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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: June 2, 2002
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 1-8738
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SEALY CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 36-3284147
(State or other (I.R.S. Employer
jurisdiction of Identification No.)
incorporation or
organization)
Sealy Drive
One Office Parkway
Trinity, North Carolina 27370
(Address of principal (Zip Code)
executive offices)*
Registrant's telephone number, including area code--(336) 861-3500
-----------------
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 and Exchange Act
of 1934 during the preceding 12 months and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
The number of shares of the registrant's common stock outstanding as of July
1, 2002 was 31,033,457.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
SEALY CORPORATION
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Quarter Ended Quarter Ended
June 2, 2002 May 27, 2001
------------- -------------
Net sales--Non-Affiliates............................................................ $256,248 $228,142
Net sales--Affiliates................................................................ 43,507 35,800
-------- --------
Total net sales................................................................ 299,755 263,942
Costs and expenses:
Cost of goods sold--Non-Affiliates................................................ 147,148 137,978
Cost of goods sold--Affiliates.................................................... 23,114 19,015
-------- --------
Total cost of goods sold....................................................... 170,262 156,993
Selling, general and administrative............................................... 119,671 88,329
Stock based compensation.......................................................... 654 --
Business closure charge (Note 3).................................................. 5,802 --
Amortization of intangibles....................................................... 95 3,597
Royalty income, net............................................................... (3,111) (2,636)
-------- --------
Income from operations............................................................... 6,382 17,659
Interest expense.................................................................. 17,815 18,099
Other (income) expense (Note 5)................................................... 2,791 (3,417)
-------- --------
Income (loss) before income tax expense and extraordinary item....................... (14,224) 2,977
Income tax (benefit) expense......................................................... (5,832) 1,582
-------- --------
Income (loss) before extraordinary item.............................................. (8,392) 1,395
Extraordinary item--loss from early extinguishment of debt (net of income tax benefit
of $452) (Note 7).................................................................. -- 679
-------- --------
Net income (loss).................................................................... (8,392) 716
Liquidation preference for common L&M shares......................................... 4,640 4,072
-------- --------
Net loss available to common shareholders............................................ $(13,032) $ (3,356)
======== ========
Earnings per share--basic:
Income (loss) before extraordinary item........................................... $ (0.27) $ 0.04
Extraordinary item................................................................ -- (0.02)
-------- --------
Net income (loss)................................................................. (0.27) 0.02
Liquidation preference for common L & M shares.................................... (0.15) (0.13)
-------- --------
Net loss available to common shareholders......................................... $ (0.42) $ (0.11)
======== ========
Earnings per share--diluted:
Income (loss) before extraordinary item........................................... $ (0.27) $ 0.04
Extraordinary item................................................................ -- (0.02)
-------- --------
Net income (loss)................................................................. (0.27) 0.02
Liquidation preference for common L & M shares.................................... (0.15) (0.13)
-------- --------
Net loss available to common shareholders......................................... $ (0.42) $ (0.11)
======== ========
Weighted average number of common shares outstanding:
Basic............................................................................. 30,779 30,733
Diluted........................................................................... 30,779 30,733
See accompanying notes to condensed consolidated financial statements.
2
SEALY CORPORATION
Condensed Consolidated Statements of Operations
(In thousands, except per share data)
(Unaudited)
Six Months Ended Six Months Ended
June 2, 2002 May 27, 2001
---------------- ----------------
Net sales--Non-Affiliates............................................................ $512,230 $449,169
Net sales--Affiliates................................................................ 79,298 73,381
-------- --------
Total net sales............................................................... 591,528 522,550
Costs and expenses:
Cost of goods sold--Non-Affiliates............................................... 292,984 264,337
Cost of goods sold--Affiliates................................................... 42,288 38,888
-------- --------
Total cost of goods sold...................................................... 335,272 303,225
Selling, general and administrative.............................................. 213,357 171,734
Stock based compensation......................................................... 1,228 500
Restructuring charge............................................................. -- 1,183
Business closure charge (Note 3)................................................. 5,802 --
Amortization of intangibles...................................................... 268 7,023
Royalty income, net.............................................................. (5,598) (6,106)
-------- --------
Income from operations............................................................... 41,199 44,991
Interest expense................................................................. 36,019 35,090
Other (income) expense (Note 5).................................................. 5,059 (2,134)
-------- --------
Income before income tax expense, extraordinary item and cumulative effect of change
in accounting principle............................................................. 121 12,035
Income tax expense................................................................... 67 5,857
-------- --------
Income before extraordinary item and cumulative effect of change in accounting
principle........................................................................... 54 6,178
Extraordinary item--loss from early extinguishment of debt (net of income tax benefit
of $452) (Note 7)................................................................... -- 679
Cumulative effect of change in accounting principle (net of income tax expense of
$101) (Note 8)...................................................................... -- (152)
-------- --------
Net income........................................................................... 54 5,651
Liquidation preference for common L&M shares......................................... 9,280 8,144
-------- --------
Net loss available to common shareholders............................................ $ (9,226) $ (2,493)
======== ========
Earnings per share--basic:
Income before extraordinary item and cumulative effect of change in accounting
principle....................................................................... $ -- $ 0.20
Extraordinary item............................................................... -- (0.02)
Cumulative effect of change in accounting principle.............................. -- --
-------- --------
Net income....................................................................... -- 0.18
Liquidation preference for common L & M shares................................... (0.30) (0.26)
-------- --------
Net loss available to common shareholders........................................ $ (0.30) $ (0.08)
======== ========
Earnings per share--diluted:
Income before extraordinary item and cumulative effect of change in accounting
principle....................................................................... $ -- $ 0.20
Extraordinary item............................................................... -- (0.02)
Cumulative effect of change in accounting principle.............................. -- --
-------- --------
Net income....................................................................... -- 0.18
Liquidation preference for common L & M shares................................... (0.30) (0.26)
-------- --------
Net loss available to common shareholders........................................ $ (0.30) $ (0.08)
======== ========
Weighted average number of common shares outstanding:
Basic............................................................................ 30,825 30,916
Diluted.......................................................................... 30,825 30,916
See accompanying notes to condensed consolidated financial statements.
3
SEALY CORPORATION
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)
June 2, 2002 December 2, 2001*
------------ -----------------
ASSETS
Current assets:
Cash and cash equivalents........................... $ 36,894 $ 12,010
Accounts receivable--Non-Affiliates, net............ 154,268 152,045
Accounts receivable--Affiliates, net (Note 13)...... 13,339 29,061
Inventories......................................... 62,685 58,711
Prepaid expenses and deferred taxes................. 44,078 37,540
--------- ---------
311,264 289,367
Property, plant and equipment, at cost................. 275,904 271,239
Less: accumulated depreciation......................... (96,534) (86,942)
--------- ---------
179,370 184,297
Other assets:
Goodwill............................................ 374,147 371,354
Other intangibles, net.............................. 5,732 5,842
Investments in and advances to affiliates (Note 13). 22,663 15,468
Debt issuance costs, net, and other assets.......... 32,495 36,799
--------- ---------
435,037 429,463
--------- ---------
$ 925,671 $ 903,127
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Current portion of long-term obligations............ $ 44,662 $ 29,858
Accounts payable.................................... 90,331 74,584
Accrued interest.................................... 15,688 14,910
Accrued incentives and advertising.................. 37,634 41,449
Accrued compensation................................ 16,266 14,909
Other accrued expenses.............................. 36,763 33,326
--------- ---------
241,344 209,036
Long-term obligations.................................. 740,675 748,253
Other noncurrent liabilities........................... 49,444 49,885
Deferred income taxes.................................. 27,242 27,819
Minority interest...................................... -- 1,040
Stockholders' equity (deficit):
Common stock........................................ 321 317
Additional paid-in capital.......................... 146,136 145,712
Accumulated deficit................................. (236,631) (236,685)
Accumulated other comprehensive loss................ (29,796) (29,987)
Common stock held in treasury, at cost.............. (13,064) (12,263)
--------- ---------
(133,034) (132,906)
--------- ---------
$ 925,671 $ 903,127
========= =========
- --------
* Condensed from audited financial statements.
See accompanying notes to condensed consolidated financial statements.
4
SEALY CORPORATION
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)
Six Months Ended Six Months Ended
June 2, 2002 May 27, 2001
---------------- ----------------
Net cash provided by (used in) operating activities............ $ 48,869 $(22,035)
Cash flows from investing activities:
Purchase of property, plant and equipment, net.............. (7,714) (9,816)
Purchase of businesses, net of cash acquired................ (1,390) (26,643)
Advances to affiliate....................................... (12,500) --
-------- --------
Net cash used in investing activities................... (21,604) (36,459)
-------- --------
Cash flows from financing activities:
Treasury stock repurchase................................... (801) (12,178)
Proceeds from issuance of long-term notes................... -- 127,500
Repayments of long-term obligations, net.................... (1,383) (54,033)
Equity issuances............................................ 428 1,462
Purchase of interest rate cap............................... (625) --
Debt issuance costs......................................... -- (5,806)
-------- --------
Net cash (used in) provided by financing activities..... (2,381) 56,945
-------- --------
Change in cash and cash equivalents............................ 24,884 (1,549)
Cash and cash equivalents:
Beginning of period......................................... 12,010 18,114
-------- --------
End of period............................................... $ 36,894 $ 16,565
======== ========
Supplemental disclosures:
Selected noncash items:
Non-cash compensation....................................... $ 1,228 $ 500
Depreciation and amortization............................... 10,917 15,177
Business closure charge..................................... 5,802 --
Non-cash interest expense associated with:
Junior Subordinated Notes................................... 2,575 2,163
Debt issuance costs......................................... 2,143 2,227
Discount on Senior Subordinated Notes, net.................. 6,034 5,534
See accompanying notes to condensed consolidated financial statements
5
SEALY CORPORATION
Notes to Consolidated Financial Statements
Six months ended June 2, 2002
Note 1: Basis of Presentation
This report covers Sealy Corporation and its subsidiaries (collectively,
"Sealy" or the "Company").
The accompanying unaudited condensed consolidated financial statements
should be read together with the Company's Annual Report on Form 10-K for the
year ended December 2, 2001.
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 at June 2, 2002, 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.
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amount of assets and liabilities and disclosures of
contingent assets and liabilities at the end of the quarter and the reported
amounts of revenue and expenses during the reporting period. Actual results
could differ from those estimates.
The Company regularly assesses all of its long-lived assets and investments
for impairment when events or circumstances indicate their carrying value may
not be recoverable. The Company believes no such impairment existed at June 2,
2002.
Certain reclassifications of previously reported financial information were
made to conform to the 2002 presentation.
