**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

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**FORM 10-Q**

 

| **ý**                                                  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE ACT OF 1934** |
|-------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------|
|                                                        |       |                                                                                               |
| **For the quarterly period  ended: February 27, 2005** |
|                                                        |       |                                                                                               |
| **o**                                                       | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) SECURITIES EXCHANGE  ACT OF 1934**       |

 

**For the Transition Periodfrom            to             **

 

**Commission file number333-117081-27**

 

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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**                                | ** ** |                                  |
| **One  Office Parkway**                         | ** ** | ** **                            |
| **Trinity,  North Carolina**                    | ** ** | **27370**                             |
| (Address  of principal executive offices)       | ** ** | (Zip  Code)                           |

 

**(336)861-3500**

Registrant’stelephone number, including area code

 

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 monthsand (2) has been subject to such filing requirements for the past 90 days.Yes  ý  No  o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of theExchange Act).    Yes  o    No  ý

 

**The numberof shares of the registrant’s common stock outstanding as of April 12,2005 is approximately: 1,000.**

 

 

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**PART I.FINANCIAL INFORMATION**

 

**Item 1—*Financial Statements***

 

**SEALYMATTRESS CORPORATIONCondensed Consolidated Statements of Operations(in thousands)(unaudited)**

 
| ** **                                   | ** ** | **Quarter Ended** | ** ** |
|----------------------------------------------|------------|------------------------|------------|
| ** **                                   | ** ** | **February  27, 2005** | ** ** | **February  29, 2004** | ** ** |
| Net sales—Non-affiliates                |       | $                      | 359,023    |   | $ | 312,609 |   |
| Net sales—Affiliates (Note 13)          |       | —                 |       | 5,589 |   |
| Total net sales                              |       | 359,023                |       | 318,198 |   |
|                                         |       |                   |       |   |   |
| Cost of goods sold—Non-affiliates       |       | 199,973                |       | 180,393 |   |
| Cost of goods sold—Affiliates (Note 13) |       | —                 |       | 3,208 |   |
| Total cost of goods sold                     |       | 199,973                |       | 183,601 |   |
|                                         |       |                   |       |   |   |
| Gross Profit                                 |       | 159,050                |       | 134,597 |   |
|                                         |       |                   |       |   |   |
| Selling, general and  administrative         |       | 108,331                |       | 101,626 |   |
| Amortization of intangibles                  |       | 175                    |       | 294 |   |
| Royalty income, net of royalty  expense      |       | (2,628                 | )          | (3,384 | ) |
| Income from operations                       |       | 53,172                 |       | 36,061 |   |
| Interest expense                             |       | 17,799                 |       | 16,944 |   |
| Other income (Note 7)                        |       | (93                    | )          | (434 | ) |
| Income before income tax  expense            |       | 35,466                 |       | 19,551 |   |
| Income tax expense                           |       | 13,613                 |       | 8,290 |   |
| Net income                                   |       | $                      | 21,853     |   | $ | 11,261 |   |

 

See accompanying notes tocondensed consolidated financial statements.

 

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 **SEALYMATTRESS CORPORATION****CondensedConsolidated Balance Sheets(in thousands)**

 
| ** **                                                                        | ** ** | **February 27,  2005** | ** ** | **November 28,  2004*** | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------------------|------------|------------------------------|------------|
| ** **                                                                        | ** ** | **(Unaudited)**             | ** ** | ** **                   | ** ** |
| **Assets**                                                                        |       |                        |       |                         |       |
| Current assets:                                                                   |       |                        |       |                         |       |
| Cash and cash equivalents                                                         |       | $                           | 37,838     |                         | $          | 22,779 |   |
| Accounts receivable, net  of allowances for bad debts, cash discounts and returns |       | 197,375                     |       | 172,829                      |       |
| Inventories (Note 3)                                                              |       | 57,177                      |       | 51,923                       |       |
| Assets held for sale                                                              |       | 4,370                       |       | 8,983                        |       |
| Prepaid expenses, deferred  taxes and other current assets                        |       | 31,299                      |       | 42,611                       |       |
|                                                                              |       | 328,059                     |       | 299,125                      |       |
|                                                                              |       |                        |       |                         |       |
| Property, plant and  equipment—at cost                                       |       | 312,255                     |       | 309,919                      |       |
| Less: accumulated  depreciation                                                   |       | (148,380                    | )          | (145,740                     | )          |
|                                                                              |       | 163,875                     |       | 164,179                      |       |
| Other assets:                                                                     |       |                        |       |                         |       |
| Goodwill (Note 5)                                                                 |       | 385,863                     |       | 387,508                      |       |
| Other intangibles (Note 5)                                                        |       | 4,411                       |       | 4,555                        |       |
| Debt issuance costs, net,  and other assets                                       |       | 41,061                      |       | 41,910                       |       |
|                                                                              |       | 431,335                     |       | 433,973                      |       |
|                                                                              |       | $                           | 923,269    |                         | $          | 897,277 |   |
|                                                                              |       |                        |       |                         |       |
| **Liabilities and Stockholders’  Deficit**                                   |       |                        |       |                         |       |
| Current liabilities:                                                              |       |                        |       |                         |       |
| Current portion of  long-term obligations (Note 6)                                |       | $                           | 12,025     |                         | $          | 8,542 |   |
| Accounts payable                                                                  |       | 107,911                     |       | 96,566                       |       |
| Accrued incentives and  advertising                                               |       | 33,380                      |       | 35,829                       |       |
| Accrued compensation                                                              |       | 41,080                      |       | 37,142                       |       |
| Accrued interest                                                                  |       | 13,054                      |       | 27,366                       |       |
| Other accrued expenses                                                            |       | 43,382                      |       | 49,795                       |       |
|                                                                              |       | 250,832                     |       | 255,240                      |       |
|                                                                              |       |                        |       |                         |       |
| Due to parent company                                                             |       | 3,405                       |       | 3,376                        |       |
| Long-term obligations, net  of current portion (Note 6)                           |       | 977,361                     |       | 965,795                      |       |
| Other noncurrent  liabilities                                                     |       | 43,619                      |       | 45,774                       |       |
| Deferred income taxes                                                             |       | 12,647                      |       | 10,835                       |       |
| Commitments and  contingencies (Note 12)                                          |       | —                      |       | —                       |       |
|                                                                              |       |                        |       |                         |       |
| Stockholders’ deficit  (Note 11):                                            |       |                        |       |                         |       |
| Common stock                                                                      |       | —                      |       | —                       |       |
| Additional paid-in capital                                                        |       | 458,620                     |       | 458,620                      |       |
| Accumulated deficit                                                               |       | (826,305                    | )          | (848,158                     | )          |
| Accumulated other  comprehensive loss                                             |       | 3,090                       |       | 5,795                        |       |
|                                                                              |       | (364,595                    | )          | (383,743                     | )          |
|                                                                              |       | $                           | 923,269    |                         | $          | 897,277 |   |

 

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*Condensed from audited financial statements.

See accompanying notes tocondensed consolidated financial statements.

 

3

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**SEALYMATTRESS CORPORATIONCondensed Consolidated Statements of Cash Flows(in thousands)(unaudited)**

 
| ** **                                                                 | ** ** | **Quarter Ended**      | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                                 | ** ** | **February 27,  2005** | ** ** | **February 29,  2004** | ** ** |
| Net cash provided by (used  in) operating activities                       |       | $                      | 1,892      |   | $ | (18,452 | ) |
|                                                                       |       |                   |       |   |   |
| Cash flows from investing  activities:                                     |       |                   |       |   |   |
| Purchase of property,  plant and equipment, net                            |       | (5,698                 | )          | (5,342 | ) |
| Proceeds from the sale of  property, plant and equipment                   |       | 4,648                  |       | — |   |
| Net cash used in investing  activities                                     |       | (1,050                 | )          | (5,342 | ) |
|                                                                       |       |                   |       |   |   |
| Cash flows from financing  activities:                                     |       |                   |       |   |   |
| Repayments of long-term  obligations                                       |       | (5,000                 | )          | — |   |
| Net borrowings under  revolving credit facilities                          |       | 17,251                 |       | — |   |
| Treasury stock repurchase                                                  |       | —                 |       | (508 | ) |
| Equity issuances                                                           |       | —                 |       | 314 |   |
| Other                                                                      |       | 2,938                  |       | 817 |   |
| Net cash provided by  financing activities                                 |       | 15,189                 |       | 623 |   |
|                                                                       |       |                   |       |   |   |
| Effect of exchange rate  changes on cash                                   |       | (972                   | )          | (88 | ) |
|                                                                       |       |                   |       |   |   |
| Change in cash and cash  equivalents                                       |       | 15,059                 |       | (23,259 | ) |
| Cash and cash equivalents:                                                 |       |                   |       |   |   |
| Beginning of period                                                        |       | 22,779                 |       | 101,100 |   |
| End of period                                                              |       | $                      | 37,838     |   | $ | 77,841 |   |
|                                                                       |       |                   |       |   |   |
| Supplemental disclosures:                                                  |       |                   |       |   |   |
| Selected noncash items:                                                    |       |                   |       |   |   |
| Non-cash compensation                                                      |       | $                      | 156        |   | $ | — |   |
| Depreciation and  amortization                                             |       | 5,488                  |       | 6,123 |   |
| Non-cash interest expense  associated with:                                |       |                   |       |   |   |
| Debt issuance costs                                                        |       | 1,220                  |       | 1,422 |   |
| Premium on Senior  Subordinated Notes, net                                 |       | —                 |       | (173 | ) |
| Net interest income  associated with interest rate swap and cap agreements |       | (334                   | )          | (342 | ) |

 

See accompanying notes tocondensed consolidated financial statements.

 

4

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**SEALYMATTRESS CORPORATIONNotes to Condensed Consolidated Financial Statements**

 

**Note 1:****                      *****Basis ofPresentation***

 

Thecondensed consolidated interim financial statements are unaudited, and certaininformation and footnote disclosures related thereto normally included infinancial statements prepared in accordance with accounting principlesgenerally accepted in the United States of America have been omitted inaccordance with Rule 10-01 of Regulation S-X. In the opinion of management, the accompanying unaudited consolidatedfinancial statements were prepared following the same policies and proceduresused in the preparation of the audited financial statements and reflect alladjustments (consisting of normal recurring adjustments) necessary to presentfairly the financial position of Sealy Mattress Corporation and itssubsidiaries (the “Company”).  Theresults of operations for the interim periods are not necessarily indicative ofthe results for the entire fiscal year. These consolidated financial statements should be read in conjunctionwith the company’s Annual Report on Form 10-K for the year ended November 28,2004.

 

Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the amount of assets and liabilities and disclosures on contingentassets and liabilities at quarter end and the reported amounts of revenue andexpenses during the reporting period. Actual results may differ from theseestimates.

