10-Q 1 d10q.txt FORM 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 2001 Commission File No. 333-95945 MATTRESS DISCOUNTERS CORPORATION (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 52-1710722 (I.R.S. Employer Identification No.) 9822 Fallard Court Upper Marlboro, MD 20722 (Address of principal executive offices) (301) 856-6755 Registrant's telephone number, including area code Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. No Yes X --------- --------- Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Outstanding at May 12, 2001 Class --------------------------- ----- 100 Common Stock, $.01 Par Value ================================================================================ MATTRESS DISCOUNTERS CORPORATION -------------------------------- TABLE OF CONTENTS ----------------- Page ----

-2- PART I. FINANCIAL INFORMATION Item 1. Financial Statements MATTRESS DISCOUNTERS CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (in thousands, except for share data)

See accompanying notes to consolidated financial statements. -3- MATTRESS DISCOUNTERS CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS (in thousands)

See accompanying notes to consolidated financial statements. -4- MATTRESS DISCOUNTERS CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS (in thousands)

See accompanying notes to consolidated financial statements. -5- MATTRESS DISCOUNTERS CORPORATION AND SUBSIDIARIES UNAUDITED CONSOLIDATED STATEMENT OF STOCKHOLDER'S EQUITY (in thousands)

See accompanying notes to consolidated financial statements. -6- MATTRESS DISCOUNTERS CORPORATION AND SUBSIDIARIES NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (in thousands) 1. Organization and Basis of Financial Statement Presentation Mattress Discounters Corporation and subsidiaries are engaged in the manufacture and retail sale of mattresses and bedding products, in various markets throughout the United States. The accompanying consolidated financial statements at March 31, 2001 and December 30, 2000 include the accounts of Mattress Discounters Corporation (''Mattress Discounters''), and its wholly owned subsidiaries T.J.B., Inc. (''T.J.B.''), and The Bedding Experts, Inc. (''Bedding Experts'') (collectively referred to as the ''Company''). All significant intercompany accounts and transactions of the Company have been eliminated. Certain amounts in the consolidated financial statements for prior periods have been reclassified to conform to the current period's presentation. The accompanying unaudited consolidated financial statements contain all adjustments which, in the opinion of management, are necessary to present fairly the financial position of the Company at March 31, 2001, 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 accompanying unaudited consolidated financial statements should be read together with the audited consolidated financial statements for the year ended December 30, 2000. The results of operations for the three-month interim period ended March 31, 2001 are not necessarily indicative of the results of operations for the year ending December 29, 2001. The preparation of financial statements in conformity with generally accepted accounting principles requires that management make estimates and assumptions affecting the assets and liabilities (including contingent assets and liabilities) reported at the date of the consolidated financial statements and the revenues and expenses reported for the periods presented. Actual amounts could differ from those estimates. 2. Senior Credit Facility On August 6, 1999, the Company entered into a new credit agreement with a consortium of banks (the "Senior Credit Facility"), to finance a portion of the recapitalization of the Company's parent and to provide available borrowings for use in the normal course of business. The Senior Credit Facility provides for revolving loans for up to $20.0 million, including letters of credit of up to $5.0 million. The interest rate under the Senior Credit Facility is either: (1) the base rate, which is the higher of the prime lending rate, 1% in excess of the secondary market rate for three-month depository certificates or 0.5% in excess of the Federal funds effective rate, plus a margin or (2) the Eurodollar rate plus a margin. The margins of the loans under the Senior Credit Facility will be established and then will vary according to a pricing grid based upon the achievement of performance targets. Commitment fees are payable at a rate per annum of 0.5% on the undrawn amounts of the revolving loans but may be reduced depending upon the achievement of performance targets, as defined by the Senior Credit Facility. There were no amounts outstanding under the Senior Credit Facility as of December 30, 2000 or March 31, 2001. In April 2001, the Company borrowed $18 million under the Senior Credit Facility. The Senior Credit Facility is subject to mandatory prepayment in a variety of circumstances, including upon certain asset sales and financing transactions, and, also from excess cash flow (as defined in the Senior Credit Facility). T.J.B., Bedding Experts and Mattress Holdings Corporation (the Company's parent) have guaranteed the Company's obligations under the Senior Credit Facility. The Senior Credit Facility is collateralized by substantially all assets of the Company (see Note 5). -7- Further, the Senior Credit Facility requires that the Company meet certain financial covenants which include a maximum total debt ratio and a minimum interest coverage ratio. In addition, the Senior Credit Facility contains restrictions, subject to certain exceptions, including, but not limited to, engaging in transactions with affiliates; prepaying subordinate debt and the senior notes; incurring indebtedness and liens; declaring dividends or redeeming or repurchasing capital stock; and making loans and investments; engaging in mergers, acquisitions, consolidations and asset sales; and making capital expenditures. The revolving loans under the Senior Credit Facility are due in August 2005. Pursuant to the terms of the Senior Credit Facility, non-compliance with one or more of the financial covenants permits the lenders to exercise certain remedies, which include the termination of the commitment and to declare the related principal balance and any accrued interest immediately due and payable. As of March 31, 2001, the Company was not in compliance with the total debt ratio and the interest coverage ratio covenants. On May 14, 2001, the Company entered into an agreement to amend the Senior Credit Facility. Such amendment waived the Company's non-compliance with respect to the financial covenants as of March 31, 2001 through the period ending June 22, 2001. Further, such amendment increased the applicable margin, as defined, to 3.5% per annum with respect to Eurodollar loans and to 2.5% per annum with respect to Prime Rate based loans. Additionally, the Company anticipates that it will not be in compliance with the financial covenants in the second quarter of 2001 without further modifications to the agreement and, accordingly, is currently in discussions with its lenders to amend the agreement. Inability of the Company to reach an agreement with its lenders on an amendment or to arrange for alternative financing could have a material adverse effect on the Company. In the event the Company and the bank group are able to satisfactorily amend the financial covenants under the Senior Credit Facility, the Company believes that funds generated from operations, together with borrowings under the Senior Credit Facility, should be sufficient to finance its current operations, debt service requirements and planned capital expenditures for at least the next twelve months. Alternatively, the Company may be able to satisfy its liquidity needs by arranging for alternative financing, although no assurances can be given in that regard. Additionally, the Company had approximately $2.3 million of outstanding letters of credit at December 30, 2000 and March 31, 2001. 3. Inventories Inventories are summarized as follows, as of:

