**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe quarterly period ended: February 25, 2007**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Transition Period from             to**

**Commissionfile number 001-08738**

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**SEALY CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                    |   | **36-3284147**                        |
|-------------------------------------------------|--------|---------------------------------------|
| (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’s telephone number,including area code

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Indicate by check mark whether the registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of theSecurities Exchange Act of 1934 during the preceding 12 months (or forsuch shorter period that the registrant was required to file such reports) and (2) hasbeen subject to such filing requirements for the past 90 days. Yes x No o

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

Large acceleratedfiler o        Accelerated filer o       Non-accelerated filer x

Indicate by check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

**The number ofshares of the registrant’s common stock outstanding as of March 30, 2007is approximately: 91,447,308.**

 

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**PART I.FINANCIAL INFORMATION**

**Item 1—*Financial Statements***

**SEALY CORPORATION**

**CondensedConsolidated Statements of Operations(in thousands, except per share data)(unaudited)**

| ** **                                                                                                | ** ** | **Three Months Ended** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                                | ** ** | **February 25,**            | ** ** | **February 26,** | ** ** |
| ** **                                                                                                | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| Net sales                                                                                                 |       |                             | $          | 412,567 |   |   |   | $ | 395,735 |   |   |
| Cost of goods  sold                                                                                       |       |                             | 235,293    |   |   |   | 219,038 |   |   |
| Gross profit                                                                                              |       |                             | 177,274    |   |   |   | 176,697 |   |   |
| Selling, general and administrative expenses                                                              |       |                             | 126,913    |   |   |   | 123,604 |   |   |
| Amortization of  intangibles                                                                              |       |                             | 783        |   |   |   | 122 |   |   |
| Royalty income,  net of royalty expense                                                                   |       |                             | (5,292     | ) |   |   | (3,689 | ) |   |
| Income from operations                                                                                    |       |                             | 54,870     |   |   |   | 56,660 |   |   |
| Interest expense                                                                                          |       |                             | 15,905     |   |   |   | 18,736 |   |   |
| Other income, net                                                                                         |       |                             | (80        | ) |   |   | (187 | ) |   |
| Income before income tax expense                                                                          |       |                             | 39,045     |   |   |   | 38,111 |   |   |
| Income tax  expense                                                                                       |       |                             | 14,411     |   |   |   | 14,852 |   |   |
| Income before  cumulative effect of change in accounting principle                                        |       |                             | 24,634     |   |   |   | 23,259 |   |   |
| Cumulative effect of the adoption of FASB  Interpretation No. 47, net of related tax benefit of $191 |       |                             | —     |   |   |   | 287 |   |   |
| Net income                                                                                                |       |                             | $          | 24,634 |   |   |   | $ | 22,972 |   |   |
| Earnings per common  share—Basic                                                                     |       |                             |       |   |   |   |   |   |   |
| Income before cumulative effect of change in  accounting principle                                        |       |                             | $          | 0.27 |   |   |   | $ | 0.33 |   |   |
| Cumulative effect of a change in accounting  principle                                                    |       |                             | —     |   |   |   | — |   |   |
| Earnings per common share—Basic                                                                      |       |                             | $          | 0.27 |   |   |   | $ | 0.33 |   |   |
| Earnings per  common share—Diluted                                                                   |       |                             |       |   |   |   |   |   |   |
| Income before cumulative effect of change in  accounting principle                                        |       |                             | $          | 0.26 |   |   |   | $ | 0.30 |   |   |
| Cumulative effect of a change in accounting  principle                                                    |       |                             | —     |   |   |   | — |   |   |
| Earnings per common share—Diluted                                                                    |       |                             | $          | 0.26 |   |   |   | $ | 0.30 |   |   |
| Weighted average  number of common shares outstanding:                                                    |       |                             |       |   |   |   |   |   |   |
| Basic                                                                                                     |       |                             | 91,349     |   |   |   | 70,482 |   |   |
| Diluted                                                                                                   |       |                             | 96,585     |   |   |   | 76,386 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATION**

**CondensedConsolidated Balance Sheets(in thousands except per share amounts)(unaudited)**

| ** **                                                                                                                                                                                                                            | ** ** | **February 25,** | ** ** | **November 26,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                            | ** ** | **2007**              | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                                                                                                                                            | ** ** | ** **            | ** ** |                  | ** ** | ** ** |   |
| Current assets:                                                                                                                                                                                                                       |       |                  |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                            |       | $                     | 31,750     |                  |       | $ | 45,620 |   |   |
| Accounts receivable, net  of allowances for bad debts, cash discounts and returns                                                                                                                                                |       | 217,704               |       |                  | 193,838    |   |   |
| Inventories                                                                                                                                                                                                                           |       | 65,334                |       |                  | 66,126     |   |   |
| Assets held for sale                                                                                                                                                                                                                  |       | 2,338                 |       |                  | 2,338      |   |   |
| Prepaid expenses and  other current assets                                                                                                                                                                                            |       | 22,835                |       |                  | 24,710     |   |   |
| Deferred income taxes                                                                                                                                                                                                                 |       | 12,932                |       |                  | 12,627     |   |   |
|                                                                                                                                                                                                                                  |       | 352,893               |       |                  | 345,259    |   |   |
| Property, plant and  equipment—at cost                                                                                                                                                                                           |       | 411,685               |       |                  | 397,167    |   |   |
| Less accumulated  depreciation                                                                                                                                                                                                        |       | (182,934              | )          |                  | (178,957   | ) |   |
|                                                                                                                                                                                                                                  |       | 228,751               |       |                  | 218,210    |   |   |
| Other assets:                                                                                                                                                                                                                         |       |                  |       |                  |       |   |   |
| Goodwill                                                                                                                                                                                                                              |       | 387,685               |       |                  | 388,204    |   |   |
| Other intangibles, net  of accumulated amortization                                                                                                                                                                                   |       | 12,284                |       |                  | 13,026     |   |   |
| Debt issuance costs,  net, and other assets                                                                                                                                                                                           |       | 39,316                |       |                  | 38,033     |   |   |
|                                                                                                                                                                                                                                  |       | 439,285               |       |                  | 439,263    |   |   |
|                                                                                                                                                                                                                                  |       | $                     | 1,020,929  |                  |       | $ | 1,002,732 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                                                                                        | ** ** | ** **            | ** ** |                  | ** ** | ** ** |   |
| Current liabilities:                                                                                                                                                                                                                  |       |                  |       |                  |       |   |   |
| Current portion—long-term  obligations                                                                                                                                                                                           |       | $                     | 22,996     |                  |       | $ | 18,282 |   |   |
| Accounts payable                                                                                                                                                                                                                      |       | 129,001               |       |                  | 118,885    |   |   |
| Accrued incentives and  advertising                                                                                                                                                                                                   |       | 36,973                |       |                  | 40,578     |   |   |
| Accrued compensation                                                                                                                                                                                                                  |       | 37,892                |       |                  | 35,484     |   |   |
| Accrued interest                                                                                                                                                                                                                      |       | 11,220                |       |                  | 17,286     |   |   |
| Other accrued expenses                                                                                                                                                                                                                |       | 54,144                |       |                  | 57,669     |   |   |
|                                                                                                                                                                                                                                  |       | 292,226               |       |                  | 288,184    |   |   |
| Long-term obligations,  net of current portion                                                                                                                                                                                        |       | 811,756               |       |                  | 814,236    |   |   |
| Other noncurrent  liabilities                                                                                                                                                                                                         |       | 42,382                |       |                  | 42,688     |   |   |
| Deferred income taxes                                                                                                                                                                                                                 |       | 10,837                |       |                  | 10,199     |   |   |
| Common stock and options  subject to redemption                                                                                                                                                                                       |       | 17,517                |       |                  | 20,263     |   |   |
| Stockholders’ deficit:                                                                                                                                                                                                           |       |                  |       |                  |       |   |   |
| Common stock, $0.01 par  value; Authorized shares: 2007 and 2006—200,000 Issued and outstanding:  2007—91,532; 2006—90,983 (including shares classified above as subject to  redemption: 2007—402; 2006—424) |       | 909                   |       |                  | 904        |   |   |
| Additional paid-in  capital                                                                                                                                                                                                           |       | 666,815               |       |                  | 664,609    |   |   |
| Accumulated deficit                                                                                                                                                                                                                   |       | (828,366              | )          |                  | (846,144   | ) |   |
| Accumulated other  comprehensive income                                                                                                                                                                                               |       | 6,853                 |       |                  | 7,793      |   |   |
|                                                                                                                                                                                                                                  |       | (153,789              | )          |                  | (172,838   | ) |   |
|                                                                                                                                                                                                                                  |       | $                     | 1,020,929  |                  |       | $ | 1,002,732 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATION**

**CondensedConsolidated Statement of Stockholders’ Deficit(in thousands)(unaudited)**

| ** **                                                   | ** ** | ** **        | ** ** | ** **            | ** ** | ** **     | ** ** | ** **   | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|--------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|----------------|------------|--------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                   | ** ** | ** **        | ** ** | **Class A**      | ** ** | **Additional** | ** ** | **Retained** | ** ** | **Other**         | ** ** | ** **      | ** ** |
| ** **                                                   | ** ** | **Comprehensive** | ** ** | **Common Stock** | ** ** | **Paid-in**    | ** ** | **Earnings** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                   | ** ** | **Income**        | ** ** | **Shares**            | ** ** | **Amount**     | ** ** | **Capital**  | ** ** | **(Deficit)**     | ** ** | **Income**      | ** ** | **Total**  | ** ** |
| Balance at  November 26, 2006                           |       |              |       |                  |       |           | 90,983     |         |       |              | $          | 904             |       |       |       | $ | 664,609 |   |   | $ | (846,144 | ) |   | $ | 7,793 |   |   | $ | (172,838 | ) |
| Net income                                                   |       |              | $          | 24,634                |       |           |       |         |       |              |       |            |       |       |       |   |   |   | 24,634 |   |   |   |   |   | 24,634 |   |
| Foreign currency  translation adjustment                     |       |              | (721       | )                     |       |           |       |         |       |              |       |            |       |       |       |   |   |   |   |   | (721 | ) |   | (721 | ) |
| Change in fair value of  cash flow hedge, net of tax of $104 |       |              | (219       | )                     |       |           |       |         |       |              |       |            |       |       |       |   |   |   |   |   | (219 | ) |   | (219 | ) |
| Stock based compensation:                                    |       |              |       |                  |       |           |       |         |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |
| Compensation associated  with stock option grants            |       |              |       |                  |       |           |       |         |       |              |       |            |       |       | 331        |   |   |   |   |   |   |   |   | 331 |   |
| Directors’ deferred stock  compensation                 |       |              |       |                  |       |           |       |         |       |              |       |            |       |       | 174        |   |   |   |   |   |   |   |   | 174 |   |
| Cash dividend                                                |       |              |       |                  |       |           |       |         |       |              |       |            |       |       |       |   |   | (6,856 | ) |   |   |   |   | (6,856 | ) |
| Exercise of stock options                                    |       |              |       |                  |       |           | 549        |         |       |              | 5          |            |       |       | (5,443     | ) |   |   |   |   |   |   |   | (5,438 | ) |
| Excess tax benefit on  options exercised                     |       |              |       |                  |       |           |       |         |       |              |       |            |       |       | 4,348      |   |   |   |   |   |   |   |   | 4,348 |   |
| Adjustment of temporary  equity subject to redemption        |       |              |       |                  |       |           |       |         |       |              |       |            |       |       | 2,746      |   |   |   |   |   |   |   |   | 2,746 |   |
| Other                                                        |       |              |       |                  |       |           |       |         |       |              |       |            |       |       | 50         |   |   |   |   |   |   |   |   | 50 |   |
| Balance at February 25, 2007                            |       |              | $          | 23,694                |       |           |       | 91,532       |       |              |       | $               | 909        |       |       |   | $ | 666,815 |   |   | $ | (828,366 | ) |   | $ | 6,853 |   |   | $ | (153,789 | ) |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATION**