 

On April 6, 2004, Sealy Corporation,owner of 100% of the Company’s common stock, completed a merger with affiliatesof Kohlberg Kravis Roberts & Co. L.P. (“KKR”) whereby KKR acquired 92% ofSealy Corporation’s capital stock. Certain of Sealy Corporation’s previous stockholders, includingaffiliates of Bain Capital, LLC and others, retained an 8% interest in SealyCorporation’s stock.  The merger wasaccounted for as a recapitalization. Subsequentto the recapitalization, the Company received as contributed capital all ofSealy Corporation’s 100% interest in Sealy Mattress Company.  The Company also replaced Sealy Corporationas the parent-guarantor of the 8.25% Senior Subordinated Notes due 2014 issuedby Sealy Mattress Company.  Accordingly,the Company is now the reporting guarantor-parent company and as a result ofbeing an entity under common control has reflected the operation of Sealy Corporationprior to April 6, 2004 in a manner similar to a pooling-of-interests.  Additionally, all assets, liabilities, andstockholders’ deficit of Sealy Corporation existing upon the completion of therecapitalization as of April 6, 2004 has been pushed down to and includedwith those of the Company for all periods presented.  Therefore, all reported amounts for the threemonths ended February 27, 2005 are comparable in all material respects tothose for the prior periods presented herein except as to common stock and additional paid-in capital, which reflectthe respective outstanding shares of the Company and Sealy Corporation.  Subsequent to the recapitalization, none ofthe activity of Sealy Corporation has been or will be included in theconsolidated financial statements of the Company and its subsidiaries.

 

Certainreclassifications of previously reported financial information were made toconform to the 2005 presentation.

 

**Note 2:****                      *****StockOption and Restricted Stock Plans***

 

Certain employees of the Companyhave been granted options to purchase the common stock of the Company’s 100%owner, Sealy Corporation.  Such optionsare accounted for by the Company and reported herein as if granted by theCompany.  As permitted by FAS 123, “Accountingfor Stock-Based Compensation”, the Company continues to account for its stockoption and stock incentive plans in accordance with Accounting Principles Board(“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and makesno charges (except to the extent required by APB Opinion No. 25) againstearnings with respect to options granted. FAS No. 148, “Accounting forStock-Based Compensation-Transition and Disclosure an Amendment of FASBStatement No. 123” does however require interim disclosure of pro forma informationregarding net income and earnings per share determined as if the Company hadaccounted for its stock options under the fair value method.

 

For purposes of this proforma disclosure, the estimated fair value of the options is amortized as anexpense over the options’ vesting periods.

 

5

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| ** **                                                                                                                    | ** ** | **Three months ended**     | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                                                                                    | ** ** | **February 27, 2005** | ** ** | **February 29, 2004** | ** ** |
| ** **                                                                                                                    | ** ** | **(in thousands)**         | ** ** |
| Net income, as reported                                                                                                       |       | $                          | 21,853     |   | $ | 11,261 |   |
| Add: Stock-based  compensation expense included in reported net income net of related tax  effects.                           |       | 93                         |       | — |   |
| Deduct: Total stock-based  employee compensation expense determined under fair value based method for  all awards, net of tax |       | (386                       | )          | (40 | ) |
| Pro forma net income                                                                                                          |       | $                          | 21,560     |   | $ | 11,221 |   |

 

The Company recognizedapproximately $0.2 million of expense during the three months ended February 27,2005 resulting from accretion of an obligation to three executives of theCompany for their right to put to the Company, upon their retirement, shares ofSealy Corporation currently held as vested or partially vested options.

 

**Note 3:****                      *****Inventories***

 

Themajor components of inventories were as follows: 

 
| ** **       | ** ** | **February 27,  2005** | ** ** | **November 28,  2004** | ** ** |
|------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **       | ** ** | **(in thousands)**          | ** ** |
| Raw  materials   |       | $                           | 29,969     |                        | $          | 27,269 |   |
| Work in  process |       | 18,272                      |       | 16,626                      |       |
| Finished  goods  |       | 8,936                       |       | 8,028                       |       |
|             |       | $                           | 57,177     |                        | $          | 51,923 |   |

 

**Note 4:****                      *****WarrantyCosts***

 

The Company’s warrantypolicy provides a 10-year non-prorated warranty service period on all currentlymanufactured Sealy Posturepedic, Stearns & Foster and Bassett beddingproducts and some other Sealy-branded products, and a 20-year warranty on itsnew TrueFormTM product line introduced late in the first quarter offiscal 2005. The Company’s policy is to accrue the estimated cost of warranty coverageat the time the sale is recorded. The change in the company’s accrued warrantyobligations for the periods ending February 29, 2004, November 28,2004, and February 27, 2005 was as follows (in thousands):

 
| ** **                                           | ** ** | **February 27,  2005** | ** ** | **November 28,  2004** | ** ** | **February 29,  2004** | ** ** |
|------------------------------------------------------|------------|-----------------------------|------------|------------------------|------------|------------------------|------------|
|                                                 |       |                        |       |                   |       |                   |       |
| Accrued  warranty obligations at beginning of period |       | $                           | 13,857     |                   | $          | 9,135                  |       | $ | 9,135 |   |
| Warranty  claims                                     |       | (3,814                      | )          | (14,607                | )          | (3,051                 | )          |
| Warranty  provisions                                 |       | 3,271                       |       | 19,329                 |       | 2,977                  |       |
|                                                 |       |                        |       |                   |       |                   |       |
| Accrued  warranty obligations at end of period       |       | $                           | 13,314     |                   | $          | 13,857                 |       | $ | 9,061 |   |

 

6

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**Note 5:****                      *****Goodwilland Other Intangible Assets***

 

In accordance with FAS 142,the Company reviews the carrying amounts of goodwill and certain otherintangibles for impairment at least annually, or when events or circumstancesindicate that their carrying value may not be recoverable from future cashflows.  The Company has not recorded anyimpairment charges during the three months ended February 27, 2005 or February 29,2004.

 

The changes inthe carrying amount of goodwill for the three months ended February 27,2005, are as follows (in thousands):

 
| Balance as of November 28,  2004         |   | $      |  387,508 | ** ** |
|-----------------------------------------------|--------|--------|---------------|------------|
| Decrease due to foreign  currency translation |   | (1,645 | )             |
|                                          |   |   |          |
| Balance as of  February 27, 2005         |   | $      | 385,863       |       |

 

Total other intangibles of $4.4million (net of accumulated amortization of $4.7 million) as of February 27,2005 primarily consist of acquired licenses, which are amortized on thestraight-line method over periods ranging from 5 to 15 years, and an intangibleasset consisting of unamortized pension prior service costs of $1.2 million.

 

**Note 6:****                      *****Long-TermObligations***

 

Long-term debt as of February 27,2005 and November 28, 2004 consisted of the following: 

 
| ** **                        | ** ** | **February 27,  2005** | ** ** | **November 28,  2004** | ** ** |
|-----------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                        | ** ** | **(in thousands)**          | ** ** |
| Senior Revolving Credit  Facility |       | $                           | 22,148     |                        | $          | 5,000 |   |
| Senior Secured Term Loan          |       | 465,000                     |       | 470,000                     |       |
| Senior Unsecured Term Loan        |       | 100,000                     |       | 100,000                     |       |
| Senior Subordinated Notes         |       | 390,000                     |       | 390,000                     |       |
| Other                             |       | 12,238                      |       | 9,337                       |       |
|                              |       | 989,386                     |       | 974,337                     |       |
| Less current portion              |       | (12,025                     | )          | (8,542                      | )          |
|                              |       | $                           | 977,361    |                        | $          | 965,795 |   |

 

The totalborrowing capacity under the senior revolving credit facility is $125 million,of which up to $25 million may be borrowed in Canada.  At February 27, 2005, amountsoutstanding under the senior revolving credit facility included $16.5 millionand $5.6 million under the U.S. and Canadian portions of the facility,respectively.  At February 27, 2005,the Company had approximately $75.1 million total available under the revolvingcredit facility after taking into account letters of credit issued totaling$27.8 million.

 

Annually, theCompany may be required to make principal prepayments equal to 50% of excesscash flow for the preceding fiscal year, as defined in its senior securedcredit agreement.  At February 27,2005, the Company is unable to determine the amount of such requiredprepayment, if any, that would be due in the first quarter of fiscal 2006 withrespect to any excess cash flow for the 2005 fiscal year.

 

The Companyintends to amend its senior secured credit facility in April of 2005. Thefinal terms and timing of the refinancing, if it occurs, will depend on marketconditions and other factors.  Inconnection with the amendment, amounts outstanding under the senior securedterm loan will increase to $565 million.  The additional $100 million borrowing will beused for the repayment of the outstanding senior unsecured term loan.  Management believes that the amended seniorsecured credit facility will have substantially the same terms as the existingfacility, although the interest rate margins under the new facility will likelybe lower than those under the existing facility.  The Company expects to incur certain costs inthe second quarter of fiscal 2005 in connection with the amendment resultingfrom related fees, expenses, and, depending upon the final terms of the amendedfacility, the write-off of deferred debt issuance costs associated with theexisting facilities.

 

7

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**Note 7:****                      *****OtherIncome***

 

Other income includesinterest income of $0.1 million and $0.4 million for the quarters ended February 27,2005 and February 29, 2004, respectively.

 

**Note 8:****                      *****RecentlyIssued Accounting Pronouncements***

 

In November of 2004, the FASB issued SFAS 151, “Inventory Costs,an amendment of ARB No. 43 Chapter 4, “Inventory Pricing,” to clarify theaccounting for abnormal amounts of idle facility expense, freight, handlingcosts, and wasted material (spoilage) and requires that those items berecognized as current-period charges.  Inaddition, this statement requires that allocation of fixed production overheadsto the costs of conversion be based on the normal capacity of the productionfacilities.  This statement is effectivefor fiscal years beginning after June 15, 2005. The Company will adoptthis statement as of the beginning of fiscal 2006, and does not expect that itwill have a material impact on our financial position or results of operations.

 

In December 2004, the FASB issued FAS 123 (Revised), “Share-BasedPayment” (“FAS 123R”) which replaces FAS 123 and supercedes APB Opinion No. 25,“Accounting for Stock Issued to Employees” (“APB 25”).  This statement requires compensation costsrelating to share-based payment transactions to be recognized in financialstatements based upon the fair value of the award.  FAS 123R eliminates the option to account forthe cost of stock-based compensation using the intrinsic value method asallowed under APB 25.  Having no publiclytraded equity securities, the Company is considered a “nonpublic entity” asdefined in the statement.  FAS 123R iseffective for nonpublic entities for fiscal years beginning after December 15,2005.  Therefore, the Company expects toadopt FAS 123R as of the beginning of its fiscal year ending December 2,2007.  The Company currently measurescompensation costs related to its share-based awards under APB 25, as allowedby FAS 123, and provides pro forma disclosure in the notes to the financial statementsof the effects of accounting for share-based payments under FAS 123, asrequired by that standard (Note 2).  TheCompany expects the adoption of FAS 123R to have an impact on its results ofoperations.  The Company is still in theprocess of evaluating the extent of such impact.

