Amendment No. 2 to Form S-1
Table of Contents

As filed with the Securities and Exchange Commission on December 3, 2003

Registration No. 333-109798


UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549


AMENDMENT NO. 2

TO

FORM S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933


Tempur-Pedic International Inc.

(f/k/a “TWI Holdings, Inc.”)

(Exact name of registrant as specified in its charter)


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

(I.R.S. Employer

Identification Number)

 

1713 Jaggie Fox Way

Lexington, Kentucky 40511

800-878-8889

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

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


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

Tempur World, Inc.

1713 Jaggie Fox Way

Lexington, Kentucky 40511

800-878-8889

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

area code, of agent for service)


Copies to:

 

John R. Utzschneider, Esq.

Bingham McCutchen LLP

150 Federal Street

Boston, MA 02110

617-951-8000

 

Jeremy W. Dickens, Esq.

Weil, Gotshal & Manges LLP

767 Fifth Avenue

New York, NY 10153

212-310-8000


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

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

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

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

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


CALCULATION OF REGISTRATION FEE

 


Title of Each Class of

Securities to be Registered

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

Common Stock, par value $0.01 per share

   $345,000,000    $27,910.50(3)


         
(1) Estimated solely for the purpose of calculating the amount of the registration fee pursuant to Rule 457(o) under the Securities Act of 1933, as amended.
(2) Calculated pursuant to Rule 457(a) based on an estimate of the proposed maximum aggregate offering price.
(3) $24,270 was previously paid to the Commission in connection with the initial filing of this Registration Statement on October 17, 2003. An additional $3,640.50 was paid in connection with the filing of Amendment No. 1 to this Registration Statement on November 20, 2003.

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



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

 

Subject to Completion, dated December 3, 2003

 

PROSPECTUS

 

 

18,750,000 Shares

 

LOGO

 

Common Stock

 


 

This is our initial public offering of common stock. We are offering 6,250,000 shares and the selling stockholders identified in this prospectus are offering 12,500,000 shares. No public market currently exists for our shares. We will not receive any proceeds from the sale of the shares offered by the selling stockholders.

 

We have applied to have our common stock listed on the New York Stock Exchange under the symbol “TPX.” We currently estimate that the initial public offering price will be between $15 and $17 per share.

 

Investing in the shares involves risks. Risk Factors begin on page 9.

 

     Per Share

   Total

Public offering price

   $                         $                     

Underwriting discount

   $      $     

Proceeds to Tempur-Pedic International Inc. (before expenses)

   $         $     

Proceeds to selling stockholders

   $         $     

 

The selling stockholders have granted the underwriters a 30-day option to purchase up to an aggregate of 2,812,500 additional shares of common stock on the same terms and conditions as set forth above to cover over-allotments, if any.

 

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

 

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

 


 

LEHMAN BROTHERS    GOLDMAN, SACHS & CO.

 


 

UBS INVESTMENT BANK   CITIGROUP

 


 

CIBC WORLD MARKETS   U.S. BANCORP PIPER JAFFRAY

 

                     , 2003


Table of Contents

LOGO


Table of Contents

TABLE OF CONTENTS

 

     Page

Prospectus Summary

   1

Risk Factors

   9

Special Note Regarding Forward-Looking Statements

   20

Use of Proceeds

   21

Dividend Policy

   21

Capitalization

   22

Dilution

   23

Unaudited Pro Forma As Adjusted Financial Information

   24

Selected Historical Consolidated Financial and Operating Data

   29

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

   31

 

     Page

Business

   47

Management

   59
Principal and Selling Stockholders    68

Certain Relationships and Related Party Transactions

   72
Description of Capital Stock    75
Shares Eligible for Future Sale    79

Material U.S. Federal Income Tax Considerations for Non-U.S. Holders of Our Common Stock

   81
Underwriting    83
Legal Matters    89
Experts    89

Where You Can Find More Information

   90
Index to Historical Financial Statements    F-1

 

ABOUT THIS PROSPECTUS

 

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

 

Through and including                     , 2004 (the 25th day after the date of this prospectus), all dealers effecting transactions in our common stock, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligations to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.


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PROSPECTUS SUMMARY

 

This summary highlights all material information contained elsewhere in this prospectus. This summary does not contain all of the information that you should consider before investing in shares of our common stock. We encourage you to read this entire prospectus carefully, including “Risk Factors” beginning on page 9 and our consolidated financial statements and the notes to those financial statements beginning on page F-1, before making an investment decision. Unless otherwise noted, all of the financial information in this prospectus is consolidated financial information for Tempur-Pedic International Inc. (f/k/a “TWI Holdings, Inc.”) or its predecessors. As used in this prospectus, the term “Tempur-Pedic International” refers to Tempur-Pedic International Inc. only and the terms “we,” “our,” “ours” and “us” refer to Tempur-Pedic International and its consolidated subsidiaries. Unless otherwise noted in this prospectus, all references to dollars are to United States dollars.

 

Tempur-Pedic International Inc.

 

We are a rapidly growing, vertically-integrated manufacturer, marketer and distributor of premium visco-elastic foam mattresses and pillows that we sell globally in 54 countries primarily under the Tempur® and Tempur-Pedic® brands. We believe our premium mattresses and pillows are more comfortable than standard bedding products because our proprietary visco-elastic foam is temperature sensitive, has a high density and conforms to the body to therapeutically align the neck and spine, thus reducing neck and lower back pain, two of the most common complaints about other sleep surfaces. In April 2003, Consumers Digest named one of our products among the eight “best buys” of the mattress industry in the applicable price range because of the strong value our products provide to consumers. Consumer surveys commissioned on our behalf over the last several years have indicated that our products achieve satisfaction ratings generally ranging from 80% to 92%. In the three years ended December 31, 2002, our total net sales grew at a compound annual rate of approximately 36% and for the nine months ended September 30, 2003 we had total net sales of $342.4 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 41.7% 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 approximately 21.5 million mattress units sold in the United States in 2002, although sales decreased during the 2000 to 2002 period. 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. Based on information derived from an ISPA report, we believe that 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. 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.

 

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

 

Based on our market research, we estimate that the United States retail market for pillows is approximately $1.1 billion. The United States pillow market has a traditional and specialty segment. Specialty pillows include all alternatives to traditional pillows, including visco-elastic and other foam, sponge rubber and down. We believe the international pillow market is generally the same size as the domestic pillow market.

 

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

 

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

 

Competitive Strengths

 

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

 

  Superior Product Offering.    Our proprietary visco-elastic foam mattresses and pillows contour to the body more naturally and provide better spinal alignment, reduced pressure points, greater relief of lower back and neck pain, and better quality sleep than traditional bedding products. 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. We believe our Tempur brand’s global recognition is reinforced by our high level of customer satisfaction. Furthermore, we believe our direct response business and associated multi-channel advertising in our domestic and international markets have enhanced awareness of our brand.

 

  Diversified Product Offerings Sold Globally Through Multiple Distribution Channels.    Our diversified product offerings include mattresses, pillows and other products, primarily adjustable beds, which we sell through multiple distribution channels including retail, direct, healthcare and third party distributor channels. For the nine months ended September 30, 2003, mattress, pillow and other product sales, primarily adjustable beds, represented 52.9%, 27.8% and 19.3%, respectively, of our net sales. For the nine months ended September 30, 2003, our retail channel represented 63.5% of our net sales, with our direct, healthcare and third party distributor channels representing 18.6%, 9.3% and 8.6%, respectively.

 

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

 

  Significant Growth Opportunities.    We believe we have significant growth opportunities because 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. 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 a collective bed count in excess of 2.7 million). 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 into a global business with approximately $342.4 million in total net sales for the nine months ended September 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 13% of our common equity on a fully-diluted as-converted basis, after giving effect to the vesting of all outstanding options (11.9% after this offering).

 

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.

 

  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.

 

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  Continue to Expand Internationally.    We plan to increase international sales growth 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 Albuquerque, New Mexico. 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

 

TA Associates, Inc. (TA) manages $5.0 billion of capital for buyouts and private equity investments in profitable growth companies in the consumer, technology, financial services, business services and healthcare industries. Founded in 1968, TA has a staff of over 40 investment professionals operating from offices in Boston, Massachusetts, Menlo Park, California, and London, and has invested in approximately 350 companies over its 35 year history.

 

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 Tempur-Pedic International to purchase Tempur World, Inc. for approximately $268.0 million plus the refinancing of approximately $88.8 million of existing debt obligations and a deferred earn-out payment of approximately $40.0 million. Tempur-Pedic International funded that purchase and related transaction fees and expenses using $150.0 million of senior bank financing, $50.0 million in mezzanine debt financing, net of cash on hand, and approximately $160.0 million in cash contributions and non-cash equity contributions from our owners. Collectively, TA and FFL currently own 79.7% of our fully diluted common stock, after giving effect to the vesting of all outstanding options (63.4% after this offering), 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.”

 

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The Recapitalization

 

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

 

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

 

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

 

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

 

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

 

  Tempur-Pedic International distributed approximately $160.0 million as a return of capital to its equityholders.

 

Our Structure

 

Tempur-Pedic, Inc. and Tempur Production USA, Inc. are indirect wholly-owned subsidiaries of Tempur-Pedic International 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 Tempur-Pedic International. Set forth below is a chart showing our structure:

 

LOGO


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

 

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The Offering

 

Common stock offered by Tempur-Pedic International in this offering

   6,250,000 shares

Common stock offered by selling stockholders in this offering

   12,500,000 shares

Common stock to be outstanding after this offering

   97,266,520 shares

Use of proceeds

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

Proposed New York Stock Exchange symbol

   “TPX”                

 

The number of shares of our common stock that will be outstanding after this offering is based on the number of shares outstanding as of November 15, 2003, and unless otherwise indicated herein, assumes the conversion of all outstanding shares of our convertible preferred stock and all outstanding classes of our common stock and the mandatory exercise of all our outstanding warrants into common stock on a one-for-one basis, and excludes:

 

  6,533,720 shares of our common stock issuable upon the exercise of stock options outstanding as of November 15, 2003 at a weighted average exercise price of $1.87 per share, none of which options were then exercisable; and

 

  8,000,000 shares of our common stock reserved for future grant under our 2003 Equity Incentive Plan.

 

Unless specifically stated otherwise, the information in this prospectus:

 

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

 

  assumes an initial public offering price of $16.00 per share, the midpoint of the initial public offering price range indicated on the cover of this prospectus;

 

  reflects the automatic conversion of all shares of our convertible preferred stock and outstanding classes of our common stock and the mandatory exercise of our outstanding warrants for a total of 91,016,520 shares of our common stock upon the completion of this offering;

 

  gives effect to a 525-for-one stock split of our common stock, in the form of a stock dividend, which will occur immediately prior to the closing of the offering; and

 

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

 

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

 

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Unaudited Summary and Historical Pro Forma As Adjusted 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 as adjusted 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 nine months ended September 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 nine month period ended September 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 nine months ended September 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 nine months ended September 30, 2003 are included elsewhere in this prospectus.

 

The summary unaudited pro forma as adjusted financial data for the nine months ended September 30, 2003 has been prepared to give pro forma effect to the Tempur acquisition, the recapitalization and the offering as if they had occurred on January 1, 2003. Because the balance sheet as of September 30, 2003 includes the effects of the recapitalization, no pro forma balance sheet data information with respect to the Tempur acquisition and the recapitalization is presented. The summary unaudited pro forma as adjusted financial data is for informational purposes only and should not be considered indicative of actual results that would have been achieved had the Tempur acquisition, the recapitalization or the offering actually been consummated on the date indicated and do not purport to indicate balance sheet data or results of operations for any future period. The following data should be read in conjunction with “Unaudited Pro Forma As Adjusted Financial Information,” “Selected Historical Consolidated Financial and Operating Data,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our predecessor company’s financial statements and related notes thereto included elsewhere in this prospectus.

 

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     Predecessor

    Tempur-
Pedic
International


    Predecessor

    Tempur-Pedic International

 
     Year ended December 31,

    Period from
January 1,
2002 to
October 31,
2002


    Period from
November 1,
2002 to
December 31,
2002


    Nine Months
ended
September 30,
2002


    Nine Months
ended
September 30,
2003


    Pro forma
As Adjusted
Nine Months
ended
September 30,
2003(1)


 
     2000

    2001

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

Statement of Operations Data:

                                                        

Net sales

   $ 161,969     $ 221,514     $ 237,314     $ 60,644     $ 205,944     $ 342,359     $ 342,359  

Cost of sales(2)

     89,450       107,569       110,228       37,811       95,822       158,804       158,804  
    


 


 


 


 


 


 


Gross profit

     72,519       113,945       127,086       22,833       110,122       183,555       183,555  

Operating expenses(3)

     50,081       83,574       86,693       23,816       77,627       125,015       125,015  
    


 


 


 


 


 


 


Operating income/(loss)

     22,438       30,371       40,393       (983 )     32,495       58,540       58,540  

Net interest expense

     2,225       6,555       6,292       2,955       5,713       13,741       18,180  

Other (income)/expense

     947       316       1,724       (1,330 )     (652 )     1,478       1,478  
    


 


 


 


 


 


 


Income/(loss) before income taxes

     19,266       23,500       32,377       (2,608 )     27,434       43,321       38,882  

Income taxes

     6,688       11,643       12,436       640       12,493       17,332       15,601  
    


 


 


 


 


 


 


Net income/(loss)

     12,578       11,857       19,941       (3,248 )     14,941       25,989       23,281  

Preferred stock
dividend

           345       1,238       1,958       1,109       8,764        
    


 


 


 


 


 


 


Net income/(loss) available to common stockholders

   $ 12,578     $ 11,512     $ 18,703     $ (5,206 )   $ 13,832     $ 17,225     $ 23,281  
    


 


 


 


 


 


 


Earnings per share(4)

                                                        

Basic

                           $ (.67 )           $ 2.13     $ .24  

Diluted

                           $ (.67 )           $ .28     $ .23  

Weighted average shares (in thousands)

                                                        

Basic

                             7,815               8,091       95,689  

Diluted

                             7,815               93,143       100,907  

Balance Sheet Data (at end of period):

                                                        

Cash and cash equivalents

   $ 10,572     $ 7,538     $ 6,380     $ 12,654     $ 5,518     $ 12,512          

Total assets

     144,305       176,841       199,641       448,593       193,432       535,183          

Total debt

     71,164       106,023       89,050       198,352       91,454       382,532          

Redeemable preferred stock

           11,715       15,331             15,199                

Total stockholders’ equity

     38,237       16,694       39,895       151,606       34,746       25,523          

Other Financial and Operating Data (GAAP):

                                                        

Depreciation and amortization

   $ 6,002     $ 10,051     $ 10,383     $ 3,306     $ 10,066     $ 14,437     $ 14,437  

Net cash provided by operating activities

     1,125       19,716       22,706       12,385       15,091       41,770       43,054  

Net cash used in investing activities

     (27,014 )     (34,862 )     (4,646 )     (1,859 )     (3,534 )     (16,545 )     (16,545 )

Net cash (used in)/provided by financing activities

     34,314       12,593       (19,702 )     (4,221 )     (13,330 )     (24,808 )     (10,928 )

Capital expenditures

     27,418       35,241       9,175       1,961       7,660       17,266       17,266  

Other Financial and Operating Data (non-GAAP):

                                                        

Number of pillows sold(5)

     1,717,476       1,819,993       1,528,608       407,476       1,354,331       2,199,223       2,199,223  

Number of mattresses sold(5)

     173,338       212,695       218,656       50,564       194,085       283,078       283,078  

(1) The summary unaudited pro forma as adjusted financial data give effect to the recapitalization, the Tempur acquisition and the offering.
(2) Includes $9.8 million in non-cash charges for the two months ended December 31, 2002 relating to the step-up in inventory as of November 1, 2002 relating to the Tempur acquisition.
(3) Includes $19.3 million in non-cash charges for the nine months ended September 30, 2003 comprised of $13.6 million relating to the non-recurring write-off of deferred financing fees in connection with the recapitalization, $3.8 million in amortization of definite-lived intangibles and $1.9 million in non-cash stock-based compensation expense relating to stock option grants and acceleration.
(4) Predecessor company earnings per share has been omitted as such information is not considered meaningful due to the change in capital structure that occurred with the Tempur acquisition.
(5) Number of units sold is before consideration of returned mattresses and pillows.

 

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RISK FACTORS

 

You should carefully consider the risks described below, as well as other information and data included in this prospectus, before deciding whether to invest in shares of our common stock. 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 our significant competitors 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 $342.4 million for the nine months ended September 30, 2003. 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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We may be unable to sustain growth or profitability, which could impair our ability to service our indebtedness and make investments in 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;

 

  our ability to maintain public association of our brand with premium products, including overcoming any impact on our brand caused by some of our customers seeking to sell our products at a discount to our recommended price;

 

  the level of consumer acceptance of our products; and

 

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

 

We may not be successful in executing our growth strategy and even if we achieve our strategic plan, we may not be able to sustain profitability. Failure to successfully execute any material part of our strategic plan or growth strategy could significantly impair our ability to service our indebtedness and make investments in our business.

 

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 nine months ended September 30, 2003, in the United States we had approximately $19.4 million in returns for a return rate of approximately 9.6% of our total net sales in the United States. 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. 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. However, our actual level of warranty claims could prove to be greater than the level of warranty claims we estimated based on our products’ performance during product testing. If our warranty reserves are not adequate to cover future warranty claims, their inadequacy could have a material adverse effect on our liquidity and profitability if our warranty costs exceed our reserves.

 

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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 could impair our liquidity and profitability, and any claim or product recall that results in significant adverse publicity against us, could result in consumers purchasing fewer of our products, which would also impair our liquidity and profitability.

 

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.

 

Allegations of the possibility of price fixing in the mattress industry could increase our costs or otherwise adversely affect our operations.