**CondensedConsolidated Statements of Cash Flows(in thousands)(unaudited)**
|                                                                                              | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                                                   | ** ** | **February 25,  2007**      | ** ** | **February 26,  2006** | ** ** |
| Cash flows from  operating activities:                                                       |       |                             |       |   |   |   |   |   |   |
| Net income                                                                                   |       |                             | $          | 24,634 |   |   |   | $ | 22,972 |   |   |
| Adjustments to  reconcile net income to net cash provided by (used in) operating activities: |       |                             |       |   |   |   |   |   |   |
| Depreciation and amortization                                                                |       |                             | 7,322      |   |   |   | 5,700 |   |   |
| Deferred income taxes                                                                        |       |                             | 429        |   |   |   | (23 | ) |   |
| Non-cash interest  expense:                                                                  |       |                             |       |   |   |   |   |   |   |
| Senior Subordinated PIK Notes                                                                |       |                             | —     |   |   |   | 2,113 |   |   |
| Amortization of debt issuance costs and other                                                |       |                             | 687        |   |   |   | 235 |   |   |
| Stock-based compensation                                                                     |       |                             | 639        |   |   |   | 372 |   |   |
| Excess tax benefits from share-based payment arrangements                                    |       |                             | (4,348     | ) |   |   | — |   |   |
| Loss on sale of assets                                                                       |       |                             | 161        |   |   |   | 22 |   |   |
| Cumulative effect of accounting change                                                       |       |                             | —     |   |   |   | 287 |   |   |
| Other, net                                                                                   |       |                             | (1,031     | ) |   |   | (717 | ) |   |
| Changes in operating  assets and liabilities:                                                |       |                             |       |   |   |   |   |   |   |
| Accounts receivable                                                                          |       |                             | (24,358    | ) |   |   | (28,563 | ) |   |
| Inventories                                                                                  |       |                             | 899        |   |   |   | (6,344 | ) |   |
| Prepaid expenses and other current assets                                                    |       |                             | 1,724      |   |   |   | (150 | ) |   |
| Accounts payable                                                                             |       |                             | 9,961      |   |   |   | (9,085 | ) |   |
| Accrued expenses                                                                             |       |                             | (12,135    | ) |   |   | 350 |   |   |
| Other liabilities                                                                            |       |                             | (331       | ) |   |   | (1,225 | ) |   |
| Net cash provided by (used in) operating activities                                          |       |                             | 4,253      |   |   |   | (14,056 | ) |   |
| Cash flows from investing  activities:                                                       |       |                             |       |   |   |   |   |   |   |
| Purchase of property, plant and equipment                                                    |       |                             | (12,913    | ) |   |   | (5,577 | ) |   |
| Proceeds from sale of property, plant and equipment                                          |       |                             | 77         |   |   |   | 29 |   |   |
| Net cash used in investing activities                                                        |       |                             | (12,836    | ) |   |   | (5,548 | ) |   |
| Cash flows from  financing activities:                                                       |       |                             |       |   |   |   |   |   |   |
| Cash dividends                                                                               |       |                             | (6,856     | ) |   |   | — |   |   |
| Borrowings under revolving credit facilities                                                 |       |                             | 8,627      |   |   |   | 78,841 |   |   |
| Repayments under revolving credit facilities                                                 |       |                             | (11,249    | ) |   |   | (82,136 | ) |   |
| Exercise of employee stock options, including  related excess tax benefits                   |       |                             | 4,592      |   |   |   | — |   |   |
| Other                                                                                        |       |                             | (344       | ) |   |   | (17 | ) |   |
| Net cash used in financing activities                                                        |       |                             | (5,230     | ) |   |   | (3,312 | ) |   |
| Effect of  exchange rate changes on cash                                                     |       |                             | (57        | ) |   |   | 122 |   |   |
| Change in cash  and cash equivalents                                                         |       |                             | (13,870    | ) |   |   | (22,794 | ) |   |
| Cash and cash  equivalents:                                                                  |       |                             |       |   |   |   |   |   |   |
| Beginning of period                                                                          |       |                             | 45,620     |   |   |   | 36,554 |   |   |
| End of period                                                                                |       |                             | $          | 31,750 |   |   |   | $ | 13,760 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATION**

**Notes to CondensedConsolidated Financial Statements(unaudited)**

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

The interim condensed consolidated financialstatements are unaudited, and certain related information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been omitted in accordance with Rule 10-01 ofRegulation S-X. The accompanying interim condensed consolidated financialstatements were prepared following the same policies and procedures used in thepreparation of the audited financial statements and reflect all adjustments(consisting of normal recurring adjustments) necessary to present fairly thefinancial position of Sealy Corporation and its subsidiaries (the “Company”).The results of operations for the interim periods are not necessarilyindicative of the results for the fiscal year. These condensed consolidatedfinancial statements should be read in conjunction with the auditedconsolidated financial statements for the year ended November 26, 2006included within the Company’s Annual Report on Form 10-K (File No. 001-08738).

On April 6, 2004, the Company completed a mergerwith affiliates of Kohlberg Kravis Roberts & Co. L.P. (“KKR”) wherebyKKR acquired 92% of the Company’s capital stock. Certain of the Company’sprevious stockholders, including affiliates of Bain Capital, LLC and others,retained an 8% interest in the Company’s stock. The merger was accounted for asa recapitalization. Subsequent to the recapitalization, the Company contributedall of its interest in Sealy Mattress Company, of which it was the soleshareholder, to a newly formed subsidiary holding company, Sealy MattressCorporation, which also replaced the Company as the parent-guarantor ofthe 8.25% Senior Subordinated Notes due 2014 (the “Notes”) issued by SealyMattress Company. Effective May 25, 2006, Sealy Corporation was named aguarantor of the Notes. At February 25, 2007, KKR controlled approximately50.9% of the issued and outstanding common stock of the Company.

The preparation of financial statements in conformitywith generally accepted accounting principles in the United States of Americarequires management to make estimates and assumptions that affect the amount ofassets and liabilities and disclosures on contingent assets and liabilities atperiod end and the reported amounts of revenue and expenses during thereporting period. Actual results may differ from these estimates.

All common stock and pershare amounts presented in the condensed consolidated financial statements andaccompanying notes thereto have been restated to reflect a 0.7595 for 1 reversestock split which became effective on March 23, 2006.

**Note 2:  *Recently Issued AccountingPronouncements***

In May 2005, the Financial Accounting StandardsBoard (“FASB”) issued FAS 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3.” Thisstatement provides guidance on the accounting for and reporting of accountingchanges and error corrections. It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition guidance specific toany newly adopted pronouncement. This statement also addresses the reporting ofthe correction of an error in previously issued financial statements, whichrequires similar retrospective adjustment. Changes in accounting estimatescontinue to be reported in the period of the change and any future periodsaffected. This statement became effective for accounting changes and errorcorrections made in fiscal years beginning after December 15, 2005. TheCompany adopted this statement as of the beginning of fiscal 

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2007. It did not have amaterial impact on the Company’s consolidated financial position or results ofoperations.

In June 2006, the FASB issued Interpretation No. 48,“Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109” (“FIN 48”). This interpretation clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FAS 109, “Accounting for Income Taxes.” This interpretationprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. This interpretation also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. The interpretation is effective for fiscalyears beginning after December 15, 2006. The Company will adopt thisinterpretation as of the beginning of fiscal 2008 and is still assessing thepotential impact of adoption.

In September 2006, the FASB issued FAS 157, “FairValue Measurements” which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles (“GAAP”) andexpands disclosure about fair value measurements. The statement is effectivefor fiscal years beginning after November 15, 2007. The Company will adoptthis statement as of the beginning of fiscal 2008 and is still assessing thepotential impact of adoption.

In September 2006, the FASB also issued FAS 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106, and 132(R).” This statementrequires an employer to recognize the overfunded or underfunded status of adefined benefit postretirement plan as an asset or liability in its statementof financial position and to recognize changes in that funded status in theyear in which the changes occur through comprehensive income of a businessentity. This statement also requires an employer to measure the funded statusof a plan as of the date of its year end statement of financial position, withlimited exceptions. The Company will be required to initially recognize thefunded status of a defined benefit postretirement plan and to provide therequired disclosures as of the end of the fiscal year ending after December 15,2006, which for the Company will be the end of fiscal 2007. The requirement tomeasure plan assets and benefit obligations as of the date of the employer’sfiscal year end statement of financial position is effective for fiscal yearsending after December 15, 2008, or fiscal 2009 for the Company. TheCompany is still assessing the potential impact of adoption.

In February 2007, theFASB issued FAS 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—including an amendment to FASB Statement No. 115” whichpermits entities to choose to measure many financial instruments and certainother items at fair value that are not currently required to be measured atfair value. The statement is effective for fiscal years beginning after November 15,2007. The Company will adopt this statement as of the beginning of fiscal 2008and does not expect it to have a material impact on the Company’s financial positionor results of operations.