Note 2: Inventories
The major components of inventories were as follows:
June 2, 2002 December 2, 2001
------------ ----------------
(In thousands)
Raw materials.. $33,066 $30,734
Work in process 18,860 18,701
Finished goods. 10,759 9,276
------- -------
$62,685 $58,711
======= =======
Note 3: Business Acquisitions and Closures
On April 6, 2001, the Company acquired the outstanding capital stock of
Sapsa Bedding, S.A., of Paris, France for $31.5 million, including costs
associated with the acquisition. Sapsa, with primary locations in Paris, France
and Milan, Italy, manufactures and sells latex bedding and bedding products to
retailers and wholesalers in Europe. Sapsa also sells latex mattress cores and
pillows to other manufacturers which sell the finished products under their own
trademark. As part of the purchase price, EUR 3.0 million (approximately $2.8
million) is being held in escrow pursuant to the Share Sale Agreement. In
addition, the Company is holding EUR 4.3 million (approximately $4.0 million)
as additional escrow funds to be disbursed by December 31, 2002. The Company
recorded the acquisition using the purchase method of accounting and,
accordingly, the purchase price has been allocated to the assets acquired and
liabilities assumed based on the estimated fair market values. As a result of
the purchase price allocation, the Company recorded $18.1 million of indefinite
lived goodwill and $2.3 million of other intangibles.
6
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
Cash paid........................ $31.5
Fair value of liabilities assumed 44.8
-----
Purchase price................... 76.3
Fair value of assets acquired.... 55.9
-----
Goodwill and other intangibles... $20.4
=====
During the first quarter of 2002, the Company took control of a retail
mattress company in which it had previously made investments in the form of a
supply agreement and additional equity. This investment provided the Company an
opportunity to determine whether the entity would be a viable distribution
source for the Company's products. It is not the Company's strategy to own or
control retail operations. Based on management's assessment, evaluation and
consideration of alternative business strategies of the Company, it was
determined that the acquired entity did not represent a valid business strategy
and ceased its operations in May 2002. The Company recorded a non-cash charge
of $5.8 million associated with this shut-down of the business representing a
write-off of previously recorded goodwill of $5.3 million and a write-down of
other assets to their estimated liquidation value.
On August 10, 2000, the Company acquired 70% of the outstanding capital
stock of Rozen S.R.L. for $9.5 million. Rozen, located in Buenos Aires,
Argentina, manufactures and sells bedding to retailers located in Argentina.
Rozen also owns and operates several retail sleep shops in the Buenos Aires
area. During the second quarter of 2002, the Company acquired the remaining 30%
interest for $1.4 million including fees and expenses and recorded additional
indefinite lived goodwill of $1.2 million.
Note 4: Goodwill and Other Intangible Assets
The FASB issued FAS 142, "Goodwill and Other Intangible Assets", effective
for years beginning after December 15, 2001, the Company's first quarter of
fiscal year 2003. FAS 142 addresses financial accounting and reporting for
acquired goodwill and other intangible assets and supersedes APB Opinion No.
17, "Intangible Assets". Goodwill and some intangible assets will no longer be
amortized, but will be reviewed at least annually for impairment. FAS 142
specifies that at the time of adoption an impairment review should be
performed. If an impairment of the existing goodwill is determined, any charge
would be recorded as a cumulative effect of a change in accounting principle.
Subsequent impairment charges would be presented within operating results. The
Company adopted the non amortization provision for acquisitions with a closing
date subsequent to June 30, 2001. The Company adopted the remaining provisions
of FAS 142 effective December 3, 2001. The Company completed its initial
impairment review and determined that no impairment of its goodwill existed as
of the December 3, 2001.
The changes in the carrying amount of goodwill for the six months ended June
2, 2002, are as follows:
Balance as of December 2, 2001.............. $371.4
Goodwill acquired........................... 6.5
Goodwill reduced due to business closure.... (5.3)
Increase due to foreign currency translation 1.5
------
Balance as of June 2, 2002.................. $374.1
======
The Company recorded goodwill amortization of $3.0 million and $5.8 million
for the three and six months ended May 27, 2001, respectively. Had the Company
been required to adopt FAS 142 in the second quarter of
7
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
fiscal 2001, net income would have been $3.7 million and $11.5 million for the
three and six months ended May 27, 2001. The basic earnings per share effect of
the goodwill amortization would have been $0.10 and $0.19 and the diluted
earnings per share effect of the goodwill amortization would have been $0.09
and $0.17 for the three and six months ended May 27, 2001, respectively. In
addition basic earnings per share available to common shareholders would have
been $(0.01) and $0.11 and diluted earnings per share available to common
shareholders would have been $(0.01) and $0.10 for the three and six months
ended May 27, 2001, respectively.
Total other intangibles of $5.7 million (net of accumulated amortization of
$12.5 million) primarily consist of acquired licenses, which are amortized on
the straight-line method over periods ranging from 5 to 15 years.
Note 5: Other (Income) Expense
The Company previously contributed cash and other assets to Mattress
Holdings International LLC ("MHI") in exchange for a non-voting interest. MHI
was formed to invest in domestic and international loans, advances and
investments in joint ventures, licensees and retailers and is controlled by the
Company's largest stockholder, Bain Capital, LLC. The investment in MHI was
made to fund its activities in order to enhance business relationships and
build incremental sales. MHI's investments were principally minority interests
in two retailers; one of which is accounted for under the cost method and the
other under the equity method. The Company recorded losses of $2.9 million and
$5.3 million for the three and six months ended June 2, 2002 and $1.0 million
and $2.4 million for the three and six months ended May 27, 2001, respectively,
for the proportionate share of the net loss of the equity investee. See also
Note 13.
In May 2001, the Company and one of its licensees terminated its existing
contract that allowed the licensee to manufacture and sell certain products
under the Sealy brand name and entered into a new agreement for the sale of
certain other Sealy branded products. In conjunction with the termination of
the license agreement, Sealy received a $4.6 million termination fee that is
recorded as other income in the second quarter of fiscal 2001.
Note 6: Restructuring Charge
During the first quarter of 2001, the Company commenced a plan to shutdown
its Memphis facility and recorded a $0.5 million charge primarily for
severance. The Company ceased operations in this facility during the second
quarter of 2001 and is actively pursuing the sale of the facility. Also during
the first quarter of 2001, the Company recorded a $0.7 million charge for
severance related to a management reorganization. All payments related to these
charges have been made.
Note 7: Long-term obligations
On April 10, 2001, the Company completed a private placement of $125 million
of 9.875% senior subordinated notes. These notes, which are due and payable on
December 15, 2007 require semi-annual interest payments commencing June 15,
2001. The proceeds from the placement were used to repay existing bank debt. As
a result, the Company recognized an extraordinary loss on the write-off of a
portion of the previous debt issuance costs of $0.7 million (net of a $0.5
million tax benefit).
Note 8: Recently Issued Accounting Pronouncements
The Company adopted FAS 133, "Accounting for Derivative Instruments and
Hedging Activities," which requires that all derivatives be recorded on the
balance sheet at fair value. Derivatives that are not hedges must be adjusted
to fair value through income. The Company recorded a $0.2 million gain, upon
adoption as of
8
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
November 27, 2000, net of income tax expense which is recorded in the
consolidated statement of operations as a cumulative effect of a change in
accounting principle.
The FASB issued FAS 143, "Accounting for Asset Retirement Obligations",
effective for years beginning after June 15, 2002, the Company's first quarter
of fiscal year 2003. FAS 143 addresses financial accounting and reporting for
obligations associated with the retirement of tangible long-lived assets and
the associated asset retirement costs. It applies to legal obligations
associated with the retirement of long-lived assets that result from the
acquisition, construction, development and (or) the normal operation of a
long-lived asset, except for certain obligations of lessees. The Company is
currently evaluating the effects of this Statement.
The FASB issued FAS 144, "Accounting for the Impairment or Disposal of
Long-Lived Assets", effective for years beginning after December 15, 2001 and
interim periods within those years, the Company's second quarter of fiscal
2002. The objectives of FAS 144 are to address significant issues relating to
the implementation of FASB Statement No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of ", and to develop
a single accounting model, based on the framework established in FAS 121, for
long-lived assets to be disposed of by sale, whether previously held and used
or newly acquired. The Company adopted the provisions of this pronouncement for
related transactions. This did not have a significant impact on the
consolidated financial statements.
In April 2002, the FASB issued FAS 145, "Recission of FASB Statements No. 4,
44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections",
effective for fiscal years beginning after, transactions entered into after and
financial statements issued on or subsequent to May 15, 2002. FAS 145 rescinds
both FAS 4, "Reporting Gains and Losses from Extinguishment of Debt," and the
amendment of FAS 4, FAS 64, "Extinguishments of Debt Made to Satisfy
Sinking-Fund Requirements". This Statement also rescinds FAS 44, "Accounting
for Intangible Assets of Motor Carriers". This Statement amends FAS 13,
"Accounting for Leases", to eliminate an inconsistency between the accounting
for sale-leaseback transactions and the accounting for certain lease
modifications that have economic effects that are similar to sale-leaseback
transactions. This Statement also amends other existing authoritative
pronouncements to make various technical corrections, clarify meanings, or
describe their applicability under changed conditions. The Company adopted the
provisions of this pronouncement for related transactions subsequent to May 15,
2002. This did not have a significant impact on the consolidated financial
statements.
The Emerging Issues Task Force of the FASB released Issue 00-25, "Vendor
Income Statement Characterization of Consideration from a Vendor to a Retailer"
to provide guidance primarily on income statement classification of
consideration from a vendor to a purchaser of the vendor's products, including
both customers and consumers. Generally, cash consideration is to be classified
as a reduction of revenue, unless specific criteria are met regarding goods or
services that the vendor may receive in return for this consideration. The
Company has historically classified certain costs such as volume rebates,
promotional money and amortization of supply agreements covered by the
provisions of EITF 00-25 as marketing and selling expenses which are recorded
in selling, general and administrative in the Statement of Operations. The
Company adopted EITF 00-25 effective March 4, 2002, the first day of our fiscal
second quarter, and reclassified previous period amounts to comply with the
consensus. As a result of the adoption, both net sales and selling, general and
administrative expenses were reduced $13.5 million and $9.0 million for the
quarters ended June 2, 2002 and May 27, 2001 and $22.7 million and $16.3
million for the six months ended June 2, 2002 and May 27, 2001, respectively.
These changes did not affect the Company's financial position or results of
operations.
Note 9: Hedging Strategies
In 2000, the Company entered into an interest rate swap agreement that
effectively converted $235.3 million of its floating-rate debt to a fixed-rate
basis through December 2006, thereby hedging against the impact of
9
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
interest rate changes on future interest expense (forecasted cash flows). Use
of hedging contracts allows the Company to reduce its overall exposure to
interest rate changes, since gains and losses on these contracts will offset
losses and gains on the transactions being hedged. The Company formally
documents all hedged transactions and hedging instruments, and assesses, both
at inception of the contract and on an ongoing basis, whether the hedging
instruments are effective in offsetting changes in cash flows of the hedged
transaction. The fair values of the interest rate agreements are estimated by
obtaining quotes from brokers and are the estimated amounts that the Company
would receive or pay to terminate the agreements at the reporting date, taking
into consideration current interest rates and the current creditworthiness of
the counterparties. At June 2, 2002, the fair value carrying amount of this
instrument, which is included in other noncurrent liabilities, was a liability
of $12.9 million. In addition, $3.0 million and $6.1 million was recorded as
income in accumulated other comprehensive loss for the three and six months
ended June 2, 2002. Effective June 3, 2002, the Company dedesignated the
interest rate swap agreement for hedge accounting. As a result of the
dedesignation, the $12.9 million included in accumulated other comprehensive
loss will be amortized into interest expense over the remaining life of the
interest rate swap agreement. In addition, future changes in the fair market
value of the interest rate swap will be recorded in interest expense. During
the second quarter of 2002, the Company entered into another interest rate swap
agreement that has the effect of reestablishing as floating rate debt the
$235.3 million of debt previously converted to fixed rate debt. This interest
rate swap agreement has not been designated for hedge accounting and,
accordingly, any changes in the fair value will be recorded in interest
expense. At June 2, 2002, the fair value carrying amount of this instrument,
which is included in other noncurrent liabilities, was a liability of $0.5
million. In addition, $0.5 million was recorded as additional interest expense.
