Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on October 17, 2003

Registration No. 333-                    


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933


TWI Holdings, Inc.

(Exact name of registrant as specified in its charter)


Delaware   2510   33-1022198
(State or other jurisdiction of incorporation or organization)   (Primary Standard Industrial Classification Code Number)  

(I.R.S. Employer

Identification Number)

 

1713 Jaggie Fox Way

Lexington, Kentucky 40511

800-878-8889

(Address, including zip code, and telephone number, including

area code, of the registrant’s principal executive offices)


Robert B. Trussell, Jr., President and Chief Executive Officer

Tempur World, Inc.

1713 Jaggie Fox Way

Lexington, Kentucky 40511

800-878-8889

(Name, address, including zip code, and telephone number, including

area code, of agent for service)


Copies to:

 

John R. Utzschneider, Esq.

Bingham McCutchen LLP

150 Federal Street

Boston, MA 02110

617-951-8000

 

Jeremy W. Dickens, Esq.

Weil, Gotshal & Manges LLP

767 Fifth Avenue

New York, NY 10153

212-310-8000


Approximate date of commencement of proposed sale to the public:    As soon as practicable after the effective date of this Registration Statement.

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act, check the following box. ¨

If this form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If this form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. ¨

If delivery of the Prospectus is expected to be made pursuant to Rule 434, please check the following box. ¨


CALCULATION OF REGISTRATION FEE

 


Title of Each Class of

Securities to be Registered

  

Amount

to be Registered

   Proposed
Maximum
Offering Price
Per Share
   Proposed
Maximum
Aggregate
Offering Price(1)
   Amount of
Registration Fee(2)

Common Stock, par value $0.01 per share

        $                    $300,000,000    $24,270


(1) Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Calculated pursuant to Rule 457(a) based on an estimate of the proposed maximum aggregate offering price.

 


THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE.



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The information in this prospectus is not complete and may be changed. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This prospectus is not an offer to sell these securities, and we are not soliciting offers to buy these securities in any state or jurisdiction where the offer or sale is not permitted.

 

Subject to Completion, dated                     , 2003

 

PROSPECTUS

 

 

             Shares

 

LOGO

 

TWI HOLDINGS, INC.

 

Common Stock

 


 

This is our initial public offering of common stock. We are offering              shares and the selling stockholders identified in this prospectus are offering             shares. No public market currently exists for our shares. We will not receive any proceeds from the sale of the shares offered by the selling stockholders.

 

We intend to apply to have our common stock listed on the New York Stock Exchange under the symbol “        .” We currently estimate that the initial public offering price will be between $             and $             per share.

 

Investing in the shares involves risks. Risk Factors begin on page 13.

 

     Per Share

   Total

Public offering price

   $                         $                     

Underwriting discount

   $      $     

Proceeds to TWI Holdings, Inc. (before expenses)

   $         $     

Proceeds to selling stockholders

   $         $     

 

The selling stockholders have granted the underwriters a 30-day option to purchase up to an aggregate of                  additional shares of common stock on the same terms and conditions as set forth above to cover over-allotments, if any.

 

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined if this prospectus is accurate or complete. Any representation to the contrary is a criminal offense.

 

Lehman Brothers, on behalf of the underwriters, expect to deliver the shares on or about             , 2003.

 


 

LEHMAN BROTHERS                 


 

                     , 2003


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   13

Special Note Regarding Forward-Looking Statements

   23

Use of Proceeds

   25

Dividend Policy

   25

Capitalization

   26

Dilution

   27

Unaudited Pro Forma Financial Information

   28

Selected Historical Consolidated Financial and Operating Data

   36

Management’s Discussion and Analysis of Financial Condition and Results of
Operations

   39

Business

   54

 

     Page

Management

   66
Principal and Selling Stockholders    74

Certain Relationships and Related Party Transactions

   77
Description of Capital Stock    79
Shares Eligible for Future Sale    82

Certain U.S. Federal Income Tax Considerations for Non-U.S. Holders of our Common Stock

   84
Underwriting    86
Legal Matters    92
Experts    92

Where You Can Find More Information

   93
Index to Historical Financial Statements    F-1

 

ABOUT THIS PROSPECTUS

 

You should rely only on the information contained in this prospectus. We have not, and the underwriters have not, authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not, and the underwriters are not, making an offer to sell these securities in any jurisdiction where an offer or sale is not permitted. You should assume that the information appearing in this prospectus is accurate as of the date on the front cover of this prospectus only. Our business, financial condition, results of operations and prospectus may have changed since that date.

 

Through and including                     , 2003 (the 25th day after the date of this prospectus), all dealers effecting transactions in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligations to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

 


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PROSPECTUS SUMMARY

 

This summary highlights selected information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider before investing in shares of our common stock. We encourage you to read this entire prospectus carefully, including “Risk Factors” beginning on page 13 and our consolidated financial statements and the notes to those financial statements beginning on page F-1, before making an investment decision. Unless otherwise noted, all of the financial information in this prospectus is consolidated financial information for TWI Holdings, Inc. or its predecessors. As used in this prospectus, the terms “TWI” and “TWI Holdings” refer to TWI Holdings, Inc. only and the terms “we,” “our,” “ours” and “us” refer to TWI Holdings and its consolidated subsidiaries. Unless otherwise noted in this prospectus, all references to dollars are to United States dollars.

 

TWI Holdings

 

We are a rapidly growing, vertically-integrated manufacturer, marketer and distributor of premium visco-elastic foam mattresses and pillows that we sell globally in 54 countries primarily under the Tempur® and Tempur-Pedic® brands. We believe our premium mattresses and pillows are more comfortable than standard bedding products because our proprietary visco-elastic foam is temperature sensitive, has a high density and conforms to the body to therapeutically align the neck and spine, thus reducing neck and lower back pain, two of the most common complaints about other sleep surfaces. In April 2003, Consumers Digest named one of our products among the eight “best buys” of the mattress industry in the applicable price range because of the strong value our products provide to consumers. Consumer surveys commissioned on our behalf over the last several years have indicated that our products achieve satisfaction ratings generally ranging from 80% to 92%. Since 2000, our total net sales have grown at a compound annual rate of approximately 36% and for the pro forma as adjusted twelve months ended June 30, 2003, we had total net sales of $387.0 million.

 

We sell our products through four distribution channels: retail (furniture and specialty stores, as well as department stores internationally); direct (direct response and internet); healthcare (chiropractors, medical retailers, hospitals and other healthcare channels); and third party distributors. In the United States, we sell a majority of our mattresses and pillows through furniture and specialty retailers. We also have a direct response business that generates product sales. International sales account for approximately 45% of our total net sales, with the United Kingdom, Germany, France, Spain and Japan representing our largest markets. In Asia, our net sales consist primarily of pillows. Internationally, in addition to sales through our retail channel, we sell a significant amount of our products through the healthcare channel and third party distributors.

 

The International Sleep Products Association (ISPA) estimates that the United States wholesale market for mattresses and foundations in 2002 was approximately $4.8 billion. We believe the international mattress market is generally the same size as the domestic mattress market. The international market consists primarily of sales in Canada and Europe. According to ISPA, from 1991 to 2002 mattress unit sales grew in the United States at an average of approximately 500,000 units annually, with 21.5 million mattress units sold in the United States in 2002. We believe a similar number of mattress units were sold outside the United States in 2002. ISPA further estimates that approximately 20% of those mattress units were sold at retail price points greater than $1,000, which is the premium segment of the market we target. According to ISPA, the premium segment of the market grew in the United States at an annual rate of 32% in 2002, and is the fastest-growing segment of this market.

 

Most standard mattresses are made using innersprings and most innerspring mattresses are sold for under $1,000, primarily through retail furniture and bedding stores. Alternatives to standard and premium innerspring mattresses include visco-elastic and other foam mattresses, as well as airbeds and waterbeds. Four large manufacturers (Sealy Corporation, Serta, Inc., Simmons Company and The Spring Air Company) dominate the standard innerspring mattress market in the United States, accounting for approximately 60% of wholesale

 

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mattress dollar sales in 2001 according to Furniture/Today, a trade publication. The balance of the United States wholesale mattress market is fragmented, with a large number of other manufacturers, many of which operate primarily on a regional basis. Standard innerspring mattresses represent approximately 80% of the overall mattress market in the United States.

 

The medical community is also a large consumer of mattresses to furnish hospitals and nursing homes. In the United States, there are over 15,400 nursing homes with a total bed count in excess of 1.7 million. Medical facilities typically purchase twin mattresses with standard operating functions such as adjustable height and mechanisms to turn patients to prevent pressure ulcers (or bedsores). We believe demographic trends suggest that as the population ages, the healthcare market for mattresses will continue to grow.

 

Based on our market research, we estimate that the United States retail market for pillows is approximately $1.1 billion. The United States pillow market has a traditional and specialty segment. Traditional pillows are generally made of low cost foam or feathers, other than down. Specialty pillows include all alternatives to traditional pillows, including visco-elastic and other foam, sponge rubber and down. We estimate that specialty pillows accounted for approximately 27%, or $300.0 million, of retail sales in the United States in 1999. We believe the international pillow market is generally the same size as the domestic pillow market.

 

We believe we are the leading global manufacturer, marketer and distributor of visco-elastic foam mattresses and pillows, and we estimate we had an approximate 70% market share in 2002 in both the United States and internationally. We believe consumer demand for our premium products in the United States is being driven primarily by increased housing and home furnishing purchases by the baby boom generation, significant growth in our core demographic market as the baby boom generation ages, increased awareness of the health benefits of a better quality mattress, and shifting consumer preference from firmness to comfort. Our net sales of mattresses, including overlays, have increased from $79.3 million in 2000 to $156.0 million in 2002 (a 40.3% compound annual growth rate), and net sales of pillows have increased from $63.1 million in 2000 to $91.2 million in 2002 (a 20.3% compound annual growth rate). As consumers continue to prefer alternatives to standard innerspring mattresses, our products become more widely available and our brand gains broader consumer recognition, we expect that our premium products will continue to attract sales away from the standard mattress market.

 

Our principal executive office is located at 1713 Jaggie Fox Way, Lexington, Kentucky 40511 and our telephone number is (800) 878-8889. We were incorporated under the laws of the State of Delaware in September 2002.

 

Competitive Strengths

 

We believe we are well-positioned for continued growth in our target markets, and that the following competitive strengths differentiate us from our competitors:

 

 

Superior Product Offering.    Our proprietary visco-elastic foam mattresses and pillows contour to the body more naturally and provide better spinal alignment, reduced pressure points, greater relief of lower back and neck pain and better quality sleep than traditional bedding products. We believe the benefits of our products have become widely recognized, as evidenced by the more than 25,000 healthcare professionals who recommend our products, and the approval of one or more of our products for purchase or reimbursement by the government healthcare agencies in several European countries. Consumer surveys commissioned on our behalf over the last several years indicate that our products achieve satisfaction ratings generally ranging from 80% to 92%. Net sales of our mattresses, including overlays, have increased from $116.8 million in 2001 to $156.0 million in 2002, and net sales of our

 

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pillows have increased from $75.3 million in 2001 to $91.2 million in 2002. Further, we continue to leverage our unique and proprietary manufacturing process to develop new products and refine existing products to meet the changing demands and preferences of consumers. Our innovative products distinguish us from the major manufacturers of standard innerspring mattresses and traditional pillows in the United States, which we believe offer generally similar products and must compete primarily on price.

 

  Increasing Global Brand Awareness.    We believe consumers in the United States and internationally increasingly associate our brand name with premium quality products that enable better overall sleep. We sell our products in 54 countries primarily under the Tempur® and Tempur-Pedic® brands. Our Tempur brand has been in existence since 1991, and we believe its global recognition is reinforced by our high level of customer satisfaction. One of our products was recently ranked among the eight “best buys” of the mattress industry in the applicable price range by Consumers Digest, a recognition awarded to products that provide strong value to consumers. In addition, we believe our direct response business and associated multi-channel advertising in our domestic and international markets have enhanced awareness of our brand. We believe that our major competitors in the United States have limited brand awareness outside of the United States and our major international competitors have limited brand awareness outside of their respective regions.

 

  Diversified Product Offerings Sold Globally Through Multiple Distribution Channels.    We believe we have a highly-diversified, well-balanced business model, which provides us with a competitive advantage over our major competitors, which primarily sell standard innerspring mattresses or traditional pillows in the United States almost exclusively through retail furniture and bedding stores. In contrast, for the combined twelve months ended December 31, 2002, mattress, pillow and other product sales, primarily adjustable beds, represented 52%, 31% and 17%, respectively, of our net sales. For the combined twelve months ended December 31, 2002, our retail channel represented 60% of our net sales, with our direct, healthcare and third party distributor channels representing 19%, 14% and 7%, respectively. Domestic and International operations generated 55% and 45%, respectively, of net sales for the combined twelve months ended December 31, 2002.

 

LOGO

 

  Strong Financial Performance.    Over the last several years, our highly-diversified, well-balanced business model has enabled us to achieve rapidly growing revenues and strong gross and operating margins, with low maintenance capital expenditure and working capital requirements. Further, our vertically-integrated operations generated an average of approximately $340,000 in net sales per employee in 2002, which is more than 1.5 times the average for three of the major bedding manufacturers in the United States. For the combined twelve months ended December 31, 2002, our gross margin was 50.3% on net sales of $298.0 million. Our strong financial performance gives us the flexibility to invest in our manufacturing operations, enhance our sales force and marketing, invest in information systems and recruit talented management and other personnel.

 

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  Significant Growth Opportunities.    We believe our competitors in the United States standard innerspring mattress market have penetrated the majority of their addressable channels and, therefore, have limited growth opportunities in their core markets. In contrast, we have penetrated only a small percentage of our addressable market. For example, we currently sell our products in approximately 2,500 furniture retail stores in the United States, out of a total of approximately 9,000 stores we have identified as appropriate targets. Similarly, we currently sell our products in approximately 2,500 furniture retail stores outside the United States, out of a total of approximately 7,000 stores we have identified as appropriate targets. Furthermore, we have recently begun to expand our direct response business in our European markets, based on our similar, successful initiatives in the United States and in the United Kingdom, to reach a greater number of consumers and increase our brand awareness. In addition, we currently supply only a small percentage of the approximately 15,400 nursing homes and 5,000 hospitals in the United States (with approximately 2.7 million beds). As this healthcare market expands over time, we expect our growth potential in this market will also increase.

 

  Management Team with Proven Track Record.    Since launching our United States operations in 1992, Robert Trussell, Jr., has helped grow our company from its early stages into a global business with approximately $387.0 million in total net sales for the twelve months ended June 30, 2003. Furthermore, Mr. Trussell has assembled a highly experienced management team with significant sales, marketing, consumer products, manufacturing, accounting and treasury expertise. From 2000 to 2002, our management team has:

 

  further penetrated the United States market, with net sales in our Domestic segment growing from $74.1 million in 2000 to $165.3 million in net sales for 2002;

 

  achieved a compound annual sales growth rate of 36% from $162.0 million for our predecessor company for the year ended December 31, 2000 to $298.0 million for the combined twelve months ended December 31, 2002;

 

  expanded our market share in the premium segment of the global mattress industry;

 

  successfully developed and constructed a manufacturing facility in the United States; and

 

  improved the efficiency of our product distribution network.

 

The management team and certain key employees currently own approximately 12.4% of our common equity on a fully-diluted as-converted basis, after giving effect to the vesting of all outstanding options.

 

Business Strategy

 

Our goal is to become the leading global manufacturer, marketer and distributor of premium mattresses and pillows by pursuing the following key initiatives:

 

  Maintain Focus on Core Products.    We believe we are the leading provider of visco-elastic foam mattresses and pillows, which we sell at attractive margins. We utilize a vertically-integrated, proprietary process to manufacture a comfortable, durable and high quality visco-elastic foam. Although this foam could be used in a number of different products, we are currently committed to maintaining our focus primarily on premium mattresses and pillows. We also plan to lead the industry in product innovation and sleep expertise by continuing to develop and market mattress and pillow products that enable better overall sleep and personalized comfort. This strategy has contributed to significant growth in net sales of both mattresses (40.2% compound annual growth rate) and pillows (20.3% compound annual growth rate) over the past three years. We believe our focused sales, marketing and product strategies will enable us to increase market share in the premium market, while maintaining our margins and our ability to generate free cash flow.

 

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  Continue to Build Global Brand Awareness.    We plan to continue to invest in increasing our global brand awareness through targeted marketing and advertising campaigns that further associate our brand name with better overall sleep and premium quality products. We estimate that our current advertising campaign yields 2.7 billion consumer “impressions” per month via television, radio, magazines and newspapers. Our high level of customer satisfaction further drives brand awareness through “word-of-mouth” marketing. Consumer surveys commissioned on our behalf over the last several years indicate that our products achieve satisfaction ratings generally ranging from 80% to 92%.

 

  Further Penetrate U.S. Retail Channel.    In the United States, the retail sales division is our largest sales division. Of the over 33,000 retail stores in the United States selling mattresses, we have established a target market of over 9,000 potential stores. We plan to build and maintain our base of furniture retailers including Jordan’s Furniture, Art Van Furniture, Inc. and Haverty Furniture Companies, Inc. and specialty retailers including Brookstone, Relax the Back Corporation and Bed, Bath & Beyond Inc. We target retail stores that have significant sales volumes, experience marketing premium products and a corporate image that is consistent with our efforts to further build our brand awareness. In order to continue to penetrate this channel, we have increased our salesforce and have increased the number of personnel who train retail salespersons to sell our products more effectively. We believe we are able to more effectively attract and retain retailers because our premium products provide retailers with higher per unit profits than standard innerspring products.

 

  Continue to Expand Internationally.    We plan on to increase sales growth internationally by further penetrating each of our existing distribution channels. We plan to expand our direct response business, which has increased both sales and brand awareness in the United States. We have already successfully introduced this program to the United Kingdom, and we intend to expand this program to our operations elsewhere in Europe and in Asia. In addition, we are focused on managing our third party distributors, including hiring regional sales managers, establishing training programs and expanding distribution. We will continue to promote our operations in Japan, which now represents a significant portion of our international business. In addition, we intend to further enhance sales growth in our retail channel by attracting new retailers that meet our criteria and by expanding sales within our existing customers’ retail stores through the introduction of new mattress and pillow products tailored for specific markets, continued investment in our brand and ongoing sales and product training and education.