**Note 3:  *Share-BasedCompensation***

The Company accounts for all new stock options grantedor outstanding options modified after August 29, 2005 ( the beginning ofthe fourth quarter of fiscal 2005) under the provisions of FAS No. 123(revised 2004) “Share-Based Payment” (“FAS 123(R)”). The Company hascontinued to account for any portion of awards outstanding at August 29,2005 using the provisions of Accounting Principles Board Opinion no. 25 “Accountingfor Stock Issued to Employees,” as previously permitted under FAS No. 123,“Accounting for Stock-Based Compensation”.

No newstock options were granted, nor were outstanding options modified during thefirst quarter of fiscal 2006. During the three months ended February 25, 2007,the Company granted new options to purchase 432,461 shares of common stock, andrecognized compensation expense associated with these grants of approximately$0.2 million. As of February 25, 2007, there was approximately$2.0 million of 

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unrecognized compensation costs associated with thesegrants. That cost is expected to be recognized over a weighted average periodof 7.7 years. The options granted during the first quarter of fiscal 2007had a weighted average grant-date fair value of $5.08 per option. The Companyvalued these stock option grants using the trinomial lattice valuation modelwith the following assumptions:

| Expected  volatility      |   | 30            | %      |
|---------------------------|--------|---------------|--------|
| Expected dividend  yield  |   | 2.011 - 2.031 | %      |
| Expected term (in  years) |   | 6.71 - 7.88   |   |
| Risk-free rate            |   | 4.54% - 4.72  | %      |

 

Due to the lack of sufficient historical tradinginformation with respect to its own shares, the Company estimates expectedvolatility based on a portfolio of selected stocks of companies believed tohave market and economic characteristics similar to its own. The expecteddividend yield is based on the Company’s current quarterly dividend of $0.075per share relative to the fair value of the underlying stock at grant date. Therisk-free rate is based on the U.S. Treasury yield curve in effect at the timeof grant. The expected term is based on an analysis of the early exercisebehavior of employees.

During the three months ended February 25, 2007,the Company recognized total compensation expense associated with stock optionsof $0.3 million.

During the three monthsended February 25, 2007 and February 26, 2006, the Company recognizedexpense of $0.1 million and $0.3 million, respectively, resultingfrom the accretion of an obligation to certain executives of the Company fortheir right to sell to the Company, upon their retirement, vested shares of theCompany’s common stock.

**Note 4:  *Inventories***

Themajor components of inventories were as follows (in thousands):

| ** **      | ** ** | **February 25,** | ** ** | **November 26,** | ** ** |
|-----------------|------------|-----------------------|------------|-----------------------|------------|
| ** **      | ** ** | **2007**              | ** ** | **2006**              | ** ** |
| Raw materials   |       |                  | $          | 31,559                |       |   |   | $ | 35,041 |   |   |
| Work in process |       |                  | 18,638     |                  |       |   | 19,594 |   |   |
| Finished goods  |       |                  | 15,137     |                  |       |   | 11,491 |   |   |
|            |       |                  | $          | 65,334                |       |   |   | $ | 66,126 |   |   |

 

7

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**Note 5:  *Warranty Costs***

TheCompany’s warranty policy provides a 10-year non-prorated warrantyservice period on all currently manufactured *Sealy Posturepedic,Stearns & Foster* and *Bassett* beddingproducts and certain other Sealy-branded products, a 20-yearwarranty on its *TrueForm *product line and a20-year limited warranty on its *RightTouch*productline that covers only certain parts of the product and is prorated for part ofthe twenty years. In fiscal 2007, the Company amended its warranty policy onSealy-branded promotional bedding to three years for the new line introduced inJanuary 2007 and shipping in the second quarter of fiscal 2007. The Company’spolicy is to accrue the estimated cost of warranty coverage at the time thesale is recorded. The change in the Company’s accrued warranty obligations foreach of the three months ended February 25, 2007 and February 26,2006 and the year ended November 26, 2006 was as follows (in thousands):

| ** **                                           | ** ** | **February 25,** | ** ** | **November 26,** | ** ** | **February 26,** | ** ** |
|------------------------------------------------------|------------|-----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                           | ** ** | **2007**              | ** ** | **2006**              | ** ** | **2006**              | ** ** |
| Accrued warranty  obligations at beginning of period |       |                  | $          | 15,349                |       |                  |       | $ | 14,321 |   |   |   | $ | 14,321 |   |   |
| Warranty claims                                      |       |                  | (3,425     | )                     |       |                  | (15,832    | ) |   |   | (3,453 | ) |   |
| Warranty  provisions                                 |       |                  | 2,930      |                  |       |                  | 16,860     |   |   |   | 3,691 |   |   |
| Accrued warranty  obligations at end of period       |       |                  | $          | 14,854                |       |                  |       | $ | 15,349 |   |   |   | $ | 14,559 |   |   |

 

Warranty claims for theyear ended November 26, 2006 include approximately $10.5 million forclaims associated with products sold prior to November 27, 2005 that werestill under warranty. In estimating its warranty obligations, the Companyconsiders the impact of recoverable salvage value on warranty cost indetermining its estimate of future warranty obligations. Warranty claims andprovisions shown above do not include estimated salvage recoveries that reducedcost of sales by $1.3 million, $5.5 million and $1.4 million forthe three months ended February 25, 2007, the year ended November 26,2006 and the three months ended February 26, 2006, respectively.

**Note 6:  *Assets Held for Sale***

The Company has assetsheld for sale totaling $2.3 million at February 25, 2007 and at November 26,2006. The amount is for a facility that was sold in March 2007. A gain onsale of the facility of approximately $2.6 million will be recorded in thesecond quarter of fiscal 2007.

**Note**7:  *Assets Constructed onBehalf of the Company*

The Company has engagedthird parties to construct production facilities to be leased by the Company.Emerging Issues Task Force Issue No. 97-10, “The Effect of LesseeInvolvement in Asset Construction” (“EITF 97-10”), is applied to entitiesinvolved with certain structural elements of the construction of an asset thatwill be leased when construction of the asset is completed. EITF 97-10requires the Company to be considered the owner, for accounting purposes, ofthese production facilities. Accordingly, the Company has recorded anadditional $5.2 million in property, plant and equipment with an offsettingfinancing obligation in the Condensed Consolidated Balance Sheets for afacility that was placed in service in February 2007. During the leaseterms, the Company recognizes building depreciation and interest expense forthe obligations.

**Note 8:  *Goodwill and Other IntangibleAssets***

The Company performs an annual assessment of itsgoodwill for impairment as of the beginning of the fiscal fourth quarter. TheCompany also assesses its goodwill and other intangible assets for impairment 

8

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when events orcircumstances indicate that their carrying value may not be recoverable fromfuture cash flows.

Thechanges in the carrying amount of goodwill for the three months ended February 25,2007 are as follows:

| ** **                                               | ** ** | **Americas**            | ** ** | **Europe** | ** ** | **Total** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|------------|------------|-----------|------------|
| ** **                                               | ** ** | **(in thousands)** | ** ** |
| Balance as of  November 26, 2006                    |       | $                       | 362,675    |       | $          | 25,529    |       | $ | 388,204 |   |
| Increase  (decrease) due to foreign currency translation |       | (653                    | )          | 134        |       | (519      | )          |
| Balance as of  February 25, 2007                    |       | $                       | 362,022    |       | $          | 25,663    |       | $ | 387,685 |   |

 

Total other intangibles of$12.3 million (net of accumulated amortization of $8.0 million) as ofFebruary 25, 2007 consist primarily of licenses, which are amortized onthe straight-line method over periods ranging from 5 to 15 years, andunamortized pension prior service costs of $1.7 million.

**Note 9:  *Long-Term Obligations***

Long-termobligations as of February 25, 2007 and November 26, 2006 consistedof the following:

| ** **                        | ** ** | **February 25, 2007** | ** ** | **November 26, 2006** | ** ** |
|-----------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                        | ** ** | **(in thousands)**         | ** ** |
| Senior revolving  credit facility |       |                            | $          | 11,215                          |       |   |   | $ | 14,090 |   |   |
| Senior secured  term loans        |       |                            | 415,000    |                            |       |   | 415,000 |   |   |
| Senior  subordinated notes        |       |                            | 342,000    |                            |       |   | 342,000 |   |   |
| Financing  obligations            |       |                            | 42,410     |                            |       |   | 37,535 |   |   |
| Other                             |       |                            | 24,127     |                            |       |   | 23,893 |   |   |
|                              |       |                            | 834,752    |                            |       |   | 832,518 |   |   |
| Less current  portion             |       |                            | 22,996     |                            |       |   | 18,282 |   |   |
|                              |       |                            | $          | 811,756                         |       |   |   | $ | 814,236 |   |   |

 

The total borrowing capacity under the seniorrevolving credit facility is $125 million, of which up to $25 millionmay be borrowed in Canada. At February 25, 2007, amounts outstanding underthe senior revolving credit facility were $11.2 million under the Canadianportion of the facility. At February 25, 2007, the Company hadapproximately $82.3 million available under the revolving credit facilityafter taking into account letters of credit issued totaling $31.5 million.

Annually, the Company may be required to makeprincipal prepayments depending on certain financial ratios, as defined in itssenior secured credit agreement. At February 25, 2007, the Company isunable to determine the amount of such required payment, if any, that would bedue following the first quarter of fiscal 2008 with respect to excess cash flowfor the 2007 fiscal year.

At February 25, 2007the Company was in compliance with the covenants contained within its seniorcredit agreements and indenture governing the senior subordinated notes. Thesenior credit agreements and the senior subordinated notes restrict the Company’sability to pay dividends.

**Note 10:  *Hedging Strategy***

Use of hedging contracts allows the Company to reduceits overall exposure to interest rate changes, since gains and losses on thesecontracts will offset losses and gains on the transactions being hedged. TheCompany formally documents all hedged transactions and hedging instruments, andassesses, both at inception of the contract and on an ongoing basis, whetherthe hedging instruments are effective in 

9

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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.