The Company also entered into an interest rate cap agreement with a notional
amount of $175.0 million that caps the LIBOR rate on which the floating rate
debt is based at 8% through December 2006. This agreement has not been
designated for hedge accounting and, accordingly, any changes in the fair value
will be recorded in interest expense. At June 2, 2002, the fair value carrying
amount of this instrument, which is included in noncurrent assets, was an asset
of $0.1 million. In addition, $0.1 million was recorded as a reduction to
interest expense.
To protect against the reduction in value of forecasted foreign currency
cash flows resulting from purchases in a foreign currency, the Company has
instituted a forecasted cash flow hedging program. The Company hedges portions
of its purchases denominated in foreign currencies with forward and option
contracts. At June 2, 2002, the Company had forward contracts to sell a total
of 41.6 million Mexican pesos with expiration dates ranging from June 7, 2002
through November 29, 2002, forward contracts to sell a total of 1.5 million
Canadian dollars with expiration dates ranging from June 7, 2002 through June
21, 2002, option contracts to sell a total of 36.0 million Mexican pesos with
expiration dates ranging from August 30, 2002 through November 29, 2002 and
option contracts to sell a total of 21.9 million Canadian dollars with
expiration dates ranging from June 7, 2002 through December 6, 2002.
10
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
Note 10: Net Income Per Common Share
The following table sets forth the computation of basic and diluted earnings
per share (in thousands):
Three months ended Six months ended
------------------------ ------------------------
June 2, 2002 May 27, 2001 June 2, 2002 May 27, 2001
------------ ------------ ------------ ------------
Numerator:
Income (loss) before extraordinary item and cumulative
effect of change in accounting principle............ $ (8,392) $ 1,395 $ 54 $ 6,178
Extraordinary item.................................... -- 679 -- 679
Cumulative effect of change in accounting principle... -- -- -- (152)
-------- ------- ------- -------
Net income (loss)..................................... (8,392) 716 54 5,651
Liquidation preference for common L&M shares.......... 4,640 4,072 9,280 8,144
-------- ------- ------- -------
Net loss available to common shareholders............. $(13,032) $(3,356) $(9,226) $(2,493)
======== ======= ======= =======
Denominator:
Denominator for basic earnings per share--weighted
average shares...................................... 30,779 30,733 30,825 30,916
Effect of dilutive securities:
Stock options......................................... * * * *
-------- ------- ------- -------
Denominator for diluted earnings per share--adjusted
weighted-average shares and assumed conversions..... 30,779 30,733 30,825 30,916
======== ======= ======= =======
- --------
* The dilutive securities are antidilutive for the three and six months ended
June 2, 2002 and May 27, 2001.
Note 11: Comprehensive Income
Total comprehensive income (loss) for the three and six months ended June 2,
2002 was ($7.7) million and $0.2 million and for the three and six months ended
May 27, 2001 was ($4.1) million and ($3.9) million, respectively.
Activity in Stockholders' Equity is as follows (dollar amounts in thousands):
Accumulated
Additional Other
Comprehensive Common Paid-in Accumulated Treasury Comprehensive
Income Stock Capital Deficit Stock Loss Total
------------- ------ ---------- ----------- -------- ------------- ---------
Balance at December 2,
2001....................... $317 $145,712 $(236,685) $(12,263) $(29,987) $(132,906)
Comprehensive Income:
Net income for the six
months ended June 2,
2002....................... $ 54 -- -- 54 -- -- 54
Exercise of stock options... -- 4 424 -- -- -- 428
Purchase of treasury
stock...................... -- -- -- -- (801) -- (801)
Change in fair value of cash
flow hedge................. 2,963 -- -- -- -- 2,963 2,963
Foreign currency translation
adjustment................. (2,772) -- -- -- -- (2,772) (2,772)
------- ---- -------- --------- -------- -------- ---------
Balance at June 2, 2002..... $ 245 $321 $146,136 $(236,631) $(13,064) $(29,796) $(133,034)
======= ==== ======== ========= ======== ======== =========
11
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
Note 12: Contingencies
The Company is currently conducting an environmental cleanup at a formerly
owned facility in South Brunswick, New Jersey pursuant to the New Jersey
Industrial Site Recovery Act. The Company and one of its subsidiaries are
parties to an Administrative Consent Order issued by the New Jersey Department
of Environmental Protection. Pursuant to that order, the Company and its
subsidiary agreed to conduct soil and groundwater remediation at the property.
The Company does not believe that its manufacturing processes were the source
of contamination. The Company sold the property in 1997. The Company and its
subsidiary retained primary responsibility for the required remediation. The
Company has completed essentially all soil remediation with the New Jersey
Department of Environmental Protection approval, and has concluded a pilot test
of the groundwater remediation system. The Company is working with the New
Jersey Department of Environmental Protection to develop a remediation plan for
the sediment in Oakeys Brook adjoining the site.
The Company is also remediating soil and groundwater contamination at an
inactive facility located in Oakville, Connecticut. Although the Company is
conducting the remediation voluntarily, it obtained Connecticut Department of
Environmental Protection approval of the remediation plan. The Company has
completed essentially all soil remediation under the remediation plan and is
currently monitoring groundwater at the site. The Company believes the
contamination is attributable to the manufacturing operations of previous
unaffiliated occupants of the facility.
The Company removed three underground storage tanks previously used for
diesel, gasoline, and waste oil from its South Gate, California facility in
March 1994 and remediated the soil in the area. Since August 1998, the Company
has been working with the California Regional Water Quality Control Board, Los
Angeles Region to monitor ground water at the site.
While the Company cannot predict the ultimate timing or costs of the South
Brunswick, Oakville, and South Gate environmental matters, based on facts
currently known, the Company believes that the accruals recorded are adequate
and does not believe the resolution of these matters will have a material
adverse effect on the financial position or future operations of the Company;
however, in the event of an adverse decision, these matters could have a
material adverse effect.
The Company was identified as a potential responsible party pursuant to the
Comprehensive Environmental Response Compensation and Liability Act ("CERCLA")
with regard to a waste disposal site, the Skinner Landfill Superfund Site,
located in West Chester, Ohio. The Company has reached a consent settlement
with the United States Environmental Protection Agency and paid $23,695 to the
United States government and $94,780 to the Skinner Landfill Site Group. As
part of this settlement, the Company received a covenant not to sue from the
United States in this matter and protection from contribution actions and
claims as provided by Section 113(f)(2) of CERCLA. The Company does not believe
that it has any further liability for this site.
In April 1997, a subsidiary of the Company responded to a questionnaire from
the Minnesota Pollution Control Agency concerning the Waste Disposal
Engineering Sanitary Landfill site located in Anoka County, Minnesota. The
Company does not believe that it contributed any hazardous substances to that
landfill and has not been further contacted by the Minnesota Pollution Control
Agency. Although liability under these statutes is generally joint and several,
as a practical matter, liability is usually allocated among all financially
responsible parties. Based on the nature and quantity of the Company's wastes,
the Company believes that any liability of the Company at this site in unlikely
to be material.
12
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
Note 13: Related Party Transactions
The Company previously contributed cash and other assets to Mattress
Holdings International LLC ("MHI") in exchange for a non-voting interest. MHI
was formed to invest in domestic and international loans, advances and
investments in joint ventures, licensees and retailers and is controlled by the
Company's largest stockholder, Bain Capital, LLC. The investment in MHI was
made to fund its activities in order to enhance business relationships and
build incremental sales. MHI's investments are principally minority interests
in two retailers; one accounted for under the cost method and the other under
the equity method. The Company had sales of $20.9 million and $19.8 million for
the three months ended June 2, 2002 and $38.7 million and $34.5 million for the
six months ended June 2, 2002 and $18.8 million and $14.4 million for the three
months ended May 27, 2001 and $39.3 million and $29.5 million for the six
months ended May 27, 2001 of finished mattress products pursuant to multi-year
supply contracts to these affiliates, respectively. The Company believes that
the terms on which mattresses are supplied to these affiliates are not
materially more or less favorable than those that might reasonably be obtained
in a comparable transaction on an arm's length basis from a person that is not
an affiliate or related party. The Company also had sales of $2.8 million and
$6.1 million for the three and six months ended June 2, 2002 and $2.6 million
and $4.6 million for the three and six months ended May 27, 2001, respectively,
to an international affiliate.
Various operating factors combined with weak economic conditions during
2001, resulted in a review by Company management of the equity values related
to these affiliates. The Company determined that the decline in the value of
such investments was other than temporary and, as a consequence, recognized a
non-cash impairment charge of $26.3 million to write-down the investments to
their estimated fair values as of the end of the third quarter of 2001.
One MHI affiliate successfully renegotiated the terms of its credit
agreement with its principal lenders in the first quarter of 2002. The Company
is participating in the renegotiated bank facility through a $12.5 million
secured loan that was disbursed in January 2002. The loan bears interest at
either the applicable Eurodollar rate plus 3.50% or the greater of (a) the
Prime Rate, (b) the Base CD Rate plus 1% or (c) the Federal Funds Effective
Rate plus 1/2 of 1%, plus 2.50%. The interest rate in effect at June 2, 2002
was 5.34%. Principal is due and payable on February 15, 2004. In exchange for
this participation, the Company received enhancements to the existing supply
agreement including a three-year extension to June 30, 2007. The affiliate is
required to make quarterly payments of $250,000 to the other participants in
the banking facility. Should the affiliate be unable to make the quarterly
payments, the Company is required to fund such payments on behalf of the
affiliate. The Company's maximum additional exposure under the affiliate's bank
facility is $1.8 million. This affiliate also has other significant long-term
debt and is required to fund significant interest payments. The affiliate has
been operating at a loss and its liquidity has been, and continues to be
constrained. As a result, the affiliate has retained a financial advisor to
assist it in evaluating its liquidity needs, capital structure and strategic
options. The affiliate did not make its $8.8 million semi-annual interest
payment on July 15, 2002 required under its bond indenture. The affiliate is
currently in negotiations with bondholders and other creditors to restructure,
which may consider all aspects of the business. The restructuring may result in
the sale of some assets and lower sales by Sealy. Various alternatives have
been discussed related to obtaining relief on some or all of the affiliate's
indebtedness. As part of this restructuring, the Company is considering a
limited increase in its secured loan to the affiliate. The Company is unable to
predict when or if the affiliate will be able to effect a restructuring. There
is also the possibility that the affiliate may be forced to seek bankruptcy
protection. If the affiliate were to file for bankruptcy and liquidate, the
Company would likely incur additional losses in excess of amounts previously
provided. As of June 2, 2002, the affiliate owes the Company $21.4 million in
trade receivables and $12.5 million under the secured loan described above.
