Amendment No. 1 to Form S-4
Table of Contents

As filed with the Securities and Exchange Commission on October 30, 2003

 

Registration No. 333-109054


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

AMENDMENT NO. 1

TO

FORM S-4

REGISTRATION STATEMENT UNDER

THE SECURITIES ACT OF 1933

 


 

Tempur-Pedic, Inc.   Kentucky   2510   61-1187378
Tempur Production USA, Inc.   Virginia   2510   61-1368322
TWI Holdings, Inc.*   Delaware   2510   33-1022198
Tempur World, Inc.*   Delaware   2510   61-1364709
Tempur World Holdings, Inc.*   Delaware   2510   61-1394602
Tempur-Pedic, Direct Response, Inc.*   Kentucky   2510   31-1491797
Tempur-Medical, Inc.*   Kentucky   2510   31-1491807
(Exact name of each registrant as specified in its charter)   (State or other jurisdiction of incorporation or organization)   (Primary Standard Industrial Classification Code Number)   (I.R.S. Employer Identification Number)

 

*   Guarantor

 

1713 Jaggie Fox Way

Lexington, Kentucky 40511

800-878-8889

(Address, including zip code, and telephone number, including area code, of the registrants’ 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

 


 

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

 

If the securities being registered on this form are being offered in connection with the formation of a holding company and there is compliance with General Instruction G, 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.    ¨

 

THE REGISTRANTS HEREBY AMEND THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANTS SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8 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, 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 an offer to buy these securities in any state where the offer or sale is not permitted.

 

Subject to completion, dated October 30, 2003

 

PRELIMINARY PROSPECTUS

 

TEMPUR-PEDIC, INC.

TEMPUR PRODUCTION USA, INC.

 

OFFER TO EXCHANGE

 

$150,000,000 principal amount of 10 1/4% Senior Subordinated Notes due 2010, which have been registered under the Securities Act of 1933, for any and all of the outstanding 10 1/4% Senior Subordinated Notes due 2010

 

This is an offering by Tempur-Pedic, Inc. and Tempur Production USA, Inc. (the Issuers) to exchange all of their outstanding 10 1/4% Senior Subordinated Notes due 2010, which are referred to herein as the old notes, for their registered 10 1/4% Senior Subordinated Notes due 2010, which are referred to herein as the exchange notes, and together with the old notes, the notes. The terms of the exchange notes are substantially identical to the terms of the old notes except that the exchange notes have been registered under the Securities Act of 1933 and, therefore, are freely transferable. The exchange notes will represent the same debt as the old notes, and the Issuers will issue the exchange notes under the same indenture.

 

The principal features of the exchange offer are as follows:

 

    The exchange offer expires at 5:00 p.m., New York City time, on                     , 2003, unless extended.

 

    The Issuers will exchange all old notes that are validly tendered and not validly withdrawn prior to the expiration of the exchange offer.

 

    You may withdraw tendered old notes at any time prior to the expiration of the exchange offer.

 

    The exchange of old notes for exchange notes pursuant to the exchange offer will not be a taxable event for U.S. federal income tax purposes.

 

    We will not receive any proceeds from the exchange offer.

 

    There is no established trading market for the exchange notes, and we do not intend to apply for listing of the exchange notes on any securities exchange or automated quotation system.

 

Each broker-dealer that receives exchange notes for its own account pursuant to the exchange offer must acknowledge that it will deliver a prospectus in connection with any resale of such exchange notes. The letter of transmittal states that by so acknowledging and by delivering a prospectus, a broker-dealer will not be deemed to admit that it is an “underwriter” within the meaning of the Securities Act. This prospectus, as it may be amended or supplemented from time to time, may be used by a broker-dealer in connection with resales of exchange notes received in exchange for old notes where such old notes were acquired by such broker-dealer as a result of market-making activities or other trading activities. The Issuers have agreed that, for a period of 90 days after the expiration date (as defined herein), they will make this prospectus available to any broker-dealer for use in connection with any such resale. See “Plan of Distribution.”

 

The exchange notes will be the unsecured senior subordinated obligations of the Issuers and will be guaranteed on an unsecured senior subordinated basis by the Issuers’ ultimate parent, TWI Holdings, Inc. and all of TWI Holdings’ current and future domestic restricted subsidiaries, other than the Issuers. The exchange notes and guarantees will rank equally in right of payment with all of the Issuers’ and the guarantors’ existing and future unsecured senior subordinated indebtedness, including the old notes, and will be subordinated in right of payment to all of the Issuers’ and the guarantors’ existing and future senior indebtedness.

 

Participating in the exchange offer involves risks. See “Risk Factors” beginning on page 17.

 

Neither the Securities and Exchange Commission nor any other federal or state agency has approved or disapproved of the securities to be distributed in the exchange offer, nor have any of these organizations determined that this prospectus is truthful or complete. Any representation to the contrary is a criminal offense.

 

The date of this prospectus is                     , 2003.


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TABLE OF CONTENTS

 

PROSPECTUS SUMMARY

  

2

RISK FACTORS

  

16

FORWARD-LOOKING STATEMENTS

  

28

USE OF PROCEEDS

  

29

CAPITALIZATION

  

29

UNAUDITED PRO FORMA FINANCIAL INFORMATION

  

30

SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

  

38

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

  

41

BUSINESS

  

55

MANAGEMENT

  

67

PRINCIPAL SECURITY OWNERSHIP AND CERTAIN BENEFICIAL OWNERS

  

73

CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS

  

76

THE EXCHANGE OFFER

  

78

DESCRIPTION OF OTHER INDEBTEDNESS

  

86

DESCRIPTION OF THE NOTES

  

89

BOOK-ENTRY; DELIVERY AND FORM

  

132

MATERIAL U.S. FEDERAL INCOME TAX CONSIDERATIONS

  

134

PLAN OF DISTRIBUTION

  

138

LEGAL MATTERS

  

138

EXPERTS

  

138

WHERE YOU CAN FIND MORE INFORMATION

  

139

INDEX TO HISTORICAL FINANCIAL STATEMENTS

  

F-1

 

We have not authorized any dealer, salesperson or other person to give any information or to make any representation other than those contained in this prospectus. You must not rely upon any information or representation not contained in this prospectus as if we had authorized it. This prospectus does not constitute an offer to sell or a solicitation of an offer to buy any securities other than the registered securities to which it relates, nor does this prospectus constitute an offer to sell or a solicitation of an offer to buy securities in any jurisdiction to any person to whom it is unlawful to make such offer or solicitation.


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INDUSTRY AND MARKET DATA

 

This prospectus includes market share and industry data that we obtained from industry publications and surveys and internal company surveys. International Sleep Products Association (ISPA) and Furniture/Today were the primary sources for third-party industry data. Industry publications and surveys generally state that the information contained therein has been obtained from sources believed to be reliable. We have not independently verified any of the data from third-party sources nor have we ascertained the underlying economic assumptions relied upon therein. Statements as to our market position are based on the most readily available market data. While we are not aware of any misstatements regarding our industry data presented herein, our estimates involve risks and uncertainties and are subject to change based on various factors, including those discussed under the heading “Risk Factors” in this prospectus.

 

PRESENTATION OF FINANCIAL INFORMATION

 

Ernst & Young LLP, independent auditors, have audited our consolidated financial statements and schedules as of and for the two-month period ended December 31, 2002 and the consolidated financial statements and schedules of our Predecessor as of and for the ten-month period ended October 31, 2002 as set forth in their reports. We’ve included our consolidated financial statements and schedules as of and for the two-month period ended December 31, 2002 and the consolidated financial statements and schedules of our Predecessor as of and for the ten-month period ended October 31, 2002 in this prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP’s reports, given on their authority as experts in accounting and auditing.

 

Arthur Andersen LLP, independent auditors, have audited the consolidated financial statements of our Predecessor 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’ve included these consolidated financial statements of our Predecessor 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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PROSPECTUS SUMMARY

 

This summary highlights material information contained elsewhere in this prospectus. It does not contain all of the information that may be important to you. We encourage you to read this prospectus in its entirety. The exchange notes offered hereby are being offered by Tempur-Pedic, Inc. and Tempur Production USA, Inc., as co-issuers. These companies are referred to in this prospectus as the “Issuers.” The Issuers are indirect, wholly-owned subsidiaries of TWI Holdings, Inc. TWI Holdings, Inc. and its domestic restricted subsidiaries (other than the Issuers) will guarantee the exchange notes on a senior subordinated basis. 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.

 

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.