 

  Increase Growth Capacity.    We intend to continue to invest in our operating infrastructure to meet the requirements of our rapidly growing business. Currently, we manufacture our products in two highly automated, vertically-integrated facilities located in Aarup, Denmark and Duffield, Virginia. Over the past three years, we have invested more than $50.0 million to upgrade and expand these facilities. To accommodate our anticipated growth, we plan to invest an additional $75.0 to $100.0 million to increase productivity and expand manufacturing capacity during the next several years, including the development and construction of an additional manufacturing facility in North America. We also plan to continue to enhance our internal information technology systems and our product distribution network, as well as augment our personnel in management, sales, marketing and customer service.

 

TA Associates, Inc. and Friedman Fleischer & Lowe

 

Founded in 1968, TA Associates, Inc. (TA) is one of the largest and most experienced private equity firms in the world. Equipped with a $5.0 billion capital base and over 40 investment professionals in Massachusetts, California and London, TA has invested in more than 330 companies throughout its 35 year history. TA focuses its investments in growth companies in the consumer, technology, financial services, business services and healthcare industries.

 

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Friedman Fleischer & Lowe, LLC (FFL) is a San Francisco-based private equity firm specializing in value-added investing. FFL’s principals have invested approximately $2.0 billion in more than 50 companies over the past 20 years across many industry sectors. The principals have over 90 years of combined experience as investors, senior operating executives and advisors.

 

The Acquisition of Our Business

 

In November 2002, TA and FFL formed TWI Holdings to purchase Tempur World, Inc. for approximately $350 million plus a deferred earn-out payment of approximately $40.0 million. TWI Holdings funded that purchase and related transaction fees and expenses using $150.0 million of senior bank financing, $50.0 million in mezzanine debt financing and a cash and non-cash equity contribution from our owners of approximately $161.0 million. Collectively, TA and FFL currently own 79.8% of our fully diluted common stock, after giving effect to the vesting of all outstanding options, and our management and employees and certain third party investors own the balance. We refer to this acquisition of Tempur World as the “Tempur acquisition.”

 

The Recapitalization

 

In August 2003, we completed a recapitalization consisting of the following transactions:

 

  TWI and certain of our domestic and foreign subsidiaries entered into amended and restated senior credit facilities providing for borrowings in an aggregate principal amount of up to $270.0 million, including term loan A facilities of $95.0 million, a term loan B facility of $135.0 million and revolving credit facilities providing for borrowings of up to $40.0 million. We refer to these facilities in this prospectus as the amended senior credit facilities.

 

  Tempur-Pedic, Inc. and Tempur Production USA, Inc., indirect wholly-owned subsidiaries of TWI, issued $150.0 million aggregate principal amount of 10¼% Senior Subordinated Notes due 2010. We refer to these notes in this prospectus as the senior subordinated notes.

 

  We repaid all of the outstanding borrowings under our then existing mezzanine debt facility and terminated that facility.

 

  We paid approximately $40.0 million in satisfaction in full of the earn-out payment payable in connection with the Tempur acquisition.

 

  TWI Holdings distributed approximately $160.0 million to its equityholders.

 

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Our Structure

 

Tempur-Pedic, Inc. and Tempur Production USA, Inc. are indirect wholly-owned subsidiaries of TWI Holdings that, directly or through subsidiaries, operate all of our business in the United States and certain portions of our business in Canada and Mexico. All of our business operations in the rest of the world are conducted by foreign subsidiaries owned by Tempur World Holdings S.L., an indirect wholly-owned subsidiary of TWI Holdings. Set forth below is a chart showing our structure:

 

 

LOGO


(1) TWI Holdings owns a 1% interest in one foreign subsidiary and a 10% interest in another foreign subsidiary. Tempur World Holdings, Inc. owns directly or indirectly all other capital stock in the foreign subsidiaries.

 

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The Offering

 

Common stock offered by TWI Holdings in this offering

                                shares

Common stock offered by selling stockholders in this offering

                                shares

Common stock to be outstanding after this offering

                                shares

Use of proceeds

   We intend to use the proceeds we receive from this offering to repay outstanding debt. We will not receive any proceeds from the sale of shares by the selling stockholders. See “Use of Proceeds.”

Proposed New York Stock Exchange symbol

   “          ”                

 

The number of shares of our common stock that will be outstanding after this offering is based on the number of shares outstanding as of             , and unless otherwise indicated herein, assumes the conversion of all outstanding shares of our convertible preferred stock and our convertible common stock into common stock on a one-for-one basis, and excludes:

 

               shares of our common stock issuable upon the exercise of stock options outstanding as of              at an exercise price of $             per share, of which options to purchase              shares of our common stock were then exercisable;

 

               shares of our common stock issuable upon the exercise of warrants to purchase common stock at an exercise price of $             per share; and

 

               shares of our common stock reserved for future grant under our 2003 Stock Incentive Plan.

 

Unless specifically stated otherwise, the information in this prospectus:

 

  assumes no exercise of the underwriters’ over-allotment option;

 

  assumes an initial public offering price of $             per share, the midpoint of the initial public offering price range indicated on the cover of this prospectus;

 

  reflects the automatic conversion of all shares of our convertible preferred stock and convertible common stock into              shares of our common stock upon the completion of this offering;

 

  gives effect to a         -for-one stock split of our common stock which will occur immediately prior to the closing of the offering; and

 

  reflects the filing, prior to the completion of this offering, of our restated certificate of incorporation, referred to in this prospectus as our certificate of incorporation, and the adoption of our amended and restated by-laws, referred to in this prospectus as our by-laws, implementing the provisions described under “Description of Capital Stock.”

 

Tempur®, Tempur-Pedic®, Tempur-Med®, Swedish Sleep System®, Airflow System and Dual Airflow System are our trademarks, trade names and service marks. All other trademarks, trade names and service marks used in this prospectus are the property of their respective owners.

 

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Unaudited Summary and Historical Pro Forma Condensed Consolidated Financial  

and Operating Data

 

Our predecessor company for the period from January 1, 2000 to October 31, 2002 is Tempur World, Inc. We completed the Tempur acquisition (which was accounted for using the purchase method of accounting) as of November 1, 2002. As a result of adjustments to the carrying value of assets and liabilities pursuant to the Tempur acquisition, the financial position and results of operations for periods subsequent to the Tempur acquisition are not comparable to those of our predecessor company.

 

The following table sets forth our summary historical and unaudited pro forma condensed consolidated financial and operating data for the periods indicated. We have derived the statement of operations and balance sheet data for our predecessor company as of and for the years ended December 31, 2000 and 2001 and the ten months ended October 31, 2002 from our predecessor company’s audited financial statements. We have derived our statements of operations and balance sheet data as of and for the two months ended December 31, 2002 from our audited financial statements. We have derived the statement of operations data for the six months ended  June 30, 2002 from our predecessor company’s unaudited condensed consolidated interim financial statements. We have derived the statement of operations and balance sheet data as of and for the six month period ended  June 30, 2003 from our unaudited condensed consolidated interim financial statements. In the opinion of management, such unaudited condensed consolidated interim financial statements have been prepared on a basis consistent with our audited financial statements for the two months ended December 31, 2002 and include all adjustments, which are normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for the interim period. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year or any future period. Our predecessor company’s financial statements as of and for the years ended December 31, 2000 and 2001 and the ten months ended October 31, 2002, its unaudited condensed consolidated interim statements of operations and cash flows for the six months ended June 30, 2002 and our financial statements for the two months ended December 31, 2002 and our unaudited condensed consolidated interim financial statements as of and for the six months ended  June 30, 2003 are included elsewhere in this prospectus.

 

The summary unaudited pro forma financial data for the twelve months ended June 30, 2003 has been prepared to give pro forma effect to the Tempur acquisition and to the recapitalization as if they had occurred on July 1, 2002. The unaudited pro forma balance sheet data as of June 30, 2003 has been adjusted to give effect to the recapitalization as if it occurred on June 30, 2003. The summary unaudited pro forma as adjusted financial data for the twelve months ended June 30, 2003 has been prepared to give effect to the offering as if it had occurred on July 1, 2002. The summary unaudited pro forma as adjusted balance sheet data as of June 30, 2003 has been adjusted to give effect to the offering as if it had occurred on June 30, 2003. The summary unaudited pro forma and pro forma as adjusted financial data is for informational purposes only and should not be considered indicative of actual results that would have been achieved had the Tempur acquisition, the recapitalization or the offering actually been consummated on the date indicated and do not purport to indicate balance sheet data or results of operations for any future period. The following data should be read in conjunction with “Unaudited Pro Forma Financial Information,” “Selected Historical Consolidated Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our predecessor company’s financial statements and related notes thereto included elsewhere in this prospectus.

 

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    Predecessor

    TWI Holdings

    Combined

    Predecessor

    TWI Holdings

    Year ended December 31,

    Period from
January 1,
2002 to
October 31,
2002


    Period from
November 1,
2002 to
December 31,
2002


    Twelve Months
ended
December 31,
2002


    Six Months
ended
June 30,
2002


    Six Months
ended
June 30,
2003


    Pro forma
Twelve
Months
ended
June 30,
2003(1)


    Pro forma
As Adjusted
Twelve
Months
ended
June 30,
2003(2)


    2000

    2001

               
                            (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)

($ in thousands except

per share data)

         

Statement of
Operations Data:

                                                                     

Net sales

  $ 161,969     $ 221,514     $ 237,314     $ 60,644     $ 297,958     $ 129,809     $ 218,804     $ 386,954     $             

Cost of sales

    89,450       107,569       110,228       37,811       148,039       61,894       98,635       185,776        
   


 


 


 


 


 


 


 


 

Gross profit

    72,519       113,945       127,086       22,833       149,919       67,915       120,169       201,178        

Operating expenses

    50,081       83,574       86,693       23,174       109,867       48,828       69,017       130,771        
   


 


 


 


 


 


 


 


 

Operating income/(loss)

    22,438       30,371       40,393       (341 )     40,052       19,087       51,152       70,407        

Net interest expense

    2,225       6,555       6,292       2,955       9,247       3,680       8,161       29,361        

Other (income)/expense

    947       316       1,724       (1,331 )     393       183       505       714        
   


 


 


 


 


 


 


 


 

Income/(loss) before income taxes

    19,266       23,500       32,377       (1,965 )     30,412       15,224       42,486       40,332        

Income taxes

    6,688       11,643       12,436       889       13,325       7,274       15,739       15,027        
   


 


 


 


 


 


 


 


 

Net income/(loss)

  $ 12,578     $ 11,857     $ 19,941     $ (2,854 )   $ 17,087     $ 7,950     $ 26,747     $ 25,305     $             

Preferred stock dividend

          345       1,238       1,958       3,196       718       5,810       8,288        
   


 


 


 


 


 


 


 


 

Net income/(loss) available to common stockholders

  $ 12,578     $ 11,512     $ 18,703     $ (4,812 )   $ 13,891     $ 7,232     $ 20,937     $ 17,077     $             
   


 


 


 


 


 


 


 


 

Net income/(loss) per share(3)

                                                                     

Basic

                          $                       $               $  

Diluted

                          $                       $               $  

Weighted average shares (in thousands)

                                                                     

Basic

                                                                     

Diluted

                                                                     

Balance Sheet Data
(at end of period):

                                                                     

Cash and cash equivalents

  $ 10,572     $ 7,538     $ 6,380     $ 12,654             $ 3,155     $ 7,984     $ 7,984     $  

Total assets

    144,305       176,841       199,641       448,494               189,195       510,598       512,959        

Total debt

    71,164       106,023       89,050       198,352               90,826       178,102       391,789        

Redeemable preferred stock

          11,715       15,331                     14,809                    

Total stockholders’ equity

  $ 38,237     $ 16,694     $ 39,895     $ 151,999             $ 30,673     $ 180,576     $ 8,859     $  

Other Financial and
Operating Data:

                                                                     

Adjusted EBITDA(4)

  $ 38,948     $ 40,422     $ 50,776     $ 12,103     $ 62,879     $ 25,063     $ 59,385     $ 97,202     $  

Adjusted EBITDA margin(5)

    24.1 %     18.3 %     21.4 %     20.0 %     21.1 %     19.3 %     27.1 %     25.1 %     %

Depreciation and
amortization

  $ 6,002     $ 10,051     $ 10,383     $ 2,664     $ 13,047     $ 5,976     $ 8,233     $ 16,020     $  

Net cash provided by operating activities

  $ 1,125     $ 19,716     $ 22,706     $ 12,385     $ 35,091     $ 10,024     $ 22,959     $ 38,163     $  

Capital expenditures

  $ 27,418     $ 35,241     $ 9,175     $ 1,961     $ 11,136     $ 4,835     $ 6,744     $ 13,045     $  

Number of pillows sold

    1,717,476       1,819,993       1,528,608       407,476       1,936,084       860,918       1,455,435       2,530,601        

Number of mattresses sold

    173,338       212,695       218,656       50,564       269,220       124,104       180,125       325,241        

(1) The summary unaudited pro forma financial data give effect to the Tempur acquisition, which occurred on November 1, 2002, and the recapitalization, which occurred in August 2003.
(2) The summary unaudited pro forma as adjusted financial data give effect to the offering.
(3) Pre-predecessor company and predecessor company net income/(loss) per share have been omitted as such information is not considered meaningful due to the change in capital structure that occurred with the Tempur acquisition.
(4)

EBITDA is defined as operating income plus depreciation and amortization. We consider EBITDA a measure of our liquidity. Management uses this measure as an indicator of cash generated from operating activities. Further, it provides management with a consistent measurement tool for evaluating the operating financial performance under GAAP and may not be comparable to similarly captioned information reported by other companies. In addition, it does not replace net income, operating income or cash flow provided by operating activities as indicators of

 

10


Table of Contents
 

operating performance. Management believes the most directly comparable GAAP financial measure is “net cash provided by operating activities” presented in the Consolidated Statement of Cash Flows. EBITDA is reconciled directly to net cash provided by operating activities as follows:

 

    Predecessor

    TWI Holdings

    Combined

    Predecessor

    TWI Holdings

    Year ended
December 31,


    Period from
January 1,
2002 to
October 31,
2002


    Period from
November 1,
2002 to
December 31,
2002


    Twelve Months
ended
December 31,
2002


    Six Months
ended
June 30,
2002


    Six Months
ended
June 30,
2003


    Pro forma
Twelve
Months
ended
June 30,
2003


    Pro forma
As Adjusted
Twelve
Months
ended
June 30,
2003


    2000

    2001

               
                            (unaudited)     (unaudited)     (unaudited)     (unaudited)     (unaudited)
($ in thousands)          

EBITDA

  $ 28,440     $ 40,422     $ 50,776     $ 2,323     $ 53,099     $ 25,063     $ 59,385     $ 86,427     $             

Depreciation and amortization

    (6,002 )     (10,051 )     (10,383 )     (2,664 )     (13,047 )     (5,976 )     (8,233 )     (16,020 )      

Net interest expense

    (2,225 )     (6,555 )     (6,292 )     (2,955 )     (9,247 )     (3,680 )     (8,161 )     (29,361 )      

Provision for income taxes

    (6,688 )     (11,643 )     (12,436 )     (889 )     (13,325 )     (7,274 )     (15,739 )     (15,027 )      

Other income/(expense), net

    (947 )     (316 )     (1,724 )     1,331       (393 )     (183 )     (505 )     (714 )      
   


 


 


 


 


 


 


 


 

Net income/ (loss)

    12,578       11,857       19,941       (2,854 )     17,087       7,950       26,747       25,305        
   


 


 


 


 


 


 


 


 

Depreciation and amortization

    6,002       10,051       10,383       2,664       13,047       5,976       8,233       16,020        

(Gain)/loss on sale or disposal of property, plant and equipment

    203       (53 )     268       233       501       533       (206 )     (238 )      

Change in working capital and other, net

    (17,658 )     (2,139 )     (7,886 )     12,342       4,456       (4,435 )     (11,815 )     (2,924 )      
   


 


 


 


 


 


 


 


 

Net cash provided by operating activities

  $ 1,125     $ 19,716     $ 22,706     $ 12,385     $ 35,091     $ 10,024     $ 22,959     $ 38,163     $             
   


 


 


 


 


 


 


 


 


Adjusted EBITDA is defined as EBITDA plus certain items that we believe are not indicative of our future operating performance. Adjusted EBITDA is not a measurement of financial performance under GAAP or a measure of our liquidity and may not be comparable to similarly captioned information reported by other companies. In addition, it does not replace net income, operating income or cash flow provided by operating activities as indicators of operating performance. We believe Adjusted EBITDA provides a useful indicator of levels of our financial performance and is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Moreover, the amended senior credit facilities and indenture contain covenants in which Adjusted EBITDA is used as a measure of financial performance and, accordingly, we believe this information will be useful to investors. Adjusted EBITDA for the twelve months ended December 31, 2000 excludes $10.5 million in charges related to the termination of our license agreement on December 31, 2000. Adjusted EBITDA for the combined twelve months ended December 31, 2002 excludes $9.8 million in charges related to a purchase accounting adjustment to our inventory. Pro forma Adjusted EBITDA for the twelve months ended June 30, 2003 excludes $10.8 million in charges related to a purchase accounting adjustment to our inventory, calculated as if the Tempur acquisition had occurred as of July 1, 2002. Adjusted EBITDA is reconciled directly to EBITDA as follows:

 

11


Table of Contents
    Predecessor

  TWI Holdings

  Combined

  Predecessor

  TWI Holdings

    Year ended
December 31,


  Period from
January 1,
2002 to
October 31,
2002


  Period from
November 1,
2002 to
December 31,
2002


  Twelve Months
ended
December 31,
2002


  Six Months
ended
June 30,
2002


  Six Months
ended
June 30,
2003


 

Pro forma
Twelve Months
ended

June 30,

2003


  Pro forma
As Adjusted
Twelve
Months
ended
June 30,
2003


    2000

  2001

             
                    (unaudited)   (unaudited)   (unaudited)   (unaudited)   (unaudited)
($ in thousands)        

EBITDA

  $ 28,440   $ 40,422   $ 50,776   $ 2,323   $ 53,099   $ 25,063   $ 59,385   $ 86,427   $             

License agreement terminated on
December 31, 2000

    10,508                                  

Purchase accounting adjustment to inventory

                9,780     9,780             10,775      
   

 

 

 

 

 

 

 

 

Adjusted EBITDA

  $ 38,948   $ 40,422   $ 50,776   $ 12,103   $ 62,879   $ 25,063   $ 59,385   $ 97,202   $             
   

 

 

 

 

 

 

 

 


(5) Adjusted EBITDA margin is the ratio of Adjusted EBITDA to total net sales.