 

Our retail pricing policies are subject to antitrust regulations. If federal or state regulators initiate investigations into our pricing policies, 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 federal, state or other antitrust laws, there could be an imposition of damages for persons injured, as well as injunctive relief. Any requirement that we pay fines or damages could decrease our liquidity and profitability, and any investigation that requires significant management attention or causes us to change our business practices could disrupt our operations, also resulting in a decrease in our liquidity and profitability.

 

 

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

 

Our business focuses on mattresses and pillows made with our visco-elastic foam, and we are vulnerable to shifting consumer tastes and demands. 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.

 

We are subject to risks arising 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 41.7% of our net sales from non-U.S. operations during the first nine 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 22.4% of our net sales for the nine months ended September 30, 2003. During this period, our largest customer, Brookstone Company, Inc., accounted for 7.9% 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 liquidity and profitability.

 

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 not reached by our wholly-owned subsidiaries. Most of these arrangements provide for exclusive rights for such distributors in a designated territory. If our third party distributors were to cease distributing our products, sales of our products 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 could 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;

 

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  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.

 

If we are not able to protect our trade secrets or maintain our trademarks, patents and other intellectual property, we may not be able to prevent competitors from developing similar products or from marketing in a manner that capitalizes on our trademarks, and this loss of a competitive advantage could decrease our profitability and liquidity.

 

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 10 United States patent applications pending. Further, we own approximately thirty-two foreign patents, and we have approximately fifteen foreign patent applications pending. In addition, we hold approximately 86 trademark registrations worldwide. We own United States and foreign registered trade names and service marks and have applications for the registration of trade names and service marks pending domestically and abroad. We also license certain intellectual property rights from third parties.

 

Although our trademarks are currently registered in the United States and registered or pending in thirty foreign countries, 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. Any loss of trademark protection could result in a decrease in sales or cause us to spend additional amounts on marketing, either of which could decrease our liquidity and profitability. In addition, if we incur significant costs defending our trademarks that could also decrease our liquidity and profitability. In addition, we may not have the financial resources necessary to enforce or defend our trademarks. Furthermore, our patents may not provide meaningful protection and patents may never be issued for our 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, this loss of a competitive advantage could result in decreased sales or increased operating costs, either of which would decrease our liquidity and profitability.

 

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.

 

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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. We currently acquire almost all of our polyol from one supplier. If we were unable to obtain polyol from this supplier, we would have to find a replacement supplier. Any substitute arrangements for polyol might not be on terms as favorable to us as our current terms. In addition, we purchase proprietary additives from a number of vendors, including one from whom we are obligated to purchase minimum quantities. We may 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, which could result in a decrease of our sales, or could cause an increase in our cost of sales, and either of these results could decrease our liquidity and profitability. In addition, we outsource much of the sewing and cutting of our mattress and pillow covers to Poland and the Ukraine. If we were no longer able to outsource this labor, we could be forced to source it elsewhere at a higher cost. To the extent we were unable to pass those higher costs to our customers, those costs could reduce our gross profit margin, which could result in a decrease in our liquidity and profitability.

 

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

 

Approximately 41.7% of our net sales were received or denominated in foreign currency for the nine months ended September 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

 

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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. We have introduced new distribution programs to increase our ability to deliver products on a timely basis, but if we fail to deliver products on a timely basis, we may lose sales which could decrease our liquidity and profitability. 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 effect on our liquidity. In March 2003, we began construction of 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 $10.1 million through September 30, 2003. Additionally, we plan to begin expanding mattress production capacity in our Denmark manufacturing facility in the fourth quarter of 2004. We 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 will be located in Albuquerque, New Mexico. This facility is currently expected to require capital expenditures of approximately $45.0 million and to be completed by the fourth quarter of 2006. 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.

 

A deterioration in labor relations could disrupt our business operations and increase our costs, which could decrease our liquidity and profitability.

 

As of September 30, 2003, we had approximately 1,000 full-time employees, with approximately 400 in the United States, 300 in Denmark and 300 in the rest of the world. The employees in Denmark are under a government labor union contract but those in the United States are not. Any significant increase in our labor costs could decrease our liquidity and profitability, and any deterioration of employee relations, slowdowns or work stoppages at any of our locations, whether due to union activities, employee turnover or otherwise, could result in a decrease in our net sales or an increase in our costs, either of which could decrease our liquidity and profitability.

 

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.

 

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

 

As of September 30, 2003, the book value of our long-term debt was $382.5 million, and our stockholders’ equity was $25.5 million and as of September 30, 2003 on a pro forma basis after giving effect to this offering, the book value of our long-term debt would be $296.4 million and our stockholders’ equity would be $111.6 million. Our high degree of leverage could have important consequences to you, such as:

 

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

 

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

 

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

 

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

 

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

 

Our ability to meet our debt obligations and to reduce our indebtedness will depend on our future performance, which depends partly on general economic conditions and financial, business, political and other factors that are beyond our control. We may not be able to continue to generate cash flow from operations at or above current levels and meet our cash interest payments on all of our debt and other liquidity needs. If our cash flow and capital resources are insufficient to allow us to make scheduled payments on the senior subordinated notes or our other debt, we may have to sell assets, seek additional capital or restructure or refinance our debt. We may not be able to pay or refinance our debt on acceptable terms or at all. Our ability to refinance all or a portion of our debt or to obtain additional financing is substantially limited under the terms of the indenture governing the senior subordinated notes and the amended senior credit facilities. Under the terms of our debt instruments, we and our subsidiaries may be able to incur substantial additional indebtedness in the future, which would exacerbate the risks associated with our substantial leverage.

 

If our business plans change or if general economic, financial or political conditions in any of our markets or competitive practices in our industry change materially from those currently prevailing or from those now anticipated, or if other presently unexpected circumstances arise that have a material effect on the cash flow or profitability of our business, the anticipated cash needs of our business as well as the conclusions as to the adequacy of the available sources could change significantly. Any of these events or circumstances could involve significant additional funding needs in excess of the identified currently available sources, and could require us to raise additional capital to meet those needs. However, our ability to raise additional capital, if necessary, is subject to a variety of additional factors, including the commercial success of our operations, the volatility and demand of the capital and lending markets and the future market prices of our securities.

 

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

 

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Risks Related to this Offering

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

  changes in our financial estimates by securities analysts;

 

  conditions or trends in the specialty bedding industry;

 

  additions or departures of key personnel;

 

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

 

  regulatory developments in the United States and abroad; and

 

  economic and political factors.

 

In addition, the stock market in general has experienced significant price and volume fluctuations that have often been unrelated or disproportionate to operating performance. These broad market factors may seriously harm the market price of our common stock, regardless of our operating performance. In the past, following periods of volatility in the market price of a company’s securities, securities class action litigation has often been instituted. A securities class action suit against us could result in potential liabilities, substantial costs, and the diversion of our management’s attention and resources, regardless of the outcome.

 

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

 

The market price of our common stock could decline as a result of sales of substantial amounts of our common stock in the public market after the closing of this offering, or the perception that these sales could occur. In addition, these factors could make it more difficult for us to raise funds through future offerings of common stock. There will be 97,266,520 shares of our common stock outstanding immediately after this offering, based on the number of shares of our common stock outstanding as of November 15, 2003. All of the shares of our common stock sold in this offering will be freely transferable without restriction or further registration under the Securities Act of 1933, except for any shares of our common stock purchased by our executive officers, directors, principal stockholders, and some related parties. For more information, see “Shares Eligible for Future Sale.”

 

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

 

After this offering, we intend to register 15,033,720 shares of our common stock that are reserved for issuance upon the exercise of options granted or reserved for grant under our 2002 Stock Option Plan, our 2003 Equity Incentive Plan and our 2003 Employee Stock Purchase Plan. Once we register these shares of our common stock, stockholders can sell them in the public market upon issuance, subject to restrictions under the securities laws and any applicable lock-up agreements. In addition, some of our existing stockholders will be entitled to register their shares of our common stock after this offering.

 

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

 

If you purchase common stock in this offering, you will pay more for your shares than the amounts paid by existing stockholders for their shares. As a result, you will incur immediate and substantial dilution of $17.84 per share, representing the difference between our pro forma net tangible book value per share after giving effect to this offering and the initial public offering price. In addition, after giving effect to the $160.0 million return of capital paid to our equityholders in August 2003 as part of the recapitalization, purchasers of shares of our common stock in this offering will have contributed approximately 88.2% of the aggregate price paid by all purchasers of our stock, but will own only approximately 6.4% of the shares of our common stock outstanding after the offering based on the number of shares of our common stock and common stock equivalents outstanding as of November 15, 2003. In addition, if the holders of outstanding options and warrants exercise those options at prices below the initial public offering price, you will incur further dilution. We may also acquire other companies or technologies or finance strategic alliances by issuing equity, which may result in additional dilution to you.

 

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

 

Immediately after this offering, our executive officers, directors, current principal stockholders, and their respective affiliates will beneficially own, in the aggregate, approximately 73.6% of our outstanding common stock. These stockholders, as a group, would be able to control substantially all matters requiring approval by our stockholders, including mergers, sales of assets, the election of all directors, and approval of other significant corporate transactions, in a manner with which you may not agree or that may not be in your best interest.

 

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

 

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

 

These provisions include:

 

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

 

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

 

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

 

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Our management will have broad discretion in the use of net proceeds from this offering and may not use those proceeds in ways that will enhance our market value.

 

As of the date of this prospectus, we cannot specify with certainty the amounts we will spend on particular uses from the net proceeds we will receive from this offering. Our management will have broad discretion in the application of the net proceeds but currently intends to use the net proceeds as described in “Use of Proceeds.” If our management does not apply these funds effectively, we could lose significant business opportunities. Furthermore, our stock price could decline if the market does not view favorably our use of the proceeds from the offering.

 

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

 

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

 

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

 

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

 

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

 

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

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

 

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

 

  the level of competition in the mattress and pillow industries;

 

  our ability to effectively manage and sustain our growth;

 

  risks arising from having a new senior management team;

 

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

 

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

 

  risks arising from our international operations;

 

  our dependence on our significant customers;

 

  our ability to maintain our third party distributor arrangements;

 

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

 

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

 

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

 

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

 

  fluctuations in exchange rates;

 

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

 

  potential conflicts of interest between you and our controlling stockholders;

 

  our ability to maintain our labor relations;

 

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

 

  risks arising from our degree of leverage; and

 

  increase in interest expense.

 

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

 

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

 

USE OF PROCEEDS

 

We estimate that the net proceeds from this offering with respect to the shares to be sold by us will be $91.5 million, based on an assumed initial public offering price of $16.00 per share and after deducting underwriting discounts and commissions and estimated offering expenses payable by us. We will not receive any of the proceeds from the sale of shares by the selling stockholders.

 

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

 

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

 

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

 

DIVIDEND POLICY

 

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

 

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CAPITALIZATION

 

The following table sets forth our consolidated capitalization as of September 30, 2003, on an actual basis and on an as adjusted basis to give effect to the offering.

 

    

As of

September 30, 2003


 
     Actual

     As
Adjusted


 
($ in millions)       

Cash and cash equivalents

   $ 12.5      $ 12.5  
    


  


Long-term debt (including current portion):

                 

Amended senior credit facilities(1)

   $ 229.9      $ 196.3  

Senior Subordinated Notes due 2010

     150.0        97.5  

Mortgage payable

     2.1        2.1  

Capital leases and other

     0.5        0.5  
    


  


Total long-term debt

     382.5        296.4  

Stockholders’ equity:

                 

Series A convertible preferred stock

     157.2         

Class A common stock

       —         

Class B-1 common stock

             

Common stock

            1.0  

Additional paid in capital

     20.8        270.8  

Class B-1 common stock warrants

     2.3         

Deferred stock compensation, net of amortization

     (0.1 )      (0.1 )

Unearned stock-based compensation

     (11.3 )      (11.3 )

Retained earnings(2)

     (148.0 )      (153.4 )

Accumulated other comprehensive income

     4.6        4.6  
    


  


Total stockholders’ equity

     25.5        111.6  
    


  


Total capitalization

   $ 408.0      $ 408.0  
    


  



(1) Does not include outstanding revolving credit borrowings of approximately $11.5 million under our amended senior credit facilities as of November 30, 2003.
(2) In connection with our proposed redemption of our senior subordinated notes, we will be required to pay approximately $5.4 million in prepayment penalty to the holders of the senior subordinated notes.

 

Shares of common stock to be outstanding after the offering do not include 6,533,720 shares of common stock issuable upon exercise of outstanding options at a weighted average exercise price of $1.87 per share as of September 30, 2003. None of these outstanding options were vested and exercisable as of September 30, 2003.

 

 

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DILUTION

 

The historical net tangible book value of our common stock as of September 30, 2003 was a deficit of $(264.9) million, or $(2.91) per share. The historical net tangible book value per share of our common stock is the difference between our tangible assets and our liabilities, divided by the number of common shares outstanding. The pro forma net tangible book value of our common stock as of September 30, 2003 was a deficit of $(178.8) million, or $(1.84) per share. The pro forma net tangible book value per share of our common stock is the difference between our tangible assets and our liabilities, divided by the number of shares of our common stock outstanding as of September 30, 2003, after giving effect to the automatic conversion of all outstanding shares of our convertible preferred stock and all outstanding classes of our common stock and the mandatory exercise of all of our outstanding warrants into 91,016,520 shares of our common stock upon the completion of this offering. For new investors in our common stock, dilution is the per share difference between the initial public offering price of our common stock and the pro forma net tangible book value of our common stock immediately after completing this offering. Dilution in this case results from the fact that the per share offering price of our common stock is substantially in excess of the per share price paid by our current stockholders.

 

As of September 30, 2003, after giving effect to the sale of the shares of our common stock offered by us under this prospectus at an assumed initial public offering price of $16.00 per share and after deducting the underwriting discounts and commissions and estimated offering expenses payable by us, the pro forma net tangible book value per share of our common stock would have been a deficit of $(1.84) per share. Therefore, the new investors in our common stock would have paid $16.00 for a share of common stock having a pro forma net tangible book value of a deficit of approximately $(1.84) per share after this offering. That is, their investment would have been diluted by approximately $17.84 per share. At the same time, our current stockholders would have realized an increase in pro forma net tangible book value of $1.07 per share after this offering without further cost or risk to themselves. The following table illustrates this per share dilution:

 

Assumed initial public offering price per share

  $ 16.00  

Pro forma net tangible book value per share before this offering

   $ (2.91 )        

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

   $       1.07          
    


       

Pro forma net tangible book value per share after this offering

  $ (1.84 )
            


Dilution per share to new investors

  $ 17.84  
            


 

The following table sets forth, as of September 30, 2003, on a pro forma basis to give effect to the conversion of all shares of our convertible preferred stock and all outstanding classes of our common stock and the mandatory exercise of all of our outstanding warrants into 91,016,520 shares of common stock, the number of shares of common stock purchased in this offering, the total consideration paid, and the average price per share paid by existing and new stockholders, before deducting underwriting discounts and commissions and our estimated offering expenses:

 

     Shares Purchased

    Total Consideration

   

Average Price

Per Share


     Number

    Percent

    Amount

   Percent

   

Existing stockholders(1)

   91,016,520 (2)   93.6 %   $ 13.4    11.8 %   $ .15

New investors

   6,250,000     6.4       100.0    88.2     $ 16.00
    

 

 

  

 

Total

   97,266,520     100.0 %   $ 113.4    100.0 %   $ 1.17

(1) Total consideration to existing stockholders reflects $160.0 million distributed to these existing stockholders as a return of capital.
(2) Excludes an aggregate of 6,533,720 shares of common stock issuable pursuant to stock options outstanding as of September 30, 2003 at an exercise price per share of $1.87.

 

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UNAUDITED PRO FORMA AS ADJUSTED FINANCIAL INFORMATION

 

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

 

The recapitalization occurred in August 2003. Because the balance sheet as of September 30, 2003 included elsewhere in this prospectus includes the effects of the Tempur acquisition and recapitalization, no pro forma as adjusted balance sheet information is presented. The pro forma as adjusted condensed consolidated statements of operations for the nine months ended September 30, 2003 and the twelve months ended December 31, 2002 are adjusted to give effect to the Tempur acquisition, the recapitalization and the offering as if they had occurred at the beginning of the periods presented. The pro forma adjustments are described in the accompanying notes and are based upon available information and certain assumptions that management believes are reasonable.