 

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. In April 2003, Consumers Digest named one of our products among the eight “best buys” of the mattress industry in the applicable price range. 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%. In the three years ended December 31, 2002, our total net sales, net income and Adjusted EBITDA have grown at compound annual rates of approximately 36%, 17% and 28%, respectively, and for the pro forma as adjusted twelve months ended June 30, 2003, we had total net sales of $387.0 million, net income of $25.3 million and Adjusted EBITDA of $96.5 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. International sales account for approximately 45% of our total net sales.

 

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. 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.

 

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Most standard mattresses are made using innersprings and most innerspring mattresses are sold for under $1,000. 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. 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.

 

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. 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 the shifting consumer preference from firmness to comfort. 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.

 

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. In addition, 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. Our significant presence in both the United States and Europe, combined with our sales elsewhere, have also created significant global brand awareness. Furthermore, 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.

 

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    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.

 

    Strong Free Cash Flow Characteristics.    Our business generates significant free cash flow due to the combination of our rapidly growing revenues, strong gross and operating margins, low maintenance capital expenditure and working capital requirements, and limited corporate overhead. 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.

 

    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. 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.

 

    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.

 

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 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 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.

 

    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.

 

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  Further Penetrate U.S. Retail Channel.    In the United States, the retail sales division is our largest sales division. We plan to build and maintain our base of furniture retailers and specialty retailers. 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 to increase sales growth internationally by further penetrating each of our existing distribution channels.

 

    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.

 

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. TA and FFL, together, 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

 

We used the proceeds of the offering of 10 1/4% Senior Subordinated Notes due 2010 on August 15, 2003, together with borrowings under our amended senior credit facilities and available cash on hand, to finance our recapitalization and pay related fees and expenses. The recapitalization consisted of the following transactions:

 

   

TWI, the Issuers and certain of our 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

 

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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.

 

    The Issuers issued $150.0 million in aggregate principal amount of 10 1/4% Senior Subordinated Notes due 2010.

 

    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.

 

The Issuers and Guarantors

 

Tempur-Pedic, Inc. and Tempur Production USA, Inc., the Issuers, 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. TWI Holdings, two intermediate United States holding companies and United States subsidiaries of Tempur-Pedic, Inc. will guarantee the notes. Tempur World Holdings S.L. and our other foreign subsidiaries will not guarantee the notes. 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.

 

Recent Developments

 

TWI Holdings filed a registration statement with the Securities and Exchange Commission on October 17, 2003 for the initial public offering of shares of its common stock. Shares of common stock will be offered by both TWI Holdings and certain selling stockholders. The number of shares to be offered on behalf of TWI Holdings and certain selling stockholders and the price range for this offering have not yet been determined. TWI Holdings expects gross proceeds of approximately $100 million, and expects the net proceeds to it will be used to pay outstanding debt. Please note that the completion of this offering is subject to the SEC review process and market conditions, and we cannot assure you that this offering will be completed.

 

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The Exchange Offer

 

The following is a brief summary of the terms of the exchange offer. For a more complete description, see “The Exchange Offer.”

 

On August 15, 2003, Tempur-Pedic, Inc. and Tempur Production USA, Inc. completed an offering of $150,000,000 in aggregate principal amount of 10 1/4% Senior Subordinated Notes due 2010, which was exempt from registration under the Securities Act.

 

Lehman Brothers Inc., UBS Securities LLC and Credit Suisse First Boston LLC, the initial purchasers, subsequently resold the old notes to qualified institutional buyers pursuant to Rule 144A under the Securities Act, to non-U.S. persons outside the United States in reliance on Regulation S under the Securities Act and to institutional accredited investors in reliance on Rule 501(a)(1), (2), (3) or (7) under the Securities Act.

 

In connection with the sale of the old notes, we entered into a registration rights agreement with the initial purchasers. We are obligated to file a registration statement with respect to an offer to exchange the old notes for a new issue of equivalent notes registered under the Securities Act within 90 days after the date on which the old notes were purchased by the initial purchasers. We are also obligated to use our reasonable best efforts to cause the registration statement to be declared effective on or prior to 180 days after the date on which the old notes were purchased by the initial purchasers. We may be required to provide a shelf registration statement to cover resales of the notes under certain circumstances.

 

If we and the guarantors fail to meet any of these requirements, we and the guarantors must pay additional interest on the notes in an amount equal to $0.05 per week per $1,000 principal amount of notes for the first 90-day period after any such default. This interest rate will increase by an additional $0.05 per week per $1,000 principal amount of notes with respect to each subsequent 90-day period until all such defaults have been cured, up to a maximum additional interest amount of $0.50 per week per $1,000 principal amount of notes. The exchange offer is being made pursuant to the registration rights agreement and is intended to satisfy the rights granted under the registration rights agreement, which rights terminate upon completion of the exchange offer.

 

Securities Offered

   $150,000,000 in aggregate principal amount of 10 1/4% Senior Subordinated Notes due 2010.

Exchange Offer

   The exchange notes are being offered in exchange for a like amount of old notes. $1,000 principal amount of exchange notes will be issued in exchange for each $1,000 principal amount of old notes validly tendered.
     The form and terms of the exchange notes are the same as the form and terms of the outstanding notes except that:
    

•      the exchange notes have been registered under the federal

       securities laws and will not bear any legend restricting their transfer;

    

•      the exchange notes bear a different CUSIP number than the old

       notes; and

    

•      the holders of the exchange notes will not be entitled to certain

       rights under the registration rights agreement, including the

       provisions for an increase in the interest rate on the old notes in

       some circumstances relating to the timing of the exchange offer.

 

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Resale

   Based upon interpretations by the staff of the SEC set forth in no-action letters issued to unrelated third parties, we believe that the exchange notes may be offered for resale, resold or otherwise transferred to you without compliance with the registration and prospectus delivery requirements of the Securities Act of 1933, unless you:
    

•      are an “affiliate” of ours within the meaning of Rule 405 under the Securities Act;

    

•      are a broker-dealer who purchased the old notes directly from us for resale under Rule 144A or any other available exemption under the Securities Act of 1933;

    

•      acquired the exchange notes other than in the ordinary course of your business; or

    

•      have an arrangement or understanding with any person to participate in the distribution of exchange notes.

     However, we have not submitted a no-action letter and there can be no assurance that the SEC will make a similar determination with respect to the exchange offer. Furthermore, in order to participate in the exchange offer, you must make the representations set forth in the letter of transmittal that we are sending you with this prospectus.

Expiration Date

   The exchange offer will expire at 5:00 p.m., New York City time, on                     , 2003, which we refer to as the expiration date, unless we, in our sole discretion, extend it. Any old notes not accepted for exchange for any reason will be returned without expense to the tendering holders promptly after the expiration or termination of the exchange offer.

Conditions to Exchange Offer

   The exchange offer is subject to certain customary conditions, some of which may be waived by us. See “The Exchange Offer—Conditions to the Exchange Offer.”

Procedure for Tendering Old Notes

  

 

The exchange offer will expire at 5:00 p.m., New York City time, on                     , 2003. If you wish to accept the exchange offer, you must complete, sign and date the letter of transmittal, or a copy of the letter of transmittal, in accordance with the instructions contained in this prospectus and in the letter of transmittal, and mail or otherwise deliver the letter of transmittal, or the copy, together with the old notes and any other required documentation, to the exchange agent at the address set forth in this prospectus and in the letter of transmittal.

 

We will accept for exchange any and all old notes that are properly tendered in the exchange offer prior to the expiration date. The exchange notes issued in the exchange offer will be delivered promptly following the expiration date. See “The Exchange Offer—Terms of the Exchange Offer.”

 

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Special Procedures for
Beneficial Owners

  

 

If you are the beneficial owner of old notes registered in the name of a broker, dealer, commercial bank, trust company or other nominee and wish to tender in the exchange offer, you should contact the person in whose name your notes are registered and promptly instruct the person to tender on your behalf.

Guaranteed Delivery

    Procedures

  

 

If you wish to tender your old notes and time will not permit your required documents to reach the exchange agent by the expiration date, or the procedure for book-entry transfer cannot be completed on time, you may tender your notes according to the guaranteed delivery procedures. For additional information, you should read the discussion under “The Exchange Offer—Guaranteed Delivery Procedures.”

Withdrawal Rights

   The tender of the old notes pursuant to the exchange offer may be withdrawn at any time prior to 5:00 p.m., New York City time, on the expiration date.

Acceptance of Old Notes and Delivery of Exchange Notes

  

 

Subject to customary conditions described in the section “The Exchange Offer—Conditions to the Exchange Offer”, we will accept old notes which are properly tendered in the exchange offer and not withdrawn prior to the expiration date. The exchange notes will be delivered promptly following the expiration date.

Effect of Not Tendering

   Any old notes that are not tendered or that are tendered but not accepted will remain subject to the restrictions on transfer. Since the old notes have not been registered under the federal securities laws, they bear a legend restricting their transfer absent registration or the availability of a specific exemption from registration. Upon the completion of the exchange offer, we will have no further obligations, except under limited circumstances, to provide for registration of the old notes under the federal securities laws.

