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HIGH YIELD RESEARCH

.

M

ORGAN

J OSEPH

Howard Goldberg

212-218-3701

HGOLDBERG@MORGANJOSEPH.COM

March 4, 2004

Foamex International Inc. (“FMXI”): Primed For A

Recovery, In Need Of Cost Relief; Hold The Bonds.

Table 1: Security Details

Issuer

Issue

Coupon

Amount

Maturity

Ratings

Price

YTW

Foamex LP/

Sr Sec’d (2 nd lien)

10.75%

$300mm

04/901/09

B3/B-

92.5

12.2%

Capital Corp

Foamex LP

Senior

13.50%

$53.5mm

08/15/05

Caa2/CCC+

93

19.3%

Sub Nts

Foamex LP

Senior

9.875%

$148.5mm

02/15/07

Caa2/CCC+

73

19.3%

Sub Nts

* Source: Company reports

Summary and recommendation: We continue with our recommendation to hold the Foamex bonds (prior report dated 11/13/03). Following several rounds of debilitating raw material price increases beginning in mid-02, FMXI has stabilized its business by raising prices to keep pace with costs, cutting employment, consolidating facilities, and aiding liquidity through a new lending agreement. Even with these steps, EBITDA remains considerably below historical levels and total debt of $732mm, a hefty 8.4X EBITDA, remains daunting. We note that while FMXI subordinated debt is cheap in the context of triple-C quality issuers, our near-term outlook for the company provides little justification for higher bond prices.

Looking ahead to 2004, we believe that the key issues facing the company include the following:

Sales remain subdued, with recent quarterly declines near 4% likely to be repeated into the first half of 2004. While some of this erosion represents the loss of marginal business, automotive segment volume will lead the decline (“desourcing” of a piece of Johnson Controls business). Our forecasts assume a recovery in technical products (especially ink jet printer foams) following 2003’s surprise shortfall.

FMXI has demonstrated its ability to offset raw material price costs through price increases, but slippage can occur (as we expect in Q1:04). FMXI is attempting to get ahead of the pricing curve through some combination of improved/expanded relationships with key suppliers and higher value-added products to restore gross margins to the 13%+ range of earlier prosperous periods.

Our forecasts assume successful reductions in SG&A, with the company executing on its plan to cut out $5-$6mm in 2004.

Liquidity is thin. A $3mm cushion at year-end (relative to the credit facility’s key 1.00X fixed charge coverage test) should expand through Q1:04, but otherwise remains stressed.

Management guidance on key financial metrics is limited. Since FMXI’s business is very volatile, short-term results may vary significantly from our estimates.

Table 2: Financial Summary

$ millions

2001

2002

2003

2004 E

Total Revenues

$1,253

$1,328

$1,305

$1,278

EBITDA

134

81

87

93

Interest Expense

63

71

73

73

Total Debt

629

722

732

724

EBITDA / Int Expense

2.2X

1.2X

1.2X

1.3X

EBITDA / Tot Debt

5.1X

9.0X

8.4X

7.8X

Source: Company reports and Morgan Joseph & Co. Inc. estimates.

The Disclosure section may be found on the last page of this report.

reports and Morgan Joseph & Co. Inc. estimates. The Disclosure section may be found on the

Foamex International Inc.

March 4, 2004

Recent Results – Q4:03 (see Table 6 for details): Sales of $315mm were down 3.7% YOY, exceeding guidance. Reported EBITDA of $20.9mm fell shy of our $22mm estimate, with a relatively healthy gross margin of 11.8% offset by unusually high SG&A expenses. Management did not quantify any amounts related to higher bad debt expenses or spending in pursuit of opportunities in China, though we suspect these were more than enough to make up the $1.1mm shortfall in our estimates. For this reason, we believe that FMXI has a head start on its programs to reduce SG&A in ’04.

Capital expenditures were only $1.8mm in Q4 and $6.5mm for the year. Notwithstanding management assurance that capex has been adequate, spending in relation to depreciation and amortization ($26mm) or net p,p&e ($165mm) is quite small. The company plans to spend in excess of $10mm in ’04. Working capital appears to have been well-managed during Q4, with receivables, inventory and payables generating roughly $10mm in cash. However, we estimate that total financing costs in Q4 were near $30mm (semi- annual bond interest, credit facility interest plus $1.8mm amortization), causing year-end borrowings to go up $10mm.