4. Segment Information The Company operates in two reportable segments, as described below: (a) Retail Segment--Sale of mattresses and bedding products through 297 and 256 retail locations as of March 31, 2001 and April 1, 2000, respectively. (b) Manufacturing Segment--Manufacture and sale of mattresses, box springs and foundations to the retail segment and to external retailers at current market prices. All intersegment sales prices are market-based. The Company evaluates performance based on the operating earnings of the respective business units. -8- Summarized unaudited financial information concerning the Company's reportable segments is shown in the following table:

(1) Segment profit (loss) represents income (loss) from operations. (2) Identifiable assets represent only inventories and net property and equipment in the retail and manufacturing segments. All other assets are included in Corporate/Other. For management purposes, depreciation and amortization of corporate identifiable assets are allocated to the retail and manufacturing segments. 5. Summarized Financial Information The Company's Senior Credit Facility and Senior Notes are guaranteed, fully, jointly and severally, and unconditionally by all of the Mattress Discounters' current and future, direct and indirect subsidiaries. The following is summarized condensed consolidating financial information of the Company, segregating the parent company (Mattress Discounters) and its guarantor subsidiaries. As described in Note 1--Organization and Basis of Financial Statement Presentation, each of Mattress Discounters' subsidiaries are wholly owned. Separate financial statements of the guarantor subsidiaries are not presented because management believes that separate financial statements would not be beneficial to investors. Index to Unaudited Condensed Consolidating Information ------------------------------------------------------ o Consolidating Balance Sheets at March 31, 2001 o Consolidating Statements of Operations for the three months ended March 31, 2001 o Condensed Consolidating Statements of Cash Flows for the three months ended March 31, 2001 o Consolidating Balance Sheets at December 30, 2000 o Consolidating Statements of Operations for the three months ended April 1, 2000 o Condensed Consolidating Statements of Cash Flows for the three months ended April 1, 2000 -9- Unaudited Consolidating Balance Sheets March 31, 2001 (in thousands)