In June 2004,the Company entered into a swap agreement that has the effect of converting$200 million of the floating-rate debt under the Company’s senior creditfacilities to a fixed-rate basis, declining to $150 million from December 2005through 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. Effective August 25, 2006, theCompany de-designated $13 million of the interest rate swap for hedgeaccounting due to an amendment of the senior secured term loan agreement. As aresult of the dedesignation, $0.2 million previously recorded inaccumulated other comprehensive income was recorded as a reduction of interestexpense. The effective portion of changes in the market value of$137 million of the swap is recorded in other comprehensive income andwill be amortized into interest expense over the remaining life of the interestrate swap agreement. For the three months ended February 25, 2007 and February 26,2006, $0.6 million and $0.3 million, respectively, was recorded as a reductionof interest expense. At February 25, 2007 and November 26, 2006, thefair value carrying amount of the instrument was recorded as follows:

| ** **                   | ** ** | **February 25, 2007** | ** ** | **November 26, 2006** | ** ** |
|------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **(in thousands)**         | ** ** |
| Accrued interest  receivable |       |                            | $          | 590                             |       |   |   | $ | 607 |   |   |
| Other current  assets        |       |                            | 1,806      |                            |       |   | 2,160 |   |   |
| Total net asset              |       |                            | $          | 2,396                           |       |   |   | $ | 2,767 |   |   |

 

At February 25, 2007 and November 26, 2006,accumulated other comprehensive income associated with the interest rate swapwas $1.0 million and $1.2 million, respectively, net of income taxeffects.

The Company had also entered into two interest rateswap agreements associated with debt that no longer exists. Although therelated debt was repaid, the swaps remained in effect until their expiration inDecember 2006. Because the first swap converted a portion of floating ratedebt to a fixed rate and the subsequent swap effectively reestablished afloating rate on the same debt, the effect of the two instruments on both cashflows and earnings was largely off-setting. Changes in the fair market value ofthese swaps was recorded in interest expense. At November 26, 2006, thefair value carrying amount of these instruments was a current liability of $0.1million.

To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, the Company enters into foreign currencyforward and option contracts. The Company does not designate its foreign currencyforward and option contracts as hedges for accounting purposes, therefore allchanges in fair value are charged to earnings. At February 25, 2007, theCompany had forward contracts to sell a total of 33.0 million Canadiandollars with expiration dates ranging from February 28, 2007 through November 30,2007. At February 25, 2007 and November 26, 2006, the fair value ofthe Company’s net receivable under the forward contracts was an asset of $0.2million and $0.1 million, respectively. For the three months ended February 25,2007, recognized foreign currency transaction gains were $0.1 million,compared with an insignificant gain for the three months ended February 26,2006.

**Note 11:  *Other Income, Net***

Other income, net,includes interest income for the three months ended February 25, 2007 and February 26,2006 of $0.1 million and $0.2 million, respectively.

10

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**Note 12:  *Conditional AssetRetirement Obligations***

The Company adopted FASBInterpretation No. 47, “Accounting**forConditional Asset Retirement Obligations” (“FIN 47”) as of the beginning offiscal 2006 and has recorded an adjustment as of November 28, 2005, thefirst day of fiscal 2006, of approximately $0.3 million, net of income taxbenefit of $0.2 million, to recognize the cumulative effect of theaccounting change. During fiscal 2006, the Company recorded $0.4 millionin property, plant and equipment and a liability of $0.9 million in othernoncurrent liabilities. In the first quarter of fiscal 2007, the Companyrecorded an additional $0.1 million in property, plant and equipment and othernoncurrent liabilities. These amounts resulted from obligations in certain ofthe Company’s facility leases that require the Company to return thoseproperties to the same or similar condition at the end of the lease as existedwhen the Company began using those facilities. Although the lease terminationdates range from 2008 to 2022, the Company may be able to renegotiate suchleases to extend the terms.

In addition to the aboveobligations, the Company also owns certain factories that contain asbestos.Current regulations require that the Company remove and dispose of asbestos ifthe factory undergoes major renovations or is demolished. Although the Companyis not required to remove the asbestos unless renovation or demolition occurs,it is required to monitor and ensure that it remains stable and is required tonotify any potential buyer of its existence. The Company has recognized anasset retirement obligation of $0.1 million to remove asbestos at a facility beingrenovated. The Company has not recognized asset retirement obligations in itsfinancial statements for asbestos at other facilities because managementbelieves that there is an indeterminate settlement date for the retirementobligation as the range of time over which the Company may be required toremove and dispose of the asbestos is unknown or cannot be estimated. TheCompany currently has no plans to demolish a factory or to undertake a majorrenovation that would require removal of the asbestos at any of these otherfacilities. Management will continue to monitor this issue and will record anasset retirement obligation when sufficient information becomes available toestimate the obligation.

**Note 13:  *Defined Benefit PensionExpense***

Thecomponents of net periodic pension cost recognized for the Company’s definedbenefit pension plan for the three months ended February 25, 2007 and February 26,2006 are as follows (in thousands):

| ** **                                       | ** ** | **Three months ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|
| ** **                                       | ** ** | **February 25,**            | ** ** | **February 26,** | ** ** |
| ** **                                       | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                                       | ** ** | **(in thousands)**          | ** ** |
| Service cost                                     |       |                             | $          | 147 |   |   |   | $ | 150 |   |   |
| Interest cost                                    |       |                             | 207        |   |   |   | 219 |   |   |
| Expected return  on plan assets                  |       |                             | (218       | ) |   |   | (221 | ) |   |
| Amortization of  unrecognized gains and losses   |       |                             | 30         |   |   |   | 67 |   |   |
| Amortization of  unrecognized transition asset   |       |                             | (22        | ) |   |   | (22 | ) |   |
| Amortization of  unrecognized prior service cost |       |                             | 50         |   |   |   | 51 |   |   |
| Net periodic  pension cost*                      |       |                             | $          | 194 |   |   |   | $ | 244 |   |   |
| Cash contributions                               |       |                             | $          | 145 |   |   |   | $ | 274 |   |   |

 

----

*                    Net periodicpension cost recognized for the three months ended February 25, 2007 isbased upon preliminary estimates pending the final actuarial determination ofsuch costs for fiscal 2007. Similarly, net periodic pension cost for the threemonths ended February 26, 2006 is based upon preliminary estimates.

11

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The Company expects tomake additional cash contributions to the plan of approximately$1.6 million during the remainder of fiscal 2007.

**Note 14:  *IncomeTaxes***

The Company’s effective income tax rates differ fromthe Federal statutory rate principally because of the effect of certain foreigntax rate differentials and state and local income taxes. The effective tax ratefor the three months ended February 25, 2007 is approximately 36.9%compared to 39% for the three months ended February 26, 2006.

Significant judgment isrequired in evaluating the Company’s federal, state and foreign tax positionsand in the determination of its tax provision. Despite the Company’s beliefthat its tax return positions are fully supportable, reserves have beenestablished where the Company believes that certain tax positions are likely tobe challenged and the Company may not fully prevail in overcoming thesechallenges. The Company may adjust these reserves as relevant circumstancesevolve, such as guidance from the relevant tax authority, or resolution ofissues in the courts. In addition the Company is still assessing the potentialimpact of FIN 48 (Note 2). The Company’s tax expense includes the impactof reserve positions and changes to reserves that it considers appropriate, aswell as related interest and penalties. While the Company is currentlyundergoing examinations of certain of its corporate income tax returns by taxauthorities, no issues related to these reserves have been presented to theCompany and the Company believes that such audits will not result in anassessment or payment of taxes related to these positions during the one yearfollowing February 25, 2007. The Company also cannot predict when or ifany other future tax payments related to these tax positions may occur.

**Note 15:  *Comprehensive Income***

Comprehensive income for the three months endedFebruary 25, 2007 was $23.7 million and for the three months endedFebruary 26, 2006 was $24.1 million.

**Note 16:  *Contingencies***

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

The Company is currently conducting an environmentalcleanup at a formerly owned facility in South Brunswick, New Jersey pursuant tothe New Jersey Industrial Site Recovery Act. The Company and one of itssubsidiaries are parties to an Administrative Consent Order issued by the NewJersey Department of Environmental Protection. Pursuant to that order, theCompany and its subsidiary agreed to conduct soil and groundwater remediationat the property. The Company does not believe that its manufacturing processeswere the source of contamination. The Company sold the property in 1997. TheCompany and its subsidiary retained primary responsibility for the requiredremediation. The Company has completed essentially all soil remediation withNew Jersey Department of Environmental Protection approval, and has concluded apilot test of the groundwater remediation system. During 2005, with the approvalof the New Jersey Department of Environmental Protection, the Company removedand disposed of sediment in Oakeys Brook adjoining the site. The Companycontinues to monitor ground water at the site. The Company has recorded areserve for $2.2 million ($2.7 million prior to discounting at 4.75%)associated with this remediation project. Also in connection with this site,the Company received a written complaint from the New Jersey Department ofEnvironmental Protection alleging natural resources damages in an unspecifiedamount. Because the natural resources damages claim is in an early stage andthe Company’s liability, if any, cannot be reasonably estimated at this time,no amounts have been accrued related to this matter.

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The Company is also remediating soil and groundwatercontamination at an inactive facility located in Oakville, Connecticut.Although the Company is conducting the remediation voluntarily, it obtainedConnecticut Department of Environmental Protection approval of the remediationplan. The Company has completed essentially all soil remediation under theremediation plan and is currently monitoring groundwater at the site. TheCompany has identified cadmium in the ground water at the site and intends toaddress that during fiscal 2007. The Company has recorded a reserve ofapproximately $0.8 million associated with the additional work and ongoingmonitoring. The Company believes the contamination is attributable to themanufacturing operations of previous unaffiliated occupants of the facility.

The Company removed three underground storage tankspreviously used for diesel, gasoline, and waste oil from its South Gate,California facility in March 1994 and remediated the soil in the area.Since August 1998, the Company has been working with the CaliforniaRegional Water Quality Control Board, Los Angeles Region to monitor groundwater at the site.

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

On October 12, 2006,the Canadian government passed legislation providing for tariff refunds oncertain purchases of wood made by the Company from 2002 through 2005. TheCompany received $2.1 million as refunds in March 2007. The Company hasnot recognized a receivable or income relating to this refund in the firstquarter of fiscal 2007. The Company will record this refund in the secondquarter of fiscal 2007.

**Note 17:    *Related Party Transactions***

The Company used $11.0million of IPO proceeds received in the second quarter of fiscal 2006 to payKKR a termination fee to end the Management Services Agreement between theCompany and KKR. As a result these fees are no longer being paid starting in April 2006.During the three months ended February 26, 2006, the Company paidmanagement fees of $0.5 million to KKR.

**Note 18:    *Segment Information***

The Company has determined that it has two reportablesegments: the Americas and Europe. These segments have been identified andaggregated based on the Company’s organizational structure which is organizedaround geographic areas.