 

The unaudited condensed consolidated pro forma as adjusted 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 as adjusted condensed consolidated financial data should be read in conjunction with our and our predecessor company’s historical financial statements and related notes thereto included elsewhere in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

 

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Unaudited Pro Forma As Adjusted Condensed Consolidated Statement of Income

for the Twelve Months ended December 31, 2002

 

   

Historical Period
from

January 1, 2002 to
October 31, 2002


 

Historical Period
from

November 1, 2002 to
December 31, 2002


    Pro Forma
Tempur
Acquisition
Adjustments


    Pro Forma
Recapitalization
Adjustments


    Pro Forma

   

Pro Forma

Offering

Adjustments


   

Pro Forma

as Adjusted


 
($ in thousands, except per share data)  

Net sales

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

Cost of sales

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

Operating expenses

    86,693     23,816       7,605  (b)           118,114             118,114  
   

 


 


 


 


 


 


Operating income/(loss)

    40,393     (983 )     (5,594 )           33,816               33,816  

Net interest (income)/expense

    6,292     2,955       5,888  (c)     14,165 (d)     29,300       (6,679 )(e)     22,621  

Other (income)/expense

    1,724     (1,330 )                 394             394  
   

 


 


 


 


 


 


Income/(loss) before income taxes

    32,377     (2,608 )     (11,482 )     (14,165 )     4,122       6,679       10,801  

Income taxes

    12,436     640       (4,478 )(f)     (5,524 )(f)     3,074       2,607  (f)     5,681  
   

 


 


 


 


 


 


Net income/(loss)

  $ 19,941   $ (3,248 )   $ (7,004 )   $ (8,641 )   $ 1,048     $ 4,072     $ 5,120  

Preferred stock dividend

    1,238     1,958                   3,196       (3,196 )(g)     —    
   

 


 


 


 


 


 


Net income/(loss) available to common stockholders

  $ 18,703   $ (5,206 )   $ (7,004 )   $ (8,641 )   $ (2,148 )   $ 7,268     $ 5,120  
   

 


 


 


 


 


 


Earnings per share

                                                     

Basic

        $ (.67 )                   $ .01             $ .05  

Diluted

        $ (.67 )                   $ .01             $ .05  

Weighted average shares (in thousands)

                                                     

Basic

          7,815                       95,689 (h)             95,689 (h)

Diluted

          7,815                       100,907 (h)             100,907 (h)

 

 

See accompanying Notes to Unaudited Pro Forma As Adjusted Financial Data

 

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Unaudited Pro Forma As Adjusted Condensed Consolidated Statement of Income

for the Nine Months Ended September 30, 2003

 

    

Historical

Period from
January 1, 2003
to September 30, 2003


   Pro Forma
Recapitalization
Adjustments


    Pro Forma

  

Pro Forma

Offering

Adjustments


   

Pro Forma

as Adjusted


 
($ in thousands, except per share data)                  

Net sales

   $ 342,359    $ —       $ 342,359    $ —       $ 342,359  

Cost of sales

     158,804              158,804      —         158,804  

Operating expenses

     125,015      —         125,015      —         125,015  
    

  


 

  


 


Operating income/(loss)

     58,540              58,540      —         58,540  

Net interest (income)/expense

     13,741      9,316  (d)     23,057      (4,877 )(e)     18,180  

Other (income)/expense

     1,478      —         1,478      —         1,478  
    

  


 

  


 


Income/(loss) before income taxes

     43,321      (9,316 )     34,005      4,877       38,882  

Income taxes

     17,332      (3,633 )(f)     13,699      1,902  (f)     15,601  
    

  


 

  


 


Net income/(loss)

   $ 25,989    $ (5,683 )   $ 20,306    $ 2,975     $ 23,281  

Preferred stock dividend

     8,764      —         8,764      (8,764 )(g)     —    
    

  


 

  


 


Net income/(loss) available to common stockholders

   $ 17,225    $ (5,683 )   $ 11,542    $ 11,739     $ 23,281  
    

  


 

  


 


Earnings per share

                                      

Basic

   $ 2.13            $ 1.43            $ .24  

Diluted

   $ .28            $ .22            $ .23  

Weighted average shares (in thousands)

                                      

Basic

     8,091              8,091              95,689 (h)

Diluted

     93,143              93,143              100,907 (h)

 

 

 

See accompanying Notes to Unaudited Pro Forma As Adjusted Financial Data

 

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Notes to Unaudited Pro Forma As Adjusted 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


 

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

   $ 7,769  

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

     9,780  
    


     $ (2,011 )
    


 

(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


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

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

     7,301
    

     $ 7,605
    

 

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

 

     Twelve months
Ended
December 31,
2002


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

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

     1,033
    

     $ 5,888
    

 

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 December 31, 2002 by approximately $0.7 million.

 

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

 

     Twelve months
Ended
December 31,
2002


   Nine months
Ended
September 30,
2003


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

   $ 12,724    $ 8,382

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

     1,441      934
    

  

     $ 14,165    $ 9,316
    

  

 

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 nine months ended September 30, 2003 and the twelve months ended December 31, 2002 by approximately $0.8 million and $2.0 million, respectively.

 

(e) Represents reduction of interest expense due to the prepayment of debt from the proceeds of this offering, net of additional amortization of deferred financing costs.

 

     Twelve months
Ended
December 31,
2002


    Nine months
Ended
September 30,
2003


 

Reduction of interest expense due to prepayment of debt

   $ (6,988 )   $ (5,226 )

Additional amortization of deferred financing cost

     309       349  
    


 


     $ (6,679 )   $ (4,877 )
    


 


 

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

 

(g) Represents elimination of preferred stock dividend as preferred stock will convert to common stock following this offering.

 

(h) Pro forma earnings per share is based on the weighted average number of shares of common stock outstanding after giving effect to the offering, the automatic conversion of all outstanding shares of our convertible preferred stock and all outstanding classes of our common stock and the mandatory exercise of our outstanding warrants into shares of our common stock upon completion of the offering and the 525-for-one stock split granted in the form of a stock dividend.

 

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SELECTED HISTORICAL CONSOLIDATED FINANCIAL AND OPERATING DATA

 

The following table sets forth our selected historical consolidated financial and operating data for the periods indicated. Our predecessor company for periods prior to January 1, 2000 is a combination of our Danish manufacturing operations and the United States distribution entity and is sometimes referred to as the pre-predecessor company. Tempur World, Inc. was formed on January 1, 2000 to combine the manufacturing facilities and the worldwide distribution capabilities of all Tempur products, and our predecessor company for the period from January 1, 2000 to October 31, 2002 is Tempur World, Inc. We completed the Tempur acquisition (which we accounted for using the purchase method of accounting) as of November 1, 2002. As a result of 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 statements 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 nine month period ended September 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 nine month period ended September 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 nine months ended September 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 nine months ended September 30, 2003 are included elsewhere in this prospectus.

 

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Table of Contents
    Pre-Predecessor

  Predecessor

    Tempur-
Pedic
International


    Predecessor

    Tempur-
Pedic
International


 
   

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


    Nine Months
ended
September 30,
2002


    Nine Months
ended
September 30,
2003


 
    1998

    1999

      2000

    2001

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

Statement of Operations Data:

                                                                     

Net sales

  $ 58,800     $ 85,245     $ 73,635   $ 161,969     $ 221,514     $ 237,314     $ 60,644     $ 205,944     $ 342,359  

Cost of sales(1)

    37,932       55,500       45,755     89,450       107,569       110,228       37,811       95,822       158,804  
   


 


 

 


 


 


 


 


 


Gross profit

    20,868       29,745       27,880     72,519       113,945       127,086       22,833       110,122       183,555  

Operating expenses(2)

    10,795       21,678       16,410     50,081       83,574       86,693       23,816       77,627       125,015  
   


 


 

 


 


 


 


 


 


Operating income/(loss)

    10,073       8,067       11,470     22,438       30,371       40,393       (983 )     32,495       58,540  

Net interest expense

    482       976       997     2,225       6,555       6,292       2,955       5,713       13,741  

Other (income)/expense

    (1,337 )     (10 )     793     947       316       1,724       (1,330 )     (652 )     1,478  
   


 


 

 


 


 


 


 


 


Income/(loss) before income taxes

    10,928       7,101       9,680     19,266       23,500       32,377       (2,608 )     27,434       43,321  

Income taxes

    4,821       2,821       3,851     6,688       11,643       12,436       640       12,493       17,332  
   


 


 

 


 


 


 


 


 


Net income/(loss)

    6,107       4,280       5,829     12,578       11,857       19,941       (3,248 )     14,941       25,989  

Preferred stock dividend

                          345       1,238       1,958       1,109       8,764  
   


 


 

 


 


 


 


 


 


Net income/(loss) available to common stockholders

  $ 6,107     $ 4,280     $ 5,829   $ 12,578     $ 11,512     $ 18,703     $ (5,206 )   $ 13,832     $ 17,225  
   


 


 

 


 


 


 


 


 


Earnings per share(3)

                                                                     

Basic

                                                $ (.67 )           $ 2.13  

Diluted

                                                $ (.67 )           $ .28  

Weighted average shares (in thousands)

                                                                     

Basic

                                                  7,815               8,091  

Diluted

                                                  7,815               93,143  

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     $ 5,518     $ 12,512  

Total assets

    34,520       49,276       66,404     144,305       176,841       199,641       448,593       193,432       535,183  

Total debt

    6,496       8,637       19,508     71,164       106,023       89,050       198,352       91,454       382,532  

Redeemable preferred stock

                          11,715       15,331             15,199        

Total stockholders’ equity

    9,495       12,862       14,424     38,237       16,694       39,895       151,606       34,746       25,523  

Other Financial and
Operating Data (GAAP):

                                                                     

Depreciation and amortization

                        $ 6,002     $ 10,051     $ 10,383     $ 3,306     $ 10,066     $ 14,437  

Net cash provided by operating activities

                          1,125       19,716       22,706       12,385       15,091       41,770  

Net cash used in investing activities

                          (27,014 )     (34,862 )     (4,646 )     (1,859 )     (3,534 )     (16,545 )

Net cash (used in)/provided by financing activities

                          34,314       12,593       (19,702 )     (4,221 )     (13,330 )     (24,808 )

Capital expenditures

                          27,418       35,241       9,175       1,961       7,660       17,266  

Other Financial and
Operating Data (non-GAAP):

                                                                     

Number of pillows sold(4)

                          1,717,476       1,819,993       1,528,608       407,476       1,354,331       2,199,223  

Number of mattresses sold(4)

                          173,338       212,695       218,656       50,564       194,085       283,078  

(1) Includes $9.8 million in non-cash charges for the two months ended December 31, 2002 relating to the step-up in inventory as of November 1, 2002 relating to the Tempur acquisition.
(2) Includes $19.3 million in non-cash charges for the nine months ended September 30, 2003 comprised of $13.6 million relating to the non-recurring write-off of deferred financing fees in connection with the recapitalization, $3.8 million in amortization of definite-lived intangibles and $1.9 million in non-cash stock-based compensation expense relating to stock option grants and acceleration.
(3) Pre-predecessor company and predecessor company earnings per share have been omitted as such information is not considered meaningful due to the change in capital structure that occurred with the Tempur acquisition.
(4) Number of units sold is before the consideration of returned mattresses and pillows.

 

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

 

The following discussion and analysis should be read in conjunction with the section “Selected Historical Consolidated Financial and Operating Data,” the audited consolidated financial statements and accompanying notes thereto and the unaudited consolidated financial statements and accompanying notes thereto included elsewhere in this prospectus. Unless otherwise noted, all of the financial information in this prospectus is consolidated financial information for Tempur-Pedic International 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 grew at a compound annual rate of approximately 36% and for the nine months ended September 30, 2003 we had total net sales of $342.4 million.

 

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

 

Business Segment Information

 

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.

 

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Table of Contents

Critical Accounting Policies

 

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

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires that the management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Revenue Recognition

 

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

 

Warranties

 

Cost of sales includes estimated costs to service warranty claims of our customers. Our estimate is based on our historical claims experience and extensive product testing that we perform from time to time. We provide a 20-year warranty for United States sales and a 15-year warranty for non-United States sales on mattresses, each prorated for the last 10 years. Because our products have not been in use by our customers for the full warranty period, we rely on the combination of historical experience and product testing for the development of our estimate for warranty claims. Our estimate of warranty claims could be adversely affected if our historical experience ultimately proves to be greater than the performance of the product in our product testing. We also provide 2-year to 3-year warranties on pillows. Estimated future obligations related to these products are provided by charges to operations in the period in which the related revenue is recognized. Our estimated obligation for warranty claims as of September 30, 2003 was $3.8 million.

 

Impairment of Goodwill, Intangibles and Long-Lived Assets

 

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

 

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

 

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

 

Estimates of fair value for our reporting units involve highly subjective judgments on the part of management, including the amounts of cash flows to be received, their estimated duration, and perceived risk as reflected in selected discount rates. In some cases, cash flows may be required to be estimated without the benefit of historical data, although historical data will be used where available. Although we believe our estimates and judgments are reasonable, different assumptions and judgments could result in different impairment, if any, of some or all of our recorded goodwill and indefinite-lived intangibles of $264.2 million as of September 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, Tempur-Pedic International 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, Tempur-Pedic International

 

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has provided for the 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 September 30, 2003 were approximately $68.4 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 Tempur-Pedic International or a United States subsidiary, or if Tempur-Pedic International should sell its stock in the subsidiaries.

 

Stock-Based Compensation.

 

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

 

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

 

In connection with stock option grants to certain employees, we recorded non-cash stock-based compensation expense during 2003 in the amount of approximately $1.9 million. The Company has recorded unearned non-cash stock-based compensation of $11.3 million as of September 30, 2003. The unearned non-cash stock-based compensation will be amortized to compensation expense over the respective vesting term, based on the “graded vesting” methodology.

 

Results of Operations

 

The results of operations include the effect of the 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.

 

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

 

    Year ended December 31,

   

Period from
January 1,
2002 to

October 31,

   

Period from

November 1,

2002 to

December 31,

    Pro forma as
Adjusted
Twelve Months
Ended
December 31,
   

Nine
Months ended

September 30,


 
    2000

    2001

    2002

    2002

    2002

    2002

     2003

 

Net sales

  100.0 %   100.0 %   100.0 %   100.0 %   100.0 %   100.0 %    100.0 %

Cost of sales

  55.2     48.6     46.5     62.4     49.0     46.5      46.4  
   

 

 

 

 

 

  

Gross profit

  44.8     51.4     53.5     37.6     51.0     53.5      53.6  

Selling expenses

  18.3     23.5     25.1     25.3     25.1     25.2      22.0  

General and administrative and other

  12.6     14.2     11.4     14.0     12.5     12.5      14.5  
   

 

 

 

 

 

  

Operating income

  13.9     13.7     17.0     (1.7 )   13.4     15.8      17.1  
   

 

 

 

 

 

  

Interest expense, net

  1.4     3.0     2.7     5.0     7.6     2.8      4.0  

Other expense, net

  0.6     0.1     0.7     (2.4 )   0.1     (0.3 )    0.4  
   

 

 

 

 

 

  

Income before income taxes

  11.9     10.6     13.6     (4.3 )   5.7     13.3      12.7  

Income tax provision

  4.1     5.2     5.2     1.0     2.7     6.1      5.1  
   

 

 

 

 

 

  

Net income

  7.8 %   5.4 %   8.4 %   (5.3 )%   3.0 %   7.2 %    7.6 %
   

 

 

 

 

 

  

 

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

 

     Year ended
December 31,


  

Period from
January 1,

2002 to
October 31,
2002


  

Period from
November 1,

2002 to
December 31,
2002


   Pro forma as
Adjusted
Twelve Months
Ended
December 31,
2002


  

Nine months

ended

September 30,


     2000

   2001

            2002

   2003

($ in millions)                                   

Retail

   $ 77.8    $ 116.9    $ 141.7    $ 36.0    $ 177.7    $ 123.2    $ 217.5

Direct

     31.1      47.6      46.4      12.4      58.8      38.6      63.7

Healthcare

     33.1      33.5      32.8      8.4      41.2      29.1      31.9

Third Party

     20.0      23.5      16.5      3.8      20.3      15.2      29.3

Domestic

   $ 74.1    $ 113.2    $ 131.3    $ 33.8    $ 165.3    $ 114.0    $ 199.7

International

     87.9      108.3      106.1      26.8      132.7      91.9      142.7

 

Nine Months Ended September 30, 2003 Compared With Nine Months Ended September 30, 2002

 

Net Sales.    Net sales for the nine months ended September 30, 2003 were $342.4 million as compared to $205.9 million for the nine months ended September 30, 2002, an increase of $136.5 million, or 66.3%. The increase in net sales was attributable to growth in our Domestic net sales to $199.7 million for the nine months ended September 30, 2003 as compared to $114.0 million for the nine months ended September 30, 2002, an increase of $85.7 million, or 75.2%, and an increase in our International net sales to $142.7 million for the nine months ended September 30, 2003 as compared to $91.9 million for the nine months ended September 30, 2002,

 

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an increase of $50.8 million, or 55.3%. The growth in our Domestic net sales was attributable primarily to an increase in net sales in our retail channel of $60.4 million and in the direct channel of $24.1 million, and the growth in our International net sales was attributable primarily to growth in the retail channel of $34.1 million. During the second quarter 2002, we introduced a new mattress, the Deluxe Mattress, which represented $23.2 million, or 11.6%, of Domestic net sales for the nine months ended September 30, 2003, and a new pillow, the Comfort Pillow, which represented $6.0 million, or 3.0%, of Domestic net sales for the nine months ended September 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 $158.8 million for the nine months ended September 30, 2003 as compared to $95.8 million for the nine months ended September 30, 2002, an increase of $63.0 million, or 65.8%, although cost of sales decreased as a percentage of net sales from 46.5% in the nine months ended September 30, 2002 to 46.4% in the nine months ended September 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 $104.7 million for the nine months ended September 30, 2003 as compared to $56.4 million for the nine months ended September 30, 2002, an increase of $48.3 million, or 85.6%. Our International cost of sales increased to $48.8 million for the nine months ended September 30, 2003 as compared to $39.4 million for the nine months ended September 30, 2002, an increase of $9.4 million, or 23.9%, excluding eliminations for sales from the International segment to the Domestic segment.