 

**Note 9:****                      *****HedgingStrategy***

 

In 2000, the Company enteredinto an interest rate swap agreement that effectively converted $236 million ofits floating-rate debt to a fixed-rate basis through December 2006,thereby hedging against the impact of interest rate changes on future interestexpense (forecasted cash flows). Use of hedging contracts allows the Company toreduce its overall exposure to interest rate changes, since gains and losses onthese contracts will offset losses and gains on the transactions being hedged.The Company formally documents all hedged transactions and hedging instruments,and assesses, both at inception of the contract and on an ongoing basis,whether the hedging instruments are effective in offsetting changes in cashflows of the hedged transaction. The fair values of the interest rateagreements are estimated by obtaining quotes from brokers and are the estimatedamounts that the Company would receive or pay to terminate the agreements atthe reporting date, taking into consideration current interest rates and thecurrent creditworthiness of the counterparties. Effective June 3, 2002,the Company dedesignated the interest rate swap agreement for hedge accounting.As a result of the dedesignation, $12.9 million previously recorded inaccumulated other comprehensive loss as of the date of dedesignation was beingamortized into interest expense over the remaining life of the interest rateswap agreement. Due to the retirement of the existing debt in connection withthe April 2004 recapitalization, the remaining $4.7 million previouslyrecorded in accumulated other comprehensive loss was charged to expense duringthe second fiscal quarter of 2004. Prior to the recapitalization, for the threemonths ended February 29, 2004, $0.6 million was amortized into interestexpense. Prior to June 3, 2002, the changes in the fair market value ofthe interest rate swap were recorded in accumulated other comprehensive income(loss). Subsequent to June 3, 2002, changes in the fair market value ofthe interest rate swap are recorded in interest expense. For the three monthsended February 27, 2005 and February 29, 2004, $0.4 million and $2.1million, respectively,  was recorded asnet 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 27, 2005 and November 28,2004, the fair value carrying amount of this instrument was recorded asfollows:

 
| ** **                    | ** ** | **February 27, 2005** | ** ** | **November 28, 2004** | ** ** |
|-------------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **                    | ** ** | **(in thousands)**         | ** ** |
| Accrued interest payable      |       | $                          | 825        |                       | $          | 1,162 |   |
| Other accrued expenses        |       | 2,440                      |       | 3,030                      |       |
| Other noncurrent  liabilities |       | 1,342                      |       | 2,250                      |       |
|                          |       | $                          | 4,607      |                       | $          | 6,442 |   |

 

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During the second quarter of2002, the Company entered into another interest rate swap agreement that hasthe effect of reestablishing as floating rate debt the $236 million of debtpreviously converted to fixed rate debt through December 2006. Thisinterest rate swap agreement was not designated for hedge accounting and,accordingly, any changes in the fair value are recorded in interest expense.For the three months ended February 27, 2005 and February 29, 2004,$0.4 million and $2.1 million, respectively, was recorded as a reduction of netinterest expense as a result of the cash interest received on the swap net ofthe non-cash interest associated with the change in its fair market value. At February 27,2005 and November 28, 2004, the fair value carrying amount of this instrumentwas a net asset of $1.0 million and $2.2 million, respectively, with $1.0million and $1.8 million recorded in prepaid expenses and other current assets,and $0.0 million and $0.3 million recorded in noncurrent assets, respectively.

 

The Company also enteredinto an interest rate cap agreement during the second quarter of 2002 with anotional amount of $175.0 million that caps the LIBOR rate on which thefloating rate debt is based at 8% through December 2006. This agreementhas not been designated for hedge accounting and, accordingly, any changes inthe fair value are recorded in interest expense. The fair value of thisinstrument is not material.

 

In June 2004, theCompany 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 fixed-rate basis through November 2005,declining to $150 million through November 2007.  The Company has formally designated this swapagreement as a cash flow hedge and expects the hedge to be highly effective inoffsetting fluctuations in the designated interest payments resulting fromchanges in the benchmark interest rate. Accordingly, the effective portion of changes in the market value of theswap is recorded in other comprehensive income (loss). As of February 27,2005, $0.6 million was recorded in interest expense.  At February 27, 2005 and November 28,2004, the fair value carrying amount of the instrument was recorded as follows:

 
| ** **               | ** ** | **February 27, 2005** | ** ** | **November 28, 2004** | ** ** |
|--------------------------|------------|----------------------------|------------|----------------------------|------------|
| ** **               | ** ** | **(In thousands)**         | ** ** |
| Accrued interest payable |       | $                          | 663        |                       | $          | 978 |   |
| Other accrued expenses   |       | 616                        |       | 1,420                      |       |
| Long term receivable     |       | (1,326                     | )          | (377                       | )          |
|                     |       | $                          | (47        | )                          | $          | 2,021 |   |

 

At February 27, 2005and November 28, 2004, accumulated other comprehensive income (loss)associated with the interest rate swaps was $0.4 million and $(0.6) million,respectively.

 

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 27, 2005, the Company had forward contracts to sell atotal of 26.5 million Canadian dollars with expiration dates ranging from March 3,2004 through November 15, 2005.  At February 27,2005 and November 28, 2004, the fair value of the Company’s net obligationunder the forward contracts was a liability of $1.4 million and $3.1 million,respectively.  For the quarter endedFebruary, 27, 2005, the Company recognized foreign currency transaction gainsof $2.4 million, compared with gains of $1.0 million for the first quarter of2004.

 

9

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**Note 10:****               *****DefinedBenefit Pension Expense***

 

The components of netperiodic pension cost recognized for the Company’s defined benefit pension planfor the three months ended February 27, 2005 and February 29, 2004are as follows (in thousands):

 
| ** **                                       | ** ** | **Three months ended**     | ** ** |
|--------------------------------------------------|------------|----------------------------|------------|
| ** **                                       | ** ** | **February 27, 2005** | ** ** | **February 29, 2004** | ** ** |
| Service cost                                     |       | $                          | 158        |   | $ | 119 |   |
| Interest cost                                    |       | 191                        |       | 180 |   |
| Expected return on plan  assets                  |       | (178                       | )          | (136 | ) |
| Amortization of  unrecognized losses             |       | 63                         |       | 188 |   |
| Amortization of  unrecognized transition asset   |       | (22                        | )          | (22 | ) |
| Amortization of  unrecognized prior service cost |       | 44                         |       | 40 |   |
|                                             |       |                       |       |   |   |
| Net periodic pension cost*                       |       | $                          | 256        |   | $ | 369 |   |
|                                             |       |                       |       |   |   |   |   |
| Cash  contributions                              |       | $                          | —     |   | $ | 129 |   |

 

----

* Net periodic pension costs recognized for the three months ended February 27,2005 are based upon preliminary estimates pending the final actuarialdetermination of such costs for fiscal 2005. Similarly, net periodic pension costs for the three months ended February 29,2004 were based upon preliminary estimates.

 

The Company expects to make additional cashcontributions to the plan of approximately $1.0 million during the remainder offiscal 2005.

 

**Note 11:****               *****Stockholders’Deficit***

 

Totalcomprehensive income for the quarters ended February 27,2005 and February 29, 2004 was $19.1 million and $14.5 million,respectively.

 

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

 
| ** **                                                    | ** ** | **Comprehensive  Income** | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Accumulated  Deficit** | ** ** | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total**  | ** ** |
|---------------------------------------------------------------|------------|---------------------------|------------|-------------------|------------|----------------------------------|------------|--------------------------|------------|-----------------------------------------------|------------|------------|------------|
| ** **                                                    | ** ** | ** **                | ** ** | ** **        | ** ** | ** **                       | ** ** | ** **               | ** ** | ** **                                    | ** ** | ** ** | ** ** |
| Balance at November  28, 2004                                 |       |                      |       | $                 | —     |                             | $          | 458,620                  |       | $                                             | (848,158   | )          | $          | 5,795 |   | $ | (383,743 | ) |
| Comprehensive  Income:                                        |       |                      |       |              |       |                             |       |                     |       |                                          |       |       |       |
| Net income  for the three months ended February 27, 2005 |       | $                         | 21,853     |              | —     |                             | —     |                     | 21,853     |                                          | —     |       | 21,853     |   |
| Change in  fair value of cash flow hedge                      |       | 1,053                     |       | —            |       | —                           |       | —                   |       | 1,053                                         |       | 1,053      |       |
| Foreign  currency translation adjustment                      |       | (3,758                    | )          | —            |       | —                           |       | —                   |       | (3,758                                        | )          | (3,758     | )          |
|                                                          |       |                      |       |              |       |                             |       |                     |       |                                          |       |       |       |
| Balance at  February, 27 2005                                 |       | $                         | 19,148     |              | $          | —                           |       | $                        | 458,620    |                                          | $          | (826,305   | )          | $ | 3,090 |   | $ | (364,595 | ) |

 

10

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**Note 12:****               *****Contingencies***

 

The Company is subject tolegal proceedings, claims, and litigation arising in the ordinary course ofbusiness. While the outcome of these matters is currently not determinable,management does not expect that the ultimate costs to resolve these matterswill have a material adverse effect on the Company’s consolidated financialposition, results of operations or cash flows.

 

The Company is currentlyconducting an environmental cleanup at a formerly owned facility in SouthBrunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act.The Company and one of its subsidiaries are parties to an AdministrativeConsent Order issued by the New Jersey Department of Environmental Protection.Pursuant to that order, the Company and its subsidiary agreed to conduct soiland groundwater remediation at the property. The Company does not believe thatits manufacturing processes were the source of contamination. The Company soldthe property in 1997. The Company and its subsidiary retained primaryresponsibility for the required remediation. The Company has completedessentially all soil remediation with the New Jersey Department ofEnvironmental Protection approval, and has concluded a pilot test of thegroundwater remediation system. The Company has received approval from the NewJersey Department of Environmental Protection of a remediation plan for thesediment in Oakeys Brook adjoining the site, which the Company expects to startin 2005.  The Company is also monitoringground water at the site.  The Companyhas recorded a reserve for $2.4 million ($3.0 million prior to discounting at4.75%) associated with this remediation project, and it is reasonably possiblethat up to an additional $0.3 million may be incurred to complete the project.

 

The Company is alsoremediating soil and groundwater contamination at an inactive facility locatedin Oakville, Connecticut. Although the Company is conducting the remediationvoluntarily, it obtained Connecticut Department of Environmental Protectionapproval of the remediation plan. The Company has completed essentially allsoil remediation under the remediation plan and is currently monitoringgroundwater at the site. The Company has identified cadmium in the ground waterat the site and intends to address that during 2005.  The Company has recorded a reserve of approximately$0.4 million associated with the additional work and ongoing monitoring.  The Company believes the contamination isattributable to the manufacturing operations of previous unaffiliated occupantsof the facility.

 

The Company removed three undergroundstorage tanks previously used for diesel, gasoline, and waste oil from itsSouth Gate, California facility in March 1994 and remediated the soil inthe area. Since August 1998, the Company has been working with theCalifornia Regional Water Quality Control Board, Los Angeles Region to monitorground water at the site.

 

While the Company cannotpredict the ultimate timing or costs of the South Brunswick, Oakville, andSouth Gate environmental matters, based on facts currently known, the Companybelieves that the accruals recorded are adequate and does not believe theresolution of these matters will have a material adverse effect on thefinancial position or future operations of the Company; however, in the eventof an adverse decision, these matters could have a material adverse effect.

 

The state of Californiaadopted new flame retardant regulations related to manufactured mattresses andbox springs which became effective January 1, 2005. The Company believesthat it is in full compliance with those regulations. The Company does notexpect the impact of those regulations to be significant to the Company’sresults of operations or financial position.

 

In 2000, Montgomery Ward, acustomer of Sealy, declared bankruptcy and filed for protection under Chapter 7of the U.S. Bankruptcy Code. In 2003, the bankruptcy trustee filed a claim of$3.7 million associated with certain alleged preferential payments byMontgomery Ward to Sealy. In December of 2004 the Company reached asettlement of this matter with the bankruptcy trustee for $0.2 million, whichhas been approved by the bankruptcy court.

 

**Note 13:****               *****RelatedParty Transactions***

 

The Company previously contributed cash and other assets to MattressHoldings International LLC (“MHI”), a company which was controlled by theCompany’s previous largest stockholder, Bain Capital, LLC (“Bain”), in exchangefor a non-voting interest. MHI was formed to invest in domestic andinternational loans, advances and investments in joint ventures, licensees andretailers. The equity ownership of MHI was transferred from Bain to the Companyin November 2002. In 1999, MHI, indirectly through a Bain controlledholding company, acquired a minority interest in Mattress Holdings Corporation(“MHC”). MHC owns an interest in Mattress Discounters Corporation (“MattressDiscounters”), a domestic mattress retailer.