(See table below.)
13
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
The other affiliate is currently operating under a forbearance agreement
with one of its lenders while renegotiating its credit agreement. The Company
believes that the affiliate will be successful in either renegotiating its
credit agreement with the current lenders or obtaining financing from other
lending institutions. There can be no assurance that the affiliate will be able
to either refinance or obtain other financing. The Company is considering
various alternatives including, among others, converting a portion of
outstanding trade receivables owed by the affiliate into a convertible note
receivable and issuing guarantees to the affiliate's lenders associated with
outstanding bank debt. The Company may also modify terms and conditions of its
sales and accounts receivable. On May 13, 2002, MHI entered into an agreement
to acquire the majority of the remaining outstanding stock of the affiliate in
exchange for 2% of the Company's outstanding common equity. Such equity will be
funded through shares of Sealy stock currently owned by Sealy investors. The
closing of the transaction is pending and is conditioned upon the affiliate
either successfully renegotiating the current credit agreement or obtaining
long-term financing from another lending institution among other conditions. It
is the Company's intention that concurrent with the closing of the proposed
acquisition, the Company would sell substantially all of its interest in MHI to
an entity controlled by Bain Capital, LLC for an amount yet to be determined.
The Company would have no equity interest or Board representation in this new
entity that will be controlled by Bain Capital, LLC. As of June 2, 2002, the
affiliate owes the Company $33.0 million in trade receivables; of which $15.0
million was reclassified to investments in and advances to affiliates in the
fourth quarter of 2001 due to uncertainty on the timing of collection of such
amounts. The Company also has minority representation on the affiliate's Board
of Directors. In addition, a former executive of the Company is an executive
officer of this affiliate. (See table below.)
As discussed above, the Company expects the affiliates to effect
restructurings during 2002. Based on the weak operating results, reduced
liquidity and financial flexibility combined with the actions described above
since the end of the first quarter; management reevaluated its financial
exposure and determined that further reserves were required. Among the positive
and negative factors considered were the current retail and economic
environment, collateral position with respect to the secured loan, critical
vendor status coupled with long-term supply agreements and the probability of
successful operational and financial restructurings. Accordingly, the Company
recognized an additional bad debt charge of $19.5 million in the second quarter
of 2002. The total reserve for affiliate receivables is $28.1 million. Although
the Company feels that adequate allowances have been established, should either
the business of the affiliates further deteriorate or the affiliates be
required in the future to restructure its debts or file for protection under
the bankruptcy courts, the Company may lose a significant portion of its
current business with these affiliates resulting in an adverse effect to the
Company. If conditions with either or both of the affiliates worsen, the
Company may also be required to recognize further allowances and charges to
earnings and such charges could be material.
A summary of the Company's accounts receivable from domestic affiliates and
the investment in and advances to affiliates as of June 2, 2002 and December 2,
2001 is as follows:
June 2, 2002 December 2, 2001
------------ ----------------
(in millions)
Accounts receivable from domestic affiliates $ 54.4 $47.9
Less: Allowance for doubtful accounts....... (28.1) (6.2)
Accrued cooperative advertising/rebates.. (7.4) (5.5)
Net investment (deficit) in affiliates... (4.8) 0.4
------ -----
Net unsecured position...................... 14.1 36.6
Secured loan................................ 12.5 --
------ -----
Total....................................... $ 26.6 $36.6
====== =====
14
SEALY CORPORATION
Notes To Consolidated Financial Statements--(Continued)
Note 14: Segment Information
The Company operates predominately in one industry segment, that being the
manufacture and marketing of conventional bedding.
Note 15: Guarantor/Non-Guarantor Financial Information
The Parent and each of the Guarantor Subsidiaries has fully and
unconditionally guaranteed, on a joint and several basis, the obligation to pay
principal and interest with respect to the Senior Subordinated and Senior
Subordinated Discount Notes (collectively, the "Notes") of Sealy Mattress
Company (the "Issuer"). Substantially all of the Issuer's operating income and
cash flow is generated by its subsidiaries. As a result, funds necessary to
meet the Issuer's debt service obligations are provided in part by
distributions or advances from its subsidiaries. Under certain circumstances,
contractual and legal restrictions, as well as the financial condition and
operating requirements of the Issuer's subsidiaries, could limit the Issuer's
ability to obtain cash from its subsidiaries for the purpose of meeting its
debt service obligations, including the payment of principal and interest on
the Notes. Although holders of the Notes will be direct creditors of the
Issuer's principal direct subsidiaries by virtue of the guarantees, the Issuer
has subsidiaries ("Non-Guarantor Subsidiaries") that are not included among the
Guarantor Subsidiaries, and such subsidiaries will not be obligated with
respect to the Notes. As a result, the claims of creditors of the Non-Guarantor
Subsidiaries will effectively have priority with respect to the assets and
earnings of such companies over the claims of creditors of the Issuer,
including the holders of the Notes.
The following supplemental consolidating condensed financial statements
present:
1. Consolidating condensed balance sheets as of June 2, 2002 and December
2, 2001 and consolidating condensed statements of operations and cash
flows for the six months ended June 2, 2002 and May 27, 2001 and the
consolidating condensed statements of operations for the three months
ended June 2, 2002 and May 27, 2001.
2. Sealy Corporation (the "Parent" and a "guarantor"), Sealy Mattress
Company (the "Issuer"), combined Guarantor Subsidiaries and combined
Non-Guarantor Subsidiaries with their investments in subsidiaries
accounted for using the equity method.
3. Elimination entries necessary to consolidate the Parent and all of its
subsidiaries.
Separate financial statements of each of the Guarantor Subsidiaries are not
presented because Management believes that these financial statements would not
be material to investors.
15
SEALY CORPORATION
Supplemental Consolidating Condensed Balance Sheet
June 2, 2002
(in thousands)
Sealy Combined Combined
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- --------- ------------ ------------- ------------ ------------
Assets
Current assets:
Cash and cash equivalents.......... $ -- $ 30 $ 32,637 $ 4,227 $ -- $ 36,894
Accounts receivable--Non-
Affiliates, net.................. 8 6,014 102,313 45,933 -- 154,268
Accounts receivable--Affiliates,
net.............................. -- -- 11,398 1,941 -- 13,339
Inventories........................ -- 1,651 44,323 16,711 -- 62,685
Prepaids and deferred taxes........ 263 335 37,886 5,594 -- 44,078
--------- --------- --------- -------- -------- ---------
271 8,030 228,557 74,406 -- 311,264
Property, plant and equipment, at
cost............................. -- 5,308 220,357 50,239 -- 275,904
Less: accumulated
depreciation..................... -- (2,380) (87,212) (6,942) -- (96,534)
--------- --------- --------- -------- -------- ---------
-- 2,928 133,145 43,297 -- 179,370
Other assets:
Goodwill........................... -- 14,816 314,698 44,633 -- 374,147
Other intangibles, net............. -- -- 3,833 1,899 -- 5,732
Net investment in and advances to
(from) subsidiaries and
affiliates....................... (85,220) 590,077 (402,627) (89,591) (12,639) --
Investment in and advances to
affiliates....................... -- -- -- 22,663 -- 22,663
Debt issuance costs, net and other
assets........................... 108 19,134 10,633 2,620 -- 32,495
--------- --------- --------- -------- -------- ---------
(85,112) 624,027 (73,463) (17,776) (12,639) 435,037
--------- --------- --------- -------- -------- ---------
Total assets....................... $ (84,841) $ 634,985 $ 288,239 $ 99,927 $(12,639) $ 925,671
========= ========= ========= ======== ======== =========
Liabilities and Stockholders'
Equity(Deficit)
Current liabilities:
Current portion of long-term
obligations...................... $ -- $ 34,588 $ 8 $ 10,066 $ -- $ 44,662
Accounts payable................... -- 146 59,520 30,665 -- 90,331
Accrued interest................... -- 774 14,618 296 -- 15,688
Accrued incentives and
advertising...................... -- 1,161 32,169 4,304 -- 37,634
Accrued compensation............... -- 208 11,252 4,806 -- 16,266
Other accrued expenses............. 21 1,399 24,094 11,249 -- 36,763
--------- --------- --------- -------- -------- ---------
21 38,276 141,661 61,386 -- 241,344
Long-term obligations, net......... 42,613 687,705 79 10,278 -- 740,675
Other noncurrent liabilities....... 7,258 13,233 24,012 4,941 -- 49,444
Deferred income taxes.............. (1,699) 703 22,368 5,870 -- 27,242
Stockholders' equity (deficit)..... (133,034) (104,932) 100,119 17,452 (12,639) (133,034)
--------- --------- --------- -------- -------- ---------
Total liabilities and stockholders'
equity (deficit)................. $ (84,841) $ 634,985 $ 288,239 $ 99,927 $(12,639) $ 925,671
========= ========= ========= ======== ======== =========
16
SEALY CORPORATION
Supplemental Consolidating Condensed Balance Sheet
December 2, 2001
(in thousands)
Sealy Combined Consolidated
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- --------- ------------ ------------- ------------ ------------
Assets
Current assets:
Cash and cash equivalents.......... $ -- $ 55 $ 6,442 $ 5,513 $ -- $ 12,010
Accounts receivable--Non-
Affiliates, net.................. 7 6,847 102,854 42,337 -- 152,045
Accounts receivable--Affiliates,
net.............................. -- -- 26,703 2,358 -- 29,061
Inventories........................ -- 1,521 42,429 14,761 -- 58,711
Prepaid expenses and other
assets........................... 263 335 27,786 9,156 -- 37,540
--------- --------- --------- -------- -------- ---------
270 8,758 206,214 74,125 -- 289,367
Property, plant and equipment, at
cost............................. -- 5,231 219,591 46,417 -- 271,239
Less accumulated depreciation...... -- (2,220) (79,234) (5,488) -- (86,942)
--------- --------- --------- -------- -------- ---------
-- 3,011 140,357 40,929 -- 184,297
Other assets:
Goodwill........................... -- 14,816 316,323 40,215 -- 371,354
Other intangibles, net............. -- 3,974 1,868 -- 5,842
Net investment in and advances to
(from) subsidiaries and
affiliates....................... (88,818) 586,266 (385,167) (80,820) (31,461) --
Investment in and advances to
affiliates....................... -- -- -- 15,468 -- 15,468
Debt issuance costs, net and other
assets........................... 156 20,652 13,412 2,579 -- 36,799
--------- --------- --------- -------- -------- ---------
(88,662) 621,734 (51,458) (20,690) (31,461) 429,463
--------- --------- --------- -------- -------- ---------
Total assets....................... $ (88,392) $ 633,503 $ 295,113 $ 94,364 $(31,461) $ 903,127