Table 3 Segment Data ($ in millions) (1)

Segment

2000

2001

2002

2003

Foam Products Revenues

$519

$500

$471

$508

 

EBITDA

73

82

39.4

33

Carpet Cushion Revenues

256

231

234

209

 

EBITDA

10

1.3

(6)

4

Auto Products

Revenues

342

378

467

447

 

EBITDA

28

26

29

25

Technical Products Revs

107

111

124

117

 

EBITDA

32

26

23

24

Total

Revenues (2)

1,258

1,253

1,328

1,305

 

EBITDA (2)

130

131

83

88

(1) Revenues are as reported. Beginning with Q4:03 FMXI ceased reporting segment EBITDA; our figures are estimates. (2) Includes “Other” segment accounting for about 2% of revenues and modest EBITDA losses, including corporate adjustments.

Source: Company reports and Morgan Joseph & Co. Inc. estimates.

Forecasts : FMXI ought to enjoy its final easy YOY comparison in Q1, despite a sales decline which we estimate will approach 5% (due largely to auto products) to about $312mm. We are reasonably comfortable that SG&A will be returned to more normal Q2-Q3:03 levels, and have anticipated sequential gross margin softness because of polyol and TDI price increases effective January 1. Management was imprecise on the call, so we are unsure of the magnitude (Q4 11.8% to Q1E 10.6%). An additional 50b.p. erosion is worth $1.5mm relative to our $19.5mm estimate.

With another raw material price increase slated for April 1, prospects for Q2 are decidedly unfavorable relative to last year’s peak quarter, when FMXI earned $26.2mm in EBITDA. We consider it likely that FMXI will give up much of its Q1 gain in Q2, and begin the second half looking for a back-ended recovery. Better alliances with key suppliers, more value-added technology and consumer products, and possible price initiatives suggest that this is not out of reach.

FMXI restated results for the first three quarters of 2003, which we have updated on table 6. In the aggregate the changes were not material, although we point out that we are unable to make appropriate retroactive adjustments to these quarterly numbers. This may affect comparisons to 2004 periods.

Capital Structure: FMXI’s capital structure is described in detail below and laid out in Table 4.

Bank facilities: On August 18, 2003 the company announced a new bank credit agreement consisting of a $240mm asset-based credit facility and an $80mm secured term loan. The $240mm facility, led by Bank of America, includes a $190mm revolver commitment and a $50mm term loan, and is due 4/07.

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$240mm facility, led by Bank of America, includes a $190mm revolver commitment and a $50mm term

Foamex International Inc.

March 4, 2004

The $80mm term loan was provided by Silver Point Finance, and matures concurrently. These facilities replace a smaller-sized financing of $262mm, providing increased liquidity to FMXI, and pushes out about $190mm in maturities which were scheduled to come due 2004-07. Key provisions include the following:

The company must maintain at least a 1.00X fixed charge coverage ratio annually through 2007 (no escalation). Fixed charges include interest payments, certain principal payments (excluding the 13.5s), and cash distributions and restructuring expenses (with allowances).

Capital expenditures are limited to $17.7mm in 2003 $24.8mm in 2004, and $27.5mm thereafter. There is a one year carryover of unused amounts.

FMXI may borrow $10mm to repurchase subordinated debt (subject to availability requirements). Some investors seem to believe a repurchase of the 13.5s is highly likely; we suggest the company is more apt to preserve any excess liquidity, given its experiences over the past year.

10.75% Senior Notes (Second Lien): These bonds were issued as a 144A in March 2002 in the principal amount of $300mm (excluding a $14mm deferred credit on an interest rate swap, which is added to principal in FMXI’s financials). They were guaranteed on a senior basis by domestic restricted subsidiaries that are guarantors of FMXI’s credit facilities, and that guarantee remains under the new structure. Further, the Notes are secured on a second-priority basis.

The 13.5% and 9.875% Senior Subordinated Notes rank pari passu. Importantly, one distinction between the two issues is that “….in connection with Asset Sales, Foamex is required to offer to repurchase the 9.875% Notes before it offers to repurchase the 13.5% Notes”. Refinancing of the 13.5s is permitted under the new credit facilities. We believe that the refinancing of the 13.5s prior to maturity will require much stronger performance; the bonds become par callable in August 2004.

Table 4 Capital Structure ($ in millions)

Issue

2001

2002

2003

2004E

Credit facility

$361

$214

$224mm

$217mm

IRB’s, other

10

8

8

7

Tot first priority

371

222

232

224

10.75% 2 nd priority (1)

0

300

300

300

1 st + 2 nd priority

371

522

532

524

13.50% Sr Subs (2)

98

52

52

52

9.75% Sr Subs

150

149

149

149

Total debt

629

723

733

725

Current maturities (inc above)

4

0

7

7

Letters of Credit

 

21

21

 

Cash Overdrafts

4

18

N/A

 

Cash balances

15

5

7

 

Source: Company reports and Morgan Joseph & Co. Inc. estimates debt premium.