Both reportable segments manufacture and marketconventional and specialty bedding. The Americas segment’s operations areconcentrated in the United States, Canada, Mexico, Argentina, Brazil and PuertoRico. Europe’s operations are concentrated in western Europe. The accountingpolicies of the segments are the same as those described in Note 1. The Companyevaluates performance based on profit or loss from operations before interestexpense, income taxes, depreciation and amortization (“EBITDA”). The Companyaccounts for inter-segment sales and transfers as if the sales or transferswere to third parties, that is, at current market prices.

Sales outside the UnitedStates were $95.9 million and $81.2 million for the first quarter offiscal 2007 and 2006 respectively. Sales from Europe to the Americas were $2.4million and $4.5 million for the first quarter of fiscal 2007 and 2006respectively. Long lived assets (principally property, plant and equipment)outside the United States were $57.0 million and $57.6 million as ofFebruary 25, 2007 and November 26, 2006, respectively.

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| ** **                                         | ** ** | **Three Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|
| ** **                                         | ** ** | **February 25, 2007**  | ** ** | **Febraury 26, 2006** | ** ** |
| ** **                                         | ** ** | **(in thousands)**          | ** ** |
| Net sales from  external customers:                |       |                             |       |   |   |   |   |   |   |
| Americas                                           |       |                             | $          | 380,562 |   |   |   | $ | 371,667 |   |   |
| Europe                                             |       |                             | 32,005     |   |   |   | 24,068 |   |   |
|                                               |       |                             | 412,567    |   |   |   | 395,735 |   |   |
| Capital  expenditures:                             |       |                             |       |   |   |   |   |   |   |
| Americas                                           |       |                             | 11,770     |   |   |   | 3,584 |   |   |
| Europe                                             |       |                             | 1,143      |   |   |   | 1,993 |   |   |
|                                               |       |                             | 12,913     |   |   |   | 5,577 |   |   |
| EBITDA:                                            |       |                             |       |   |   |   |   |   |   |
| Americas                                           |       |                             | 62,040     |   |   |   | 62,534 |   |   |
| Europe                                             |       |                             | 717        |   |   |   | 1,458 |   |   |
| Inter-segment eliminations                         |       |                             | (485       | ) |   |   | (1,445 | ) |   |
|                                               |       |                             | 62,272     |   |   |   | 62,547 |   |   |
| Reconciliation of  EBITDA to net income:           |       |                             |       |   |   |   |   |   |   |
| EBITDA from segments                               |       |                             | 62,272     |   |   |   | 62,547 |   |   |
| Interest                                           |       |                             | 15,905     |   |   |   | 18,736 |   |   |
| Income taxes                                       |       |                             | 14,411     |   |   |   | 14,852 |   |   |
| Depreciation and amortization                      |       |                             | 7,322      |   |   |   | 5,700 |   |   |
| Cumulative effect of change in acconting principle |       |                             | —     |   |   |   | 287 |   |   |
| Net Income                                         |       |                             | $          | 24,634 |   |   |   | $ | 22,972 |   |   |

 

| ** **                | ** ** | **February 25,  2007** | ** ** | **November 26,  2006** | ** ** |
|---------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **(in thousands)**     | ** ** |
| Total assets:             |       |                        |       |                        |       |   |   |
| Americas                  |       | $                           | 913,210    |                        |       | $ | 894,628 |   |   |
| Europe                    |       | 108,475                     |       |                        | 109,345    |   |   |
| Intersegment eliminations |       | (756                        | )          |                        | (1,241     | ) |   |
|                      |       | 1,020,929                   |       |                        | 1,002,732  |   |   |
|                           |            |                             |            |                             |            |  |  |  |  |

 

**Note 19:    *Guarantor/Non-GuarantorFinancial Information***

Sealy Corporation, Sealy Mattress Corporation (a 100%owned subsidiary of Sealy Corporation) and each of the subsidiaries of SealyMattress Company (the “Issuer”) that guarantee the Notes (the “GuarantorSubsidiaries”) have fully and unconditionally guaranteed, on a joint andseveral basis, the obligation to pay principal and interest with respect to theNotes of the Issuer. Substantially all of the Issuer’s operating income andcash flow is generated by its subsidiaries. As a result, funds necessary tomeet the Issuer’s debt service obligations are provided in part bydistributions or advances from its subsidiaries. Under certain circumstances,contractual and legal restrictions, as well as the financial condition andoperating requirements of the Issuer’s subsidiaries, could limit the Issuer’sability to obtain cash from its subsidiaries for the purpose of meeting itsdebt service obligations, including the payment of principal and interest onthe Notes. Although holders of the Notes will be direct creditors of the Issuer’sprincipal direct subsidiaries by virtue of the guarantees, the Issuer hassubsidiaries (“Non-Guarantor Subsidiaries”) that are not included among theGuarantor Subsidiaries, and such subsidiaries will not be obligated withrespect to the Notes. As a result, the claims of creditors of the Non-GuarantorSubsidiaries will effectively have priority with respect to the assets andearnings of such companies over the claims of creditors of the Issuer,including the holders of the Notes.

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The Company has corrected certain errors in thepresentation of net investment in subsidiaries, due from (to) subsidiaries andaffiliates, stockholders’ deficit, income from equity investees, capital chargeand intercompany interest allocation, income taxes, and net income line itemsfor Sealy Mattress Corporation, the Combined Guarantor Subsidiaries and theCombined Non-Guarantor Subsidiaries from amounts previously reported. Thenature of the errors related principally to eliminations of intercompanytransactions within certain of the consolidating columns in the SupplementalCondensed Consolidating Balance Sheet as well as the Supplemental Condensed ConsolidatingStatements of Operations and Cash Flows. Specifically, an intercompany dividendfrom the Combined Non-Guarantor Subsidiaries to the Combined GuarantorSubsidiaries in fiscal 2005 was improperly eliminated, an amount allocated fromSealy Mattress Corporation to the Combined Guarantor Subsidiaries in fiscal2005 was not properly reflected on the Supplemental Condensed ConsolidatingBalance Sheet, and an allocation of capital charges from Sealy Mattress Companyto the Combined Guarantor Subsidiaries in fiscal 2006 was incorrect, all as theresult of clerical errors. These corrections are limited to intercompany,investment and subsidiary equity consolidating amounts within this Note 19, anddo not affect the Condensed Consolidated Financial Statements of the Company. TheCompany has also shown separately the net investment in subsidiaries and thedue from (to) affiliates into separate line items on the CondensedConsolidating Balance Sheets. The following schedules present the specific lineitem amounts that have changed as a result of the separation of theintercompany line items and corrections (in thousands):

 

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**Supplemental Condensed Consolidating Balance Sheets asof November 26, 2006**

| ** **                           | ** ** | ** **      | ** ** | ** **              | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Combined Non-** | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------------|------------|-----------------|------------|-------------------------|------------|--------------|------------|------------------|------------|------------------------|------------|------------------|------------|------------------|------------|
| ** **                           | ** ** | **Sealy**       | ** ** | **Sealy Mattress** | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**          | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                           | ** ** | **Corporation** | ** ** | **Corporation**         | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**       | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| As Originally Reported:              |       |            |       |                    |       |         |       |             |       |                   |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net investment in subsidiaries       |       |            | (229,646   | )                       |       |         | 194,817    |             |       |                   | 340,427    |             |       |             | 14,068     |   |   |   | — |   |   |   | (319,666 | ) |   |   | — |   |   |
| Due from (to) affiliates             |       |            | 77,632     |                    |       |         | (424,463   | )                |       |                   | 567,356    |             |       |             | (176,693   | ) |   |   | (43,982 | ) |   |   | 150 |   |   |   | — |   |   |
| Stockholders’  deficit          |       |            | (172,838   | )                       |       |         | (229,646   | )                |       |                   | 194,817    |             |       |             | 290,734    |   |   |   | 65,032 |   |   |   | (320,937 | ) |   |   | (172,838 | ) |   |
| As Corrected:                        |       |            |       |                    |       |         |       |             |       |                   |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net investment in subsidiaries       |       |            | (229,646   | )                       |       |         | 186,057    |             |       |                   | 329,602    |             |       |             | 14,068     |   |   |   | — |   |   |   | (300,081 | ) |   |   | — |   |   |
| Due from (to) affiliates             |       |            | 77,632     |                    |       |         | (415,703   | )                |       |                   | 569,421    |             |       |             | (137,551   | ) |   |   | (93,949 | ) |   |   | 150 |   |   |   | — |   |   |
| Stockholders’  (deficit) equity |       |            | (172,838   | )                       |       |         | (229,646   | )                |       |                   | 186,057    |             |       |             | 329,876    |   |   |   | 15,065 |   |   |   | (301,352 | ) |   |   | (172,838 | ) |   |

 

 

**SupplementalCondensed Consolidating Statements of Operations for the year endedNovember 26, 2006**

| ** **                                          | ** ** | **Sealy  Corporation** | ** ** | **Sealy Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|--------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------------|------------|------------------|------------|------------------|------------|
| As  Originally Reported:                            |       |                   |       |                                 |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss (income) from equity investees            |       |                   | (78,417    | )                                    |       |                         | (78,756    | )                                     |       |                                            | (80,805    | )                |       |             | —     |   |   |   | — |   |   |   | 237,978 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                                 |       |                         | —     |                                  |       |                                            | (47,028    | )                |       |             | 40,765     |   |   |   | 6,263 |   |   |   | — |   |   |   | — |   |   |
| Income tax expense (benefit)                        |       |                   | (2,364     | )                                    |       |                         | (194       | )                                     |       |                                            | (1,381     | )                |       |             | 29,428     |   |   |   | 12,236 |   |   |   | (149 | ) |   |   | 37,576 |   |   |
| Net income (loss)                                   |       |                   | 73,967     |                                 |       |                         | 78,417     |                                  |       |                                            | 78,756     |             |       |             | 81,026     |   |   |   | 21,922 |   |   |   | (260,121 | ) |   |   | 73,967 |   |   |
| As  Corrected:                                      |       |                   |       |                                 |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss (income) from equity investees            |       |                   | (78,417    | )                                    |       |                         | (78,756    | )                                     |       |                                            | (78,737    | )                |       |             | —     |   |   |   | — |   |   |   | 235,910 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                                 |       |                         | —     |                                  |       |                                            | (50,535    | )                |       |             | 44,272     |   |   |   | 6,263 |   |   |   | — |   |   |   | — |   |   |
| Income tax expense (benefit)                        |       |                   | (2,364     | )                                    |       |                         | (194       | )                                     |       |                                            | 58         |             |       |             | 27,989     |   |   |   | 12,236 |   |   |   | (149 | ) |   |   | 37,576 |   |   |
| Net income (loss)                                   |       |                   | 73,967     |                                 |       |                         | 78,417     |                                  |       |                                            | 78,756     |             |       |             | 78,958     |   |   |   | 21,922 |   |   |   | (258,053 | ) |   |   | 73,967 |   |   |