========= ========= ========= ======== ======== =========
Liabilities and Stockholders'
Equity
Current liabilities:
Current portion of long-term
obligations...................... $ -- $ 18,658 $ 64 $ 11,136 $ -- $ 29,858
Accounts payable................... -- 327 51,078 23,179 -- 74,584
Accrued interest................... -- 741 13,884 285 -- 14,910
Accrued incentives and
advertising...................... -- 1,496 35,789 4,164 -- 41,449
Accrued compensation............... -- 372 10,464 4,073 -- 14,909
Other accrued expenses............. 51 1,614 20,073 11,588 -- 33,326
--------- --------- --------- -------- -------- ---------
51 23,208 131,352 54,425 -- 209,036
Long-term obligations, net......... 40,038 698,350 80 9,785 -- 748,253
Other noncurrent liabilities....... 6,124 15,853 23,569 4,339 -- 49,885
Deferred income taxes.............. (1,699) 703 21,656 7,159 -- 27,819
Minority interest.................. -- -- -- 1,040 -- 1,040
Stockholders' equity (deficit)..... (132,906) (104,611) 118,456 17,616 (31,461) (132,906)
--------- --------- --------- -------- -------- ---------
Total liabilities and stockholders'
equity........................... $ (88,392) $ 633,503 $ 295,113 $ 94,364 $(31,461) $ 903,127
========= ========= ========= ======== ======== =========
17
SEALY CORPORATION
Supplemental Consolidated Condensed Statements of Operations
Three Months Ended June 2, 2002
(in thousands)
Sealy Combined Combined
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- -------- ------------ ------------- ------------ ------------
Net sales--Non-Affiliates...... $ -- $ 12,006 $200,233 $ 46,478 $ (2,469) $256,248
Net sales--Affiliates.......... -- -- 40,757 2,750 -- 43,507
------- -------- -------- -------- -------- --------
Total net sales......... -- 12,006 240,990 49,228 (2,469) 299,755
Costs and expenses:
Cost of goods sold--Non-
Affiliates................ -- 8,040 111,897 29,680 (2,469) 147,148
Cost of goods sold--
Affiliates................ -- -- 21,471 1,643 -- 23,114
------- -------- -------- -------- -------- --------
Total cost of goods
sold.................. -- 8,040 133,368 31,323 (2,469) 170,262
Selling, general and
administrative............ 45 2,913 95,363 21,350 -- 119,671
Stock based
compensation.............. 654 -- -- -- -- 654
Business closure charge..... -- -- -- 5,802 -- 5,802
Amortization of
intangibles............... -- 72 23 -- 95
Royalty income, net......... -- -- (3,330) 219 -- (3,111)
------- -------- -------- -------- -------- --------
Income from operations......... (699) 1,053 15,517 (9,489) -- 6,382
Interest expense............ 1,428 16,109 96 182 -- 17,815
Other (income) expense...... -- -- -- 2,791 -- 2,791
Loss (income) from equity
investees................. 8,181 16,803 -- -- (24,984) --
Loss (income) from
nonguarantor equity
investees................. -- (8,677) 14,632 -- (5,955) --
Capital charge and
intercompany interest
allocation................ (1,473) (15,033) 15,574 932 -- --
------- -------- -------- -------- -------- --------
Income (loss) before income
taxes........................ (8,835) (8,149) (14,785) (13,394) 30,939 (14,224)
Income tax expense (benefit)... (443) 32 2,018 (7,439) -- (5,832)
------- -------- -------- -------- -------- --------
Net income (loss).............. $(8,392) $ (8,181) $(16,803) $ (5,955) $ 30,939 $ (8,392)
======= ======== ======== ======== ======== ========
18
SEALY CORPORATION
Supplemental Consolidating Condensed Statements of Operations
Three Months Ended May 27, 2001
(in thousands)
Combined
Sealy Combined Non-
Sealy Mattress Guarantor Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- -------- ------------ ------------ ------------ ------------
Net sales--Non-Affiliates......... $ -- $ 12,576 $176,639 $42,893 $(3,966) $228,142
Net sales--Affiliates............. -- -- 33,222 2,578 -- 35,800
------- -------- -------- ------- ------- --------
Total net sales............. -- 12,576 209,861 45,471 (3,966) 263,942
Costs and expenses:
Cost of goods sold--Non-
Affiliates................... -- 8,719 104,910 28,315 (3,966) 137,978
Cost of goods sold--
Affiliates................... -- -- 17,410 1,605 -- 19,015
------- -------- -------- ------- ------- --------
Total cost of goods sold.... -- 8,719 122,320 29,920 (3,966) 156,993
Selling, general and
administrative............... 45 3,852 72,890 11,542 -- 88,329
Amortization of intangibles.... -- 91 2,994 512 -- 3,597
Royalty income, net............ -- -- (1,682) (954) -- (2,636)
------- -------- -------- ------- ------- --------
Income from operations............ (45) (86) 13,339 4,451 -- 17,659
Interest expense.................. 1,164 16,933 (325) 327 -- 18,099
Other (income) expense......... -- -- (4,625) 1,208 -- (3,417)
Loss (income) from equity
investees.................... (708) (666) -- -- 1,374 --
Loss (income) from non-
guarantor equity investees... -- (1,345) (787) -- 2,132 --
Capital charge and.............
intercompany interest
allocation................... (1,209) (16,086) 17,417 (122) -- --
------- -------- -------- ------- ------- --------
Income (loss) before income
taxes and extraordinary
item......................... 708 1,078 1,659 3,038 (3,506) 2,977
Income tax expense (benefit)... (8) (238) 922 906 -- 1,582
------- -------- -------- ------- ------- --------
Income (loss) before
extraordinary item........... 716 1,316 737 2,132 (3,506) 1,395
Extraordinary item--loss from
early extinguishment of
debt......................... -- 608 71 -- -- 679
------- -------- -------- ------- ------- --------
Net income (loss)................. $ 716 $ 708 $ 666 $ 2,132 $(3,506) $ 716
======= ======== ======== ======= ======= ========
19
SEALY CORPORATION
Supplemental Consolidating Condensed Statements of Operations
Six Months Ended June 2, 2002
(in thousands)
Sealy Combined Combined
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- -------- ------------ ------------- ------------ ------------
Net sales--Non-Affiliates...... $ -- $ 23,774 $400,723 $ 92,631 $(4,898) $512,230
Net sales--Affiliates.......... -- -- 73,161 6,137 -- 79,298
------- -------- -------- -------- ------- --------
Total net sales......... -- 23,774 473,884 98,768 (4,898) 591,528
Costs and expenses:
Cost of goods sold--Non-
Affiliates................ -- 15,664 223,088 59,130 (4,898) 292,984
Cost of goods sold--
Affiliates................ -- -- 38,481 3,807 -- 42,288
------- -------- -------- -------- ------- --------
Total cost of goods
sold.................. -- 15,664 261,569 62,937 (4,898) 335,272
Selling, general and
administrative............ 90 5,622 171,823 35,822 -- 213,357
Stock based
compensation.............. 1,228 -- -- -- -- 1,228
Business closure charge..... -- -- -- 5,802 -- 5,802
Amortization of
intangibles............... -- -- 144 124 -- 268
Royalty income, net......... -- -- (5,987) 389 -- (5,598)
------- -------- -------- -------- ------- --------
Income from operations......... (1,318) 2,488 46,335 (6,306) -- 41,199
Interest expense............ 2,698 33,596 (699) 424 -- 36,019
Other (income) expense...... -- -- 12 5,047 -- 5,059
Loss (income) from equity
investees................. (603) 9,141 -- -- (8,538) --
Loss (income) from
nonguarantor equity
investees................. -- (9,616) 15,704 -- (6,088) --
Capital charge and
intercompany interest
allocation................ (2,788) (31,395) 32,341 1,842 -- --
------- -------- -------- -------- ------- --------
Income (loss) before income
taxes........................ (625) 762 (1,023) (13,619) 14,626 121
Income tax expense (benefit)... (679) 159 8,118 (7,531) -- 67
------- -------- -------- -------- ------- --------
Net income (loss).............. $ 54 $ 603 $ (9,141) $ (6,088) $14,626 $ 54
======= ======== ======== ======== ======= ========
20
SEALY CORPORATION
Supplemental Consolidating Condensed Statements of Operations
Six Months Ended May 27, 2001
(in thousands)
Sealy Combined Combined
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- -------- ------------ ------------- ------------ ------------
Net sales--Non-Affiliates....... $ -- $ 24,336 $362,205 $69,688 $ (7,060) $449,169
Net sales--Affiliates........... -- -- 68,769 4,612 -- 73,381
------- -------- -------- ------- -------- --------
Total net sales.......... -- 24,336 430,974 74,300 (7,060) 522,550
Costs and expenses:
Cost of goods sold--Non-
Affiliates................. -- 16,609 210,093 44,695 (7,060) 264,337
Cost of goods sold--
Affiliates................. -- -- 36,017 2,871 -- 38,888
------- -------- -------- ------- -------- --------
Total cost of goods
sold................... -- 16,609 246,110 47,566 (7,060) 303,225
Selling, general and
administrative............. 90 7,178 143,902 20,564 -- 171,734
Stock based
compensation............... 500 -- -- -- -- 500
Restructuring charge......... -- -- 1,183 -- -- 1,183
Amortization of
intangibles................ -- 181 6,074 768 -- 7,023
Royalty income, net.......... -- -- (4,256) (1,850) -- (6,106)
------- -------- -------- ------- -------- --------
Income from operations.......... (590) 368 37,961 7,252 -- 44,991
Interest expense............. 2,280 32,594 29 187 -- 35,090
Other (income) expense....... -- -- (4,625) 2,491 -- (2,134)
Loss (income) from equity
investees.................. (5,908) (4,248) -- -- 10,156 --
Loss (income) from
nonguarantor equity
investees.................. -- (2,986) (446) -- 3,432 --
Capital charge and
intercompany interest
allocation................. (2,370) (30,964) 33,568 (234) -- --
------- -------- -------- ------- -------- --------
Income (loss) before income
taxes and extraordinary item
and cumulative effect of
change in accounting
principle..................... 5,408 5,972 9,435 4,808 (13,588) 12,035
Income tax expense (benefit).... (243) (392) 5,116 1,376 -- 5,857
------- -------- -------- ------- -------- --------
Income (loss) before
extraordinary item and
cumulative effect of change in
accounting principle.......... 5,651 6,364 4,319 3,432 (13,588) 6,178
Extraordinary item-loss from
early extinquishment of
debt.......................... -- 608 71 -- -- 679
Cumulative effect of change in
accounting principle.......... -- (152) -- -- -- (152)
------- -------- -------- ------- -------- --------
Net income (loss)............... $ 5,651 $ 5,908 $ 4,248 $ 3,432 $(13,588) $ 5,651
======= ======== ======== ======= ======== ========
21
SEALY CORPORATION
Supplemental Consolidating Condensed Statements of Cash Flows
Six Months Ended June 2, 2002
(in thousands)
Sealy Combined Combined
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- -------- ------------ ------------- ------------ ------------
Net cash operating activities.... $ -- $ 1,046 $ 38,014 $ 9,809 $ -- $ 48,869
----- ------- -------- -------- ----- --------
Cash flows from investing
activities:
Purchase of property, plant
and equipment, net.......... -- (96) (6,875) (743) -- (7,714)
Purchase of businesses, net
of cash acquired............ -- -- -- (1,390) -- (1,390)
Advances to affiliate......... -- -- -- (12,500) -- (12,500)
Net activity in investment in
and advances to (from)
subsidiaries and
affiliates.................. 373 408 (4,896) 4,115 -- --
----- ------- -------- -------- ----- --------
Net proceeds provided by (used
in) investing activities....... 373 312 (11,771) (10,518) -- (21,604)
Cash flows from financing
activities:
Treasury stock repurchase,
including direct
expenses.................... (801) -- -- -- -- (801)
Repayment of long-term
obligations, net............ -- (758) (48) (577) -- (1,383)
Equity issuances.............. 428 -- -- -- -- 428
Purchase of interest rate
cap......................... -- (625) -- -- -- (625)
----- ------- -------- -------- ----- --------
Net cash (used in) financing
activities..................... (373) (1,383) (48) (577) -- (2,381)
----- ------- -------- -------- ----- --------