 

In October 2002,Mattress Discounters filed a voluntary joint petition with the U.S. BankruptcyCourt for the District of Maryland for reorganization under Chapter 11 of theU.S. Bankruptcy Code and was operating as a debtor in possession under theBankruptcy Code. Effective March 14, 2003, Mattress Discounters emergedfrom bankruptcy. At the time Mattress Discounters

 

11

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filed for bankruptcy protection, the Company hadrecorded in its financial statements a $12.5 million participation in MattressDiscounters’ banking facility and $16.0 million in trade receivables. TheCompany had fully-reserved the trade receivables. As part of the approvedbankruptcy settlement, the Company received a non-controlling minority interestin Mattress Discounters and a $12.9 million secured note, guaranteed by MHC.Other entities affiliated with Bain also received a minority interest inMattress Discounters. Sealy consummated the sale to MHC of the $12.9 millionnote and the equity interest that the Company received in the MattressDiscounters bankruptcy, as well as MHI’s equity interest in MHC for $13.6million. As a result of these transactions, the Company no longer has anydirect interest in Mattress Discounters other than trade receivables in thenormal course of business.   In addition,as a result of the acquisition by KKR on April 6, 2004, Bain relinquishedits controlling interest in the Company and Mattress Discounters ceased to beconsidered an affiliate of the Company subsequent to that date.  Fiscal 2004 sales and cost of sales toMattress Discounters during its period of affiliation with the Company up to April 6,2004 are reported in the statement of operations as sales and cost of sales toaffiliate.  The Company believes that theterms on which mattresses were supplied to Mattress Discounters while anaffiliate were not materially different than those that might reasonably beobtained in a comparable transaction on an arm’s length basis from a personthat is not an affiliate or related party.

 

During the three months ended February 27,2005, the Company paid management fees of $0.7 million to KKR.  Also during the three months ended February 27,2005, the Company incurred $0.7 million for consulting services provided byCapstone Consulting LLC, the chief executive officer of which is on the Company’sboard of directors.

 

**Note 14:****               *****SegmentInformation***

 

The Company has determinedthat it has two operating segments, domestic and international, that qualifyfor aggregation as prescribed in SFAS 131. Accordingly, the Company has onereportable industry segment, the manufacture and marketing of conventional andspecialty bedding. During the first quarterof 2005 and 2004 no one customer represented 10% or more of total net sales.Sales outside the United States were $72.3 million and $63.7 million for the first quarter of 2005 and 2004,respectively. In addition, long-lived assets (principally property, plant andequipment and other investments) outside the United States were $52.3 millionand $ 53.5 million as of February 27, 2005 and November 28, 2004,respectively.

 

**Geographicdistribution of sales:**

 
| ** **                     | ** ** | **February 27,  2005** | ** ** | **February 29,  2004** | ** ** |
|--------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                     | ** ** | **(dollars in millions)**   | ** ** |
|                           |       |                        |       |                        |       |   |   |   |   |
| **US  domestic**               |       | $                           | 286.7      |                        | 79.9       | % | $ | 254.5 |   | 80.0 | % |
|                           |       |                        |       |                        |       |   |   |   |   |
| **International:**             |       |                        |       |                        |       |   |   |   |   |
| Canada                         |       | 28.4                        |       | 7.9                         |       | 24.3 |   | 7.6 |   |
| Europe                         |       | 25.6                        |       | 7.1                         |       | 23.0 |   | 7.2 |   |
| Mexico                         |       | 6.3                         |       | 1.8                         |       | 6.4 |   | 2.0 |   |
| Other  International Locations |       | 12.0                        |       | 3.3                         |       | 10.0 |   | 3.2 |   |
|                           |       |                        |       |                        |       |   |   |   |   |
| **Total  international**       |       |                        | 72.3       |                        | 20.1       |   |   | 63.7 |   | 20.0 |   |
| **Total  company**             |       | $                           | 359.0      |                        | 100.0      | % | $ | 318.2 |   | 100.0 | % |
|                                |            |                             |            |                             |            |  |  |  |  |  |  |  |  |

 

12

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**Note 15:****               *****Guarantor/Non-GuarantorFinancial Information***

 

The Parent (as definedbelow) and each of the subsidiaries of Sealy Mattress Company (the “Issuer”)that guarantee the Notes (as defined below) (the “Guarantor Subsidiaries”) hasfully and unconditionally guaranteed, on a joint and several basis, the obligationto pay principal and interest with respect to the 8.25% Senior SubordinatedNotes due in 2014 (the “Notes”) of the Issuer. Substantially all of the Issuer’soperating income and cash flow is generated by its subsidiaries. As a result,funds necessary to meet the Issuer’s debt service obligations are provided inpart by distributions or advances from its subsidiaries. Under certaincircumstances, contractual and legal restrictions, as well as the financialcondition and operating requirements of the Issuer’s subsidiaries, could limitthe Issuer’s ability to obtain cash from its subsidiaries for the purpose ofmeeting its debt service obligations, including the payment of principal andinterest on the Notes. Although holders of the Notes will be direct creditorsof the Issuer’s principal direct subsidiaries by virtue of the guarantees, theIssuer has subsidiaries (“Non-Guarantor Subsidiaries”) that are not includedamong the Guarantor Subsidiaries, and such subsidiaries will not be obligatedwith respect to the Notes. As a result, the claims of creditors of theNon-Guarantor Subsidiaries will effectively have priority with respect to theassets and earnings of such companies over the claims of creditors of theIssuer, including the holders of the Notes.

 

The following supplementalconsolidating condensed financial statements present:

 

1.               Condensedconsolidating balance sheets as of February 27, 2005 and November 28,2004 and condensed consolidating statements of operations and cash flows forthe three months ended February 27, 2005 and February 29, 2004. 

 

2                  SealyCorporation, for periods prior to April 6, 2004, and Sealy MattressCorporation, as Successor to Sealy Corporation from April 6, 2004 (seeNote 1) (each, for the respective period, the “Parent” and a “guarantor”), theIssuer, combined Guarantor Subsidiaries and combined Non-Guarantor Subsidiarieswith their investments in subsidiaries accounted for using the equity method(see Note 1). 

 

3.               Elimination entriesnecessary to consolidate the Parent and all of its subsidiaries. 

 

Separate financialstatements of each of the Guarantor Subsidiaries are not presented becausemanagement believes that these financial statements would not be material toinvestors.

 

13

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**SEALYMATTRESS CORPORATION**

 

**SupplementalConsolidating Condensed Balance SheetFebruary 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                                         |       | $                                | —     |                         | $          | 2                                     |       | $                                           | 4,115      |             | $          | 33,721           |       | $ | — |   | $ | 37,838 |   |
| Accounts receivable, net                                          |       | —                           |       | 25                           |       | 139,480                               |       | 57,870                                      |       | —           |       | 197,375          |       |
| Inventories                                                       |       | —                           |       | 2,810                        |       | 38,098                                |       | 16,269                                      |       | —           |       | 57,177           |       |
| Assets held for sale                                              |       | —                           |       | —                       |       | 4,370                                 |       | —                                      |       | —           |       | 4,370            |       |
| Prepaid expenses, deferred  income taxes and other current assets |       | —                           |       | 3,808                        |       | 22,997                                |       | 4,494                                       |       | —           |       | 31,299           |       |
|                                                              |       | —                           |       | 6,645                        |       | 209,060                               |       | 112,354                                     |       | —           |       | 328,059          |       |
| Property, plant and  equipment, at cost                           |       | —                           |       | 6,982                        |       | 235,692                               |       | 69,581                                      |       | —           |       | 312,255          |       |
| Less accumulated  depreciation                                    |       | —                           |       | (3,694                       | )          | (124,316                              | )          | (20,370                                     | )          | —           |       | (148,380         | )          |
|                                                              |       | —                           |       | 3,288                        |       | 111,376                               |       | 49,211                                      |       | —           |       | 163,875          |       |
| Other assets:                                                     |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Goodwill                                                          |       | —                           |       | 24,741                       |       | 304,797                               |       | 56,325                                      |       | —           |       | 385,863          |       |
| Other intangibles, net                                            |       | —                           |       | —                       |       | 4,231                                 |       | 180                                         |       | —           |       | 4,411            |       |
| Net investment in and  advances to (from) subsidiaries            |       | (373,891                         | )          | 962,917                      |       | (208,027                              | )          | (100,435                                    | )          | (280,564         | )          | —           |       |
| Debt issuance costs, net,  and other assets                       |       | —                           |       | 33,118                       |       | 6,750                                 |       | 1,193                                       |       | —           |       | 41,061           |       |
|                                                              |       | (373,891                         | )          | 1,020,776                    |       | 107,751                               |       | (42,737                                     | )          | (280,564         | )          | 431,335          |       |
| Total assets                                                      |       | $                                | (373,891   | )                            | $          | 1,030,709                             |       | $                                           | 428,187    |             | $          | 118,828          |       | $ | (280,564 | ) | $ | 923,269 |   |
|                                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| **Liabilities And Stockholders’  deficit**                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Current liabilities:                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Current portion—long-term  obligations                       |       | $                                | —     |                         | $          | —                                |       | $                                           | 17         |             | $          | 12,008           |       | $ | — |   | $ | 12,025 |   |
| Accounts payable                                                  |       | —                           |       | 829                          |       | 69,813                                |       | 37,269                                      |       | —           |       | 107,911          |       |
| Accrued customer  incentives and advertising                      |       | —                           |       | 4                            |       | 29,675                                |       | 3,701                                       |       | —           |       | 33,380           |       |
| Accrued compensation                                              |       | —                           |       | 67                           |       | 34,658                                |       | 6,355                                       |       | —           |       | 41,080           |       |
| Accrued interest                                                  |       | —                           |       | 699                          |       | 12,312                                |       | 43                                          |       | —           |       | 13,054           |       |
| Other accrued expenses                                            |       | —                           |       | 3,908                        |       | 34,586                                |       | 4,888                                       |       | —           |       | 43,382           |       |
|                                                              |       | —                           |       | 5,507                        |       | 181,061                               |       | 64,264                                      |       | —           |       | 250,832          |       |
| Due to Parent Company                                             |       | —                           |       | —                       |       | 3,405                                 |       | —                                      |       | —           |       | 3,405            |       |
| Long-term obligations                                             |       | —                           |       | 971,500                      |       | 22                                    |       | 5,839                                       |       | —           |       | 977,361          |       |
| Other noncurrent  liabilities                                     |       | —                           |       | 1,360                        |       | 34,196                                |       | 8,063                                       |       | —           |       | 43,619           |       |
| Deferred income taxes                                             |       | (9,296                           | )          | 824                          |       | 14,675                                |       | 6,444                                       |       | —           |       | 12,647           |       |
| Stockholders’ deficit                                        |       | (364,595                         | )          | 51,518                       |       | 194,828                               |       | 34,218                                      |       | (280,564         | )          | (364,595         | )          |
| Total liabilities and  stockholders’ deficit                 |       | $                                | (373,891   | )                            | $          | 1,030,709                             |       | $                                           | 428,187    |             | $          | 118,828          |       | $ | (280,564 | ) | $ | 923,269 |   |

 

