**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**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: February 26, 2006                                                                                                                                        |
| o                                                                                                                                                                                              | TRANSITION REPORT  PURSUANT TO SECTION 13 OR 15(d) SECURITIES EXCHANGE ACT OF 1934       |
| For  the Transition Period  from            to               |

 

Commission file number 333-1178482-27

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**SEALY MATTRESS CORPORATION**

**(Exactname of registrant as specified in its charter)**

| **Delaware**                                    | **20-1178482**                        |
|-------------------------------------------------|---------------------------------------|
| (State or other  jurisdiction of incorporation) | (I.R.S. Employer  Identification No.) |
| **Sealy Drive**                                 | **27370**                             |
| **One  Office Parkway**                         | (Zip Code)                            |
| **Trinity,  North Carolina**                    |                                  |
| (Address of  principal executive offices)       |                                  |

 

**(336) 861-3500**

**Registrant’s telephone number,including area code**

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months and (2) hasbeen subject to such filing requirements for the past 90 days. Yes xNo o

Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer,or a non-accelerated filer. See definition of “accelerated filer” and “largeaccelerated filer” in Rule 12b-2 of the Exchange Act. (check one):

| Large accelerated filer o | Accelerated Filer  o | Non-accelerated  filer x |
|--------------------------------|----------------------|--------------------------|

 

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 if the Exchange Act). Yes oNo x

**The number of shares ofthe registrant’s common stock outstanding as of April 1, 2006 isapproximately: 1,000.**

 

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**PART I.   FINANCIALINFORMATION**

**Item 1—FinancialStatements**

**SEALY MATTRESSCORPORATION**

**CondensedConsolidated Statements of Operations(in thousands)(unaudited)**

| ** **                                                                                                                                            | ** ** | **Quarter Ended**            | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                            | ** ** | **February  26,  2006** | ** ** | **February  27,  2005** | ** ** |
| Net sales                                                                                                                                             |       |                              | $          | 395,735 |   |   |   | $ | 359,023 |   |   |
| Cost of goods  sold                                                                                                                                   |       |                              | 219,038    |   |   |   | 199,973 |   |   |
| Gross Profit                                                                                                                                          |       |                              | 176,697    |   |   |   | 159,050 |   |   |
| Selling, general  and administrative                                                                                                                  |       |                              | 123,604    |   |   |   | 108,331 |   |   |
| Amortization of  intangibles                                                                                                                          |       |                              | 122        |   |   |   | 175 |   |   |
| Royalty income,  net of royalty expense                                                                                                               |       |                              | (3,689     | ) |   |   | (2,628 | ) |   |
| Income from operations                                                                                                                                |       |                              | 56,660     |   |   |   | 53,172 |   |   |
| Interest expense                                                                                                                                      |       |                              | 16,616     |   |   |   | 17,799 |   |   |
| Other income, net                                                                                                                                     |       |                              | (187       | ) |   |   | (93 | ) |   |
| Income before  income tax expense                                                                                                                     |       |                              | 40,231     |   |   |   | 35,466 |   |   |
| Income tax  expense                                                                                                                                   |       |                              | 15,646     |   |   |   | 13,613 |   |   |
| Income before  cumulative effect of a change in accounting principle                                                                                  |       |                              | 24,585     |   |   |   | 21,853 |   |   |
| Cumulative effect  on prior years (to November 28, 2005) of the adoption of FASB  Interpretation No. 47, net of related tax benefit of $191 |       |                              | 287        |   |   |   | — |   |   |
| Net income                                                                                                                                            |       |                              | $          | 24,298 |   |   |   | $ | 21,853 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY MATTRESSCORPORATIONCondensed Consolidated Balance Sheets(in thousands)**

| ** **                                                                        | ** ** | **February 26,  2006** | ** ** | **November 27,  2005** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                                                                        | ** ** | **(Unaudited)**             | ** ** | ** **                  | ** ** |
| **Assets**                                                                        |       |                        |       |                        |       |   |   |   |   |
| Current assets:                                                                   |       |                        |       |                        |       |   |   |   |   |
| Cash and cash equivalents                                                         |       |                        | $          | 13,760                      |       |   |   | $ | 36,554 |   |   |
| Accounts receivable, net of allowances for bad debts,  cash discounts and returns |       |                        | 203,977    |                        |       |   | 175,414 |   |   |
| Inventories                                                                       |       |                        | 66,485     |                        |       |   | 60,141 |   |   |
| Assets held for sale                                                              |       |                        | 1,405      |                        |       |   | 1,405 |   |   |
| Prepaid expenses and other current assets                                         |       |                        | 12,890     |                        |       |   | 12,372 |   |   |
| Deferred income taxes                                                             |       |                        | 16,661     |                        |       |   | 16,555 |   |   |
|                                                                              |       |                        | 315,178    |                        |       |   | 302,441 |   |   |
| Property, plant  and equipment—at cost                                       |       |                        | 335,415    |                        |       |   | 328,935 |   |   |
| Less: accumulated  depreciation                                                   |       |                        | (166,447   | )                           |       |   | (160,958 | ) |   |
|                                                                              |       |                        | 168,968    |                        |       |   | 167,977 |   |   |
| Other assets:                                                                     |       |                        |       |                        |       |   |   |   |   |
| Goodwill                                                                          |       |                        | 385,487    |                        |       |   | 384,646 |   |   |
| Other intangibles                                                                 |       |                        | 4,486      |                        |       |   | 4,559 |   |   |
| Debt issuance costs, net, and other assets                                        |       |                        | 32,012     |                        |       |   | 32,812 |   |   |
|                                                                              |       |                        | 421,985    |                        |       |   | 422,017 |   |   |
|                                                                              |       |                        | $          | 906,131                     |       |   |   | $ | 892,435 |   |   |
| **Liabilities  and Stockholders’ Deficit**                                   |       |                        |       |                        |       |   |   |   |   |
| Current liabilities:                                                              |       |                        |       |                        |       |   |   |   |   |
| Current portion of long-term obligations                                          |       |                        | $          | 11,288                      |       |   |   | $ | 12,769 |   |   |
| Accounts payable                                                                  |       |                        | 110,473    |                        |       |   | 119,558 |   |   |
| Accrued incentives and advertising                                                |       |                        | 34,480     |                        |       |   | 37,958 |   |   |
| Accrued compensation                                                              |       |                        | 46,168     |                        |       |   | 44,138 |   |   |
| Accrued interest                                                                  |       |                        | 10,019     |                        |       |   | 18,414 |   |   |
| Other accrued expenses                                                            |       |                        | 57,164     |                        |       |   | 47,360 |   |   |
|                                                                              |       |                        | 269,592    |                        |       |   | 280,197 |   |   |
| Due to parent  company                                                            |       |                        | 6,857      |                        |       |   | 6,231 |   |   |
| Long-term  obligations, net of current portion                                    |       |                        | 861,798    |                        |       |   | 863,209 |   |   |
| Other noncurrent  liabilities                                                     |       |                        | 43,194     |                        |       |   | 43,659 |   |   |
| Deferred income  taxes                                                            |       |                        | 12,492     |                        |       |   | 12,356 |   |   |
| Commitments and  contingencies                                                    |       |                        | —     |                        |       |   | — |   |   |
| Stockholders’  deficit:                                                      |       |                        |       |                        |       |   |   |   |   |
| Common stock                                                                      |       |                        | —     |                        |       |   | — |   |   |
| Additional paid-in capital                                                        |       |                        | 458,620    |                        |       |   | 458,620 |   |   |
| Accumulated deficit                                                               |       |                        | (750,177   | )                           |       |   | (774,475 | ) |   |
| Accumulated other comprehensive loss                                              |       |                        | 3,755      |                        |       |   | 2,638 |   |   |
|                                                                              |       |                        | (287,802   | )                           |       |   | (313,217 | ) |   |
|                                                                              |       |                        | $          | 906,131                     |       |   |   | $ | 892,435 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY MATTRESS CORPORATION**

**Condensed ConsolidatedStatements of Cash Flows(in thousands)(unaudited)**

| ** **                                                     | ** ** | **Quarter Ended**      | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                     | ** ** | **February 26,  2006** | ** ** | **February 27,  2005** | ** ** |
| Net cash provided  by (used in) operating activities           |       |                        | $          | (14,691 | ) |   |   | $ | 1,892 |   |   |
| Cash flows from  investing activities:                         |       |                        |       |   |   |   |   |   |   |
| Purchase of property, plant and equipment, net                 |       |                        | (5,577     | ) |   |   | (5,698 | ) |   |
| Proceeds from the sale of property, plant and  equipment       |       |                        | 29         |   |   |   | 4,648 |   |   |
| Net cash used in investing activities                          |       |                        | (5,548     | ) |   |   | (1,050 | ) |   |
| Cash flows from  financing activities:                         |       |                        |       |   |   |   |   |   |   |
| Repayments of long-term obligations                            |       |                        | —     |   |   |   | (5,000 | ) |   |
| Net borrowings (repayments) under revolving credit  facilities |       |                        | (3,295     | ) |   |   | 17,251 |   |   |
| Other                                                          |       |                        | 618        |   |   |   | 2,938 |   |   |
| Net cash provided by (used in) financing activities            |       |                        | (2,677     | ) |   |   | 15,189 |   |   |
| Effect of exchange rate changes on cash                        |       |                        | 122        |   |   |   | (972 | ) |   |
| Change in cash and cash equivalents                            |       |                        | (22,794    | ) |   |   | 15,059 |   |   |
| Cash and cash  equivalents:                                    |       |                        |       |   |   |   |   |   |   |
| Beginning of period                                            |       |                        | 36,554     |   |   |   | 22,779 |   |   |
| End of period                                                  |       |                        | $          | 13,760 |   |   |   | $ | 37,838 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY MATTRESSCORPORATION**

**Notes to CondensedConsolidated Financial Statements**

**Note 1:   *Basis of Presentation***

The condensed consolidated interim financialstatements are unaudited, and certain information and footnote disclosuresrelated thereto normally included in financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been omitted in accordance with Rule 10-01 ofRegulation S-X. In the opinion of management, the accompanying unauditedconsolidated financial statements were prepared following the same policies andprocedures used in the preparation of the audited financial statements andreflect all adjustments (consisting of normal recurring adjustments) necessaryto present fairly the financial position of Sealy Mattress Corporation and itssubsidiaries (the “Company”). The results of operations for the interim periodsare not necessarily indicative of the results for the entire fiscal year. Thesecondensed consolidated financial statements should be read in conjunction withthe Company’s Annual Report on Form 10-K for the year ended November 27,2005.

The preparation of financial statements in conformitywith generally accepted accounting principles requires management to makeestimates and assumptions that affect the amount of assets and liabilities anddisclosures on contingent assets and liabilities at period end and the reportedamounts of revenue and expenses during the reporting period. Actual results maydiffer from these estimates.

These condensed consolidated financial statementspresent the financial position and results of operations of Sealy MattressCorporation and its subsidiaries, but do not include the financial position orresults of operations of Sealy Mattress Corporation’s parent company, SealyCorporation, a holding company which owns 100% of the Company’s common stock. SealyCorporation is controlled by an affiliate of Kohlberg Kravis Roberts &Co. L.P. (“KKR”) subsequent to an April 6, 2004 merger, which was accountedfor as a recapitalization.

**Note 2:   *Subsequent Event—Initial Public Offering of Parent Company Common Stock***

On April 12, 2006, the Company’s parent company,Sealy Corporation, completed an initial public offering (“IPO”) of its commonstock. The Company expects that approximately $82.5 million of the net proceedsreceived by Sealy Corporation from the IPO will be contributed to the Companyto be used as follows:  (i) approximately$54.3 million to retire approximately $48.5 million aggregate principal amountof the Company’s 8.25% Senior Subordinated Notes (the “Notes”) due in 2014,along with prepayment penalties and accrued interest thereon; (ii) $11.0million to terminate the Company’s management services agreement with KKR; and (iii) approximately$17.2 million to pay a transaction-related bonus to members of management.

Through February 26,2006, Sealy Corporation has incurred approximately $2.1 million of costs inconnection with the IPO, all of which have been funded by the Company.

**Note 3:   *Share-Based Compensation***

Effective August 29, 2005 (the beginning of thefourth quarter of fiscal 2005) the Company adopted the provisions of FAS No. 123(revised 2004) ‘‘Share-Based Payment’’ (FAS 123(R)). Previously, as permittedby FAS No. 123, ‘‘Accounting for Stock-Based Compensation’’ (FAS 123), theCompany accounted for its stock option and stock incentive plans in accordancewith Accounting Principles Board (‘‘APB’’) Opinion No. 25, ‘‘Accountingfor Stock Issued to Employees’’, and recorded no charges (except to the extentrequired by APB Opinion No. 25) against earnings with respect to optionsgranted. Prior to the Sealy Corporation’s June 30, 2005 filing of aregistration statement on Form S-1, the Company had been considereda nonpublic entity as defined by both FAS 123 and FAS 123(R), and had used the 

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minimum value method ofmeasuring equity share options for pro forma disclosure purposes. Accordingly,the Company is required to apply the provisions of FAS 123(R) prospectivelyto new awards and to awards modified, repurchased, or cancelled after the dateof adoption. The Company has continued to account for any portion of awardsoutstanding at August 29, 2005 using the provisions of APB 25 aspreviously permitted under FAS 123. In addition, the Company has discontinuedpro forma disclosures previously required by FAS 123 for equity share optionsaccounted for using the intrinsic value method of APB 25.

Since the date of its adoption of FAS 123(R) andthrough February 26, 2006, the Company has neither issued nor modified anyequity share option awards or other forms of share-based payment. Therefore,the Company has recognized no compensation expense with respect to equity shareoptions during the three months ended February 26, 2006. The Company will recognizecompensation expense when new awards are granted, in accordance with thestandard. During the second quarter of fiscal 2006, the Company expects tobegin recognizing share-based compensation expense for options to purchaseSealy Corporation stock granted in connection with Sealy Corporation’s IPO, aswell as for other stock options granted in the ordinary course of business.