 

Selling Expenses.    Selling expenses include advertising and media production associated with our direct channel, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials, and sales force compensation and customer service. We also include in selling expenses our new product development costs, including market research and testing for new products. Selling expenses increased to $75.2 million for the nine months ended September 30, 2003 as compared to $51.9 million for the nine months ended September 30, 2002, an increase of $23.3 million, or 44.9%, but decreased as a percentage of net sales to 22.0% during the nine months ended September 30, 2003 from 25.2% for the nine months ended September 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 $217.4 million for the nine months ended September 30, 2003 as compared to $123.2 million for the nine months ended September 30, 2002, an increase of $94.2 million or 76.5%. This increase was due primarily to an increase in net sales in our retail channel, as a percentage of total net sales, to 63.5% of total net sales for the nine months ended September 30, 2003 as compared to 59.7% of total net sales for the nine months ended September 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 are 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 $49.8 million for the nine months ended September 30, 2003 as compared to $25.8 million for the nine months ended September 30, 2002, an increase of $24.0 million, or 93.0%. Included in general and administrative and other expenses are expenses totaling $13.6 million relating to the write off of deferred financing fees, original issue discount and prepayment penalties relating to our recapitalization in August 2003, expenses totaling $3.8 million in amortization of definite-lived intangibles and expenses totaling $1.9 million relating to stock option grants and accelerations. The Company has recorded unearned non-cash stock-based compensation of $11.3 million as of September 30, 2003. The unearned non-cash stock-based compensation will be amortized to compensation expense over the respective vesting term, based on the “graded vesting” methodology. Excluding the expenses related to the recapitalization, general and administrative and other expenses increased as a percentage of net sales to 13.4% during the nine

 

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months ended September 30, 2003 from 12.5% for the nine months ended September 30, 2002. The increase, excluding the expenses associated with the recapitalization, was due to additional spending on corporate overhead expenses, including information technology and professional services. The decrease, excluding the expenses associated with the recapitalization, 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 $13.7 million for the nine months ended September 30, 2003 as compared to $5.7 million for the nine months ended September 30, 2002, an increase of $8.0 million. This increase was due to higher average debt levels and the incurrence of additional debt from the recapitalization in August 2003. 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 nine months ended September 30, 2003 and September 30, 2002 was approximately 40.0% and 45.5%, respectively. Our effective tax rate between the nine month periods has decreased principally as a result of decreasing foreign net operating losses, which are fully reserved, and a decrease in foreign income taxable in the U.S. (“Subpart F”) income.

 

Unaudited Pro forma as Adjusted for the Twelve Months Ended December 31, 2002 Compared With Year Ended December 31, 2001

 

The following unaudited pro forma as adjusted data for the twelve months ended December 31, 2002 (“pro forma twelve months ended December 31, 2002”) are based on the historical financial statements for our predecessor for the ten months ended October 31, 2002 and Tempur-Pedic International for the two months ended December 31, 2002. The pro forma 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 period presented.

 

For the predecessor ten months ended October 31, 2002, our net sales were $237.3 million and cost of sales was $110.2 million. Our selling expenses were $59.6 million and general and administrative and other expenses were $27.1 million. Interest expense, net was $6.3 million and the income tax provision was $12.4 million.

 

For the successor two months ended December 31, 2002 our net sales were $60.6 million and cost of sales was $37.8 million. Our selling expenses were $15.3 million and general and administrative and other expenses were $8.5 million. Interest expense, net was $3.0 million and the income tax provision was $0.6 million.

 

Net Sales.    Net sales were $298.0 million for pro forma twelve months ended December 31, 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 pro forma twelve months ended December 31, 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 pro forma twelve months ended December 31, 2002, as compared to $108.3 million for the year ended December 31, 2001, an increase of $24.4 million, or 22.5%. Growth in Domestic net sales was due primarily to an increase in net sales in our retail channel of $40.6 million and an increase in net sales in our direct channel of $8.2 million. Growth in International net sales was due primarily to an increase in net sales in Japan, consisting primarily of pillows, of 51.2% for pro forma twelve months ended December 31, 2002, partially offset by the general economic slowdown in Europe over the year ended December 31, 2001.

 

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Cost of Sales.    Cost of sales increased to $146.0 million for pro forma twelve months ended December 31, 2002 as compared to $107.6 million for the year ended December 31, 2001, an increase of $38.4 million, or 35.7%. The increase was 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 49.0% for pro forma twelve months ended December 31, 2002 as compared to 48.6% for the year ended December 31, 2001, due primarily to the pro forma inventory step-up of $7.8 million and 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 pro forma twelve months ended December 31, 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 pro forma twelve months ended December 31, 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 $37.1 million for pro forma twelve months ended December 31, 2002 as compared to $31.5 million for the year ended December 31, 2001, an increase of $5.6 million, or 17.8%, but decreased as a percentage of net sales to 12.5% for pro forma twelve months ended December 31, 2002 as compared to 14.2% for the year ended December 31, 2001. The increase was due primarily to additional spending on corporate overhead expenses of $0.2 million, including information technology and professional services and an increase in the pro forma depreciation and amortization of property, plant and equipment and intangible assets of $1.6 million.

 

Interest Expense, Net.    Interest expense, net increased to $22.6 million for pro forma twelve months ended December 31, 2002 as compared to $6.6 million for the year ended December 31, 2001, an increase of $16.0 million, or 242.4%. This increase was due to higher average pro forma debt levels as a result of the Tempur acquisition and the recapitalization during the period.

 

Income Tax Provision.    The effective income tax rates in 2003 and pro forma twelve months ended December 31, 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. The effective tax rate for pro forma twelve months ended December 31, 2002 was approximately 52.6% compared to approximately 49.4% in 2001. This higher effective tax rate for pro forma twelve months ended December 31, 2002 compared to 2001 was primarily due to increased pro forma interest expense and partially offset by the fact that we no longer amortize goodwill which was previously a non-deductible item for tax purposes.

 

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

 

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

 

Cost of Sales.    Cost of sales increased to $107.6 million for the year ended December 31, 2001 as compared to $89.5 million for the year ended December 31, 2000, an increase of $18.1 million, or 20.2%, but

 

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

 

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

 

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

 

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

 

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

 

 

Liquidity and Capital Resources

 

Liquidity

 

At September 30, 2003, we had working capital of $39.5 million including cash and cash equivalents of $12.5 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 $0.2 million increase in cash and cash equivalents was primarily related to net income for the nine month period ended September 30, 2003 of $26.0 million and an increase in the change in income taxes payments of $10.7 million offset by investments in property, plant and equipment of $17.2 million and cash used in financing activities of $24.8 million. The $8.2 million increase in working capital was driven primarily by an increase in accounts receivable and inventory offset by an increase in income taxes payable, accounts payable and accrued expenses.

 

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  pro forma twelve months ended December 31, 2002 and $17.3 million for the nine months ended September 30, 2003. We expect 2003 capital expenditures to be approximately $25.4 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. Through September 30, 2003 we have spent approximately $10.1 million in connection with the expansion of our United States manufacturing facility. 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. On August 15, 2003, in connection with the recapitalization, we amended and restated our senior secured credit facility, with a syndicate of United States and European lenders. The facility was increased from $170.0 million to a total of $270.0 million of senior secured U.S. and European term loans and revolving credit facilities. The amended senior facility consists of a (i) $20.0 million U.S. revolving credit facility; (ii) $30.0 million U.S. term loan A; (iii) $135.0 million U.S. term loan B (the U.S. revolving credit facility, term loan A and term loan B are collectively referred to as the “US Facility”); (iv) $20.0 million European revolving credit facility; and (v) $65.0 million European term loan A (the European revolving credit facility and term loan A are collectively referred to as the “European Facility”). The U.S. and European revolving credit facilities provide for the issuance of letters of credit to support local operations. At September 30, 2003, we had approximately $33.7 million available under our United States and European revolving credit facilities. Our net weighted-average borrowing cost was 6.9% for pro forma twelve months ended December 31, 2002 and 6.2% for the year ended December 31, 2001, and 6.9% and 5.7% for the nine months ended September 30, 2003 and September 30, 2002, respectively.

 

Our cash flow from operations increased to $35.1 million for pro forma twelve months ended December 31, 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 $41.8 million for the nine months ended September 30, 2003 as compared to $15.1 million for the nine months ended September 30, 2002, an increase of $26.7 million, or 176.8%. 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 pro forma twelve months ended December 31, 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 pro forma twelve months ended December 31, 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 the nine month period ended September 30, 2003 were $17.3 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 pro forma twelve months ended December 31, 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

 

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credit facilities and issued new debt totaling $200.0 million to fund the Tempur acquisition. Cash flow used by financing activities increased to $24.8 million for the nine months ended September 30, 2003 as compared to $13.3 million for the nine months ended September 30, 2002, an increase of $11.5 million or 86.5%. 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 $10.1 million in capital expenditures related to this expansion through September 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 will be located in Albuquerque, New Mexico. 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 $230.0 million in borrowing 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.

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

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

 

Future Liquidity Sources

 

Our primary sources of liquidity are cash flow from operations and borrowings under our revolving credit facilities. We expect that ongoing requirements for debt service and capital expenditures will be funded from these sources. We incurred substantial indebtedness in connection with the recapitalization, including as a result of the issuance of the senior subordinated notes. As of September 30, 2003, we had approximately $382.5 million of indebtedness outstanding, excluding letters of credit. In addition, as of September 30, 2003, we had

 

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stockholders’ equity of approximately $25.5 million. Our significant debt service obligations following the recapitalization could, under certain circumstances, have material consequences to our security holders, including holders of the senior subordinated notes. Total cash interest payments related to our amended senior credit facilities and the senior subordinated notes is expected to be in excess of approximately $26.0 million annually. The scheduled installments for principal payments on our term loans under our amended senior credit facilities (as currently in effect) total to $3.0 million in 2003, $11.9 million in 2004, $15.4 million in 2005, $15.4 million in 2006, $22.4 million in 2007 and $159.0 million thereafter.

 

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

 

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 under the senior credit facilities then in effect. We were not in compliance with certain non-financial covenants as of September 30, 2003 but obtained waivers from our lenders under our amended senior credit facilities.

 

Contractual Obligations

 

Our contractual obligations and other commercial commitments as of September 30, 2003 are summarized below:

 

Contractual Obligations


   2003

   2004

   2005

   2006

   2007

   2008

  

After

2008


  

Total

Obligations


($ in millions)          

Long-term Debt

   $ 3.5    $ 12.3    $ 15.8    $ 15.8    $ 22.9    $ 32.1    280.1    $ 382.5

Operating Leases

     1.0      2.8      2.3      1.8      1.7      1.6    1.1      12.3
    

  

  

  

  

  

  
  

Total

   $ 4.5    $ 15.1    $ 18.1    $ 17.6    $ 24.6    $ 33.7    281.2    $ 394.8
    

  

  

  

  

  

  
  

 

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

 

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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 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 ARB No. 51” (FIN 46). FIN 46 requires an entity to consolidate a variable interest entity if it is designated as the primary beneficiary of that entity even if the entity does not have a majority of voting interests. A variable interest entity is generally defined as an entity where its equity is unable to finance its activities or where the owners of the entity lack the risk and rewards of ownership. The provisions of this statement apply at inception for any entity created after January 31, 2003. On October 10, 2003, the FASB issued Staff Position (FSP) FIN 46-6, “Effective Date of FASB Interpretation No. 46, Consolidation of Variable Interest Entities” (the FSP). The FSP defers the effective date of FIN 46 for VIEs created or acquired prior to February 1, 2003 until the end of fiscal periods ending after December 15, 2003. Although we do not expect FIN 46 to have a material impact on our consolidated financial statements, we are continuing to evaluate our interest in other entities in accordance with this complex interpretation.

 

In April 2003, the FASB issued SFAS 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities” (SFAS 149). SFAS 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS 133. The new guidance amends SFAS 133 for decisions made: (a) as part of the Derivatives Implementation Group process that effectively required amendments to SFAS 133, (b) in connection with other FASB projects dealing with financial instruments, and (c) regarding implementation issues raised in relation to the application of the definition of a derivative, particularly regarding the meaning of an “underlying” and the characteristics of a derivative that contains financing components. The amendments set forth in SFAS 149 improve financial

 

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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 15, 2003 (with a few exceptions) and for hedging relationships designated after June 15, 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. We do not believe that the adoption of SFAS 150 will 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 the exchange rate of the United States Dollar to foreign currency at September 30, 2003 increased by 10%, we would incur losses of approximately $0.6 million on foreign currency forward contracts outstanding at September 30, 2003. Such losses would be largely offset by gains from the revaluation or settlement of the underlying positions economically hedged. This calculation assumes that each exchange rate would change in the same direction relative to the United States Dollar.

 

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

 

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

 

Interest Rate Risk

 

We are exposed to changes in interest rates. All of our indebtedness under our amended senior credit facilities is variable rate debt. Interest rate changes therefore generally do not affect the market value of such debt but do impact the amount of our interest payments and therefore, our future earnings and cash flows, assuming other factors are held constant. On September 30, 2003, we had variable rate debt of approximately $230.0 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 $1.3 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.

 

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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 $0.0 million at September 30, 2003, which is recorded as follows:

 

     December 31,
2001


   December 31,
2002


    September 30,
2003


 
($ in millions)       

Foreign exchange receivable

   $ 0.1    $     $ —    

Foreign exchange payable

          (2.0 )     (0.2 )

Interest rate caps

                0.2  
    

  


 


Total

   $ 0.1    $ (2.0 )   $ 0.0  
    

  


 


 

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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 grew at a compound annual rate of approximately 36% and for the nine months ended September 30, 2003 we had total net sales of $342.4 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 41.7% 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, although sales decreased during the 2000 to 2002 period. 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. Based on information derived from an ISPA report, we believe that 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 collective 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 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 20.2% compound annual growth rate). As consumers continue to prefer alternatives to standard innerspring mattresses, our products become more widely available, and our brand gains broader consumer recognition, we expect 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 we believe its global recognition is reinforced by our high level of customer satisfaction. One of our products was recently ranked among the eight “best buys” of the mattress industry in the applicable price range by Consumers Digest, a recognition awarded to products that provide strong value to consumers. In addition, we believe our direct response business and associated multi-channel advertising in our domestic and international markets have enhanced awareness of our brand.

 

Diversified Product Offerings Sold Globally Through Multiple Distribution Channels.    Our diversified product offerings include mattresses, pillows and other products, primarily adjustable beds, which we sell through multiple distribution channels including retail, direct, healthcare and third party distributor channels. For the nine months ended September 30, 2003, mattress, pillow and other product sales, primarily adjustable beds, represented 52.9%, 27.8% and 19.3%, respectively, of our total net sales. For the nine months ended September 30, 2003, our retail channel represented 63.5% of total net sales, with our direct, healthcare and third party distributor channels representing 18.6%, 9.3% and 8.6%, respectively. Domestic and International operations generated 58.3% and 41.7%, respectively, of net sales for the nine months ended September 30, 2003.

 

LOGO

 

Strong Financial Performance.    Over the last several years, our highly-diversified, well-balanced business model has enabled us to achieve rapidly growing revenues and strong gross and operating margins, with low maintenance capital expenditure and working capital requirements. Further, our vertically-integrated operations generated an average of approximately $340,000 in net sales per employee in 2002, which we believe is more than 1.5 times the average for three of the major bedding manufacturers in the United States. For the nine months ended September 30, 2003, our gross margin exceeded 53.6% on net sales of $342.4 million. Our strong financial performance gives us the flexibility to invest in our manufacturing operations, enhance our sales force and marketing, invest in information systems and recruit talented management and other personnel.

 

Significant Growth Opportunities.    We believe we have significant growth opportunities because 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 a collective bed count in excess of 2.7 million). 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 $342.4 million in total net sales for the nine months ended September 30, 2003. Furthermore, Mr. Trussell has

 

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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 pro forma 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 for the pro forma twelve months ended December 31, 2002;

 

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

 

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

 

  improved the efficiency of our product distribution network.

 

The management team and certain key employees currently own approximately 13% of our common equity on a fully-diluted as-converted basis, after giving effect to the vesting of all outstanding options (11.9% after this offering).

 

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 (40.3% compound annual growth rate) and pillows (20.2% 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.

 

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 international sales growth 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

   

 

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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.

 

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.

   62 %   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.

   30 %   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 retail stores. In addition, since 2000, we have prioritized expanding our products into more traditional furniture stores in both the United States and Europe. We now sell our products in approximately 2,500 such stores in Europe and 2,500 in the United States.

 

As of September 30, 2003, we had 198 employees in our worldwide retail sales force, including regional sales managers, trainers, sales representatives and regional vice presidents. Our sales force develops this channel through identifying and contacting potential targets, trade publication advertising, presentations at trade shows and referrals. Our sales force seeks to convince potential accounts to stock our products based on our superior

 

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product offerings, strong brand awareness and attractive margins. As part of our marketing and sales effort in the United States, our trainers train in-store personnel in our products and their benefits in order to make the in-store personnel more effective sellers of our products, and we often provide mattresses and pillows to these in-store personnel so that they become personally familiar with the benefits of our products.

 

Direct

 

Our direct response marketing in the United States and United Kingdom targets customers through television, radio, magazine and newspaper product offering advertisements. Sales from this division in the United States has grown from $7.0 million of sales in 1997 to $48.8 million of sales in 2002. During the same period in the United Kingdom, direct sales increased from $970,000 to $10.1 million. Growth in direct response is primarily a function of advertising, which we intend to increase over the next three years. We have recently introduced a direct response program in certain European markets to replicate the success achieved in the United States and the United Kingdom. Most direct response sales orders are taken through responding to in-bound telephone calls, although some orders are also accepted through the internet. We will seek to increase the portion of direct sales orders taken over the internet in order to make our direct sales process more efficient.

 

As of September 30, 2003, we had 42 employees in our worldwide direct response sales force.

 

Healthcare

 

Our healthcare sales division offers medical mattresses, pillows and wheelchair cushions to the worldwide medical market. The structure of our healthcare business varies according to the local market. Within our healthcare channel, approximately 25,000 healthcare professionals recommend and/or sell our products to their patients; medical retailers, including pharmacists; and hospitals and nursing homes. Our principal markets in this channel are in the United States and in Europe, in Germany, Sweden, Norway and Spain. In each of our local markets, we operate our healthcare business on a local basis with direct sales forces and telemarketing programs. As of September 30, 2003, we had 34 employees in our healthcare channel worldwide.

 

Our healthcare sales division in the United States, which we refer to as Tempur Medical, began primarily through indirect sales of our mattresses and pillows through a network of medical professionals, and has grown to include direct sales to hospitals, nursing homes and medical retailers. In 2001, we developed a joint initiative with Swiss-American Products, Inc., a wound care management company, in the nursing home market to address the use of our products to help prevent and treat pressure ulcers (or bed sores). We believe that this is a large potential market for our products, including approximately 15,400 nursing homes in the United States with a total bed count in excess of 1.7 million beds, and that this market should expand over time as the baby boom generation ages. We now sell products to five major nursing home chains, which operate a total of more than 85 facilities. We believe this program can be expanded to aid nursing homes across the United States, which currently face sizeable lawsuits regarding damages resulting from bed sores. Our products can help prevent these injuries and the subsequent lawsuits against nursing homes, thus helping both the patient and caregiver.