14

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**SEALYMATTRESS CORPORATIONSupplemental Consolidating Condensed Balance SheetNovember 28, 2004(in thousands)**

 
| ** **                                                        | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                        |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Current assets:                                                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Cash and cash equivalents                                         |       | $                                | —     |                         | $          | 2                                     |       | $                                           | 5,142      |             | $          | 17,635           |       | $ | — |   | $ | 22,779 |   |
| Accounts receivable, net                                          |       | —                           |       | 61                           |       | 106,511                               |       | 66,257                                      |       | —           |       | 172,829          |       |
| Inventories                                                       |       | —                           |       | 1,047                        |       | 35,014                                |       | 15,862                                      |       | —           |       | 51,923           |       |
| Assets held for sale                                              |       | —                           |       | —                       |       | 8,983                                 |       | —                                      |       | —           |       | 8,983            |       |
| Prepaid expenses, deferred  income taxes and other current assets |       | —                           |       | 4,616                        |       | 33,933                                |       | 4,062                                       |       | —           |       | 42,611           |       |
|                                                              |       | —                           |       | 5,726                        |       | 189,583                               |       | 103,816                                     |       | —           |       | 299,125          |       |
| Property, plant and  equipment, at cost                           |       | —                           |       | 6,962                        |       | 233,339                               |       | 69,618                                      |       | —           |       | 309,919          |       |
| Less accumulated  depreciation                                    |       | —                           |       | (3,620                       | )          | (123,132                              | )          | (18,988                                     | )          | —           |       | (145,740         | )          |
|                                                              |       | —                           |       | 3,342                        |       | 110,207                               |       | 50,630                                      |       | —           |       | 164,179          |       |
| Other assets:                                                     |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Goodwill                                                          |       | —                           |       | 24,741                       |       | 304,773                               |       | 57,994                                      |       | —           |       | 387,508          |       |
| Other intangibles, net                                            |       | —                           |       | —                       |       | 4,303                                 |       | 252                                         |       | —           |       | 4,555            |       |
| Net investment in and  advances to (from) subsidiaries            |       | (389,163                         | )          | 941,617                      |       | (210,360                              | )          | (94,885                                     | )          | (247,209         | )          | —           |       |
| Debt issuance costs, net,  and other assets                       |       | —                           |       | 33,729                       |       | 7,094                                 |       | 1,087                                       |       | —           |       | 41,910           |       |
|                                                              |       | (389,163                         | )          | 1,000,087                    |       | 105,810                               |       | (35,552                                     | )          | (247,209         | )          | 433,973          |       |
| Total assets                                                      |       | $                                | (389,163   | )                            | $          | 1,009,155                             |       | $                                           | 405,600    |             | $          | 118,894          |       | $ | (247,209 | ) | $ | 897,277 |   |
|                                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| **Liabilities And Stockholders’  deficit**                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Current liabilities:                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Current portion—long-term  obligations                       |       | $                                | —     |                         | $          | —                                |       | $                                           | 22         |             | $          | 8,520            |       | $ | — |   | $ | 8,542 |   |
| Accounts payable                                                  |       | —                           |       | 189                          |       | 56,056                                |       | 40,321                                      |       | —           |       | 96,566           |       |
| Accrued customer  incentives and advertising                      |       | —                           |       | 1,552                        |       | 28,549                                |       | 5,728                                       |       | —           |       | 35,829           |       |
| Accrued compensation                                              |       | —                           |       | 270                          |       | 29,622                                |       | 7,250                                       |       | —           |       | 37,142           |       |
| Accrued interest                                                  |       | —                           |       | 2,518                        |       | 24,790                                |       | 58                                          |       | —           |       | 27,366           |       |
| Other accrued expenses                                            |       | —                           |       | 5,428                        |       | 39,857                                |       | 4,510                                       |       | —           |       | 49,795           |       |
|                                                              |       | —                           |       | 9,957                        |       | 178,896                               |       | 66,387                                      |       | —           |       | 255,240          |       |
| Due to (from) Parent  Company                                     |       | 3,876                            |       | (500                         | )          | —                                |       | —                                      |       | —           |       | 3,376            |       |
| Long-term obligations                                             |       | —                           |       | 965,000                      |       | 21                                    |       | 774                                         |       | —           |       | 965,795          |       |
| Other noncurrent  liabilities                                     |       | —                           |       | 2,254                        |       | 34,847                                |       | 8,673                                       |       | —           |       | 45,774           |       |
| Deferred income taxes                                             |       | (9,296                           | )          | 122                          |       | 13,101                                |       | 6,908                                       |       | —           |       | 10,835           |       |
| Stockholders’ deficit                                        |       | (383,743                         | )          | 32,322                       |       | 178,735                               |       | 36,152                                      |       | (247,209         | )          | (383,743         | )          |
| Total liabilities and  stockholders’ deficit                 |       | $                                | (389,163   | )                            | $          | 1,009,155                             |       | $                                           | 405,600    |             | $          | 118,894          |       | $ | (247,209 | ) | $ | 897,277 |   |

 

15

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**SEALYMATTRESS CORPORATION**

 

**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 |   |

 

16

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**SEALYMATTRESS CORPORATION**

 

**SupplementalConsolidating Condensed Statements of OperationsThree Months Ended February 29, 2004(in thousands)**

 
| ** **                                           | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales—Non-Affiliates                        |       | $                                | —     |                         | $          | 10,699                                |       | $                                           | 244,348    |             | $          | 61,480           |       | $ | (3,918 | ) | $ | 312,609 |   |
| Net sales—Affiliates                            |       | —                           |       | —                       |       | 5,589                                 |       | —                                      |       | —           |       | 5,589            |       |
| Total net sales                                      |       | —                           |       | 10,699                       |       | 249,937                               |       | 61,480                                      |       | (3,918           | )          | 318,198          |       |
| Costs and expenses:                                  |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Cost of goods sold—  Non-Affiliates             |       | —                           |       | 6,997                        |       | 138,776                               |       | 38,538                                      |       | (3,918           | )          | 180,393          |       |
| Cost of goods sold—  Affiliates                 |       | —                           |       | —                       |       | 3,208                                 |       | —                                      |       | —           |       | 3,208            |       |
| Total cost of goods sold                             |       | —                           |       | 6,997                        |       | 141,984                               |       | 38,538                                      |       | (3,918           | )          | 183,601          |       |
| Selling, general and  administrative                 |       | 21                               |       | 3,233                        |       | 80,833                                |       | 17,539                                      |       | —           |       | 101,626          |       |
| Amortization of  intangibles                         |       | —                           |       | —                       |       | 72                                    |       | 222                                         |       | —           |       | 294              |       |
| Royalty (income) expense,  net                       |       | —                           |       | —                       |       | (3,651                                | )          | 267                                         |       | —           |       | (3,384           | )          |
| Income (loss) from  operations                       |       | (21                              | )          | 469                          |       | 30,699                                |       | 4,914                                       |       | —           |       | 36,061           |       |
| Interest expense                                     |       | 1,309                            |       | 15,340                       |       | 2                                     |       | 293                                         |       | —           |       | 16,944           |       |
| Other income                                         |       | —                           |       | —                       |       | (187                                  | )          | (247                                        | )          | —           |       | (434             | )          |
| Income from equity  investees                        |       | (11,261                          | )          | (11,241                      | )          | —                                |       | —                                      |       | 22,502           |       | —           |       |
| Income from nonguarantor  equity investees           |       | —                           |       | (216                         | )          | (2,206                                | )          | —                                      |       | 2,422            |       | —           |       |
| Capital charge and  intercompany interest allocation |       | (1,330                           | )          | (14,530                      | )          | 15,198                                |       | 662                                         |       | —           |       | —           |       |
| Income before income taxes                           |       | 11,261                           |       | 11,116                       |       | 17,892                                |       | 4,206                                       |       | (24,924          | )          | 19,551           |       |
| Income tax expense  (benefit)                        |       | —                           |       | (145                         | )          | 6,651                                 |       | 1,784                                       |       | —           |       | 8,290            |       |
| Net income                                           |       | $                                | 11,261     |                         | $          | 11,261                                |       | $                                           | 11,241     |             | $          | 2,422            |       | $ | (24,924 | ) | $ | 11,261 |   |

 

17

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**SEALYMATTRESS CORPORATION**

 

**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 |   |

 

18

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**SEALYMATTRESS CORPORATION**

 

**SupplementalConsolidating Condensed Statements of Cash FlowsThree Months Ended February 29, 2004(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                              |       | $                                | —     |                         | $          | 452                                   |       | $                                           | (19,834    | )                | $          | 930              |       | $ | — |   | $ | (18,452 | ) |
| Cash flows  from investing activities:                                            |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Purchase of  property, plant and equipment, net                                   |       | —                           |       | (76                          | )          | (5,097                                | )          | (169                                        | )          | —           |       | (5,342           | )          |
| Net activity  in investment in and advances to (from) subsidiaries and affiliates |       | 194                              |       | (343                         | )          | (235                                  | )          | 384                                         |       | —           |       | —           |       |
| Net cash  provided by (used in) investing activities                              |       | 194                              |       | (419                         | )          | (5,332                                | )          | 215                                         |       | —           |       | (5,342           | )          |
| Cash flows  from financing activities:                                            |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Treasury stock repurchase                                                         |       | (508                             | )          | —                       |       | —                                |       | —                                      |       | —           |       | (508             | )          |
| Equity issuances                                                                  |       | 314                              |       | —                       |       | —                                |       | —                                      |       | —           |       | 314              |       |
| Other                                                                             |       | —                           |       | (33                          | )          | —                                |       | 850                                         |       | —           |       | 817              |       |
| Net cash  provided by (used in) financing activities                              |       | (194                             | )          | (33                          | )          | —                                |       | 850                                         |       | —           |       | 623              |       |
|                                                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Effect of  exchange rate changes on cash                                          |       | —                           |       | —                       |       | —                                |       | (88                                         | )          | —           |       | (88              | )          |
|                                                                              |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Change in  cash and cash equivalents                                              |       | —                           |       | —                       |       | (25,166                               | )          | 1,907                                       |       | —           |       | (23,259          | )          |
| Cash and cash equivalents:                                                        |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |
| Beginning of  period                                                              |       | —                           |       | 31                           |       | 90,985                                |       | 10,084                                      |       | —           |       | 101,100          |       |
| End of  period                                                                    |       | $                                | —     |                         | $          | 31                                    |       | $                                           | 65,819     |             | $          | 11,991           |       | $ | — |   | $ | 77,841 |   |

 

19

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**SEALYMATTRESS CORPORATION**

 

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

 

***BUSINESS OVERVIEW***

 

Sealy Mattress Corporation,through our subsidiaries, is the largest bedding manufacturer in the world,with a 21% domestic market share in 2003. We estimate that our market share hasincreased slightly through February 27, 2005.  We manufacture and market a complete line ofconventional bedding (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 2003, the Sealy brand ranked 9th among the top 150 home productsbrands.  Our conventional beddingproducts include the SEALY®, SEALYPOSTUREPEDIC®, STEARNS & FOSTER® and BASSETT® brands and account for approximately 88.4%of the our total net sales for the year ended November 28, 2004.  In addition to our innerspring bedding, wealso produce a variety of foam latex and viscose foam bedding products.  Though sales of such products were notsignificant in the first quarter of 2005, we expect to experience growth inthese product lines in 2005 as we seek to strengthen our competitive positionin the specialty bedding (non-innerspring mattress) market.  We distinguish ourselves from our majorcompetitors by maintaining our own component parts manufacturing capability andproducing substantially all of our mattress innerspring requirements andapproximately 48% of our boxspring component 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 industry has been supported by economic anddemographic factors such as increasing disposable income among the “baby boomer”segment of the population, an increase in the number of bedrooms per home andalso second home purchases, and growing awareness of the health benefits ofquality sleep.

