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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[x] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 27, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from __________ to __________
Commission file number 333-76723
---------
SIMMONS COMPANY
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 06-1007444
- ------------------------------------ -----------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification No.)
incorporation or organization)
One Concourse Parkway, Suite 800, Atlanta, Georgia 30328-5369
- -------------------------------------------------- ---------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (770) 512-7700
---------------------
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [ ] No
Indicate by check mark whether the Registrant is an accelerated filer
(as defined in Exchange Act Rule 12b-2). [ ] Yes [X] No
The number of shares of the registrant's common stock outstanding as of
November 10, 2003 was 3,196.
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Simmons Company and Subsidiaries
Condensed Consolidated Statements of Operations
(in thousands)
(Unaudited)
Quarter Ended Nine Months Ended
------------- -----------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2003 2002 2003 2002
---- ---- ---- ----
(Restated)* (Restated)*
Net sales $ 217,924 $ 191,410 $ 603,838 $ 541,670
Cost of products sold 113,433 99,234 316,404 280,855
--------- --------- --------- ---------
Gross profit 104,491 92,176 287,434 260,815
Operating expenses:
Selling, general and administrative expenses 74,243 67,388 211,682 197,472
Non-cash variable stock compensation expense 4,697 2,076 15,118 11,561
Amortization of intangibles 71 60 241 1,178
Other 65 - 887 -
--------- --------- --------- ---------
79,076 69,524 227,928 210,211
--------- --------- --------- ---------
Operating income 25,415 22,652 59,506 50,604
Interest expense, net 6,161 6,769 18,154 21,030
Other expense, net 813 520 2,405 1,456
--------- --------- --------- ---------
Income before income taxes and
minority interest 18,441 15,363 38,947 28,118
Income tax expense 1,854 6,238 9,736 11,605
--------- --------- --------- ---------
Income before minority interest 16,587 9,125 29,211 16,513
Minority interest in loss - (17) - (87)
--------- --------- --------- ---------
Net income 16,587 9,142 29,211 16,600
Other comprehensive income:
Foreign currency translation adjustment (3) (50) 222 (28)
--------- --------- --------- ---------
Comprehensive income $ 16,584 $ 9,092 $ 29,433 $ 16,572
========= ========= ========= =========
* Restated for the acquisition of an entity under common control (Note 3).
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
Simmons Company and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands)
(Unaudited)
Sept. 27, Dec. 28,
2003 2002*
---- -----
(Restated)
ASSETS
Current assets:
Cash and cash equivalents $ 2,028 $ 7,108
Accounts receivable, less allowances for doubtful
receivables, discounts, and returns of $5,378 and
$5,245, respectively 83,719 67,192
Inventories 23,260 21,049
Deferred income taxes 1,841 3,264
Other current assets 22,857 20,781
Assets of subsidiaries held for sale 38,679 36,617
-------- --------
Total current assets 172,384 156,011
-------- --------
Property, plant and equipment, net 31,063 37,673
Goodwill, net 165,519 165,519
Intangible assets, net 8,355 6,711
Deferred income taxes 23,049 24,505
Other assets 23,597 16,678
-------- --------
$423,967 $407,097
======== ========
* Restated for the acquisition of an entity under common control (Note 3).
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
Simmons Company and Subsidiaries
Condensed Consolidated Balance Sheets
(in thousands)
(Unaudited)
Sept. 27, Dec. 28,
2003 2002*
---- -----
(Restated)
LIABILITIES AND STOCKHOLDER'S DEFICIT
Current liabilities:
Current maturities of long-term debt $ 935 $ 19,039
Accounts payable 39,749 38,711
Accrued wages and benefits 18,954 18,051
Accrued advertising and incentives 23,585 18,310
Accrued interest 1,391 5,084
Other accrued expenses 10,283 11,713
Liabilities of subsidiaries held for sale 16,300 13,239
--------- ---------
Total current liabilities 111,197 124,147
--------- ---------
Non-current liabilities:
Long-term debt 229,672 249,400
Accrued stock compensation 39,796 26,778
Other 13,703 14,583
--------- ---------
Total liabilities 394,368 414,908
--------- ---------
Commitments and contingencies
Redemption obligation - ESOP 76,380 61,218
Common stockholder's deficit:
Common stock, $.01 par value; 5,000 shares
authorized; 3,196 issued and outstanding 1 1
Additional paid-in-capital - 319
Accumulated deficit (46,860) (69,205)
Accumulated other comprehensive income (loss) 78 (144)
--------- ---------
Total common stockholder's deficit (46,781) (69,029)
--------- ---------
$ 423,967 $ 407,097
========= =========
* Restated for the acquisition of an entity under common control (Note 3).
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
Simmons Company and Subsidiaries
Condensed Consolidated Statements of Cash Flows
(in thousands)
(Unaudited)
Nine Months Ended
----------------------------------
Sept. 27, Sept. 28,
2003 2002
---- ----
(Restated)*
Cash flows from operating activities:
Net income $ 29,211 $ 16,600
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 16,814 14,291
Provision for bad debts 2,758 3,364
Provision for deferred income taxes 2,880 10,565
Non-cash interest expense 1,913 2,173
Non-cash variable stock option compensation expense 15,118 11,561
Other, net (249) (87)
Net changes in operating assets and liabilities:
Accounts receivable (19,820) (13,499)
Inventories (2,982) 4,751
Other current assets (7,727) (8,345)
Accounts payable 691 5,152
Accrued liabilities 2,442 5,913
Other, net (6,475) 462
-------- --------
Net cash provided by operating activities 34,574 52,901
-------- --------
Cash flows from investing activities:
Purchases of property, plant and equipment (4,857) (3,904)
Proceeds from disposals of property, plant and equipment, net 38 181
Acquisition and development of intellectual properties (1,720) (2,963)
-------- --------
Net cash used in investing activities (6,539) (6,686)
-------- --------
Cash flows from financing activities:
Repurchase of SC Holdings, Inc. minority interest and payment of SC
Holdings, Inc. debt (18,653) (1,750)
Distributions to Holdings (2,478) (3,282)
Payments of Senior Credit Facility, net (12,005) (41,548)
Payments of other long-term debt, net (201) (561)
-------- --------
Net cash used in financing activities (33,337) (47,141)
-------- --------
Net effect of exchange rate changes on cash 222 (40)
-------- --------
Change in cash and cash equivalents (5,080) (966)
Cash and cash equivalents, beginning of period 7,108 3,264
-------- --------
Cash and cash equivalents, end of period $ 2,028 $ 2,298
======== ========
* Restated for the acquisition of an entity under common control (Note 3).
The accompanying notes are an integral part of these condensed consolidated
financial statements.