Interest on the Exchange Notes and the Old Notes

  

 

The exchange notes will bear interest from the most recent interest payment date to which interest has been paid on the old notes. Interest on the old notes accepted for exchange will cease to accrue upon the issuance of the exchange notes.

Certain U.S. Federal Income Tax Considerations

  

 

The exchange of old notes for exchange notes by tendering holders will not be a taxable exchange for federal income tax purposes, and such holders will not recognize any taxable gain or loss or any interest income for federal income tax purposes as a result of such exchange. See “Certain U.S. Federal Income Tax Considerations.”

Exchange Agent

   Wells Fargo Bank Minnesota, National Association, the trustee under the indenture, is serving as exchange agent in connection with the

 

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     exchange offer. Contact details for the exchange agent are set forth under “The Exchange Offer—Exchange Agent.”

Use of Proceeds

   We will not receive any proceeds from the issuance of exchange notes pursuant to the exchange offer.

 

 

Terms of the Exchange Notes

 

The following is a summary of the terms of the exchange notes. For a more complete description, see “Description of the Notes.”

 

Issuers

   Tempur-Pedic, Inc. and Tempur Production USA, Inc.

Notes Offered

   $150,000,000 aggregate principal amount of 10 1/4% Senior Subordinated Notes due 2010.

Maturity Date

   August 15, 2010.

Interest

   10 1/4% per annum, payable semiannually in arrears on February 15 and August 15, commencing February 15, 2004.

Ranking

   The exchange notes and the guarantees will be unsecured and:
    

•      subordinate in right of payment to all existing and future senior

       indebtedness of the Issuers and the guarantors, including TWI;

    

•      equal in right of payment to existing and future senior

       subordinated indebtedness of the Issuers and the guarantors,

       including TWI, including the old notes;

    

•      senior in right of payment to future subordinated indebtedness of

       the Issuers and guarantors, including TWI; and

    

•      effectively junior to the liabilities of our non-guarantor

       subsidiaries.

     As of June 30, 2003, after giving pro forma effect to the recapitalization:
    

•      the Issuers and their subsidiary guarantors would have had outstanding senior indebtedness of approximately $171.6 million, and the Issuers’ parent guarantors would have had outstanding guarantees with respect to an aggregate of approximately $244.6 million of senior indebtedness;

    

•      our non-guarantor subsidiaries (all of which are foreign), would have had outstanding indebtedness of approximately $73.0 million, substantially all of which would have been guaranteed on a senior basis by TWI Holdings, the Issuers and our domestic restricted subsidiaries; and

    

•      the Issuers’ outstanding senior subordinated indebtedness, including the old notes, would have been $150.0 million.

 

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     We are permitted to incur additional senior indebtedness under the indenture governing the notes, including $215.0 million of indebtedness incurred under credit facilities, $20.0 million of capital lease obligations, mortgage financings or purchase money obligations, $30.0 million of general indebtedness and an unlimited amount of indebtedness if we satisfy certain debt incurrence requirements. In addition, under the indenture, our foreign restricted subsidiaries, which are not guarantors of the notes, may incur additional indebtedness in an amount equal to the greater of $100 million or an amount based on a borrowing base.

Optional Redemption

   Before August 15, 2006, the Issuers may redeem up to 35% of the aggregate principal amount of the exchange notes with the net proceeds of certain equity offerings. The Issuers may make that redemption only if, after the redemption, at least 65% of the aggregate principal amount of the exchange notes remains outstanding.
     On or after August 15, 2007, the Issuers may redeem some or all of the exchange notes at any time at the redemption prices described in the section “Description of the Notes—Optional Redemption.”
     The Issuers may redeem some or all of the exchange notes at any time prior to August 15, 2007, at a redemption price equal to the make-whole amount set forth in this prospectus.

Mandatory Offer to
Repurchase

  

 

If the Issuers, TWI or any of TWI’s other restricted subsidiaries sell certain assets or experience specific kinds of changes of control, the Issuers must offer to repurchase the exchange notes at the prices, plus accrued and unpaid interest, and additional interest, if any, to the date of redemption listed in the section “Description of the Notes—Repurchase at the Option of Holders.” However, we may not have sufficient funds to pay the repurchase price in the event of an asset sale or change of control.

Covenants

   The indenture governing the exchange notes contains covenants that, among other things, limit the ability of the Issuers, TWI and the restricted subsidiaries to:
    

•     incur additional indebtedness and issue preferred stock;

    

•     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.

     Each of these covenants is subject to a number of important exceptions and qualifications. See “Description of the Notes—Material Covenants.”

 

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Absence of Public Market

   The exchange notes generally will be freely transferable but will also be new securities for which there will not initially be a market. Accordingly, we cannot assure you that a market for the exchange notes will develop or as to the liquidity of any market that does develop. We do not intend to apply for the listing of the exchange notes on any securities exchange or automated dealer quotation system. The initial purchasers in the private offering of the outstanding notes have advised us that they currently intend to make a market in the exchange notes. However, they are not obligated to do so, and any market making with respect to the exchange notes may be discontinued at any time without notice. See “Plan of Distribution.”

 

 

Before deciding to tender your old notes in exchange for exchange notes pursuant to the exchange offer, you should carefully consider the information included in the “Risk Factors” section, as well as all other information included in this prospectus.

 

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Unaudited Summary and Historical and 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 as of and for the years ended December 31, 2000 and 2001 and the ten months ended October 31, 2002 from the audited financial statements of 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 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 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 or the recapitalization 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 Data,” “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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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

As Adjusted
Twelve
Months
ended
June 30,

2003


 
    2000

    2001

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

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  
   


 


 


 


 


 


 


 


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       511,859  

Total senior debt

    64,866       104,352       88,817       148,121               90,186       127,418       238,676  

Total debt

    71,164       106,023       89,050       198,352               90,826       178,102       389,360  

Redeemable preferred stock

    —         11,715       15,331       —                 14,809       —         —    

Total stockholders’ equity

  $ 38,237     $ 16,694     $ 39,895     $ 151,999             $ 30,673     $ 180,576     $ 10,859  

Other Financial and Operating Data (GAAP):

                                                               

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  

Net cash used by investing activities

  $ (27,014 )   $ (34,862 )   $ (4,646 )   $ (1,859 )   $ (6,505 )   $ (339 )   $ (6,088 )   $ (12,254 )

Net cash provided (used) by financing activities

  $ 34,314     $ 12,593     $ (19,702 )   $ (4,221 )   $ (23,923 )   $ (13,724 )   $ (21,949 )   $ (32,148 )

Basic earnings (loss) per share

                          $ (323.31 )                   $ 1,406.56          

Capital expenditures

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

Other Financial and Operating Data (non-GAAP):

                                                               

EBITDA(1)

  $ 27,493     $ 40,106     $ 49,052     $ 3,654     $ 52,706     $ 24,880     $ 58,880     $ 85,713  

EBITDA margin(2)

    17.0 %     18.1 %     20.7 %     6.0 %     17.7 %     19.2 %     26.9 %     22.2 %

Net income margin(3)

    7.8 %     5.4 %     8.4 %     (4.7 )%     5.7 %     6.1 %     12.2 %     6.5 %

Adjusted EBITDA(4)

  $ 38,001     $ 40,106     $ 49,052     $ 13,434     $ 62,486     $ 24,880     $ 58,880     $ 96,488  

Adjusted EBITDA margin(5)

    23.5 %     18.1 %     20.7 %     22.2 %     21.0 %     19.2 %     26.9 %     24.9 %

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  

Total senior debt/adjusted EBITDA

                                                            2.5x  

Total debt/adjusted EBITDA

                                                            4.0x  

Adjusted EBITDA/interest expense

                                                            3.3x  

(1)   EBITDA is defined as net income (loss) plus interest expense, income taxes and 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 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:

 

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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

As Adjusted
Twelve

Months ended
June 30,

2003


 
    2000

    2001

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

EBITDA

  $ 27,493     $ 40,106     $ 49,052     $ 3,654     $ 52,706     $ 24,880     $ 58,880     $ 85,713  

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 )
   


 


 


 


 


 


 


 


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  
   


 


 


 


 


 


 


 



(2)   EBITDA margin is the ratio of EBITDA to total net sales.
(3)   Net income margin is the ratio of net income to total net sales.
(4)   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. We also 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:

 

    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

As Adjusted
Twelve
Months
ended
June 30,

2003


    2000

  2001

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

EBITDA

  $ 27,493   $ 40,106   $ 49,052   $ 3,654   $ 52,706   $ 24,880   $ 58,880   $ 85,713

License agreement terminated on December 31, 2000

    10,508                            

Purchase accounting adjustment to inventory

                9,780     9,780             10,775
   

 

 

 

 

 

 

 

Adjusted EBITDA

  $ 38,001   $ 40,106   $ 49,052   $ 13,434   $ 62,486   $ 24,880   $ 58,880   $ 96,488
   

 

 

 

 

 

 

 


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

 

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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 participate in the exchange offer. 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

 

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

 

Participants in the mattress and pillow industries compete primarily on price, quality, brand name recognition, product availability and product performance. 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 companies now offer foam mattress products similar to our visco-elastic foam mattresses and pillows. These competitors or other mattress manufacturers may 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 by causing our products to lose market share. 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 significantly impair our liquidity and profitability. 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, which could adversely affect our liquidity and profitability.