 

As part of our marketing to the healthcare channel, we offer the Tempur Ultimate Skin Management Program, under which we provide a $250,000 indemnity reimbursement for pressure ulcer claims for nursing home facilities in compliance with the program. If a facility is in complete compliance with the program, but nevertheless becomes liable for a pressure sore claim, we will pay up to $250,000. To date, we have never had a claim, and we have insurance to mitigate our risk with respect to this indemnity.

 

Third Party

 

We have entered into written and verbal arrangements with third party distributors located in Eastern Europe, Asia/Pacific, the Middle East, Central and South America and Canada and Mexico. We utilize third party distributors to serve markets that are currently outside the range of our wholly-owned subsidiaries, which has enabled us to reach new markets with minimal capital investment. We have recently made an additional investment in personnel to manage and grow this important form of product distribution, and have restructured our organization to better track and manage our third party distribution arrangements.

 

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Operations

 

Manufacturing and Related Technology

 

Our products are manufactured at plants in Aarup, Denmark and Duffield, Virginia, both of which we own. Much of the sewing and production of mattress and pillow covers is outsourced to third party suppliers.

 

The Danish plant has undergone several major plant extensions in the past four years, including an $11.5 million facility expansion in 1999. The Danish plant is approximately 440,000 square feet, which we plan to expand to double its mattress production capacity. This plant is currently running close to capacity for mattresses and at approximately 85% of capacity for pillows. Our current mattress production at this plant is near capacity in part to support inventory build-up in the United States in anticipation of additional growth until we complete the expansion of our manufacturing capacity in the United States.

 

The opening of the Virginia plant in 2001 has provided needed capacity while reducing working capital. The Virginia plant is about 327,000 square feet and we are in the process of doubling the manufacturing capacity, which we expect to complete in the first quarter of 2004. This plant is currently running close to capacity for mattresses and pillows.

 

In order to increase productivity and expand our manufacturing capacity, we plan to develop and construct a third manufacturing facility which will be located in Albuquerque, New Mexico.

 

Our foam is a polyurethane product manufactured from polyol and proprietary additives. We limit the number of individuals who know or have access to the exact formula and manufacturing processes to make the foam. Our manufacturing process begins with the material used to make the foam being mixed and poured into molds for pillows or formed into slabs for mattresses. For mattresses, the foam is then cut into appropriate sizes which are laminated before covering and shipping.

 

Suppliers

 

We currently obtain all of the materials used to produce our visco-elastic foam from outside sources. We currently acquire almost all our polyol, an industrial commodity based on petroleum, from one supplier with a number of manufacturing locations around the world. We purchase proprietary additives from a number of vendors, including one from whom we are obligated to purchase minimum quantities. We expect to continue these supplier relationships for the foreseeable future. We do not consider ourselves dependent upon any single outside vendor as a source of raw materials and believe that sufficient alternative sources of supply for the same or similar raw materials are available.

 

Distribution

 

We recently launched two key supply chain initiatives developed to improve the overall efficiency of our product distribution network. We believe these initiatives will optimize management of our inventories throughout our network, enable us to meet or exceed our targeted delivery goals and enhance our customer service levels.

 

The first initiative is the design and implementation of a $1.6 million warehouse management system. This system provides network-wide scan, bar code and electronic processing capabilities for receipt, movement and shipment transactions for all distribution center activities. Additionally, we redesigned our distribution network by implementing a two-tier network structure. The first tier consists of two regional distribution centers, with a third scheduled to open in 2004. These regional centers provide inventories that service both our high volume retail customers and replenish our second tier distribution centers. The second tier consists of 16 home delivery service centers located throughout the United States, which are replenished as required with custom assembled truckloads of product that meet location-specific demand requirements. We use third party delivery services to transport our products from our distribution centers to our customers.

 

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Research and Development

 

We continuously seek to improve our products’ performance and benefits. Through consumer surveys and consumer focus groups, we seek feedback on a regular basis to help enhance our products. Since the introduction of our first product in 1991, we have continued to improve and expand our product line, including new mattresses and pillows for all channels. In addition to our research and development efforts, we also devote significant efforts to product development as part of our sales and marketing operations. We intend to increase our spending on research and development efforts in order to continue providing superior and innovative mattress and pillow products to our target markets, as well as develop new consumer products using our proprietary visco-elastic foam.

 

Competition

 

The mattress and pillow industries are highly competitive. Participants in the mattress and pillow industries have traditionally competed primarily based on price. Our premium mattresses compete with a number of different types of premium and standard mattress alternatives, including innerspring mattresses, foam mattresses, waterbeds, futons, air beds and other air-supported mattresses that 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. The pillow industry is characterized by an extremely large number of competitors, none of which is dominant.

 

The standard mattress market is dominated by four large manufacturers of innerspring mattresses with nationally recognized brand names, Sealy, Serta, Simmons and Spring Air. These four competitors also offer premium innerspring mattresses and collectively have a significant share of the premium mattress market in the United States. Select Comfort Corporation competes in the premium specialty mattress market and focuses on the air mattress market segment. The balance of the mattress market is served by a large number of other manufacturers, primarily operating on a regional basis. Many of these competitors and, in particular, the four largest manufacturers named above, have greater financial, marketing and manufacturing resources and better brand name recognition than our products and sell their products through broader and more established distribution channels. We also believe that a number of companies have begun to offer foam mattress products similar to our products.

 

Intellectual Property

 

We hold various United States and foreign patents and patent applications regarding certain elements of the design and function of our products, including our Combi and Deluxe mattress products, and our Millennium, Comfort and Leg-Spacer pillow products, among others. We have eight issued United States patents, expiring at various points between 2013 and 2021, and 10 United States patent applications pending. We also hold approximately thirty-two foreign patents and have approximately fifteen foreign patent applications pending. Notwithstanding these patents and patent applications, we cannot assure you that these patent rights will provide substantial protection or that others will not be able to develop products that are similar to or competitive with our products. In addition, the principal product formula and manufacturing processes for our visco-elastic foam products are not patented. To our knowledge, no third party has asserted a claim against us alleging that any element of our product infringes or otherwise violates any intellectual property rights of any third party.

 

We hold approximately 86 trademark registrations worldwide, which we believe have significant value and are important to the marketing of our products to retailers. Tempur® and Tempur-Pedic® are trademarks registered with the United States Patent and Trademark Office. We have a number of other registered marks, including Swedish Sleep System® and Tempur-Med®, and our Tempur-Pedic logo is registered. In addition, we have United States applications pending for additional marks. Several of our trademarks have been registered, or are the subject of pending applications, in various foreign countries. Each United States trademark registration is renewable indefinitely as long as the mark remains in use. We periodically review our portfolio of patents, patent applications, trademarks, trademark registrations and trademark registration applications, as well as our business plans, to

 

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determine whether our intellectual property portfolio is appropriately aligned with our business. Accordingly, we sometimes permit certain intellectual property to lapse or go abandoned under appropriate circumstances. In addition, due to the uncertainties inherent in prosecuting patent applications and trademark registration applications, sometimes patent applications and trademark applications are rejected and we subsequently abandon them. In other circumstances, applications are allowed and either issue as patents or are registered. We are not aware of any material claims of infringement or other challenges asserted against our right to use these marks.

 

Governmental Regulation

 

Our operations are subject to state, local and foreign consumer protection and other regulations relating to the mattress and pillow industry. These regulations vary among the states and countries in which we do business. The regulations generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling and sale and penalties for violations.

 

The U.S. Consumer Product Safety Commission and various state regulatory agencies are considering new rules relating to fire retardancy standards for the mattress and pillow industry. The State of California plans to adopt, proposed to be effective in 2005, new fire retardancy standards that have yet to be fully defined. If adopted, such new rules may adversely affect our costs, manufacturing processes and materials. We are developing product solutions that are intended to enable us to meet the new standards. Because the new standards have not been finally determined, however, no assurance can be given that our solutions will enable us to meet the new standards. We expect that any required product modifications will add cost to our product. Many foreign jurisdictions also regulate fire retardancy standards, and changes to these standards and changes in our products that require compliance with additional standards would raise similar risks.

 

Information Systems

 

We use technology to support our business and reduce operating costs, enhance our customer service and provide real-time information to manage our business. We use technology platforms from market leaders such as Microsoft, Oracle and Hyperion to run both packaged applications and internally developed systems. We have purchased upgraded replacements for the majority of our technology infrastructure over the past several years as equipment has come off of lease. Our major systems include manufacturing resource planning, direct marketing and customer service in-bound/out-bound telemarketing systems, e-commerce systems, retail partners support systems, Oracle ERP and Hyperion financial reporting systems.

 

The retail, direct marketing, customer service, and e-commerce applications are interfaced together to provide a fully integrated view of our customers and their activities across sales channels. Our Oracle based ERP applications include modules in support of our finance and distribution operations. We are currently upgrading our Oracle applications to the 11i version to provide significantly more flexibility, functionality and productivity cost savings. Our Microsoft-based manufacturing systems provide integrated resource planning and cost accounting applications to provide support for our manufacturing operations.

 

We use our own employees, supplemented by consultants and contractors, to deliver and maintain our technology systems and assets. Outsourcing is occasionally used for cost effectiveness or strategic reasons. We have a disaster recovery plan in place.

 

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Facilities

 

We operate in 54 countries and have wholly-owned subsidiaries in fifteen countries, including our wholly-owned subsidiaries that own our manufacturing facilities in Denmark and Virginia. The following table sets forth certain information regarding our principal facilities at September 30, 2003.

 

Name/Location


   Approximate
Square
Footage


  

Title


  

Type of Facility


Tempur Production USA, Inc.

    Duffield, Virginia

   327,000    Owned    Manufacturing

Tempur World Holding Company ApS

    Aarup, Denmark

   440,000    Owned    Manufacturing

Tempur-Pedic, Inc.

    Lexington, Kentucky

   72,000    Leased (until 2009)    Office and Warehouse

Tempur UK Ltd.

    Tempur House

    Middlesex, UB3 1BE,

    United Kingdom

   56,650    Leased (until 2010 with a cancellation option in 2007)    Office and Warehouse

Tempur Deutschland GmbH

    Steinhagen, Germany

   121,277    Owned    Office and Warehouse

 

We have additional facilities in 14 locations in 12 countries under leases with one to ten year terms.

 

Employees

 

As of September 30, 2003, we have approximately 1,000 employees, with approximately 400 in the United States, 300 in Denmark and 300 in the rest of the world. As of September 30, 2003, we have approximately 340 employees in sales and marketing, 450 employees in manufacturing, 130 employees in general and administrative, 75 employees in warehouse operations, and 5 employees in research and development, and a number of part-time employees. Our employees in Denmark are under a government labor union contract. None of our United States employees are covered by a collective bargaining agreement. We believe our relations with our employees are generally good.

 

Legal Proceedings

 

We are involved in various legal proceedings incident to the ordinary course of our business. We believe that the outcome of all pending legal proceedings in the aggregate will not have a material adverse effect on our business, financial condition, liquidity or operating results.

 

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MANAGEMENT

 

Tempur-Pedic International Inc.’s executive officers and directors and their ages as of November 15, 2003 are as follows:

 

Name


   Age

  

Position


Robert B. Trussell, Jr.

   52    President, Chief Executive Officer and Director

H. Thomas Bryant

   56   

Executive Vice President and President of North American Operations

David Montgomery

   43   

Executive Vice President and President of International Operations

Dale E. Williams

   40    Senior Vice President, Chief Financial Officer, Secretary and Treasurer

David C. Fogg

   44   

Senior Vice President of Tempur-Pedic International and President of Tempur-Pedic, Inc. Retail Division

Jeffrey B. Johnson

   38   

Vice President, Corporate Controller, Chief Accounting Officer and Assistant Secretary

P. Andrews McLane

   56    Chairman and Director

Jeffrey S. Barber

   30    Director

Tully M. Friedman

   61    Director

Christopher A. Masto

   36    Director

Francis A. Doyle

   55    Director

 

The present principal occupations and recent employment history of each of our executive officers and directors listed above is as follows:

 

Executive Officers

 

Robert B. Trussell, Jr. is the President and Chief Executive Officer of Tempur-Pedic International and a member of Tempur-Pedic International’s board of directors. He has served in these capacities at Tempur-Pedic International or its predecessor since 2000. From 1992 to 2000, Mr. Trussell served as President of Tempur-Pedic, Inc., one of the predecessors to Tempur-Pedic International. Prior to joining Tempur-Pedic International, Mr. Trussell was general partner of several racing limited partnerships that owned racehorses in England, France and the United States. He was also the owner of several start-up businesses in the equine lending and insurance business. Mr. Trussell received his B.S. degree from Marquette University.

 

H. Thomas Bryant joined Tempur-Pedic International in July 2001 and serves as Executive Vice President and President of North American Operations. From 1998 to 2001, Mr. Bryant was the President and Chief Executive Officer of Stairmaster Sports & Medical Products, Inc. From 1989 to 1997, Mr. Bryant served in various senior management positions at Dunlop Maxfli Sports Corporation, most recently as President. Prior to that, Mr. Bryant spent 15 years in various management positions at Johnson & Johnson. Mr. Bryant received his B.S. degree from Georgia Southern University.

 

David Montgomery joined Tempur-Pedic International in February 2003 and serves as Executive Vice President and President of International Operations. From 2001 to November 2002, Mr. Montgomery was employed by Rubbermaid, Inc., where he served as President of Rubbermaid Europe. From 1988 to 2001, Mr. Montgomery held various management positions at Black & Decker Corporation, most recently as Vice President of Black & Decker Europe, Middle East and Africa. Mr. Montgomery received his B.A. degree, with honors, from L’ Ecole Superieure de Commerce de Reims, France and Middlesex Polytechnic, London.

 

Dale E. Williams joined Tempur-Pedic International in July 2003 and serves as Senior Vice President and Chief Financial Officer. From 2001 to September 2002, Mr. Williams served as Vice President and Chief Financial Officer of Honeywell Control Products, a division of Honeywell International, Inc. From September 2002, when he

 

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left Honeywell in connection with a reorganization, to July 2003, Mr. Williams received severance from Honeywell and was not employed. From 2000 to 2001, Mr. Williams served as a Vice President and Chief Financial Officer of Saga Systems, Inc./Software AG, Inc. Prior to that, Mr. Williams spent 15 years in various management positions at General Electric Company, most recently as Vice President and Chief Financial Officer of GE Information Services, Inc. Mr. Williams received his B.A. degree in finance from Indiana University.

 

David C. Fogg has served as a Senior Vice President and President of our North American Retail Division since 2001, and has been employed with Tempur-Pedic International or its predecessor, since 1995. Prior to that, Mr. Fogg was Vice President of International Sales at Occidental Petroleum’s Island Creek Coal Company. Mr. Fogg’s professional activities include participation in the International Sleep Products Association (ISPA) Board of Trustees, Better Sleep Council Board and Strategic Planning Committee. Mr. Fogg received his B.A. degree from Pomona College.

 

Jeffrey B. Johnson joined Tempur-Pedic International in November 1999 and serves as Vice President, Corporate Controller and Chief Accounting Officer. From 1993 to 1999, Mr. Johnson was an experienced manager at Arthur Andersen in the audit and business advisory services division. Mr. Johnson is a certified public accountant and a certified management accountant and holds a B.S. degree, with honors, from the University of Kentucky and an M.B.A. degree, with honors, from the University of Chicago.

 

Directors

 

P. Andrews McLane has served as Chairman of Tempur-Pedic International’s board of directors since November 2002. Mr. McLane joined TA Associates, Inc., a private equity firm, which is one of our controlling stockholders, in 1979, where he is Senior Managing Director and a member of the firm’s Executive Committee. Mr. McLane’s activity at TA Associates centers on buyouts and leveraged recapitalizations of companies in the consumer, financial services and business services sectors. Mr. McLane is a director of IXION Technologies and United Pet Group and also serves on the boards of the United States Ski and Snowboard Team, St. Paul’s School and the Appalachian Mountain Club. Mr. McLane graduated from Dartmouth College in 1969 with an A.B. degree and from the Tuck School of Business at Dartmouth in 1973 with an M.B.A. degree.

 

Jeffrey S. Barber has served as a member of Tempur-Pedic International’s board of directors since November 2002. Mr. Barber is Vice President of TA Associates, Inc., a private equity firm, which is one of our controlling stockholders, where he has been employed since 2001. Mr. Barber’s activity at TA Associates centers on buyouts and leveraged recapitalizations of companies in the consumer, financial services and business services sectors. Prior to joining TA Associates, Mr. Barber was employed as an Associate both in the Private Equity Group of Weiss, Peck & Greer, LLC during 2000 and as an Associate in the Private Equity Group of Vestar Capital Partners from 1997 to 1999. Prior to that, Mr. Barber was employed at Morgan Stanley & Co., where he worked in the investment banking department. Mr. Barber received his B.A. degree, with University and Departmental Honors, from Johns Hopkins University and his M.B.A. degree, as a Beta Gamma Sigma Scholar, from Columbia University.

 

Tully M. Friedman has served as a member of Tempur-Pedic International’s board of directors since November 2002. Mr. Friedman is Chairman and Chief Executive Officer of Friedman Fleischer & Lowe, LLC, a private equity firm he co-founded in 1997, which is one of our controlling stockholders. Prior to forming Friedman Fleischer & Lowe, Mr. Friedman co-founded and served as one of two managing general partners of private equity firm Hellman & Friedman. He is currently on the board of directors of Advanced Career Technologies, Inc., Archimedes Technology Group, CapitalSource Inc., The Clorox Company and Mattel, Inc. He received his B.A. degree, with great distinction, from Stanford University and received a J.D. degree from Harvard Law School.