5
Simmons Company and Subsidiaries
Consolidated Statements of Changes in Common Stockholder's Deficit
(in thousands, except share amounts)
Accumulated
Additional Other Total
Common Common Paid-In Accumulated Comprehensive Stockholder's
Shares Stock Capital Deficit (Loss) Income Deficit
--------- ---------- ----------- -------------- ---------------- --------------
Balance at December 29, 2001* 3,196 $ 1 $ 319 $(50,697) $ (125) $(50,502)
(Note 9)
Net income - - - 2,719 - 2,719
Other comprehensive loss:
Change in foreign currency
translation - - - - (19) (19)
-------- -------- --------
Comprehensive income - - - 2,719 (19) 2,700
Increase in redemption
obligation - ESOP based on
fair market value - - - (17,139) - (17,139)
Distributions to Holdings - - - (4,088) - (4,088)
----- -------- ------- -------- -------- --------
Balance at December 28, 2002* 3,196 1 319 (69,205) (144) (69,029)
Net income - - - 29,211 - 29,211
Other comprehensive income:
Change in foreign currency
translation - - - - 222 222
-------- -------- --------
Comprehensive income - - - 29,211 222 29,443
Contribution of debt to an
affiliate to SC Holdings, Inc. - - 7,916 - - 7,916
Acquisition of SC Holdings,
Inc. minority interest - - (25) - - (25)
Increase in redemption
obligation - ESOP based on
fair market value - - (8,749) (6,413) - (15,162)
Capital contribution from
Holdings - - 2,564 - - 2,564
Distributions to Holdings - - (2,025) (453) - (2,478)
----- -------- ------- -------- -------- --------
Balance at September 27,
2003 (unaudited) 3,196 $ 1 $ - $(46,860) $ 78 $(46,781)
===== ======== ======= ======== ======== ========
* Restated for the acquisition of an entity under common control (Note 3).
The accompanying notes are an integral part of these condensed consolidated
financial statements.
6
Simmons Company and Subsidiaries
Notes to Condensed Consolidated Financial Statements
(Unaudited)
1. Basis of Presentation
For purposes of this report the "Company" refers to Simmons Company and
its subsidiaries, collectively. The Condensed Consolidated Financial Statements
of the Company have been prepared in accordance with accounting principles
generally accepted in the United States of America for interim financial
information and the rules and regulations of the Securities and Exchange
Commission (the "Commission"). The accompanying unaudited condensed consolidated
financial statements contain all adjustments, which, in the opinion of
management, are necessary to present fairly the financial position of the
Company as of September 27, 2003, and its results of operations and cash flows
for the periods presented herein. All adjustments in the periods presented
herein are normal and recurring in nature unless otherwise disclosed. These
unaudited condensed consolidated financial statements should be read together
with the Company's Annual Report on Form 10-K for the year ended December 28,
2002 and the revised 2002 consolidated financial statements filed on Form 8-K/A
on September 16, 2003. Operating results for the period ended September 27,
2003, are not necessarily indicative of future results that may be expected for
the year ending December 27, 2003.
2. Sale of Simmons Holdings, Inc. ("Holdings")
Holdings, the parent of Simmons Company, working with its advisors, has
initiated an exploratory process to evaluate a potential change in the ownership
of Holdings. However, no assurances can be given that a proposed transaction or
transactions will be completed or will be completed on terms favorable to
Holdings. A sale of Holdings could have an impact on the recorded values of
certain assets and liabilities of the Company.
3. Business Combination
On February 28, 2003, the Company acquired the stock of SC Holdings,
Inc. ("Sleep Country") from a fund affiliated with Fenway Partners, Inc.
("Fenway") for approximately $18.4 million, plus additional contingent
consideration based upon future performance. Sleep Country is a leading mattress
retailer in the Pacific Northwest which currently operates 47 stores under the
Sleep Country USA and Mattress Gallery names. This acquisition was financed from
borrowings under the Company's Senior Credit Facility. Sleep Country used the
proceeds received to repay bank debt of $17.8 million and debt to an affiliate
of $0.6 million.
Because the Company and Sleep Country were controlled by affiliates of
Fenway at the time of the acquisition, the Company is required to account for
the acquisition as a transfer of assets within a group under common control.
Under this accounting methodology, the Company and Sleep Country are treated as
if they had been combined for accounting and financial reporting purposes for
the periods in which both entities were controlled by Fenway (from March 1,
2000). As a result, the Company's consolidated financial statements have been
restated for all periods prior to the business combination to reflect the
combined results of the Company
7
and Sleep Country as of the beginning of the earliest period presented. In
addition to combining the separate historical results of the Company and Sleep
Country, the consolidated financial statements include all adjustments necessary
to conform accounting methods and presentation, to the extent they were
different, and to eliminate significant intercompany transactions.
The Company filed under Form 8-K/A on September 16, 2003, revised
consolidated financial statements for the year ended December 28, 2002 to
restate fiscal years 2000, 2001 and 2002 to reflect the combined results of the
Company and Sleep Country.
Selected combining financial data for the nine months ended September
27, 2003 and September 28, 2002 are as follows:
September 27, 2003
- ----------------------------------------------------------------------------------------------------------------
Simmons
(in thousands) Company Sleep Country Adjustments Combined
------- ------------- ----------- --------
Net sales $571,680 $ 43,055 $ (10,897) $603,838
Net income 27,747 1,719 (255) 29,211
September 28, 2002
- ---------------------------------------------------------------------------------------------------------------
Simmons
(in thousands) Company Sleep Country Adjustments Combined
------- ------------- ----------- --------
Net sales $513,743 $ 36,662 $ (8,735) $541,670
Net income (loss) 18,031 (1,306) (125) 16,600
4. Assets/Liabilities Held For Sale
In April 2003, the Company, continuing its strategy to focus on the
wholesale bedding business, initiated a sales process of its retail operations
in one or more transactions. However, no assurances can be given that a
proposed transaction or transactions will be completed or will be completed on
terms favorable to the Company.
In accordance with the provisions of Statement of Financial Accounting
Standard ("SFAS") No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, the Company has reflected assets and liabilities for its
subsidiaries in its retail segment as held for sale in the consolidated balance
sheets. The Company expects to have significant continued involvement in the
revenue stream of the retail segment after a sales transaction is consummated.
Therefore, the retail segment's results of operations continue to be presented
in the Company's results of continuing operations.
