporting units and indefinite-lived intangible assets using a quantitative approach, which indicated that the fair values of each of our reporting units and indefinite-lived intangible assets were substantially in excess of their carrying values. In 2022, we elected to qualitatively perform our annual impairment analysis for all reporting units and indefinite-lived intangible assets. Subsequent to our October 1, 2022 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.