Change in cash and cash
equivalents.................... -- (25) 26,195 (1,286) -- 24,884
Cash and cash equivalents:
Beginning of period........... -- 55 6,442 5,513 -- 12,010
----- ------- -------- -------- ----- --------
End of period................. $ -- $ 30 $ 32,637 $ 4,227 $ -- $ 36,894
===== ======= ======== ======== ===== ========
22
SEALY CORPORATION
Supplemental Consolidating Condensed Statements of Cash Flows
Six Months Ended May 27, 2001
(in thousands)
Sealy Combined Combined
Sealy Mattress Guarantor Non-Guarantor
Corporation Company Subsidiaries Subsidiaries Eliminations Consolidated
----------- -------- ------------ ------------- ------------ ------------
Net cash provided by (used in)
operating activities........... $ -- $ (139) $ (6,200) $(15,696) $ -- $(22,035)
-------- -------- -------- -------- ----- --------
Cash flows from investing
activities:
Purchase of property, plant
and equipment, net.......... -- (224) (8,178) (1,414) -- (9,816)
Acquisition of business, net
of cash acquired............ -- -- -- (26,643) -- (26,643)
Net activity in investment
in and advances to
(from) subsidiaries and
affiliates.................. 10,716 (67,338) 32,974 23,648 -- --
-------- -------- -------- -------- ----- --------
Net proceeds provided by (used
in) investing activities....... 10,716 (67,562) 24,796 (4,409) -- (36,459)
Cash flows from financing
activities:
Treasury stock repurchase,
including direct
expenses.................... (12,178) -- -- -- -- (12,178)
Proceeds from repayment
of long-term obligations,
net......................... -- 127,500 -- -- -- 127,500
Proceeds from (payments
on) long-term
obligations, net............ -- (54,150) (14,032) 14,149 -- (54,033)
Equity issuances.............. 1,462 -- -- -- -- 1,462
Debt issuance costs........... -- (5,579) -- (227) -- (5,806)
-------- -------- -------- -------- ----- --------
Net cash provided by
(used in) financing
activities.............. (10,716) 67,771 (14,032) 13,922 -- 56,945
-------- -------- -------- -------- ----- --------
Change in cash and cash
equivalents.................... -- 70 4,564 (6,183) -- (1,549)
Cash and cash equivalents:
Beginning of period........... -- 354 6,672 11,088 -- 18,114
-------- -------- -------- -------- ----- --------
End of period................. $ -- $ 424 $ 11,236 $ 4,905 $ -- $ 16,565
======== ======== ======== ======== ===== ========
23
SEALY CORPORATION
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Item 2. Quarter Ended June 2, 2002 compared with Quarter Ended May 27, 2001
Net Sales. Net sales for the quarter ended June 2, 2002, were $299.8
million, an increase of $35.9 million, or 13.6% from the quarter ended May 27,
2001. Net sales were reduced by $13.5 million and $9.0 million for the three
months ended June 2, 2002 and May 27, 2001, respectively, as a result of the
adoption of EITF 00-25, "Vendor Income Statement Characterization of
Consideration from a Vendor to a Retailer", as of March 4, 2002. EITF 00-25
provides guidance primarily on income statement classification of consideration
from a vendor to a purchaser of the vendor's products, including both customers
and consumers. Generally, cash consideration is to be classified as a reduction
of revenue, unless specific criteria are met regarding goods or services that
the vendor may receive in return for this consideration. The Company has
historically classified certain costs such as volume rebates, promotional money
and amortization of supply agreements covered by the provisions of EITF 00-25
as marketing and selling expenses which are recorded in selling, general and
administrative. Total domestic sales were $248.4 million for the second quarter
of 2002 compared to $218.0 million for the second quarter of 2001. Domestic
sales growth of $30.4 million was attributable to a 2.6% increase in average
unit selling price and an 11.3% increase in volume. Total international sales
were $51.4 million for the second quarter of 2002 compared to $45.9 for the
second quarter of 2001. Growth of $5.0 million in the international operations
was attributable to the recently acquired Sapsa Bedding S.A. in Europe which
was acquired in the second quarter of 2001. Other existing international
operations also experienced sales growth of $0.5 million.
Cost of Goods Sold. Cost of goods sold for the quarter, as a percentage of
net sales, decreased 2.7 percentage points to 56.8%. Cost of goods sold for the
domestic business decreased 2.7 percentage points to 55.5%. This decrease is
primarily due to the fact that sales of Sealy Posturepedic and Stearns & Foster
products represented a greater percentage of total sales. The Company also
recorded a $2.9 million physical inventory loss during the second quarter of
2001. Cost of goods sold for the international business decreased 2.0
percentage points to 63.8%. This decrease is primarily due to the flow-through
in the second quarter of 2001 of the purchase accounting adjustments associated
with the inventory acquired as part of the Sapsa acquisition.
Selling, General, and Administrative. Selling, general, and administrative
expenses increased $31.3 million to $119.7 million, or 39.9% of net sales,
compared to $88.3 million, or 33.5% of net sales. This increase is primarily
due to higher bad debt expense of $18.3 million primarily associated with
affiliated customers (as discussed more fully in Note 13 and "Liquidity and
Capital Resources") and higher variable expenses due to increased business
activity. Excluding the increase in bad debt expense, selling, general, and
administrative expenses were 33.8% of net sales for the quarter ended June 2,
2002. Selling, general, and administrative expenses were reduced by $13.5
million and $9.0 million for the three months ended June 2, 2002 and May 27,
2001, respectively, as a result of the adoption of EITF 00-25, "Vendor Income
Statement Characterization of Consideration from a Vendor to a Retailer", as of
March 4, 2002. EITF 00-25 provides guidance primarily on income statement
classification of consideration from a vendor to a purchaser of the vendor's
products, including both customers and consumers. Generally, cash consideration
is to be classified as a reduction of revenue, unless specific criteria are met
regarding goods or services that the vendor may receive in return for this
consideration. The Company has historically classified certain costs such as
volume rebates, promotional money and amortization of supply agreements covered
by the provisions of EITF 00-25 as marketing and selling expenses which are
recorded in selling, general and administrative.
Stock Based Compensation. The Company has an obligation to repurchase
certain securities of the Company held by an officer at the greater of
estimated fair market value or original cost. The Company recorded a $0.7
million charge during the quarter ended June 2, 2002 to revalue this obligation
to reflect an increase in the fair market value of the securities. No such
charge was necessary for the quarter ended May 27, 2001.
24
Business Closure Charge. During the first quarter of 2002, the Company took
control of a retail mattress company in which it had previously made
investments in the form of a supply agreement and additional equity. This
investment provided the Company an opportunity to determine whether the entity
would be a viable distribution source for the Company's products. It is not the
Company's strategy to own or control retail operations. Based on management's
assessment, evaluation and consideration of alternative business strategies of
the Company, it was determined that the acquired entity did not represent a
valid business strategy and ceased its operations in May 2002. The Company
recorded a non-cash charge of $5.8 million associated with this shut-down of
the business representing a write-off of previously recorded goodwill of $5.3
million and a write-down of other assets to their estimated liquidation value.
Amortization Expense. Amortization expense was $0.1 million and $3.6
million for the quarters ended June 2, 2002 and May 27, 2001, respectively. The
decrease of $3.5 million is due to the adoption of FAS 142 during the first
quarter of 2002, as the Company no longer records amortization expense for
indefinite lived goodwill.
Interest Expense. Interest expense decreased $0.3 million primarily due to
lower effective interest rates, partially offset by higher average debt levels.
Other (Income) Expense, net. In May 2001, the Company and one of its
licensees terminated its existing contract that allowed the licensee to
manufacture and sell certain products under the Sealy brand name and entered
into a new agreement for the sale of certain other Sealy branded products. In
conjunction with the termination of the license agreement, Sealy received a
$4.6 million termination fee which was recorded as other income in the second
quarter of 2001. Other (income) expense, net also includes the equity in the
(earnings) loss of equity investees and minority interest.
Income Tax. The Company's effective income tax rates in 2002 and 2001
differ from the Federal statutory rate principally because of the effect of
certain foreign tax rate differentials, state and local income taxes, operating
losses from equity investee for which no tax benefit has been recorded and the
application of purchase accounting in 2001. The Company's effective tax rate
for the quarter ended June 2, 2002 is approximately (41.0)% compared to 53.1%
for quarter ended May 27, 2001. The lower effective tax rate is primarily the
result of the Company's adoption of FAS 142, as the Company no longer records
amortization expense for indefinite lived goodwill that was not deductible for
tax purposes. The Company also determined in the second quarter of 2002 that a
previously recorded tax benefit for operating losses of an equity investee was
not assured based on available tax strategies.
Six Months Ended June 2, 2002 compared with Six Months Ended May 27, 2001
Net Sales. Net sales for the six months ended June 2, 2002, were $591.5
million, an increase of $69.0 million, or 13.2% from the six months ended May
27, 2001. Net sales were reduced by $22.7 million and $16.3 million for the six
months ended June 2, 2002 and May 27, 2001, respectively, as a result of the
adoption of EITF 00-25, "Vendor Income Statement Characterization of
Consideration from a Vendor to a Retailer", as of March 4, 2002. EITF 00-25
provides guidance primarily on income statement classification of consideration
from a vendor to a purchaser of the vendor's products, including both customers
and consumers. Generally, cash consideration is to be classified as a reduction
of revenue, unless specific criteria are met regarding goods or services that
the vendor may receive in return for this consideration. The Company has
historically classified certain costs such as volume rebates, promotional money
and amortization of supply agreements covered by the provisions of EITF 00-25
as marketing and selling expenses which are recorded in selling, general and
administrative. Total domestic sales were $489.7 million for the six months of
2002 compared to $447.2 million for the six months of 2001. Domestic sales
growth of $42.5 million was attributable to a 2.7% increase in average unit
selling price and a 6.8% increase in volume. Total international sales were
$101.8 million for the six months ended June 2, 2002 compared to $75.3 for the
six months ended May 27, 2001. Growth of $22.3 million in the
25
international operations was attributable to the acquisition of Sapsa Bedding
S.A. in Europe which was acquired in the second quarter of 2001. Other existing
international operations also experienced sales growth of $4.2 million.