8
The components of the assets and liabilities of subsidiaries held for
sale as of September 27, 2003 are as follows (amounts in thousands):
Assets Held for Sale
--------------------
Accounts receivable, net $ 1,857
Inventories 5,467
Other current assets 1,167
Property, plant and equipment, net 6,510
Goodwill, net 22,383
Intangible assets, net 367
Other assets 928
-------
Total assets held for sale $38,679
=======
Liabilities Held for Sale
-------------------------
Accounts payable $ 4,797
Other current liabilities 4,919
Other long-term liabilities 6,584
-------
Total liabilities held for sale $16,300
=======
5. Inventories
A summary of inventories follows (amounts in thousands):
Sept. 27, Dec. 28,
2003 2002
---- ----
Raw materials $12,436 $11,198
Work in progress 1,108 1,240
Finished goods 9,716 8,611
------- -------
$23,260 $21,049
======= =======
6. Warranty Liability
The Company's wholesale segment warranty policy provides a 10-year
non-prorated warranty service period on all first quality products, except for
certain products for the hospitality industry, which have varying non-prorated
warranty periods generally ranging from five to ten years. The Company's policy
is to accrue the estimated costs of warranty coverage at the time the sale is
recorded. Accrued warranties totaled $3.9 million and $3.4 million,
respectively, as of September 27, 2003 and December 28, 2002. The following
table presents a reconciliation of the Company's warranty liability at September
27, 2003 (amounts in thousands):
9
Warranty
Liability
---------------
Balance at December 28, 2002 $3,434
2003 warranty provisions 3,242
2003 warranty settlements (2,791)
------
Balance at September 27, 2003 $3,885
======
7. Long-Term Debt
A summary of long-term debt follows (amounts in thousands):
Sept. 27, Dec. 28,
2003 2002
---- ----
Senior Credit Agreement:
Tranche A Term Loan $ - $ 14,500
-------- --------
Tranche B Term Loan 25,000 42,505
Tranche C Term Loan 39,006 19,006
-------- --------
Total Senior Credit Facility 64,006 76,011
Industrial Revenue Bonds, 7.00%, due 2017 9,700 9,700
Industrial Revenue Bonds, 4.52%, due 2016 4,200 4,200
Banco Santander Loan, 3.91% 2,151 2,329
Sleep Country Senior Credit Facility:
Revolving Loan - 1,500
Term Loan - 16,500
-------- --------
Total Sleep Country Senior Credit Facility - 18,000
10.25% Series Subordinated Notes, due 2009 150,000 150,000
Other, including capital lease obligations 550 134
Sleep Country Debt to an Affiliate:
Note Payable to an Affiliate - 3,000
Bridge Loan - net of original issue discount - 1,000
Affiliate Term Loan I - 2,123
Affiliate Term Loan II - net of original issue
discount - 1,942
Total Sleep Country Debt to an Affiliate - 8,065
-------- --------
230,607 268,439
Less current portion (935) (19,039)
-------- --------
$229,672 $249,400
======== ========
The 10.25% Series B Senior Subordinated Notes ("Notes") bear interest
at the rate of 10.25% per annum and are payable semi-annually in cash in arrears
on March 15 and September 15. The Notes are subordinated in right of payment to
all existing and future senior indebtedness of the Company.
The Notes are redeemable at the option of the Company on or after March
15, 2004 at prices decreasing from 105.125% of the principal amount thereof to
par on March 15, 2007 and thereafter. The Company is required to redeem the
outstanding notes based upon certain events
10
as described in the indenture for the Notes. If the Notes are redeemed prior to
March 15, 2004 in connection with a sale of Holdings (see Note 2), a premium
above the recorded value of the Notes may have to be paid.
The indenture for the Notes requires the Company to comply with certain
restrictive covenants, including a restriction on dividends and limitations on
the incurrence of indebtedness, certain payments and distributions, and sales of
the Company's assets and stock.
The Notes are fully and unconditionally guaranteed on an unsecured,
senior subordinated basis by all of the Company's active domestic subsidiaries.
Exclusive of the allocation of the debt and related interest of the Company, the
total sales, total assets, cash flow from operations, income before income
taxes, and stockholder's equity of the three active non-guarantor international
subsidiaries combined was $7.9 million, $9.2 million, $1.0 million, $0.3
million, and $4.5 million, respectively, as of and for the nine months ended
September 27, 2003.
On June 6, 2003, the Company entered into a Joinder Agreement which
supplements its Senior Credit Facility whereby an additional $20.0 million was
borrowed under the Tranche C Term Loan. The proceeds from this additional loan
were utilized to repay borrowings under the Revolving Loan Facility.
The Senior Credit Facility, as supplemented, provides for loans of up
to $124.0 million, consisting of a Term Loan Facility of $64.0 million and a
Revolving Loan Facility of $60.0 million. The Company's indebtedness under the
Senior Credit Facility bears interest at a floating rate, is guaranteed by
Holdings, and all of our active domestic subsidiaries, and is collateralized by
substantially all of the Company's assets.
Borrowings under the Senior Credit Facility bear interest at our choice
of LIBOR or Prime plus the following applicable interest rate margins as
follows:
LIBOR Prime
--------- ----------
Revolving Loan Facility 2.00% 1.00%
Tranche A Term Loan 2.00% 1.00%
Tranche B Term Loan 3.25% 2.25%
Tranche C Term Loan 3.50% 2.50%
The weighted average interest rates per annum in effect as of September
27, 2003 for the Tranche B term and Tranche C term loans were 5.10% and 4.75%,
respectively.
The Company is exposed to market risk from changes in interest rates.
In order to address this risk, the Company has developed and implemented a
policy to utilize six-month LIBOR contracts to minimize the impact of near term
LIBOR base rate increases. The Company elected to set its interest rate at the
six-month LIBOR rate for approximately $60.0 million of the Term Loan Facility,
which fixed the LIBOR base rate at 1.23% through November 27, 2003 for
approximately 85% of floating rate debt outstanding as of September 27, 2003.
In connection with the acquisition of Sleep Country by the Company,
Sleep Country used a portion of the $18.4 million proceeds received to repay its
outstanding bank debt at
11
February 28, 2003 of $17.8 million. Additionally, $0.6 million of proceeds
received were utilized to repay debt to an affiliate. The remaining $7.7 million
balance of Sleep Country debt to an affiliate at February 28, 2003 was
contributed to Sleep Country paid-in capital.
As of September 27, 2003, the amount under the Revolving Credit
Facility that was available to be drawn was $54.6 million, after giving effect
to $5.4 million reserved for the Company's reimbursement obligations with
respect to outstanding letters of credit. The remaining availability under the
Revolving Credit Facility may be utilized to meet the Company's current working
capital requirements, including issuance of stand-by and trade letters of
credit. The Company also may utilize the remaining availability under the
Revolving Credit Facility to fund distributions to Holdings, acquisitions and
capital expenditures.
The Senior Credit Facility requires the Company to maintain certain
financial ratios including fixed-charge, cash interest coverage and leverage
ratios. The Senior Credit Facility also contains covenants which, among other
things, limit capital expenditures, the incurrence of additional indebtedness,
investments, dividends, transactions with affiliates, asset sales, mergers and
consolidations, prepayments of other indebtedness, liens and encumbrances and
other matters customarily restricted in such agreements. As of September 27,
2003, the Company was in compliance with all of its financial covenants.
The Revolving Credit Facility expires on October 29, 2004. The Company
expects that it will have the ability to renew the existing facility or have the
ability to find new financing with comparable terms prior to expiration. The
failure of the Company to renew its existing arrangement or obtain new financing
could have an adverse affect on the Company's ability to fund operations.
Should a sale of Holdings occur (Note 2), balances payable under the
Senior Credit Facility will be repaid from proceeds of the sale.
8. Segment Information
The Company operates in two business segments, (1) wholesale bedding
and (2) retail bedding. The wholesale bedding segment consists of (i) the
manufacture, sale and distribution of premium branded bedding products; (ii) the
licensing of intellectual property to other manufacturers; and (iii) the sale of
product returns, off-quality product and excess inventory through retail outlet
stores. The retail bedding segment operates specialty sleep stores in
California, Washington and Oregon that sell to consumers principally premium
branded bedding products.
The Company announced in April 2003 that it is pursuing the possible
sale of its retail bedding segment and has classified the assets and liabilities
for this segment as held for sale in the accompanying balance sheets (see Note 4
for further explanation).