 

12


Table of Contents

RISK FACTORS

 

You should carefully consider the risks described below, as well as other information and data included in this prospectus, before deciding whether to invest in shares of our common stock. The risks described below may not be the only ones we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial may also materially and adversely affect our business operations. Any of the following risks could materially adversely affect our business, financial condition or results of operations, which may result in your loss of all or part of your original investment.

 

Risks Related to Our Business

 

The mattress and pillow industries are highly competitive.

 

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

 

Many of our competitors have greater financial, marketing and manufacturing resources and better brand name recognition than our brand, and sell their products through broader and more established distribution channels. In addition, we believe that a number of our significant competitors now offer foam mattress products similar to our visco-elastic foam mattresses and pillows. There can be no assurance that these competitors or any other mattress manufacturers will not aggressively pursue the visco-elastic foam mattress market. Any such competition by established manufacturers or new entrants into the market could have a material adverse effect on our business, financial condition and operating results. In addition, should any of our competitors reduce prices on premium mattress products, we may be required to implement price reductions in order to remain competitive, which could have a material adverse effect on our sales, financial condition and operating results. The pillow industry is characterized by a large number of competitors, none of which is dominant, but many of which have greater resources than us and greater brand name recognition for their products than us.

 

We may be unable to effectively manage our growth.

 

We have grown rapidly, with our net sales increasing from approximately $162.0 million in 2000 to approximately $298.0 million for the combined twelve months ended December 31, 2002. Our growth has placed, and will continue to place, a strain on our management, production, product distribution network, information systems and other resources. To manage growth effectively, we must:

 

  significantly increase the volume of products manufactured at our manufacturing facilities;

 

  continue to enhance our operational, financial and management systems, including our database management, tracking of inquiries, inventory control and product distribution network; and

 

  expand, train and manage our employee base.

 

We may not be able to effectively manage this expansion in any one or more of these areas, and any failure to do so could significantly harm our business, financial condition and operating results. In addition, several members of our senior management team have been hired since 2001, and, as a result, our management team has not worked together as a group for a significant amount of time.

 

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Table of Contents

We may be unable to sustain growth or profitability.

 

Our ability to service our increased level of indebtedness depends to a significant extent on our ability to grow our business while maintaining profitability. We may not be able to sustain growth or profitability on a quarterly or annual basis in future periods. There is a limit to the extent to which we can effectively grow in our current business model and we do not know whether we are at or near that limit. Further, our future growth and profitability will depend upon a number of factors, including without limitation:

 

  the level of competition in the mattress and pillow industry;

 

  our ability to continue to successfully execute our strategic initiatives and growth strategy;

 

  our ability to effectively sell our products through our distribution channels in volumes sufficient to drive growth and leverage our cost structure and advertising spending;

 

  our ability to continuously improve our products to offer new and enhanced consumer benefits, better quality and reduced costs;

 

  our ability to maintain efficient, timely and cost-effective production and delivery of our products;

 

  the efficiency and effectiveness of our advertising campaign and other marketing programs in building product and brand awareness, driving traffic to our distribution channels and increasing sales;

 

  our ability to successfully identify and respond to emerging trends in the mattress and pillow industry;

 

  the level of consumer acceptance of our products; and

 

  general economic conditions and consumer confidence, which affect discretionary spending levels for premium items such as our products.

 

We may not be successful in executing our growth strategy and even if we achieve our strategic plan, we may not be able to sustain profitability. Failure to successfully execute any material part of our strategic plan or growth strategy could significantly harm our business, financial condition and operating results.

 

An increase in our return rates or an inadequacy in our warranty reserves could have a material adverse effect on our business, financial condition and operating results.

 

Part of our domestic marketing and advertising strategy in certain domestic channels focuses on providing a 90-day money back guarantee under which customers may return their mattress and obtain a refund of the purchase price. For the six months ended June 30, 2003, in the United States, we had approximately $13.7 million in returns for a return rate of approximately 11.0%. As we expand our sales, there can be no assurance that our return rates will remain within our historical levels. An increase in return rates could have a material adverse effect on our business, financial condition and operating results. We also currently provide our customers with a limited 20-year warranty on mattresses sold in the United States and a limited 15-year warranty on mattresses sold outside of the United States. However, as we have only been selling mattresses in significant quantities since 1992, and have released new products in recent years, many are fairly early in their product life cycles. Because our products have not been in use by our customers for the full warranty period, we rely on the combination of historical experience and product testing for the development of our estimate for warranty claims. Our estimate of warranty claims could be adversely affected if our historical experience ultimately proves to be greater than the performance of the product in our product testing. However, we cannot predict with certainty what our warranty experience will be with respect to these products. In addition, there can be no assurance that our warranty reserves will be adequate to cover future warranty claims, and their inadequacy could have a material adverse effect on our business, financial condition and operating results.

 

We may face exposure to product liability.

 

We face an inherent business risk of exposure to product liability claims if the use of any of our products results in personal injury or property damage. In the event that any of our products prove to be defective, we may

 

14


Table of Contents

be required to recall or redesign those products. We maintain insurance against product liability claims, but there can be no assurance that such coverage will continue to be available on terms acceptable to us or that such coverage will be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our business.

 

Regulatory requirements may have a material adverse effect on our business, financial condition or operating results.

 

Our products and our marketing and advertising programs are and will continue to be subject to regulation in the United States by various federal, state and local regulatory authorities, including the Federal Trade Commission and the U.S. Food and Drug Administration. In addition, other governments and agencies in other jurisdictions regulate the sale and distribution of our products. Compliance with these regulations may have an adverse effect on our business. For example, compliance with anticipated changes in fire resistance laws may be costly and could have an adverse impact on the performance of our products. The U.S. Consumer Product Safety Commission and various state regulatory agencies are considering new rules relating to fire retardancy standards for the mattress and pillow industry. The State of California plans to adopt, proposed to be effective in 2005, new fire retardancy standards that have yet to be fully defined. If adopted, such new rules may adversely affect our costs, manufacturing processes and materials. We are developing product solutions that are intended to enable us to meet the new standards. Because the new standards have not been finally determined, however, no assurance can be given that our solutions will enable us to meet the new standards. We expect that any required product modifications will add cost to our product. Many foreign jurisdictions also regulate fire retardancy standards, and changes to these standards and changes in our products that require compliance with additional standards would raise similar risks.

 

There can be no assurance that our marketing and advertising practices will not be the subject of proceedings before regulatory authorities or the subject of claims by other parties. In addition, we are subject to federal, state and local laws and regulations relating to pollution, environmental protection and occupational health and safety. There can be no assurance that we are at all times in complete compliance with all such requirements. We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. If a release of hazardous substances occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of our properties, we may be held liable and the amount of such liability could be material.

 

Our involvement in a government investigation and associated litigation or proceedings relating to any allegations of the possibility of price fixing in the mattress industry could increase our costs or otherwise adversely affect our operations.

 

On July 29, 2003, we were served with a Civil Investigative Demand from the office of the Attorney General of the State of Texas in connection with that office’s investigation into “the possibility of price fixing in the mattress industry.” In connection with the investigation, we have been asked to produce certain documents that may be relevant to the investigation and to respond to written interrogatories. The demand seeks, among other things, documents relating to the retail pricing of our products, including retail pricing policies and correspondence with retail accounts. We are unable to predict the scope or possible outcome of the investigation or to quantify its potential impact on our business or operations. If the investigation were to become protracted or wide-ranging with respect to us, our efforts to respond could force us to divert management resources and incur significant unanticipated costs. If the investigation resulted in a charge that our pricing practices or policies were in violation of applicable antitrust regulations, we could be subject to significant additional costs of defending such charges in a variety of venues and, ultimately, if there were an adjudication that we were in violation of Texas or other antitrust laws, there could be an imposition of damages for persons injured, as well as injunctive relief. Any of the foregoing could disrupt our operations and have a material adverse effect on our business, results of operations and financial condition.

 

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Table of Contents

Our product development and enhancements may not be successful.

 

Our growth and future success will depend, in part, upon our ability to enhance our existing products and to develop and market new products on a timely basis that respond to customer needs and achieve market acceptance. There can be no assurance that we will be successful in developing or marketing enhanced or new products, or that any such products will be accepted by the market.

 

We are dependent on our significant customers.

 

Our top five customers, collectively, accounted for 24.4% of our net sales for the combined twelve months ended December 31, 2002. During this period, our largest customer, Brookstone Company, Inc., accounted for 10.1% of our net sales. Many of our customer arrangements, including the one with Brookstone, are by purchase order or are terminable at will at the option of either party. A substantial decrease or interruption in business from our significant customers could result in write-offs or in the loss of future business and could have a material adverse effect on our business, financial condition or results of operations.

 

In the future, retailers may consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration in the retail industry. Some of these retailers may decide to carry only a limited number of brands of mattress products, which could affect our ability to sell our products to them on favorable terms, if at all, and could have a material adverse effect on our business, financial condition or results of operations.

 

We are subject to the possible loss of our third party distributor arrangements and disruption in product distribution in markets not reached by our wholly-owned subsidiaries.

 

We have third party distributor arrangements in the Asia/Pacific, Middle East, Eastern Europe, Central and South America, Canada and Mexico markets not reached by our wholly-owned subsidiaries. Most of these arrangements provide for exclusive rights for such distributors in a designated territory. If our third party distributors were to cease distributing our products, sales of our products would be adversely affected. We cannot assure you that we would be able to find replacement third party distributors on favorable terms or at all. In addition, under the laws of the applicable countries, we could have difficulty terminating these third party distributor arrangements even if such termination were in our best interests.

 

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

 

A significant component of our marketing strategy involves the use of direct marketing to generate sales. Future growth and profitability will depend in part on the effectiveness and efficiency of our advertising expenditures, including our ability to:

 

  create greater awareness of our products and brand name;

 

  determine the appropriate creative message and media mix for future advertising expenditures;

 

  effectively manage advertising costs, including creative and media, to maintain acceptable costs per inquiry, costs per order and operating margins; and

 

  convert inquiries into actual orders.

 

No assurance can be given that our advertising expenditures will result in increased sales or will generate sufficient levels of product and brand name awareness or that we will be able to manage such advertising expenditures on a cost effective basis.

 

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Table of Contents

Our ability to compete effectively depends on our ability to protect our trade secrets and maintain our trademarks, patents and other intellectual property.

 

We rely on trade secrets to protect the design, technology and function of our visco-elastic foam and our products. To date, we have not sought United States or international patent protection for our principal product formula and manufacturing processes. Accordingly, no assurance can be given that we will be able to prevent others from developing visco-elastic foam and products that are similar to or competitive with our products. Our ability to compete effectively with other companies also depends, to a significant extent, on our ability to maintain the proprietary nature of our owned and licensed intellectual property. We own several patents on aspects of our products and have patent applications pending on aspects of our manufacturing processes. However, the principal product formula and manufacturing processes for our visco-elastic foam and our products are not patented. We own eight United States patents, and we have 10 United States patent applications pending. Further, we own approximately thirty-two foreign patents, and we have approximately fifteen foreign patent applications pending. In addition, we hold approximately 86 trademark registrations worldwide. We own United States and foreign registered trade names and service marks and have applications for the registration of trade names and service marks pending domestically and abroad. We also license certain intellectual property rights from third parties.

 

Although our trademarks are currently registered in the United States and registered or pending in thirty foreign countries, there can be no assurance that our trademarks cannot and will not be circumvented, or do not or will not violate the proprietary rights of others, or that we would not be prevented from using our trademarks if challenged. A challenge to our use of our trademarks could result in a negative ruling regarding our use of our trademarks, their validity or their enforceability, or could prove expensive and time consuming in terms of legal costs and time spent defending against it. Either situation could have a material adverse effect on our financial condition or results of operations. In addition, there can be no assurance that we will have the financial resources necessary to enforce or defend our trademarks. Furthermore, there can be no assurance as to the degree of protection offered by our patents or the likelihood that patents will be issued for pending patent applications. It is also possible that others could bring claims of infringement against us, as our principal product formula and manufacturing processes are not patented, and that any licenses protecting our intellectual property could be terminated. If we were unable to maintain the proprietary nature of our intellectual property and our significant current or proposed products, our financial condition or results of operations could be materially adversely affected.

 

In addition, the laws of certain foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States or the European Union. There can be no assurance that third parties, including competitors, will not assert intellectual property infringement or invalidity claims against us or that, if asserted, such claims will not be upheld. Intellectual property litigation, which could result in substantial cost to and diversion of effort by us, may be necessary to protect our trade secrets or proprietary technology or for us to defend against claimed infringement of the rights of others and to determine the scope and validity of others’ proprietary rights. There can be no assurance that we would prevail in any such litigation or that, if we are unsuccessful, we would be able to obtain any necessary licenses on reasonable terms or at all.

 

We are subject to fluctuations in the cost of raw materials, the possible loss of suppliers and disruptions in the supply of our raw materials.

 

The major raw materials that we purchase for production are polyol, an industrial commodity based on petroleum, and proprietary additives. The price and availability of these raw materials are subject to market conditions affecting supply and demand. Our financial condition or results of operations may be materially and adversely affected by increases in raw material costs to the extent we are unable to pass those higher costs to our customers.

 

We currently obtain all of the materials used to produce our visco-elastic foam from outside sources. We currently acquire almost all of our polyol from one supplier. If we were unable to obtain polyol from this

 

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supplier, we would have to obtain polyol from another supplier. We cannot assure you that any substitute arrangements for polyol would be on terms as favorable to us. We purchase proprietary additives from a number of vendors, including one from whom we are obligated to purchase minimum quantities. We cannot assure you that we would be able to prevent an interruption of production if any supplier were to discontinue supplying us for any reason. We maintain relatively small supplies of our raw materials on-site, and any disruption in the on-going shipment of supplies to us could interrupt production of our products and have a material adverse effect on our business, financial condition or results of operations. In addition, we outsource much of the sewing and cutting of our mattress and pillow covers to Poland and the Ukraine. If we were no longer able to outsource this labor, we could be forced to source it elsewhere at a higher cost. To the extent we were unable to pass those higher costs to our customers, those costs could reduce our operating margins and profits. Even if we were able to pass these on to customers, the price increase could reduce the growth of our sales and adversely affect our revenues.

 

We produce all of our products in two manufacturing facilities, and unexpected equipment failures, delays in deliveries or catastrophic loss may lead to production curtailments or shutdowns.

 

We manufacture all of our products at our two facilities in Aarup, Denmark and Duffield, Virginia. An interruption in production capabilities at these plants as a result of equipment failure could result in our inability to produce our products, which would reduce our sales and earnings for the affected period. In addition, we generally deliver our products only after receiving the order from the customer or the retailer and thus do not hold large inventories. In the event of a stoppage in production at either of our manufacturing facilities, even if only temporary, or if we experience delays as a result of events that are beyond our control, delivery times could be severely affected. For example, our third party carrier could potentially be unable to deliver our products within acceptable time periods due to a labor strike or other disturbance in its business. Any significant delay in deliveries to our customers could lead to increased returns or cancellations and cause us to lose future sales. Any increase in freight charges could increase our costs of doing business and harm our profitability. Although we have introduced new distribution programs to increase our ability to deliver products on a timely basis, there can be no assurance that our efforts will be successful. Our manufacturing facilities are also subject to the risk of catastrophic loss due to unanticipated events such as fires, explosions or violent weather conditions. We may in the future experience material plant shutdowns or periods of reduced production as a result of equipment failure, delays in deliveries or catastrophic loss.

 

We may be adversely affected by fluctuations in exchange rates.

 

Approximately 43.2% of our net sales were received or denominated in foreign currency for the six months ended June 30, 2003. As a result, we are exposed to foreign currency exchange rate risk, primarily with respect to changes in value of certain foreign currency denominated assets and liabilities of our Denmark manufacturing operations. Although we have in the past entered into hedging transactions to manage this risk and expect that we will continue to do so in the future, the hedging transactions may not succeed in managing our foreign currency exchange rate risk. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Foreign Currency Exposures.”

 

For the purposes of financial reporting, any change in the value of foreign currency against the United States Dollar during a given financial reporting period would result in a foreign exchange gain or loss on the translation of any United States Dollar-denominated debt into such foreign currency. We do not enter into hedging transactions to hedge this risk. Consequently, our reported earnings and financial position debt could fluctuate materially as a result of foreign exchange gains or losses. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Foreign Currency Exposures.”

 

We are subject to risks arising from our international operations.

 

We currently conduct international operations in 15 countries directly and in 39 additional countries through distributors, and we may pursue additional international opportunities. We generated approximately 43.2% of our

 

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net sales from non-U.S. operations during the first six months of 2003, and international suppliers provided a significant portion of our manufacturing material during this period. Our international operations are subject to the customary risks of operating in an international environment, including the potential imposition of trade or foreign exchange restrictions, tariff and other tax increases, fluctuations in exchange rates, inflation and unstable political situations, the potential unavailability of intellectual property protection and labor issues.

 

A deterioration in labor relations could have a material effect on our business.

 

As of September 30, 2003, we had approximately 1,000 full-time employees, with approximately 400 in the United States, 300 in Denmark and 300 in the rest of the world. The employees in Denmark are under a government labor union contract but those in the United States are not. Any significant increase in labor costs, deterioration of employee relations, slowdowns or work stoppages at any of our locations, whether due to union activities, employee turnover or otherwise, could have a material adverse effect on our business, financial condition and results of operation.

 

The loss of the services of any members of our senior management team could adversely affect our business.

 

We depend on the continued services of our senior management team. The loss of such key personnel could have a material adverse effect on our business, financial condition and results of operations.

 

Our leverage limits our flexibility and increases our risk of default.