 

Christopher A. Masto has served as a member of Tempur-Pedic International’s board of directors since November 2002. Mr. Masto is a Managing Director of Friedman Fleischer & Lowe, LLC, a private equity firm

 

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he co-founded in 1997, which is one of our controlling stockholders. Prior to 1997, he worked as a management consultant with Bain & Company. Prior to that, Mr. Masto was employed at Morgan Stanley & Co., where he worked in the investment banking department. He currently serves on the board of Archimedes Technology Group. Mr. Masto received his B.A. degree, magna cum laude, from Brown University with an Sc.B. in Electrical Engineering and received his M.B.A. degree from Harvard Business School.

 

Francis A. Doyle has served as a member of Tempur-Pedic International’s board of directors since March 2003. Mr. Doyle has served as President and Chief Executive Officer of Connell Limited Partnership since 2001. From 1972 to 2001, he was a partner at PricewaterhouseCoopers LLP, where he was Global Technology and E-Business Leader and a member of the firm’s Global Leadership Team. He currently serves on the board of directors of Liberty Mutual Holding Company, Inc. and Citizens Financial Group. He is a trustee of the Joslin Diabetes Center and Boston College. Mr. Doyle is a certified public accountant and holds a B.S. degree and an M.B.A. degree from Boston College.

 

Board Committees

 

Upon completion of this offering, our board of directors will have three standing committees to assist it with its responsibilities. These committees are described below.

 

Compensation Committee

 

After this offering, our board of directors will have a compensation committee consisting initially of three directors, who are Messrs. Doyle, McLane and Friedman. The composition of the compensation committee will satisfy the independence requirements of the New York Stock Exchange, including its transitional rules. Our compensation committee reviews the salaries and other compensation of our executive officers, including equity-based compensation, and makes recommendations to our board of directors. In addition, the compensation committee reviews and administers our incentive compensation and other stock-based plans.

 

Audit Committee

 

After this offering, our board of directors will have an audit committee consisting initially of three directors, who are Messrs. Barber, Doyle and Masto. The composition of the audit committee will satisfy the independence and other requirements of the New York Stock Exchange, including its transitional rules, and the Securities and Exchange Commission. Each member of the audit committee will be financially literate at the time such director is appointed. In addition, our board of directors has determined that Mr. Doyle is an audit committee financial expert within the meaning of Item 401(h) of Regulation S-K of the Securities Act. Our audit committee makes recommendations to our board of directors regarding the selection of our independent auditors and reviews the professional services provided by our independent auditors, the independence of our auditors, the professional fees payable to our auditors, our annual financial statements, and our system of internal accounting procedures and controls.

 

Nominating and Governance Committee

 

After this offering, our board of directors will have a nominating and governance committee initially consisting of three directors, who are Messrs. Doyle, McLane and Friedman. The composition of the nominating and governance committee will satisfy the independence requirements of the New York Stock Exchange, including its transitional rules.

 

Compensation Committee Interlocks and Insider Participation

 

None of our executive officers serves as a member of the board of directors or compensation committee of any other company that has one or more executive officers serving as a member of our board of directors or compensation committee. Prior to the formation of the compensation committee, the board of directors as a whole made decisions relating to compensation of our executive officers.

 

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Compensation of Executive Officers

 

The following table sets forth information concerning the annual and long-term compensation for services in all capacities to Tempur-Pedic International or Tempur World, Inc. for each year in the three-year period ended December 31, 2002 of those persons who served as (i) the chief executive officer during each year in the three- year period ended December 31, 2002 and (ii) our other four most highly compensated executive officers for the year ended December 31, 2002, whom together with the chief executive officer we refer to collectively as the “Named Executive Officers”:

 

SUMMARY COMPENSATION TABLE

 

Annual Compensation Long-Term Compensation

 

Name and Principal Position


   Year

   Salary

   Bonus

   Other Annual
Compensation
(a)


   All Other
Compensation
(b)


Robert B. Trussell, Jr.

President and Chief Executive Officer

   2002
2001
2000
  

$

 

 

282,500

276,975

269,500

  

$

 

 

84,893

40,425

73,500

  

$

 

 

7,200

6,000

  

$

 

 

10,270

9,691

1,440

Jeffrey P. Heath(c)

   2002
2001
2000
  

$

 

 

166,700

164,000

157,000

   $
 
 
49,455
47,100
  

$

 

 

7,200

6,000

  

$

 

 

46,568

24,475

1,308

H. Thomas Bryant(d)

Executive Vice President

   2002
2001
2000
  

$

 

 

213,300

206,000

n/a

  

$
 

 

45,833

n/a

  

$

 

 

7,200

90,864

n/a

  

$

 

 

5,140

n/a

David C. Fogg

Senior Vice President

   2002
2001
2000
  

$

 

 

241,100

237,300

220,000

   $
 
 
71,190
33,000
  

$

 

 

7,200

6,000

  

$

 

 

10,451

9,265

1,440

Jeffrey B. Johnson

Vice President, Corporate Controller and Chief Accounting Officer

   2002
2001
2000
  

$

 

 

115,000

100,000

95,000

  

$

 
 


5,000

  

$

 

 

  

$

 

 

5,576

4,627

781


(a) Represents amounts paid on behalf of each of the Named Executive Officers for the following four respective categories of other annual compensation: (i) compensation recorded associated with the exercise of stock options, (ii) compensation associated with the pay out of previously deferred compensation, (iii) relocation expenses incurred and (iv) car and financial planning allowances paid on behalf of the Named Executive Officers. Amounts for each of the Named Executive Officers for each of the four respective preceding categories is as follows: Mr. Trussell: (2002-$0, $0, $0, $7,200; 2001-$0, $0, $0, $6,000; 2000-$0, $0, $0, $0); Mr. Heath: (2002-$0, $0, $0, $7,200; 2001-$0, $0, $39,411, $6,000; 2000-$0, $0, $17,554, $0); Mr. Bryant: (2002-$0, $0, $216, $7,200; 2001-$0, $0, $90,384, $0; 2000-$0, $0, $0, $0); Mr. Fogg: (2002-$0, $0, $0, $7,200; 2001-$0, $0, $0, $6,000; 2000-$0, $0, $0, $0); Mr. Johnson (2002-$0, $0, $0, $0; 2001-$0, $0, $7,186; 2000-$0, $0, $27,930).
(b) Represents amounts paid on behalf of each of the Named Executive Officers for the following three respective categories of compensation: (i) premiums for life and accidental death and dismemberment insurance, (ii) premiums for long-term disability benefits and (iii) contributions to our defined contribution plans. Amounts for each of the Named Executive Officers for each of the three respective preceding categories is as follows: Mr. Trussell: (2002-$1,020, $420, $8,830; 2001-$1,020, $420, $8,251; 2000-$1,020, $420, $0); Mr. Bryant: (2002-$1,020, $420, $3,484; 2001-$340, $140, $0; 2000-$0, $0, $0); Mr. Fogg: (2002-$1,020, $420, $9,011; 2001 $1,020, $420, $7,825; 2000-$1,020, $420, $0); Mr. Johnson: (2002-$612, $210, $4,754; 2001-$581, $199, $3,846; 2000-$581, $199, $0).
(c) Mr. Heath served as Executive Vice President and Chief Financial Officer until July 2003.
(d) Data for 2000 is not available for Mr. Bryant as he joined our company in July 2001.

 

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OPTIONS/SAR GRANTS IN LAST FISCAL YEAR

 

          Individual Grants

              

Name


   Number of
Securities
Underlying
Options/SARS
Granted(#)


   % of Total
Options/SARS
Granted to
Employees in
Fiscal Year


    Exercise or
Base
Price ($/Sh)


   Expiration
Date


   Potential Realizable Value
At Assumed Annual Rates of
Stock Price Appreciation
For Option Term(a)


              5%($)

   10%($)

Robert B. Trussell, Jr.

   0/1,732,500    28.4 %   $ 1.52    11/01/2012    $ 1,662,007    $ 6,842,419

Jeffrey P. Heath

   0/619,500    10.6 %     1.52    11/01/2012      594,293      2,446,702

H. Thomas Bryant

   0/892,500    14.6 %     1.52    11/01/2012      856,185      3,524,896

David C. Fogg

   0/842,100    13.8 %     1.52    11/01/2012      807,836      3,325,829

Jeffrey B. Johnson

   0/84,000     1.4 %     1.52    11/01/2012      80,582      331,765

(a) Potential Realizable Value is based on certain assumed rates of appreciation from the option exercise price since our board of directors determined that the stock’s then current value was equal to or less than such option exercise price. These values are not intended to be a forecast of our stock price. Actual gains, if any, on stock option exercises are dependent on the future performance of the stock. There can be no assurance that the amounts reflected in this table will be achieved. In accordance with the rules promulgated by the Securities and Exchange Commission, Potential Realizable Value is based upon the exercise price of the options.

 

AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR

AND FISCAL YEAR-END OPTION/SAR VALUES

 

Name


   Number of Securities
Underlying Unexercised
Options/SARS at Fiscal
Year-End(#)
Exercisable/Unexercisable(a)


Robert B. Trussell, Jr.

   0/1,732,500

Jeffrey P. Heath

   0/619,500

H. Thomas Bryant

   0/892,500

David C. Fogg

   0/842,100

Jeffrey B. Johnson

   0/84,000 

(a) Includes options exercisable within 60 days after December 31, 2002.

 

Employee Benefit Plans

 

2002 Stock Option Plan

 

In November 2002, our board of directors and stockholders approved a stock option plan, effective for a ten-year term, to encourage ownership of stock by our employees, directors and consultants and to provide them with additional financial incentives. Under the plan, the number of outstanding shares of our common stock attributable to the exercise of options, together with the number of shares issuable upon the exercise of outstanding options, shall not exceed 9,907,349 shares except in the event of a stock dividend, split, reclassification or other similar corporate transaction. No individual may be granted options for more than 66 2/3% of this total number of shares.

 

Employees, directors and consultants are eligible to receive options under the plan. However, directors who are not also employees are not eligible to receive incentive options. In the case of incentive options, the option price shall be not less than 100% of the fair market value of our common stock on the date the option is granted, or not less than 110% of that fair market value for a holder of 10% of our voting stock. Incentive options expire ten years after the date on which they are granted, or five years after the grant date for holders of 10% of our voting stock. Other options under the plan are not subject to such limitation.

 

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In connection with the adoption of our 2003 Equity Incentive Plan, described below, the Board of Directors will amend the 2002 Stock Option Plan to provide that no additional options will be issued under that plan.

 

2003 Equity Incentive Plan

 

Upon completion of the offering, a new incentive compensation plan will go into effect, which we refer to in this prospectus as the 2003 Equity Incentive Plan. The 2003 Equity Incentive Plan will be administered by the compensation committee of our board of directors, which committee has the exclusive authority, including the power to determine eligibility to receive awards, the types and number of shares of stock subject to the awards, the price and timing of awards and the acceleration or waiver of any vesting, and performance of forfeiture restriction. The compensation committee, however, does not have the authority to waive any performance restrictions for performance-based awards. As used in this prospectus, the term “administrator” means the compensation committee.

 

Participants.    Any of our employees, our non-employee directors, consultants and advisors to us, as determined by the compensation committee may be selected to participate in the 2003 Equity Incentive Plan. We may award these individuals with one or more of the following:

 

stock options;

 

stock appreciation rights;

 

restricted stock and stock unit awards;

 

performance shares;

 

stock grants; and

 

performance-based awards.

 

Stock options.    Stock options may be granted under the 2003 Equity Incentive Plan, including incentive stock options, as defined under Section 422 of the Internal Revenue Code, as amended (Code), and nonqualified stock options. The option exercise price of all stock options granted under the 2003 Equity Incentive Plan will be determined by the administrator, except that any incentive stock option or any option intended to qualify as performance-based compensation under Code Section 162(m) will not be granted at a price that is less than 100% of the fair market value of the stock on the date of grant. Stock options may be exercised as determined by the administrator, but in no event after the tenth anniversary date of grant.

 

Upon the exercise of a stock option, the purchase price must be paid in full in either cash or its equivalent. The administrator may also allow payment by tendering previously acquired shares of our common stock with a fair market value at the time of exercise equal to the exercise price, provided such shares have been held for at least six months prior to tender and broker-assisted cashless exercises and may authorize loans for the purpose of exercise as permitted under applicable law.

 

Stock appreciation rights (SAR).    SAR entitle a participant to receive a payment equal in value to the difference between the fair market value of a share of stock on the date of exercise of the SAR over the grant price of the SAR. The administrator may pay that amount cash, in shares of our common stock, or a combination. The terms, methods of exercise, methods of settlement, form of consideration payable in settlement, and any other terms and conditions of any SAR will be determined by the administrator at the time of the grant of award and will be reflected in the award agreement.

 

Restricted Stock and Stock Units.    A restricted stock award or restricted stock unit award is the grant of shares of our common stock either currently (in the case of restricted stock) or at a future date (in the case of restricted stock units) at a price determined by the administrator (including zero), that is nontransferable and is subject to substantial risk of forfeiture until specific conditions or goals are met. Conditions may be based on

 

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continuing employment or achieving performance goals. During the period of restriction, participants holding shares of restricted stock may, if permitted by the administrator, have full voting and dividend rights with respect to such shares. The restrictions will lapse in accordance with a schedule or other conditions determined by the administrator.

 

Performance shares.    A performance share award is a contingent right to receive pre-determined shares of our common stock if certain performance goals are met. The value of performance units will depend on the degree to which the specified performance goals are achieved but are generally based on the value of our common stock. The administrator may, in its discretion, pay earned performance shares in cash, or stock, or a combination of both.

 

Stock Grants.    A stock grant is an award of shares of common stock within restriction. Stock grants may only be made in limited circumstances, such as in lieu of other earned compensation.

 

Performance-based awards.    Grants of performance-based awards enable us to treat other awards granted under the 2003 Equity Incentive Plan as “performance-based compensation” under Section 162(m) of the Code and preserve the deductibility of these awards for federal income tax purposes. Because Section 162(m) of the Code only applies to those employees who are “covered employees” as defined in Section 162(m) of the Code, only covered employees and those likely to become covered employees are eligible to receive performance-based awards.

 

Participants are only entitled to receive payment for a performance-based award for any given performance period to the extent that pre-established performance goals set by the administrator for the period are satisfied. These pre-established performance goals must be based on one or more of the following performance criteria: pre- or after-tax net earnings, sales or revenue, operating earnings, operating cash flow, return on net assets, return on stockholders’ equity, return on assets, return on capital, stock price growth, stockholder returns, gross or net profit margin, earnings per share, price per share, and market share. These performance criteria may be measured in absolute terms or as compared to any incremental increase or as compared to results of a peer group. With regard to a particular performance period, the administrator will have the discretion to select the length of the performance period, the type of performance-based awards to be granted, and the goals that will be used to measure the performance for the period. In determining the actual size of an individual performance-based award for a performance period, the administrator may reduce or eliminate (but not increase) the award. Generally, a participant will have to be employed on the date the performance-based award is paid to be eligible for a performance-based award for that period.

 

Shares reserved for issuance.    Subject to certain adjustments, we may issue a maximum of 8,000,000 shares of our common stock, including shares of common stock that may be issued upon the exercise of options, under the 2003 Equity Incentive Plan.

 

Amendment and termination.    The administrator, with the board’s approval, may terminate, amend, or modify the 2003 Equity Incentive Plan at any time; however, stockholder approval will be obtained for any amendment to the extent necessary and desirable to comply with any applicable law, regulation or stock exchange rule. We may not make any grants under the 2003 Equity Incentive Plan after December 1, 2013.

 

Adoption by stockholders.    The 2003 Equity Incentive Plan has been approved by the holders of a majority of outstanding shares of our common stock and preferred stock.

 

2003 Employee Stock Purchase Plan

 

We plan to sponsor an employee stock purchase plan following the completion of the offering, which we refer to in this prospectus as the 2003 Employee Stock Purchase Plan. The 2003 Employee Stock Purchase Plan will permit eligible employees (as defined in the 2003 Employee Stock Purchase Plan) to purchase up to $25,000

 

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worth of our common stock annually over the course of two semi-annual offering periods at a price of no less than 85% of the price per share of our common stock either at the beginning or the end of each six-month offering period, whichever is less. The compensation committee of our board of directors will administer the 2003 Employee Stock Purchase Plan. Our board may amend or terminate the plan. The 2003 Employee Stock Purchase Plan will comply with the requirements of Section 423 of the Code. We may issue a maximum of 500,000 shares of our common stock under this plan. This plan has been approved by the holders of a majority of outstanding shares of our common stock and preferred stock.

 

Director Compensation

 

Francis A. Doyle has been granted options to purchase 210,000 shares of common stock for service as a director and as chairman of the audit committee. Our directors may be reimbursed for expenses incurred in attending board and committee meetings.

 

Compensation Committee Interlocks and Insider Participation

 

No member of our compensation committee serves as a member of the board of directors or compensation committee of any entity that has one or more executive officers serving as members of our board of directors or compensation committee.

 

Employment Arrangements, Termination of Employment Arrangements and Change in Control Arrangements

 

In October 2002, we entered into several executive employment agreements described below, which became effective upon the closing of the Tempur acquisition on November 1, 2002. We entered into an amended and restated employment agreement with Robert B. Trussell, Jr., providing for his employment as Chief Executive Officer. The agreement has an initial term of two years and will be automatically renewed for successive one-year periods. Either party may terminate the agreement, upon written notice, 90 days prior to the expiration of the initial or renewal term. The agreement provides for an annual base salary of $310,000, subject to annual adjustment by Tempur-Pedic International’s board of directors beginning January 1, 2004, plus a variable performance bonus set to target 30% of Mr. Trussell’s base salary if certain criteria are met, plus options to purchase shares of our voting common stock.