The Company evaluates performance and allocates resources based on net
sales, operating income and earnings before income taxes, depreciation and
amortization. The accounting policies of the reportable segments are the same as
those described in the summary of significant accounting policies as reported in
the Company's Annual Report on Form 10-K for
12
the year ended December 28, 2002. The following tables summarize the segment
information for the quarters and nine months ended September 27, 2003 and
September 28, 2002:
Quarter Ended September 27, 2003
- -------------------------------------------------------------------------------------------------
Wholesale
(in thousands) Bedding Retail Eliminations Totals
- -------------------------------------------------------------------------------------------------
Net sales $199,573 $ 27,252 $ (8,901) $217,924
Operating income 23,980 1,688 (253) 25,415
Income before income taxes and
minority interest 16,335 2,359 (253) 18,441
Adjusted EBITDA* 34,157 1,743 (253) 35,647
Depreciation and amortization expense 5,380 55 - 5,435
Segment assets 435,267 42,990 (54,290) 423,967
Expenditures for long-lived assets 3,281 1,073 - 4,354
Quarter Ended September 28, 2002
- -------------------------------------------------------------------------------------------------
Wholesale
(in thousands) Bedding Retail Eliminations Totals
- -------------------------------------------------------------------------------------------------
Net sales $179,183 $ 19,149 $ (6,922) $191,410
Operating income 23,045 72 (465) 22,652
Income (loss) before income taxes and
minority interest 17,878 (2,040) (475) 15,363
Adjusted EBITDA* 29,502 400 (703) 29,199
Depreciation and amortization expense 4,291 328 (238) 4,381
Segment assets 398,653 59,194 (34,547) 423,300
Expenditures for long-lived assets 1,788 19 - 1,807
13
Nine Months Ended September 27, 2003
- -------------------------------------------------------------------------------------------------
Wholesale
(in thousands) Bedding Retail Eliminations Totals
- -------------------------------------------------------------------------------------------------
Net sales $555,718 $ 72,902 $(24,782) $603,838
Operating income 57,924 2,266 (684) 59,506
Income before income taxes and
minority interest 39,007 624 (684) 38,947
Adjusted EBITDA* 90,149 2,997 (684) 92,462
Depreciation and amortization expense 16,269 545 - 16,814
Segment assets 435,267 42,990 (54,290) 423,967
Expenditures for long-lived assets 5,239 1,277 - 6,516
Nine Months Ended September 28, 2002
- -------------------------------------------------------------------------------------------------
Wholesale
(in thousands) Bedding Retail Eliminations Totals
- -------------------------------------------------------------------------------------------------
Net sales $505,657 $ 53,090 $(17,077) $541,670
Operating income (loss) 51,724 (346) (774) 50,604
Income (loss) before income taxes and
minority interest 32,603 (3,701) (784) 28,118
Adjusted EBITDA* 77,149 695 (1,012) 76,832
Depreciation and amortization expense 13,507 1,022 (238) 14,291
Segment assets 398,653 59,194 (34,547) 423,300
Expenditures for long-lived assets 6,423 444 - 6,867
* The table above sets forth EBITDA as defined in the Company's Senior
Credit Facility, which the Company refers to as "Adjusted EBITDA".
Adjusted EBITDA as presented above is a financial measure that is used
in the Company's Senior Credit Facility and is one measure used by the
Company in evaluating its operating performance. Adjusted EBITDA is
not a defined term under US GAAP and should not be considered as an
alternative to income from operations or net income as a measure of
operating results or cash flows as a measure of liquidity. Adjusted
EBITDA differs from the term "EBITDA" (earnings before interest
expense, income tax expense, and depreciation and amortization). In
addition to adjusting net income to exclude interest expense, income
tax expense, and depreciation and amortization, Adjusted EBITDA also
adjusts net income by excluding certain other items and expenses, such
as ESOP expenses, minority interest in losses, non-cash variable stock
compensation expense, interest income, transaction fees and management
fees paid to an affiliate. A reconciliation between net income to
Adjusted EBITDA is in the management's discussion and analysis of
financial condition and results of operations section. The Senior
Credit Facility requires, among other things, that the Company comply
with a specified debt to Adjusted EBITDA leverage ratio and a
specified Adjusted EBITDA to interest expense ratio for specified
periods. Borrowings under the Senior Credit Facility are a key source
of the Company's liquidity. The Company's ability to borrow under the
Senior Credit Facility is dependent on, among other things, its
compliance with the financial ratio covenants referred to in the
preceding paragraph. Failure to comply with these financial ratio
covenants would result in a violation of the Senior Credit Facility
and, absent a waiver or amendment from the lenders under such
agreement, permit lenders to accelerate all outstanding borrowings
under the Senior Credit Facility.
14
In the "Eliminations" column of each period presented above, the
segment assets consists primarily of investments in subsidiaries, receivables
and payables, and gross wholesale bedding profit in ending retail inventory. The
segment operating loss elimination consists of the removal of the wholesale
bedding profit in ending retail inventory.
9. Reverse Stock Split
On May 30, 2003, the Company's Board of Directors approved a
one-for-ten thousand reverse stock split of the Company's authorized and
outstanding Common Stock shares. The reverse stock split reduced the Company's
50,000,000 authorized Common Stock shares to 5,000 authorized Common Stock
shares and the Company's 31,964,452 outstanding Common Stock shares to 3,196
outstanding Common Stock shares. The par value of the Common Stock was not
affected by the reverse stock split and remains at $0.01 per share after the
reverse stock split. Consequently, the aggregate par value of the issued Common
Stock was reduced by reclassifying the par value amount of the reversed common
shares from Common Stock to Additional Paid-in-Capital for all periods
presented. All outstanding shares have been retroactively restated in the
accompanying consolidated financial statements for all periods presented to
reflect the reverse stock split.
10. Contingencies
On December 11, 2001, FDL, Inc. ("FDL"), one of the Company's
licensees, filed a lawsuit against the Company and United Sleep Products Denver,
Inc. ("United Sleep"), another Company licensee, alleging that the Company had
licensed overlapping trademark rights to both FDL and United Sleep. The Company
has denied the material allegations of FDL's initial and amended complaints and
has brought counterclaims against FDL for breach of the parties' license
agreement. The Company has also assumed the defense of and agreed to indemnify
United Sleep with respect to FDL's claims. On July 24, 2003, in response to a
joint motion by the parties, the Court vacated the current trial date of
November 3, 2003, and entered a temporary stay of discovery until the earlier of
October 15, 2003 and the date upon which the Court issues a written decision on
the Company's pending summary judgment motion filed April 10, 2003. On November
3, 2003, the Court entered an order to extend the foregoing stay until the
earlier of November 15, 2003 or the Court's issuance of a ruling on the pending
motion for summary judgment. The Court has not yet ruled on the Company's
summary judgment motion and has not set a new trial date. The Company intends to
maintain its vigorous defense of this lawsuit.
At September 27, 2003, Holdings had $23.0 million of outstanding Junior
Subordinated PIK Notes payable to an affiliate of Fenway, which bear interest at
17.5% per annum and are due on October 29, 2011. Holdings is unable to repay the
debt without receiving dividends from the Company. The Company's indenture for
the Notes and Senior Credit Facility restrict the payment of dividends by the
Company to Holdings.
15
11. Accounting Pronouncements
In November 2002, the EITF reached a consensus on EITF 02-16,
Accounting by a Reseller for Cash Consideration Received from a Vendor, which
addresses the accounting for cash consideration (which includes slotting fees,
cooperative advertising payments etc.) and rebates or refunds from a vendor that
are payable only if the merchant completes a specified cumulative level of
purchases or remains a customer of the vendor for a specified period of time.