TheCompany recognized approximately $0.3 million and $0.2 million of expenseduring the three months ended February 26, 2006 and February 27,2005, respectively, resulting from the accretion of an obligation to threeexecutives of the Company for their right to put to the Company, upon theirretirement, shares of Sealy Corporation currently held as vested or partiallyvested options.

**Note 4:   *Inventories***

Themajor components of inventories were as follows: 

| ** **      | ** ** | **February 26,  2006** | ** ** | **November 27,  2005** | ** ** |
|-----------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **      | ** ** | **(in thousands)**     | ** ** |
| Raw materials   |       |                        | $          | 36,320                      |       |   |   | $ | 32,336 |   |   |
| Work in process |       |                        | 20,340     |                        |       |   | 18,945 |   |   |
| Finished goods  |       |                        | 9,825      |                        |       |   | 8,860 |   |   |
|            |       |                        | $          | 66,485                      |       |   |   | $ | 60,141 |   |   |

 

**Note 5:   *Warranty Costs***

TheCompany’s warranty policy provides a 10-year non-prorated warrantyservice period on all currently manufactured Sealy Posturepedic, Stearns &Foster and Bassett bedding products and some other Sealy-branded products, anda 20-year warranty on its new TrueFormTM product line introduced late in the firstquarter of fiscal 2005. The Company’s policy is to accrue the estimated cost ofwarranty coverage at the time the sale is recorded. The change in the Company’saccrued warranty obligations for the quarters ending February 26, 2006 andFebruary 27, 2005 and the year ended November 27, 2005 was as follows(in thousands):

| ** **                                           | ** ** | **February 26,  2006** | ** ** | **November 27,  2005** | ** ** | **February 27,  2005** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| Accrued warranty  obligations at beginning of period |       |                        | $          | 14,321                      |       |                        |       | $ | 13,857 |   |   |   | $ | 13,857 |   |   |
| Warranty claims                                      |       |                        | (3,453     | )                           |       |                        | (14,484    | ) |   |   | (3,814 | ) |   |
| Warranty  provisions                                 |       |                        | 3,691      |                        |       |                        | 14,948     |   |   |   | 3,271 |   |   |
| Accrued warranty  obligations at end of period  |       |                        | $          | 14,559                      |       |                        |       | $ | 14,321 |   |   |   | $ | 13,314 |   |   |

 

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Warranty claims for the year ended November 27,2005 include approximately $8.9 million for claims associated with productssold prior to November 28, 2004 that were still under warranty. Inestimating its warranty obligations, the Company considers the impact ofrecoverable salvage value on warranty cost in determining its estimate offuture warranty obligations. Warranty claims and provisions shown above do notinclude estimated salvage recoveries that reduced cost of sales by $1.4million, $4.3 million and $1.0 million for the three months ended February 26,2006, the year ended November 27, 2005 and the three months ended February 27,2005, respectively.

**Note 6:   *Goodwill and Other Intangible Assets***

The Company performs an annualassessment of its goodwill for impairment as of the beginning of the fiscalfourth quarter. The Company also assesses its goodwill and other intangibleassets for impairment when events or circumstances indicate that their carryingvalue may not be recoverable from future cash flows.

The changes in the carrying amount of goodwill for thethree months ended February 26, 2006 are as follows (in thousands):

| Balance as of  November 27, 2005         |   | $384,646 |   |   |
|-----------------------------------------------|--------|----------|--------|--------|
| Increase due to  foreign currency translation |   | 841      |   |   |
| Balance as of  February 26, 2006         |   | $385,487 |   |   |

 

Total other intangibles of $4.5million (net of accumulated amortization of $5.0 million) as of February 26,2006 consist primarily of acquired licenses, which are amortized on thestraight-line method over periods ranging from 5 to 15 years, and unamortizedpension prior service costs of $1.4 million.

**Note 7:   *Long-Term Obligations***

Long-termdebt as of February 26, 2006 and November 27, 2005 consisted of thefollowing: 

| ** **                        | ** ** | **February 26,  2006** | ** ** | **November 27,  2005** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(in thousands)**     | ** ** |
| Senior Revolving  Credit Facility |       |                        | $          | 15,446                      |       |   |   | $ | 18,814 |   |   |
| Senior Secured  Term Loan         |       |                        | 450,000    |                        |       |   | 450,000 |   |   |
| Senior  Subordinated Notes        |       |                        | 389,500    |                        |       |   | 389,500 |   |   |
| Other                             |       |                        | 18,140     |                        |       |   | 17,664 |   |   |
|                              |       |                        | 873,086    |                        |       |   | 875,978 |   |   |
| Less current  portion             |       |                        | (11,288    | )                           |       |   | (12,769 | ) |   |
|                              |       |                        | $          | 861,798                     |       |   |   | $ | 863,209 |   |   |

 

The total borrowing capacity under the seniorrevolving credit facility is $125 million, of which up to $25 million may beborrowed in Canada. At February 26, 2006, amounts outstanding under thesenior revolving credit facility included $5.0 million and $10.4 million underthe U.S. and Canadian portions of the facility, respectively. At February 26,2006, the Company had approximately $77.6 million available under the revolvingcredit facility after taking into account letters of credit issued totaling$32.0 million.

Annually, the Company may be required to makeprincipal prepayments equal to 25% of excess cash flow for the preceding fiscalyear, as defined in its senior secured credit agreement. At February 26,2006, the Company is unable to determine the amount of such required payment,if any, that would be due following the first quarter of fiscal 2007 withrespect to excess cash flow for the 2006 fiscal year.

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In connection with SealyCorporation’s IPO (Note 2), the Company expects to use a portion of theproceeds from the offering to retire approximately $48.5 million aggregateprincipal amount of the Notes.

**Note 8:**   *Other Income*

Other income includesinterest income of $0.2 million and $0.1 million for the three months ended February 26,2006 and February 27, 2005, respectively.

**Note 9:   *Conditional Asset Retirement Obligations***

In March 2005, the FASB issued Interpretation No. 47,‘‘Accounting for Conditional Asset Retirement Obligations—an interpretation ofFASB Statement No. 143’’ (‘‘FIN 47’’). This interpretation clarifies theterm ‘‘conditional asset retirement obligation’’ as used in FAS 143 andprovides additional guidance on the timing and method for the recognition andmeasurement of such conditional obligations. FIN 47 becomes effective forfiscal years ending after December 15, 2005. The Company adopted FIN 47 asof the beginning of fiscal 2006 and has recorded an adjustment as of November 28,2005, the first day of fiscal 2006, of approximately $0.3 million, net ofincome tax benefit of $0.2 million, to recognize the cumulative effect of theaccounting change. In addition, the Company recorded $0.1 million in property,plant and equipment and a liability of $0.6 million in other noncurrentliabilities. These resulted from obligations in certain of the Company’sfacility leases that require the Company to return those properties to the sameor similar condition at the end of the lease as existed when the Company beganusing those facilities. Although the lease termination dates range from 2008 to2032, the Company may be able to renegotiate such leases to extend the terms. Ona pro forma basis for the quarter ended February 27, 2005, the effectswould have been immaterial.

In addition to the aboveobligations, the Company also has certain factories that contain asbestos. Currentregulations require that the Company remove and dispose of asbestos if thefactory undergoes major renovations or is demolished. Although the Company isnot required to remove the asbestos unless renovation or demolition occurs, itis required to monitor it to ensure that it remains stable and is required tonotify any potential buyer of its existence. The Company has not recognized theasset retirement obligations for asbestos in its financial statements becausemanagement believes that there is an indeterminate settlement date for theretirement obligation as the range of time over which the Company may berequired to remove and dispose of the asbestos is unkown or cannot be estimated.The Company currently has no plans to demolish a factory or to undertake amajor renovation that would require removal of the asbestos. Management willcontinue to monitor this issue and will record an asset retirement obligationwhen sufficient information becomes available to estimate the obligation.

**Note 10:   *Recently Issued Accounting Pronouncements***

In November of 2004, the Financial AccountingStandards Board (‘‘FASB’’) issued FAS 151, ‘‘Inventory Costs, an amendment ofARB No. 43 Chapter 4, ‘‘Inventory Pricing,’’ to clarify the accounting forabnormal amounts of idle facility expense, freight, handling costs, and wastedmaterial (spoilage) and requires that those items be recognized ascurrent-period charges. In addition, this statement requires that allocation offixed production overheads to the costs of conversion be based on the normalcapacity of the production facilities. This statement is effective for fiscalyears beginning after June 15, 2005. The Company adopted this statement asof the beginning of fiscal 2006, and it has not had a material impact on theCompany’s financial position or results of operations.

In December 2004, the FASB issued FAS 153, ‘‘Exchangesof Nonmonetary Assets—an amendment of APB Opinion No. 29’’ which amendsOpinion 29 to eliminate the exception for nonmonetary exchanges of similarproductive assets and replaces it with a general exception for exchanges ofnonmonetary assets that do not have commercial substance. This statement becameeffective for nonmonetary asset exchanges 

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occurring in fiscalperiods beginning after June 15, 2005. The adoption of this statement hashad no impact on the Company’s financial position or results of operations.

In May 2005, the FASBissued FAS 154, ‘‘Accounting Changes and Error Corrections—a replacement of APBOpinion No. 20 and FASB Statement No. 3.’’ This statement providesguidance on the accounting for and reporting of accounting changes and errorcorrections. It establishes, unless impracticable, retrospective application asthe required method for reporting a change in accounting principle in theabsence of explicit transition guidance specific to any newly adoptedpronouncement. This statement also addresses the reporting of the correction ofan error in previously issued financial statements, which requires similarretrospective adjustment. Changes in accounting estimates continue to bereported in the period of the change and any future periods affected. Thisstatement will become effective for accounting changes and error correctionsmade in fiscal years beginning after December 15, 2005. The Company willadopt this statement as of the beginning of fiscal 2007.

**Note 11:   *Hedging Strategy***

In 2000, the Company entered into an interest rateswap agreement that effectively converted $236 million of its floating-ratedebt to a fixed-rate basis through December 2006, thereby hedging againstthe impact of interest rate changes on future interest expense (forecasted cashflows). Use of hedging contracts allows the Company to reduce its overallexposure to interest rate changes, since gains and losses on these contractswill offset losses and gains on the transactions being hedged. The Companyformally documents all hedged transactions and hedging instruments, andassesses, both at inception of the contract and on an ongoing basis, whetherthe hedging instruments are effective in offsetting changes in cash flows ofthe hedged transaction. The fair values of the interest rate agreements areestimated by obtaining quotes from brokers and are the estimated amounts thatthe Company would receive or pay to terminate the agreements at the reportingdate, taking into consideration current interest rates and the currentcreditworthiness of the counterparties. Effective June 3, 2002, theCompany dedesignated the interest rate swap agreement for hedge accounting. Asa result of the dedesignation, $12.9 million previously recorded in accumulatedother comprehensive loss as of the date of dedesignation was being amortizedinto interest expense over the remaining life of the interest rate swapagreement. Due to the retirement of the existing debt in connection with the April 2004recapitalization, the remaining unamortized balance of $4.7 million included inaccumulated other comprehensive loss was charged to expense during the secondfiscal quarter of 2004. Subsequent to the June 3, 2002 dedesignation,changes in the fair market value of the interest rate swap have been recordedin interest expense. For the three months ended February 26, 2006 and February 27,2005, $(0.1) million and $0.4 million, respectively,  was recorded as net addition to (reductionof) interest expense as a result of the cash requirements of the swap net ofthe non-cash interest associated with the change in its fair market value. At February 26,2006 and November 27, 2005, the fair value carrying amount of thisinstrument was a current liability of $0.9 million and $1.6 million,respectively.

During the second quarter of 2002, the Company enteredinto another interest rate swap agreement that has the effect of reestablishingas floating rate debt the $236 million of debt previously converted to fixedrate debt through December 2006. This interest rate swap agreement was notdesignated for hedge accounting and, accordingly, any changes in the fair valueare recorded in interest expense. For the three months ended February 26,2006 and February 27, 2005, $0.1 million and $0.4 million, respectively,was recorded as an addition to net interest expense as a result of the cashinterest paid on the swap net of the non-cash interest associated with the changein its fair market value. At February 26, 2006 and November 27, 2005,the fair value carrying amount of this instrument was a net obligation of $0.5million and $0.3 million, respectively, with $0.1 million and $0.4 millionrecorded in accrued interest and other accrued expenses, and $0.3 millionrecorded in other accrued expenses, respectively.

In June 2004,the Company entered into an additional swap agreement that has the effect ofconverting $200 million of the floating-rate debt under the Company’s newsenior credit facilities to a 

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fixed-rate basis, declining to $150 million fromDecember 2005 through November 2007. The Company has formally designatedthis swap agreement as a cash flow hedge and expects the hedge to be highlyeffective in offsetting fluctuations in the designated interest paymentsresulting from changes in the benchmark interest rate. Accordingly, theeffective portion of changes in the market value of the swap is recorded inother comprehensive income (loss). For the three months ended February 26,2006 and February 27, 2005, $(0.3) million and $0.6 million, respectively,was recorded as an addition to (reduction of) interest expense. At February 26,2006 and November 27, 2005, the fair value carrying amount of theinstrument was recorded as follows:

| ** **                   | ** ** | **February 26,2006** | ** ** | **November 27, 2005** | ** ** |
|------------------------------|------------|---------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **(In thousands)**   | ** ** |
| Accrued interest  receivable |       |                      | $          | 0.3                             |       |   |   | $ | — |   |   |
| Other current  assets        |       |                      | 1.4        |                            |       |   | 1.1 |   |   |
| Long term  receivable        |       |                      | 1.9        |                            |       |   | 1.7 |   |   |
|  Total  net asset       |       |                      | $          | 3.6                             |       |   |   | $ | 2.8 |   |   |

 

At February 26, 2006 and November 27, 2005,accumulated other comprehensive income (loss) associated with the interest rateswaps was $2.0 million and $1.6 million, respectively, net of income taxeffects.