 

We entered into an amended and restated employment agreement with David C. Fogg, providing for his employment as Senior Vice President, or such other executive position as may be assigned from time to time by our Chief Executive Officer. The agreement has an initial term of one-year and a perpetual one-year renewal term. Either party may terminate the agreement, upon written notice, 90 days prior to the expiration of the initial or renewal term. The agreement provides for an annual base salary of $260,000, subject to annual adjustment by Tempur-Pedic International’s board of directors beginning January 1, 2004, a variable performance bonus set to target 30% of Mr. Fogg’s base salary if certain criteria are met, and options to purchase shares of our voting common stock.

 

We entered into an amended and restated employment agreement with H. Thomas Bryant for his employment as Executive Vice President, or such other executive position as may be assigned from time to time by our Chief Executive Officer. The agreement has an initial term of one-year and a perpetual one-year renewal term. Either party may terminate the agreement, upon written notice, 90 days prior to the expiration of the initial or renewal term. Mr. Bryant’s agreement provides for an annual base salary of $250,000, subject to annual adjustment by Tempur-Pedic International’s board of directors beginning January 1, 2004, a variable performance bonus set to target 30% of Mr. Bryant’s base salary if certain criteria are met, and options to purchase shares of our voting common stock.

 

We entered into an amended and restated employment agreement with Jeffrey P. Heath for his employment as Chief Financial Officer. The agreement had an initial term of one year and a perpetual one-year renewal term.

 

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Mr. Heath’s agreement provided for an annual base salary of $180,000, subject to annual adjustment by Tempur-Pedic International’s board of directors beginning January 1, 2004, a variable performance bonus set to target 30% of Mr. Heath’s base salary if certain criteria were met, and options to purchase shares of our voting common stock. In July 2003, we entered into a separation agreement with Mr. Heath containing customary terms and conditions, including provisions related to severance, option acceleration, note forgiveness and non-competition.

 

On July 11, 2003, we entered into an executive employment agreement with Dale E. Williams, providing for his employment as Senior Vice President and Chief Financial Officer, or such other executive position as may be assigned from time to time by our Chief Executive Officer. The agreement has an initial term of one-year and a perpetual one-year renewal term. Either party may terminate the agreement, upon written notice, 90 days prior to the expiration of the initial or renewal term. The agreement provides for an annual base salary of $225,000, subject to annual adjustment by Tempur-Pedic International’s board of directors beginning January 1, 2004, a variable performance bonus set to target 30% of Mr. Williams’ base salary if certain criteria are met, and options to purchase shares of our voting common stock.

 

On September 12, 2003, we entered into an executive employment agreement with David Montgomery, providing for his employment as Executive Vice President, or such other executive position as may be assigned from time to time by our Chief Executive Officer. The agreement provides that employment shall continue unless and until terminated by either party. Mr. Montgomery may terminate employment with six months written notice. We may terminate employment with 12 months written notice. The agreement provides for an annual base salary of £192,500, subject to an annual adjustment by Tempur-Pedic International’s board of directors on or about January 1 of each year beginning with January 1, 2004, and a variable performance bonus set to target 30% of Mr. Montgomery’s base salary if certain criteria are met.

 

By the terms of their employment agreements, Mr. Trussell, Mr. Fogg, Mr. Bryant, Mr. Heath, Mr. Williams and Mr. Montgomery are prohibited from disclosing certain confidential information and trade secrets, soliciting any employee for one or two years following their employment and working with or for any competing companies during their employment and for one or two years thereafter.

 

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PRINCIPAL AND SELLING STOCKHOLDERS

 

The following table sets forth information regarding the beneficial ownership of our outstanding equity securities as of the date of this prospectus by:

 

  each person known to beneficially own more than 5% of Tempur-Pedic International’s outstanding common stock;

 

  each of Tempur-Pedic International’s directors and the Named Executive Officers;

 

  all of Tempur-Pedic International’s directors and executive officers as a group; and

 

  each of our stockholders who are selling shares in this offering.

 

To our knowledge, each selling stockholder purchased the shares of our stock in the ordinary course of business and, at the time of acquiring the securities to be resold, the selling stockholder had no agreements or understandings, directly or indirectly, with any person to distribute the securities.

 

Beneficial ownership of shares is determined under rules of the Securities and Exchange Commission and generally includes any shares over which a person exercises sole or shared voting or investment power. The information set forth in the table below gives effect to the conversion of all preferred stock into common stock. The table also includes the number of shares underlying options and warrants that are exercisable within 60 days of the date of this offering. Common stock subject to these options or warrants is deemed to be outstanding for the purpose of computing the ownership percentage of the person holding such options or warrants, but are not deemed to be outstanding for the purpose of computing the ownership percentage of any other person. The table assumes 91,016,520 shares of common stock outstanding as of the date of this prospectus and 97,266,520 shares of common stock outstanding upon completion of this offering.

 

Certain of the selling stockholders have granted the underwriters a 30-day option to purchase up to 2,812,500 shares of common stock to cover over-allotments, if any. If this option is exercised in full, the selling stockholders will sell 2,812,500 shares of common stock to the underwriters.

 

The selling stockholders may be deemed to be “underwriters” within the meaning of the Securities Act of 1933. Any discounts, commissions, concessions or profits they earn on any sale of the shares may be underwriting discounts and commissions under the Securities Act. Selling stockholders who are deemed to be “underwriters” within the meaning of the Securities Act will be subject to the prospectus delivery requirements of the Securities Act.

 

One of the selling stockholders, Gleacher Mezzanine Funds (as defined below), is an affiliate of Gleacher Partners LLC, a broker-dealer. Gleacher Mezzanine Funds acquired shares of our stock in the ordinary course of its business, and at the time of acquiring shares of our stock had no agreements or understandings, directly or indirectly, with any person to distribute these securities.

 

Except as otherwise indicated, the persons named in the table below have sole voting and investment power with respect to all shares of capital stock held by them. Unless otherwise indicated, the address of each officer, director and 5% stockholder listed below is c/o Tempur-Pedic International Inc., 1713 Jaggie Fox Way, Lexington, Kentucky 40511.

     Number of Shares    Number of
Shares to be
Sold in
Offering(11)


   Percentage of Shares  
     Beneficially Owned

      Beneficially Owned

 

Name of Beneficial Owner:


   Before
Offering


   After
Offering


      Before
Offering


    After
Offering


 

5% Stockholders:

                           

TA Associates Funds(1)(11)

   52,215,455    44,190,198    8,025,257    58.2 %   45.4 %

Friedman Fleischer & Lowe Funds(2)(11)

   25,570,151    21,640,145    3,930,006    29.5 %   22.2 %

Executive Officers and Directors:

                           

Robert B. Trussell, Jr.(3)(11)

   3,377,472    3,377,472    —      3.9 %   3.5 %

H. Thomas Bryant(11)

   287,946    287,946    —      *       *    

David C. Fogg(11)

   1,351,161    1,351,161    —      1.6 %   1.4 %

 

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     Number of Shares   Number of
Shares to be
Sold in
Offering(11)


  Percentage of Shares  
     Beneficially Owned

    Beneficially Owned

 

Name of Beneficial Owner:


   Before
Offering


  After
Offering


    Before
Offering


    After
Offering


 

David Montgomery

   196,875   196,875     *     *  

Jeffrey B. Johnson(11)

   21,000   21,000     *     *  

Dale E. Williams(4)(11)

   52,500   52,500       *     *  

P. Andrews McLane(5)

   52,215,455   44,190,198   8,025,257   58.2 %   45.4 %

Jeffrey S. Barber(6)(11)

   52,215,455   44,190,198   8,025,257   58.2 %   45.4 %

Tully M. Friedman(7)

   25,570,151   21,640,145   3,930,006   29.5 %   22.2 %

Christopher A. Masto(8)

   25,570,151   21,640,145   3,930,006   29.5 %   22.2 %

Francis A. Doyle(9)

   52,500   52,500     *     *  

All Executive Officers and Directors as a group (11 persons)(10)(11):

   83,125,060   71,169,797   11,955,263   92.6 %   72.5 %

Other Selling Stockholders:

                        

Gleacher Mezzanine Funds(11)

   2,912,490   2,464,856   447,634   3.3 %   2.6 %

Antares Capital Corp.(11)

   131,250   111,077   20,173   *     *  

Jean H. Downey Living Trust(11)

   163,978   138,775   25,203   *     *  

Alain Falourd(11)

   409,941   389,768   20,173   *     *  

Keansburg Investments Limited(11)

   177,733   164,074   13,659   *     *  

Thomas Jameson(11)

   46,977   39,756   7,221   *     *  

George Khouri(11)

   210,000   206,772   3,228   *     *  

Robert Hoeller(11)

   538,676   536,574   2,102   *     *  

David Wright(11)

   114,780   113,252   1,528   *     *  

Robert W. and Mary M. Mulcahy, JTWROS(11)

   37,437   35,984   1,453   *     *  

Lynda Davey and Alan Schiffres, JTWROS(11)

   131,250   130,039   1,211   *     *  

John Paul Pucek(11)

   48,667   47,919   748   *     *  

Frank Passante(11)

   201,757   201,353   404   *     *  

* Represents ownership of less than one percent
(1) Amounts shown reflect the aggregate number of shares of common stock held by TA IX L.P., TA/Atlantic and Pacific IV L.P., TA/Advent VIII L.P., TA Strategic Partners Fund A L.P., TA Strategic Partners Fund B L.P., TA Investors LLC and TA Subordinated Debt Fund, L.P. (collectively, the “TA Associates Funds”). Includes 3,120,815 shares of common stock issuable upon exercise of outstanding and currently exercisable warrants. Investment and voting control of the TA Associates Funds is held by TA Associates, Inc. No stockholder, director or officer of TA Associates, Inc. has voting or investment power with respect to the shares of the Company held by TA Associates Funds. Voting and investment power with respect to such shares is vested in a four-person Investment Committee comprised of Jeffrey S. Barber, Brian J. Conway, C. Kevin Landry and P. Andrews McLane. Mr. McLane is Senior Managing Director of TA Associates, Inc., the manager of the general partner of TA IX L.P., TA Advent VIII L.P. and TA Subordinated Debt Fund, L.P.; the manager of TA Investors LLC; and the general partner of TA/Atlantic and Pacific IV L.P., TA Strategic Partners Fund A L.P. and TA Strategic Partners Fund B L.P. Mr. Barber is Vice President of TA Associates, Inc., the manager of the general partner of TA IX L.P., TA Advent VIII L.P. and TA Subordinated Debt Fund, L.P.; the manager of TA Investors LLC; and the general partner of TA/Atlantic and Pacific IV L.P., TA Strategic Partners Fund A L.P. and TA Strategic Partners Fund B L.P. The address of the TA Associates Funds is c/o TA Associates, Inc., High Street Tower, Suite 2500, 125 High Street, Boston, MA 02110.
(2)

Amounts shown reflect the aggregate number of shares of common stock held by Friedman Fleischer & Lowe Capital Partners, LP and FFL Executive Partners, LP (collectively, the “Friedman Fleischer & Lowe Funds”). The Friedman Fleischer & Lowe Funds are controlled by Friedman Fleischer & Lowe GP, LLC,

 

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their general partner. Mr. Friedman and Mr. Masto are Managing Members of Friedman Fleischer & Lowe GP, LLC and direct the vote of the FFL funds as shareholders of Tempur-Pedic International. The address of the Friedman Fleischer & Lowe Funds is c/o Friedman Fleischer & Lowe, LLC, One Maritime Plaza, 10th Floor, San Francisco, CA 94111.

(3) Amount reflects the aggregate number of shares owned by RBT Investments, LLC and Robert B. Trussell and Martha O. Trussell, Tenants in Common.
(4) Includes 52,500 shares of common stock issuable upon exercise of outstanding and currently exercisable options.
(5) Includes 3,120,815 shares of common stock issuable upon exercise of outstanding and currently exercisable warrants. Mr. McLane is Senior Managing Director of TA Associates, Inc., the manager of the general partner of TA IX L.P., TA Advent VIII L.P. and TA Subordinated Debt Fund, L.P.; the manager of TA Investors LLC; and the general partner of TA/Atlantic and Pacific IV L.P., TA Strategic Partners Fund A L.P. and TA Strategic Partners Fund B L.P. Accordingly, Mr. McLane may be deemed to beneficially own shares owned by TA IX L.P., TA Advent VIII L.P., TA Subordinated Debt Fund, L.P., TA Investors LLC, TA/Atlantic and Pacific IV L.P., TA Strategic Partners Fund A L.P. and TA Strategic Partners Fund B L.P. Mr. McLane disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest. The address for Mr. McLane is c/o TA Associates, Inc., High Street Tower, Suite 2500, 125 High Street, Boston, MA 02110.
(6) Includes 3,120,815 shares of common stock issuable upon exercise of outstanding and currently exercisable warrants. Mr. Barber is Vice President of TA Associates, Inc., the manager of the general partner of TA IX L.P., TA Advent VIII L.P. and TA Subordinated Debt Fund, L.P.; the manager of TA Investors LLC; and the general partner of TA/Atlantic and Pacific IV L.P., TA Strategic Partners Fund A L.P. and TA Strategic Partners Fund B L.P. Accordingly, Mr. Barber may be deemed to beneficially own shares owned by TA IX L.P., TA Advent VIII L.P., TA Subordinated Debt Fund, L.P., TA Investors LLC, TA/Atlantic and Pacific IV L.P., TA Strategic Partners Fund A L.P. and TA Strategic Partners Fund B L.P. Mr. Barber disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest. The address for Mr. Barber is c/o TA Associates, Inc., High Street Tower, Suite 2500, 125 High Street, Boston, MA 02110.
(7) Mr. Friedman is Senior Managing Member of Friedman Fleischer & Lowe GP, LLC, which is the general partner of Friedman Fleischer & Lowe Capital Partners, LP and FFL Executive Partners, LP. Accordingly, Mr. Friedman may be deemed to beneficially own shares owned by the Friedman Fleischer & Lowe Funds. Mr. Friedman disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest. The address for Mr. Friedman is c/o Friedman Fleischer & Lowe, LLC, One Maritime Plaza, 10th Floor, San Francisco, CA 94111.
(8) Mr. Masto is Managing Member of Friedman Fleischer & Lowe GP, LLC, which is the general partner of Friedman Fleischer & Lowe Capital Partners, LP and FFL Executive Partners, LP. Accordingly, Mr. Masto may be deemed to beneficially own shares owned by the Friedman Fleischer & Lowe Funds. Mr. Masto disclaims beneficial ownership of any such shares in which he does not have a pecuniary interest. The address for Mr. Masto is c/o Friedman Fleischer & Lowe, LLC, One Maritime Plaza, 10th Floor, San Francisco, CA 94111.
(9) The address for Mr. Doyle is c/o Connell Limited Partnership, One International Place, Fort Hill Square, Boston, MA 02110.
(10) Includes 3,120,815 shares of common stock issuable upon exercise of outstanding and currently exercisable warrants and 52,500 shares of common stock issuable upon exercise of outstanding and currently exercisable options.
(11)

Assumes the underwriters’ over-allotment option is not exercised. In the event that the underwriters’ over-allotment option is exercised in full, the following persons named in the table above will sell the additional number of shares set forth after their respective names: TA Associates Funds (1,485,172), Friedman Fleischer & Lowe Funds (727,296), Gleacher Mezzanine Funds (82,840), Antares Capital Corp. (3,733), Robert Hoeller (389), Alain Falourd (3,734), George Khouri (598), Frank Passante (75), Keansburg Investments Limited (2,528), Jean H. Downey Living Trust (4,664), Lynda Davey and Alan Schiffres, JTWROS (224), David Wright (283), John Paul Pucek (139), Thomas Jameson (1,337), Robert W. and

 

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Mary M. Mulcahy, JTWROS (269), Robert B. Trussell and Martha O. Trussell, Tenants in Common (125,000), H. Thomas Bryant (51,476), David C. Fogg (102,543) and Dale E. Williams (26,250). In the event that the underwriters’ over-allotment option is exercised in full, the following additional persons who are employees of our company but are not named in the table above will sell the number of shares set forth after their respective names: Joel Guerin (13,583), Christian Magnusson (23,204), Dany Sfeir (26,250), Lars Hansen (11,916), Paer Roland Siljedahl (11,860), Paul Key (5,250), Mathias Ingvarsson (9,590), Jeffrey B. Johnson (21,000), Michael Smith (2,101), Kenneth Mitchell (9,079), Frank Henry (2,101), Jeffrey T. Lillich (526), Miguel Lorenzo Searl (8,569), Rick Peak (6,242), John Miller (3,806), Charles W. Tauchert (5,391), William H. Poche (2,626), Tom Dam Mikkelson (5,391), Jean Paul Palman (526), Richard D. Zander (4,987), Harald Stokkeland (4,725), Simon Walsh (4,725), Jason P. Broyles (4,725), Johnny Cagle (3,151) and Beat Lucy (2,626).

 

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CERTAIN RELATIONSHIPS AND RELATED

PARTY TRANSACTIONS

 

Contribution Agreement

 

In October 2002, Tempur-Pedic International entered into a contribution agreement with a number of parties, including the TA Associates Funds and the Friedman Fleischer & Lowe Funds. In exchange for shares of our Class A common stock, Series A preferred stock or Class B-1 common stock, these parties pledged to deliver to Tempur-Pedic International common stock of Tempur World, cash or promissory notes, respectively. The agreement also allowed for additional investments to be made by certain accredited investors in our Class A common stock or Series A preferred stock.