-10- Unaudited Consolidating Statements of Operations For the three months ended March 31, 2001 (in thousands)

Unaudited Condensed Consolidating Statements of Cash Flows For the three months ended March 31, 2001 (in thousands)

-11- Unaudited Consolidating Balance Sheets December 30, 2000 (in thousands)

-12- Unaudited Consolidating Statements of Operations For the three months ended April 1, 2000 (in thousands)

Unaudited Condensed Consolidating Statements of Cash Flows For the three months ended April 1, 2000 (in thousands)

-13- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Overview Mattress Discounters Corporation ("MDC" or the "Company") operates in two segments: mattress retailing and mattress manufacturing. We currently operate our retail business through a nationwide network of 297 stores in 15 markets. Our manufacturing segment consists of three manufacturing facilities that produce mattresses for sale in our retail stores under the Comfort Source brand and for sale to external retailers under separate brands. Results of Operations The following discussion compares our results of operations for the three months ended March 31, 2001 to the three months ended April 1, 2000. The table below sets for our statement of operations in dollars and as a percentage of sales for the periods indicated.

Three Months Ended March 31, 2001 Compared to Three Months Ended April 1, 2000 Net sales: The Company's net sales for the three months ended March 31, 2001 decreased $12.4 million to $60.0 million from $72.4 million for the three months ended April 1, 2000. The decrease in sales is primarily due to the overall decline in mattress sales throughout the industry. The decrease represents a $4.7 million, or 7.4% decrease in our retail net sales coupled with a decrease of $7.7 million, or 88.5% in the external net sales of our manufacturing operation. Our net sales from retail operations, manufacturing sales to our retail operations, and manufacturing sales to external retailers were $59.0 million, $8.6 million, and $1.0 million, respectively, in the three months ended March 31, 2001, and $63.7 million, $9.6 million and $8.7 million, respectively, in the three months ended April 1, 2000. Overall, MDC's retail sales for the three months ended March 31, 2001 decreased $4.7 million or 7.4%. The decrease in retail sales for the three months ended March 31, 2001 is attributable to (a) a $9.8 million decrease in comparable store sales offset by (b) a $5.1 million net increase resulting from net new store openings since April 1, 2000. Comparable store sales declines were reflected throughout all of our markets nationwide, with -14- Denver and Chicago markets showing the largest decline with 55% and 30% declines, respectively. Management continues to pursue initiatives to improve the operating performance of the retail stores in the Chicago and other markets. Net sales generated by the Company's manufacturing operations during the three months ended March 31, 2001, decreased $8.7 million to $9.6 million from $18.3 million for the three months ended April 1, 2000. Substantially all of our manufacturing output is now consumed by our retail operations. Sales to external retailers decreased to $1.0 million from $8.7 million. The decrease in external net sales of our manufacturing operations is due to lower sales to Heilig-Meyers. Heilig-Meyers is currently reorganizing under Chapter 11 of the U.S. Bankruptcy Code. Gross profit: Gross profit for the three months ended March 31, 2001 decreased $7.2 million or 28.9% to $17.7 million from $24.9 million for the three months ended April 1, 2000. The $7.2 million decrease is comprised of $5.0 million lower gross profit on retail sales and $2.2 million lower gross profit on manufacturing sales to external retailers. As a percentage of net sales, gross profit was 29.5% in the three months ended March 31, 2001, compared to 34.4% in the three months ended April 1, 2000. The decrease in gross profit percentage is primarily attributable to higher occupancy costs as a result of additional store openings in relation to lower sales volumes in the current period. As of March 31, 2001, 297 stores were in operation compared to 256 stores operating as of April 1, 2000. Retail segment gross profit for the three months ended March 31, 2001 was $15.5 million, a decrease of $5.0 million. Manufacturing segment gross profit was $2.2 million, a decrease of $2.2 million. Retail gross profit expressed as a percentage of net retail sales was 26.2% in the three months ended March 31, 2001, compared to 32.1% in the three months ended April 1, 2000. This decrease is driven by