 

On April 6, 2004 our parent company,Sealy Corporation, completed a merger with affiliates of Kohlberg Kravis Roberts& Co. L.P. (“KKR”) whereby KKR acquired approximately 92% of SealyCorporation’s capital stock.  Inconnection with the merger, we recapitalized substantially all of ouroutstanding debt. A full description of the effects of the merger and recapitalizationis included in our 2004 Annual Report on Form 10-K, filed with the Securitiesand Exchange Commission on February 28, 2005.  Althoughwe incurred substantially increased levels of debt in the recapitalization, ourcost of capital was reduced due to lower interest rates on the new debtcompared with our earlier financing, and our total interest costs have remainedcomparable with those prior to the recapitalization.  Due to our strong operating cash flow sincethe recapitalization, we have been able to repay $95 million of our seniorsecured term debt significantly ahead of schedule.  Our first quarter cash flow from operations,normally negative due primarily to semi-annual interest payments on our seniorsubordinated debt, was flat for the quarter ended February 27, 2005 due tothe timing of payments for annual incentive bonuses and profit sharingcontributions compared to the prior year. Our strategy for the remainder of 2005 is to continue to deleverage ourbusiness through additional prepayments of our long-term debt as permitted byour senior credit agreements and our operating cash flow.

 

In 2004, we successfullycompleted the rollout of our new single-sided, “no-flip” Sealy UniCased® and Stearns & Foster TripLCased® product lines inthe United States, Canada, and Mexico, representing the broadest productredesign in our history.  The manufactureand sale of these products for our Sealy Posturepedic lines began early in2003, followed by the introduction  ofthe new Stearns & Foster lines in the first quarter of 2004.  Our initial profitability from the sales ofthese new products was limited as we worked to gain manufacturing efficiencywith the new designs and supported our customers’ transition to the newproducts with price rollbacks.  In 2004,with these issues substantially behind us, we began to realize the anticipatedcontribution of these products to our sales growth and profitability, which hascontinued into the first quarter of 2005. Our profitability has been further enhanced by rapid growth among ourhigh-end price point ($1,000 and up) luxury bedding lines.  Our shares of the Luxury and Ultra-Luxuryproduct segments are greater than our overall market share, and our Stearns& Foster and Luxury Posturepedic lines directly target these segments.

 

Late in the first quarter of2005, we introduced our new TrueFormTM visco-elastic bedding productline to take advantage of the rapid growth of the specialty beddingmarket.  This market, which includeslatex foam, visco-elastic and air-adjustable mattress products, has experiencedsubstantial growth both domestically and internationally.  We believe that by successfully leveragingour strong brand advantage and our marketing and distribution capabilities, wehave the potential to make significant gains in the specialty bedding market.

 

Our industry continues to bechallenged by the high cost of steel and petroleum products, which affect thecost of our steel innerspring and our polyurethane foam and polyethylenecomponent parts.  Thus far, we have beenable to successfully address these cost pressures through a price increaseannounced in May of 2004 and cost reduction efforts.  During the first quarter of 2005, the cost ofthese components has continued to remain elevated above their recent historicalaverages, and we expect this trend to continue throughout the remainder of2005.

 

20

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Historically, the beddingindustry has had limited exposure to competition from imports due to highshipping costs, short lead times, the large number of finished goods SKUs andthe importance of brands.  Recently,however Chinese bedding manufacturers have begun to explore the feasibility ofexporting their products into the United States.  We do not expect that competition fromChinese bedding imports will have a significant impact on our business.  We believe that by focusing on furtherimprovements in the efficiency of our supply chain, controlling costs, andcontinuing to invest in product innovation and our brands, we can ensure thatour domestically produced products will remain competitive with Chinese beddingimports. Furthermore, we believe that the relatively low labor content of ourdomestically produced mattresses lessens any competitive advantage provided bylower Chinese labor costs.

 

***RESULTS OFOPERATIONS***

 

***Tabular Information***

 

The following table setsforth our summarized results of operations for three months ended February 27,2005 and February 29, 2004, expressed in millions of dollars as well as apercentage of each year’s net sales:

 
| ** **                              | ** ** | **For the three months ended** | ** ** |
|-----------------------------------------|------------|--------------------------------|------------|
| ** **                              | ** ** | **February 27,  2005**    | ** ** | **February 29,  2004** | ** ** |
| ** **                              | ** ** | **millions**                   | ** ** | **percentage  of net sales** | ** ** | **millions** | ** ** | **percentage  of net sales** | ** ** |
|                                    |       |                           |       |   |   |   |   |   |   |
| Total net  sales                        |       | $                              | 359.0      |   | 100.0 | % | $ | 318.2 |   | 100.0 | % |
| Total cost  of goods sold               |       | 200.0                          |       | 55.7 |   | 183.6 |   | 57.7 |   |
|                                    |       |                           |       |   |   |   |   |   |   |
| Gross Profit                            |       | 159.0                          |       | 44.3 |   | 134.6 |   | 42.3 |   |
|                                    |       |                           |       |   |   |   |   |   |   |
| Selling,  general and administrative    |       | 108.3                          |       | 30.2 |   | 101.6 |   | 31.9 |   |
| Amortization  of intangibles            |       | 0.2                            |       | 0.1 |   | 0.3 |   | 0.1 |   |
| Royalty  income, net of royalty expense |       | (2.6                           | )          | (0.7 | ) | (3.4 | ) | (1.1 | ) |
|                                    |       |                           |       |   |   |   |   |   |   |
| Income from  operations                 |       | 53.1                           |       | 14.8 |   | 36.1 |   | 11.3 |   |
|                                    |       |                           |       |   |   |   |   |   |   |
| Interest  expense                       |       | 17.8                           |       | 5.0 |   | 16.9 |   | 5.3 |   |
| Other  (income) expense, net            |       | (0.1                           | )          | — |   | (0.4 | ) | (0.1 | ) |
|                                    |       |                           |       |   |   |   |   |   |   |
| Income  before income taxes             |       | 35.4                           |       | 9.9 |   | 19.6 |   | 6.2 |   |
| Income taxes                            |       | 13.6                           |       | 3.8 |   | 8.3 |   | 2.6 |   |
|                                    |       |                           |       |   |   |   |   |   |   |
| Net income                              |       | $                              | 21.8       |   | 6.1 | % | $ | 11.3 |   | 3.6 | % |
|                                    |       |                           |       |   |   |   |   |   |   |
| Effective  tax rate                     |       | 38.4                           | %          |   |   | 42.4 | % |   |   |

 

The following tableindicates the percentage distribution of our net sales in U.S. dollarsthroughout our international operations:

 

**Geographic distribution of sales:**

 
| ** **         | ** ** | **Three Months Ended:**    | ** ** |
|--------------------|------------|----------------------------|------------|
| ** **         | ** ** | **February 27, 2005** | ** ** | **February 29, 2004** | ** ** |
| **US Domestic**    |       | 79.9                       | %          | 80.0 | % |
| **International:** |       |                       |       |   |   |
| Canada             |       | 7.9                        |       | 7.6 |   |
| Europe             |       | 7.1                        |       | 7.2 |   |
| Mexico             |       | 1.8                        |       | 2.0 |   |
| Other              |       | 3.3                        |       | 3.2 |   |
| **Total**          |       | **100.0**                  | **%**      | **100.0** | % |

 

21

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The following table showsour net sales and margin profitability for the major geographic regions of ouroperations, including local currency results for the significant internationaloperations:

 
| ** **                             | ** ** | **For the Three Months Ended:** | ** ** |
|----------------------------------------|------------|---------------------------------|------------|
| ** **                             | ** ** | **February 27,  2005**     | ** ** | **February 29,   2004** | ** ** |
| ** **                             | ** ** | **Millions**                    | ** ** | **percentage  of net sales** | ** ** | **millions** | ** ** | **percentage  of net sales** | ** ** |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Total  Domestic (US Dollars):**      |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | $                               | 286.7      |   | 100.0 | % | $ | 254.5 |   | 100.0 | % |
| Total cost  of goods sold              |       | 153.6                           |       | 53.6 |   | 143.6 |   | 56.4 |   |
| Gross profit                           |       | 133.1                           |       | 46.4 |   | 110.9 |   | 43.6 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Total  International (US Dollars):** |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | 72.3                            |       | 100.0 |   | 63.7 |   | 100.0 |   |
| Total cost  of goods sold              |       | 46.4                            |       | 64.2 |   | 40.0 |   | 62.8 |   |
| Gross profit                           |       | 25.9                            |       | 35.8 |   | 23.7 |   | 37.2 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Canada:**                            |       |                            |       |   |   |   |   |   |   |
| **US Dollars:**                        |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | 28.4                            |       | 100.0 |   | 24.3 |   | 100.0 |   |
| Total cost  of goods sold              |       | 17.3                            |       | 60.9 |   | 14.3 |   | 58.8 |   |
| Gross profit                           |       | 11.1                            |       | 39.1 |   | 10.0 |   | 41.2 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Canadian  Dollars:**                 |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | 34.5                            |       | 100.0 |   | 31.9 |   | 100.0 |   |
| Total cost  of goods sold              |       | 21.5                            |       | 62.3 |   | 18.9 |   | 59.2 |   |
| Gross profit                           |       | 13.0                            |       | 37.7 |   | 13.0 |   | 40.8 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Europe:**                            |       |                            |       |   |   |   |   |   |   |
| **US Dollars:**                        |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | 25.6                            |       | 100.0 |   | 23.0 |   | 100.0 |   |
| Total cost  of goods sold              |       | 17.3                            |       | 67.6 |   | 15.3 |   | 66.5 |   |
| Gross profit                           |       | 8.3                             |       | 32.4 |   | 7.7 |   | 33.5 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Euros:**                             |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | 19.3                            |       | 100.0 |   | 18.5 |   | 100.0 |   |
| Total cost  of goods sold              |       | 13.0                            |       | 67.4 |   | 12.3 |   | 66.5 |   |
| Gross profit                           |       | 6.3                             |       | 32.6 |   | 6.2 |   | 33.5 |   |
|                                   |       |                            |       |   |   |   |   |   |   |
| **Other  International (US Dollars):** |       |                            |       |   |   |   |   |   |   |
| Total net  sales                       |       | 18.3                            |       | 100.0 |   | 16.4 |   | 100.0 |   |
| Total cost  of goods sold              |       | 11.8                            |       | 64.5 |   | 10.4 |   | 63.4 |   |
| Gross profit                           |       | $                               | 6.5        |   | 35.5 | % | $ | 6.0 |   | 36.6 | % |

 

***Quarter Ended February 27, 2005 compared with Quarter Ended February 29,2004***

 

*Net Sales.***    **Our net sales forthe quarter ended February 27, 2005, were $359.0 million, an increase of$40.8 million, or 12.8% from the quarter ended February 29, 2004.  Total domestic sales were $286.7 million forthe first quarter of 2005 compared to $254.5 million for the first quarter of2004. The domestic sales increase of $32.2 million was attributable to a 1.7%increase in volume and a 10.8% increase in average unit selling price. The increase in average unit selling price isdue primarily to price increases announced in May 2004 to offset the effects ofrising steel costs, and an improved sales mix from our new UniCased® Posturepedic and TripLCased® Stearns &Foster lines.  Also, net sales for thefirst quarter of 2004 were reduced by the effects of close-out pricing onexisting products in conjunction with the roll-out of our new Stearns &Foster product lines.  Total internationalsales were $72.3 million in the first quarter of 2005 compared to $63.7 million in the first quarter of 2004,an increase of $8.6 million, or13.5%.  This increase was significantlyinfluenced by favorable exchange rate fluctuations, most notably in ourEuropean and Canadian markets, where local currency sales gains of 4.3% and8.2%, respectively, translated into gains of 11.3% and 16.8%, respectively, inUS Dollars.  Local currency gains in ourCanadian market were driven by a 1.9% increase in average unit selling priceresulting from the successful introduction of our UniCased® product line, combined with a

 

22

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6.2% increase in volume primarily attributable togains among national retail accounts. Sales gains in the European market were primarily attributable to a10.5% increase in average unit selling price, partially offset by a 5.6%decline in volume. Elsewhere, sales gains in our South American markets wereslightly offset by continued weakness in Mexico.