To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, the Company has instituted a forecasted cashflow hedging program. The Company hedges portions of its purchases denominatedin foreign currencies with forward and option contracts. The Company does notdesignate its foreign currency hedges for accounting purposes, therefore allchanges in fair value are charged to earnings. At February 26, 2006, theCompany had forward contracts to sell a total of 9.0 million Canadian dollarswith expiration dates ranging from March 15, 2006 through November 15,2006. At February 26, 2006 and November 27, 2005, the fair value ofthe Company’s net obligation under the forward contracts was a liability of $0.3million and $0.3 million, respectively. For the quarter ended February, 26,2006, recognized foreign currency transaction gains were insignificant,compared with gains of $2.4 million for the first quarter of 2005.

9

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**Note 12:   *Defined Benefit Pension Expense***

Thecomponents of net periodic pension cost recognized for the Company’s definedbenefit pension plan for the three months ended February 26, 2006 and February 27,2005 are as follows (in thousands):

| ** **                                       | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **February 26, 2006**  | ** ** | **February 27, 2005** | ** ** |
| Service cost                                     |       |                             | $          | 150 |   |   |   | $ | 158 |   |   |
| Interest cost                                    |       |                             | 219        |   |   |   | 191 |   |   |
| Expected return  on plan assets                  |       |                             | (221       | ) |   |   | (178 | ) |   |
| Amortization of  unrecognized losses             |       |                             | 67         |   |   |   | 63 |   |   |
| Amortization of  unrecognized transition asset   |       |                             | (22        | ) |   |   | (22 | ) |   |
| Amortization of  unrecognized prior service cost |       |                             | 51         |   |   |   | 44 |   |   |
| Net periodic  pension cost*                      |       |                             | $          | 244 |   |   |   | $ | 256 |   |   |
| Cash  contributions                              |       |                             | $          | 274 |   |   |   | $ | — |   |   |

----

*                    Net periodicpension cost recognized for the three months ended February 26, 2006 is basedupon preliminary estimates pending the final actuarial determination of suchcosts for fiscal 2006. Similarly, net periodic pension cost for the threemonths ended February 27, 2005 is also based upon preliminary estimates.

The Company expects to makeadditional cash contributions to the plan of approximately $1.8 million duringthe remainder of fiscal 2006.

**Note 13:   *Stockholders’ Deficit***

Total comprehensive income for the quarters ended February 26,2006 and February 27, 2005 was $25.4 million and $19.1 million,respectively.

Activityin Stockholders’ deficit is as follows (in thousands):  

| ** **                                                    | ** ** | **Comprehensive  Income** | ** ** | **Common Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total** | ** ** |
|---------------------------------------------------------------|------------|---------------------------|------------|-----------------------|------------|----------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|-----------|------------|
| Balance at  November 27, 2005                            |       |                      |       |                  |       |                             | $          | —                   |       |                                          |       | $         | 458,620    |   |   |   | $ | (774,475 | ) |   |   | $ | 2,638 |   |   | $ | (313,217 | ) |
| Comprehensive  Income:                                        |       |                      |       |                  |       |                             |       |                     |       |                                          |       |      |       |   |   |   |   |   |   |   |   |   |   |
| Net income for the three months ended  February 26, 2006 |       |                      | $          | 24,298                |       |                             |       | —                   |       |                                          |       | —    |       |   |   | 24,298 |   |   |   | — |   |   | 24,298 |   |
| Change in fair value of cash flow hedge                       |       |                      | 365        |                  |       |                             | —     |                     |       |                                          | —     |      |       |   | — |   |   |   | 365 |   |   | 365 |   |
| Foreign currency translation adjustment                       |       |                      | 752        |                  |       |                             | —     |                     |       |                                          | —     |      |       |   | — |   |   |   | 752 |   |   | 752 |   |
| Balance at February, 26  2006                                 |       |                      | $          | 25,415                |       |                             |       | $                        | —     |                                          |       |      | $          | 458,620 |   |   |   | $ | (750,177 | ) |   |   | $ | 3,755 |   |   | $ | (287,802 | ) |

 

10

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**Note 14:   *Contingencies***

The Company is subject to legal proceedings, claims,and litigation arising in the ordinary course of business. While the outcome ofthese matters is currently not determinable, management does not expect thatthe ultimate costs to resolve these matters will have a material adverse effecton the Company’s consolidated financial position, results of operations or cashflows.

The Company is currently conducting an environmentalcleanup at a formerly owned facility in South Brunswick, New Jersey pursuant tothe New Jersey Industrial Site Recovery Act. The Company and one of itssubsidiaries are parties to an Administrative Consent Order issued by the NewJersey Department of Environmental Protection. Pursuant to that order, theCompany and its subsidiary agreed to conduct soil and groundwater remediationat the property. The Company does not believe that its manufacturing processeswere the source of contamination. The Company sold the property in 1997. TheCompany and its subsidiary retained primary responsibility for the requiredremediation. The Company has completed essentially all soil remediation withthe New Jersey Department of Environmental Protection approval, and hasconcluded a pilot test of the groundwater remediation system. During 2005, withthe approval of the New Jersey Department of Environmental Protection, theCompany removed and disposed of sediment in Oakeys Brook adjoining the site.The Company continues to monitor ground water at the site. The Company hasrecorded a reserve for $1.9 million ($2.4 million prior to discounting at4.50%) associated with this remediation project, and it is reasonably possiblethat up to an additional $0.2 million may be incurred to complete the project.

The Company is also remediating soil and groundwatercontamination at an inactive facility located in Oakville, Connecticut.Although the Company is conducting the remediation voluntarily, it obtainedConnecticut Department of Environmental Protection approval of the remediationplan. The Company has completed essentially all soil remediation under theremediation plan and is currently monitoring groundwater at the site. TheCompany has identified cadmium in the ground water at the site and intends toaddress that during fiscal 2006. The Company has recorded a reserve ofapproximately $0.7 million associated with the additional work and ongoingmonitoring. The Company believes the contamination is attributable to themanufacturing operations of previous unaffiliated occupants of the facility.

11

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The Company removed three underground storage tankspreviously 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 CaliforniaRegional Water Quality Control Board, Los Angeles Region to monitor groundwater at the site.

While the Company cannot predict the ultimate timingor costs of the South Brunswick, Oakville, and South Gate environmentalmatters, based on facts currently known, the Company believes that the accrualsrecorded are adequate and does not believe the resolution of these matters willhave a material adverse effect on the financial position or future operationsof the Company; however, in the event of an adverse decision by the agenciesinvolved, these matters could have a material adverse effect.

The state of California adopted new flame retardantregulations related to manufactured mattresses and box springs which becameeffective January 1, 2005. The Company believes that it is in fullcompliance with those regulations. The Company believes that those regulationshave not had a significant impact on the Company’s results of operations orfinancial position.

Significant judgment isrequired in evaluating the Company’s federal, state and foreign tax positionsand in the determination of its tax provision. Despite the Company’s beliefthat the its tax return positions are fully supportable, reserves have beenestablished where the Company believes that certain tax positions are likely tobe challenged and the Company may not fully prevail in overcoming thesechallenges. The Company may adjust these reserves as relevant circumstancesevolve, such as guidance from the relevant tax authority, the Company’s taxadvisors, or resolution of issues in the courts. The Company’s tax expenseincludes the impact of reserve positions and changes to reserves that itconsiders appropriate, as well as related interest. Because the Company is notcurrently undergoing examinations of any of its corporate income tax returns bytax authorities, the Company believes that it is unlikely that an audit couldbe initiated which would result in an assessment and payment of taxes relatedto these positions during the one year following February 26, 2006. TheCompany also cannot predict when or if any other future tax payments related tothese tax positions may occur. Therefore, substantially all of the reserves forthese positions are classified as noncurrent liabilities in the accompanying balancesheet.

**Note 15:   *Related Party Transactions***

During the three monthsended February 26, 2006 and February 27, 2005, the Company incurred managementfees of $0.5 million and $0.5 million, respectively, to Kohlberg Kravis Roberts &Co. L.P. (“KKR”), Sealy Corporation’s primary owners. As a result of SealyCorporation’s IPO, these fees will no longer be paid after the second quarterof fiscal 2006. Also during the three months ended February 27, 2005, theCompany incurred $0.7 million for consulting services provided by CapstoneConsulting LLC, the chief executive officer of which is on the Company’s boardof directors.

12

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**Note 16:**   *Segment Information*

TheCompany has determined that it has two operating segments, domestic andinternational, that qualify for aggregation as prescribed in SFAS 131.Accordingly, the Company has one reportable industry segment, the manufactureand marketing of conventional and specialty bedding. Sales outside the United States were $81.2 million and $72.3 million for the first quarter of 2006 and 2005, respectively.In addition, long-lived assets (principally property, plant and equipment andother investments) outside the United States were $52.1 million and $ 50.4million as of February 26, 2006 and November 27, 2005, respectively.

| **Geographic distribution of sales:** |       |                                |       |                  |       |       |       |       |       |
|------------------------------------------------------|------------|-------------------------------------|------------|-----------------------|------------|------------|------------|------------|------------|
| ** **                                           | ** ** | **February 26,**               | ** ** | **February 27,** | ** ** |
| ** **                                           | ** ** | **2006**                            | ** ** | **2005**              | ** ** |
| ** **                                           | ** ** | **(dollars in millions)** | ** ** |
| **US  domestic**                                     | ** ** | $                                   | 314.5      |                  | 79.5       | %          | $          | 286.7      |       | 79.9 | % |
| **International:**                                   | ** ** | ** **                          | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Canada                                               |       | 36.3                                |       | 9.2                   |       | 28.4       |       | 7.9        |       |
| Europe                                               |       | 24.1                                |       | 6.1                   |       | 25.6       |       | 7.1        |       |
| Other International Locations                        |       | 20.8                                |       | 5.2                   |       | 18.3       |       | 5.1        |       |
| **Total  international**                             |       | 81.2                                |       | 20.5                  |       | 72.3       |       | 20.1       |       |
| **Total  company**                                   |       | $                                   | 395.7      |                  | 100.0      | %          | $          | 359.0      |       | 100.0 | % |

 

**Note 17:   *Guarantor/Non-Guarantor Financial Information***

The Parent (as defined below) and each of thesubsidiaries of Sealy Mattress Company (the “Issuer”) that guarantee the Notes(as defined below) (the “Guarantor Subsidiaries”) have fully andunconditionally guaranteed, on a joint and several basis, the obligation to payprincipal and interest with respect to the Notes of the Issuer. Substantiallyall of the Issuer’s operating income and cash flow is generated by itssubsidiaries. As a result, funds necessary to meet the Issuer’s debt serviceobligations are provided in part by distributions or advances from itssubsidiaries. Under certain circumstances, contractual and legal restrictions,as well as the financial condition and operating requirements of the Issuer’ssubsidiaries, could limit the Issuer’s ability to obtain cash from itssubsidiaries for the purpose of meeting its debt service obligations, includingthe payment of principal and interest on the Notes. Although holders of theNotes will be direct creditors of the Issuer’s principal direct subsidiaries byvirtue of the guarantees, the Issuer has subsidiaries (“Non-GuarantorSubsidiaries”) that are not included among the Guarantor Subsidiaries, and suchsubsidiaries will not be obligated with respect to the Notes. As a result, theclaims of creditors of the Non-Guarantor Subsidiaries will effectively havepriority with respect to the assets and earnings of such companies over theclaims of creditors of the Issuer, including the holders of the Notes.

The followingsupplemental consolidating condensed financial statements present:

          1.  Condensed consolidating balance sheets as ofFebruary 26, 2006 and November 27, 2005 and condensed consolidatingstatements of operations and cash flows for the three months endedFebruary 26, 2006 and February 27, 2005. 

          2.  Sealy Mattress Corporation, as the “Parent”and a “guarantor”, the Issuer, combined Guarantor Subsidiaries and combinedNon-Guarantor Subsidiaries with their investments in subsidiaries accounted forusing the equity method (see Note 1). 

          3.  Elimination entries necessary to consolidatethe Parent and all of its subsidiaries. 

Separate financial statements of each of the GuarantorSubsidiaries are not presented because management believes that these financialstatements would not be material to investors.