 

As of June 30, 2003, after giving effect to the recapitalization, the book value of our long-term debt was $389.4 million, and our stockholders’ equity was $8.9 million. Our high degree of leverage could have important consequences to you, such as:

 

  limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we compete and increasing our vulnerability to general adverse economic and industry conditions;

 

  limiting our ability to obtain in the future additional financing we may need to fund future working capital, capital expenditures, product development, acquisitions or other corporate requirements;

 

  requiring the dedication of a substantial portion of our cash flow from operations to the payment of principal and interest on our debt, which will reduce the availability of cash flow to fund working capital, capital expenditures, product development, acquisitions and other corporate requirements; and

 

  placing us at a competitive disadvantage compared to competitors who are less leveraged and have greater financial and other resources.

 

In addition, the instruments governing our debt contain financial and other restrictive covenants, which limit our operating flexibility and could prevent us from taking advantage of business opportunities. In addition, our failure to comply with these covenants may result in an event of default. If such event of default is not cured or waived, we may suffer adverse effects on our operations, business or financial condition, including acceleration of our debt.

 

Our ability to meet our debt obligations and to reduce our indebtedness will depend on our future performance, which depends partly on general economic conditions and financial, business, political and other factors that are beyond our control. We cannot assure you that we will continue to generate cash flow from operations at or above current levels, that we will be able to meet our cash interest payments on all of our debt and our other liquidity needs. If our cash flow and capital resources are insufficient to allow us to make scheduled payments on the senior subordinated notes or our other debt, we may have to sell assets, seek additional capital or restructure or refinance our debt. We cannot assure you that we will be able to pay or

 

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refinance our debt on acceptable terms or at all. Our ability to refinance all or a portion of our debt or to obtain additional financing is substantially limited under the terms of the indenture governing the senior subordinated notes and the amended senior credit facilities. Under the terms of our debt instruments, we and our subsidiaries may be able to incur substantial additional indebtedness in the future, which would exacerbate the risks associated with our substantial leverage.

 

If our business plans change or if general economic, financial or political conditions in any of our markets or competitive practices in our industry change materially from those currently prevailing or from those now anticipated, or if other presently unexpected circumstances arise that have a material effect on the cash flow or profitability of our business, the anticipated cash needs of our business as well as the conclusions as to the adequacy of the available sources could change significantly. Any of these events or circumstances could involve significant additional funding needs in excess of the identified currently available sources, and could require us to raise additional capital to meet those needs. However, our ability to raise additional capital, if necessary, is subject to a variety of additional factors that we cannot presently predict with certainty, including the commercial success of our operations, the volatility and demand of the capital and lending markets and the future market prices of our securities.

 

Risks Related to this Offering

 

There may not be an active, liquid trading market for our common stock.

 

Prior to this offering, there has been no public market for our common stock. An active, liquid trading market for our common stock may not develop or be maintained following this offering. As a result, you may not be able to sell your shares of our common stock quickly or at the market price. The initial public offering price of our common stock was determined by negotiation between us and representatives of the underwriters based upon a number of factors and may not be indicative of prices that will prevail following the completion of this offering. The market price of our common stock may decline below the initial public offering price, and you may not be able to resell your shares of our common stock at or above the initial offering price.

 

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

 

The trading price of our common stock is likely to be volatile and subject to wide price fluctuations in response to various factors, including:

 

  actual or anticipated variations in our quarterly operating results, including those resulting from seasonal variations in our business;

 

  introductions or announcements of technological innovations or new products by us or our competitors;

 

  disputes or other developments relating to proprietary rights, including patents, litigation matters, and our ability to patent our products and technologies;

 

  changes in our financial estimates by securities analysts;

 

  conditions or trends in the specialty bedding industry;

 

  additions or departures of key personnel;

 

  announcements by us or our competitors of significant acquisitions, strategic partnerships, joint ventures or capital commitments;

 

  regulatory developments in the United States and abroad; and

 

  economic and political factors.

 

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

 

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periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in potential liabilities, substantial costs, and the diversion of our management’s attention and resources, regardless of the outcome.

 

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

 

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market after the closing of this offering, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. There will be              shares of our common stock outstanding immediately after this offering, based on the number of shares of our common stock outstanding as of             . All of the shares of our common stock sold in this offering will be freely transferable without restriction or further registration under the Securities Act of 1933, except for any shares of our common stock purchased by our executive officers, directors, principal stockholders, and some related parties. For more information, see “Shares Eligible for Future Sale.”

 

Although substantially all our stockholders have agreed with our underwriters to be bound by a 180-day lock-up agreement that prohibits these holders from selling or transferring their stock, except in limited circumstances, the underwriters, at their discretion, can waive the restrictions of the lock-up agreement at an earlier time without prior notice or announcement and allow our stockholders to sell their shares of our common stock. If the restrictions of the lock-up agreement are waived, shares of our common stock will be available for sale into the market, subject only to applicable securities rules and regulations, which would likely reduce the market price for shares of our common stock.

 

After this offering, we intend to register              shares of our common stock that are reserved for issuance upon the exercise of options granted or reserved for grant under our stock incentive plans and our employee stock purchase plan. Once we register these shares of our common stock, stockholders can sell them in the public market upon issuance, subject to restrictions under the securities laws and any applicable lock-up agreements. In addition, some of our existing stockholders will be entitled to register their shares of our common stock after this offering.

 

You will experience immediate and substantial dilution as a result of this offering and may experience additional dilution in the future.

 

If you purchase common stock in this offering, you will pay more for your shares than the amounts paid by existing stockholders for their shares. As a result, you will incur immediate and substantial dilution of $             per share, representing the difference between our pro forma net tangible book value per share after giving effect to this offering and the initial public offering price. In addition, purchasers of shares of our common stock in this offering will have contributed approximately             % of the aggregate price paid by all purchasers of our stock, but will own only approximately             % of the shares of our common stock outstanding after the offering based on the number of shares of our common stock and convertible preferred stock outstanding as of             . In addition, if the holders of outstanding options and warrants exercise those options at prices below the initial public offering price, you will incur further dilution. We may also acquire other companies or technologies or finance strategic alliances by issuing equity, which may result in additional dilution to our stockholders.

 

Our current principal stockholders own a large percentage of our voting common stock and could limit new stockholders from influencing corporate decisions.

 

Immediately after this offering, our executive officers, directors, current principal stockholders, and their respective affiliates will beneficially own, in the aggregate, approximately             % of our outstanding common stock. These stockholders, as a group, would be able to control substantially all matters requiring approval by our stockholders, including mergers, sales of assets, the election of all directors, and approval of other significant corporate transactions, in a manner with which you may not agree or that may not be in the best interest of other stockholders.

 

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

 

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

 

These provisions include:

 

  the application of a Delaware law prohibiting us from entering into a business combination with the beneficial owner of 15% or more of our of our outstanding voting stock for a period of three years after such 15% or greater owner first reached that level of stock ownership, unless we meet specified criteria;

 

  our ability to issue preferred stock with rights senior to those of the common stock without any further vote or action by the holders of our common stock;

 

  the requirements that our stockholders provide advance notice when nominating our directors; and

 

  the inability of our stockholders to convene a stockholders’ meeting without the chairperson of the board, the president, or a majority of the board of directors first calling the meeting.

 

Our management will have broad discretion in the use of net proceeds from this offering.

 

As of the date of this prospectus, we cannot specify with certainty the amounts we will spend on particular uses from the net proceeds we will receive from this offering. Our management will have broad discretion in the application of the net proceeds but currently intends to use the net proceeds as described in “Use of Proceeds.” The failure by our management to apply these funds effectively could affect our ability to continue to develop our business.

 

We do not anticipate paying dividends on our capital stock in the foreseeable future.

 

In August 2003, in connection with the recapitalization, we paid approximately $160.0 million to our equityholders and we do not anticipate paying any dividends in the foreseeable future. We currently intend to retain our future earnings, if any, to fund the development and growth of our business. In addition, the terms of the instruments governing our existing debt and any future debt or credit facility may preclude us from paying any dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of gain for the foreseeable future.

 

You may be unable to pursue claims against Arthur Andersen, the independent auditors who audited financial statements of our predecessor company.

 

Arthur Andersen LLP, independent auditors, have audited the consolidated financial statements of our predecessor company at December 31, 2001 and 2000, and for each of the two years in the period ended December 31, 2001, as set forth in their report. We have included these consolidated financial statements of our predecessor company in this prospectus and elsewhere in the registration statement in reliance on Arthur Andersen LLP’s report, given on their authority as experts in accounting and auditing.

 

In June 2002, Arthur Andersen LLP was convicted of federal obstruction of justice charges. As a result of its conviction, Arthur Andersen has ceased operations and is no longer in a position to reissue its audit reports or to provide consent to include financial statements reported on by it in this prospectus. Because Arthur Andersen has not reissued its reports and because we are not able to obtain a consent from Arthur Andersen, you will be unable to sue Arthur Andersen for material misstatements or omissions, if any, in this prospectus, including the financial statements covered by its previously issued reports. Even if you have a basis for asserting a remedy against, or seeking recovery from, Arthur Andersen, we believe that it is unlikely that you would be able to recover damages from Arthur Andersen.

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This prospectus contains “forward-looking statements,” which include information concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, and other information that is not historical information. Many of these statements appear, in particular, under the headings “Prospectus Summary,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” When used in this prospectus, the words “estimates,” “expects,” “anticipates,” projects,” “plans,” “intends,” “believes” and variations of such words or similar expressions are intended to identify forward-looking statements. All forward-looking statements, including, without limitation, our examination of historical operating trends, are based upon our current expectations and various assumptions. We believe there is a reasonable basis for our expectations and beliefs, but there can be no assurance that we will realize our expectations or that our beliefs will prove correct.

 

There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this prospectus. Important factors that could cause our actual results to differ materially from those expressed as forward-looking statements are set forth in this prospectus, including under the heading “Risk Factors.” As described herein, such risks, uncertainties and other important factors include, among others:

 

  the level of competition in the mattress and pillow industries;

 

  our ability to effectively manage and sustain our growth;

 

  our ability to maintain our return rates and warranty reserves;

 

  liability relating to our products;

 

  changes in, or failure to comply with, federal, state and/or local governmental regulations;

 

  our involvement in a government investigation and associated litigation or proceedings relating to any allegations of the possibility of price fixing in the mattress industry;

 

  our ability to enhance our existing products and to develop and market new products on a timely basis;

 

  risks arising from our international operations;

 

  our dependence on our significant customers;

 

  our ability to maintain our third party distributor arrangements;

 

  the efficiency and effectiveness of our advertising campaign and other marketing programs in building product and brand awareness and increasing sales;

 

  our ability to protect our patents and other intellectual property, as well as successfully defend against claims brought by our competitors under their patents and intellectual property;

 

  our ability to comply with environmental, health and safety requirements;

 

  fluctuations in the cost of raw materials, the possible loss of suppliers and disruptions in the supply of our raw materials;

 

  fluctuations in exchange rates;

 

  unexpected equipment failures, delays in deliveries or catastrophic loss at our manufacturing facilities;

 

  potential conflicts of interest between you and our controlling stockholders;

 

  our ability to maintain our labor relations; and

 

  our ability to rely on the services of our senior management team.

 

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There may be other factors that may cause our actual results to differ materially from the forward-looking statements.

 

All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this prospectus and are expressly qualified in their entirety by the cautionary statements included in this prospectus. Except as may be required by law, we undertake no obligation to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.

 

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USE OF PROCEEDS

 

We estimate that the net proceeds from this offering with respect to the shares to be sold by us will be $             million, based on an assumed initial public offering price of $             per share and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of shares by the selling stockholders.

 

We intend to use the net proceeds of this offering to repay a portion of our outstanding indebtedness.

 

Our amended senior credit facilities consist of term loan A facilities, a term loan B facility and revolving credit facilities. The revolving credit facilities and the term loan A facilities will mature in 2008, and the term loan B facility will mature in 2009. Borrowings under our amended senior credit facilities bear interest, at the option of the borrower subsidiaries, at either a base rate, plus an applicable margin for the term loan facilities and revolving credit facilities, respectively, or a Eurodollar rate on deposits for one, two, three or six-month periods, plus an applicable margin for the term loan facilities and revolving credit facilities, respectively. Borrowings under our amended senior credit facilities as of September 30, 2003 had a blended annual interest rate of 4.65%. Our senior subordinated notes bear interest at an annual rate of 10.25% and mature on August 15, 2010. Borrowings under the amended senior credit facilities and the net proceeds from the senior subordinated notes were used to fund the recapitalization in August 2003, refinance amounts borrowed to fund the acquisition of Tempur in 2002 and for working capital purposes.

 

The foregoing use of the net proceeds from this offering represents our current intentions based upon our present plans and business condition. We retain broad discretion in the allocation and use of the net proceeds of this offering, and a change in our plans or business condition could result in the application of the net proceeds from this offering in a manner other than as described in this prospectus. Pending the uses described above, we intend to invest the net proceeds from this offering in short-term, investment grade, interest-bearing securities.

 

DIVIDEND POLICY

 

In connection with the recapitalization, we made a distribution of approximately $160.0 million to our equityholders in August 2003. We currently intend to retain our future earnings, if any, to support the growth and development of our business, and we do not anticipate paying any dividends in the foreseeable future. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital requirements, and other factors that our board of directors may deem relevant.

 

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CAPITALIZATION

 

The following table sets forth our consolidated capitalization as of June 30, 2003, on an actual basis and on a pro forma basis to give effect to the Tempur acquisition and the recapitalization and on a pro forma as adjusted basis to give effect to the offering.

 

     As of June 30, 2003

     Actual

    Pro
Forma


    Pro
Forma as
Adjusted


($ in millions)           

Cash and cash equivalents(1)

   $ 8.0     $ 8.0     $             
    


 


 

Long-term debt (including current portion):

                      

Existing senior credit facilities

   $ 125.2     $     $  

Amended senior credit facilities(2)

           236.5        

Senior Subordinated Notes due 2010

           150.0        

Existing mezzanine debt facility

     50.0              

Mortgage payable

     2.2       2.2        

Capital leases and other

     0.7       0.7        
    


 


 

Total long-term debt

     178.1       389.4        

Stockholders’ equity(1):

                      

Series A convertible preferred stock, $.01 par value, 180,000 shares authorized, 146,463.65 shares issued and outstanding

     154.3       154.3        

Class A common stock, $.01 par value, 25,000 shares authorized,

    14,006 shares issued and outstanding

     —         —          

Class B-1 common stock, $.01 par value, 300,000 shares authorized,

    878.64 shares issued and outstanding

     —         —          

Additional paid in capital

     4.9       4.9        

Class B-1 common stock warrants

     2.3       2.3        

Notes receivable

     (0.1 )     (0.1 )      

Deferred stock compensation, net of amortization of $14,339

     (0.1 )     (0.1 )      

Retained earnings

     16.1       (155.6 )      

Accumulated other comprehensive income

     3.2       3.2        
    


 


 

Total stockholders’ equity

     180.6       8.9        
    


 


 

Total capitalization

   $ 358.7     $ 398.3     $  
    


 


 


(1) In connection with the recapitalization, we made a distribution of approximately $160.0 million to our equityholders subsequent to June 30, 2003.

 

(2) Does not include available borrowings of up to approximately $28.3 million under our amended senior credit facilities.

 

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DILUTION

 

The historical net tangible book value of our common stock as of June 30, 2003 was $         million, or $         per share. The historical net tangible book value per share of our common stock is the difference between our tangible assets and our liabilities, divided by the number of common shares outstanding. The pro forma net tangible book value of our common stock as of June 30, 2003 was $         million, or $         per share. The pro forma net tangible book value per share of our common stock is the difference between our tangible assets and our liabilities, divided by the number of shares of our common stock outstanding as of June 30, 2003, after giving effect to the automatic conversion of all outstanding shares of our convertible preferred stock into            shares of our common stock upon the completion of this offering. For new investors in our common stock, dilution is the per share difference between the initial public offering price of our common stock and the pro forma net tangible book value of our common stock immediately after completing this offering. Dilution in this case results from the fact that the per share offering price of our common stock is substantially in excess of the per share price paid by our current stockholders.

 

As of June 30, 2003, after giving effect to the sale of the shares of our common stock offered by us under this prospectus at an assumed initial public offering price of $         per share and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, the pro forma net tangible book value per share of our common stock would have been $         per share. Therefore, the new investors in our common stock would have paid $         for a share of common stock having a pro forma net tangible book value of approximately $         per share after this offering. That is, their investment would have been diluted by approximately $         per share. At the same time, our current stockholders would have realized an increase in pro forma net tangible book value of $         per share after this offering without further cost or risk to themselves. The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

   $         

Pro forma net tangible book value per share before this offering

   $                

Increase in pro forma net tangible book value per share attributable to investors in this offering

   $                
    

      

Pro forma net tangible book value per share after this offering

   $  
           

Dilution per share to new investors

   $  
           

 

The following table sets forth, as of June 30, 2003, on a pro forma basis to give effect to the conversion of all shares of our convertible preferred stock into          shares of common stock, the number of shares of common stock purchased in this offering, the total consideration paid, and the average price per share paid by existing and new stockholders, before deducting underwriting discounts and commissions and our estimated offering expenses:

 

     Shares Purchased

  Total Consideration

 

Average Price

Per Share


     Number

   Percent

  Amount

   Percent

 

Existing stockholders

   $               %   $                 %   $       

New Investors

                            
    

  
 

  
     

Total

   $            %   $            %   $  

Excludes (i) an aggregate of              shares of common stock issuable pursuant to stock options outstanding as of              at an exercise price per share of $            , and (ii)              shares of common stock issuable pursuant to warrants outstanding as of              at an exercise price per share of $            .

 

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UNAUDITED PRO FORMA FINANCIAL INFORMATION

 

The following unaudited pro forma condensed consolidated financial data as of and for the six months ended June 30, 2003, the twelve months ended June 30, 2003 and the twelve months ended December 31, 2002 are based on the historical financial statements included elsewhere in this prospectus.