Cash consideration should be treated as a reduction of the prices of the vendor
products or services and included as a reduction of cost of sales unless the
vendor receives, or will receive, an identifiable benefit in exchange for the
consideration. Rebates or refunds should be recognized as a reduction of the
cost of sales based on a systematic and rational allocation of the consideration
to be received. The adoption of this pronouncement did not have a material
impact on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 113
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 amendments set forth by SFAS 149 improve financial reporting
by requiring that contracts with comparable characteristics be accounted for
similarly. SFAS 149 is generally effective for contracts entered into or
modified after June 30, 2003. The guidance is to be applied prospectively. The
Company does not have any derivative instruments.
In May 2003, the FASB issued SFAS No. 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. This statement is effective for financial instruments
entered into or modified after May 31, 2003, and otherwise was effective at the
beginning of the Company's third quarter of fiscal 2003. The Company does not
have any financial instruments with characteristics of both liabilities and
equity.
16
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Management's Discussion and Analysis of Financial Condition and
Results of Operations should be read in conjunction with the Company's
consolidated financial statements, including related notes, and Management's
Discussion and Analysis of Financial Condition and Results of Operations
contained in the revised 2002 consolidated financial statements filed under Form
8-K on September 16, 2003, and the unaudited interim financial statements
included elsewhere in this report.
BUSINESS COMBINATION
On February 28, 2003, we acquired the stock of SC Holdings, Inc.
("Sleep Country") from a fund affiliated with Fenway Partners, Inc. ("Fenway")
for approximately $18.4 million, plus additional contingent consideration based
upon future performance. Sleep Country is a leading mattress retailer in the
Pacific Northwest which currently operates 47 stores under the Sleep Country USA
and Mattress Gallery names. This acquisition was financed from borrowings under
our Senior Credit Facility. Sleep Country used the proceeds received to repay
bank debt of $17.8 million and debt to an affiliate of $0.6 million.
Because Sleep Country and we were controlled by affiliates of Fenway at
the time of the acquisition, we are required to account for the acquisition as a
transfer of assets within a group under common control. Under this accounting
methodology, Sleep Country and the Company are treated as if they had been
combined for accounting and financial reporting purposes for the period in which
both entities were controlled by affiliates of Fenway (from March 1, 2000). As a
result, our consolidated financial statements have been restated for all periods
prior to the business combination to reflect the combined results of Sleep
Country and us as of the beginning of the earliest periods presented. In
addition to combining the separate historical results of Sleep Country and us,
the consolidated financial statements include all adjustments necessary to
conform accounting methods and presentation, to the extent they were different,
and to eliminate significant intercompany transactions.
We filed under Form 8-K/A on September 16, 2003, revised consolidated
financial statements for the year ended December 28, 2002 to restate fiscal
years 2002, 2001 and 2000 to reflect the combined results of the Company and
Sleep Country.
17
RESULTS OF OPERATIONS
The following table sets forth items included in the Condensed
Consolidated Statements of Operations expressed as a percentage of net sales:
Quarter Ended Nine Months Ended
------------------------------- -----------------------------
Sept. 27, Sept. 28, Sept. 27, Sept. 28,
2003 2002 2003 2002
---- ---- ---- ----
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of products sold 52.1% 51.8% 52.4% 51.8%
------ ------ ------ ------
Gross margin 47.9% 48.2% 47.6% 48.2%
Selling, general and administrative expenses 34.1% 35.3% 35.1% 36.6%
Non-cash variable stock compensation expense 2.2% 1.1% 2.5% 2.1%
Amortization of intangibles 0.0% 0.0% 0.0% 0.2%
Other operating expenses 0.0% 0.0% 0.1% 0.0%
------ ------ ------ ------
Operating income 11.6% 11.8% 9.9% 9.3%
Interest expense, net 2.8% 3.5% 3.0% 3.9%
Other expense, net 0.3% 0.3% 0.5% 0.3%
------ ------ ------ ------
Income before income taxes and
minority interest 8.5% 8.0% 6.4% 5.1%
Income tax expense 0.9% 3.2% 1.6% 2.1%
------ ------ ------ ------
Income before minority interest 7.6% 4.8% 4.8% 3.0%
Minority interest 0.0% 0.0% 0.0% 0.0%
------ ------ ------ ------
Net income 7.6% 4.8% 4.8% 3.0%
====== ====== ====== ======
QUARTER ENDED SEPTEMBER 27, 2003 AS COMPARED TO QUARTER ENDED SEPTEMBER 28, 2002
Net sales. Net sales for the quarter ended September 27, 2003 increased $26.5
million, or 13.9%, to $217.9 million from $191.4 million for the quarter ended
September 28, 2002.
Wholesale bedding segment sales increased $20.4 million, or 11.4%, to
$199.6 million for the quarter ended September 27, 2003 from $179.2 million for
the quarter ended September 28, 2002. The wholesale bedding segment sales
increase was primarily due to an increase in unit shipments and average unit
selling price ("AUSP") of 5.9% and 6.1%, respectively, versus the third quarter
of 2002. Our AUSP benefited from a shift in sales mix toward our higher priced
Beautyrest(R) and BackCare(R) products which generally are sold at a higher
AUSP. Unit volume growth resulted from higher sales at new and existing
customers due principally from additional floor placements. The increases in
AUSP and unit volume were partially offset by an increase in promotional
expenditures, such as volume rebates and amortization of supply agreements,
provided to our customers. Promotional expenditures classified as a reduction of
sales were $17.6 million for the third quarter of 2003 compared to $13.3 million
for same period of 2002.
Our third quarter 2003 wholesale bedding sales, exclusive of certain
sales deductions, which is the methodology used by the International Sleep
Products Association ("ISPA") in
18
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
calculating market share, were up 12.3% over the prior year. In comparison, ISPA
reported that for its leading U.S. manufacturer reporting sample, of which the
Company is included, third quarter 2003 industry sales were up 9.7% over the
prior year, comprised of an increase in unit shipments and AUSP of 5.1% and
4.3%, respectively.
Our retail segment sales for the quarter ended September 27, 2003
increased $8.1 million, or 42.3%, to $27.3 million from $19.1 million for the
third quarter of 2002. On a comparable store basis, sales for our retail stores
increased 17.6% in the third quarter of 2003 versus the comparable period of
2002. The retail segment sales increase was due principally to (i) the
acquisition of 26 retail stores in Southern California from Mattress Discounters
Corporation ("Mattress Discounters") in December 2002; (ii) an increase in
advertising expenditures; and (iii) an improving retail sales environment.
Cost of Products Sold. Cost of products sold, as a percentage of net sales, for
the quarter ended September 27, 2003 increased 0.3 percentage points to 52.1%
from 51.8% in the third quarter of 2002, resulting in a gross margin decline to
47.9% for the third quarter of 2003 from 48.2% for the third quarter of 2002.
The gross margin decline is primarily the result of an increase in (i)
promotional expenditures that are classified as a reduction of sales as noted
above; (ii) certain raw material costs resulting from supplier price increases
without a corresponding price increase in our Beautyrest(R) 2003 product line in
2003; and (iii) labor costs resulting from growth in factory headcount due to
increased production demands. Overhead costs as percentage of net sales
decreased due to fixed manufacturing costs remaining relatively flat to the
prior year despite unit volume growth over the prior year.