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**SEALY MATTRESSCORPORATION**

**SupplementalConsolidating Condensed Balance SheetFebruary 26, 2006(in thousands)**

| ** **                                                        | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                        |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Current assets:                                                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                        |       |                             | $          | —                       |       |                                  | $          | 1                                           |       |             | $          | 5,485            |       |   |   | $ | 8,274 |   |   |   | $ | — |   |   |   | $ | 13,760 |   |   |
| Accounts  receivable, net                                         |       |                             | —     |                         |       | 292                                   |       |                                        | 136,770    |             |       |             | 66,915     |   |   |   | — |   |   |   | 203,977 |   |   |
| Inventories                                                       |       |                             | —     |                         |       | 1,515                                 |       |                                        | 49,278     |             |       |             | 15,692     |   |   |   | — |   |   |   | 66,485 |   |   |
| Assets held for  sale                                             |       |                             | —     |                         |       | —                                |       |                                        | 1,405      |             |       |             | —     |   |   |   | — |   |   |   | 1,405 |   |   |
| Prepaid expenses,  deferred income taxes and other current assets |       |                             | —     |                         |       | 2,569                                 |       |                                        | 25,053     |             |       |             | 1,929      |   |   |   | — |   |   |   | 29,551 |   |   |
|                                                              |       |                             | —     |                         |       | 4,377                                 |       |                                        | 217,991    |             |       |             | 92,810     |   |   |   | — |   |   |   | 315,178 |   |   |
| Property, plant  and equipment, at cost                           |       |                             | —     |                         |       | 7,571                                 |       |                                        | 255,625    |             |       |             | 72,219     |   |   |   | — |   |   |   | 335,415 |   |   |
| Less accumulated  depreciation                                    |       |                             | —     |                         |       | (4,029                                | )          |                                        | (139,146   | )                |       |             | (23,272    | ) |   |   | — |   |   |   | (166,447 | ) |   |
|                                                              |       |                             | —     |                         |       | 3,542                                 |       |                                        | 116,479    |             |       |             | 48,947     |   |   |   | — |   |   |   | 168,968 |   |   |
| Other assets:                                                     |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                          |       |                             | —     |                         |       | 24,741                                |       |                                        | 304,774    |             |       |             | 55,972     |   |   |   | — |   |   |   | 385,487 |   |   |
| Other intangibles,  net                                           |       |                             | —     |                         |       | —                                |       |                                        | 4,122      |             |       |             | 364        |   |   |   | — |   |   |   | 4,486 |   |   |
| Net investment in  and advances to (from) subsidiaries            |       |                             | (287,802   | )                            |       | 931,204                               |       |                                        | (170,421   | )                |       |             | (64,578    | ) |   |   | (408,403 | ) |   |   | — |   |   |
| Debt issuance  costs, net, and other assets                       |       |                             | —     |                         |       | 24,510                                |       |                                        | 5,580      |             |       |             | 1,922      |   |   |   | — |   |   |   | 32,012 |   |   |
|                                                              |       |                             | (287,802   | )                            |       | 980,455                               |       |                                        | 144,055    |             |       |             | (6,320     | ) |   |   | (408,403 | ) |   |   | 421,985 |   |   |
| Total assets                                                      |       |                             | $          | (287,802                     | )          |                                  | $          | 988,374                                     |       |             | $          | 478,525          |       |   |   | $ | 135,437 |   |   |   | $ | (408,403 | ) |   |   | $ | 906,131 |   |   |
| **Liabilities  and stockholders’ deficit**                   | ** ** |                             |       |                         | ** ** | ** **                            | ** ** |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Current  liabilities:                                             |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Current  portion—long-term obligations                       |       |                             | $          | —                       |       |                                  | $          | —                                      |       |             | $          | 2,038            |       |   |   | $ | 9,250 |   |   |   | $ | — |   |   |   | $ | 11,288 |   |   |
| Accounts payable                                                  |       |                             | —     |                         |       | 267                                   |       |                                        | 73,290     |             |       |             | 36,916     |   |   |   | — |   |   |   | 110,473 |   |   |
| Accrued customer  incentives and advertising                      |       |                             | —     |                         |       | —                                |       |                                        | 30,374     |             |       |             | 4,106      |   |   |   | — |   |   |   | 34,480 |   |   |
| Accrued  compensation                                             |       |                             | —     |                         |       | 259                                   |       |                                        | 38,603     |             |       |             | 7,306      |   |   |   | — |   |   |   | 46,168 |   |   |
| Accrued interest                                                  |       |                             | —     |                         |       | 497                                   |       |                                        | 9,464      |             |       |             | 58         |   |   |   | — |   |   |   | 10,019 |   |   |
| Other accrued  expenses                                           |       |                             | —     |                         |       | 1,097                                 |       |                                        | 51,304     |             |       |             | 4,763      |   |   |   | — |   |   |   | 57,164 |   |   |
|                                                              |       |                             | —     |                         |       | 2,120                                 |       |                                        | 205,073    |             |       |             | 62,399     |   |   |   | — |   |   |   | 269,592 |   |   |
| Parent Company                                                    |       |                             | —     |                         |       | —                                |       |                                        | 6,857      |             |       |             | —     |   |   |   | — |   |   |   | 6,857 |   |   |
| Long-term  obligations                                            |       |                             | —     |                         |       | 844,500                               |       |                                        | 985        |             |       |             | 16,313     |   |   |   | — |   |   |   | 861,798 |   |   |
| Other noncurrent  liabilities                                     |       |                             | —     |                         |       | —                                |       |                                        | 34,854     |             |       |             | 8,340      |   |   |   | — |   |   |   | 43,194 |   |   |
| Deferred income  taxes                                            |       |                             |       |                         |       | 4,659                                 |       |                                        | 2,066      |             |       |             | 5,767      |   |   |   | — |   |   |   | 12,492 |   |   |
| Stockholders’  deficit                                       |       |                             | (287,802   | )                            |       | 137,095                               |       |                                        | 228,690    |             |       |             | 42,618     |   |   |   | (408,403 | ) |   |   | (287,802 | ) |   |
| Total liabilities and  stockholders’ deficit                 |       |                             | $          | (287,802                     | )          |                                  | $          | 988,374                                     |       |             | $          | 478,525          |       |   |   | $ | 135,437 |   |   |   | $ | (408,403 | ) |   |   | $ | 906,131 |   |   |

 

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**SEALY MATTRESSCORPORATION**

**SupplementalConsolidating Condensed Balance SheetNovember 27, 2005(in thousands)**

| ** **                                                        | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                        |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Current assets:                                                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Cash and cash  equivalents                                        |       |                             | $          | —                       |       |                                  | $          | 1                                           |       |             | $          | 25,387           |       |   |   | $ | 11,166 |   |   |   | $ | — |   |   |   | $ | 36,554 |   |   |
| Accounts  receivable, net                                         |       |                             | —     |                         |       | 60                                    |       |                                        | 106,559    |             |       |             | 68,795     |   |   |   | — |   |   |   | 175,414 |   |   |
| Inventories                                                       |       |                             | —     |                         |       | 1,429                                 |       |                                        | 42,836     |             |       |             | 15,876     |   |   |   | — |   |   |   | 60,141 |   |   |
| Assets held for  sale                                             |       |                             | —     |                         |       | —                                |       |                                        | 1,405      |             |       |             | —     |   |   |   | — |   |   |   | 1,405 |   |   |
| Prepaid expenses,  deferred income taxes and other current assets |       |                             |       |                         |       | 2,200                                 |       |                                        | 24,349     |             |       |             | 2,378      |   |   |   | — |   |   |   | 28,927 |   |   |
|                                                              |       |                             | —     |                         |       | 3,690                                 |       |                                        | 200,536    |             |       |             | 98,215     |   |   |   | — |   |   |   | 302,441 |   |   |
| Property, plant  and equipment, at cost                           |       |                             | —     |                         |       | 7,542                                 |       |                                        | 252,190    |             |       |             | 69,203     |   |   |   | — |   |   |   | 328,935 |   |   |
| Less accumulated  depreciation                                    |       |                             | —     |                         |       | (3,949                                | )          |                                        | (135,176   | )                |       |             | (21,833    | ) |   |   | — |   |   |   | (160,958 | ) |   |
|                                                              |       |                             | —     |                         |       | 3,593                                 |       |                                        | 117,014    |             |       |             | 47,370     |   |   |   | — |   |   |   | 167,977 |   |   |
| Other assets:                                                     |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                          |       |                             | —     |                         |       | 24,741                                |       |                                        | 304,774    |             |       |             | 55,131     |   |   |   | — |   |   |   | 384,646 |   |   |
| Other intangibles,  net                                           |       |                             | —     |                         |       | —                                |       |                                        | 4,192      |             |       |             | 367        |   |   |   | — |   |   |   | 4,559 |   |   |
| Net investment in  and advances to (from) subsidiaries            |       |                             | (313,217   | )                            |       | 901,550                               |       |                                        | (177,037   | )                |       |             | (56,964    | ) |   |   | (354,332 | ) |   |   | — |   |   |
| Debt issuance  costs, net, and other assets                       |       |                             |       |                         |       | 25,168                                |       |                                        | 5,793      |             |       |             | 1,851      |   |   |   | — |   |   |   | 32,812 |   |   |
|                                                              |       |                             | (313,217   | )                            |       | 951,459                               |       |                                        | 137,722    |             |       |             | 385        |   |   |   | (354,332 | ) |   |   | 422,017 |   |   |
| Total assets                                                      |       |                             | $          | (313,217                     | )          |                                  | $          | 958,742                                     |       |             | $          | 455,272          |       |   |   | $ | 145,970 |   |   |   | $ | (354,332 | ) |   |   | $ | 892,435 |   |   |
| **Liabilities and stockholders’  deficit**                   | ** ** |                             |       |                         | ** ** | ** **                            | ** ** |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Current liabilities:                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Current  portion—long-term obligations                       |       |                             | $          | —                       |       |                                  | $          | —                                      |       |             | $          | 922              |       |   |   | $ | 11,847 |   |   |   | $ | — |   |   |   | $ | 12,769 |   |   |
| Accounts payable                                                  |       |                             | —     |                         |       | 269                                   |       |                                        | 82,894     |             |       |             | 36,395     |   |   |   | — |   |   |   | 119,558 |   |   |
| Accrued interest                                                  |       |                             | —     |                         |       | 824                                   |       |                                        | 17,471     |             |       |             | 119        |   |   |   | — |   |   |   | 18,414 |   |   |
| Accrued customer  incentives and advertising                      |       |                             |       |                         |       | —                                |       |                                        | 31,184     |             |       |             | 6,774      |   |   |   | — |   |   |   | 37,958 |   |   |
| Accrued  compensation                                             |       |                             | —     |                         |       | 411                                   |       |                                        | 35,506     |             |       |             | 8,221      |   |   |   | — |   |   |   | 44,138 |   |   |
| Other accrued  expenses                                           |       |                             | —     |                         |       | 1,599                                 |       |                                        | 37,451     |             |       |             | 8,310      |   |   |   | — |   |   |   | 47,360 |   |   |
|                                                              |       |                             |       |                         |       | 3,103                                 |       |                                        | 205,428    |             |       |             | 71,666     |   |   |   | — |   |   |   | 280,197 |   |   |
| Due to (from)  Parent Company                                     |       |                             | —     |                         |       | —                                |       |                                        | 6,231      |             |       |             | —     |   |   |   | — |   |   |   | 6,231 |   |   |
| Long-term  obligations                                            |       |                             | —     |                         |       | 839,500                               |       |                                        | 858        |             |       |             | 22,851     |   |   |   | — |   |   |   | 863,209 |   |   |
| Other noncurrent  liabilities                                     |       |                             | —     |                         |       | 116                                   |       |                                        | 35,421     |             |       |             | 8,122      |   |   |   | — |   |   |   | 43,659 |   |   |
| Deferred income  taxes                                            |       |                             | —     |                         |       | 4,416                                 |       |                                        | 2,247      |             |       |             | 5,693      |   |   |   | — |   |   |   | 12,356 |   |   |
| Stockholders’  deficit                                       |       |                             | (313,217   | )                            |       | 111,607                               |       |                                        | 205,087    |             |       |             | 37,638     |   |   |   | (354,332 | ) |   |   | (313,217 | ) |   |
| Total liabilities and  stockholders’ deficit                 |       |                             | $          | (313,217                     | )          |                                  | $          | 958,742                                     |       |             | $          | 455,272          |       |   |   | $ | 145,970 |   |   |   | $ | (354,332 | ) |   |   | $ | 892,435 |   |   |

 

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**SEALY MATTRESSCORPORATION**

**SupplementalConsolidating Condensed Statements of OperationsThree Months Ended February 26, 2006(in thousands)**

| ** **                                          | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                           |       |                             | $          | —                       |       |                                  | $          | 15,707                                      |       |             | $          | 304,657          |       |   |   | $ | 78,446 |   |   |   | $ | (3,075 | ) |   |   | $ | 395,735 |   |   |
| Costs and expenses:                                 |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |                             | —     |                         |       | 9,410                                 |       |                                        | 164,922    |             |       |             | 47,781     |   |   |   | (3,075 | ) |   |   | 219,038 |   |   |
| Selling, general and administrative            |       |                             | —     |                         |       | 1,550                                 |       |                                        | 100,557    |             |       |             | 21,497     |   |   |   | — |   |   |   | 123,604 |   |   |
| Amortization of intangibles                         |       |                             | —     |                         |       | —                                |       |                                        | 72         |             |       |             | 50         |   |   |   | — |   |   |   | 122 |   |   |
| Royalty (income)expense, net                        |       |                             | —     |                         |       | —                                |       |                                        | (4,216     | )                |       |             | 527        |   |   |   | — |   |   |   | (3,689 | ) |   |
| Income from  operations                             |       |                             | —     |                         |       | 4,747                                 |       |                                        | 43,322     |             |       |             | 8,591      |   |   |   | — |   |   |   | 56,660 |   |   |
| Interest expense                                    |       |                             | 120        |                         |       | 16,076                                |       |                                        | (82        | )                |       |             | 502        |   |   |   | — |   |   |   | 16,616 |   |   |
| Other income                                        |       |                             | —     |                         |       | —                                |       |                                        | (19        | )                |       |             | (168       | ) |   |   | — |   |   |   | (187 | ) |   |
| Income from equity investees                        |       |                             | (24,371    | )                            |       | (21,987                               | )          |                                        | —     |             |       |             | —     |   |   |   | 46,358 |   |   |   | — |   |   |
| Income from nonguarantor equity investees           |       |                             | —     |                         |       | —                                |       |                                        | (4,263     | )                |       |             | —     |   |   |   | 4,263 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                             | —     |                         |       | (15,232                               | )          |                                        | 14,217     |             |       |             | 1,015      |   |   |   | — |   |   |   | — |   |   |
| Income before  income taxes                         |       |                             | 24,251     |                         |       | 25,890                                |       |                                        | 33,469     |             |       |             | 7,242      |   |   |   | (50,621 | ) |   |   | 40,231 |   |   |
| Income tax expense (benefit)                        |       |                             | (47        | )                            |       | 1,519                                 |       |                                        | 11,195     |             |       |             | 2,979      |   |   |   | — |   |   |   | 15,646 |   |   |
| Income before  cumulative effect                    |       |                             | 24,298     |                         |       | 24,371                                |       |                                        | 22,274     |             |       |             | 4,263      |   |   |   | (50,621 | ) |   |   | 24,585 |   |   |
| Cumulative effect of change in accounting principle |       |                             | —     |                         |       | —                                |       |                                        | 287        |             |       |             | —     |   |   |   | — |   |   |   | 287 |   |   |
| Net income                                          |       |                             | $          | 24,298                       |       |                                  | $          | 24,371                                      |       |             | $          | 21,987           |       |   |   | $ | 4,263 |   |   |   | $ | (50,621 | ) |   |   | $ | 24,298 |   |   |