 

The unaudited pro forma condensed consolidated balance sheet as of June 30, 2003 is adjusted to give effect to the recapitalization as if it occurred on June 30, 2003 and to the offering as if it occurred as of June 30, 2003. The pro forma condensed consolidated statements of operations for the six months ended June 30, 2003, the twelve months ended June 30, 2003 and the twelve months ended December 31, 2002 are adjusted to give effect to the Tempur acquisition, the recapitalization and the offering as if they had occurred at the beginning of the periods presented. The pro forma adjustments are described in the accompanying notes and are based upon available information and certain assumptions that management believes are reasonable.

 

The unaudited condensed consolidated pro forma financial data do not purport to represent what our results of operations or financial condition would actually have been had these transactions occurred on the dates indicated or to project our results of operations or financial condition for any future period or date. The unaudited pro forma condensed consolidated financial data should be read in conjunction with our and our predecessor company’s historical financial statements and related notes thereto included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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Unaudited Pro Forma Condensed Consolidated Statement of Income

for the Twelve Months ended December 31, 2002

 

   

Historical Period
from

January 1, 2002 to
October 31, 2002


 

Historical Period
from

November 1, 2002 to
December 31, 2002


    Pro Forma
Tempur
Acquisition
Adjustments


    Pro Forma
Recapitalization
Adjustments


    Pro Forma

 

Pro Forma

Offering

Adjustments


 

Pro Forma

as Adjusted


($ in thousands, except per share data)

Net sales

  $ 237,314   $ 60,644     $     $     $ 297,958   $                $             

Cost of sales

    110,228     37,811       (2,011 )(a)           146,028            

Operating expenses

    86,693     23,174       1,578  (b)           111,445            
   

 


 


 


 

 

 

Operating income/(loss)

    40,393     (341 )     433             40,485            

Net interest expense

    6,292     2,955       5,888  (c)     14,383 (d)     29,518            

Other (income)/expense

    1,724     (1,331 )                 393            
   

 


 


 


 

 

 

Income/(loss) before income taxes

    32,377     (1,965 )     (5,455 )     (14,383 )     10,574            

Income taxes

    12,436     889       (2,128 )(e)     (5,609 )(e)     5,588            
   

 


 


 


 

 

 

Net income/(loss)

  $ 19,941   $ (2,854 )   $ (3,327 )   $ (8,774 )   $ 4,986   $     $  

Preferred stock dividend

    1,238     1,958                   3,196            
   

 


 


 


 

 

 

Net income/(loss) available to common stockholders

  $ 18,703   $ (4,812 )   $ (3,327 )   $ (8,774 )   $ 1,790   $                $             
   

 


 


 


 

 

 

Net income/(loss) per share

                                               

Basic

                                      $     $  

Diluted

                                      $     $  

Weighted average shares (in thousands)

                                               

Basic

                                               

Diluted

                                               

 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

29


Table of Contents

Unaudited Pro Forma Condensed Consolidated Statement of Income

for the Twelve Months ended June 30, 2003

 

    Historical
Period from
July 1, 2002
to October 31,
2002


 

Historical

Period from
November 1, 2002
to June 30,

2003


    Pro Forma
Tempur
Acquisition
Adjustments


    Pro Forma
Recapitalization
Adjustments


    Pro Forma

 

Pro Forma

Offering

Adjustments


  Pro Forma
as Adjusted


($ in thousands, except per share data)    

Net sales

  $ 107,506   $ 279,448     $     $     $ 386,954   $                $             

Cost of sales

    48,334     136,447       995  (a)           185,776            

Operating expenses

    37,866     92,190       715  (b)           130,771            
   

 


 


 


 

 

 

Operating income/(loss)

    21,306     50,811       (1,710 )           70,407            

Net interest expense

    2,612     11,116       1,250  (c)     14,383 (d)     29,361            

Other (income)/expense

    1,540     (826 )                 714            
   

 


 


 


 

 

 

Income/(loss) before income taxes

    17,154     40,521       (2,960 )     (14,383 )     40,332            

Income taxes

    5,162     16,628       (1,154 )(e)     (5,609 )(e)     15,027            
   

 


 


 


 

 

 

Net income/(loss)

  $ 11,992   $ 23,893     $ (1,806 )   $ (8,774 )   $ 25,305   $     $  

Preferred stock dividend

    520     7,768                   8,288            
   

 


 


 


 

 

 

Net income/(loss) available to common stockholders

  $ 11,472   $ 16,125     $ (1,806 )   $ (8,774 )   $ 17,017   $                $             
   

 


 


 


 

 

 

Net income/(loss) per share

                                               

Basic

                                      $     $  

Diluted

                                      $     $  

Weighted average shares (in thousands)

                                               

Basic

                                               

Diluted

                                               

 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

30


Table of Contents

Unaudited Pro Forma Condensed Consolidated Statement of Income

for the Six Months Ended June 30, 2003

 

    

Historical

Period from
January 1, 2003
to June 30, 2003


   Pro Forma
Recapitalization
Adjustments


    Pro Forma

  

Pro Forma

Offering

Adjustments


  

Pro Forma

as Adjusted


($ in thousands, except per share data)               

Net sales

   $ 218,804    $     $ 218,804    $                 $             

Cost of sales

     98,635            98,635              

Operating expenses

     69,017            69,017              
    

  


 

  

  

Operating income

     51,152            51,152              

Net interest expense

     8,161      7,213 (d)     15,374              

Other expense

     505            505              
    

  


 

  

  

Income/(loss) before income taxes

     42,486      (7,213 )     35,273              

Income taxes

     15,739      (2,813 )(e)     12,926              
    

  


 

  

  

Net income/(loss)

   $ 26,747    $ (4,400 )   $ 22,347    $      $  

Preferred stock dividend

     5,810              5,810              
    

  


 

  

  

Net income/(loss) available to common stockholders

   $ 20,937    $ (4,400 )   $ 16,537    $                 $             
    

  


 

  

  

Income/(loss) per share

                                   

Basic

                         $      $  

Diluted

                         $      $  

Weighted average shares (in thousands)

                                   

Basic

                                   

Diluted

                                   

 

 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

31


Table of Contents

Unaudited Pro Forma Condensed Consolidated Balance Sheet

as of June 30, 2003

 

    

Historical

As of
June 30, 2003


    Pro Forma
Recapitalization
Adjustments


    Pro Forma

   

Pro Forma

Offering

Adjustments


    Pro Forma
as Adjusted


($ in thousands)                 

Assets:

                                      

Cash and cash equivalents

   $ 7,984     $  (f)   $ 7,984     $                  $               

Accounts receivable, net of allowance for doubtful accounts of ($3,076)

     49,039               49,039                

Inventories

     54,449               54,449                

Prepaid and other current assets

     5,062               5,062                

Deferred tax assets

     5,182               5,182                
    


 


 


 


 

Total current assets

     121,716             121,716                

Property, plant and equipment, net

     92,047               92,047                

Goodwill

     205,076               205,076                

Other intangible assets, net of amortization of $1,595

     82,790               82,790                

Other assets non current

     8,969       2,361  (g)     11,330                
    


 


 


 


 

Total assets

   $ 510,598     $ 2,361     $ 512,959     $       $  
    


 


 


 


 

Liabilities and stockholders’ equity:

                                      

Accounts payable

   $ 23,458     $       $ 23,458     $       $  

Accrued expenses

     32,753               32,753                

Income taxes payable

     12,927       (2,302 )(e)     10,625                

Value added taxes taxable

     1,250               1,250                

Current portion of long-term debt

     13,710       5,654  (h)     19,364                

Current portion of capital lease obligation and other

     671               671                

Accrued earn-out payable

     40,000       (40,000 )(i)                    
    


 


 


 


 

Current liabilities

     124,769       (36,648 )     88,121                

Deferred taxes

     41,668               41,668                

Senior long-term debt

     113,708       108,704  (j)     222,412                

Subordinated-long term debt

     47,978       102,022  (k)     150,000                

Other long-term debt

     13               13                

Other long-term liabilities

     1,886               1,886                
    


 


 


 


 

Total liabilities

     330,022       174,078       504,100                

Stockholders’ equity:

                                      

Series A convertible preferred stock, $.01 par value, 180,000 shares authorized, 146,463.65 shares issued and outstanding

     154,232               154,232                

Class A common stock, $.01 par value, 25,000 shares authorized, 14,006 shares issued and outstanding

                                  

Class B-1 common stock, $.01 par value, 300,000 shares authorized, 878.64 shares issued and outstanding

                                  

Additional paid in capital

     4,865               4,865                

Class B-1 common stock warrants

     2,348               2,348                

Notes receivable

     (100 )             (100 )              

Deferred stock compensation, net of amortization of $14,339

     (129 )             (129 )              

Retained earnings

     16,124       (171,717 )(l)     (155,593 )              

Accumulated other comprehensive income

     3,236               3,236                
    


 


 


 


 

Total stockholders’ equity

     180,576       (171,717 )     8,859                
    


 


 


 


 

Total liabilities and stockholders’ equity

   $ 510,598     $ 2,361     $ 512,959     $       $  
    


 


 


 


 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

32


Table of Contents

Notes to Unaudited Pro Forma Financial Data

(dollars in thousands)

 

(a) Represents the step-up in the value of inventories acquired in the Tempur acquisition to fair market value.

 

     Twelve months
Ended
December 31,
2002


    Twelve months
Ended
June 30,
2003


Estimated inventory step-up adjustment as if the Tempur acquisition occurred at the beginning of the respective period

   $ 7,769     $ 10,775

Actual Tempur acquisition step-up adjustment recorded as of November 1, 2002

     9,780       9,780
    


 

     $ (2,011 )   $ 995
    


 

 

(b) Represents additional depreciation expense on step-up in the value of property, plant and equipment acquired in the Tempur acquisition to fair market value and additional amortization of the intangibles resulting from the Tempur acquisition.

 

     Twelve months
Ended
December 31,
2002


   Twelve months
Ended
June 30,
2003


Additional depreciation expense on the step-up in the value of property, plant and equipment as if the Tempur acquisition occurred as of the beginning of the respective period

   $ 304    $ 121

Additional amortization expense of intangible assets resulting from the Tempur acquisition as if the Tempur acquisition occurred at the beginning of the respective period

     1,274      594
    

  

     $ 1,578    $ 715
    

  

 

(c) Represents additional interest expense and amortization of debt issuance costs associated with Tempur acquisition borrowings for the Tempur pre-acquisition period.

 

     Twelve months
Ended
December 31,
2002


   Twelve months
Ended
June 30,
2003


Additional interest expense as if the Tempur acquisition occurred at the beginning of the respective period, net of the elimination of Tempur pre-acquisition interest expense

   $ 4,855    $ 882

Additional debt issuance costs amortization as if the Tempur acquisition occurred at the beginning of the respective period

     1,033      368
    

  

     $ 5,888    $ 1,250
    

  

 

Interest expense was calculated using an assumed variable interest rate of 4.6% (three-month LIBOR plus applicable margin of 375 points) on the amended senior credit facilities and 12.5% on the mezzanine debt facility entered into in conjunction with Tempur acquisition. The actual interest rates on the variable rate indebtedness incurred to consummate the Tempur acquisition could vary from those used to compute the above adjustment of interest expense. A one-half percent increase in these rates would increase interest expense for the the twelve months ended June 30, 2003 and December 31, 2002 by approximately $0.7 million and $0.7 million, respectively.

 

33


Table of Contents
(d) Represents additional interest expense and amortization of debt issuance costs associated with the recapitalization.

 

     Twelve months
Ended
December 31,
2002


   Six months
Ended
June 30,
2003


   Twelve months
Ended
June 30,
2003


Additional interest expense as if the recapitalization occurred at the beginning of the respective period

   $ 12,942    $ 6,471    $ 12,942

Additional debt issuance costs amortization as if the recapitalization occurred at the beginning of the respective period, net of the elimination of amortization with respect to the mezzanine debt facility

     1,441      742      1,441
    

  

  

     $ 14,383    $ 7,213    $ 14,383
    

  

  

 

Interest expense on the notes was calculated using the actual interest rate on the notes. The assumed weighted average variable interest rate of 4.5% (three-month LIBOR plus applicable margin of 325 to 350 points) on the variable rate indebtedness incurred to consummate the recapitalization could vary from those used to compute the above adjustment of interest expense. A one-half percent increase in these variable rates would increase interest expense for the six months ended June 30, 2003, twelve months ended June 30, 2003 and December 31, 2002 by approximately $0.6 million, $1.2 million and $1.2 million, respectively.

 

(e) Reflects the tax effects of the recapitalization and Tempur acquisition pro forma adjustments based upon an effective tax rate of 39%.

 

(f) Represents net change in cash from the recapitalization, as follows:

 

     As of
June 30,
2003


 

Proceeds from amended senior credit facilities

   $ 239,600  

Proceeds from Senior Subordinated Notes due 2010

     150,000  

Payment of existing senior credit facility outstanding as of June 30, 2003

     (125,242 )

Payment of existing mezzanine debt facility

     (50,000 )

Payment of prepayment penalty on existing mezzanine debt facility

     (3,000 )

Payment of interest on existing mezzanine debt facility

     (758 )

Earn-out payment related to Tempur acquisition

     (40,000 )

Payment of equityholder dividend

     (160,000 )

Payment of estimated fees and expenses

     (10,600 )
    


     $  
    


 

(g) Represents the capitalization of deferred financing costs related to the recapitalization, net of the write-off of deferred financing costs.

 

     As of
June 30,
2003


 

Deferral of estimated fees and expenses related to the recapitalization

   $ 10,600  

Write-off of historical deferred financing costs associated with the senior debt and revolver

     (6,980 )

Write-off of historical deferred financing costs associated with the mezzanine debt facility

     (1,259 )
    


     $ 2,361  
    


 

34


Table of Contents
(h) Represents the recapitalization adjustments to current portion of long term debt.

 

    As of
June 30,
2003


 

Current portion of new debt incurred as part of the recapitalization

  $ 19,364  

Elimination of a current portion of Term Loan A

    (13,710 )
   


    $ 5,654  
   


 

(i) Represents the earn-out payment related to the Tempur acquisition.

 

(j) Represents indebtedness incurred as part of the recapitalization net of the repayment of existing indebtedness, as follows:

 

    As of
June 30,
2003


 

Term Loan B

  $ 135,000  

Reclassification of current portion of Term Loan B

    (1,364 )

Term Loan A

    95,000  

Reclassification of current portion of Term Loan A

    (18,000 )

Revolver

    9,600  

Reduction in Term Loan A and Revolver

    (111,532 )
   


    $ 108,704  
   


 

(k) Represents net change in senior subordinated debt.

 

   

As of

June 30,
2003


 

Senior Subordinated Notes due 2010

  $ 150,000  

Elimination of existing subordinated notes

    (50,000 )

Elimination of original issue discount related to extinguishment of mezzanine debt facility

    2,022  
   


    $ 102,022  
   


 

(l) Represents the reduction in retained earnings to reflect the dividend to equityholders as part of the recapitalization, write-off of debt issuance costs, original issue discount, prepayment penalty on mezzanine debt facility, interest payment on mezzanine debt facility, and income tax effect on recapitalization, as follows:

 

    As of
June 30,
2003


 

Elimination of historical debt issuance costs related to extinguishment of mezzanine debt facility

  $ (1,259 )

Prepayment penalty on mezzanine debt facility

    (3,000 )

Elimination of original issue discount related to extinguishment of mezzanine debt facility

    (2,022 )

Write-off of historical deferred financing costs associated with existing senior credit facility

    (6,980 )

Dividend payment to equityholders

    (160,000 )

Payment of interest on mezzanine debt facility

    (758 )

Income tax effect on recapitalization pro forma adjustments

    2,302  
   


    $ (171,717 )
   


 

35


Table of Contents

SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following table sets forth our selected historical consolidated financial and operating data for the periods indicated. Our predecessor company for periods prior to January 1, 2000 is a combination of our Danish manufacturing operations and the United States distribution entity and is sometimes referred to as the pre-predecessor company. Tempur World, Inc. was formed on January 1, 2000 to combine the manufacturing facilities and the worldwide distribution capabilities of all Tempur products, and our predecessor company for the period from January 1, 2000 to October 31, 2002 is Tempur World, Inc. We completed the Tempur acquisition (which we accounted for using the purchase method of accounting) as of November 1, 2002. As a result of preliminary adjustments to the carrying value of assets and liabilities pursuant to the acquisition, the financial position and results of operations for periods subsequent to the Tempur acquisition are not comparable to those of our predecessor or pre-predecessor companies.

 

We have derived the statement of operations and balance sheet data for our predecessor company and pre-predecessor company as of and for the years ended April 30, 1998 and 1999, the eight months ended December 31, 1999, the years ended December 31, 2000 and 2001 and the ten months ended October 31, 2002 from the audited financial statements of our pre-predecessor company and our predecessor company. We have derived our statements of operations and balance sheet data as of and for the two months ended December 31, 2002 from our audited financial statements. We have derived the statement of operations data and balance sheet data as of and for the six month period ended June 30, 2002 from our predecessor company’s unaudited condensed consolidated interim financial statements. We have derived the statement of operations and balance sheet data as of and for the six month period ended June 30, 2003 from our unaudited condensed consolidated interim financial statements. In the opinion of management, our unaudited condensed consolidated interim financial statements have been prepared on a basis consistent with our audited financial statements for the two months ended December 31, 2002 and include all adjustments, which are normal recurring adjustments, necessary for a fair presentation of the financial position and results of operations for the interim period. The results of operations for interim periods are not necessarily indicative of the results to be expected for the full year or any future period. Our predecessor company’s financial statements as of and for the years ended December 31, 2000 and 2001 and the ten months ended October 31, 2002, its unaudited condensed consolidated interim financial statements for the six months ended June 30, 2002 and our financial statements for the two months ended December 31, 2002 and our unaudited condensed consolidated interim financial statements as of and for the six months ended June 30, 2003 are included elsewhere in this prospectus.