 

16

----

**SupplementalCondensed Consolidating Statements of Cash Flows for the year ended,November 26, 2006**

| ** **                                                                             | ** ** | **Sealy  Corporation** | ** ** | **Sealy Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------|------------|--------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------------|------------|------------------|------------|------------------|------------|
| As  Originally Reported:                                                               |       |                   |       |                                 |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by operating activities                                              |       |                   | —     |                                 |       |                         | —     |                                  |       |                                            | 4,816      |             |       |             | 33,054     |   |   |   | 20,355 |   |   |   | — |   |   |   | 58,225 |   |   |
| Net activity in investment in and advances to  (from) subsidiaries and affiliates |       |                   | (69,211    | )                                    |       |                         | —     |                                  |       |                                            | 79,265     |             |       |             | 5,224      |   |   |   | (15,278 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                                    |       |                   | (69,211    | )                                    |       |                         | —     |                                  |       |                                            | 78,804     |             |       |             | (17,746    | ) |   |   | (22,184 | ) |   |   | — |   |   |   | (30,337 | ) |   |
| As  Corrected:                                                                         |       |                   |       |                                 |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by operating activities                                              |       |                   | —     |                                 |       |                         | —     |                                  |       |                                            | 6,882      |             |       |             | 30,879     |   |   |   | 20,464 |   |   |   | — |   |   |   | 58,225 |   |   |
| Net activity in investment in and advances to  (from) subsidiaries and affiliates |       |                   | (69,211    | )                                    |       |                         | —     |                                  |       |                                            | 77,199     |             |       |             | 7,399      |   |   |   | (15,387 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) investing activities                                   |       |                   | (69,211    | )                                    |       |                         | —     |                                  |       |                                            | 76,738     |             |       |             | (15,571    | ) |   |   | (22,293 | ) |   |   | — |   |   |   | (30,337 | ) |   |

 

The following supplementalcondensed consolidating financial statements present:

1.                Condensedconsolidating balance sheets as of February 25, 2007 and November 26,2006 and condensed consolidating statements of operations and cash flows forthe three months ended February 25, 2007 and February 26, 2006.

2.                Sealy Corporation,who became a guarantor of the Notes effective May 25, 2006, (as “GuarantorParent”), Sealy Mattress Corporation (a guarantor), the Issuer, combinedGuarantor Subsidiaries and combined Non-Guarantor Subsidiaries with theirinvestments in subsidiaries accounted for using the equity method (see Note 1).

3.                Eliminationentries necessary to consolidate the Guarantor Parent and all of its subsidiaries.

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

17

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**SEALY CORPORATION**

**Supplemental CondensedConsolidating Balance Sheets**

**February 25,2007(in thousands)**

| ** **                                                             | ** ** | ** **      | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |   |
|------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|--------|
| ** **                                                             | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |   |
| ** **                                                             | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |   |
| ** **                                                             | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |   |
| **Assets**                                                             | ** ** |            | ** ** | ** **      |       |         | ** ** | ** **       |       | ** **       |       |             | ** ** | ** **       |       |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   |
| Current assets:                                                        |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |       |            | $          | 460             |       |         |       | $                | —     |             |       | $                | 1          |             |       | $      | 22,903 |   |   |   | $ | 8,386 |   |   |   | $ | — |   |   |   | $ | 31,750 |   |   |   |
| Accounts receivable, net                                               |       |            | 30         |            |       |         | —     |             |       | 600              |       |             | 139,694    |             |       |   | 77,380 |   |   |   | — |   |   |   | 217,704 |   |   |   |
| Inventories                                                            |       |            | —     |            |       |         | —     |             |       | 1,195            |       |             | 43,816     |             |       |   | 21,244 |   |   |   | (921 | ) |   |   | 65,334 |   |   |   |
| Assets held for sale                                                   |       |            | —     |            |       |         | —     |             |       | —           |       |             | 2,338      |             |       |   | — |   |   |   | — |   |   |   | 2,338 |   |   |   |
| Prepaid expenses, deferred income taxes and  other current assets |       |            | 1,018      |            |       |         | —     |             |       | 1,654            |       |             | 30,291     |             |       |   | 2,804 |   |   |   | — |   |   |   | 35,767 |   |   |   |
|                                                                   |       |            | 1,508      |            |       |         | —     |             |       | 3,450            |       |             | 239,042    |             |       |   | 109,814 |   |   |   | (921 | ) |   |   | 352,893 |   |   |   |
| Property, plant and equipment, at cost                                 |       |            | —     |            |       |         | —     |             |       | 7,860            |       |             | 320,793    |             |       |   | 83,032 |   |   |   | — |   |   |   | 411,685 |   |   |   |
| Less accumulated depreciation                                          |       |            | —     |            |       |         | —     |             |       | (3,745           | )          |             | (149,568   | )                |       |   | (29,621 | ) |   |   | — |   |   |   | (182,934 | ) |   |   |
|                                                                   |       |            | —     |            |       |         | —     |             |       | 4,115            |       |             | 171,225    |             |       |   | 53,411 |   |   |   | — |   |   |   | 228,751 |   |   |   |
| Other assets:                                                          |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                               |       |            | —     |            |       |         | —     |             |       | 24,741           |       |             | 304,773    |             |       |   | 58,171 |   |   |   | — |   |   |   | 387,685 |   |   |   |
| Other intangibles, net                                                 |       |            | 8,104      |            |       |         | —     |             |       | —           |       |             | 4,174      |             |       |   | 6 |   |   |   | — |   |   |   | 12,284 |   |   |   |
| Net investment in subsidiaries                                         |       |            | (206,095   | )               |       |         | 209,697    |             |       | 350,184          |       |             | 18,989     |             |       |   | — |   |   |   | (372,775 | ) |   |   | — |   |   |   |
| Due from (to) affiliates                                               |       |            | 71,065     |            |       |         | (415,792   | )                |       | 572,647          |       |             | (137,459   | )                |       |   | (90,605 | ) |   |   | 144 |   |   |   | — |   |   |   |
| Debt issuance costs, net and other assets                         |       |            | —     |            |       |         | —     |             |       | 14,573           |       |             | 22,367     |             |       |   | 2,376 |   |   |   | — |   |   |   | 39,316 |   |   |   |
|                                                                   |       |            | (126,926   | )               |       |         | (206,095   | )                |       | 962,145          |       |             | 212,844    |             |       |   | (30,052 | ) |   |   | (372,631 | ) |   |   | 439,285 |   |   |   |
| Total assets                                                           |       |            | $          | (125,418        | )          |         |       | $                | (206,095   | )                |       | $                | 969,710    |             |       | $      | 623,111 |   |   |   | $ | 133,173 |   |   |   | $ | (373,552 | ) |   |   | $ | 1,020,929 |   |   |
|                                                                        |            |                 |            |                 |            |              |            |                  |            |                  |            |                  |            |                  |            |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

| **Liabilities  and Stockholders’ Equity (Deficit)**   | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |     | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |     |   |
|------------------------------------------------------------|------------|--------|------------|------------|--------|--------|------------|------------|----------|------------|--------|--------|------------|------------|--------|--------|------------|------------|--------|--------|------------|------------|--------|--------|------------|------------|----------|--------|
| Current liabilities:                                       |       |   |       |       |   |   |       |       |     |       |   |   |       |       |   |   |       |       |   |   |       |       |   |   |       |       |     |   |
| Current portion - long-term obligations               |       |   | $          | —     |   |   |       | $          | —   |       |   | $      | 7,500      |       |   | $      | 2,058      |       |   |   | $          | 13,438     |   |   |       | $          | —   |   |   |   | $ | 22,996 |   |   |
| Accounts payable                                           |       |   | —     |       |   |   | —     |       |     | 248        |   |   | 82,391     |       |   |   | 46,362     |       |   |   | —     |       |   |   | 129,001    |       |     |
| Accrued customer incentives and advertising                |       |   | —     |       |   |   | —     |       |     | —     |   |   | 32,206     |       |   |   | 4,767      |       |   |   | —     |       |   |   | 36,973     |       |     |
| Accrued compensation                                       |       |   | —     |       |   |   | —     |       |     | 401        |   |   | 28,978     |       |   |   | 8,513      |       |   |   | —     |       |   |   | 37,892     |       |     |
| Accrued interest                                           |       |   | 63         |       |   |   | —     |       |     | 667        |   |   | 10,178     |       |   |   | 312        |       |   |   | —     |       |   |   | 11,220     |       |     |
| Other accrued expenses                                     |       |   | 3,016      |       |   |   | —     |       |     | 572        |   |   | 45,476     |       |   |   | 5,080      |       |   |   | —     |       |   |   | 54,144     |       |     |
|                                                       |       |   | 3,079      |       |   |   | —     |       |     | 9,388      |   |   | 201,287    |       |   |   | 78,472     |       |   |   | —     |       |   |   | 292,226    |       |     |
| Long-term obligations                                      |       |   | —     |       |   |   | —     |       |     | 749,500    |   |   | 42,095     |       |   |   | 20,161     |       |   |   | —     |       |   |   | 811,756    |       |     |
| Other noncurrent liabilities                               |       |   | 7,608      |       |   |   | —     |       |     | —     |   |   | 25,529     |       |   |   | 9,245      |       |   |   | —     |       |   |   | 42,382     |       |     |
| Deferred income taxes                                      |       |   | 167        |       |   |   | —     |       |     | 1,125      |   |   | 3,829      |       |   |   | 5,716      |       |   |   | —     |       |   |   | 10,837     |       |     |
| Common stock and options subject to redemption             |       |   | 17,517     |       |   |   | —     |       |     | —     |   |   | —     |       |   |   | —     |       |   |   | —     |       |   |   | 17,517     |       |     |
| Stockholders’ equity (deficit)                        |       |   | (153,789   | )          |   |   | (206,095   | )          |     | 209,697    |   |   | 350,371    |       |   |   | 19,579     |       |   |   | (373,552   | )          |   |   | (153,789   | )          |     |
| Total liabilities  and stockholders’ equity (deficit) |       |   | $          | (125,418   | )      |   |       | $          | (206,095 | )          |   | $      | 969,710    |       |   | $      | 623,111    |       |   |   | $          | 133,173    |   |   |       | $          | (373,552 | )      |   |   | $ | 1,020,929 |   |   |
|                                                            |            |        |            |            |        |        |            |            |          |            |        |        |            |            |        |        |            |            |        |        |            |            |        |        |            |            |          |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