Cost of Goods Sold. Cost of goods sold for the six months ended June 2,
2002, as a percentage of net sales, decreased 1.3 percentage points to 56.7%.
Cost of goods sold for the domestic business decreased 1.9 percentage points to
55.2%. This decrease is primarily due to the fact that sales of Sealy
Posturepedic and Stearns & Foster products represented a greater percentage of
total sales. The Company also recorded a $2.9 million physical inventory loss
during the second quarter of 2001. Cost of goods sold for the international
business was flat at 64.0%.
Selling, General, and Administrative. Selling, general, and administrative
expenses increased $41.7 million to $213.4 million, or 36.1% of net sales,
compared to $171.7 million or 32.9% of net sales. This increase is primarily
due to higher bad debt expense of $20.4 million primarily associated with
affiliated customers (as discussed more fully in Note 13 and "Liquidity and
Capital Resources") and higher variable expenses due to increased business
activity. Excluding the increase in bad debt expense, selling, general, and
administrative expenses were 32.6% of net sales for the six months June 2,
2002. Selling, general, and administrative expenses were reduced by $22.7
million and $16.3 million for the six months ended June 2, 2002 and May 27,
2001, respectively, as a result of the adoption of EITF 00-25, "Vendor Income
Statement Characterization of Consideration from a Vendor to a Retailer", as of
March 4, 2002. EITF 00-25 provides guidance primarily on income statement
classification of consideration from a vendor to a purchaser of the vendor's
products, including both customers and consumers. Generally, cash consideration
is to be classified as a reduction of revenue, unless specific criteria are met
regarding goods or services that the vendor may receive in return for this
consideration. The Company has historically classified certain costs such as
volume rebates, promotional money and amortization of supply agreements covered
by the provisions of EITF 00-25 as marketing and selling expenses which are
recorded in selling, general and administrative.
Stock Based Compensation. The Company has an obligation to repurchase
certain securities of the Company held by an officer at the greater of
estimated fair market value or original cost. The Company recorded a $1.2
million and $0.5 million charge for the six months ended June 2, 2002 and May
27, 2001, respectively, to revalue this obligation to reflect an increase in
the fair market value of the securities.
Business Closure Charge. During the first quarter of 2002, the Company took
control of a retail mattress company in which it had previously made
investments in the form of a supply agreement and additional equity. This
investment provided the Company an opportunity to determine whether the entity
would be a viable distribution source for the Company's products. It is not the
Company's strategy to own or control retail operations. Based on management's
assessment, evaluation and consideration of alternative business strategies of
the Company, it was determined that the acquired entity did not represent a
valid business strategy and ceased its operations in May 2002. The Company
recorded a non-cash charge of $5.8 million associated with this shut-down of
the business representing a write-off of previously recorded goodwill of $5.3
million and a write-down of other assets to their estimated liquidation value.
Restructuring Charges. During the first half of 2001, the Company shutdown
its Memphis facility and recorded a $0.5 million charge primarily for
severance. Additionally, the Company recorded a $0.7 million charge for
severance due to a management reorganization.
Amortization Expense. Amortization expense was $0.3 million and $7.0
million for the six months ended June 2, 2002 and May 27, 2001, respectively.
The decrease of $6.7 million is due to the adoption of FAS 142 during the first
quarter of 2002, as the Company no longer records amortization expense for
indefinite lived goodwill.
26
Interest Expense. Interest expense increased $0.9 million primarily due to
increased average debt levels, partially offset by lower effective interest
rates.
Other (Income) Expense, net. In May 2001, the Company and one of its
licensees terminated its existing contract that allowed the licensee to
manufacture and sell certain products under the Sealy brand name and entered
into a new agreement for the sale of certain other Sealy branded products. In
conjunction with the termination of the license agreement, Sealy received a
$4.6 million termination fee which was recorded as other income in the second
quarter of 2001. Other (income) expense, net also includes the equity in the
(earnings) loss of equity investees and minority interest.
Income Tax. The Company's effective income tax rates in 2002 and 2001
differ from the Federal statutory rate principally because of the effect of
certain foreign tax rate differentials, state and local income taxes, operating
losses from equity investee for which no tax benefit has been recorded and the
application of purchase accounting in 2001. The Company's effective tax rate
for the six months ended June 2, 2002 is approximately 55.4% compared to 48.7%
for the six months ended May 27, 2001. The higher effective tax rate is
primarily due to the fact that the Company determined in the second quarter of
2002 that a previously recorded tax benefit for operating losses of an equity
investee was not assured based on available tax strategies. This is partially
offset by the Company's adoption of FAS 142, as the Company no longer records
amortization expense for indefinite lived goodwill that was not deductible for
tax purposes.
Liquidity and Capital Resources
The Company's principal sources of funds are cash flows from operations and
borrowings under its Revolving Credit Facility. The Company's principal use of
funds consists of payments of principal and interest on its Senior Credit
Agreements, capital expenditures and interest payments on its outstanding
Notes. Capital expenditures totaled $7.7 million for the six months ended June
2, 2002. Management believes that annual capital expenditure limitations in its
current debt agreements will not significantly inhibit the Company from meeting
its ongoing capital needs. At June 2, 2002, the Company had approximately $88.2
million available under its Revolving Credit Facility including Letters of
Credit issued totaling approximately $11.8 million. The Company's net weighted
average borrowing cost was 9.1% for the six months ended June 2, 2002. The
Tranche A Term Loan of $25.7 million and the Revolving Credit Facility mature
in December 2002. The Company is currently negotiating to renew the Revolving
Credit Facility and expects it will have the ability to renew the existing
facility or to find new financing with comparable terms. If the Company is
unable to renew its existing arrangement or obtain new financing, this could
have an adverse affect on the Company's ability to fund its operations.
Currently, the Company has no borrowings under its Revolving Credit Facility.
The Company is subject to certain restrictive financial covenants under its
credit facility. The Company is in compliance and anticipates continued
compliance with these covenants. A material deterioration of operating results
could impact compliance with such covenants and cause the Company to seek
amendments or waivers of such covenants. Failure to obtain waivers or
amendments of covenants would also adversely affect the Company's ability to
fund its operations.
The Company's cash flow from operations increased $70.9 million to $48.9
million for the six months ended June 2, 2002. This increase is primarily the
result of better working capital management as the Company experienced improved
cash collections on accounts receivable and increased accounts payable days.
The Company also had increased payments in the first half of 2001 associated
with stock based compensation and other incentive compensation as compared to
2002.
The Company previously contributed cash and other assets to Mattress
Holdings International LLC ("MHI") in exchange for a non-voting interest. MHI
was formed to invest in domestic and international loans, advances and
investments in joint ventures, licensees and retailers and is controlled by the
Company's largest stockholder, Bain Capital, LLC. The investment in MHI was
made to fund its activities in order to enhance business
27
relationships and build incremental sales. MHI's investments are principally
minority interests in two retailers; one accounted for under the cost method
and the other under the equity method. The Company had sales of $20.9 million
and $19.8 million for the three months ended June 2, 2002 and $38.7 million and
$34.5 million for the six months ended June 2, 2002 and $18.8 million and $14.4
million for the three months ended May 27, 2001 and $39.3 million and $29.5
million for the six months ended May 27, 2001 of finished mattress products
pursuant to multi-year supply contracts to these affiliates, respectively. The
Company believes that the terms on which mattresses are supplied to these
affiliates are not materially more or less favorable than those that might
reasonably be obtained in a comparable transaction on an arm's length basis
from a person that is not an affiliate or related party. The Company also had
sales of $2.8 million and $6.1 million for the three and six months ended June
2, 2002 and $2.6 million and $4.6 million for the three and six months ended
May 27, 2001, respectively, to an international affiliate.
Various operating factors combined with weak economic conditions during
2001, resulted in a review by Company management of the equity values related
to these affiliates. The Company determined that the decline in the value of
such investments was other than temporary and, as a consequence, recognized a
non-cash impairment charge of $26.3 million to write-down the investments to
their estimated fair values as of the end of the third quarter of 2001.
One MHI affiliate successfully renegotiated the terms of its credit
agreement with its principal lenders in the first quarter of 2002. The Company
is participating in the renegotiated bank facility through a $12.5 million
secured loan that was disbursed in January 2002. The loan bears interest at
either the applicable Eurodollar rate plus 3.50% or the greater of (a) the
Prime Rate, (b) the Base CD Rate plus 1% or (c) the Federal Funds Effective
Rate plus 1/2 of 1%, plus 2.50%. The interest rate in effect at June 2, 2002
was 5.34%. Principal is due and payable on February 15, 2004. In exchange for
this participation, the Company received enhancements to the existing supply
agreement including a three-year extension to June 30, 2007. The affiliate is
required to make quarterly payments of $250,000 to the other participants in
the banking facility. Should the affiliate be unable to make the quarterly
payments, the Company is required to fund such payments on behalf of the
affiliate. The Company's maximum additional exposure under the affiliate's bank
facility is $1.8 million. This affiliate also has other significant long-term
debt and is required to fund significant interest payments. The affiliate has
been operating at a loss and its liquidity has been, and continues to be
constrained. As a result, the affiliate has retained a financial advisor to
assist it in evaluating its liquidity needs, capital structure and strategic
options. The affiliate did not make its $8.8 million semi-annual interest
payment on July 15, 2002 required under its bond indenture. The affiliate is
currently in negotiations with bondholders and other creditors to restructure,
which may consider all aspects of the business. The restructuring may result in
the sale of some assets and lower sales by Sealy. Various alternatives have
been discussed related to obtaining relief on some or all of the affiliate's
indebtedness. As part of this restructuring, the Company is considering a
limited increase in its secured loan to the affiliate. The Company is unable to
predict when or if the affiliate will be able to effect a restructuring. There
is also the possibility that the affiliate may be forced to seek bankruptcy
protection. If the affiliate were to file for bankruptcy and liquidate, the
Company would likely incur additional losses in excess of amounts previously
provided. As of June 2, 2002, the affiliate owes the Company $21.4 million in
trade receivables and $12.5 million under the secured loan described above.
(See table below.)
The other affiliate is currently operating under a forbearance agreement
with one of its lenders while renegotiating its credit agreement. The Company
believes that the affiliate will be successful in either renegotiating its
credit agreement with the current lenders or obtaining financing from other
lending institutions. There can be no assurance that the affiliate will be able
to either refinance or obtain other financing . The Company is considering
various alternatives including, among others, converting a portion of
outstanding trade receivables owed by the affiliate into a convertible note
receivable and issuing guarantees to the affiliate's lenders associated with
outstanding bank debt. The Company may also modify terms and conditions of its
sales and accounts receivable. On May 13, 2002, MHI entered into an agreement
to acquire the majority of the remaining outstanding stock of the affiliate in
exchange for 2% of the Company's outstanding common equity.
28
Such equity will be funded through shares of Sealy stock currently owned by
Sealy investors. The closing of the transaction is pending and is conditioned
upon the affiliate either successfully renegotiating the current credit
agreement or obtaining long-term financing from another lending institution
among other conditions. It is the Company's intention that concurrent with the
closing of the proposed acquisition, the Company would sell substantially all
of its interest in MHI to an entity controlled by Bain Capital, LLC for an
amount yet to be determined. The Company would have no equity interest or Board
representation in this new entity that will be controlled by Bain Capital, LLC.