 

36


Table of Contents
    Pre-Predecessor

  Predecessor

    TWI
Holdings


    Combined

    Predecessor

    TWI
Holdings


 
   

Year ended

April 30,


    8 Months
ended
December 31,
1999


 

Year ended

December 31,


    Period
from
January 1,
2002 to
October 31,
2002


   

Period

from
November 1,
2002 to
December 31,
2002


    Twelve
Months
ended
December 31,
2002


    Six Months
ended
June 30,
2002


    Six Months
ended
June 30,
2003


 
    1998

    1999

      2000

    2001

           
                                            (unaudited)     (unaudited)     (unaudited)  
($ in thousands, except per share
data)
     

Statement of Operations Data:

                                                                             

Net sales

  $ 58,800     $ 85,245     $ 73,635   $ 161,969     $ 221,514     $ 237,314     $ 60,644     $ 297,958     $ 129,809     $ 218,804  

Cost of sales

    37,932       55,500       45,755     89,450       107,569       110,228       37,811       148,039       61,894       98,635  
   


 


 

 


 


 


 


 


 


 


Gross profit

    20,868       29,745       27,880     72,519       113,945       127,086       22,833       149,919       67,915       120,169  

Operating expenses

    10,795       21,678       16,410     50,081       83,574       86,693       23,174       109,867       48,828       69,017  
   


 


 

 


 


 


 


 


 


 


Operating income/(loss)

    10,073       8,067       11,470     22,438       30,371       40,393       (341 )     40,052       19,087       51,152  

Net interest expense

    482       976       997     2,225       6,555       6,292       2,955       9,247       3,680       8,161  

Other (income)/expense

    (1,337 )     (10 )     793     947       316       1,724       (1,331 )     393       183       505  
   


 


 

 


 


 


 


 


 


 


Income/(loss) before income taxes

    10,928       7,101       9,680     19,266       23,500       32,377       (1,965 )     30,412       15,224       42,486  

Income taxes

    4,821       2,821       3,851     6,688       11,643       12,436       889       13,325       7,274       15,739  
   


 


 

 


 


 


 


 


 


 


Net income/(loss)

  $ 6,107     $ 4,280     $ 5,829   $ 12,578     $ 11,857     $ 19,941     $ (2,854 )   $ 17,087     $ 7,950     $ 26,747  

Preferred stock dividend

                          345       1,238       1,958       3,196       718       5,810  
   


 


 

 


 


 


 


 


 


 


Net income/(loss) available to common stockholders

  $ 6,107     $ 4,280     $ 5,829   $ 12,578     $ 11,512     $ 18,703     $ 4,812     $ 13,891     $ 7,232     $ 20,937  
   


 


 

 


 


 


 


 


 


 


Net income/(loss) per share(1)

                                                                             

Basic

                                                $                       $    

Diluted

                                                $                       $    

Weighted average shares (in thousands)

                                                                             

Basic

                                                                             

Diluted

                                                                             

Balance Sheet Data (at end of period):

                                                                             

Cash and cash equivalents

  $ 2,412     $ 2,877     $ 1,984   $ 10,572     $ 7,538     $ 6,380     $ 12,654             $ 3,155     $ 7,984  

Total assets

    34,520       49,276       66,404     144,305       176,841       199,641       448,494               189,195       510,598  

Total debt

    6,496       8,637       19,508     71,164       106,023       89,050       198,352               90,826       178,102  

Redeemable preferred stock

                          11,715       15,331                     14,809        

Total stockholders’ equity

  $ 9,495     $ 12,862     $ 14,424   $ 38,237     $ 16,694     $ 39,895     $ 151,999             $ 30,693     $ 180,576  

Other Financial and
Operating Data:

                                                                             

Adjusted EBITDA(2)

                        $ 38,948     $ 40,422     $ 50,776     $ 12,103     $ 62,879     $ 25,063     $ 59,385  

Adjusted EBITDA margin(3)

                          24.1 %     18.3 %     21.4 %     20.0 %     21.1 %     19.3 %     27.1 %

Depreciation and amortization

                        $ 6,002     $ 10,051     $ 10,383     $ 2,664     $ 13,047     $ 5,976     $ 8,233  

Net cash provided by operating activities

                        $ 1,125     $ 19,716     $ 22,706     $ 12,385     $ 35,091     $ 10,024     $ 22,959  

Capital expenditures

                        $ 27,418     $ 35,241     $ 9,175     $ 1,961     $ 11,136     $ 4,835     $ 6,744  

Number of pillows sold

                          1,717,476       1,819,993       1,528,608       407,476       1,936,084       860,918       1,455,435  

Number of mattresses sold

                          173,338       212,695       218,656       50,564       269,220       124,104       180,125  

(1) Pre-predecessor company and predecessor company net income/(loss) per share have been omitted as such information is not considered meaningful due to the change in capital structure that occurred with the Tempur acquisition.
(2) EBITDA is defined as operating income plus depreciation and amortization. We consider EBITDA a measure of our liquidity. Management uses this measure as an indicator of cash generated from operating activities. Further, it provides management with a consistent measurement tool for evaluating the operating activities of a business unit before investing activities, interest and taxes. EBITDA is not an indicator of financial performance under generally accepted accounting principles and may not be comparable to similarly captioned information reported by other companies. In addition, it does not replace net income, operating income, or cash flow

 

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provided by operating activities as indicators of operating performance. Management believes the most directly comparable GAAP financial measure is “net cash provided by operating activities” presented in our Consolidated Statement of Cash Flows. EBITDA is reconciled directly to net cash provided by operating activities as follows:

 

     Predecessor

    TWI
Holdings


    Combined

    Predecessor

    TWI
Holdings


 
     Year ended
December 31,


    Period
from
January 1,
2002 to
October 31,
2002


   

Period

from
November 1,
2002 to
December 31,
2002


    Twelve
Months
ended
December 31,
2002


    Six Months
ended
June 30,
2002


    Six Months
ended
June 30,
2003


 
     2000

    2001

           
                             (unaudited)     (unaudited)     (unaudited)  

($ in thousands)

      

EBITDA

   $ 28,440     $ 40,422     $ 50,776     $ 2,323     $ 53,099     $ 25,063     $ 59,385  

Depreciation and amortization

     (6,002 )     (10,051 )     (10,383 )     (2,664 )     (13,047 )     (5,976 )     (8,233 )

Net interest expense

     (2,225 )     (6,555 )     (6,292 )     (2,955 )     (9,247 )     (3,680 )     (8,161 )

Provision for income taxes

     (6,688 )     (11,643 )     (12,436 )     (889 )     (13,325 )     (7,274 )     (15,739 )

Other income/(expense), net

     (947 )     (316 )     (1,724 )     1,331       (393 )     (183 )     (505 )
    


 


 


 


 


 


 


Net income/(loss)

     12,578       11,857       19,941       (2,854 )     17,087       7,950       26,747  
    


 


 


 


 


 


 


Depreciation and amortization

     6,002       10,051       10,383       2,664       13,047       5,976       8,233  

(Gain)/loss on sale or disposal of property, plant and equipment

     203       (53 )     268       233       501       533       (206 )

Change in working capital and other, net

     (17,658 )     (2,139 )     (7,886 )     12,342       4,456       (4,435 )     (11,815 )
    


 


 


 


 


 


 


Net cash provided by operating activities

   $ 1,125     $ 19,716     $ 22,706     $ 12,385     $ 35,091     $ 10,024     $ 22,959  
    


 


 


 


 


 


 



   Adjusted EBITDA is defined as EBITDA plus certain items that we believe are not indicative of our future operating performance. Adjusted EBITDA is not a measurement of financial performance under generally accepted accounting principles or a measure of our liquidity and may not be comparable to similarly captioned information reported by other companies. In addition, it does not replace net income, operating income or cash flow provided by operating activities as indicators of operating performance. We believe Adjusted EBITDA provides a useful indicator of levels of our financial performance and is frequently used by securities analysts, investors and other interested parties in the evaluation of companies in our industry. Moreover, the amended senior credit facilities and indenture contain covenants in which Adjusted EBITDA is used as a measure of financial performance and, accordingly, we believe this information will be useful to investors. Adjusted EBITDA for the twelve months ended December 31, 2000 excludes $10.5 million in charges related to the termination of our license agreement on December 31, 2000. Adjusted EBITDA for the combined twelve months ended December 31, 2002 excludes $9.8 million in charges related to a purchase accounting adjustment to our inventory. Adjusted EBITDA is reconciled directly to EBITDA as follows:

 

     Predecessor

   TWI
Holdings


   Combined

   Predecessor

   TWI
Holdings


     Year ended
December 31,


   Period
from
January 1,
2002 to
October 31,
2002


  

Period

from
November 1,
2002 to
December 31,
2002


   Twelve
Months
ended
December 31,
2002


   Six
Months
ended
June 30,
2002


   Six Months
ended
June 30,
2003


     2000

   2001

              
                         (unaudited)    (unaudited)    (unaudited)

($ in thousands)

    

EBITDA

   $ 28,440    $ 40,422    $ 50,776    $ 2,323    $ 53,099    $ 25,063    $ 59,385

License agreement terminated on December 31, 2000

     10,508                              

Purchase accounting adjustment to inventory

                    9,780      9,780          
    

  

  

  

  

  

  

Adjusted EBITDA

   $ 38,948    $ 40,422    $ 50,776    $ 12,103    $ 62,879    $ 25,063    $ 59,385
    

  

  

  

  

  

  


(3) Adjusted EBITDA margin is the ratio of Adjusted EBITDA to total net sales.

 

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MANAGEMENT’S DISCUSSION AND ANALYSIS OF  FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion and analysis should be read in conjunction with the section “Selected Historical Consolidated Financial and Operating Data,” the audited consolidated financial statements and accompanying notes thereto and the unaudited consolidated financial statements and accompanying notes thereto included elsewhere in this prospectus. Unless otherwise noted, all of the financial information in this prospectus is consolidated financial information for TWI Holdings, Inc. or its predecessors. 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 include numerous risks and uncertainties, as described under “Risk Factors” and elsewhere in this prospectus. Our actual results may differ materially from those contained in any forward-looking statements.

 

General

 

We are a rapidly growing, vertically-integrated manufacturer, marketer and distributor of premium visco-elastic foam mattresses and pillows that we sell globally in 54 countries primarily under the Tempur® and Tempur-Pedic® brands. We believe our premium mattresses and pillows are more comfortable than standard bedding products because our proprietary visco-elastic foam is temperature sensitive, has a high density and conforms to the body to therapeutically align the neck and spine, thus reducing neck and lower back pain, two of the most common complaints about other sleep surfaces. Since 2000, our total net sales have grown at a compound annual rate of approximately 36% and for the combined pro forma as adjusted twelve months ended June 30, 2003, we had total net sales of $387.0 million.

 

TWI Holdings, Inc. was formed in 2002 by TA and FFL to acquire Tempur World, Inc., or Tempur World. This acquisition occurred effective November 1, 2002. The financial information for the periods prior to November 1, 2002 are based on the financial information for Tempur World and its consolidated subsidiaries, which we sometimes collectively refer to as our “predecessor company.” For purposes of this Management’s Discussion and Analysis of Financial Condition and Results of Operations, “we,” “our,” “ours” and “us” refer to TWI Holdings, Inc. and its consolidated subsidiaries for the period from and after November 1, 2002 and refer to our predecessor company for periods prior to November 1, 2002.

 

Business Segment Information

 

Beginning in 2002, following the opening of our United States manufacturing facility, we changed our reporting structure from a single segment to Domestic and International reporting segments. This change was consistent with our ability to monitor and report operating results in each of these segments. The Domestic segment consists of our United States manufacturing facility, which commenced operations in July 2001 and whose customers include our United States distribution subsidiary and certain North American third party distributors. The International segment consists of our manufacturing facility in Denmark, whose customers include all of our distribution subsidiaries and third party distributors outside the Domestic segment. Our International segment includes our sales and distribution companies operating in Europe, Japan, South Africa and Singapore. In addition, we have third party distributor arrangements in the Asia/Pacific, Middle East, Eastern Europe, Central and South America, Canada and Mexico markets. We evaluate segment performance based on sales and operating income.

 

As we operated in one segment prior to the commencement of our United States manufacturing operations, we have not restated prior year segment information to reflect our new reporting structure.

 

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Table of Contents

Critical Accounting Policies

 

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 will be 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 accounting principles generally accepted in the United States requires that the 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. Actual results could differ from those estimates.

 

Revenue Recognition

 

Our estimates of sales returns are a critical component of our revenue recognition. We recognize sales, net of estimated returns, when we ship our products to customers and the risks and rewards of ownership are transferred to them. Estimated sales returns are provided at the time of sale, based on our level of historical sales returns. We allow returns for up to 120 days following a sale, depending on the channel and promotion. Our level of sales returns differs by channel, with our direct channel typically experiencing the highest rate of returns. Our level of returns has been generally stable over the last five years and consistent with our estimates.

 

Warranties

 

Cost of sales includes estimated costs to service warranty claims of our customers. Our estimate is based on our historical claims experience and extensive product testing that we perform from time to time. We provide a 20-year warranty for United States sales and a 15-year warranty for non-United States sales on mattresses, each prorated for the last 10 years. Because our products have not been in use by our customers for the full warranty period, we rely on the combination of historical experience and product testing for the development of our estimate for warranty claims. Our estimate of warranty claims could be adversely affected if our historical experience ultimately proves to be greater than the performance of the product in our product testing. We also provide 2-year to 3-year warranties on pillows. Estimated future obligations related to these products are provided by charges to operations in the period in which the related revenue is recognized. Our estimated obligation for warranty claims as of June 30, 2003 was $3.3 million.

 

Impairment of Goodwill, Intangibles and Long-Lived Assets

 

Goodwill reflected in our consolidated balance sheet consists of the purchase price from the Tempur acquisition in excess of the estimated fair values of identifiable net assets as of the date of the Tempur acquisition. Intangibles consist of tradenames for various brands under which our products are sold. Other intangibles include our customer database for our direct channel, process technology and the formulation of our visco-elastic foam.

 

As of January 1, 2002, we adopted Statement of Financial Accounting Standards No. 142 (SFAS 142), “Goodwill and Other Intangible Assets.” Pursuant to the provisions of SFAS 142, we stopped amortizing goodwill and indefinite-lived intangible assets and perform an impairment test on goodwill and indefinite-lived intangibles at least annually. The impairment test requires the identification of potential impairment by comparing the fair value of our reporting units to their carrying values, including the applicable goodwill and indefinite-lived intangibles. These fair values are determined by calculating the discounted cash flow expected to be generated by each reporting unit taking into account what we consider to be the appropriate industry and market rate assumptions. If the carrying value exceeds the fair value, then a second step is performed which

 

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compares the implied fair value of the applicable reporting unit’s goodwill and indefinite-lived intangibles with the carrying amount of that goodwill and indefinite-lived intangible to measure the amount of impairment, if any. In addition to performing the required impairment test, SFAS 142 requires us to reassess the expected useful lives of existing intangible assets including those for which the useful life is determinable.

 

Estimates of fair value for our reporting units involve highly subjective judgments on the part of management, including the amounts of cash flows to be received, their estimated duration, and perceived risk as reflected in selected discount rates. In some cases, cash flows may be required to be estimated without the benefit of historical data, although historical data will be used where available. Although we believe our estimates and judgments are reasonable, different assumptions and judgments could result in different impairment, if any, of some or all of our recorded goodwill and indefinite-lived intangibles of $287.9 million as of June 30, 2003.

 

Long-lived assets reflected in our consolidated balance sheet consists of property, plant and equipment. Accounting for the impairment of long-lived assets is governed by Statement of Financial Accounting Standards No. 144 (SFAS 144), “Accounting for the Impairment or Disposal of Long-Lived Assets.”

 

SFAS 144 requires that whenever events or circumstances indicate that we may not be able to recover the net book value of our productive assets through future cash flows, an assessment must be performed of expected future cash flows, and undiscounted estimated future cash flows must be compared to the net book value of these productive assets to determine if impairment is indicated. Impaired assets are written down to their estimated fair value by recording an impairment charge to earnings. SFAS 144 provides that fair values may be estimated using discounted cash flow analysis or quoted market prices, together with other available information, to estimate fair values. We primarily use discounted cash flow analysis to estimate the fair value of productive assets when events or circumstances indicate that we may not be able to recover our net book values.

 

The application of SFAS 144 requires the exercise of significant judgment and the preparation of numerous significant estimates. Although we believe that our estimates of cash flows in our application of SFAS 144 are reasonable, and based upon all available information, including historical cash flow data about the prior use of our assets, such estimates nevertheless require substantial judgments and are based upon material assumptions about future events.

 

Income Tax Accounting

 

Income taxes are accounted for in accordance with Statement of Financial Accounting Standards No. 109 (SFAS 109), “Accounting for Income Taxes.” SFAS 109 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. These deferred taxes are measured by applying the provisions of tax laws in effect at the balance sheet date.

 

We recognize deferred tax assets in our balance sheet, and these deferred tax assets typically represent items deducted currently in the financial statements that will be deducted in future periods in tax returns. In accordance with SFAS 109, a valuation allowance is recorded against these deferred tax assets to reduce the total deferred tax assets to an amount that will, more likely than not, be realized in future periods. The valuation allowance is based, in part, on our estimate of future taxable income, the expected utilization of tax loss carryforwards, both domestic and foreign, and the expiration dates of tax loss carryforwards. Significant assumptions are used in developing the analysis of future taxable income for purposes of determining the valuation allowance for deferred tax assets which, in our opinion, are reasonable under the circumstances.

 

In conjunction with the acquisition of Tempur World on November 1, 2002, TWI Holdings repatriated approximately $44.2 million from one of its foreign subsidiaries in the form of a loan that under applicable United States tax principles is treated as a taxable dividend. In addition, TWI Holdings has provided for the

 

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remaining undistributed earnings as of November 1, 2002 of $10.1 million. Provisions have not been made for United States income taxes or foreign withholding taxes on undistributed earnings of foreign subsidiaries since the Tempur acquisition, as these earnings are considered indefinitely reinvested.

 

Undistributed foreign earnings as of ended June 30, 2003 was approximately $49.1 million. These earnings could become subject to United States income taxes and foreign withholding taxes (subject to a reduction for foreign tax credits) if they were remitted as dividends, were loaned to TWI Holdings or a United States subsidiary, or if TWI Holdings should sell its stock in the subsidiaries.

 

Stock-Based Compensation.