Selling, General and Administrative Expenses. For the quarter ended September
27, 2003, selling, general and administrative expenses, as a percentage of net
sales, decreased 1.2 percentage points to 34.1% from 35.3% in the third quarter
of 2002. This decrease as a percentage of net sales was principally attributable
to (i) greater leverage of our fixed selling, general and administrative
expenditures resulting from the above mentioned increase in sales versus the
prior year comparable period; and (ii) certain advertising production costs
which were incurred in the third quarter of 2002, but no such corresponding
production costs were incurred in the third quarter of 2003.
Non-Cash Variable Stock Compensation Expense. Non-cash variable stock
compensation expense increased $2.6 million to $4.7 million for the quarter
ended September 27, 2003 from $2.1 million in the second quarter of 2002. The
increase was attributable to a 7.9% increase in the value of Holdings' common
stock in the third quarter of 2003 and an increase in the number of vested stock
options outstanding at September 27, 2003 compared to September 28, 2002.
Interest Expense, Net. Interest expense, net, decreased $0.6 million, or 9.0%,
to approximately $6.2 million for the quarter ended September 27, 2003, from
$6.8 million in the third quarter of 2002 due to (i) decreased average
outstanding borrowings; and (ii) lower Prime and LIBOR base rates on our Senior
Credit Facility borrowings.
19
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Other Expense, Net. Other expense, net, increased $0.3 million, or 56.3%, to
$0.8 million for the quarter ended September 27, 2003 compared to $0.5 million
in the third quarter of 2002. This increase was primarily attributable to higher
management advisory fees paid to Fenway Partners.
Income Taxes. Our combined federal, state and foreign effective income tax rate
of 10.1% for the quarter ended September 27, 2003 differs from the federal
statutory rate of 35.0% primarily from the benefit of additional prior period
net operating losses not previously recognized and foreign tax credits. Our
combined federal, state and foreign effective income tax rate of 40.6% for the
quarter ended September 28, 2002 was greater than the federal statutory rate
principally due to state income taxes and the effect of establishing a valuation
allowance against Sleep Country's net deferred tax assets.
Net Income. For the reasons set forth above, our net income increased $7.4
million, or 81.4%, to $16.6 million for the quarter ended September 27, 2003
compared to $9.1 million for the quarter ended September 28, 2002.
EBITDA - Non-GAAP Financial Measure. For the reasons set forth above, our
Adjusted EBITDA, as defined below, was $35.7 million, or 16.4% of net sales, for
the quarter ended September 27, 2003, compared to $29.2 million, or 15.3% of net
sales, for the quarter ended September 28, 2002. The following table sets forth
a reconciliation of consolidated net income to Adjusted EBITDA, which is a
non-GAAP financial measure.
Quarter Ended
------------------------------
Sept. 27, Sept. 28,
2003 2002
---- ----
Net income $ 16,587 $ 9,142
Depreciation and amortization 5,435 4,381
Income tax expense 1,854 6,238
Interest expense, net 6,161 6,769
Minority interest - (17)
Other expense, net 813 520
Transaction fees 65 -
Non-cash variable stock compensation 4,697 2,076
Interest income 35 90
-------- --------
Adjusted EBITDA(a) $ 35,647 $ 29,199
======== ========
(a) The table above sets forth EBITDA as defined in the Company's Senior
Credit Facility, which the Company refers to as "Adjusted EBITDA".
Adjusted EBITDA as presented above is a financial measure that is used
in the Company's Senior Credit Facility and is one measure used by the
Company in evaluating its operating performance. Adjusted EBITDA is not
a defined term under US GAAP and should not be considered as an
alternative to income from operations or net income as a measure of
operating results or cash flows as a measure of liquidity. Adjusted
EBITDA differs from the term "EBITDA" (earnings before interest
expense, income tax expense, and depreciation and amortization). In
addition to adjusting net income to exclude interest expense, income
tax expense, and depreciation and amortization, Adjusted EBITDA also
adjusts net
20
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
income by excluding certain other items and expenses, such as ESOP
expenses, minority interest in losses, non-cash variable stock
compensation expense, interest income, transaction fees and management
fees paid to an affiliate. The Senior Credit Facility requires, among
other things, that the Company complies with a specified debt to
Adjusted EBITDA leverage ratio and a specified Adjusted EBITDA to
interest expense ratio for specified periods. Borrowings under the
Senior Credit Facility are a key source of the Company's liquidity.
The Company's ability to borrow under the Senior Credit Facility is
dependent on, among other things, its compliance with the financial
ratio covenants referred to in the preceding paragraph. Failure to
comply with these financial ratio covenants would result in a
violation of the Senior Credit Facility and, absent a waiver or
amendment from the lenders under such agreement, permit lenders to
accelerate all outstanding borrowings under the Senior Credit
Facility.
NINE MONTHS ENDED SEPTEMBER 27, 2003 AS COMPARED TO NINE MONTHS ENDED
SEPTEMBER 28, 2002
Net sales. Net sales for the nine months ended September 27, 2003 increased
$62.2 million, or 11.5%, to $603.8 million from $541.7 million for the nine
months ended September 28, 2002.
Wholesale bedding segment sales increased $50.1 million, or 9.9%, to
$555.7 million for the nine months ended September 27, 2003 from $505.7 million
for the quarter ended September 28, 2002. The wholesale bedding segment sales
increase was primarily due to an increase in unit shipments and AUSP of 5.8% and
5.3%, respectively, compared to the first nine months of 2002. Our AUSP
benefited from a shift in sales mix toward our higher priced Beautyrest(R) and
BackCare(R) products. Unit volume growth resulted from higher sales at new and
existing customers due principally from additional floor placements. The
increases in AUSP and unit volume were partially offset by an increase in
promotional expenditures, such as volume rebates and amortization of supply
agreements, provided to our customers. Promotional expenditures classified as a
reduction of sales were $45.0 million for the first nine months of 2003 compared
to $34.9 million for same period in the prior year.
Our first nine months 2003 wholesale bedding sales, exclusive of
certain sales deductions, which is the methodology used by ISPA in calculating
market share, were up 11.3% over the prior year. In comparison, ISPA reported
that for its leading U.S. manufacturer reporting sample, of which the Company is
included, the first nine months of 2003 industry sales were up 4.3% over the
prior year, comprised of an increase in unit shipments and AUSP of 0.2% and
4.1%, respectively.
Our retail segment sales for the nine months ended September 27, 2003
increased $19.8 million, or 37.3%, to $72.9 million from $53.1 million for the
comparable period of 2002. On a comparable store basis, sales for our retail
stores increased 14.5% for the first nine months of 2003 versus the comparable
period of 2002. The retail segment sales increase was due principally to (i) the
acquisition of 26 retail stores in Southern California from Mattress Discounters
Corporation ("Mattress Discounters") in December 2002; (ii) an increase in
advertising expenditures; and (iii) an improving retail sales environment.
21
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
Cost of Products Sold. Cost of products sold, as a percentage of net sales, for
the nine months ended September 27, 2003 increased 60 basis points to 52.4% from
51.8% in the first nine months of 2002, resulting in a gross margin decline to
47.6% for the first nine months of 2003 from 48.2% for the same period of 2002.