 

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. Our growth may strain these resources to the point where they are no longer adequate to support our operations, which would require us to make significant expenditures in these areas. 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.

 

Our senior management team has not worked together as a group for a significant period of time, and may not be able to effectively manage our business.

 

Several members of our senior management team have been hired since 2001. As a result, our senior management team has not worked together as a group for a significant period of time. Our senior management team’s lack of shared experience could have an adverse effect on its ability to quickly and efficiently respond to problems and effectively manage our business.

 

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Table of Contents

We may be unable to sustain growth or profitability, which could impair our ability to service our indebtedness and harm our business.

 

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.

 

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 adversely affect our liquidity and profitability.

 

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, our return rates may not remain within our historical levels. An increase in return rates could significantly impair our liquidity and profitability. 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. We have performed testing to enable us to project our warranty claims over the respective 20- or 15-year period. However, we cannot predict with certainty what our warranty experience will be with respect to these products. In addition, our warranty reserves may not be adequate to cover future warranty claims, and such failure could have a material adverse effect on our business, financial condition and operating results if we must incur warranty costs in excess of our reserves.

 

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

 

We face an inherent business risk of exposure to product liability claims if the use of any of our products results in personal injury or property damage. In the event that any of our products prove to be defective, we may be required to recall or redesign those products. We maintain insurance against product liability claims, but such coverage may not continue to be available on terms acceptable to us or be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our business.

 

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Regulatory requirements may require costly expenditures and expose us to liability.

 

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, our solutions may prove inadequate in enabling 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.

 

Our marketing and advertising practices could also become 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. We may not be in complete compliance with all such requirements at all times. We have made and will continue to make capital and other expenditures to comply with environmental and health and safety requirements. If a release of hazardous substances occurs on or from our properties or any associated offsite disposal location, or if contamination from prior activities is discovered at any of our properties, we may be held liable and the amount of such liability could be material.

 

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.

 

Our product development and enhancements may not be successful, which could adversely affect our ability to compete and our revenues and profitability.

 

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. We may not be successful in developing or marketing enhanced or new products, and such products may not be accepted by the market.

 

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We are subject to risks from our international operations, such as increased costs and the potential absence of intellectual property protection, which could impair our ability to compete and our profitability.

 

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 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.

 

Because we depend on our significant customers, a decrease or interruption in their business with us would adversely affect our sales and profitability.

 

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. Our loss of significant customers would impair our sales and profitability and have a material adverse effect on our business, financial condition and results of operations.

 

We are subject to the possible loss of our third party distributor arrangements and disruption in product distribution in markets outside the range of our wholly-owned subsidiaries, which would adversely affect our sales and profitability.

 

We have third party distributor arrangements in the Asia/Pacific, Middle East, Eastern Europe, Central and South America, Canada and Mexico markets that are currently outside the range of our wholly-owned subsidiaries. Most of these arrangements provide for exclusive rights for such distributors in a designated territory. If our third party distributors cease distributing our products, sales of our products may be adversely affected because we may not be able to find replacement third party distributors or negotiate arrangements with such replacement third party distributors that are as favorable to us. In addition, under the laws of the applicable countries, we may have difficulty terminating these third party distributor arrangements if we choose to do so.

 

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.

 

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

 

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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, we may not 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 nine 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 85 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, they could be circumvented, or violate the proprietary rights of others, or we could be prevented from using them if challenged. A challenge to our use of our trademarks could result in a negative ruling regarding our use of our trademarks, their validity or their enforceability, or could prove expensive and time consuming in terms of legal costs and time spent defending against it. Either situation could have a material adverse effect on our financial condition or results of operations. In addition, we may not 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. Third parties, including competitors, may assert intellectual property infringement or invalidity claims against us that could be upheld. Intellectual property litigation, which could result in substantial cost to and diversion of effort by us, may be necessary to protect our trade secrets or proprietary technology or for us to defend against claimed infringement of the rights of others and to determine the scope and validity of others’ proprietary rights. We may not prevail in any such litigation, and if we are unsuccessful, we may not be able to obtain any necessary licenses on reasonable terms or at all.

 

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

 

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.

 

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

 

We currently obtain all of the materials used to produce our visco-elastic foam from outside sources. If we were unable to obtain polyol from our suppliers, we would have to find replacement suppliers. Any substitute arrangements for polyol might not be on terms as favorable to us. In addition, we purchase proprietary additives from a number of vendors, including one from whom we are obligated to purchase minimum quantities. We may

 

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not 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 source it elsewhere at a higher cost. To the extent we are unable to pass those higher costs to our customers, those costs could impair our profitability and have a material adverse effect on our business, financial condition and results of operations.

 

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

 

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 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.

 

If we are unable to expand our manufacturing capacity on a timely basis, we may not be able to meet the anticipated demand for our products, and if the cost of building these expansions exceeds our estimates, it may have a material adverse affect on our liquidity. In March 2003, we began construction on a $20.0 million addition to our United States manufacturing facility. Total expected capital expenditures related to this expansion will be $18.0 million for 2003, of which we spent $4.1 million through June 30, 2003. Additionally, we plan to begin expanding mattress production capacity in our Denmark manufacturing facility in the fourth quarter of 2004. We

 

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expect our 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 $27.0 million and to be completed by the fourth quarter of 2005. If our expansion is delayed, we may not have the manufacturing capacity necessary to meet anticipated future demand for our products. In addition, if our capital expenditures exceed our estimates, our liquidity and profitability could be impaired.

 

Our controlling shareholders may have interests that conflict with yours.

 

TWI is privately owned by TA and FFL, which together own 79.8% of TWI’s voting securities on a fully diluted as-converted basis, after giving effect to the vesting of all unvested options, and by certain other third party investors and members of management. TA and FFL together control TWI’s affairs and policies. Circumstances may occur in which the interests of these shareholders could be in conflict with your interests. In addition, these shareholders may have an interest in pursuing acquisitions, divestitures or other transactions that, in their judgment, could enhance their equity investment, even though such transactions might involve risks to you. TA, FFL and TWI’s other equityholders received a dividend of approximately $160.0 million as part of our recapitalization.

 

A deterioration in labor relations could increase our costs and have a material adverse effect on our business.

 

As of April 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 ability to execute our business strategy and as a result, adversely affect our sales and profitability.

 

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 ability to execute our business strategy and on our financial condition and results of operations. We do not maintain key-person insurance for members of our senior management team other than Robert B. Trussell, Jr. We may have difficulty replacing members of our senior management team who leave and, therefore, the loss of the services of any of these individuals could harm our business.

 

Risks Related to the Notes and the Exchange Offer

 

Our level of indebtedness could adversely affect our financial position and prevent us from fulfilling our obligations under the notes.

 

We have a substantial amount of indebtedness. On a pro forma basis as if the recapitalization had occurred at June 30, 2003, the Issuers would have on a consolidated basis outstanding indebtedness of approximately $321.6 million, including approximately $100,000 in outstanding letters of credit, all of which would be guaranteed by TWI and our domestic restricted subsidiaries, other than the Issuers. As of June 30, 2003, after giving pro forma effect to the recapitalization, the Issuers and their subsidiary guarantors would have had outstanding senior indebtedness of approximately $171.6 million; the Issuers’ parent company guarantors would have had outstanding guarantees with respect to an aggregate of approximately $244.6 million of senior indebtedness; and our non-guarantor subsidiaries (all of which are foreign) would have had $73.0 million in outstanding indebtedness, including approximately $5.1 million in outstanding letters of credit, substantially all of which would also have been guaranteed by TWI, the Issuers and our domestic restricted subsidiaries. In addition, on a pro forma basis as if the recapitalization had occurred on June 30, 2003, the Issuers’ outstanding senior subordinated indebtedness, including the old notes, would have been $150.0 million.