 

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**SEALY MATTRESSCORPORATION**

**SupplementalConsolidating Condensed Statements of OperationsThree Months Ended February 27, 2005(in thousands)**

| ** **                                          | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                           |       |                             | $          | —                       |       |                                  | $          | 15,385                                      |       |             | $          | 280,555          |       |   |   | $ | 68,739 |   |   |   | $ | (5,656 | ) |   |   | $ | 359,023 |   |   |
| Costs and expenses:                                 |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |                             | —     |                         |       | 9,130                                 |       |                                        | 152,495    |             |       |             | 44,004     |   |   |   | (5,656 | ) |   |   | 199,973 |   |   |
| Selling, general and administrative                 |       |                             | —     |                         |       | 1,537                                 |       |                                        | 87,487     |             |       |             | 19,307     |   |   |   | — |   |   |   | 108,331 |   |   |
| Amortization of intangibles                         |       |                             | —     |                         |       | —                                |       |                                        | 72         |             |       |             | 103        |   |   |   | — |   |   |   | 175 |   |   |
| Royalty (income) expense, net                       |       |                             | —     |                         |       | —                                |       |                                        | (3,102     | )                |       |             | 474        |   |   |   | — |   |   |   | (2,628 | ) |   |
| Income from  operations                             |       |                             | —     |                         |       | 4,718                                 |       |                                        | 43,603     |             |       |             | 4,851      |   |   |   | — |   |   |   | 53,172 |   |   |
| Interest expense                                    |       |                             | 76         |                         |       | 17,517                                |       |                                        | (73        | )                |       |             | 279        |   |   |   | — |   |   |   | 17,799 |   |   |
| Other income, net                                   |       |                             | —     |                         |       | —                                |       |                                        | (2         | )                |       |             | (91        | ) |   |   | — |   |   |   | (93 | ) |   |
| Income from equity investees                        |       |                             | (21,900    | )                            |       | (19,590                               | )          |                                        | —     |             |       |             | —     |   |   |   | 41,490 |   |   |   | — |   |   |
| Income from non-guarantor equity investees          |       |                             | —     |                         |       | —                                |       |                                        | (2,423     | )                |       |             | —     |   |   |   | 2,423 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                             | —     |                         |       | (16,549                               | )          |                                        | 15,803     |             |       |             | 746        |   |   |   | — |   |   |   | — |   |   |
| Income before  income taxes                         |       |                             | 21,824     |                         |       | 23,340                                |       |                                        | 30,298     |             |       |             | 3,917      |   |   |   | (43,913 | ) |   |   | 35,466 |   |   |
| Income tax expense  (benefit)                       |       |                             | (29        | )                            |       | 1,440                                 |       |                                        | 10,708     |             |       |             | 1,494      |   |   |   | — |   |   |   | 13,613 |   |   |
| Net income                                          |       |                             | $          | 21,853                       |       |                                  | $          | 21,900                                      |       |             | $          | 19,590           |       |   |   | $ | 2,423 |   |   |   | $ | (43,913 | ) |   |   | $ | 21,853 |   |   |

 

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**SEALY MATTRESSCORPORATION**

**SupplementalConsolidating Condensed Statements of Cash FlowsThree Months Ended February 26, 2006(in thousands)**

| ** **                                                                        | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided  by (used in) operating activities                              |       |                             | $          | —                       |       |                                  |       | $                                           | 1,949      |             |       |             | $          | (17,316 | ) |   |   | $ | 676 |   |   |   | $ | — |   |   |   | $ | (14,691 | ) |   |
| Cash flows from  investing activities:                                            |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment, net                                    |       |                             | —     |                         |       |                                  | (31        | )                                           |       |             | (3,326     | )                |       |   | (2,220 | ) |   |   | — |   |   |   | (5,577 | ) |   |
| Proceeds from the sale of property, plant, and  equipment                         |       |                             | —     |                         |       |                                  | —     |                                        |       |             | 16         |             |       |   | 13 |   |   |   | — |   |   |   | 29 |   |   |
| Net activity in investment in and advances to (from)  subsidiaries and affiliates |       |                             | —     |                         |       |                                  | (6,918     | )                                           |       |             | (668       | )                |       |   | 7,586 |   |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                               |       |                             | —     |                         |       |                                  | (6,949     | )                                           |       |             | (3,978     | )                |       |   | 5,379 |   |   |   | — |   |   |   | (5,548 | ) |   |
| Cash flows from  financing activities:                                            |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net borrowings  under revolving credit facilities                                 |       |                             | —     |                         |       |                                  | 5,000      |                                        |       |             | —     |             |       |   | (8,295 | ) |   |   | — |   |   |   | (3,295 | ) |   |
| Other borrowings  (repayments)                                                    |       |                             | —     |                         |       |                                  | —     |                                        |       |             | —     |             |       |   | (774 | ) |   |   | — |   |   |   | (774 | ) |   |
| Other                                                                             |       |                             | —     |                         |       |                                  | —     |                                        |       |             | 1,392      |             |       |   | — |   |   |   | — |   |   |   | 1,392 |   |   |
| Net cash provided  by (used in) financing activities                              |       |                             | —     |                         |       |                                  | 5,000      |                                        |       |             | 1,392      |             |       |   | (9,069 | ) |   |   | — |   |   |   | (2,677 | ) |   |
| Effect of  exchange rate changes on cash                                          |       |                             | —     |                         |       |                                  | —     |                                        |       |             | —     |             |       |   | 122 |   |   |   | — |   |   |   | 122 |   |   |
| Change in cash and  cash equivalents                                              |       |                             | —     |                         |       |                                  | —     |                                        |       |             | (19,902    | )                |       |   | (2,892 | ) |   |   | — |   |   |   | (22,794 | ) |   |
| Cash and cash  equivalents:                                                       |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                                               |       |                             | —     |                         |       |                                  | 1          |                                        |       |             | 25,387     |             |       |   | 11,166 |   |   |   | — |   |   |   | 36,554 |   |   |
| End of period                                                                     |       |                             | $          | —                       |       |                                  |       | $                                           | 1          |             |       |             | $          | 5,485 |   |   |   | $ | 8,274 |   |   |   | $ | — |   |   |   | $ | 13,760 |   |   |

 

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**SEALY MATTRESSCORPORATION**

**SupplementalConsolidating Condensed Statements of Cash FlowsThree Months Ended February 27, 2005(in thousands)**

| ** **                                                                        | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided  by (used in) operating activities                              |       |                             | $          | —                       |       |                                  |       | $                                           | (1,501     | )                |       |             | $          | 249 |   |   |   | $ | 3,144 |   |   |   | $ | — |   |   |   | $ | 1,892 |   |   |
| Cash flows from  investing activities:                                            |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment, net                                    |       |                             | —     |                         |       |                                  | (34        | )                                           |       |             | (5,599     | )                |       |   | (65 | ) |   |   | — |   |   |   | (5,698 | ) |   |
| Proceeds from the sale of property, plant and  equipment                          |       |                             | —     |                         |       |                                  | —     |                                        |       |             | 4,648      |             |       |   | — |   |   |   | — |   |   |   | 4,648 |   |   |
| Net activity in investment in and advances to (from)  subsidiaries and affiliates |       |                             | —     |                         |       |                                  | (4,965     | )                                           |       |             | (354       | )                |       |   | 5,319 |   |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                               |       |                             | —     |                         |       |                                  | (4,999     | )                                           |       |             | (1,305     | )                |       |   | 5,254 |   |   |   | — |   |   |   | (1,050 | ) |   |
| Cash flows from  financing activities:                                            |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Repayments of  long-term obligations, net                                         |       |                             | —     |                         |       |                                  | (5,000     | )                                           |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | (5,000 | ) |   |
| Net borrowings  under revolving credit facilities                                 |       |                             | —     |                         |       |                                  | 11,500     |                                        |       |             | —     |             |       |   | 5,751 |   |   |   | — |   |   |   | 17,251 |   |   |
| Other                                                                             |       |                             | —     |                         |       |                                  | —     |                                        |       |             | 29         |             |       |   | 2,909 |   |   |   | — |   |   |   | 2,938 |   |   |
| Net cash provided  by financing activities                                        |       |                             | —     |                         |       |                                  | 6,500      |                                        |       |             | 29         |             |       |   | 8,660 |   |   |   | — |   |   |   | 15,189 |   |   |
| Effect of  exchange rate changes on cash                                          |       |                             | —     |                         |       |                                  | —     |                                        |       |             | —     |             |       |   | (972 | ) |   |   | — |   |   |   | (972 | ) |   |
| Change in cash  and cash equivalents                                              |       |                             | —     |                         |       |                                  | —     |                                        |       |             | (1,027     | )                |       |   | 16,086 |   |   |   | — |   |   |   | 15,059 |   |   |
| Cash and cash  equivalents:                                                       |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                                               |       |                             | —     |                         |       |                                  | 2          |                                        |       |             | 5,142      |             |       |   | 17,635 |   |   |   | — |   |   |   | 22,779 |   |   |
| End of period                                                                     |       |                             | $          | —                       |       |                                  |       | $                                           | 2          |             |       |             | $          | 4,115 |   |   |   | $ | 33,721 |   |   |   | $ | — |   |   |   | $ | 37,838 |   |   |

 

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**SEALY MATTRESSCORPORATION**

**Item 2.**                     Management’sDiscussion and Analysis of Financial Condition and Results of Operations

***BUSINESS OVERVIEW***

We believe that Sealy Mattress Corporation, throughour subsidiaries, is the largest bedding manufacturer in the world, with awholesale domestic market share of 20.7% in 2004. Based on preliminary datafrom the International Sleep Products Association, we believe our market sharein 2005 is comparable to 2004. We manufacture and market a complete line ofbedding (innerspring and non-innerspring) products including mattresses and boxsprings, holding leading positions in key market segments, such as luxurybedding products, and among leading retailers. According to *Home Furnishing News*in 2005, the Sealy brand ranked 15th among the top 150 home products brands. Ourconventional bedding products include the *Sealy,Sealy Posturepedic, Stearns & Foster, and Bassett* brandsand accounted for approximately 88.9% of our total net sales for the year endedNovember 27, 2005. In addition to our innerspring bedding, we also producea variety of visco-elastic (memory foam) and latex foam bedding products. Thoughsales of such products were not significant through the first quarter of 2006,we expect to experience growth in these product lines as we seek to strengthenour competitive position in the specialty bedding (non-innerspring mattress)market. We distinguish ourselves from our major competitors by maintaining ourown component parts manufacturing capability and producing substantially all ofour mattress innerspring requirements and approximately 48% of our box springcomponent parts requirements. We believe that our industry is resilient toeconomic downturns due in part to the large portion of purchases, approximately70%, which are for mattress replacements. The growth of the bedding industryhas been supported by economic and demographic factors such as increasingdisposable income among the “baby boomer” segment of the population, anincrease in the number of bedrooms per home and second home purchases, andgrowing awareness of the health benefits of quality sleep.

In 2004, we successfully completed the rollout of oursingle-sided, “no-flip” Sealy Posturepedic UniCased® andStearns & Foster product lines in the United States, Canada, andMexico, representing the broadest product redesign in our history. Themanufacture and sale of these products for our Sealy Posturepedic lines beganin mid-2003, followed by the introduction of the new Stearns &Foster lines in the first fiscal quarter of 2004. Our initial profitabilityfrom the sales of these new products was limited as we worked to gainmanufacturing efficiency with the new designs and supported our customers’transition to the new products with price rollbacks. In 2004, with these issuessubstantially behind us, we began to realize the anticipated contribution ofthese products to our sales growth and profitability, which has continued intothe first quarter of fiscal 2006. Our profitability has been further enhancedby rapid growth among our luxury bedding lines ($1,000 and up retail pricepoints). Our shares of the Luxury and Ultra-Luxury product segments are greaterthan our overall market share, and our Stearns & Foster and LuxuryPosturepedic lines directly target these segments. In the first quarter offiscal 2006, we introduced our latest product offerings from the Stearns &Foster lines, to be followed in the second quarter by our newest SealyPosturepedic products.

Late in the first quarter of 2005, we introduced ournew *TrueForm *visco-elasticbedding product line to take advantage of the rapid growth of the specialtybedding category. This market, which includes latex foam, visco-elastic,air-adjustable and other non-innerspring mattress products, has experiencedsubstantial growth both domestically and internationally. We believe that bysuccessfully leveraging our strong brand advantage and our marketing anddistribution capabilities, we have the potential to make significant gains inthe specialty bedding category.

Our industry continues to be challenged by the highcost of steel and petroleum products, which affect the cost of our steelinnerspring and our polyurethane foam and polyethylene component parts. Duringfiscal 2005 and into the first quarter of fiscal 2006, the cost of thesecomponents has continued to remain elevated above their recent historicalaverages, and we expect this trend to continue for the remainder of 

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fiscal 2006. Through February 26,2006, we have been able to successfully address these cost pressures through aprice increase announced in November 2005, and through cost reductionefforts.