 

We account for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board (APB) Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, and comply with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” Several companies recently elected to change their accounting policies and record the fair value of options as an expense. We currently are not required to record stock-based compensation charges if the employee stock option exercise price or restricted stock purchase price equals or exceeds the deemed fair value of our common stock at the grant date. Because no market for our common stock existed prior to this offering, our board of directors determines the fair value of our common stock based upon several factors, including our operating performance, forecasted future operating results, the terms of redeemable or convertible preferred stock issued by us, including the liquidation value and other preferences of our preferred stockholders and our expected valuation in an initial public offering.

 

In addition, we understand that discussions of potential changes to APB 25 and SFAS 123 standards are ongoing and the parties responsible for authoritative guidance in this area may require changes to the applicable accounting standards. If we had estimated the fair value of the options on the date of grant using a minimum value pricing model and then amortized this estimated fair value over the vesting period of the options, our net income (loss) would have been adversely affected.

 

Results of Operations

 

The financial statements for TWI Holdings, Inc. for the period ended December 31, 2002 represent only two months of activity because TWI Holdings, Inc. commenced operations in 2002 concurrently with the completion of the Tempur acquisition. Accordingly, while generally not considered appropriate to combine pre- and post-acquisition periods when analyzing results of operations and it is not in accordance with accounting principles generally accepted in the United States, for purposes of comparison only and to facilitate discussion and analysis of results of operations, the following information combines the consolidated results of operations of our predecessor company from January 1, 2002 through October 31, 2002 with the consolidated operations of TWI Holdings, Inc. from November 1, 2002 through December 31, 2002 and the combined period is referred to as combined 2002.

 

The results of operations include the effect of the preliminary allocation of the purchase price based on the fair value of assets acquired and liabilities assumed for the period from November 1, 2002 through December 31, 2002. These adjustments include, among other items, a write up to fair value of the inventory acquired of $9.8 million and is reflected in cost of sales for the two months ended December 31, 2002. We expect to finalize the allocation of the purchase price during the fourth quarter of 2003, and changes from the preliminary purchase price allocation may result in changes to the applicable items in our balance sheet.

 

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The following table sets forth the various components of our consolidated statements of operations, expressed as a percentage of net revenue, for the periods indicated:

 

     Year ended December 31,

    Six Months ended
June 30,


 
     2000

    2001

    2002

    2002

    2003

 
     (combined)  

Net sales

   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %

Cost of sales

   55.2     48.6     49.7     47.7     45.1  
    

 

 

 

 

Gross profit

   44.8     51.4     50.3     52.3     54.9  

Selling expenses

   18.3     23.5     25.1     25.6     22.5  

General and administrative and other

   12.6     14.2     11.8     12.0     9.0  
    

 

 

 

 

Operating income

   13.9     13.7     13.4     14.7     23.4  
    

 

 

 

 

Interest expense, net

   1.4     3.0     3.1     2.8     3.7  

Other expense, net

   0.6     0.1     0.1     0.2     0.3  
    

 

 

 

 

Income before income taxes

   11.9     10.6     10.2     11.7     19.4  

Income tax provision

   4.1     5.2     4.5     5.6     7.2  
    

 

 

 

 

Net income

   7.8 %   5.4 %   5.7 %   6.1 %   12.2 %
    

 

 

 

 

 

We generate sales, net of returns, by selling our products through four distribution channels: direct, retail, healthcare and third party. The direct channel sells directly to consumers. Our retail channel sells primarily to furniture and specialty stores, as well as department stores internationally. Our healthcare channel sells our products primarily to hospitals, nursing homes, healthcare professionals and medical retailers. The following table sets forth net sales information, by channel and by segment, for the periods indicated:

 

     Year ended December 31,

   Six Months ended
June 30,


     2000

   2001

   2002

   2002

   2003

($ in millions)    (combined)

Retail

   $ 77.8    $ 116.9    $ 177.7    $ 73.5    $ 135.4

Direct

     31.1      47.6      58.8      27.0      43.0

Healthcare

     33.1      33.5      41.2      19.0      21.1

Third Party

     20.0      23.5      20.3      10.3      19.3
                                    

Domestic

   $ 74.1    $ 113.2    $ 165.3    $ 71.8    $ 124.2

International

     87.9      108.3      132.7      58.0      94.6

 

Six Months Ended June 30, 2003 Compared With Six Months Ended June 30, 2002

 

Net Sales.    Net sales for the six months ended June 30, 2003 were $218.8 million as compared to $129.8 million for the six months ended June 30, 2002, an increase of $89.0 million, or 68.6%. The increase in net sales was attributable to growth in our Domestic net sales to $124.2 million for the six months ended June 30, 2003 as compared to $71.8 million for the six months ended June 30, 2002, an increase of $52.4 million, or 73.0%, and an increase in our International net sales to $94.6 million for the six months ended June 30, 2003 as compared to $58.0 million for the six months ended June 30, 2002, an increase of $36.5 million, or 62.9%. The growth in our Domestic net sales was attributable primarily to an increase in net sales in our retail channel of $37.8 million and in the direct channel of $14.7 million, and the growth in our International net sales was attributable primarily to growth in the retail channel of $24.1 million. During the second quarter 2002, we introduced a new mattress called the Deluxe Mattress, which represented $14.4 million, or 6.6%, of net sales for the six months ended June 30, 2003 and a new pillow product, the Comfort Pillow, which represented $4.8 million, or 2.2%, of total net sales for the six months ended June 30, 2003.

 

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Cost of Sales.    Cost of sales includes the cost of raw material purchases, manufacturing costs and distribution costs associated with the production and sale of products to our customers. The cost of delivering our products to customers is also included in cost of sales. Cost of sales increased to $98.6 million for the six months ended June 30, 2003 as compared to $61.9 million for the six months ended June 30, 2002, an increase of $36.7 million, or 59.3%, although cost of sales decreased as a percentage of net sales from 47.7% in the six months ended June 30, 2002 to 45.1% in the six months ended June 30, 2003. This decrease in cost of sales as a percentage of net sales was due to improved manufacturing utilization and an increase in pillow net sales as a percentage of our total net sales. We generally experience higher margins on our pillows than on our mattresses and, accordingly, our cost of sales as a percentage of our net sales is affected by changes in our product sales mix. Our Domestic cost of sales increased to $64.7 million for the six months ended June 30, 2003 as compared to $35.1 million for the six months ended June 30, 2002, an increase of $29.6 million, or 84.3%. Our International cost of sales increased to $33.9 million for the six months ended June 30, 2003 as compared to $26.8 million for the six months ended June 30, 2002, an increase of $7.1 million, or 26.5%, excluding eliminations for sales from the International segment to the Domestic segment.

 

Selling Expenses.    Selling expenses include advertising and media production associated with our direct channel, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials, and sales force compensation and customer service. We also include in selling expenses our new product development costs associated with market research and testing for new products. Selling expenses increased to $49.4 million for the six months ended June 30, 2003 as compared to $33.3 million for the six months ended June 30, 2002, an increase of $16.1 million, or 48.3%, but decreased as a percentage of net sales to 22.6% during the six months ended June 30, 2003 from 25.7% for the six months ended June 30, 2002. The increase in the dollar amount of selling expenses was due to additional spending on advertising, sales compensation and point of purchase materials. The decrease as a percentage of net sales was primarily due to an increase in the net sales of our retail channel to $135.4 million for the six months ended June 30, 2003 as compared to $73.5 million for the six months ended June 30, 2002, an increase of $61.9 million or 84.2%. This increase was due primarily to an increase in net sales in our retail channel, as a percentage of total net sales, to 61.9% of total net sales for the six months ended June 30, 2003 as compared to 56.6% of total net sales for the six months ended June 30, 2002. Our retail channel has lower selling expenses than our other channels on a combined basis and, accordingly, our selling expenses as a percentage of our net sales will be affected by the level of our retail sales as a percentage of our total sales.

 

General and Administrative and Other.    General and administrative and other expenses include management salaries; information technology; professional fees; depreciation of furniture and fixtures, leasehold improvements and computer equipment; expenses for finance, accounting, human resources and other administrative functions; and research and development costs associated with our new product developments. General and administrative and other expenses increased to $19.7 million for the six months ended June 30, 2003 as compared to $15.5 million for the six months ended June 30, 2002, an increase of $4.2 million, or 27.1%, but decreased as a percentage of net sales to 9.0% during the six months ended June 30, 2003 from 12.0% for the six months ended June 30, 2002. The increase was due to additional spending on corporate overhead expenses, including information technology and professional services. The decrease as a percentage of sales was due to increased operating leverage from fixed administrative and research and development costs.

 

Interest Expense, Net.    Interest expense, net includes the interest costs associated with our senior and mezzanine debt facilities and the amortization of deferred financing costs related to those facilities. Interest expense, net increased to $8.2 million for the six months ended June 30, 2003 as compared to $3.7 million for the six months ended June 30, 2002, an increase of $4.5 million. This increase was due to higher average debt levels. In 2003, we entered into an interest rate cap agreement that effectively capped $60.0 million of our floating-rate debt at an interest rate of 5% plus applicable margin through March 2006. We are required under our existing credit agreements to hedge at least $60.0 million of our floating rate senior term debt.

 

Income Tax Provision.    Our income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of the utilization of foreign tax credits associated with our

 

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foreign earnings and profits and net operating losses for certain of our foreign operations. Our effective income tax rates in 2003 and 2002 differed from the federal statutory rate principally because of the effect of certain foreign tax rate differentials, state and local income taxes, valuation allowances on foreign net operating losses and foreign tax credits. Our effective tax rate for the six months ended June 30, 2003 and June 30, 2002 was approximately 37.0% and 47.8%, respectively. Our effective tax rate between the six month periods has decreased principally as a result of decreasing foreign net operating losses, which are fully reserved and a decrease in Subpart F income.

 

Combined 2002 Compared With Year Ended December 31, 2001

 

Net Sales.    Net sales were $298.0 million for combined 2002 as compared to $221.5 million for the year ended December 31, 2001, an increase of $76.5 million, or 34.5%. The increase in net sales was attributable to growth in Domestic net sales to $165.3 million for combined 2002, as compared to $113.2 million for the year ended December 31, 2001, an increase of $52.1 million, or 46.0%, and an increase in International net sales to $132.7 million for combined 2002, as compared to $108.3 million for the year ended December 31, 2001, an increase of $24.4 million, or 22.5%. Growth in Domestic net sales was due primarily to an increase in net sales in our retail channel of $40.6 million and an increase in net sales in our direct channel of $8.2 million. Growth in International net sales was affected by the general economic slowdown in Europe. However, net sales in Japan, consisting primarily of pillows, continued to be strong with an increase in net sales of 51.2% for combined 2002 over the year ended December 31, 2001.

 

Cost of Sales.    Cost of sales increased to $148.0 million for combined 2002 as compared to $107.6 million for the year ended December 31, 2001, an increase of $40.4 million, or 37.6%. The increase is primarily due to increased plant capacity with the addition of our United States manufacturing facility in July 2001. Our cost of sales as a percentage of total net sales increased to 49.7% for combined 2002 as compared to 48.6% for the year ended December 31, 2001, due primarily to fixed capacity costs in our United States manufacturing facility, partially offset by a reduction in importation duties to the United States as a result of the commencement of operations at our United States manufacturing facility.

 

Selling Expenses.    Selling expenses increased to $74.9 million for combined 2002 as compared to $52.1 million for the year ended December 31, 2001, an increase of $22.8 million or 43.8%, and increased as a percentage of net sales to 25.1% for combined 2002 as compared to 23.5% for the year ended December 31, 2001. The increase was due to additional spending on direct sales advertising, sales compensation, point of purchase materials provided to the indirect channel and market research related to new product development. The increase as a percentage of net sales was primarily due to an increase in use of television advertising.

 

General and Administrative and Other.    General and administrative and other expenses increased to $35.0 million for combined 2002 as compared to $31.5 million for the year ended December 31, 2001, an increase of $3.5 million, or 11.1%, but decreased as a percentage of net sales to 11.8% for combined 2002 as compared to 14.2% for the year ended December 31, 2001. The increase was due to additional spending on corporate overhead expenses of $0.2 million, including information technology and professional services, and was partially offset by a decrease of $0.7 million due to the adoption of FAS 142 during the first quarter 2002, as we no longer record amortization expense for goodwill and indefinite-lived intangibles.

 

Interest Expense, Net.    Interest expense, net increased to $9.2 million for combined 2002 as compared to $6.6 million for the year ended December 31, 2001, an increase of $2.6 million, or 39.4%. This increase was due to higher average debt levels. During the fourth quarter of 2002, we completed the Tempur acquisition, which included $220.0 million of new senior and mezzanine debt facilities to fund the Tempur acquisition and to fund the continued growth of Tempur World’s operations.

 

Income Tax Provision.    Our effective income tax rates in 2003 and combined 2002 differed from the federal statutory rate principally because of the effect of certain foreign tax rate differentials, state and local income taxes and foreign tax credits. Our effective tax rate for combined 2002 was approximately 43.8%

 

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compared to approximately 49.5% in 2001. This lower effective tax rate for combined 2002 compared to 2001 was primarily due to the utilization of foreign tax credits and to the fact that we no longer amortize goodwill which was previously a non-deductible item for tax purposes.

 

Year Ended December 31, 2001 Compared With Year Ended December 31, 2000

 

Net Sales.    Net sales for the year ended December 31, 2001 were $221.5 million, as compared to $162.0 million for the year ended December 31, 2000, an increase of $59.5 million, or 36.7%. The increase in net sales was attributable to growth in Domestic net sales to $113.2 million for the year ended December 31, 2001 as compared to $74.1 million for the year ended December 31, 2000, an increase of $39.1 million, or 53.0%, and an increase in International net sales to $108.3 million for the year ended December 31, 2001 as compared to $87.9 million for the year ended December 31, 2000, an increase of $20.4 million, or 23.2%. The increase in Domestic net sales was attributable primarily to an increase in net sales in our retail channel of $17.7 million and an increase in net sales in our direct channel of $18.3 million, and the increase in International net sales was attributable to an increase in net sales in our retail channel of $21.4 million.

 

Cost of Sales.    Cost of sales increased to $107.6 million for the year ended December 31, 2001 as compared to $89.4 million for the year ended December 31, 2000, an increase of $18.2 million, or 20.4%, but decreased as a percentage of net sales to 48.6% for the year ended December 31, 2001 from 55.2% for the year ended December 31, 2000. This decrease as a percentage of net sales was primarily due to payments made during 2000 under a license agreement with Tempur World’s former parent company, Fagerdala Industri, AB, of $10.5 million, which was terminated at the end of 2000. Additionally, cost of sales was affected by increased plant capacity with the addition of our United States manufacturing facility in July 2001, because our new United States facility did not become operational until fourth quarter 2001.

 

Selling Expenses.    Selling expenses increased to $52.1 million for the year ended December 31, 2001 as compared to $29.6 million for the year ended December 31, 2000, an increase of $22.5 million or 76.0%, and increased as a percentage of net sales to 23.5% for the year ended December 31, 2001 from 18.3% for the year ended December 31, 2000. The increase was due to additional spending on direct sales advertising, increased direct customer mailings, sales compensation and market research related to new product development. The increase as a percentage of net sales was primarily due to an increase in the number of direct customer mailings.

 

General and Administrative and Other.    General and administrative and other expenses increased to $31.5 million for the year ended December 31, 2001 as compared to $20.5 million for the year ended December 31, 2000, an increase of $11.0 million, or 53.7%, and increased as a percentage of net sales to 14.2% for the year ended December 31, 2001 from 12.6% for the year ended December 31, 2000. The increase was due to spending on the formation and operation of our corporate headquarters in the United States and overhead expenses including information technology investments and professional services, and was partially offset by a decrease of $0.5 million due to certain identifiable intangibles being fully amortized during 2001.

 

Interest Expense, Net.    Interest expense, net increased to $6.6 million for the year ended December 31, 2001 as compared to $2.2 million for the year ended December 31, 2000, an increase of $4.4 million, primarily due to increased average debt levels. During the third quarter of 2001, Tempur World completed a financing transaction of $115.0 million of a new senior credit facility to provide long-term financing for the new United States manufacturing operations and the repurchase of stock from certain stockholders. Included in interest expense, net was $0.2 million of amortization related to deferred financing costs for the year ended December 31, 2001 that was being amortized over the life of our outstanding senior credit facility.

 

Income Tax Provision.    Our effective income tax rates in 2001 and 2000 differed from the federal statutory rate principally because of the effect of certain foreign tax rate differentials, state and local income taxes and foreign tax credits. Our effective tax rate for 2001 was approximately 49.5% compared to approximately 34.7% in 2000. This higher effective tax rate for 2001 compared to 2000 was primarily due to an increase in deferred tax asset valuation allowances for certain foreign net operating losses, limitations on the deductibility of charitable contributions and Subpart F income from foreign operations.

 

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Liquidity and Capital Resources

 

Liquidity

 

At June 30, 2003, we had working capital of $(3.1) million including cash and cash equivalents of $8.0 million as compared to working capital of $31.3 million including $12.7 million in cash and cash equivalents as of December 31, 2002. The $4.7 million decrease in cash and cash equivalents was primarily related to continuing investments in working capital. The $34.4 million decrease in working capital was driven primarily by the accrual of the payment of the deferred purchase price in accordance with the terms of the Tempur acquisition.

 

Our principal sources of funds are cash flows from operations and borrowings under our United States and European revolving credit facilities. Our principal use of funds consists of capital expenditures and payments of principal, and interest on our outstanding senior debt facilities. Capital expenditures totaled $11.1 million for combined 2002 and $6.7 million for the six months ended June 30, 2003. We expect 2003 capital expenditures to be approximately $25.0 million, including the $18.0 million associated with the expansion of our United States manufacturing facility and approximately $5.0 million related to maintenance of our existing assets. To date, we have spent $18.2 million of this amount. In November 2002, in connection with the Tempur acquisition, we obtained from a syndicate of lenders a $170.0 million senior secured credit facility under United States and European term loans and long-term revolving credit facilities. Additionally, we obtained a total of $50.0 million of 12.5% senior subordinated unsecured debt financing under United States and European term loans, all of which was drawn upon at the inception of this facility to fund a portion of the various payments required in connection with the Tempur acquisition. At June 30, 2003, we had approximately $38.2 million available under our United States and European revolving credit facilities. Our net weighted-average borrowing cost was 5.9% for combined twelve months 2002 and 6.2% for the year ended December 31, 2001, and 7.2% and 5.7% for the six months ended June 30, 2003 and June 30, 2002, respectively.