18

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**SEALY CORPORATION**

**SupplementalCondensed Consolidating Balance SheetsNovember 26, 2006 (as corrected)(in thousands)**

| ** **      | ** ** | ** **      | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |       |
|-----------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------|
| ** **      | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |       |
| ** **      | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |       |
| ** **      | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |       |
| **Assets**      | ** ** |            | ** ** | ** **      |       |         | ** ** | ** **       |       |             | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Current assets: |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |       |   |   |   |   |   |   |   |   |   |   |   |   |   |

| Cash and cash equivalents                                              |       |   | $          | 934        |   |   |       | $          | —   |   |       |       | $      | 1       |       |       |   | $      | 36,182     |       |   |   | $          | 8,503      |   |   |       | $          | —   |   |   |   | $ | 45,620    |   |   |
|------------------------------------------------------------------------|------------|--------|------------|------------|--------|--------|------------|------------|----------|--------|------------|------------|--------|---------|------------|------------|--------|--------|------------|------------|--------|--------|------------|------------|--------|--------|------------|------------|----------|--------|--------|--------|---|-----------|--------|--------|
| Accounts receivable, net                                               |       |   | 7          |       |   |   | —     |       |     |   | 620        |       |   |    | 105,812    |       |   |   | 87,399     |       |   |   | —     |       |   |   | 193,838    |       |     |
| Inventories                                                            |       |   | —     |       |   |   | —     |       |     |   | 1,218      |       |   |    | 45,977     |       |   |   | 20,352     |       |   |   | (1,421     | )          |   |   | 66,126     |       |     |
| Assets held for sale                                                   |       |   | —     |       |   |   | —     |       |     |   | —     |       |   |    | 2,338      |       |   |   | —     |       |   |   | —     |       |   |   | 2,338      |       |     |
| Prepaid expenses, deferred income taxes and  other current assets |       |   | 1,001      |       |   |   | —     |       |     |   | 1,913      |       |   |    | 31,628     |       |   |   | 2,795      |       |   |   | —     |       |   |   | 37,337     |       |     |
|                                                                   |       |   | 1,942      |       |   |   | —     |       |     |   | 3,752      |       |   |    | 221,937    |       |   |   | 119,049    |       |   |   | (1,421     | )          |   |   | 345,259    |       |     |
| Property, plant and equipment, at cost                            |       |   | —     |       |   |   | —     |       |     |   | 7,995      |       |   |    | 306,934    |       |   |   | 82,238     |       |   |   | —     |       |   |   | 397,167    |       |     |
| Less accumulated depreciation                                          |       |   | —     |       |   |   | —     |       |     |   | (4,436     | )          |   |    | (146,452   | )          |   |   | (28,069    | )          |   |   | —     |       |   |   | (178,957   | )          |     |
|                                                                   |       |   | —     |       |   |   | —     |       |     |   | 3,559      |       |   |    | 160,482    |       |   |   | 54,169     |       |   |   | —     |       |   |   | 218,210    |       |     |
| Other assets:                                                          |       |   |       |       |   |   |       |       |     |   |       |       |   |    |       |       |   |   |       |       |   |   |       |       |   |   |       |       |     |
| Goodwill                                                               |       |   | —     |       |   |   | —     |       |     |   | 24,741     |       |   |    | 304,773    |       |   |   | 58,690     |       |   |   | —     |       |   |   | 388,204    |       |     |
| Other intangibles, net                                                 |       |   | 8,773      |       |   |   | —     |       |     |   | —     |       |   |    | 4,246      |       |   |   | 7          |       |   |   | —     |       |   |   | 13,026     |       |     |
| Net investment in subsidiaries                                         |       |   | (229,646   | )          |   |   | 186,057    |       |     |   | 329,602    |       |   |    | 14,068     |       |   |   | —     |       |   |   | (300,081   | )          |   |   | —     |       |     |
| Due from (to) affiliates                                               |       |   | 77,632     |       |   |   | (415,703   | )          |     |   | 569,421    |       |   |    | (137,551   | )          |   |   | (93,949    | )          |   |   | 150        |       |   |   | —     |       |     |
| Debt issuance costs, net and other assets                         |       |   | —     |       |   |   | —     |       |     |   | 15,230     |       |   |    | 20,566     |       |   |   | 2,237      |       |   |   | —     |       |   |   | 38,033     |       |     |
|                                                                   |       |   | (143,241   | )          |   |   | (229,646   | )          |     |   | 938,994    |       |   |    | 206,102    |       |   |   | (33,015    | )          |   |   | (299,931   | )          |   |   | 439,263    |       |     |
| Total assets                                                           |       |   | $          | (141,299   | )      |   |       | $          | (229,646 | )      |       |       | $      | 946,305 |       |       |   | $      | 588,521    |       |   |   | $          | 140,203    |   |   |       | $          | (301,352 | )      |   |   | $ | 1,002,732 |   |   |
| **Liabilities  and Stockholders’ Equity (Deficit)**               | ** ** |   | ** ** | ** ** |   |   | ** ** | ** ** |     |   | ** ** | ** ** |   |    | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |     |
| Current liabilities:                                                   |       |   |       |       |   |   |       |       |     |   |       |       |   |    |       |       |   |   |       |       |   |   |       |       |   |   |       |       |     |
| Current portion—long-term obligations                             |       |   | $          | —     |   |   |       | $          | —   |   |       |       | $      | 3,750   |       |       |   | $      | 2,256      |       |   |   | $          | 12,276     |   |   |       | $          | —   |   |   |   | $ | 18,282    |   |   |
| Accounts payable                                                       |       |   | —     |       |   |   | —     |       |     |   | 326        |       |   |    | 72,106     |       |   |   | 46,453     |       |   |   | —     |       |   |   | 118,885    |       |     |
| Accrued customer incentives and advertising                            |       |   | —     |       |   |   | —     |       |     |   | —     |       |   |    | 31,735     |       |   |   | 8,843      |       |   |   | —     |       |   |   | 40,578     |       |     |
| Accrued compensation                                                   |       |   | —     |       |   |   | —     |       |     |   | 513        |       |   |    | 25,167     |       |   |   | 9,804      |       |   |   | —     |       |   |   | 35,484     |       |     |
| Accrued interest                                                       |       |   | 66         |       |   |   | —     |       |     |   | 922        |       |   |    | 16,099     |       |   |   | 199        |       |   |   | —     |       |   |   | 17,286     |       |     |
| Other accrued expenses                                                 |       |   | 2,730      |       |   |   | —     |       |     |   | 362        |       |   |    | 45,673     |       |   |   | 8,904      |       |   |   | —     |       |   |   | 57,669     |       |     |
|                                                                   |       |   | 2,796      |       |   |   | —     |       |     |   | 5,873      |       |   |    | 193,036    |       |   |   | 86,479     |       |   |   | —     |       |   |   | 288,184    |       |     |
| Long-term obligations                                                  |       |   | —     |       |   |   | —     |       |     |   | 753,250    |       |   |    | 37,449     |       |   |   | 23,537     |       |   |   | —     |       |   |   | 814,236    |       |     |
| Other noncurrent liabilities                                           |       |   | 8,313      |       |   |   | —     |       |     |   | —     |       |   |    | 24,964     |       |   |   | 9,411      |       |   |   | —     |       |   |   | 42,688     |       |     |
| Deferred income taxes                                                  |       |   | 167        |       |   |   | —     |       |     |   | 1,125      |       |   |    | 3,196      |       |   |   | 5,711      |       |   |   | —     |       |   |   | 10,199     |       |     |
| Common stock and options subject to redemption                    |       |   | 20,263     |       |   |   | —     |       |     |   | —     |       |   |    | —     |       |   |   | —     |       |   |   | —     |       |   |   | 20,263     |       |     |
| Stockholders’ equity (deficit)                                    |       |   | (172,838   | )          |   |   | (229,646   | )          |     |   | 186,057    |       |   |    | 329,876    |       |   |   | 15,065     |       |   |   | (301,352   | )          |   |   | (172,838   | )          |     |
| Total liabilities  and stockholders’ equity (deficit)             |       |   | $          | (141,299   | )      |   |       | $          | (229,646 | )      |       |       | $      | 946,305 |       |       |   | $      | 588,521    |       |   |   | $          | 140,203    |   |   |       | $          | (301,352 | )      |   |   | $ | 1,002,732 |   |   |

 

19

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**SEALY CORPORATION**

**SupplementalCondensed Consolidating Statements of OperationsThree Months Ended February 25, 2007(in thousands)**

| ** **                                          | ** ** | **Sealy  Corporation** | ** ** | **Sealy Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|--------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                           |       |                   | $          | —                               |       |                         |       | $                                     | —     |                                      |       |             | $          | 19,470           |       |   |   | $ | 306,519 |   |   |   | $ | 95,699 |   |   |   | $ | (9,121 | ) |   |   | $ | 412,567 |   |   |
| Cost and expenses:                                  |       |                   |       |                                 |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | 11,473     |             |       |             | 172,901    |   |   |   | 60,539 |   |   |   | (9,620 | ) |   |   | 235,293 |   |   |
| Selling, general and administrative                 |       |                   | 64         |                                 |       |                         | —     |                                  |       |                                      | 1,917      |             |       |             | 100,851    |   |   |   | 24,081 |   |   |   | — |   |   |   | 126,913 |   |   |
| Amortization of intangibles                         |       |                   | 710        |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | 73         |   |   |   | — |   |   |   | — |   |   |   | 783 |   |   |
| Royalty (income) expense, net                       |       |                   | (1,124     | )                                    |       |                         | —     |                                  |       |                                      | —     |             |       |             | (4,909     | ) |   |   | 741 |   |   |   | — |   |   |   | (5,292 | ) |   |
| Income from operations                              |       |                   | 350        |                                 |       |                         | —     |                                  |       |                                      | 6,080      |             |       |             | 37,603     |   |   |   | 10,338 |   |   |   | 499 |   |   |   | 54,870 |   |   |
| Interest expense                                    |       |                   | 95         |                                 |       |                         | 143        |                                  |       |                                      | 14,495     |             |       |             | 149        |   |   |   | 1,023 |   |   |   | — |   |   |   | 15,905 |   |   |
| Other income, net                                   |       |                   | (8         | )                                    |       |                         | —     |                                  |       |                                      | —     |             |       |             | (1         | ) |   |   | (71 | ) |   |   | — |   |   |   | (80 | ) |   |
| Loss (income) from equity investees                 |       |                   | (24,470    | )                                    |       |                         | (24,559    | )                                     |       |                                      | (21,332    | )                |       |             | —     |   |   |   | — |   |   |   | 70,361 |   |   |   | — |   |   |
| Loss (income) from non-guarantor equity investees   |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | (5,696     | ) |   |   | — |   |   |   | 5,696 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | (13,579    | )                |       |             | 12,447     |   |   |   | 1,132 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes                   |       |                   | 24,733     |                                 |       |                         | 24,416     |                                  |       |                                      | 26,496     |             |       |             | 30,704     |   |   |   | 8,254 |   |   |   | (75,558 | ) |   |   | 39,045 |   |   |
| Income tax expense  (benefit)                       |       |                   | 99         |                                 |       |                         | (54        | )                                     |       |                                      | 1,937      |             |       |             | 9,381      |   |   |   | 3,043 |   |   |   | 5 |   |   |   | 14,411 |   |   |
| Net income (loss)                                   |       |                   | $          | 24,634                               |       |                         |       | $                                     | 24,470     |                                      |       |             | $          | 24,559           |       |   |   | $ | 21,323 |   |   |   | $ | 5,211 |   |   |   | $ | (75,563 | ) |   |   | $ | 24,634 |   |   |