Our first nine months gross margin decreased primarily due to an increase in (i)
promotional expenditures that are classified as a reduction of sales as noted
above; (ii) certain raw material costs resulting from supplier price increases
without a corresponding price increase in our Beautyrest(R) 2003 product line in
2003; and (iii) labor costs resulting from growth in factory headcount due to
increased production demands. Overhead costs as percentage of net sales
decreased due to fixed manufacturing costs remaining relatively flat to the
prior year despite unit volume growth over the prior year.
Selling, General and Administrative Expenses. For the nine months ended
September 27, 2003, selling, general and administrative expenses, as a
percentage of net sales, decreased 1.5 percentage points to 35.1% from 36.6% in
the first nine months of 2002. This decrease as a percentage of net sales was
principally attributable to (i) greater leverage of our fixed selling, general
and administrative expenditures resulting from the above mentioned increase in
sales versus the prior year comparable period; and (ii) certain advertising
production costs which were incurred in 2002, but no such corresponding
production costs were incurred in 2003.
Non-Cash Variable Stock Compensation Expense. Non-cash variable stock
compensation expense increased $3.5 million to $15.1 million for the nine months
ended September 27, 2003 from $11.6 million in the first nine months of 2002.
The increase was attributable to a 25.6% increase in the value of Holdings'
common stock in the first nine months of 2003 and an increase in the number of
vested stock options outstanding at September 27, 2003 compared to September 28,
2002.
Amortization of Goodwill and Intangibles. Amortization of goodwill and
intangibles decreased $0.9 million, or 79.5%, to $0.2 million for the nine
months ended September 27, 2003 from $1.1 million in the first nine months of
2002 due to the expiration of the amortization period for certain patents.
Interest Expense, Net. Interest expense, net, decreased $2.9 million, or 13.7%,
to approximately $18.2 million for the nine months ended September 27, 2003,
from $21.0 million in the first nine months of 2002 due to (i) decreased average
outstanding borrowings; (ii) lower Prime and LIBOR base rates on our Senior
Credit Facility borrowings; and (iii) lower interest rate margins on our Senior
Credit Facility obligations for the first six months of 2003.
Other Expense, Net. Other expense, net, increased $0.9 million, or 65.2%, to
$2.4 million for the nine months ended September 27, 2003 compared to $1.5
million in the first nine months of 2002. This increase was primarily
attributable to (i) higher management advisory fees paid to Fenway Partners; and
(ii) the write-off of an investment in a licensee.
Income Taxes. Our combined federal, state and foreign effective income tax rate
of 25.0% for the nine months ended September 27, 2003 differs from the federal
statutory rate of 35.0% primarily from the benefit of additional prior period
net operating losses not previously recognized and foreign tax credits. Our
combined federal, state and foreign effective income tax rate of 41.3% for the
nine months ended September 28, 2002 was greater than the federal statutory rate
principally
22
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
due to state income taxes and the effect of establishing a valuation allowance
against Sleep Country's net deferred tax assets.
Net Income. For the reasons set forth above, our net income increased $12.6
million, or 75.9%, to $29.2 million for the nine months ended September 27, 2003
compared to $16.6 million for the same period of 2002.
EBITDA - Non-GAAP Financial Measure. Our Adjusted EBITDA, as defined below, was
$92.5 million, or 15.3% of net sales, for the first nine months of 2003,
compared to $76.8 million, or 14.2% of net sales, for the first nine months of
2002. The following table sets forth a reconciliation of consolidated net income
to Adjusted EBITDA, which is a non-GAAP financial measure.
Nine Months Ended
----------------------
Sept. 27, Sept. 28,
2003 2002
-------- --------
Net income $ 29,211 $ 16,600
Depreciation and amortization 16,814 14,291
Income tax expense 9,736 11,605
Interest expense, net 18,154 21,030
Minority interest - (87)
Other expense, net 2,405 1,456
Transaction fees 887 -
Non-cash variable stock compensation 15,118 11,561
Interest income 137 376
-------- --------
Adjusted EBITDA(a) $ 92,462 $ 76,832
======== ========
(a) The table above sets forth EBITDA as defined in the Company's Senior
Credit Facility, which the Company refers to as "Adjusted EBITDA".
Adjusted EBITDA as presented above is a financial measure that is used
in the Company's Senior Credit Facility and is one measure used by the
Company in evaluating its operating performance. Adjusted EBITDA is not
a defined term under US GAAP and should not be considered as an
alternative to income from operations or net income as a measure of
operating results or cash flows as a measure of liquidity. Adjusted
EBITDA differs from the term "EBITDA" (earnings before interest
expense, income tax expense, and depreciation and amortization). In
addition to adjusting net income to exclude interest expense, income
tax expense, and depreciation and amortization, Adjusted EBITDA also
adjusts net income by excluding certain other items and expenses, such
as ESOP expenses, minority interest in losses, non-cash variable stock
compensation expense, interest income, transaction fees and management
fees paid to an affiliate. The Senior Credit Facility requires, among
other things, that the Company complies with a specified debt to
Adjusted EBITDA leverage ratio and a specified Adjusted EBITDA to
interest expense ratio for specified periods. Borrowings under the
Senior Credit Facility are a key source of the Company's liquidity. The
Company's ability to borrow under the Senior Credit Facility is
dependent on, among other things, its compliance with the financial
ratio covenants referred to in the preceding paragraph. Failure to
comply with these financial
23
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
ratio covenants would result in a violation of the Senior Credit
Facility and, absent a waiver or amendment from the lenders under such
agreement, permit lenders to accelerate all outstanding borrowings
under the Senior Credit Facility.
RECENT DEVELOPMENTS
Holdings, the parent of Simmons Company, working with its advisors, has
initiated an exploratory process to evaluate a potential change in the ownership
of Holdings. However, no assurances can be given that a proposed transaction or
transactions will be completed or will be completed on terms favorable to
Holdings. A sale of Holdings could have an impact on the recorded values of
certain assets and liabilities of the Company.
LIQUIDITY AND CAPITAL RESOURCES
Our principal sources of cash to fund liquidity needs are (i) cash provided by
operating activities; and (ii) borrowings available under our Senior Credit
Facility. Our primary use of funds consists of payments of principal and
interest for our debt, capital expenditures, distributions to Holdings
principally for the repurchase of stock and vested stock options held by former
employees, acquisitions, and funding for working capital increases. In the first
nine months of 2003, we repaid $30.2 million of debt to reduce our total debt to
$230.6 million. In comparison, in the first nine months of 2002, total debt
decreased by $29.7 million.
In the first nine months of 2003, our working capital, exclusive of assets and
liabilities of our retail segment which are held for sale, increased $17.3
million. The working capital increase was principally due to increases in (i)
accounts receivable due to increased sales volumes late in the third quarter;
and (ii) inventories to meet increased sales demand supplemented by having more
expensive components in our inventory to support our high-end bedding lines.
Our capital expenditures totaled $4.9 million for the nine months ended
September 27, 2003. We expect to spend an aggregate of approximately $10.0
million for capital expenditures in fiscal year 2003. We believe that annual
capital expenditure limitations in our Senior Credit Facility will not
significantly inhibit us from meeting our ongoing capital expenditure needs.