 

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This substantial indebtedness could have important consequences to you. For example, it could:

 

    make it more difficult for us to meet all our obligations to creditors, who could then require us to do such things as restructure our indebtedness, sell assets or raise additional debt or equity capital;

 

    require us to dedicate a substantial portion of our cash flow to pay principal and interest on our debt, which will reduce the funds available for working capital, capital expenditures and other general corporate purposes;

 

    limit our ability to borrow additional amounts for working capital, capital expenditures, debt service requirements, execution of our growth strategy, research and development costs or other purposes;

 

    limit our flexibility in planning for and reacting to changes in our business and in the industry in which we operate, which could make us more vulnerable to adverse changes in general economic, industry and competitive conditions and adverse changes in government regulation; and

 

    place us at a disadvantage compared to our competitors that have less debt.

 

Any of the above listed factors could materially adversely affect our business and results of operations.

 

Despite current indebtedness levels, we and our subsidiaries may still be able to incur substantially more debt. This could further exacerbate the risks associated with our substantial leverage.

 

We and our subsidiaries, including the Issuers, may be able to incur substantial additional indebtedness in the future. We are permitted under the indenture governing the notes to incur additional senior indebtedness, including $215.0 million of indebtedness incurred under credit facilities, $20.0 million of capital lease obligations, mortgage financings or purchase money obligations, $30.0 million of general indebtedness and an unlimited amount of indebtedness if we satisfy certain debt incurrence covenants. Our foreign restricted subsidiaries, which are not guarantors of the notes, are permitted under the indenture governing the notes to incur additional indebtedness of up to the greater of $100 million or an amount based on a borrowing base. On a pro forma basis as if the recapitalization had occurred on June 30, 2003, our amended senior credit facilities would permit additional borrowings of up to $28.3 million. All of those borrowings would rank senior to the notes and the guarantees. In addition, we may need to refinance all or a portion of our indebtedness, including the notes and guarantees, on or before maturity. We cannot assure you that we will be able to refinance any of our indebtedness, including our amended senior credit facilities and the notes, on commercially reasonable terms or at all. If new debt is added to the current debt levels of the Issuers, TWI or its other subsidiaries or if we are unable to refinance our indebtedness on commercially reasonable terms or at all, the related risks that we now face could intensify.

 

Your right to receive payment on the notes and the guarantees is junior to all our existing and future senior debt.

 

The notes are unsecured and junior in right of payment to all existing and future senior debt, including obligations of the Issuers and guarantors under our amended senior credit facilities. The notes are not secured by any of our assets and, therefore they will be subordinated to any secured debt or unsecured senior debt that we or our subsidiaries may have now or may incur in the future. Subject to certain limitations, our amended senior credit facilities also permit us to incur additional senior debt in the future. The indebtedness under our amended senior credit facilities will become due prior to the time the principal obligations under the notes become due. In addition, the notes are effectively subordinated to all indebtedness and other obligations of our foreign subsidiaries.

 

In the event that the Issuers are declared bankrupt, become insolvent or are liquidated or reorganized, the Issuers’ assets and the assets of the guarantors will be available to pay obligations on the notes only after all senior debt of TWI, the Issuers and our other subsidiaries has been paid in full and there may not be sufficient assets remaining to pay amounts due on any or all of the notes. The holders of any indebtedness of the guarantors that is senior to the guarantees will be entitled to payment of their indebtedness from the guarantors’ assets prior to the holders of any of our general unsecured obligations, including the notes. In addition, substantially all of TWI’s assets and the assets of our other guarantors will be pledged to secure the indebtedness under our amended senior credit facilities.

 

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In addition, all payments on the notes will be blocked in the event of a payment default on certain of our senior debt and may be blocked for up to 179 consecutive days in the event of certain non-payment defaults on certain of our senior debt.

 

In the event of a bankruptcy, liquidation or reorganization or similar proceeding relating to the Issuers or the guarantors, holders of the notes will participate with trade creditors and all other holders of subordinated indebtedness of the Issuers or the guarantors in the assets remaining after the Issuers and guarantors have paid all of the senior debt of the Issuers and guarantors. We may not have sufficient funds to pay all of our creditors and holders of notes may receive less, ratably, than the holders of our senior debt. Further, because the indenture requires that amounts otherwise payable to holders of the notes in a bankruptcy or similar proceeding be paid to holders of senior debt instead, holders of the notes may receive less, ratably, than holders of trade payables in any such proceeding, if anything at all.

 

On a pro forma basis as if the recapitalization had occurred on June 30, 2003:

 

    the Issuers’ outstanding senior debt would have been approximately $171.6 million, which would have consisted exclusively of borrowings and approximately $100,000 in outstanding letters of credit under the amended senior credit facilities, and approximately $13.4 million would have been available for borrowing by the Issuers under the amended senior credit facilities, all of which would have been guaranteed on a senior basis by the guarantors, including TWI, and all of which would have been secured;

 

    our non-guarantor subsidiaries (all of which are foreign) would have had outstanding indebtedness of approximately $73.0 million, which would have consisted primarily of borrowings and approximately $5.1 million in outstanding letters of credit under the amended senior credit facilities, and approximately $14.9 million would have been available for borrowing by those subsidiaries under the amended senior credit facilities, substantially all of which would be guaranteed on a senior basis by TWI, the Issuers and our domestic restricted subsidiaries, and all of which would have been secured;

 

    we would have had approximately $68.1 million in current liabilities, excluding debt; and

 

    the Issuers’ outstanding senior subordinated indebtedness, including the old notes, would have been $150.0 million.

 

To service our indebtedness, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

 

Our ability to make payments on and to refinance our indebtedness, including the notes, and to fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Our business may not generate sufficient cash flow from operations, our sales growth may not be realized on schedule or at all, and future borrowings may not be available to us under our amended senior credit facilities in an amount sufficient to enable us to pay our indebtedness, including the notes, or to fund our other liquidity needs.

 

If our cash flow and capital resources are insufficient to allow us to make scheduled payments on your notes or our other debt, we may have to sell assets, seek additional capital or restructure or refinance our debt. The terms of our debt may not allow for these alternative measures, and such measures may not satisfy our scheduled debt service obligations.

 

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

 

We are subject to interest rate risk in connection with our issuance of variable rate debt under our amended senior credit facilities. Interest rate changes could increase the amount of our interest payments and thus, negatively impact our future earnings and cash flows. We estimate that our annual interest expense on the unhedged portion of our floating rate indebtedness would increase by $1.7 million for each 1% increase in

 

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interest rates. See “Management’s Discussion and Analysis of Financial Condition and Results of Operation  —Interest Rate Risk.”

 

Our failure to comply with the restrictive covenants contained in the instruments governing our indebtedness could cause events of default under, and acceleration of, that indebtedness.

 

Our agreements with senior creditors require TWI, the Issuers and our other subsidiaries to maintain specified financial ratios, meet or exceed certain financial tests and comply with certain covenants, among other obligations. We were out of compliance with certain of such covenants restricting indebtedness, operating leases, capital expenditures, investments and changes to our corporate structure and requiring the delivery of financial statements and other information, as of the year ended December 31, 2002, but we obtained waivers from our lenders and were in compliance with these restrictions as of June 30, 2003. In addition, our amended senior credit facilities restrict, among other things:

 

    our ability to incur additional indebtedness;

 

    our ability to make capital expenditures in excess of specified levels;

 

    our ability to make acquisitions; and

 

    our ability to make capital expenditures.

 

A failure to comply with the restrictions contained in our amended senior credit facilities could lead to an event of default, which could result in an acceleration of such indebtedness. Such an acceleration would also constitute an event of default under the indenture governing the notes. The indenture for the notes also restricts, among other things, our ability to incur additional indebtedness, sell assets, make certain payments and dividends or to merge or consolidate our company. A failure to comply with the restrictions in the indenture could result in an event of default under the indenture, which could result in an acceleration of the notes and, in turn, would result in an event of default under our senior debt.

 

Federal and state statutes allow courts, under specific circumstances, to void the notes, certain transactions and subsidiary guarantees, subordinate claims in respect of the notes and require our noteholders to return payments received from subsidiary guarantors.

 

Our consummation of the transactions comprising the recapitalization (including the issuance of the notes by the Issuers and the related guarantees and any future guarantee of the notes by TWI and its other domestic subsidiaries and the use of all or part of the proceeds thereof to pay dividends to TWI’s shareholders) may be subject to review under federal or state fraudulent transfer laws. While the relevant laws may vary, under such laws, the incurrence of indebtedness, the issuance of a guarantee or the payment of the dividend to TWI’s shareholders will be a fraudulent conveyance if (1) the Issuers incur the indebtedness represented by the notes or TWI or any of our subsidiaries issue guarantees, with the intent of hindering, delaying or defrauding creditors, or (2) the Issuers, TWI or any of the guarantors received less than reasonably equivalent value or fair consideration in return for incurring the indebtedness represented by the notes or issuing their respective guarantees, and, in the case of (2) only, one of the following is also true:

 

    the Issuers or any of the guarantors, including TWI, were insolvent, or became insolvent, when the Issuers or they incur the indebtedness represented by the notes or issued the guarantees, respectively;

 

    incurring the indebtedness or issuing the guarantees left the Issuers or the applicable guarantor, respectively, with an unreasonably small amount of capital; or

 

    the Issuers or the applicable guarantor, including TWI, as the case may be, intended to, or believed that the Issuers, or it would, be unable to pay debts as they matured.