(1) excludes deferred credit on interest rate swap. 2) excludes unamortized

Company Description: FMXI is the largest manufacturer and distributor of flexible polyurethane and advanced polymer foam products in North America, and is believed to be the largest in each of its four principal product areas, described below:

Foam products (39% 2003 sales and 38% Operating Income) – Consists of cushioning foams for bedding (quilts, toppers, border rolls) furniture (upholstered seating products), mattress pads and related items. Major customers include bedding products manufacturers Sealy and Simmons.

Carpet cushion (16% 2003 sales and 5% EBITDA) – Manufactures rebond (made from recycled materials), prime, felt and rubber carpet padding. Distributors and major retailers, such as Home Depot, are major customers. An agreement to sell this business to Leggett & Platt in mid-2002 for $70mm fell through. While management has not intimated this business is for sale, it is clear that a

3

in mid-2002 for $70mm fell through. While management has not intimated this business is for sale,

Foamex International Inc.

March 4, 2004

figure anywhere near $70mm for a business with modest EBITDA would be viewed favorably by bondholders.

Automotive (34% 2003 sales and 29% EBITDA) – Manufactures automotive products in such areas as foam rolls, laminates, headliner substrates, and acoustical products. FMXI distributes to major tier one suppliers and OEMs, such as Johnson Controls (“JCI”, 17.3% of total 2002 sales, or $229mm), Lear Corporation, and Daimler Chrysler. In early 2003 JCI informed FMXI that, in an effort to diversify its supply base, it would cut its purchases from FMXI by up to $70mm, a portion of which was recognized in 2003. Management indicates $60mm of this desourcing will take place in 2004, most of which we estimate will occur in Q1 and Q2.

Technical Products (9% 2003E sales and 20% EBITDA) – Includes reticulated foams used in applications to provide filtration, reservoiring, and sound absorption. Specific uses include automotive gasketing, inkjet cartridges, and acoustical computer foams. Sales fell 15% in Q3, as management stated that customers bought forward earlier this year on concerns about FMXI’s vitality. Q4 revenues recovered somewhat, though were still down 2%. Hewlett Packard and Briggs & Stratton are major customers.

4

recovered somewhat, though were still down 2%. He wlett Packard and Briggs & Stratton are major

Foamex International Inc.

March 4, 2004

Foamex International Inc.

Morgan Joseph & Co. Howard Goldberg

212-218-3701

3/3/2004

Table 6

Quarterly Financial Summary

 

$000

2002 - not restated

 

2003

 
 

1Q02

2Q02

3Q02

4Q02

1Q03

2Q03

3Q03

4Q03

2002

2003

2004E

INCOME STATEMENT

March

June

Sep

Dec

March

June

Sep

Dec

restated

these numbers do not exactly foot to restated '02

 

Net Sales Sales % Change - yr/yr Cost of Goods Sold Gross Profit Gross Margin Selling, General & Administrative SG&A Percent Sales Depreciation & Amortization

314,062

345,898

340,823

327,311

328,151

337,637

323,542

315,230

1,328,094

1,304,560

1,278,000

4.0%

10.1%

4.5%

5.4%

4.5%

(2.4%)

(5.1%)

(3.7%)

6.0%

(1.8%)

(2.0%)

276,384

298,951

310,009

299,598

297,614

298,963

286,196

278,097

1,184,392

1,160,870

1,131,500

37,678

46,947

30,814

27,713

30,537

38,674

37,346

37,133

143,702

143,690

146,500

12.0%

13.6%

9.0%

8.5%

9.3%

11.5%

11.5%

11.8%

10.8%

11.0%

11.5%

17,683

21,796

24,993

25,491

20,899

19,315

19,394

22,980

94,744

82,588

77,000

5.6%

6.3%

7.3%

7.8%

6.4%

5.7%

6.0%

7.3%

7.1%

6.3%

6.0%

7,930

8,301

7,514

7,980

6,105

6,851

6,294

6,750

31,640

26,000

23,500

EBITDA

27,925

33,452

13,335

10,202

15,743

26,210

24,246

20,903

80,598

87,102

93,000

EBITDA % Change - yr/yr EBITDA Margin

(15.0%)

(10.7%)

(61.3%)

(66.4%)

(43.6%)

(21.6%)

81.8%

104.9%

(40.4%)

8.1%

6.8%

8.9%

9.7%

3.9%

3.1%

4.80%

7.76%

7.5%

6.6%

6.1%

6.68%

7.28%

Restructuring and Other Charges Interest Expense Income - Equity Interest in JV Other expense, net

(1,538)

(1,107)

10,011

-

(1,551)

314

(522)

4,799

(1,759)