 

*Cost ofGoods Sold.***    **Our cost of goods sold for the quarter, as apercentage of net sales, decreased 2.0 percentage points to 55.7%.  Cost of goods sold for the domestic businessdecreased 2.8 percentage points to 53.6%. This decrease (as a percentage of net sales) is due primarily to theincrease in average unit selling price as discussed above, partially offset byincreased material costs. On a per unit basis, material costs increased 14.2%relative to the first quarter of 2004 due primarily to increased steel and foamproduct costs as well as changes in the sales mix toward higher price-pointproducts.  Variable conversion costs,however, decreased 8.3% primarily due to increased manufacturing efficiency,lower health insurance costs, and lower product return costs.  Fixed manufacturing costs increased 1.7% perunit primarily driven by increased supervisory wages and incentivecompensation. Cost of goods sold for the international business increased 1.4percentage points to 64.2%.  This increaseis primarily due to higher material costs, partially offset by increasedmanufacturing efficiency in Canada associated with the new product lines andbetter product mix in Brazil and Argentina.

 

*Selling,General, Administrative.***    **Our selling, general,and administrative expense as a percent of net sales was 30.2%and 31.9% for the quarters ended February 27, 2005 and February 29,2004, respectively, a decrease of 1.7 percentage points.  This decrease is primarily the result oflower promotional, cooperative advertising and national advertising costs,which declined 1.7 percentage points as a percentage of net sales, as well asincreased foreign currency exchange gains of $1.4 million over the prior yearperiod, partially offset by higher salary and incentive compensation coststotaling $3.6 million over the first quarter of fiscal 2004 due to normal meritincreases, higher administrative headcount and stronger performance relative toincentive compensation targets.

 

*Royaltyincome, net of royalty expense.***    **Our royalty income, net of royalty expenses,for the three months ended February 27, 2005 decreased $0.8 million fromthe three months ended February 29, 2004, primarily due to lower domesticroyalty revenue and higher royalty expenses in our international markets.

 

*InterestExpense.*    Our interest expense for the first quarter offiscal 2005 increased $0.9 millionover the prior year period primarily due to higher debt levels resulting fromthe April, 2004 recapitalization, largely offset by the lower borrowing costson our debt.

 

*IncomeTax.*    Our effective income tax rates differ from theFederal statutory rate principally because of the effect of certain foreign taxrate differentials and state and local income taxes. Our effective tax rate forthe quarter ended February 27, 2005 is approximately 38.4% compared to42.4% for quarter ended February 29, 2004. No provision has beenmade for U.S. or foreign taxes on the undistributed earnings of our foreignsubsidiaries permanently invested outside the United States.  Should we repatriate foreign earnings, wewould have to adjust the income tax provision in the period our managementdetermines that we would repatriate the earnings.  We are currently studying the impact of theone-time favorable foreign dividend provisions enacted on October 22,2004, as part of the American Jobs Creation Act of 2004, and may decide torepatriate earnings of some of its foreign subsidiaries during fiscal 2005 ifit qualifies for certain favorable foreign withholding rates.  We have not completed the evaluation of therange of amounts that may be repatriated and the related income taxeffects.  We believe this evaluation willbe completed by the end of the third quarter of 2005.

 

***LIQUIDITY ANDCAPITAL 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 $5.7 million for thethree months ended February 27, 2005. We expect total 2005 capitalexpenditures to be approximately $30 million. We believe that annual capitalexpenditure limitations in our current debt agreements will not significantlyprevent us from meeting our ongoing capital needs. At February 27, 2005,we had approximately $75.1 million available under our revolving creditfacility after taking into account letters of credit issued totaling $27.8million. Our net weightedaverage borrowing cost was 7.3% and 9.1% for the three months ended February 27,2005 and February 29, 2004, respectively. The decline in our borrowing cost was due to lower rates on our new debtas compared with that retired in the April 2004 recapitalization.

 

23

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***Debt***

 

As part of the April 2004recapitalization we incurred substantial debt, including new senior creditfacilities consisting of a $125 million senior secured revolving creditfacility with a six-year maturity, and a $560 million senior secured term loanfacility with an eight-year maturity.  Wealso borrowed $100 million under a senior unsecured term loan, due in 2013, andissued $390 million aggregate principal amount of new Senior Subordinated Notesdue 2014. Since the recapitalization and through February 27, 2005, wehave repaid $95.0 million of the original $560.0 million outstanding under oursenior secured term loan.  In doing so,we have effectively prepaid all principal payments due prior to the maturity ofthe loan in 2012.  Most of the prepaymentshave been funded out of our operating cash flow, along with $22.1 millionoutstanding under our senior secured revolving credit facility at February 27,2005.  As of April 12, 2005, we have$7.1 million outstanding under our revolving credit facility.

 

Annually, wemay be required to make principal prepayments equal to 50% of excess cash flowfor the preceding fiscal year, as defined in our senior secured creditagreement.  At February 27, 2005, wewere unable to determine the amount of such required prepayment, if any, thatwould be due in the first quarter of fiscal 2006 with respect to any excesscash flow for the 2005 fiscal year.

 

Borrowingsunder our new senior secured credit facilities bear interest at our choice ofthe Eurodollar rate or adjusted base rate (‘‘ABR’’), in each case, plus anapplicable margin, subject to adjustment based on a pricing grid.  On August 6, 2004, we amended the seniorsecured credit facility to reduce the applicable margin by 25 basispoints.  On March 15, 2005, Moody’sInvestor Services upgraded the credit rating on our senior secured credit facilitywhich, under the terms of the facility, resulted in a 25 basis point reductionin the applicable margin. On June 3, 2004, we entered into an interestrate swap 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 through November 2007.  To retain the designation of this swap as ahedging instrument, we must select the Eurodollar rate on the hedged portion ofthe senior secured term loan during the term of the swap.

 

The $100 million senior unsecured term loan will mature in 2013 andwill bear interest at our choice of the Eurodollar rate or ABR, plus anapplicable margin, subject to adjustment based on a pricing grid.  All principal amounts outstanding under thesenior unsecured term loan are to be repaid at maturity.

 

We intend toamend our senior secured credit facility in April of 2005. The final termsand timing of the refinancing, if it occurs, will depend on market conditionsand other factors.  In connection withthe amendment, amounts outstanding under the senior secured term loan willincrease to $565 million.  The additional$100 million borrowing will be used for the repayment of the outstanding seniorunsecured term loan.  Management believesthat the amended senior secured credit facility will have substantially thesame terms as the existing facility, although the interest rate margins underthe new facility will likely be lower than those under the existingfacility.  We expect to incur certaincosts in the second quarter of fiscal 2005 in connection with the amendmentresulting from related fees, expenses, and, depending upon the final terms ofthe amended facility, the write-off of deferred debt issuance costs associatedwith the existing facilities.

 

The outstanding Senior Subordinated Notesconsist of $390 million aggregate principal amount maturing June 15, 2014,bearing interest at 8.25% per annum payable semiannually in arrears on June 15and December 15, commencing on December 15, 2004.  On September 29, 2004, we completed anexchange offer whereby all of the Senior Subordinated Notes were exchanged forpublicly traded, registered securities with identical terms (other than certainterms relating to registration rights and certain interest rate provisionsotherwise applicable to the original senior subordinated notes).

 

At February 27, 2005 we were incompliance with the covenants contained within our senior credit agreements andnote indenture.

 

24

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***Cash Flow Analysis***

 

The following table summarizes our changes in cash:

 
| ** **                              | ** ** | **Three Months Ended:**     | ** ** |
|-----------------------------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **February 27,  2005** | ** ** | **February 29,  2004** | ** ** |
| ** **                              | ** ** | **(in  millions)**          | ** ** |
| Statement of Cash Flow  Data:           |       |                        |       |   |   |
| Cash flows provided by  (used in):      |       |                        |       |   |   |
| Operating activities                    |       | $                           | 1.9        |   | $ | (18.5 | ) |
| Investing activities                    |       | (1.1                        | )          | (5.3 | ) |
| Financing activities                    |       | 15.2                        |       | 0.6 |   |
|                                    |       |                        |       |   |   |
| Effect of exchange rate changes on cash |       | (1.0                        | )          | (0.1 | ) |
|                                    |       |                        |       |   |   |
| Change in cash and cash equivalents     |       | 15.0                        |       | (23.3 | ) |
| Cash and cash equivalents:              |       |                        |       |   |   |
| Beginning of period                     |       | 22.8                        |       | 101.1 |   |
| End of period                           |       | $                           | 37.8       |   | $ | 77.8 |   |

 

***Quarter Ended February 27,2005  Compared With Quarter Ended February 29,2004***

 

*Cash Flows from Operating Activities.*  Our cash flow from operations increased $20.4million to $1.9 for the three months ended February 27, 2005, compared to$(18.5) million for the year ended February 29, 2004.  This improvement was primarily caused by a$17.6 million change in the timing of certain annual payments associated withincentive compensation and profit sharing payments.  The remaining increase was due to higheroperating margins, partially offset by higher semi-annual interest payments onour public debt of $22.3 million in the first quarter of 2005 compared with$21.8 million in the first quarter of 2004. The 2005 semi-annual payment included approximately eight months ofinterest rather than six as there was no scheduled payment on the new seniorsubordinated notes in June 2004.

 

*Cash Flows from InvestingActivities.*  Our cash flows used in investing activitiesdecreased approximately $4.2 million from the first quarter of 2004 primarilydue to $4.6 million of proceeds from the sale of our former Randolph,Massachusetts manufacturing facility, which was closed in the second fiscalquarter of 2004.

 

*Cash Flows from FinancingActivities.*  Our cash flow provided by financingactivities for the three months ended February 27, 2005 increased $14.6million over the three months ended February 29, 2004.  This was primarily due to additional netborrowings of $11.5 million and $5.6 million under the U.S. and Canadianportions of our senior secured revolving credit facility, respectively, as wellas additional net short term borrowings at our European subsidiary that wereapproximately $2.5 million higher than in the first quarter of 2004.  These borrowings were offset by the repaymentof $5.0 million on the senior secured term loan in the first quarter of2005.  There were no significantprincipal payments on debt during the first quarter of 2004.