Historically, the bedding industry has had limitedexposure to competition from imports due to high shipping costs, short leadtimes, the large number of finished goods SKUs and the importance of brands. Furthermore,we also believe that the relatively low labor content of our domesticallyproduced mattresses lessens any competitive advantage provided by lower Asianlabor costs. Although Asian bedding manufacturers have begun to explore thefeasibility of exporting their products into the United States, we do notexpect that competition from Asian bedding imports will have a significantimpact on our business. We believe that by focusing on further improvements inthe efficiency of our supply chain, controlling costs, and continuing to investin product innovation and our brands, we can ensure that our domesticallyproduced products will remain competitive with Asian bedding imports.

We have continued to see sales growth in ourinternational operations over the last several years, with our foreignsubsidiaries contributing 20.5% during the first quarter of fiscal 2006.However, our Brazilian subsidiary, contributing less than 1% of our totalrevenues for fiscal 2005 and the first quarter of fiscal 2006, has continued toperform below our expectations and has not yet achieved profitability. While wedo not believe that we have, as yet, suffered any impairment with respect toour investment in long-lived assets in Brazil, we will continue to monitor thatoperation closely as we evaluate our strategic alternatives in that market.

On April 6, 2004 ourparent company, Sealy Corporation, completed a merger with affiliates ofKohlberg Kravis Roberts & Co. L.P. (“KKR”) whereby KKR acquiredapproximately 92% of Sealy Corporation’s capital stock. In connection with themerger, we recapitalized substantially all of our outstanding debt. A fulldescription of the effects of the merger and recapitalization is included inour 2005 Annual Report on Form 10-K, filed with the Securities andExchange Commission on February 27, 2006. Although we incurred substantially increased levels of debt in therecapitalization, our cost of capital was reduced due to lower interest rateson the new debt compared with our earlier financing. On April 14, 2005, wefurther reduced our cost of capital by amending and restating our seniorsecured credit agreement. The amendment provided an additional $100 million ofsenior secured term loans which were used to repay our senior unsecured termloans, reducing our future interest costs. Utilizing our strong operating cashflow since the recapitalization, we have been able to repay $210 million of oursenior secured term debt significantly ahead of schedule. Our strategy for 2006is to continue to deleverage our business through additional prepayments of ourlong-term debt as permitted by our senior credit agreements and our operatingcash flow. On April 12, 2006, our parent company, SealyCorporation, completed an initial public offering of its common stock. Weexpect to use a portion of the proceeds to retire approximately $48.5 millionaggregate principal amount of our 8.25% Senior Subordinated Notes due 2014 (the“Notes”). See “*Subsequent Event—Initial Public Offering of OurParent Company’s Common Stock*” below for a full description of theexpected impact of the IPO on our financial position and results of operations.

***Subsequent Event—Initial Public Offering of Our ParentCompany’s Common Stock***

On April 12, 2006, our parent company, SealyCorporation, completed an initial public offering (“IPO”) of its common stock. Weexpect that approximately $82.5 million of the net proceeds received by SealyCorporation from the IPO will be contributed to us to be used as follows:  (i) approximately $54.3 million toretire approximately $48.5 million aggregate principal amount of the Company’s8.25% Senior Subordinated Notes (the “Notes”) due in 2014, along withprepayment penalties and interest thereon; (ii) $11.0 million to terminatethe our management services agreement with KKR; and (iii) approximately$17.2 million to pay a transaction-related bonus to members of management.

On a pro forma basis, had the IPO occurred at thebeginning of the first quarter of fiscal 2006, our interest expense would havebeen approximately $1.0 million lower than reported, and selling, general and 

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administrative expenseswould have been reduced by approximately $0.1 million due to the elimination of$0.5 million in management fees paid to KKR, partially offset by $0.4 millionof share-based compensation expense arising from options to purchase SealyCorporation stock granted to certain of our management employees in connectionwith the IPO.

Through February 26,2006, Sealy Corporation has incurred approximately $2.1 million of costs inconnection with the IPO, all of which have been funded by Sealy MattressCorporation.

***RESULTS OF OPERATIONS***

***Tabular Information***

Thefollowing table sets forth our summarized results of operations for three monthsended February 26, 2006 and February 27, 2005, expressed in millionsof dollars as well as a percentage of each year’s net sales:

| ** **                                                         | ** ** | **For the three months ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                         | ** ** | **February 26,**                              | ** ** | **February 27,** | ** ** |
| ** **                                                         | ** ** | **2006**                                           | ** ** | **2005** | ** ** |
| ** **                                                         | ** ** | **millions**                                       | ** ** | **percentage  of net sales** | ** ** | **millions** | ** ** | **percentage  of net sales** | ** ** |
| Total net sales                                                    |       |                                               | $          | 395.7 |   |   |   | 100.0 | % |   |   | $ | 359.0 |   |   |   | 100.0 | % |   |
| Total cost of  goods sold                                          |       |                                               | 219.0      |   |   |   | 55.3 |   |   |   | 200.0 |   |   |   | 55.7 |   |   |
| Gross Profit                                                       |       |                                               | 176.7      |   |   |   | 44.7 |   |   |   | 159.0 |   |   |   | 44.3 |   |   |
| Selling, general and administrative                                |       |                                               | 123.6      |   |   |   | 31.2 |   |   |   | 108.3 |   |   |   | 30.2 |   |   |
| Amortization of  intangibles                                       |       |                                               | 0.1        |   |   |   | 0.0 |   |   |   | 0.2 |   |   |   | 0.1 |   |   |
| Royalty income,  net of royalty expense                            |       |                                               | (3.7       | ) |   |   | (0.9 | ) |   |   | (2.6 | ) |   |   | (0.7 | ) |   |
| Income from operations                                             |       |                                               | 56.7       |   |   |   | 14.3 |   |   |   | 53.1 |   |   |   | 14.8 |   |   |
| Interest expense                                                   |       |                                               | 16.6       |   |   |   | 4.1 |   |   |   | 17.8 |   |   |   | 4.9 |   |   |
| Other income, net                                                  |       |                                               | (0.2       | ) |   |   | — |   |   |   | (0.1 | ) |   |   | — |   |   |
| Income before income taxes                                         |       |                                               | 40.3       |   |   |   | 10.2 |   |   |   | 35.4 |   |   |   | 9.9 |   |   |
| Income taxes                                                       |       |                                               | 15.7       |   |   |   | 4.0 |   |   |   | 13.6 |   |   |   | 3.8 |   |   |
| Income before cumulative effect of change in  accounting principle |       |                                               | 24.6       |   |   |   | 6.2 |   |   |   | $ | 21.8 |   |   |   | 6.1 |   |   |
| Cumulative effect  of change in accounting principle               |       |                                               | 0.3        |   |   |   | 0.1 |   |   |   | — |   |   |   | — |   |   |
| Net Income                                                         |       |                                               | 24.3       |   |   |   | 6.1 | % |   |   | 21.8 |   |   |   | 6.1 | % |   |
| Effective tax  rate                                                |       |                                               | 38.9       | % |   |   |   |   |   |   | 38.4 | % |   |   |   |   |   |

 

Thefollowing table indicates the percentage distribution of our net sales in U.S.dollars throughout our international operations:

| **Geographic distribution of sales:** |       |                              |       |                  |       |
|------------------------------------------------------|------------|-----------------------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **Three Months Ended:** | ** ** |
| ** **                                           | ** ** | **February 26,**             | ** ** | **February 27,** | ** ** |
| ** **                                           | ** ** | **2006**                          | ** ** | **2005**              | ** ** |
| **US Domestic**                                      |       |                              | 79.5       | %                     |       |   | 79.9 | % |   |
| **International:**                                   | ** ** | ** **                        | ** ** | ** **            | ** ** | ** ** | ** ** | ** ** | ** ** |
| Canada                                               |       |                              | 9.2        |                  |       |   | 7.9 |   |   |
| Europe                                               |       |                              | 6.1        |                  |       |   | 7.1 |   |   |
| Other                                                |       |                              | 5.2        |                  |       |   | 5.1 |   |   |
| **Total**                                            | ** ** | ** **                        | 100.0      | %                     |       |   | 100.0 | % | ** ** |

 

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Thefollowing table shows our net sales and margin profitability for the majorgeographic regions of our operations, including local currency results for thesignificant international operations:

| ** **                             | ** ** | **For the Three Months Ended:** | ** ** |
|----------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                             | ** ** | **February 26,**                               | ** ** | **February 27,** | ** ** |
| ** **                             | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| ** **                             | ** ** | **millions**                                        | ** ** | **percentage of net sales** | ** ** | **millions** | ** ** | **percentage of net sales** | ** ** |
| **Total Domestic (US Dollars):**       | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                        |       |                                                | $          | 314.5 | ** ** |   |   | 100.0 | % |   |   | $ | 286.7 | ** ** |   |   | 100.0 | % |   |
| Total cost of goods sold               |       |                                                | 169.4      | ** ** |   |   | 53.9 |   |   |   | 153.6 | ** ** |   |   | 53.6 | ** ** |   |
| Gross profit                           |       |                                                | 145.1      | ** ** |   |   | 46.1 |   |   |   | 133.1 | ** ** |   |   | 46.4 | ** ** |   |
| **Total  International (US Dollars):** | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                        |       |                                                | 81.2       | ** ** |   |   | 100.0 |   |   |   | 72.3 | ** ** |   |   | 100.0 | ** ** |   |
| Total cost of goods sold               |       |                                                | 49.6       | ** ** |   |   | 61.1 |   |   |   | 46.4 | ** ** |   |   | 64.2 | ** ** |   |
| Gross profit                           |       |                                                | 31.6       | ** ** |   |   | 38.9 |   |   |   | 25.9 | ** ** |   |   | 35.8 | ** ** |   |
| **Canada:**                            | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US  Dollars:**                       |       |                                                |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   | ** ** |   |
| Total net sales                        |       |                                                | 36.3       | ** ** |   |   | 100.0 |   |   |   | 28.4 | ** ** |   |   | 100.0 | ** ** |   |
| Total cost of goods sold               |       |                                                | 20.2       | ** ** |   |   | 55.6 |   |   |   | 17.3 | ** ** |   |   | 60.9 | ** ** |   |
| Gross profit                           |       |                                                | 16.1       | ** ** |   |   | 44.4 |   |   |   | 11.1 | ** ** |   |   | 39.1 | ** ** |   |
| **Canadian  Dollars:**                 |       |                                                |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   | ** ** |   |
| Total net sales                        |       |                                                | 42.0       | ** ** |   |   | 100.0 |   |   |   | 34.5 | ** ** |   |   | 100.0 | ** ** |   |
| Total cost of goods sold               |       |                                                | 23.4       | ** ** |   |   | 55.7 |   |   |   | 21.5 | ** ** |   |   | 62.3 | ** ** |   |
| Gross profit                           |       |                                                | 18.6       | ** ** |   |   | 44.3 |   |   |   | 13.0 | ** ** |   |   | 37.7 | ** ** |   |
| **Europe:**                            | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US  Dollars:**                       | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                        |       |                                                | 24.1       | ** ** |   |   | 100.0 |   |   |   | 25.6 | ** ** |   |   | 100.0 | ** ** |   |
| Total cost of goods sold               |       |                                                | 16.8       | ** ** |   |   | 69.7 |   |   |   | 17.3 | ** ** |   |   | 67.6 | ** ** |   |
| Gross profit                           |       |                                                | 7.3        | ** ** |   |   | 30.3 |   |   |   | 8.3 | ** ** |   |   | 32.4 | ** ** |   |
| **Euros:**                             | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                        |       |                                                | 20.1       | ** ** |   |   | 100.0 |   |   |   | 19.3 | ** ** |   |   | 100.0 | ** ** |   |
| Total cost of goods sold               |       |                                                | 14.1       | ** ** |   |   | 70.1 |   |   |   | 13.0 | ** ** |   |   | 67.4 | ** ** |   |
| Gross profit                           |       |                                                | 6.0        | ** ** |   |   | 29.9 |   |   |   | 6.3 | ** ** |   |   | 32.6 | ** ** |   |
| **Other  International (US Dollars):** | ** ** |                                                | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                        |       |                                                | 20.8       | ** ** |   |   | 100.0 |   |   |   | 18.3 | ** ** |   |   | 100.0 | ** ** |   |
| Total cost of goods sold               |       |                                                | 12.6       | ** ** |   |   | 60.6 |   |   |   | 11.8 | ** ** |   |   | 64.5 | ** ** |   |
| Gross profit                           |       |                                                | $          | 8.2 | ** ** |   |   | 39.4 | % |   |   | $ | 6.5 | ** ** |   |   | 35.5 | % |   |

 

***Quarter Ended February 26, 2006 compared withQuarter Ended February 27, 2005***

*NetSales.**  *Ournet sales for the quarter ended February 26, 2006, were $395.7 million, anincrease of $36.7 million, or 10.2% from the quarter ended February 27,2005. Total domestic net sales were $314.5 million for the first quarter of2006 compared to $286.7 million for the first quarter of 2005. The domestic netsales increase of $27.8 million was attributable to a 10.1% increase in averageunit selling price, partially offset by a 0.4% decrease in volume. The increasein average unit selling price is due to improved sales mix from our Stearns &Foster and specialty bedding product lines, which we define as those productsutilizing visco-elastic or latex foam cores rather than innersprings, and dueto price increases announced in November 2005 to offset the effects ofrising raw material costs. Total international sales were $81.2 million in thefirst quarter of 2006 compared to $72.3 million in the first quarter of 2005,an increase of 

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$8.9 million, or 12.3%. Inour Canadian market, local currency sales gains of 21.7% translated into gainsof 27.8% in US Dollars. Local currency gains in our Canadian market were drivenby a 17.7% increase in average unit selling price resulting from sales miximprovement and the November 2005 price increases, combined with a 3.4%increase in volume. In our European market, local currency sales gains of 4.1%translated into a decrease of 5.9% in US dollars. Local currency sales gains inthe European market were primarily attributable to a 12.8% increase in volumeattributable to increased OEM sales of latex bed cores, partially offset by a7.7% decline in average unit selling price associated with the increased salesof lower-priced latex bed cores. Non-OEM sales in our European market decreasedapproximately 11.8%. Elsewhere, sales gains in our Mexico and Argentina marketswere partially offset by a sales volume decline in Brazil.