 

If incurring the indebtedness represented by the notes or issuing of any guarantee were a fraudulent conveyance, a court could, among other things, void the Issuers’ obligations regarding the notes or void any of the guarantors’ obligations under their respective guarantees, as the case may be, and require the repayment of any amounts paid thereunder.

 

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Generally, an entity will be considered insolvent if:

 

    the sum of its debts is greater than the fair value of its property;

 

    the present fair value of its assets is less than the amount that it will be required to pay on its existing debts as they become due; or

 

    it cannot pay its debts as they become due.

 

We believe that immediately after the issuance of the exchange notes, we and our subsidiaries, including the Issuers, will be solvent, will have sufficient capital to carry on our respective businesses and will be able to pay our respective debts as they mature. We cannot be sure, however, what standard a court would apply in making this determination or that a court would reach the same conclusions with regard to these issues.

 

Additionally, under federal bankruptcy or applicable state solvency law, if a bankruptcy or insolvency were initiated by or against the Issuers within 90 days after any payment by the Issuers with respect to the notes or by any guarantor with respect to a guarantee, or within one year after any payment to any insider of ours (which will include the dividend paid by TWI to certain of our equityholders), or if the Issuers or such guarantor, including TWI, anticipated becoming insolvent at the time of any such payment, all or a portion of the payment could be voided as a preferential transfer and the recipient of such payment could be required to return such payment. In rendering its opinion on the validity of the notes, no counsel will express any opinion as to federal or state laws relating to fraudulent transfers, which means that the holders of the notes have no independent legal verification that the notes or the guarantees or payments on the notes or guarantees will not be treated as a fraudulent conveyance or preferential transfer, respectively, by a court if we were to become insolvent. The obligations of each guarantor under its guarantee, however, will be limited in a manner intended to avoid it being deemed a fraudulent conveyance under applicable law. See “Description of the Notes.”

 

Your right to receive payments on the notes could be adversely affected if any of our non-guarantor subsidiaries declare bankruptcy, liquidate, or reorganize.

 

TWI and some, but not all, of its subsidiaries will guarantee the notes. In the event of a bankruptcy, liquidation or reorganization of any of our non-guarantor subsidiaries, holders of their indebtedness and their trade creditors will generally be entitled to payment of their claims from the assets of those subsidiaries before any assets are made available for distribution to us.

 

As of June 30, 2003, after giving pro forma effect to the recapitalization, the Issuers and their subsidiary guarantors would have had outstanding senior indebtedness of approximately $171.6 million; the Issuers’ parent guarantors would have had outstanding guarantees with respect to an aggregate of approximately $244.6 million of senior indebtedness; the Issuers’ outstanding senior subordinated indebtedness, including the old notes, would have been $150.0 million; and our non-guarantor subsidiaries (all of which are foreign) would have had $73.0 million of indebtedness and approximately $14.9 million would have been available to those subsidiaries for future borrowing under our amended senior credit facilities. Our non-guarantor subsidiaries, other than the Issuers, generated 43.2% of our consolidated net sales in the six months ended June 30, 2003 and held 45.8% of our consolidated assets as of June 30, 2003.

 

We are permitted under the indenture governing the notes to incur additional senior indebtedness, including $215.0 million of indebtedness incurred under credit facilities, $20.0 million of capital lease obligations, mortgage financings or purchase money obligations, $30.0 million of general indebtedness and an unlimited amount of indebtedness if we satisfy certain debt incurrence ratios. In addition, under the indenture, our foreign restricted subsidiaries, which are not guarantors of the notes, may incur additional indebtedness in an amount equal to the greater of $100 million and an amount based on a borrowing base.

 

We may not be able to repurchase the notes upon a change of control.

 

The Issuers are required to make an offer to purchase all or a portion of your notes in the event of a change of control, as defined in the indenture for the notes, at a price equal to 101% of the principal amount thereof, together with any interest the Issuers owe you. As a result of such offer, you may require the Issuers to

 

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repurchase any of your notes. There may not be sufficient funds to pay the repurchase price in the event of a change of control. In addition, our amended senior credit facilities restrict the Issuers from repurchasing the notes upon a change of control. Any future debt agreements may also restrict or prohibit the Issuers from repurchasing the notes upon a change of control. If the Issuers are prohibited from repurchasing the notes, the Issuers could seek the consents of the lenders to permit the repurchase or the Issuers could seek to refinance the debt. The Issuers may not be able to obtain any necessary consents or refinance the debt. In addition, even if we were able to refinance the debt, the financing may be on terms unfavorable to the Issuers and us. The Issuers’ failure to repurchase the notes would be a default under the indenture for the notes. An event of default under the indenture for the notes would in turn be a default under the amended senior credit facilities as well as certain of other debt of us and our subsidiaries. In addition, the change of control covenant does not cover all corporate reorganizations, mergers or similar transactions and may not provide you with protection in a highly leveraged transaction.

 

Your ability to sell the notes may be limited by the absence of an active trading market.

 

The old notes and the exchange notes are each a new issue of securities for which there currently is no established trading market. Consequently, the notes will be relatively illiquid and you may be unable to sell your notes. The Issuers do not intend to apply for the notes to be listed on any securities exchange or to arrange for quotation on any automated dealer quotation system. The initial purchasers of the old notes advised the Issuers that they intended to make a market in the old notes and, if issued, the exchange notes, but they are not obligated to do so. Each initial purchaser may discontinue any market making in the notes at any time, in its sole discretion. As a result, we cannot assure you as to the liquidity of any trading market for the notes. You may not be able to sell your notes at a particular time, and the prices that you receive when you sell may not be favorable.

 

Future trading prices of the notes will depend on many factors, including:

 

    our operating performance and financial condition;

 

    the Issuers’ ability to complete the offer to exchange the old notes for the exchange notes;

 

    the interest of securities dealers in making a market; and

 

    the market for similar securities.

 

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

 

Ernst & Young LLP, independent auditors, have audited our consolidated financial statements and schedules as of and for the two-month period ended December 31, 2002 and the consolidated financial statements and schedules of our Predecessor as of and for the ten-month period ended October 31, 2002 as set forth in their reports. We’ve included our consolidated financial statements and schedules as of and for the two-month period ended December 31, 2002 and the consolidated financial statements and schedules of our Predecessor as of and for the ten-month period ended October 31, 2002 in this prospectus and elsewhere in the registration statement in reliance on Ernst & Young LLP’s reports, given on their authority as experts in accounting and auditing.

 

Arthur Andersen LLP, independent auditors, have audited the consolidated financial statements of our Predecessor 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’ve included these consolidated financial statements of our Predecessor 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 charge. 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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FORWARD-LOOKING STATEMENTS

 

This prospectus includes forward-looking statements 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 shareholders;

 

    our ability to maintain our labor relations; and

 

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

 

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. 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

 

This exchange offer is intended to satisfy our obligations under the registration rights agreement, dated August 15, 2003 by and among Tempur-Pedic, Inc. and Tempur Production USA, Inc., the guarantors party thereto, and the initial purchasers of the old notes. We will not receive any proceeds from the issuance of the exchange notes in the exchange offer. We will receive in exchange old notes in like principal amount. We will retire or cancel all of the old notes tendered in the exchange offer. Accordingly, the issuance of the exchange notes will not result in any change in our capitalization.

 

On August 15, 2003, we issued and sold the old notes. We used the proceeds from the offering of the old notes, together with borrowings under our amended senior credit facilities and available cash on hand, to finance our recapitalization and pay related fees and expenses. As part of the recapitalization, we repaid all of the outstanding borrowings under our then existing mezzanine debt facility and amended and restated the terms of our senior credit facilities. Our mezzanine debt facility had an interest rate of 12.5% and would have matured in 2009 had it not been terminated. Immediately prior to the recapitalization, our senior credit facilities had a weighted average interest rate of 5.1% and would have matured in 2008. Borrowings under the mezzanine debt facility and the senior credit facilities were originally used to fund the Tempur acquisition and for working capital. See “Prospectus Summary—The Recapitalization.”

 

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 recapitalization.