 

In November 2002, stockholder notes were executed pursuant to the contribution agreement by four investors in exchange for shares of Class B-1 voting common stock. Robert B. Trussell, Jr. executed a note in the principal amount of $40,273.49; David C. Fogg executed a note in the principal amount of $24,933.10;  H. Thomas Bryant executed a note in the principal amount of $11,776.20; and Jeffrey P. Heath executed a note in the principal amount of $23,017.21. Each note matures on November 1, 2012 and accrues interest at 5% per annum. We had been granted a security interest in all shares issued under the notes, and any other shares of capital stock of our company acquired by these investors due to a stock dividend, distribution or recapitalization with respect to the pledged shares were to be delivered and pledged to us. Shares pledged under the notes were not to be sold, assigned or transferred, but holders thereof had voting rights and were to retain any issued dividends with respect thereto while the notes were not in default. As part of his separation agreement, Mr. Heath’s note was forgiven and his pledge was released. Messrs. Trussell and Fogg repaid their notes in full on September 3, 2003. Mr. Bryant repaid his note in full on September 4, 2003.

 

In October 2003, in order to resolve certain issues relating to the treatment of options of Tempur World, Inc. that were terminated in connection with the acquisition by Tempur-Pedic International in November 2002 of Tempur World, we made one-time payments of $136,596 to Mr. Trussell, $60,709 to Mr. Bryant, $83,475 to Mr. Fogg and $75,886 to Mr. Heath. We also made payments totaling approximately $210,000 to certain other former stockholders of Tempur World.

 

In connection with the transactions contemplated by the contribution agreement, TA Associates received a $1.5 million transaction fee and a $700,000 facility fee in connection with the mezzanine financing entered into in November 2002, and FFL Partners received a $1.0 million transaction fee and expense reimbursement of approximately $175,000. With respect to the $50.0 million mezzanine facility entered into in November 2002, affiliates of TA Associates provided $35.0 million of this funding. This facility was repaid in full as part of the recapitalization in August 2003.

 

Stockholder Agreements

 

In November 2002, Tempur-Pedic International and certain of our stockholders, including the TA Associates Funds and the Friedman Fleischer & Lowe Funds, entered into a stockholder agreement. The stockholder agreement, among other things, (i) grants tag-along rights (rights to participate on a pro rata basis in sales of stock by other stockholders) on certain transfers of shares of our capital stock; (ii) grants Tempur-Pedic International a first right of purchase on any proposed transfer of shares of Tempur-Pedic International’s capital stock held by stockholders other than the management investors and the TA Associates Funds and Friedman Fleischer & Lowe Funds; (iii) grants Tempur-Pedic International a first right of purchase on any proposed transfer of warrant securities held by mezzanine stockholders, including certain of the TA Associates Funds; (iv) requires stockholders to consent to a sale of Tempur-Pedic International to an independent third party if such sale is approved by Tempur-Pedic International’s board of directors and holders of more than 50% of the number of then issued and outstanding shares of Class B common stock included in the securities issued to our sponsor investors including certain of the TA Associates Funds and the Friedman Fleischer & Lowe Funds; (v) requires each stockholder to vote all of Tempur-Pedic International’s voting securities held by them and to cause to be

 

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elected to Tempur-Pedic International’s board of directors (x) four designees, one of whom will serve as chairman, of the holders of a majority of Tempur-Pedic International’s outstanding Class B common stock issued to Tempur-Pedic International’s sponsor investors, the Friedman Fleischer & Lowe Funds and certain of the TA Associates Funds, and (y) one management employee, who shall be Robert B. Trussell, Jr. as long as he is an employee; (vi) grants an irrevocable proxy to Tempur-Pedic International’s board of directors in the event of a breach of such voting requirements; and (vii) grants all sponsor and mezzanine investors, and all stockholders owning more than 1% of Tempur-Pedic International’s outstanding Class B common stock, pre-emptive rights to purchase a pro-rata portion of additional shares in certain cases when additional shares are issued. The stockholder agreement provides that it will terminate upon consummation of the offering.

 

In November 2002, Tempur-Pedic International also entered into a Series A preferred stock stockholder agreement with the TA Associates Funds and the Friedman Fleischer & Lowe Funds, which together own a majority of our outstanding Series A preferred stock and would own a majority of Tempur-Pedic International’s outstanding Class B-1 common stock if all shares of Series A preferred stock were converted. This agreement, among other things, (i) restricts both the TA Associates Funds and the Friedman Fleischer & Lowe Funds from transfers of securities that would result in their respective set of funds’ loss of majority ownership of the Class B common stock either issued to them or which would be issued to them upon conversion of their Series A preferred stock, unless they receive prior written consent from the majority holders of the other set of funds; (ii) requires that each of the parties vote all of Tempur-Pedic International’s voting securities held by them and to cause to be elected to Tempur-Pedic International’s board of directors two designees of the majority holders of the TA Associates Funds, one of whom will serve as chairman, two designees of the majority holders of the Friedman Fleischer & Lowe Funds and one management employee who shall be Robert B. Trussell, Jr. as long as he is an employee of our company; and (iii) grants an irrevocable proxy from each Friedman Fleischer & Lowe stockholder to the majority holders of the TA Associates Funds and an irrevocable proxy from each TA Associates stockholder to the majority holders of the Friedman Fleischer & Lowe Funds in the event of a breach of such voting requirements. The Series A preferred stock stockholder agreement provides that it will terminate upon consummation of the offering.

 

Registration Rights Agreement

 

On November 1, 2002, Tempur-Pedic International and certain of its stockholders, including the TA Associates Funds and the Friedman Fleischer & Lowe Funds, entered into a registration rights agreement. Under this agreement, holders of 10% of Tempur-Pedic International’s registrable securities, as defined in the registration rights agreement, and certain stockholders who held notes with an aggregate unpaid principal balance of $15.0 million have the right, subject to certain conditions, to require Tempur-Pedic International to register any or all of their shares under the Securities Act at Tempur-Pedic International’s expense. In addition, all holders of registrable securities are entitled to request the inclusion of any of their shares in any registration statement at Tempur-Pedic International’s expense whenever we propose to register any of Tempur-Pedic International’s securities under the Securities Act. In connection with all such registrations, Tempur-Pedic International has agreed to indemnify all holders of registrable securities against certain liabilities, including liabilities under the Securities Act. All holders requesting or joining in a registration have agreed to indemnify Tempur-Pedic International against certain liabilities. As of November 15, 2003, parties to the registration rights agreement held 86,558,215 shares of our common stock and warrants to purchase 4,458,305 shares of our common stock. Options to purchase 6,533,720 shares of our common stock were outstanding at this time, which when exercised, will cause the holders thereof to become parties to the registration rights agreement. All of the 12,500,000 shares of common stock being sold in this offering by selling stockholders are held by parties to the registration rights agreement. After the offering, parties to the registration rights agreement will hold 78,516,520 shares of our common stock. Options to purchase 6,533,720 shares of our common stock will be outstanding after the offering, which when exercised, will cause the holders thereof to become parties to the registration rights agreement. Although we have no current plans to file another registration statement to register these shares, certain of these holders have demand registration rights under the registration rights agreement as described above.

 

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Special Bonuses

 

In August 2003, the board of directors of Tempur-Pedic International authorized the payment of special bonuses to Robert B. Trussell, Jr., David C. Fogg and H. Thomas Bryant of $41,900, $25,900 and $12,300, respectively.

 

Senior Subordinated Notes

 

In connection with the issuance and sale by Tempur-Pedic, Inc. and Tempur Production USA, Inc. of $150,000,000 aggregate principal amount of senior subordinated notes, High Street Partners L.P., an affiliate of TA Associates, Inc., purchased $ 3.0 million aggregate principal amount of senior subordinated notes from the initial purchasers in that offering. High Street Partners L.P. continues to hold these senior subordinated notes.

 

 

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DESCRIPTION OF CAPITAL STOCK

 

General

 

Upon the closing of this offering, our board of directors will be authorized to issue 300,000,000 shares of common stock, par value $0.01 per share, of which 97,266,520 shares will be issued and outstanding, and 10,000,000 shares of undesignated preferred stock, $0.01 par value per share, of which no shares will be issued or outstanding.

 

The following summary description of our capital stock, certificate of incorporation, and by-laws assumes the filing as of the closing of the offering of our certificate of incorporation and the adoption of our by-laws.

 

Common Stock

 

As of November 15, 2003, there were 91,016,520 shares of our common stock outstanding, held of record by 74 stockholders, after giving effect to the automatic conversion of all of our outstanding shares of our convertible preferred stock and all outstanding classes of our common stock and the mandatory exercise of our outstanding warrants upon the completion of this offering.

 

Upon the closing of this offering, our board of directors will be authorized to issue up to 300,000,000 shares of common stock, $0.01 par value per share. Holders of our common stock are entitled to one vote per share for each share held of record on all matters to be voted upon by the stockholders. Accordingly, holders of a majority of the shares of our common stock entitled to vote in any election of directors may elect all of the directors standing for election. Subject to preferences that may be applicable to any outstanding preferred stock, holders of our common stock are entitled to receive ratably such dividends as may be declared from time to time by our board of directors out of funds legally available for that purpose. In the event of our liquidation, dissolution, or winding up, the holders of our common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding. The holders of our common stock have no cumulative voting rights, preemptive or conversion rights or other subscription rights. There are no redemption or sinking fund provisions applicable to our common stock. The outstanding shares of our common stock are, and the shares offered in this offering will be, when issued and paid for, fully paid and non-assessable.

 

Preferred Stock

 

Upon the closing of this offering, our board of directors will be authorized to issue up to 10,000,000 shares of preferred stock, $0.01 par value per share. The board of directors will be authorized, subject to any limitations prescribed by law, without further vote or action by the stockholders, to issue from time to time shares of preferred stock in one or more series. Each such series of preferred stock shall have such number of shares, designations, preferences, voting powers, qualifications, and special or relative rights or privileges as shall be determined by the board of directors, which may include, among others, dividend rights, voting rights, redemption and sinking fund provisions, liquidation preferences, conversion rights and preemptive rights.

 

The rights of the holders of our common stock will be subject to, and may be adversely affected by, the rights of holders of any preferred stock that may be issued in the future. Such rights may include voting and conversion rights which could adversely affect the holders of our common stock. Satisfaction of any dividend preferences of outstanding preferred stock would reduce the amount of funds available, if any, for the payment of dividends on common stock. Holders of our preferred stock would typically be entitled to receive a preference payment in the event of our liquidation, dissolution or winding up before any payment is made to the holders of common stock. Additionally, the issuance of our preferred stock could have the effect of making it more difficult for a third party to acquire, or of discouraging a third party from attempting to acquire, a majority of our outstanding voting stock. Upon the closing of the offering, there will be no shares of preferred stock outstanding, and we have no present plans to issue any shares of the preferred stock after this offering.

 

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Registration Rights

 

On November 1, 2002, we and certain of our stockholders, including the TA Associates Funds and the Friedman Fleischer & Lowe Funds, entered into a registration rights agreement. Under this agreement, holders of 10% of our registrable securities, as defined in the registration rights agreement, and certain stockholders who held notes with an aggregate unpaid principal balance of $15.0 million have the right, subject to certain conditions, to require us to register any or all of their shares under the Securities Act at our expense. In addition, all holders of registrable securities are entitled to request the inclusion of any of their shares in any registration statement at our expense whenever we propose to register any of our securities under the Securities Act. In connection with all such registrations, we have agreed to indemnify all holders of registrable securities against certain liabilities, including liabilities under the Securities Act. All holders requesting or joining in a registration have agreed to indemnify us against certain liabilities. As of November 15, 2003, parties to the registration rights agreement held 86,558,215 shares of our common stock and warrants to purchase 4,458,305 shares of our common stock. Options to purchase 6,533,720 shares of our common stock were outstanding at this time, which when exercised, will cause the holders thereof to become parties to the registration rights agreement. All of the 12,500,000 shares of common stock being sold in this offering by selling stockholders are held by parties to the registration rights agreement. After the offering, parties to the registration rights agreement will hold 78,516,520 shares of our common stock. Options to purchase 6,533,720 shares of our common stock will be outstanding after the offering, which when exercised, will cause the holders thereof to become parties to the registration rights agreement. Although we have no current plans to file another registration statement to register these shares, certain of these holders have demand registration rights under the registration rights agreement as described above.

 

Anti-takeover effects of Delaware law and certain charter and by-law provisions

 

Upon completion of this offering, we will not be subject to the provisions of Section 203 of the Delaware General Corporation Law. Subject to certain exceptions, Section 203 of the Delaware General Corporation Law prohibits a publicly-held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years after the date of the transaction in which the person became an interested stockholder, unless the interested stockholder attained such status with approval of our board of directors or unless the business combination is approved in a prescribed manner. A “business combination” includes certain mergers, asset sales or other transactions resulting in a financial benefit to the interested stockholder. Subject to various exceptions, an “interested stockholder” is a person who, together with his or her affiliates and associates, owns, or within the past three years did own, 15% or more of the corporation’s voting stock. The statute is intended to prohibit or delay mergers or other takeover or change in control attempts. Although we have elected out of the statute’s provisions, we could elect to be subject to Section 203 in the future.

 

Some provisions in our certificate of incorporation and by-laws may be deemed to have an anti-takeover effect and may delay, defer, or prevent a tender offer or takeover attempt that a stockholder might deem to be in his or her best interest. The existence of these provisions could limit the price that investors might be willing to pay in the future for shares of our common stock. These provisions include:

 

Stockholder action; special meeting of stockholders.    Our certificate of incorporation and by-laws provide that stockholders may not take action by written consent, but only at a duly called annual or special meeting of the stockholders, and that special meetings of our stockholders may be called only the chairman of the board of directors, the president, or a majority of the board of directors. Thus, without approval by the chairman of the board of directors, the president or a majority of the board of directors, stockholders may take no action between meetings. These provisions may have the effect of delaying until the next annual stockholders’ meeting stockholder actions that are favored by the holders of a majority of our outstanding voting securities, including actions to remove directors. These provisions may also discourage another person or entity from making a tender offer for our common stock, because such person or entity, even if it acquired all or a majority of our outstanding voting securities, would be able to take action as a stockholder (such as electing new directors or approving a merger) only at a duly called stockholders’ meeting, and not by written consent.

 

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Advance notice requirements for stockholder proposals and director nominations.    Our certificate of incorporation and by-laws provide that a stockholder seeking to bring business before an annual meeting of stockholders, or to nominate candidates for election as directors at an annual meeting of stockholders, provide timely notice of this intention in writing. To be timely, a stockholder’s notice must be delivered to our secretary not less than 120 nor more than 150 days prior to the first anniversary of the date of our proxy statement delivered to stockholders in connection with the preceding year’s annual meeting, or if the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary, or if no proxy statement was delivered to our stockholders in connection with the preceding year’s annual meeting, such notice must be delivered not earlier than 90 days prior to such annual meeting and not later than the later of (i) 60 days prior to the annual meeting or (ii) 10 days following the date on which public announcement of the date of such annual meeting was made. With respect to special meetings of stockholders, such notice must be delivered to our secretary not more than 90 days prior to such meeting and not later than the later of (i) 60 days prior to such meeting or (ii) 10 days following the date on which public announcement of the date of such meeting is first made. The notice must contain, among other things, certain information about the stockholder delivering the notice and, as applicable, background information about each nominee or a description of the proposed business to be brought before the meeting. These provisions may preclude stockholders from bringing matters before an annual meeting of stockholders or from making nominations for directors at an annual or special meeting of stockholders.

 

Authorized but unissued shares.    The authorized but unissued shares of common stock and preferred stock are available for future issuance without stockholder approval, subject to any limitations imposed by the New York Stock Exchange. These additional shares may be utilized for a variety of corporate acquisitions and employee benefit plans. The existence of authorized but unissued and unreserved common stock and preferred stock could make more difficult or discourage an attempt to obtain control of us by means of a proxy contest, tender offer, merger, or otherwise.

 

Super-majority voting.    Delaware law provides generally that the affirmative vote of a majority of the shares entitled to vote on any matter is required to amend a corporation’s certificate of incorporation or by-laws, unless a corporation’s certificate of incorporation or by-laws require a greater percentage. Provisions in our certificate of incorporation require the affirmative vote of the holders of at least 67% of our authorized voting stock to amend or repeal certain provisions of our certificate of incorporation which include, but are not limited to provisions which would reduce or eliminate the number of authorized common or preferred shares and all indemnification provisions. Such 67% stockholder vote would in either case be in addition to any separate class vote that might in the future be required pursuant to the terms of any preferred stock at the time any such amendments are submitted to stockholders. Our by-laws may also be amended or repealed by a majority vote of our board of directors.

 

Board discretion in considering certain offers.    Our certificate of incorporation empowers our board of directors, when considering a tender offer or merger or acquisition proposal, to take into account factors in addition to potential economic benefit to stockholders. Such factors may include (i) comparison of the proposed consideration to be received by stockholders in relation to the then-current market price of our capital stock, our estimated current value in a freely negotiated transaction, and our estimated future value as an independent entity, and (ii) the impact of such a transaction on our employees, suppliers, and customers and its effect on the communities in which we operate.

 

Limitation of liability.    Our certificate of incorporation contains certain provisions permitted under Delaware General Corporation Law relating to the liability of directors. These provisions eliminate a director’s personal liability for monetary damages resulting from a breach of fiduciary duty, except in certain circumstances involving certain wrongful acts, such as the breach of a director’s duty of loyalty or acts or omissions that involve intentional misconduct or a knowing violation of law. These provisions do not limit or eliminate our rights or the rights of any stockholder to seek non-monetary relief, such as an injunction or rescission, in the event of a breach of a director’s fiduciary duty. These provisions will not alter a director’s liability under federal securities laws. Our certificate of incorporation and by-laws also contain provisions indemnifying our directors and officers to the fullest extent permitted by the Delaware General Corporation Law. We believe that these provisions will assist us in attracting and retaining qualified individuals to serve as directors.

 

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Transfer agent and registrar

 

Upon the closing of this offering, the transfer agent and registrar for the common stock will be EquiServe LLC.

 

New York Stock Exchange listing

 

We have applied to have our common stock listed on the New York Stock Exchange under the symbol “TPX.”