 

Our cash flow from operations increased to $35.1 million for combined 2002 as compared to $19.7 million for the year ended December 31, 2001, an increase of $15.4 million, or 78.2%. This increase resulted primarily from improved net income and working capital management. Our cash flow from operations increased to $23.0 million for the six months ended June 30, 2003 as compared to $10.0 million for the six months ended June 30, 2002, an increase of $13.0 million, or 130%. This increase in operating cash flows was primarily the result of increased net income, partially offset by increased investment in inventory as we continue to build up inventories in anticipation of our expanded capacity at our United States manufacturing facility becoming operational, which we expect will occur in the first quarter of 2004.

 

Net cash used in investing activities for combined 2002 and the years ended December 31, 2001 and 2000 was $6.5 million, $34.9 million and $27.0 million, respectively. Investing activities consisted primarily of purchases of property and equipment related to investment in information technology and ongoing plant expenditures in all periods. The net cash used in investing activities was significantly higher in 2000 and 2001 than for combined 2002 because of the timing of the costs associated with the expansion of our Danish manufacturing facility and the construction of our new United States manufacturing facility. In May 2000, we began construction of our United States manufacturing facility. Capital expenditures in 2001 and 2000 included the cost to construct this facility, the equipment used in the facility and new equipment in our manufacturing facility in Denmark. Total capital expenditures in combined 2002 were $11.1 million, and proceeds from the sale of our United Kingdom distribution facility was $5.3 million.

 

Cash flow provided by financing activities decreased to $12.6 million for the year ended December 31, 2001 as compared to cash flow provided by financing activities of $34.3 million for the year ended December 31, 2000, a decrease of $21.7, or 63.3%. This decrease was caused by repayment of long-term debt. Cash flow used in financing activities increased to $23.9 million for combined 2002 as compared to cash flow provided by financing activities of $12.6 million for the year ended December 31, 2001, an increase of $36.5 million or 289.7%. This increase is due to the repayment of our long-term credit facilities. On November 1, 2002, in

 

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connection with the Tempur acquisition, we refinanced all of Tempur World’s existing credit facilities and issued new debt totaling $200.0 million to fund the Tempur acquisition. Cash flow used by financing activities increased to $21.9 million for the six months ended June 30, 2003 as compared to $13.7 million for the six months ended June 30, 2002, an increase of $8.2 million or 59.8%. This increase is due primarily to the repayment of our long-term credit facilities.

 

Capital Expenditures

 

Due to the continued growth in our business, in March 2003, we began construction on a $20.0 million addition to our United States manufacturing facility to support the continuing growth in mattress sales and to provide needed capacity to meet future demand for our products. We expect total capital expenditures related to this expansion to be $18.0 million for 2003. We spent $4.1 million in capital expenditures related to this expansion through June 30, 2003. The additional production capacity at our United States manufacturing facility will allow us to significantly increase our mattress manufacturing capacity. Additionally, we plan to begin expanding mattress production capacity in our Denmark manufacturing facility in the fourth quarter of 2004 to meet the demands for our international operations. We expect total capital expenditures related to that expansion to be $20.0 million in 2004.

 

In May 2003, we engaged a site selection firm to assist us in selecting a location for our third manufacturing facility, which we expect to be located in North America. This facility is currently expected to require capital expenditures of approximately $45.0 million and to be completed by the fourth quarter of 2006. This facility will provide additional capacity to meet anticipated future demand.

 

Debt Service

 

Amended Senior Credit Facilities.    In connection with the recapitalization, we entered into amended senior credit facilities on the terms described below.

 

Our amended senior credit facilities provide a total of $270.0 million in financing, consisting of:

 

  a $20.0 million United States revolving credit facility;

 

  a $30.0 million United States term loan A facility;

 

  a $135.0 million United States term loan B facility (the United States revolving credit facility and the United States term loans are collectively referred to herein as the “United States Facility”);

 

  a $20.0 million European revolving credit facility; and

 

  a $65.0 million European term loan A facility (the European revolving credit and the European term loan are collectively referred to herein as the “European Facility”).

 

Our revolving credit facilities and our term loan A facilities mature in 2008 and our term loan B facility matures in 2009.

 

Borrowing availability under the United States and European revolving credit facilities is subject to a borrowing base, as defined in the loan agreement. Each of the United States and European revolving facilities also provide for the issuance of letters of credit to support local operations. Allocations of the United States and European revolving facilities to such letters of credit will reduce the amounts available to be borrowed under their respective facilities.

 

Subject to exceptions for reinvestment of proceeds, we are required to prepay outstanding loans under our amended senior credit facilities with the net proceeds of certain asset dispositions, condemnation settlements and insurance settlements from casualty losses, issuances of certain equity and a portion of excess cash flow.

 

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We may voluntarily prepay loans or reduce commitments under our amended senior credit facilities, in whole or in part, subject to minimum amounts. If we prepay Eurodollar rate loans other than at the end of an applicable interest period, we will be required to reimburse lenders for their redeployment costs.

 

The amended senior credit facilities contain negative and affirmative covenants and requirements affecting us and our domestic and foreign subsidiaries that we create or acquire, with certain exceptions set forth in our amended credit agreement. Our amended senior credit facilities contain the following negative covenants and restrictions, among others: restrictions on liens, real estate purchases, sale-leaseback transactions, indebtedness, dividends and other restricted payments, guarantees, redemptions, liquidations, consolidations and mergers, acquisitions, asset dispositions, investments, loans, advances, changes in line of business, formation of new subsidiaries, changes in fiscal year, transactions with affiliates, amendments to charter, by-laws and other material documents, hedging agreements and intercompany indebtedness.

 

The amended senior credit facilities contain the following affirmative covenants, among others: delivery of financial and other information to the administrative agent, compliance with laws, maintenance of properties, licenses and insurance, access to books and records by the lenders, notice to the administrative agent upon the occurrence of events of default, material litigation and other events, conduct of business and existence, payment of obligations, maintenance of collateral and maintenance of interest rate protection agreements.

 

The incremental proceeds of our amended senior credit facilities were used along with the proceeds from the offering of the senior subordinated notes and cash on hand to fund the recapitalization and provide working capital.

 

Senior Subordinated Notes.    Pursuant to the terms of the indenture, TWI’s indirect, wholly-owned subsidiaries, Tempur-Pedic, Inc. and Tempur Production USA, Inc., issued senior subordinated notes in the aggregate principal amount of $150.0 million. The senior subordinated notes will mature on August 15, 2010.

 

Tempur-Pedic, Inc. and Tempur Production USA, Inc. are permitted to redeem some or all of the senior subordinated notes at any time after August 15, 2007 at specified redemption prices.

 

If Tempur-Pedic, Inc., Tempur Production USA, Inc., TWI or any of TWI’s other restricted subsidiaries sell certain assets or experience specific kinds of changes of control, Tempur-Pedic, Inc. and Tempur Production USA, Inc. must offer to repurchase the senior subordinated notes at the prices, plus accrued and unpaid interest, and additional interest, if any, to the date of redemption specified in the indenture.

 

The indenture governing the senior subordinated notes contains certain negative and affirmative covenants and requirements affecting us and our subsidiaries that we create or acquire. Subject to certain important exceptions and qualifications set forth in the indenture, these covenants limit the ability of Tempur-Pedic, Inc., Tempur Production USA, Inc., TWI and the restricted subsidiaries to incur additional indebtedness, pay dividends or make other distributions, make other restricted payments and investments, create liens, incur restrictions on the ability of our restricted subsidiaries to pay dividends or make other payments, sell assets, including capital stock of our restricted subsidiaries, merge or consolidate with other entities, and enter into transactions with affiliates.

 

Future Liquidity Sources

 

Our primary sources of liquidity are cash flow from operations and borrowings under our revolving credit facilities. We expect that ongoing requirements for debt service and capital expenditures will be funded from these sources. We incurred substantial indebtedness in connection with the recapitalization, including as a result of the issuance of the senior subordinated notes. Upon completion of the recapitalization, on a pro forma basis as of June 30, 2003, we had approximately $391.8 million of indebtedness outstanding, excluding letters of credit, as compared to $178.1 million of indebtedness outstanding as of June 30, 2003. In addition, upon completion of

 

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the recapitalization, on a pro forma basis as of June 30, 2003, we had stockholders’ equity of approximately $8.9 million as compared to stockholders’ equity of $180.6 million as of June 30, 2003. Our significant debt service obligations following the recapitalization could, under certain circumstances, have material consequences to our security holders, including holders of the senior subordinated notes. Total cash interest payments related to our amended senior credit facilities and the senior subordinated notes is expected to be in excess of approximately $25.9 million annually. The scheduled installments for principal payments on our term loans under our amended senior credit facilities (as currently in effect) total to $5.9 million in 2003, $11.9 million in 2004, $15.4 million in 2005, $15.4 million in 2006, $22.4 million in 2007 and $165.5 million thereafter.

 

Based upon the current level of operations and anticipated growth, we believe that cash generated from operations and amounts available under the revolving credit facilities will be adequate to meet our anticipated debt services requirements, capital expenditures and working capital needs for the foreseeable future. There can be no assurance, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available under the senior credit facilities or otherwise to enable us to service our indebtedness, including the senior credit facilities and the senior subordinated notes, or to make anticipated capital expenditures.

 

Contractual Obligations

 

Our contractual obligations and other commercial commitments as of June 30, 2003 after giving effect for the recapitalization completed in August 2003 are summarized below:

 

Contractual Obligations


   2003

   2004

   2005

   2006

   2007

   After
2007


  

Total

Obligations


($ in millions)     

Long-term Debt(1)

   $ 12.4    $ 13.9    $ 15.7    $ 19.2    $ 24.7    $ 296.3    $ 382.2

Operating Leases

     2.8      2.4      1.9      1.6      1.5      3.7      13.9
    

  

  

  

  

  

  

Total

   $ 15.2    $ 16.3    $ 17.6    $ 20.8    $ 26.2    $ 300.0    $ 396.1
    

  

  

  

  

  

  

 

(1) The long-term debt data give effect to the repayment of $177.4 million of long term debt in connection with the recapitalization in August 2003 and the incurrence of new long-term debt obligations of $382.2 million.

 

Impact of Recently Issued Accounting Pronouncements

 

In April 2002, the FASB issued SFAS 145, “Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections” (SFAS 145). SFAS 145 was effective January 1, 2003. SFAS 145 eliminates the required classification of gain or loss on extinguishment of debt as an extraordinary item of income and states that such gain or loss be evaluated for extraordinary classification under the criteria of Accounting Principles Board Opinion No. 30, “Reporting Results of Operations” (APB 30). SFAS 145 also requires sale-leaseback accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions, and makes various other technical corrections to existing pronouncements.

 

In June 2002, the FASB issued SFAS 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). This statement nullifies Emerging Issues Task Force Issue 94-3 (Issue 94-3), “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 requires that a liability for a cost associated with an exit or disposal activity is recognized when the liability is incurred. Under Issue 94-3, a liability for an exit cost as defined in Issue 94-3 was recognized at the date of an entity’s commitment to an exit plan. The provisions of SFAS 146 are effective for exit or disposal activities that are initiated after December 31, 2002. We do not expect the adoption of SFAS 146 to have a material impact on our consolidated financial statements.

 

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In November 2002, the FASB issued FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and a rescission of FASB Interpretation No. 34” (FIN 45). FIN 45 elaborates on the disclosures to be made regarding obligations under certain issued guarantees by a guarantor in interim and annual financial statements. It also clarifies the requirement of a guarantor to recognize a liability at the inception of the guarantee at the fair value of the obligation. FIN 45 does not provide specific guidance for subsequently measuring the guarantor’s recognized liability over the term of the guarantee. The provisions relating to the initial recognition and measurement of a liability are applicable on a prospective basis for guarantees issued or modified subsequent to December 31, 2002. The disclosure requirements of FIN 45 are effective for interim and annual financial statements for periods ending after December 15, 2002. This did not have a significant impact on our consolidated financial statements.

 

In November 2002, the EITF reached a consensus on Issue No. 00-21, “Revenue Arrangements with Multiple Deliverables” (EITF 00-21). EITF Issue No. 00-21 provides guidance on how to account for arrangements that involve the delivery or performance of multiple products, services and/or rights to use assets. The provisions of EITF Issue No. 00-21 will apply to revenue arrangements entered into in fiscal periods beginning after June 15, 2003. We do not expect the adoption of EITF No. 00-21 to have a material impact on our consolidated financial statements.

 

In December 2002, the FASB issued SFAS 148, “Accounting for Stock-Based Compensation—Transition and Disclosure—an Amendment of FASB Statement 123” (SFAS 148), which was effective on December 31, 2002. SFAS 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based compensation. In addition, it amends the disclosure requirements of SFAS 123 to require prominent disclosures about the method of accounting for stock-based compensation and the effect of the method on reported results. The provisions regarding alternative methods of transition do not apply to us, which accounts for stock-based compensation using the intrinsic value method. The disclosure provisions have been adopted. We do not believe that the adoption of this Statement will have a significant impact on our consolidated financial statements.

 

In January 2003, the FASB issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities, an Interpretation of Accounting Research Bulletin (“ARB”) No. 51” (FIN 46). FIN 46 requires a variable interest entity (“VIE”) to be consolidated by the primary beneficiary of the entity under certain circumstances. FIN 46 is effective for all new VIEs created or acquired after January 31, 2003. On October 10, 2003, the FASB issued Staff Position (FSP) FIN 46-6, “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities,” (the FSP). The FSP is a broad-based deferral of the effective date of FIN 46 for VIEs created or acquired prior to February 1, 2003 until the end of periods ending after December 15, 2003. Although we do not expect FIN 46 to have a material impact on our consolidated financial statements, we are continuing to evaluate our interest in other entities in accordance with this complex interpretation.

 

In April 2003, the FASB issued SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. The new guidance amends SFAS 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, (b) in connection with other FASB projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of a derivative, particularly regarding the meaning of an “underlying” and the characteristics of a derivative that contains financing components. The amendments set forth in SFAS 149 improve financial reporting by requiring that contracts with comparable characteristics be accounted for similarly. SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003 (with a few exceptions) and for hedging relationships designated after June 30, 2003. The guidance is to be applied prospectively. We do not believe that the adoption of this Statement will have a significant impact on our consolidated financial statements.

 

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In May 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 improves the accounting for certain financial instruments that, under previous guidance, issuers could account for as equity. The new guidance requires that those instruments be classified as liabilities in statements of financial position. At the present time, SFAS 150 is not expected to have an impact on our consolidated financial statements because we do not have financial instruments that are within the scope of this pronouncement.

 

Foreign Currency Exposures

 

Our earnings, as a result of our global operating and financing activities, are exposed to changes in foreign currency exchange rates, which may adversely affect our results of operations and financial position. A sensitivity analysis indicates that if the exchange rate of the United States Dollar to foreign currency at June 30, 2003 increased by 10%, we would incur losses of approximately $2.3 million on foreign currency forward contracts outstanding at June 30, 2003. Such losses would be largely offset by gains from the revaluation or settlement of the underlying positions economically hedged. This calculation assumes that each exchange rate would change in the same direction relative to the United States Dollar.

 

Within the normal course of business, we use derivative financial instruments principally to manage the exposure to changes in the value of certain foreign currency denominated assets and liabilities of our Denmark manufacturing operations. Gains and losses are recognized currently in the results of operations and are generally offset by losses and gains on the underlying assets and liabilities being hedged. Gains and losses on these contracts generally offset losses and gains on our foreign currency receivables and foreign currency debt. We do not hedge the effects of foreign exchange rates fluctuations on the translation of its foreign results of operations or financial position, nor do we hedge exposure related to anticipated transactions.

 

We do not apply hedge accounting to the foreign currency forward contracts used to offset currency-related changes in the fair value of foreign currency denominated assets and liabilities. These contracts are marked-to-market through earnings at the same time that the exposed assets and liabilities are remeasured through earnings. Our currency forward contracts are denominated in United States Dollars, British Pound Sterling and Japanese Yen, each against the Danish Krone.

 

Interest Rate Risk

 

We are exposed to changes in interest rates. All of our indebtedness under our amended senior credit facilities is variable rate debt. Interest rate changes therefore generally do not affect the market value of such debt but do impact the amount of our interest payments and therefore, our future earnings and cash flows, assuming other factors are held constant. Assuming we had completed the recapitalization, and applied the proceeds as intended as of June 30, 2003, we would have variable rate debt of approximately $236.5 million. Holding other variables constant including levels of indebtedness, a one hundred basis point increase in interest rates on our variable rate debt would have an estimated impact on income before income taxes for the next year of approximately $2.4 million. We are required under the terms of our existing senior credit facilities, and we are required under the terms of our amended senior credit facilities, to have at least $60.0 million of our total indebtedness subject to either a fixed interest rate or interest rate protection for a period of not less than three years within 60 days from the date of the closing of the recapitalization.

 

In January 2003, we paid a premium to purchase two three-year interest rate caps for the purpose of protecting $60.0 million of the existing variable interest rate debt outstanding, at any given time, against LIBOR rates rising above 5%. Under the terms of the interest rate caps, we have paid a premium to receive payments based on the difference between 3-month LIBOR and 5% during any period in which the 3-month LIBOR rate exceeds 5%. The interest rate caps settle on the last day of March, June, September and December until expiration.

 

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As a result of entering into the interest rate caps, we have mitigated our exposure to interest rate fluctuations above the predetermined level. As the interest payments on long-term debt are based on 3-month LIBOR and we receive a payment based on the difference between the set ceiling (5%) and 3-month LIBOR from the interest rate cap counter-party, we have eliminated any impact to rising interest rates above the stated ceiling, for an amount equal to $60.0 million of our total debt outstanding.

 

The fair value carrying amount of these instruments was $0.1 million at December 31, 2001, $(2.0) million at December 31, 2002 and $0.5 million at June 30, 2003, which is recorded as follows:

 

     December 31,
2001


   December 31,
2002


    June 30,
2003


($ in millions)     

Foreign exchange receivable

   $ 0.1    $     $ 0.4

Foreign exchange payable

          (2.0 )