 

     As of June 30, 2003

     Actual

  

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(1)

     —        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

Total stockholders’ equity(1)

     180.6      10.9
    

  

Total capitalization

   $ 358.7    $ 400.3
    

  


(1)   In connection with the recapitalization, we made a distribution of approximately $160.0 million to TWI’s 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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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. 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 and the recapitalization 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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Table of Contents

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

as

Adjusted


($ in thousands)     

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
    

  


 


 


 

 

 

 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

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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

as Adjusted


($ in thousands)     

Net sales

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

Cost of goods sold

     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, net

     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
    

  


 


 


 

 

 

 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

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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

as Adjusted


($ in thousands)     

Net sales

   $ 218,804    $ —       $ 218,804

Cost of sales

     98,635      —         98,635

Operating expenses

     69,017      —         69,017
    

  


 

Operating income (loss)

     51,152      —         51,152

Net interest (income) expense

     8,161      7,213 (d)     15,374

Other (income) 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
    

  


 

 

 

 

 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

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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

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       1,261 (g)     10,230  
    


 


 


Total assets

   $ 510,598     $ 1,261     $ 511,859  
    


 


 


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       105,604 (j)     219,312  

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       170,978       501,000  

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       (169,717 )(l)     (153,593 )

Accumulated other comprehensive income

     3,236               3,236  
    


 


 


Total stockholders’ equity

     180,576       (169,717 )     10,859  
    


 


 


Total liabilities and stockholders’ equity

   $ 510,598     $ 1,261     $ 511,859  
    


 


 


 

See accompanying Notes to Unaudited Pro Forma Financial Data

 

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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.

 

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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 perspective 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, as follows:

 

    

As of

June 30,

2003


 

Proceeds from amended senior credit facilities

   $ 236,500  

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

     (158,000 )

Payment of estimated fees and expenses

     (9,500 )
    


     $ —    
    


 

(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

   $ 9,500  

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 )
    


     $ 1,261  
    


 

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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

     6,500  

Reduction in Term Loan A and Revolver

     (111,532 )
    


     $ 105,604  
    


 

(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

     (158,000 )

Payment of interest on mezzanine debt facility

     (758 )

Income tax effect on recapitalization pro forma adjustments

     2,302  
    


     $ (169,717 )
    


 

37


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 U.S. 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 pre-predecessor company as of and for the years ended April 30, 1998 and 1999 and the eight months ended December 31, 1999 from the combined audited financial statements of our pre-predecessor company. We have derived the statement of operations and balance sheet data as of and for the years ended December 31, 2000 and 2001 and the ten months ended October 31, 2002 from the audited financial statements of 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.

 

38


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

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

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  
   


 


 

 


 


 


 


 


 


 


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 senior debt

    6,496       8,637       19,508     64,866       104,352       88,817       148,121               90,186       127,418  

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 (GAAP):

                                                                             

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  

Net cash used by investing activities

                        $ (27,014 )   $ (34,862 )   $ (4,646 )   $ (1,859 )   $ (6,505 )   $ (339 )   $ (6,088 )

Net cash provided (used) by financing activities

                        $ 34,314     $ 12,593     $ (19,702 )   $ (4,221 )   $ (23,923 )   $ (13,724 )   $ (21,949 )

Basic earning (loss) per share

                                                $ (323.31 )                   $ 1,406.56  

Capital expenditures

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

Other Financial and Operating Data (non-GAAP):

                                                                             

EBITDA(1)

                        $ 27,493     $ 40,106     $ 49,052     $ 3,654     $ 52,706     $ 24,880     $ 58,880  

EBITDA margin(2)

                          17.0 %     18.1 %     20.7 %     6.0 %     17.7 %     19.2 %     26.9 %

Net income margin(3)

                          7.8 %     5.4 %     8.4 %     (4.7 )%     5.7 %     6.1 %     12.2 %

Adjusted EBITDA(4)

                        $ 38,001     $ 40,106     $ 49,052     $ 13,434     $ 62,486     $ 24,880     $ 58,880  

Adjusted EBITDA margin(5)

                          23.5 %     18.1 %     20.7 %     22.2 %     21.0 %     19.2 %     26.9 %

Ratio of earnings to fixed charges (unaudited)(6)

                          5.1x       4.3x       5.1x       —         3.7x       4.3x       5.3x  

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  

 

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Table of Contents

(1)   EBITDA is defined as net income/(loss) plus interest expense, income taxes and 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 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

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

EBITDA

   $ 27,493     $ 40,106     $ 49,052     $ 3,654     $ 52,706     $ 24,880     $ 58,880  

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 )
    


 


 


 


 


 


 


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  
    


 


 


 


 


 


 



(2)   EBITDA margin is the ratio of EBITDA to total net sales.
(3)   Net income margin is the ratio of net income to total net sales.
(4)   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. We also 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

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

EBITDA

   $ 27,493    $ 40,106    $ 49,052    $ 3,654    $ 52,706    $ 24,880    $ 58,880

License agreement
terminated on December 31, 2000

     10,508      —        —        —        —        —        —  

Purchase accounting adjustment to inventory

     —        —        —        9,780      9,780      —        —  
    

  

  

  

  

  

  

Adjusted EBITDA

   $ 38,001    $ 40,106    $ 49,052    $ 13,434    $ 62,486    $ 24,880    $ 58,880
    

  

  

  

  

  

  


(5)   Adjusted EBITDA margin is the ratio of Adjusted EBITDA to total net sales.
(6)   The ratio of earnings to fixed charges for the period from November 1, 2002 to December 31, 2002 is less than one to one. Earnings deficiency for this period is $5,386,787.

 

40


Table of Contents

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. The exchange notes offered hereby are being offered by Tempur-Pedic, Inc. and Tempur Production USA, Inc., as co-issuers. These companies are referred to in this prospectus as the “Issuers.” The Issuers are indirect, wholly-owned subsidiaries of TWI Holdings, Inc. TWI Holdings, Inc. and its domestic restricted subsidiaries (other than the Issuers) have guaranteed the old notes, and will guarantee the exchange notes, on a senior subordinated basis. 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. In the three year period ended December 31, 2002, our total net sales, net income and EBITDA have grown at compound annual rates of approximately 36%, 17% and 28%, respectively, and for the combined pro forma as adjusted twelve months ended June 30, 2003, we had total net sales of $387.0 million, net income of $25.3 million and Adjusted EBITDA of $96.5 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 the “Predecessor.” 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 the Predecessor for periods prior to November 1, 2002.

 

Business Segment Information

 

We operate in two business segments: Domestic and International. These reportable segments are strategic business units that are managed separately.

 

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.

 

41


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

 

42


Table of Contents

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.

 

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 the Predecessor 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.

 

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 (income), 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

 

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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.

 

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%. Domestic cost of sales increased as a percentage of Domestic net sales from 48.8% in the six months ended June 30, 2002 to 52.1% in the six months ended June 30, 2003. This increase in cost of sales as a percentage of net sales was due to increased sales to the retail channel. We generally receive lower margins in retail channel net sales. 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. International cost of sales decreased as a percentage of International net sales from 46.2% in the six months ended June 30, 2002 to 35.8% in the six months ended June 30, 2003. This decrease in cost of sales as a percentage of net sales was due to increased sales to our third party sales channel. We generally receive higher margins in the third party channel.

 

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

 

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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 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

 

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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% 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.

 

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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 shareholders. 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.

 

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

 

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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 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

 

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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. At September 30, 2003, we had a total of $232.0 million in borrowings outstanding under the amended senior credit facilities, and a total of $4.6 million in letters of credit outstanding.

 

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.

 

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.

 

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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, the Issuers issued the old notes in the aggregate principal amount of $150.0 million. The notes will mature on August 15, 2010.

 

The Issuers are permitted to redeem some or all of the notes at any time after August 15, 2007 at specified redemption prices.

 

If the Issuers, TWI or any of TWI’s other restricted subsidiaries sell certain assets or experience specific kinds of changes of control, the Issuers must offer to repurchase the 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 notes contains certain negative and affirmative covenants and requirements affecting us and our guarantor subsidiaries that we create or acquire. Subject to certain important exceptions and qualifications set forth in the indenture, these covenants limit the ability of the Issuers, 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. See “Description of the Notes.”

 

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 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 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 notes, or to make anticipated capital expenditures.

 

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Our long-term obligations contain various financial tests and covenants. We were out of compliance with certain of such covenants restricting indebtedness, operating leases, capital expenditures, investments and changes to our corporate structure and requiring the delivery of financial statements and other reports, as of the year ended December 31, 2002, but obtained waivers from our lenders, and we were in compliance with these covenants as of June 30, 2003.

 

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

   $ 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.

 

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

 

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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. For VIEs created or acquired prior to February 1, 2003, the provisions of FIN 46 must be applied for the first interim or annual period beginning after June 15, 2003. As we do not have variable interest entities, it is not expected that the adoption of FIN 46 will have a material impact on our financial position or results of operations.