 

***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 return positions are fully supportable,we have established reserves where we believe that certain tax positions arelikely to be challenged and we may not fully prevail in overcoming thesechallenges.   We may adjust thesereserves as relevant circumstances evolve, such as guidance from the relevanttax authority, our tax advisors, or resolution of issues in the courts.  Our tax expense includes the impact ofreserve positions and changes to reserves that we consider appropriate, as wellas related interest.  Because we are notcurrently undergoing examinations of any of our corporate income tax returns bytax authorities, we believe that it is unlikely that an audit could beinitiated which would result in assessment and payment of taxes related tothese positions during the remainder of 2005. We also cannot predict when or if any other future tax payments relatedto these tax positions may occur. Therefore, substantially all of the reserves for these positions areclassified as noncurrent liabilities  inour balance sheet.

 

25

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***Debt Covenants***

 

Our new long-term obligations contain various financial tests andcovenants.  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 compliance with all debt covenants.  The specific covenants and relateddefinitions can be found in the applicable debt agreements, each of which wehave previously filed with the Securities and Exchange Commission.

 

The covenants contained in our senior secured credit facilities arebased on what we refer to herein as “Adjusted EBITDA”.  In the senior secured credit facilities,EBITDA is defined as net income plus interest, taxes, depreciation andamortization and Adjusted EBITDA is defined as EBITDA further adjusted toexclude unusual items and other adjustments permitted in calculating covenantcompliance 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 withcovenants discussed above.

 

EBITDA and Adjusted EBITDA are not recognized terms under GAAP and donot purport to be alternatives to net income as a measure of operatingperformance or to cash flows from operating activities as a measure ofliquidity. Additionally, they are not intended to be measures of free cash flowfor management’s discretionary use, as they do not consider certain cashrequirements such as interest payments, tax payments and debt servicerequirements. Because not all companies use identical calculations, thesepresentations may not be comparable to other similarly titled measures of othercompanies.

 

The following table sets forth a reconciliation of net income to EBITDAand EBITDA to Adjusted EBITDA for the three months ended February 27,2005:

 
| ** **                         | ** ** | **Three Months  Ended  February 27,  2005** | ** ** |
|------------------------------------|------------|--------------------------------------------------|------------|
| ** **                         | ** ** | **(in  millions)**                               | ** ** |
| Net Income                         |       | $                                                | 21.9       |   |
| Interest                           |       | 17.8                                             |       |
| Income Taxes                       |       | 13.6                                             |       |
| Depreciation  and Amortization     |       | 5.5                                              |       |
|                               |       |                                             |       |
| EBITDA                             |       | $                                                | 58.8       |   |
| Management  fees payable to KKR    |       | 0.5                                              |       |
|                               |       |                                             |       |
| Unusual  items:                    |       |                                             |       |
| Post-closing  residual plant costs |       | 0.5                                              |       |
| Other  (various)                   |       | (0.2                                             | )          |
|                               |       |                                             |       |
| Adjusted  EBITDA                   |       | $                                                | 59.6       |   |

 

Adjusted EBITDA for the quarter ended February 29, 2004 was fixedand defined per the terms of our senior secured credit facilities as being$47.5 million.

 

26

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The following tablereconciles EBITDA to cash flow from operations:

 
| ** **                                                     | ** ** | **February 27, 2005** | ** ** | **February 29, 2004** | ** ** |
|----------------------------------------------------------------|------------|----------------------------|------------|----------------------------|------------|
| Net income                                                     |       | $                          |  21.9 |                       | $          |  11.3 |   |
| Interest                                                       |       | 17.8                       |       | 16.9                       |       |
| Income Taxes                                                   |       | 13.6                       |       | 8.3                        |       |
| Depreciation &  Amortization                               |       | 5.5                        |       | 6.1                        |       |
| EBITDA                                                         |       |                       | 58.8       |                       |       | 42.6 |   |
| Adjustments to EBITDA to  arrive at cash flow from operations: |       |                       |       |                       |       |
| Interest expense                                               |       | (17.8                      | )          | (16.9                      | )          |
| Income taxes                                                   |       | (13.6                      | )          | (8.3                       | )          |
| Non-cash charges against  (credits to) net income              |       | 10.4                       |       | 0.8                        |       |
| Changes in operating  assets & liabilities.                |       | (35.9                      | )          | (36.7                      | )          |
| Cash flow from operations                                      |       | $                          | 1.9        |                       | $          | (18.5 | ) |

 

***Forward Looking Statements***

 

*“Safe Harbor” Statement Under thePrivate Securities Litigation Reform Act of 1995*. When used in this Quarterly Report on Form10-Q, the words “believes,” “anticipates,” “expects,” “intends,” “projects” andsimilar expressions are used to identify forward-looking statements within themeaning of the Private Securities Litigation Reform Act of 1995. Suchforward-looking statements relate to future financial and operational results.Any forward-looking statements contained in this report represent ourmanagement’s current expectations, based on present information and currentassumptions, and are thus prospective and subject to risks and uncertaintieswhich could cause actual results to differ materially from those expressed insuch forward-looking statements. Actual results could differ materially fromthose anticipated or projected due to a number of factors.  These factors include, but are not limitedto:

 

•                  the level of competition in the beddingindustry;

 

•                  legal and regulatory requirements;

 

•                  the success of new products;

 

•                  our relationships with our major suppliers;

 

•                  fluctuations in costs of raw materials;

 

•                  our relationship with significant customersand licensees;

 

•                  our labor relations;

 

•                  departure of key personnel;

 

•                  encroachments on our intellectual property;

 

•                  product liability claims;

 

•                  the timing, cost and success of opening newmanufacturing facilities;

 

•                  our level of indebtedness;

 

•                  interest rate risks;

 

•                  future acquisitions;

 

27

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•                  an increase in return rates; and

 

•                  other risks and factors identified from timeto time in the Company’s reports filed with the Securities and ExchangeCommission.

 

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 expressly qualified intheir entirety by the cautionary statements include in this Quarterly Report onFrom 10-Q. Except as may be required by law, we undertake no obligation topublicly update or revise forward-looking statements which may be made toreflect events or circumstances after the date made or to reflect theoccurrence of unanticipated events.

 

**Item 3.    *Quantitative and Qualitative Disclosures About MarketRisk***

 

Informationrelative to the Company’s market risk sensitive instruments by major categoryat November 28, 2004 is presented under Item 7a of the registrant’s AnnualReport on Form 10-K for the fiscal year ended November 28, 2004.

 

***Foreign Currency Exposures***

 

Our earnings are affected byfluctuations in the value of our subsidiaries’ functional currency as comparedto the currencies of our foreign denominated purchases. Foreign currencyforward, swap and option contracts are used to hedge against the earningseffects of such fluctuations. The result of a uniform 10% change in the valueof the U.S. dollar relative to currencies of countries in which we manufactureor sell our products would not be material to our earnings or financialposition. This calculation assumes that each exchange rate would change in thesame 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 27, 2005, we hadforward contracts to sell a total of 26.5 million Canadian dollars withexpiration dates ranging from March 3, 2005 through November 15,2005.  At February 27, 2005, thefair value of our net obligation under the forward contracts was $1.4 million.We do not designate our foreign currency hedges for accounting purposes,therefore all changes in fair value are charged to earnings.

 

***Interest Rate Risk***

 

As more fully discussed inNote 9 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 2004recapitalization.  Although the relateddebt was repaid in connection with the recapitalization, the related swaps remainin effect and are scheduled to expire in December 2006.  Because the first swap converted a portion ofour floating rate debt to a fixed rate and a subsequent swap effectivelyre-established a floating rate on the same debt, the effect of the two instrumentson both cash flows and earnings is largely off-setting.  The combined fair value carrying amount ofthese swap instruments at February 27, 2005 and November 28, 2004 wasa net obligation of $3.6 million and $4.3 million, respectively.

 

We had also entered into aninterest rate cap agreement associated with previous debt that caps thefloating rate on the debt at 8% through June 2005. The agreement alsoremains in effect following the repayment of the related debt. This agreementhas not been designated for hedge accounting and, accordingly, any changes inthe fair value are recorded in interest expense. The fair value of thisinstrument is not material.

 

On June 3,2004, we entered into an interest rate swap agreement effective July 6,2004 effectively fixing the floating portion of the interest rate at 3.725% on$200 million of our outstanding balance under the senior secured term loanthrough November 2005, declining to $150 million through November 2007.  The fair value of this swap instrument was anasset of less than $0.1 million at February 27, 2005 and an obligation of$2.0 million at November 28, 2004.

 

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 27, 2005, a 12.5basis point increase or decrease in variable interest rates would have anapproximately $0.5 million dollar impact on our annual interest expense.

 

28

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***Commodity Price Risks***

 

The cost of our steel innerspring and ourpolyurethane foam and polyethylene component parts are impacted by volatilityin the price of steel and petroleum.  Weexpect the cost of the components to remain elevated above their recenthistorical averages throughout 2005. Thus far, we have been able tosuccessfully address these cost pressures through a price increase announced inMay of 2004 and cost reduction efforts. We do not engage in commodity hedgingprograms.

 

**Item 4.    *Internal Control 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) under the SecuritiesExchange Act of 1934, as amended, as of the end of the period covered by thisreport (the “Evaluation Date”). Based on this evaluation, our principalexecutive 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 and reportedwithin 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 audit of our consolidated financial  statements, management identified certaindeficiencies in our financial statement close process primarily related to thereview and approval process for various account analyses and reserve/accrualcalculations and the consolidated financial/balance sheet review process.  Management has discussed these deficiencieswith our Audit Committee and we are currently addressing thesedeficiencies.  As part of the financialstatement close process for the quarter ended February 27, 2005, weinstituted an enhanced management review and approval process for various reservesand accruals.  In addition, we enhancedour balance sheet review procedures for the individual plant locations.  We expect to continue improving the financialstatement close process in 2005 as we continue to prepare for compliance with Section 404of the Sarbanes-Oxley Act of 2002.  Dueto the recently announced one-year delay in the required compliance schedule fornon-accelerated filers, we will be required to issue a management report on ourassessment of internal controls over financial reporting in our Annual Reporton Form 10-K for the year ended November 26, 2006.

 

There were no other changesin our internal control over financial reporting identified in connection withthe foregoing evaluation that occurred during the first quarter of 2005 that havematerially affected, or are reasonably likely to materially affect, ourinternal control over financial reporting.

 

29

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**PART II.OTHER INFORMATION**

 

**Item 1.    *Legal Proceedings***

 

SeeNote 12 to the Condensed Consolidated Financial Statements, Part I, Item 1included herein.

 

**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

 

**Item 6.    *Exhibits and Reports on Form 8-K***

 

(a)              Exhibits:

 

31.1**  **ChiefExecutive Officer Certification of the Quarterly Financial Statements.

 

31.2**  **ChiefFinancial Officer Certification of the Quarterly Financial Statements.

 

32**    **Certificationpursuant to 18 U.S.C. Section 1350.

 

(b)             Reports on Form8-K:

 

Pressrelease announcing the financial results for the year ended November 28,2004, filed March 2, 2005.

 

30

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**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, SealyMattress Corporation has duly caused this report to be signed on its behalf bythe undersigned, thereunto duly authorized.

 

SEALY MATTRESS CORPORATION

 
| **Signature**                                 | ** ** | **Title**                                             |
|-----------------------------------------------|------------|-------------------------------------------------------|
|                                          |       |                                                  |
| /S/    DAVID J. MCILQUHAM |       | Chief Executive Officer and President                 |
| **David J.  McIlquham**                       |       | (Principal Executive Officer)                         |
|                                          |       |                                                  |
| /S/    JAMES B. HIRSHORN  |       | Executive Vice President and Chief Financial  Officer |
| **James B.  Hirshorn**                        |       | (Principal Accounting Officer)                        |

 

Date: April 13, 2005

 

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