*GrossProfit.**  *Ourgross profit for the quarter was $176.7 million, an increase of $17.7 millionover the comparable prior year period. As a percentage of net sales, grossprofit increased 0.4 percentage points to 44.7%. This increase (as a percentageof net sales) is due primarily to improvements in international operations. Domesticgross profit increased $12.0 million to $145.1 million, which represented adecline of 0.3 percentage points to 46.1%. This decrease is driven by higherfloor sample costs associated with the launch of our new Stearns &Foster product line. The 10.1% increase in average unit selling price was morethan offset by increases in the cost of materials. On a per unit basis,material costs increased 14.0% relative to the first quarter of 2005 dueprimarily to increased foam and wood product costs as well as changes in thesales mix toward higher price-point products. Variable conversion costs as apercentage of sales decreased due to continued improvements in manufacturingefficiencies. Fixed manufacturing costs as a percentage of sales wereconsistent with the prior year period. On a per unit basis, variable conversioncosts and fixed manufacturing costs increased 5.4% primarily due to higheremployee health insurance costs. We believe this increase is temporary and isassociated with the transition to a new third party administrator. We expectedsuch costs to return to historical levels in subsequent periods. Gross profitfor the international business increased 3.1 percentage points to 38.9% of netsales. This increase is primarily due to higher average unit selling prices inCanada, as well as in our South American markets, partially offset by increasedmaterial costs.

*Selling,General, Administrative.**  *Our selling, general, and administrative expense as apercent of net sales was 31.2% and 30.2% for the quarters ended February 26,2006 and February 27, 2005, respectively, an increase of 1.0 percentagepoint. This increase is primarily the result of higher promotional expensesassociated with the roll out of our new Stearns & Foster andPosturepedic product lines, higher marketing costs, and a decline in foreigncurrency exchange gains, which were $2.4 million higher in the prior yearperiod, partially offset by lower cooperative advertising costs and salarycosts, which declined as a percentage of net sales.

*Royaltyincome, net of royalty expense.*   Our royaltyincome, net of royalty expenses, for the three months ended February 26,2006 increased $1.1 million from the three months ended February 27, 2005,primarily due to higher domestic royalty revenue.

*InterestExpense.**  *Our interest expense for the first quarter offiscal 2006 decreased $1.2 million from the prior year period to $16.6million, primarily due to lower debt levels resulting from $115 million involuntary prepayments of our senior term debt, partially offset by slightlyhigher borrowing costs. Our weighted average borrowing costs for the firstquarter of fiscal 2006 and 2005 were 7.5% and 7.3%, respectively. The increasein our borrowing cost was due to higher interest rates on the variable ratecomponent of our floating rate debt, largely offset by lower interest rates onthe fixed component of our senior secured term debt interest rate as a resultof the April 2005 amendment of our senior secured credit agreement and therelated extinguishment of our senior unsecured term loan.

*Income Tax.**  *Our effective income tax ratesdiffer from the Federal statutory rate principally because of the effect ofcertain foreign tax rate differentials and state and local income taxes. Oureffective tax rate 

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for the quarterended February 26, 2006 is approximately 38.9% compared to 38.4% forquarter ended February 27, 2005.

***LIQUIDITY AND CAPITAL RESOURCES***

***Principal Sources of Funds***

Our principal sources offunds are cash flows from operations and borrowings under our senior securedrevolving credit facility. Our principal use of funds consists of operatingexpenditures, payments of principal and interest on our senior creditagreements, capital expenditures and interest payments on our outstandingsenior subordinated notes. Capital expenditures totaled $ 5.6 million for thethree months ended February 26, 2006. We expect total 2006 capitalexpenditures to be approximately $53 million, including approximately $20.5million for additional production capacity in the United States and Europe. Webelieve that annual capital expenditure limitations in our current debtagreements will not significantly prevent us from meeting our ongoing capitalneeds. Ourintroductions of new products typically require us to make initial cashinvestments in inventory, promotional supplies and employee training which maynot be immediately recovered through new product sales. However, we believethat we have sufficient liquidity to absorb such expenditures related to newproducts and that these expenses will not have a significant adverse impact onour operating cash flow. At February 26, 2006, we had approximately$77.6 million available under our revolving credit facility after taking intoaccount letters of credit issued totaling $32 million. Our net weighted averageborrowing cost was 7.5% and 7.3% for the three months ended February 26,2006 and February 27, 2005, respectively. The increase in our borrowingcost was due to higher interest rates on the variable rate component of ourfloating rate debt, largely offset by lower interest rates on the fixedcomponent of our senior secured term debt interest rate as a result of the April 2005amendment of our senior secured credit agreement and the related extinguishmentof our senior unsecured term loan.

***Debt***

As part of the April 2004 recapitalization, weincurred substantial debt, including new senior credit facilities consisting ofa $125 million senior secured revolving credit facility with a six-yearmaturity, and a $560 million senior secured term loan facility with aneight-year maturity. We also borrowed $100 million under a senior unsecuredterm loan, due in 2013, and issued $390 million aggregate principal amount ofthe Notes. Since the recapitalization and through February 26, 2006, wehave repaid $210 million of the original $560.0 million outstanding under oursenior secured term loan. In doing so, we have effectively prepaid allprincipal payments due prior to the maturity of the loan in 2012. Most of theprepayments have been funded from our operating cash flow, along with $15.4 millionoutstanding under our senior secured revolving credit facility at February 26,2006. As of April 10, 2005, we have $16.4 million outstanding under ourrevolving credit facility.

Borrowings under our new senior secured creditfacilities bear interest at our choice of the Eurodollar rate or adjusted baserate (‘‘ABR’’), in each case, plus an applicable margin, subject to adjustmentbased on a pricing grid. Annually, we may be required to make principalprepayments equal to 25% of excess cash flow for the preceding fiscal year, asdefined in our senior secured credit agreement. At February 26, 2006, wewere unable to determine the amount of such required prepayment, if any, thatwould be due following the first quarter of fiscal 2007 with respect to any excesscash flow for the 2006 fiscal year.

On April 14, 2005, we amended our senior securedcredit agreement to provide for an additional $100 million of senior securedterm borrowings. The proceeds from the additional borrowing were used to repaythe $100 million outstanding under our senior unsecured term loan, effectivelyreducing the interest rate on this amount of debt by 275 basis points. Theamendment also reduced the applicable interest rate margin charged on oursenior secured term loan, provided certain financial leverage ratio tests aremet. This amendment, along with a prior amendment on August 6, 2004,reduced the applicable margin by a total of 50 basis points. In addition, thisamendment provides us with greater flexibility to make dividend 

25

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distributions to ourparent, Sealy Corporation, or to repay certain subordinated debt, providedcertain leverage ratio tests and other conditions are met. The terms andconditions of our $125 million senior revolving credit facility were unchangedby the amendment.

On June 3, 2004, we entered into an interest rateswap agreement effective July 6, 2004 effectively fixing the floatingportion of the interest rate at 3.725% on $200 million of the outstandingbalance under the senior secured term loan through November 2005,declining to $150 million from December 2005 through November 2007. Toretain the designation of this swap as a hedging instrument, we must select theEurodollar rate on the hedged portion of the senior secured term loan duringthe term of the swap.

The outstanding Notes consist of $389.5 millionaggregate principal amount maturing June 15, 2014, bearing interest at8.25% per annum payable semiannually in arrears on June 15 and December 15,commencing on December 15, 2004. On September 29, 2004, we completedan exchange offer whereby all of the Notes were exchanged for publicly traded,registered securities with identical terms (other than certain terms relatingto registration rights and certain interest rate provisions otherwiseapplicable to the original senior subordinated notes). During the fourthquarter of fiscal 2005, we repurchased $0.5 million principal amount of theNotes. During the second quarter of fiscal 2006, we intend to use a portion ofthe proceeds from our parent company’s IPO to retire approximately $48.5million aggregate principal amount of the Notes. We expect this retirement toreduce our annual interest cost by approximately $4.2 million, including areduction of approximately $0.2 million in the amortization of debt issuancecosts related to the Notes.

At February 26, 2006 we were in compliance withthe covenants contained within our senior credit agreements and note indenture.

As part of our ongoing evaluation of our capitalstructure, we continually assess opportunities to reduce our debt, whichopportunities may from time to time include voluntary prepayments of our seniorsecured term debt, or redemption or repurchase of a portion of our seniorsubordinated notes to the extent permitted by our debt covenants.

Our ability to make scheduled payments of principal,or to pay the interest or liquidated damages, if any, on, or to refinance ourindebtedness, or to fund planned capital expenditures will depend on our futureperformance, which, to a certain extent, is subject to general economic,financial, competitive, legislative, regulatory and other factors that arebeyond our control. Based upon the current level of operations, we believe thatcash flow from operations and available cash, together with availableborrowings under the senior credit agreement, will be adequate to meet thefuture liquidity needs during the one year following February 26, 2006. Wewill be required to make scheduled principal payments of approximately $11.3million during the next twelve months, substantially all of which is for debtowed by our international subsidiaries. However, as we continually evaluate ourability to make additional prepayments as permitted under our senior creditagreements, it is possible that we will make substantial prepayments on oursenior debt during that time.

While we believe that we will have the necessaryliquidity through our operating cash flow and revolving credit facility for thenext several years to fund our debt service requirements, capital expendituresand other operational cash requirements, we may not be able to generatesufficient cash flow from operations, realize anticipated revenue growth andoperating improvements or obtain future borrowings under the senior creditagreements in an amount sufficient to enable us to do so. In addition, theexpiration of the revolving credit facility in 2010, followed by the maturitiesof the senior and subordinated debt in the following years through 2015, willlikely require us to refinance such debt as it matures. We may not be able toeffect any future refinancing of our debt on commercially reasonable terms orat all.

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***Cash Flow Analysis***

Thefollowing table summarizes our changes in cash:

| ** **                               | ** ** | **Three Months Ended:** | ** ** |
|------------------------------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | **February 26,  2006**       | ** ** | **February 27,  2005** | ** ** |
| ** **                               | ** ** | **(in millions)**            | ** ** |
| Statement of Cash Flow  Data:            |       |                              |       |   |   |   |   |   |   |
| Cash flows  provided by (used in):       |       |                              |       |   |   |   |   |   |   |
| Operating activities                     |       |                              | $          | (14.7 | ) |   |   | $ | 1.9 |   |   |
| Investing activities                     |       |                              | (5.5       | ) |   |   | (1.1 | ) |   |
| Financing activities                     |       |                              | (2.7       | ) |   |   | 15.2 |   |   |
| Effect of  exchange rate changes on cash |       |                              | 0.1        |   |   |   | (1.0 | ) |   |
| Change in cash  and cash equivalents     |       |                              | (22.8      | ) |   |   | 15.0 |   |   |
| Cash and cash equivalents:               |       |                              |       |   |   |   |   |   |   |
| Beginning of  period                     |       |                              | 36.6       |   |   |   | 22.8 |   |   |
| End of period                            |       |                              | $          | 13.8 |   |   |   | $ | 37.8 |   |   |

 

***Quarter Ended February 26,2006 Compared With Quarter Ended February 27, 2005***

*Cash Flows from OperatingActivities*   Our cash flow from operationsdecreased $16.6 million to a $14.7 million net use of cash for the three monthsended February 26, 2006, compared to $1.9 million net source of cash forthe three months ended February 27, 2005. This decline was primarily theresult of changes in working capital, timing of various vendor payments andlower cash requirements for tax payments in the prior year period due tooperating losses in fiscal 2004, partially offset by lower cash payments forinterest in the first quarter of fiscal 2006 as compared to the first quarterof fiscal 2005 due to a larger initial interest payment on the Notes made inDecember, 2004.

*Cash Flows from InvestingActivities.**  *Our cashflows used in investing activities increased approximately $4.4 million fromthe first quarter of 2005 primarily due to $4.6 million of proceeds from thesale of our former Randolph, Massachusetts manufacturing facility received inthe first quarter of fiscal 2005.

*Cash Flows from FinancingActivities.**  *Our cashflow from financing activities for the three months ended February 26,2006 decreased $17.9 million to a net use of $2.7 million from a net source of$15.2 million for the three months ended February 27, 2005. Cash flowsfrom net borrowings under our revolving credit facilities decreased $21 millionfrom the first quarter of fiscal 2005, as we reduced the net outstandingbalance by $3.3 million during the first quarter of fiscal 2006, compared tonet borrowings of $17.3 million during the prior year period. There were noprepayments of our senior secured term debt during the first quarter of fiscal2006, compared with prepayments of $5 million during the first quarter offiscal 2005.

***IPO Costs***

Through February 26,2006, we have incurred approximately $2.1 million of costs on behalf of ourparent company in connection with the IPO. Total direct costs of the IPO,excluding underwriting fees deducted directly from IPO proceeds, are currentlyestimated to be $5.0 million (including the $2.1 million already incurred). Weexpect all such costs, along with approximately $34.5 million of expenses to beincurred in connection with the IPO, to be recovered from the net proceeds ofthe IPO during the second quarter of fiscal 2006.