 

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.

 

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. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003. Application of SFAS 150 to financial instruments that exist on the date of adoption should be reported through a cumulative effect of a change in an accounting principle by measuring those instruments at fair value or as otherwise required by the SFAS 150. The adoption of SFAS 150 did not have a significant impact on our consolidated financial statements.

 

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 United States Dollar to foreign currency exchange rates at June 30, 2003 increased 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.

 

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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.

 

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 )      —  

Interest rate caps

     —        —          0.1
    

  


  

Total

   $ 0.1    $ (2.0 )    $ 0.5
    

  


  

 

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BUSINESS

 

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. In April 2003, Consumers Digest named one of our products among the eight “best buys” of the mattress industry in the applicable price range in recognition of the strong value it provides 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%. In the three years ended December 31, 2002, our total net sales, net income and Adjusted EBITDA have grown at compound annual rates of approximately 36%, 17% and 28%, respectively, and for the twelve months ended June 30, 2003, we had total net sales of $387.0 million, net income of $25.3 million and Adjusted EBITDA of $96.5 million.

 

While most standard mattress companies offer pricing discounts through a single channel, we sell our premium mattresses and pillows through multiple channels at full prices. 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 and enhances awareness of our brand. 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.

 

Market Opportunity

 

Global Mattress Market

 

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 units 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, 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 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.

 

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The medical community is also a large consumer of mattresses to furnish hospitals and nursing homes. In the United States, there are approximately 15,400 nursing homes and 5,000 hospitals with a total bed count in excess of 2.7 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.

 

Global Pillow Market

 

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.

 

Our Market Position

 

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 globally. 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 the 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 as our brand gains broader consumer recognition, we expect that our premium products will continue to attract sales away from the standard mattress market.

 

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 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

 

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existence since 1991 and its global awareness 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 total net sales. For the combined twelve months ended December 31, 2002, our retail channel represented 60% of total 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 Free Cash Flow Characteristics.    Our business generates significant free cash flow due to the combination of our rapidly growing revenues, strong gross and operating margins, low maintenance capital expenditure and working capital requirements, and limited corporate overhead. 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 year ended December 31, 2002, our gross margin, net income margin and Adjusted EBITDA margins exceeded 50%, 5.7% and 21.0%, respectively, on net sales of $298.0 million. In addition, capital expenditures were $11.1 million for this period, of which approximately $3.0 million was related to the maintenance of our existing assets.

 

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

 

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$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 the combined twelve months ended December 31, 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 in 2002;

 

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

 

    improved EBITDA margins;

 

    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.

 

Our 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.

 

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 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, Art Van and Haverty’s and specialty retailers including Brookstone, Relax-the-Back and Bed, Bath & Beyond. 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.

 

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Continue to Expand Internationally.    We plan 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.

 

Our Products

 

Our proprietary visco-elastic foam mattresses and pillows contour to the body more naturally and enable better spinal alignment, reduced pressure points, greater relief of lower back and neck pain and better quality sleep compared to standard innerspring products and traditional pillows. Net sales of our mattresses, including overlays, increased from $116.8 million in 2001 to $156.0 million in 2002, and net sales of our pillows increased from $75.3 million in 2001 to $91.2 million in 2002.

 

Our high-quality, high-density, temperature-sensitive visco-elastic foam distinguishes our products from other products in the marketplace. Visco-elastic foam was originally developed by NASA in 1971 in an effort to relieve astronauts of the g-forces experienced during lift-off, and NASA subsequently made this formula publicly available. The NASA foam originally proved unstable for commercial use. However, after several years of research and development, we succeeded in developing a proprietary formulation and proprietary process to manufacture a stable, durable and commercially viable product. The key feature of our visco-elastic foam is its temperature sensitivity. It conforms to the body, becoming softer in warmer areas where the body is making the most contact with the foam and remaining firmer in cooler areas where less body contact is being made. As the material molds to the body’s shape, the body is supported in the correct anatomical position with the neck and spine in complete therapeutic alignment. The visco-elastic foam also has higher density than other foam, resulting in improved durability and enhanced comfort. In addition, clinical evidence indicates that our products are both effective and cost efficient for the prevention and treatment of decubitis, or bed sores, a major problem for elderly and bed-ridden patients.

 

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Our core product offerings are:

 

Mattresses


  

Summary Description


   Suggested U.S.
Retail Price


Classic

  

•      Composed of a patented multi-layered, heat sensitive, visco-elastic foam on top of a 4.5” high resiliency foam base (Airflow System)

     $999-$1,699
    

•      Molds to the exact body shape of the user to evenly distribute weight and eliminate pressure points

      
    

•      Recommended by over 25,000 healthcare professionals

      

Deluxe

  

•      Composed of a patented multi-layered, heat sensitive, visco-elastic foam on top of two 3” high resiliency foam layers (Dual Airflow System)

     $1,249-$2,099
    

•      Molds to the exact body shape of the user to evenly distribute weight and eliminate pressure points

      
    

•      Specially designed to fit on platform frames

      

CelebrityBed

  

•      Our highest profile bed, with a total height of 13 1/4".

  

$

1,999-$2,999

    

•      Composed of a patented multi-layered, heat sensitive, visco-elastic foam on top of two 3" high resiliency foam layers (Dual Airflow System), together with a pillowtop layer of six individual comfort sheets filling a specially designed cover.

      
    

•      Molds to the exact body shape of the user to evenly distribute weight and eliminate pressure points.

      

Medical

  

•      Designed to provide high level therapeutic pressure management for institutional and homecare providers

     $999
    

•      Proven to help prevent and treat pressure ulcers (bed sores)

      
    

•      Features waterproof cover

      

Overlays

  

•      Provides therapeutic, pressure-relieving support

     $500-$950
    

•      Ideally suited for camping, recreational vehicles and overnight guests

      
    

•      Available in most standard sizes

      

Pillows


         

Comfort

  

•      “Micro-cushions” fill a specially designed cover

     $125
    

•      Provides plush and pressure-relieving comfort in a luxurious, traditional pillow style

      

Cervical

  

•      Therapeutic, dual-lobed design provides proper neck/ spine alignment

     $70-$165
    

•      Available in a variety of sizes

      

Millennium

  

•      Patented design provides proper neck alignment and therapeutic support for sleeping on back or side

     $99-$125

Other


         

Adjustable Beds

  

•      Highest quality and most advanced adjustable bed available

     $1,300-$2,800
    

•      Mattress easily molds to shape of base to stay in place and perform better than other mattresses

      

 

Marketing and Sales

 

We are the leading worldwide manufacturer, marketer and distributor of premium visco-elastic foam mattresses and pillows. While primarily a wholesaler, we market directly to consumers in the United States and the United Kingdom and have recently begun to expand similar programs in Europe. Our marketing strategy is to increase consumer awareness of the benefits of our visco-elastic foam products and to further associate our brand name with better overall sleep and premium quality products. We position our products as high-end, high-tech, functional and unique products, which we sell at full retail prices.

 

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We have four distribution channels: retail, direct, healthcare and third party.

 

Channel


  

Summary Description


  

2002 Net Sales

% Mix


 
          U.S.

    Non-U.S.

 

Retail

  

•      This channel is our fastest growing sales channel and is driven by a sales team dedicated to introducing our products to traditional furniture and bedding retailers. We work with and target furniture retailers, sleep shops, specialty back and gift stores, home stores and international department stores.

   63 %   55 %
    

•      Retail furniture customers include Art Van, El Corte Ingles, Furniture Village and Haverty’s. Specialty retail customers include Brookstone, Bed, Bath & Beyond, Linens’n Things and Relax the Back.

            

Direct

  

•      Advertising channels include television, magazines, radio and newspapers.

   29 %   8 %

Healthcare

  

•      We sell to chiropractors, physical therapists, massage therapists, sleep clinics, other medical professionals and medical retailers that could utilize our products to treat patients or recommend and/or sell them to their clients. In addition, we work closely with hospitals, nursing homes, and medical equipment providers to place our products in facilities where they will receive general public use.

   6 %   24 %
    

•      Customers include Veterans Administration Hospitals, Marriott Senior Living Centers, Delta Health Group, Inc. and the National Institute of Health.

            

Third Party

Distributors

  

•      We have successfully expanded distribution into smaller international markets by utilizing third party distributors. Our approach to these developing markets has allowed us to build sales, marketing and brand awareness with minimal capital risk.

   2 %   13 %

 

Retail

 

We are currently positioned in approximately 5,000 furniture stores worldwide. In the United States, the largest sales division is the retail sales division, which currently sells to approximately 1,180 specialty retail and approximately 2,500 furniture stores. We plan to build and maintain our base of specialty r