On September 17, 2003, we acquired the rights to certain trademarks and other
intangibles, inventories, and machinery and equipment from Slumberland USA
Corporation for $2.1 million, consisting of $1.6 million of cash and a $0.5
million note payable, and the assumption of Slumberland's warranty liabilities.
Interest on the note payable accrues at prime plus 2% and is paid on the first
of each month. Principal and any unpaid interest on the note payable are due on
September 17, 2004.
On February 28, 2003, we acquired the stock of Sleep Country from a related
party for approximately $18.4 million, plus additional contingent consideration
based upon future performance. This acquisition was financed from borrowings
under our Senior Credit Facility. Sleep Country used the proceeds received to
repay bank debt of $17.8 million and stockholder debt of $0.6 million. We
incurred approximately $0.9 million in costs associated with this transaction.
24
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
On June 6, 2003, the Company entered into a Joinder Agreement with certain banks
party to its Senior Credit Facility whereby an additional $20.0 million was
borrowed under the Tranche C Term Loan. The proceeds from this additional loan
were utilized to repay borrowings under the Revolving Loan Facility.
As of September 27, 2003, we had availability to borrow $54.6 million under our
Revolving Credit Facility after giving effect to $5.4 million reserved for the
Company's reimbursement obligations with respect to outstanding letters of
credit. We were in compliance as of September 27, 2003 with the financial
covenants contained in all of our credit facilities.
We believe that cash generated from operations, together with the borrowings
available under our Revolving Credit Facility, will be sufficient to meet our
working capital and capital expenditure needs in the foreseeable future.
The Revolving Credit Facility expires on October 29, 2004. We expect to have the
ability to renew the existing facility or have the ability to find new financing
with comparable terms prior to expiration. If we are unable to renew our
existing arrangement or obtain new financing, this could have an adverse affect
on our ability to fund operations.
SEASONALITY/OTHER
For the past several years, there has not been significant seasonality to our
wholesale bedding business. Our retail bedding business has historically
experienced, and we expect will continue to experience, seasonal and quarterly
fluctuations in net sales, operating income, and Adjusted EBITDA. As is the case
with many bedding retailers, our retail business is subject to seasonal
influences, characterized by strong sales for the months of May through
September, which impact our second and third quarter results.
ACCOUNTING PRONOUNCEMENTS
In November 2002, the EITF reached a consensus on EITF 02-16, Accounting by a
Reseller for Cash Consideration Received from a Vendor, which addresses the
accounting for cash consideration (which includes slotting fees, cooperative
advertising payments etc.) and rebates or refunds from a vendor that are payable
only if the merchant completes a specified cumulative level of purchases or
remains a customer of the vendor for a specified period of time. Cash
consideration should be treated as a reduction of the prices of the vendor
products or services and included as a reduction of cost of sales unless the
vendor receives, or will receive, an identifiable benefit in exchange for the
consideration. Rebates or refunds should be recognized as a reduction of the
cost of sales based on a systematic and rational allocation of the consideration
to be received. The adoption of this pronouncement did not have a material
impact on the Company's financial position or results of operations.
In April 2003, the FASB issued SFAS No. 149, Amendment of Statement 113 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 amendments set forth by SFAS 149 improve
25
financial reporting by requiring that contracts with comparable characteristics
be accounted for similarly. SFAS 149 is generally effective for contracts
entered into or modified after June 30, 2003. The guidance is to be applied
prospectively. We do not have any derivative instruments.
In May 2003, the FASB issued SFAS No. 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. We do not believe that the adoption of this Statement will
have a significant impact on our consolidated financial statements.
26
Management's Discussion and Analysis of Financial Condition and Results of
Operations
- --------------------------------------------------------------------------------
FORWARD LOOKING STATEMENTS
"Safe Harbor" statement under the Private Securities Litigation Reform Act of
1995. When used in this Quarterly Report on Form 10-Q, the words "believes,"
"anticipates," "expects," "intends," "projects" and similar expressions are used
to identify forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Such forward-looking statements relate
to future financial and operating results, including expected benefits from our
Better Sleep Through Science(R) philosophy. Any forward-looking statements
contained in this report represent management's current expectations, based on
present information and current assumptions, and are thus prospective and
subject to risks and uncertainties which could cause actual results to differ
materially from those expressed in such forward-looking statements. Actual
results could differ materially from those anticipated or projected due to a
number of factors. These factors include, but are not limited to, anticipated
sales growth, success of new products, increased market share, reduction of
manufacturing costs, generation of free cash flow and reduction of debt, changes
in consumer confidence or demand, planned sale of our retail operations, and
other risks and factors identified from time to time in the Company's reports
filed with the Securities and Exchange Commission, including the Form 10-K for
2002, the revised 2002 consolidated financial statements filed under Form 8-K/A
on September 16, 2003, and the Form 10-Qs for the first and second quarters of
2003 and the first, second, and third quarters of 2002. The Company undertakes
no obligation to update or revise any forward-looking statements, either to
reflect new developments, or for any other reason.
27
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information relative to our market risk sensitive instruments by major
category at December 28, 2002 is presented under Item 7A of our Annual Report on
Form 10-K for the fiscal year ended December 28, 2002. There have been no
material changes to this information as of September 27, 2003.
Item 4. Disclosure Controls and Procedures
(a) Evaluation of Disclosure Controls and Procedures. The Company's management,
including the Chief Executive Officer and Chief Financial Officer, have
conducted an evaluation of the Company's disclosure controls and procedures (as
defined in Sections 13a-15(e) and 15d-15(e) of the Securities Exchange Act of
1934) as of the end of the period covered by this report and have concluded that
the Company's disclosure controls and procedures were effective.
(b) Changes in Internal Controls and Procedures. There were no changes in the
Company's internal control over financial reporting during the period covered by
this report that have materially affected, or are reasonably likely to
materially affect, the Company's internal control over financial reporting. The
Company is committed to ongoing periodic reviews and enhancements of its
controls and their effectiveness.
28
PART II - OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certifications of the Chief Executive Officer and Chief
Financial Officer pursuant to Section 302 of the
Sarbanes-Oxley Act.
32.1 Chief Executive Officer Certification pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
32.2 Chief Financial Officer Certification pursuant to Section 906
of the Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The following Forms 8-K were filed with or furnished to the
Commission:
On August 13, 2003, the Company filed with the Commission a
Form 8-K which reported under Item 9 the Press Release dated
August 11, 2003 announcing the results of operations for the
second quarter and first six months of 2003.
On August 28, 2003, the Company filed with the Commission a
Form 8-K which reported under Item 9 that Holdings has
initiated an exploratory process to evaluate the potential
change in ownership of Holdings.
On September 5, 2003, the Company filed with the Commission a
Form 8-K which reported under Item 5 the Company's
consolidated financial statements, selected financial data and
management's discussion and analysis of financial conditions
and results of operations as of December 28, 2002 and December
29, 2001 and for each of the three years in the period ended
December 28, 2002 to include the financial results of Sleep
Country.
On September 16, 2003, the Company filed with the Commission a
Form 8-K/A which amended the Form 8-K filed on September 5,
2003 for typographical errors.
29
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of
1934, Simmons Company has duly caused this report to be signed on its behalf by
the undersigned thereto duly authorized.
SIMMONS COMPANY
By: /s/ William S. Creekmuir
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William S. Creekmuir
Executive Vice President & Chief Financial Officer
Date: November 10, 2003