As of June 2, 2002, the affiliate owes the Company $33.0 million in trade
receivables; of which $15.0 million was reclassified to investments in and
advances to affiliates in the fourth quarter of 2001 due to uncertainty on the
timing of collection of such amounts. The Company also has minority
representation on the affiliate's Board of Directors. In addition, a former
executive of the Company is an executive officer of this affiliate. (See table
below.)
As discussed above, the Company expects the affiliates to effect
restructurings during 2002. Based on the weak operating results, reduced
liquidity and financial flexibility combined with the actions described above
since the end of the first quarter; management reevaluated its financial
exposure and determined that further reserves were required. Among the positive
and negative factors considered were the current retail and economic
environment, collateral position with respect to the secured loan, critical
vendor status coupled with long-term supply agreements and the probability of
successful operational and financial restructurings. Accordingly, the Company
recognized an additional bad debt charge of $19.5 million in the second quarter
of 2002. The total reserve for affiliate receivables is $28.1 million. Although
the Company feels that adequate allowances have been established, should either
the business of the affiliates further deteriorate or the affiliates be
required in the future to restructure its debts or file for protection under
the bankruptcy courts, the Company may lose a significant portion of its
current business with these affiliates resulting in an adverse effect to the
Company. If conditions with either or both of the affiliates worsen, the
Company may also be required to recognize further allowances and charges to
earnings and such charges could be material.
A summary of the Company's accounts receivable from domestic affiliates and
the investment in and advances to affiliates as of June 2, 2002 and December 2,
2001 is as follows:
June 2, December 2,
2002 2001
------- -----------
(in millions)
Accounts receivable from domestic affiliates $ 54.4 $47.9
Less: Allowance for doubtful accounts....... (28.1) (6.2)
Accrued cooperative advertising/rebates.. (7.4) (5.5)
Net investment (deficit) in affiliates... (4.8) 0.4
------ -----
Net unsecured position...................... 14.1 36.6
Secured loan................................ 12.5 --
------ -----
Total....................................... $ 26.6 $36.6
====== =====
During the first quarter of 2001, the Company secured an additional
revolving credit facility with a separate banking group. This facility provides
for borrowing in Canadian currency up to C$25 million. The revolving credit
facility expires in fiscal 2004. At June 2, 2002, the Company had approximately
C$13.2 million available under this facility.
On April 6, 2001, the Company completed the acquisition of Sapsa Bedding
S.A., of Paris, France. The purchase price for the acquisition was $31.5
million, including costs associated with the acquisition. The acquisition was
funded through approximately $8.6 million of existing cash and $22.9 million
from available credit facilities.
29
In 2001, the Company issued $125 million of 9.875% senior subordinated
notes. These notes, which are due and payable on December 15, 2007, require
semi-annual interest payments commencing June 15, 2001. The proceeds from the
placement were used to repay existing bank debt. As a result, the Company
recognized an extraordinary loss on the write-off of a portion of the previous
debt issuance costs of $0.7 million (net of $0.5 million tax benefit).
The Company recorded expense of $0.7 million in the second quarter of 2002
to revalue the right of one executive to require the Company to repurchase
certain securities of the Company at the greater of fair market value or
original cost. No such expense was necessary for the second quarter of 2001.
The Company recorded expense of $1.2 million and $0.5 million for the six
months ended June 2, 2002 and May 27, 2001, respectively. The expense
associated with the right was recorded in stock based compensation expense.
During 2001, the Company satisfied $10.7 million of the obligations through a
cash payment in return for the delivery of a portion of the executive's
securities. At June 2, 2002, the Company has $5.8 million recorded as a
long-term liability for the remaining repurchase obligation.
During the first quarter of 2002, the Company took control of a retail
mattress company in which it had previously made investments in the form of a
supply agreement and additional equity. This investment provided the Company an
opportunity to determine whether the entity would be a viable distribution
source for the Company's products. It is not the Company's strategy to own or
control retail operations. Based on management's assessment, evaluation and
consideration of alternative business strategies of the Company, it was
determined that the acquired entity did not represent a valid business strategy
and ceased its operations in May 2002. The Company recorded a non-cash charge
of $5.8 million associated with this shut-down of the business representing a
write-off of previously recorded goodwill of $5.3 million and a write-down of
other assets to their estimated liquidation value.
The Company's customers include furniture stores, national mass
merchandisers, specialty sleep shops, department stores, contract customers and
other stores. In the future, these retailers may consolidate, undergo
restructurings or reorganizations, or realign their affiliations, any of which
could decrease the number of stores that carry our products. These retailers
are also subject to changes in consumer spending and the overall state of the
economy both domestically and internationally. Any of these factors could have
a material adverse effect on our business, financial condition or results of
operations.
The Company's ability to make scheduled payments of principal, or to pay the
interest or liquidated damages, if any, on, or to refinance, our indebtedness,
or to fund planned capital expenditures will depend on the Company's future
performance, which, to a certain extent, is subject to general economic,
financial, competitive, legislative, regulatory and other factors that are
beyond our control. Based upon the current level of operations and certain
anticipated improvements, the Company believes that cash flow from operations
and available cash, together with available borrowings under the senior credit
agreement, will be adequate to meet our future liquidity needs throughout 2002.
The Company will, however, need to refinance all or a portion of the principal
of the notes on or prior to maturity. There can be no assurance that our
business will generate sufficient cash flow from operations, that anticipated
revenue growth and operating improvements will be realized or that future
borrowings will be available under the senior credit agreements in an amount
sufficient to enable us to service our indebtedness, including the notes, or to
fund our other liquidity needs. In addition, there can be no assurance that we
will be able to effect any such refinancing on commercially reasonable terms or
at all.
Management believes that the Company will have the necessary liquidity
through cash flow from operations, and availability under the existing
Revolving Credit Facility, and its anticipated renewal in December 2002, for
the next several years to fund its expected capital expenditures, obligations
under its credit agreement and subordinated note indentures, environmental
liabilities, and for other needs required to manage and operate its business.
30
Forward Looking Statements
This document contains forward-looking statements within the meaning of the
safe harbor provisions of the Private Securities Litigation Report Act of 1995.
Although the Company believes its plans are based upon reasonable assumptions
as of the current date, it can give no assurances that such expectations can be
attained. Factors that could cause actual results to differ materially from the
Company's expectations include: general business and economic conditions,
competitive factors, raw materials pricing, and fluctuations in demand.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Information relative to the Company's market risk sensitive instruments by
major category at December 2, 2001 is presented under Item 7a of the
registrant's Annual Report on Form 10-K for the fiscal year ended December 2,
2001.
Foreign Currency Exposures
The Company's earnings are affected by fluctuations in the value of its
subsidiaries' functional currency as compared to the currencies of its foreign
denominated purchases. Foreign currency forward, swap and option contracts are
used to hedge against the earnings effects of such fluctuations. The result of
a uniform 10% change in the value of the U.S. dollar relative to currencies of
countries in which the Company manufactures or sells its products would not be
material to earnings or financial position. This calculation assumes that each
exchange rate would change in the same direction relative to the U.S. dollar.
In January 2002, the Argentine peso experienced a significant devaluation.
Previously pegged 1 to 1 to the U.S. dollar, the peso was trading at
approximately 3.6 pesos to the dollar at June 2, 2002. This devaluation did not
have a significant affect on the Company's financial statements due to the
relative immateriality of the operation as total assets at June 2, 2002 were
$7.7 million. Based upon the volatility of the Argentine peso, future inflation
charges may have to be recorded through the income statement due to
hyperinflation rules under FAS 52, "Foreign Currency Translation".
Interest Rate Risk
In 2000, the Company entered into an interest rate swap agreement that
effectively converted $235.3 million of its floating-rate debt to a fixed-rate
basis through December 2006, thereby hedging against the impact of interest
rate changes on future interest expense (forecasted cash flows). Use of hedging
contracts allows the Company to reduce its overall exposure to interest rate
changes, since gains and losses on these contracts will offset losses and gains
on the transactions being hedged. The Company formally documents all hedged
transactions and hedging instruments, and assesses, both at inception of the
contract and on an ongoing basis, whether the hedging instruments are effective
in offsetting changes in cash flows of the hedged transaction. The fair values
of the interest rate agreements are estimated by obtaining quotes from brokers
and are the estimated amounts that the Company would receive or pay to
terminate the agreements at the reporting date, taking into consideration
current interest rates and the current creditworthiness of the counterparties.
A 10% increase or decrease in market interest rates that effect the Company's
interest rate derivative instruments would not have a material impact on
earnings during the next fiscal year.
As of June 2, 2002, the fair value carrying amounts of this instrument,
which is included in other noncurrent liabilities, was a liability of $12.9
million. In addition, $3.0 million and $6.1 million was recorded as income in
accumulated other comprehensive loss for the three and six months ended June 2,
2002. Effective June 3, 2002, the Company dedesignated the interest rate swap
agreement for hedge accounting. As a result of the dedesignation, the $12.9
million included in accumulated other comprehensive loss will be amortized into
interest expense over the remaining life of the interest rate swap agreement.
In addition, future changes in the fair market value of the interest rate swap
will be recorded in interest expense. During the second quarter of 2002, the
31
Company entered into another interest rate swap agreement that has the effect
of reestablishing as floating rate debt the $235.3 million of debt previously
coverted to fixed rate debt. This interest rate swap agreement has not been
designated for hedge accounting and, accordingly, any changes in the fair value
will be recorded in interest expense in the income statement. As of June 2,
2002, the fair value carrying amount of this instrument, which is included in
noncurrent liabilities, was a liability of $0.5 million. In addition, $0.5
million was recorded as additional interest expense.
The Company also entered into an interest rate cap agreement with a notional
amount of $175.0 million that caps the LIBOR rate on which our floating rate
debt is based at 8% through December 2006. This agreement has not been
designated for hedge accounting and, accordingly, any changes in the fair value
will be recorded in interest expense in the income statement. As of June 2,
2002, the fair value carrying amount of this instrument, which is included in
noncurrent assets, was an asset of $0.1 million. In addition, $0.1 million was
recorded as a reduction to interest expense.
To protect against the reduction in value of forecasted foreign currency
cash flows resulting from purchases in a foreign currency, the Company has
instituted a forecasted cash flow hedging program. The Company hedges portions
of its purchases denominated in foreign currencies with forward and options
contracts.
32
PART II. OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 12 to the Condensed Consolidated Financial Statements, Part I, Item
1 included herein.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
(b) Reports on Form 8-K:
None
33
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Sealy Corporation has duly caused this report to be
signed on its behalf by the undersigned, thereunto duly authorized.
SEALY CORPORATION
Signature Title
--------- -----
/s/ DAVID J. MCILQUHAM Chief Executive Officer
- ----------------------------- (Principal Executive Officer)
David J. McIlquham
/s/ E. LEE WYATT Corporate Vice
- ----------------------------- President--Administration
E. Lee Wyatt and Chief Financial Officer
(Principal Accounting Officer)
Date: July 17, 2002
34