the existence of certain fixed operating costs, primarily occupancy costs, incurred during a period of lower sales volumes. Manufacturing gross profit expressed as a percentage of manufacturing sales decreased to 22.9% in the three months ended March 31, 2001, compared to 24.3% in the three months ended April 1, 2000. General and administrative expenses: General and administrative expenses for the three months ended March 31, 2001 decreased $1.4 million or 6.7% to $19.7 million from $21.1 million for the three months ended April 1, 2000. As a percentage of net sales, general and administrative expenses were 32.9% in the three months ended March 31, 2001, compared to 29.2% in the three months ended April 1, 2000. The decrease in general and administrative expenses is primarily due to lower sales commissions earned during the quarter ended March 31, 2001 as a result of lower sales volumes in the period. Interest expense: Interest expense for the three months ended March 31, 2001 and April 1, 2000 remained stable at $5.0 million. Provision for (benefit from) income taxes: The effective income tax rate for the three months ended March 31, 2001, was 36.8% compared to 55.6% for the three months ended April 1, 2000. The Company's effective income tax rate differs from the federal statutory rate primarily as a result of state income taxes and the non-deductibility of goodwill amortization. The decrease in the effective income tax rate during the three months ended March 31, 2001, is a result of the amount of non-deductible expenses relative to pretax loss. Net loss: Primarily as a result of the reasons discussed above, net loss increased to $4.4 million or 7.3% of net sales in the three months ended March 31, 2001, from $0.5 million or 0.7% of net sales in the three months ended April 1, 2000. Liquidity and Capital Resources In connection with the leveraged recapitalization in August 1999, the Company incurred significant amounts of debt ("Senior Notes") requiring interest payments on the Senior Notes and interest and principal payments under the Senior Credit Facility. Our liquidity needs relate to working capital, debt service, capital expenditures and potential acquisitions. We intend to fund our working capital, capital expenditures and debt service requirements through cash flow generated from operations and through borrowings under the Senior Credit Facility. -15- At December 30, 2000 and March 31, 2001, there were no amounts outstanding under the Senior Credit Facility. In April 2001, the Company borrowed $18 million under the Senior Credit Facility. Cash and cash equivalents at December 30, 2000 and March 31, 2001 were approximately $8.2 million and $2.5 million, respectively. The Senior Credit Facility requires that the Company meet certain financial covenants which include a maximum total debt ratio and a minimum interest coverage ratio. In addition, the Senior Credit Facility contains restrictions, subject to certain exceptions, including, but not limited to, engaging in transactions with affiliates; prepaying subordinate debt and the senior notes; incurring indebtedness and liens; declaring dividends or redeeming or repurchasing capital stock; and making loans and investments; engaging in mergers, acquisitions, consolidations and asset sales; and making capital expenditures. The revolving loans under the Senior Credit Facility are due in August 2005. Pursuant to the terms of the Senior Credit Facility, non-compliance with one or more of the financial covenants permits the lenders to exercise certain remedies, which include the termination of the commitment and to declare the related principal balance and any accrued interest immediately due and payable. As of March 31, 2001, the Company was not in compliance with the total debt ratio and the interest coverage ratio covenants. On May 14, 2001, the Company entered into an agreement to amend the Senior Credit Facility. Such amendment waived the Company's non-compliance with respect to the financial covenants as of March 31, 2001 through the period ending June 22, 2001. Further, such amendment increased the applicable margin, as defined, to 3.5% per annum with respect to Eurodollar loans and to 2.5% per annum with respect to Prime Rate based loans. Additionally, the Company anticipates that it will not be in compliance with the financial covenants in the second quarter of 2001 without further modifications to the agreement and, accordingly, is currently in discussions with its lenders to amend the agreement. Inability of the Company to reach an agreement with its lenders on an amendment or to arrange for alternative financing could