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***Income Taxes***

Significant judgment isrequired in evaluating our federal, state and foreign tax positions and in thedetermination of our tax provision.  Despite our belief that our tax returnpositions are fully supportable, we have established reserves where we believethat certain tax positions are likely to be challenged and we may not fullyprevail in overcoming these challenges.  We may adjust these reserves as relevantcircumstances evolve, such as guidance from the relevant tax authority, our taxadvisors, or resolution of issues in the courts. Our tax expense includes theimpact of reserve positions and changes to reserves that we considerappropriate, as well as related interest. Because we are not currentlyundergoing examinations of any of our corporate income tax returns by taxauthorities, we believe that it is unlikely that an audit could be initiatedwhich would result in assessment and payment of taxes related to thesepositions during the remainder of 2006. We also cannot predict when or if anyother future tax payments related to these tax positions may occur. Therefore,substantially all of the reserves for these positions are classified asnoncurrent liabilities in our balance sheet.

***Debt Covenants***

Our long-term obligationscontain various financial tests and covenants. Our senior secured creditfacilities require us to meet a minimum interest coverage ratio and a maximumleverage ratio. The indenture governing our new senior subordinated notes alsorequires us to meet a fixed charge coverage ratio in order to incur additionalindebtedness, subject to certain exceptions. We are currently in compliancewith all debt covenants. The specific covenants and related definitions can befound in the applicable debt agreements, each of which we have previously filedwith the Securities and Exchange Commission.

The covenants contained inour senior secured credit facilities are based on what we refer to herein as “AdjustedEBITDA”. In the senior secured credit facilities, EBITDA is defined as netincome plus interest, taxes, depreciation and amortization and Adjusted EBITDAis defined as EBITDA further adjusted to exclude unusual items and otheradjustments permitted in calculating covenant compliance as discussed above. AdjustedEBITDA is presented herein as it is a material component of these covenants.Non-compliance with such covenants could result in the requirement toimmediately repay all amounts outstanding under such facilities. While thedetermination of “unusual items” is subject to interpretation and requiresjudgment, we believe the adjustments listed below are in accordance with the covenants.

EBITDA and Adjusted EBITDAare not recognized terms under GAAP and do not purport to be alternatives tonet income as a measure of operating performance or to cash flows fromoperating activities as a measure of liquidity. Additionally, they are not intendedto be measures of free cash flow for management’s discretionary use, as they donot consider certain cash requirements such as interest payments, tax paymentsand debt service requirements. Because not all companies use identicalcalculations, these presentations may not be comparable to other similarlytitled measures of other companies.

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Thefollowing table sets forth a reconciliation of net income to EBITDA and EBITDAto Adjusted EBITDA for the three months ended February 26, 2006 and February 27,2005:

| ** **                                                         | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                         | ** ** | **February 26, 2006**  | ** ** | **February 27, 2005** | ** ** |
| Income before  cumulative effect of change in accounting principle |       |                             | $          | 24.6 |   |   |   | $ | 21.9 |   |   |
| Interest cost                                                      |       |                             | 16.6       |   |   |   | 17.8 |   |   |
| Income taxes                                                       |       |                             | 15.7       |   |   |   | 13.6 |   |   |
| Depreciation and amortization                                      |       |                             | 5.7        |   |   |   | 5.5 |   |   |
| EBITDA                                                             |       |                             | 62.6       |   |   |   | 58.8 |   |   |
| Management fees to KKR                                             |       |                             | 0.5        |   |   |   | 0.5 |   |   |
| Unusual and nonrecurring losses:                                   |       |                             |       |   |   |   |   |   |   |
| Post-closing residual plant costs                                  |       |                             | 0.3        |   |   |   | 0.5 |   |   |
| Non-cash compensation                                              |       |                             | 0.4        |   |   |   | — |   |   |
| Other (various)                                                    |       |                             | 0.1        |   |   |   | (0.2 | ) |   |
| Adjusted EBITDA                                                    |       |                             | $          | 63.9 |   |   |   | $ | 59.6 |   |   |

 

Thefollowing table reconciles EBITDA to cash flow from operations:

| ** **                                                         | ** ** | **Three Months Ended** | ** ** |
|--------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                         | ** ** | **February 26,  2006**      | ** ** | **February 27,  2005** | ** ** |
| Income before  cumulative effect of change in accounting principle |       |                             | $          | 24.6 |   |   |   | $ | 21.9 |   |   |
| Interest                                                           |       |                             | 16.6       |   |   |   | 17.8 |   |   |
| Income taxes                                                       |       |                             | 15.7       |   |   |   | 13.6 |   |   |
| Depreciation & amortization                               |       |                             | 5.7        |   |   |   | 5.5 |   |   |
| EBITDA                                                             |       |                             | 62.6       |   |   |   | 58.8 |   |   |
| Adjustments to  EBITDA to arrive at cash flow from operations:     |       |                             |       |   |   |   |   |   |   |
| Interest expense                                                   |       |                             | (16.6      | ) |   |   | (17.8 | ) |   |
| Income taxes                                                       |       |                             | (15.7      | ) |   |   | (13.6 | ) |   |
| Non-cash charges against (credits to) net income                   |       |                             | (1.0       | ) |   |   | 10.4 |   |   |
| Changes in operating assets & liabilities.                |       |                             | (44.0      | ) |   |   | (35.9 | ) |   |
| Cash flow from  operations                                         |       |                             | $          | (14.7 | ) |   |   | $ | 1.9 |   |   |

 

***Forward LookingStatements***

*“Safe Harbor” StatementUnder the Private Securities Litigation Reform Act of 1995.*   Whenused in this Quarterly Report on Form 10-Q, the words “believes,” “anticipates,”“expects,” “intends,” “projects” and similar expressions are used to identifyforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Such forward-looking statements relate to futurefinancial and operational results. Any forward-looking statements contained inthis report represent our management’s current expectations, based on presentinformation and current assumptions, and are thus prospective and subject torisks and uncertainties which could cause actual results to differ materiallyfrom those expressed in such forward-looking statements. Actual results coulddiffer materially from those anticipated or projected due to a number offactors. These factors include, but are not limited to:

·       thelevel of competition in the bedding industry;

·       legaland regulatory requirements;

·       thesuccess of new products;

·       ourrelationships with our major suppliers;

·       fluctuationsin costs of raw materials;

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·       ourrelationship with significant customers and licensees;

·       ourlabor relations;

·       departureof key personnel;

·       encroachmentson our intellectual property;

·       productliability claims;

·       thetiming, cost and success of opening new manufacturing facilities;

·       ourlevel of indebtedness;

·       interestrate risks;

·       futureacquisitions;

·       anincrease in return rates; and

·       otherrisks and factors identified from time to time in the Company’s reports filedwith the Securities and Exchange Commission.

All forward-lookingstatements attributable to us or persons acting on our behalf apply only as ofthe date of this Quarterly Report on Form 10-Q and are expresslyqualified in their entirety by the cautionary statements include in thisQuarterly Report on From 10-Q. Except as may be required by law, weundertake no obligation to publicly update or revise forward-looking statementswhich may be made to reflect events or circumstances after the date made or toreflect the occurrence of unanticipated events.

**Item 3. *Quantitative and Qualitative Disclosures About Market Risk***

Information relative tothe Company’s market risk sensitive instruments by major category at November 27,2005 is presented under Item 7a of the registrant’s Annual Report on Form 10-Kfor the fiscal year ended November 27, 2005.

***Foreign CurrencyExposures***

Our earnings are affectedby fluctuations in the value of our subsidiaries’ functional currency ascompared to the currencies of our foreign denominated purchases. Foreigncurrency forward, swap and option contracts are used to hedge against theearnings effects of such fluctuations. The result of a uniform 10% change inthe value of the U.S. dollar relative to currencies of countries in which wemanufacture or sell our products would not be material to our earnings orfinancial position. This calculation assumes that each exchange rate wouldchange in the same direction relative to the U.S. dollar.

To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, we have instituted a forecasted cash flowhedging program. We hedge portions of our purchases denominated in foreigncurrencies with forward and option contracts. At February 26, 2006, we hadforward contracts to sell a total of 9.0 million Canadian dollars withexpiration dates ranging from March 15, 2006 through November 15,2006. At February 26, 2006, the fair value of our net obligation under theforward contracts was $0.3 million. We do not designate our foreign currencyhedges for accounting purposes, therefore all changes in fair value are chargedto earnings.

***Interest Rate Risk***

As more fully discussed inNote 10 to our Condensed Consolidated Financial Statements (Part I, Item 1included herein), we had entered into two interest rate swap agreementsassociated with debt existing prior to the April 2004 recapitalization.Although the related debt was repaid in connection with the recapitalization,the related swaps remain in effect and are scheduled to expire inDecember 2006. Because the first swap converted a portion of our floatingrate debt to a fixed rate and a subsequent swap effectively re-established afloating rate on the same debt, the effect of the two instruments on both cashflows and earnings is largely off-setting. The combined fair value carryingamount of these swap instruments at February 26, 2006 andNovember 27, 2005 was a net obligation of $1.4 million and $1.9 million,respectively.

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On June 3, 2004, weentered into an interest rate swap agreement on July 6, 2004 effectivelyfixing the floating portion of the interest rate at 3.725% on $200 million ofour outstanding balance under the senior secured term loan through November 2005,declining to $150 million through November 2007. The fair value of thisswap instrument was an asset of $3.6 million at February 26, 2006 and $2.8million at November 27, 2005.

A 10% increase or decreasein market interest rates that affect our interest rate derivative instrumentswould not have a material impact on our earnings during the next fiscal year.

Based on the unhedgedportion of our variable rate debt outstanding at February 26, 2006, a 12.5basis point increase or decrease in variable interest rates would have anapproximately $0.4 million dollar impact on our annual interest expense.

***Commodity PriceRisks***

The cost of our steelinnerspring and our polyurethane foam and polyethylene component parts areimpacted by volatility in the price of steel and petroleum. We expect the costof the components to remain elevated above their recent historical averagesthroughout 2006. Thus far, we have been able to successfully address these costpressures through a price increase announced in May of 2004 and November of2005, and through cost reduction efforts. We do not engage in commodity hedgingprograms.

**Item4.**                        *Controls and Procedures*

Under the supervision andwith the participation of our management, including our principal executiveofficer and principal financial officer, we conducted an evaluation of theeffectiveness of the design and operation of our disclosure controls andprocedures, as defined in Rules 13a-15(e) and 15d-15(e) underthe Securities Exchange Act of 1934, as amended, as of the end of the periodcovered by this report (the ‘‘Evaluation Date’’). Based on this evaluation, ourprincipal executive officer and principal financial officer concluded as of theEvaluation Date that our disclosure controls and procedures were effective suchthat the information relating to the Company, including our consolidatedsubsidiaries, required to be disclosed in our Securities and ExchangeCommission (‘‘SEC’’) reports (i) is recorded, processed, summarized andreported within the time periods specified in SEC rules and forms, and (ii) isaccumulated and communicated to the Company’s management, including ourprincipal executive and principal financial officer, as appropriate to allowtimely decisions regarding required disclosure.

In connection with theevaluation of our disclosure controls and procedures for the year ended November 28,2004, and in connection with observations by our independent registered publicaccountants identified in their 2004 audit of our consolidated financialstatements for fiscal 2004, management identified certain deficiencies in ourfinancial statement close process primarily related to the review and approvalprocess for various account analyses and reserve/accrual calculations and theconsolidated financial/balance sheet review process. Management discussed thesedeficiencies with our Audit Committee and we are currently addressing thesedeficiencies. Beginning with the financial statement close process for thefirst fiscal quarter of 2005, we instituted an enhanced management review andapproval process for various reserves and accruals. In addition, we enhancedour balance sheet review procedures for the individual plant locations. TheCompany continued these enhanced procedures for the financial statement closeprocess for the quarter ended February 26, 2006. While the Company madeprogress during fiscal 2005 and continued this progress through the firstquarter of 2006 as it relates to the overall control of the financial statementclose process, management believes that such deficiencies have not beensufficiently remediated to conclude that significant deficiencies no longerexist. We expect to continue to improve the financial statement close processin 2006 as we continue to prepare for compliance with Section 404 of theSarbanes-Oxley Act of 2002 for fiscal 2007.

There were no otherchanges in our internal control over financial reporting identified inconnection with the foregoing evaluation that occurred during the first quarterof fiscal 2006 that have materially affected, or are reasonably likely tomaterially affect, our internal control over financial reporting.

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**PART II. OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

See Note 14 to theCondensed Consolidated Financial Statements, Part I, Item 1 includedherein.

**Item 2.**                        *Unregistered Sales of Equity Securities and Use of Proceeds*

None

**Item 3.**                        *Defaults Upon Senior Securities*

None

**Item 4.**                        *Submission of Matters to a Vote of Security Holders*

None

**Item 5.**                        *Other Information*

None

**Item6.**                        *Exhibits*
| 31.1 |   | Chief Executive Officer Certification of the  Quarterly Financial Statements. |
|------|--------|-------------------------------------------------------------------------------|
| 31.2 |   | Chief Financial Officer  Certification of the Quarterly Financial Statements. |
| 32   |   | Certification pursuant  to 18 U.S.C. Section 1350.                       |

 

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**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) ofthe Securities Exchange Act of 1934, Sealy Mattress Corporation has duly causedthis report to be signed on its behalf by the undersigned, thereunto dulyauthorized.

SEALY  MATTRESS CORPORATION

| Signature                   | ** ** | **Title**                                                       |
|-----------------------------|------------|-----------------------------------------------------------------|
|                        |       |                                                            |
| /S/ DAVID J. MCILQUHAM |       | Chairman and Chief Executive Officer                            |
| **David  J. McIlquham**     |       | (Principal Executive Officer)                                   |
| /S/ JAMES B. HIRSHORN  |       | Senior Executive Vice  President Finance, Operations,           |
| **James  B. Hirshorn**      |       | Research & Development (Principal  Accounting Officer) |

 

Date: April 12, 2006

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