1,000

18,629

17,338

16,510

18,454

19,111

19,378

18,650

18,335

70,931

75,474

73,500

730

398

386

220

366

513

495

92

1,734

1,466

2,000

350

(27)

370

(92)

(1,615)

(233)

(13,852)

(646)

41

(16,346)

-

TOTAL PRETAX INCOME Total Income Tax Expense

3,284

8,184

(11,040)

(25,931)

(10,722)

1,812

(14,369)

(4,214)

(25,079)

(27,493)

(3,000)

851

(74,822)

(3,695)

(4,606)

(300)

(1,633)

(3,370)

(701)

(85,691)

(6,004)

(900)

NET INC (LOSS)

2,433

83,006

(7,345)

(21,325)

(10,422)

3,445

(10,999)

(3,513)

60,612

(21,489)

(2,100)

Key Credit Stats Interest expense Capital expenditures Total Debt EBITDA/Interest Total Debt / EBITDA

Debt Structure Revolving Credit Term Loan Other 10.75% Sr Nts 4/01/09 B3/B- 13.5% Sr Sb 8/15/05 Caa2/CCC+ 9.875% Sr Sb 6/15/07 Caa2/CCC+ Total Debt Bank debt/EBITDA Bank debt + 10.75s/EBITDA

Balance Sheet Items Cash A/R Inventory A/P

18,329

17,038

16,210

18,154

18,811

18,878

18,250

17,935

69,643

73,874

72,500

6354

3731

1792

3705

2028

1137

1518

1830

15582

6,513

9,500

722,877

721,495

670,524

726,916

720,877

721,446

721,863

731,585

723,585

1.52x

1.96x

0.82x

0.56x

0.96x

1.39x

1.33x

1.17x

1.16x

1.18x

1.28x

 

10.62x

11.01x

9.44x

8.96x

8.40x

7.78x

0

0

0

56,889

50,844

83,442

51,823

96,000

96,000

162,206

162,206

162,188

162,188

162,188

130,000

162,188

128,000

120,000

8,904

8,210

8,083

7,754

7,760

7,919

7,767

7,500

7,500

300,000

300,260

300,000

300,000

300,000

300,000

300,000

300,000

300,000

101,767

100,819

51,753

51,585

51,585

51,585

51,585

51,585

51,585

150,000

150,000

148,500

148,500

148,500

148,500

148,500

148,500

148,500

722,877

721,495

670,524

726,916

720,877

721,446

721,863

731,585

723,585

 

3.20x

3.48x

2.79x

 

2.66x

2.57x

2.32x

7.70x

8.51x

6.82x

6.38x

6.02x

5.55x

34,170

54,174

16,101

2,725

8,032

4,946

4,524

6,600

5,000

187,044

199,679

208,913

210,475

189,655

196,100

191,546

180,800

180,000

103,971

106,482

112,408

109,551

96,788

100,800

98,010

98,700

97,000

139,401

119,510

143,594

122,886

101,708

110,200

87,400

101,700

100,000

Source: Company reports, Morgan Joseph estimates

5

122,886 101,708 110,200 87,400 101,700 100,000 Source: Company reports, Morgan Joseph estimates 5

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I, Howard Goldberg, the author of this research report, certify that the views expressed in this report accurately reflect my personal views about the subject securities and issuers, and no part of my compensation was, is, or will be directly or indirectly tied to the specific recommendations or views contained in this research report.

The information contained herein is based upon sources believed to be reliable but is not guaranteed by us and is not considered to be all-inclusive. It is not to be construed as an offer or the solicitation of an offer to sell or buy the securities mentioned herein. Morgan Joseph & Co. Inc., its affiliates, shareholders, officers, staff, and/or members of their families, may have a position in the securities mentioned herein, and, before or after your receipt of this report, may make or recommend purchases and/or sales for their own accounts or for the accounts of other customers of the Firm from time to time in the open market or otherwise. Opinions expressed are our present opinions only and are subject to change without notice. Morgan Joseph & Co. Inc. is under no obligation to provide updates to the opinions or information provided herein. Additional information is available upon request.

Research analyst compensation is dependent, in part, upon investment banking revenues received by Morgan Joseph & Co. Inc.

Morgan Joseph & Co. Inc. may receive or intends to seek compensation for investment banking services from the subject company.

All prices are indications only, and are subject to change without notice. Prices are informational in nature only, and are not to be construed as an offer or solicitation with respect to the purchase or sale of any security or debt referred to herein. Investors in securities referenced herein should understand that statements regarding future prospects might not be realized. Investors should note that income from such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive fewer funds than originally invested. Past performance is not necessarily a guide to future performance.

© Copyright 2004 by Morgan Joseph & Co. Inc.