have a material adverse effect on the Company. In the event the Company and the bank group are able to satisfactorily amend the financial covenants under the Senior Credit Facility, the Company believes that funds generated from operations, together with borrowings under the Senior Credit Facility, should be sufficient to finance its current operations, debt service requirements and planned capital expenditures for at least the next twelve months. Alternatively, the Company may be able to satisfy its liquidity needs by arranging for alternative financing, although no assurances can be given in that regard. At December 30, 2000 and March 31, 2001, the Company had approximately $2.3 million of outstanding letters of credit. Net cash used in operating activities for the three months ended March 31, 2001 was $4.6 million, as compared to the $3.9 million of cash provided by operating activities for the three months ended April 1, 2000. The primary cause of the decreased cash flow from operations in the quarter ended March 31, 2001 is the Company's net loss of $4.4 million in the current period. Our principal use of cash for investing activities has historically been capital expenditures for new store openings. Total capital expenditures for the three months ended March 31, 2001 and April 1, 2000 were $1.1 million and $0.5 million, respectively. The increase in spending in 2001 is primarily related to new store openings as well as to the continuing implementation of a new POS/Inventory system. Net cash used for financing activities was $0.1 million for the three months ended March 31, 2001 and $2.5 million for the three months ended April 1, 2000. Cash used in financing activities primarily relates to the repurchase of stock options for $2.4 million for the three month period ended April 1, 2000. The Company is pursuing its rights in the Heilig-Meyers bankruptcy proceeding to recover an outstanding receivable in the aggregate amount of $1.6 million. Management Subsequent to the end of the first quarter, there have been changes to the management team of MDC. Effective April 2, 2001, Stephen Walker, the Company's Chief Executive Officer, has left the Company to pursue other opportunities. Stephen Newton, the Company's Chief Operating Officer has been appointed Chief Executive Officer. -16- Forward-Looking Statements This document includes forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Although we believe that our assumptions made in connection with the forward-looking statements are reasonable, we cannot assure you that our assumptions and expectations will prove to have been correct. These forward-looking statements are subject to various risks, uncertainties and assumptions about us, including, among other things: o anticipated growth strategies and pursuit of potential acquisition opportunities o dependence upon our senior management team o increased future competition o possibility of fluctuations in the cost of raw materials and loss of suppliers o changes in economic and market conditions o dependence on Sealy o reliance on certain trademarks and other intellectual property o ability to return our stores in the Chicago and Denver markets to profitability. MDC undertakes no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this quarterly report on Form 10-Q might not occur. Item 3. Quantitative and Qualitative Disclosure About Market Risk We do not believe that we have material quantitative or qualitative market risk exposures. -17- PART II. OTHER INFORMATION Item 1. Legal Proceedings We are party to various proceedings from time to time arising in the ordinary course of business. We do not expect that these matters, individually or in the aggregate, will have a material adverse effect on our business, financial condition or results of operations. We are not currently involved in any material legal proceedings. Item 2. Changes in Securities None Item 3. Defaults upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders This Item is not applicable. Item 5. Other Information None Item 6. Exhibits and Reports on Form 8-K (a) Exhibits -------- None. (b) Reports on Form 8-K ------------------- During the period covered by this report, the Company filed the following Reports on Form 8-K: (1) Form 8-K dated April 2, 2001, and filed with the Commission on April 10, 2001, reporting information under Items 5 and 7. -18- SIGNATURES ---------- Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. MATTRESS DISCOUNTERS CORPORATION /s/ Bryan J. Flanagan ----------------------------- May 15, 2001 Name: Bryan J. Flanagan Title: Chief Financial Officer -19-

MATTRESS DISCOUNTERS CORP 10-Q