 

20

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**SEALY CORPORATION**

**SupplementalCondensed Consolidating Statements of OperationsThree Months Ended February 26, 2006(in thousands)**

| ** **                                               | ** ** | **Sealy  Corporation** | ** ** | **Sealy Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|--------------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                                |       |                   | $          | —                               |       |                         |       | $                                     | —     |                                      |       |             | $          | 15,707           |       |   |   | $ | 304,657 |   |   |   | $ | 78,446 |   |   |   | $ | (3,075 | ) |   |   | $ | 395,735 |   |   |
| Costs and expenses:                                      |       |                   |       |                                 |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                       |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | 9,410      |             |       |             | 164,922    |   |   |   | 47,781 |   |   |   | (3,075 | ) |   |   | 219,038 |   |   |
| Selling, general and administrative                      |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | 1,550      |             |       |             | 100,557    |   |   |   | 21,497 |   |   |   | — |   |   |   | 123,604 |   |   |
| Amortization of intangibles                              |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | 72         |   |   |   | 50 |   |   |   | — |   |   |   | 122 |   |   |
| Royalty (income) expense, net                            |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | (4,216     | ) |   |   | 527 |   |   |   | — |   |   |   | (3,689 | ) |   |
| Income from operations                                   |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | 4,747      |             |       |             | 43,322     |   |   |   | 8,591 |   |   |   | — |   |   |   | 56,660 |   |   |
| Interest expense                                         |       |                   | 2,120      |                                 |       |                         | 120        |                                  |       |                                      | 16,076     |             |       |             | (82        | ) |   |   | 502 |   |   |   | — |   |   |   | 18,736 |   |   |
| Other income, net                                        |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | (19        | ) |   |   | (168 | ) |   |   | — |   |   |   | (187 | ) |   |
| Loss (income) from equity investees                      |       |                   | (24,298    | )                                    |       |                         | (24,371    | )                                     |       |                                      | (21,987    | )                |       |             | —     |   |   |   | — |   |   |   | 70,656 |   |   |   | — |   |   |
| Loss (income) from nonguarantor equity investees         |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | (4,263     | ) |   |   | — |   |   |   | 4,263 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation      |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | (15,232    | )                |       |             | 14,217     |   |   |   | 1,015 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes and cumulative  effect |       |                   | 22,178     |                                 |       |                         | 24,251     |                                  |       |                                      | 25,890     |             |       |             | 33,469     |   |   |   | 7,242 |   |   |   | (74,919 | ) |   |   | 38,111 |   |   |
| Income tax expense (benefit)                             |       |                   | (794       | )                                    |       |                         | (47        | )                                     |       |                                      | 1,519      |             |       |             | 11,195     |   |   |   | 2,979 |   |   |   | — |   |   |   | 14,852 |   |   |
| Income (loss)  before cumulative effect                  |       |                   | 22,972     |                                 |       |                         | 24,298     |                                  |       |                                      | 24,371     |             |       |             | 22,274     |   |   |   | 4,263 |   |   |   | (74,919 | ) |   |   | 23,259 |   |   |
| Cumulative effect  of change in accounting principle     |       |                   | —     |                                 |       |                         | —     |                                  |       |                                      | —     |             |       |             | 287        |   |   |   | — |   |   |   | — |   |   |   | 287 |   |   |
| Net income (loss)                                        |       |                   | $          | 22,972                               |       |                         |       | $                                     | 24,298     |                                      |       |             | $          | 24,371           |       |   |   | $ | 21,987 |   |   |   | $ | 4,263 |   |   |   | $ | (74,919 | ) |   |   | $ | 22,972 |   |   |

 

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**SEALY CORPORATION**

**Supplemental CondensedConsolidating Statements of Cash FlowsThree Months Ended February 25, 2007(in thousands)**

| ** **                                                                        | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Combined**      | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                        | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                        | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net cash provided by (used in) operating activities                               |       |            | $          | —          |       |         |       | $                | —     |              |       |             | $          | 3,866            |       |   |   | $ | (6,957 | ) |   |   | $ | 7,344 |   |   |   | $ | — |   |   |   | $ | 4,253 |   |   |
| Cash flows from  investing activities:                                            |       |            |       |            |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment                                         |       |            | —     |            |       |         | —     |             |       |              | (690       | )                |       |             | (10,945    | ) |   |   | (1,278 | ) |   |   | — |   |   |   | (12,913 | ) |   |
| Proceeds from the sale of property, plant, and  equipment                         |       |            | —     |            |       |         | —     |             |       |              | —     |             |       |             | 61         |   |   |   | 16 |   |   |   | — |   |   |   | 77 |   |   |
| Net activity in investment in and advances from (to)  subsidiaries and affiliates |       |            | 1,740      |            |       |         | —     |             |       |              | (3,176     | )                |       |             | 5,489      |   |   |   | (4,053 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                               |       |            | 1,740      |            |       |         | —     |             |       |              | (3,866     | )                |       |             | (5,395     | ) |   |   | (5,315 | ) |   |   | — |   |   |   | (12,836 | ) |   |
| Cash flows from financing                                                         |       |            |       |            |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Dividend                                                                          |       |            | (6,856     | )               |       |         | —     |             |       |              | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (6,856 | ) |   |
| Equity received upon exercise of stock including  related excess tax benefits     |       |            | 4,592      |            |       |         | —     |             |       |              | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | 4,592 |   |   |
| Borrowings under revolving credit facilities                                      |       |            | —     |            |       |         | —     |             |       |              | —     |             |       |             | —     |   |   |   | 8,627 |   |   |   | — |   |   |   | 8,627 |   |   |
| Repayments on revolving credit facilities                                         |       |            | —     |            |       |         | —     |             |       |              | —     |             |       |             | —     |   |   |   | (11,249 | ) |   |   | — |   |   |   | (11,249 | ) |   |
| Other                                                                             |       |            | 50         |            |       |         | —     |             |       |              | —     |             |       |             | (927       | ) |   |   | 533 |   |   |   | — |   |   |   | (344 | ) |   |
| Net cash used in financing activities                                             |       |            | (2,214     | )               |       |         | —     |             |       |              | —     |             |       |             | (927       | ) |   |   | (2,089 | ) |   |   | — |   |   |   | (5,230 | ) |   |
| Effect of exchange rate changes on cash                                           |       |            | —     |            |       |         | —     |             |       |              | —     |             |       |             | —     |   |   |   | (57 | ) |   |   | — |   |   |   | (57 | ) |   |
| Change in cash and cash equivalents                                               |       |            | (474       | )               |       |         | —     |             |       |              | —     |             |       |             | (13,279    | ) |   |   | (117 | ) |   |   | — |   |   |   | (13,870 | ) |   |
| Cash and cash  equivalents:                                                       |       |            |       |            |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                                               |       |            | 934        |            |       |         | —     |             |       |              | 1          |             |       |             | 36,182     |   |   |   | 8,503 |   |   |   | — |   |   |   | 45,620 |   |   |
| End of period                                                                     |       |            | $          | 460             |       |         |       | $                | —     |              |       |             | $          | 1                |       |   |   | $ | 22,903 |   |   |   | $ | 8,386 |   |   |   | $ | — |   |   |   | $ | 31,750 |   |   |

 

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**SEALY CORPORATION**

**SupplementalCondensed Consolidating Statements of Cash FlowsThree Months Ended February 26, 2006(in thousands)**

| ** **                                                                             | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non- Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided by (used in) operating activities                                    |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                            |       |             | $          | 1,949            |       |   |   | $ | (17,316 | ) |   |   | $ | 676 |   |   |   | $ | 635 |   |   |   | $ | (14,056 | ) |   |
| Cash flows from investing activities:                                                  |       |                   |       |                             |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment                                              |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | (31        | )                |       |             | (3,326     | ) |   |   | (2,220 | ) |   |   | — |   |   |   | (5,577 | ) |   |
| Proceeds from the sale of property, plant, and  equipment                         |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | —     |             |       |             | 16         |   |   |   | 13 |   |   |   | — |   |   |   | 29 |   |   |
| Net activity in investment in and advances to (from)  subsidiaries and affiliates |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | (6,918     | )                |       |             | (668       | ) |   |   | 7,586 |   |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                                    |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | (6,949     | )                |       |             | (3,978     | ) |   |   | 5,379 |   |   |   | — |   |   |   | (5,548 | ) |   |
| Cash flows from financing activities:                                                  |       |                   |       |                             |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Borrowings under revolving credit facilities                                      |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | 52,100     |             |       |             | —     |   |   |   | 26,741 |   |   |   | — |   |   |   | 78,841 |   |   |
| Repayments under revolving credit facilities                                      |       |                   |       |                             |       |                         |       |                                  |       |                                            | (47,100    | )                |       |             |       |   |   |   | (35,036 | ) |   |   |   |   |   |   | (82,136 | ) |   |
| Other                                                                                  |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | —     |             |       |             | 1,392      |   |   |   | (774 | ) |   |   | (635 | ) |   |   | (17 | ) |   |
| Net cash provided by (used in) financing activities                                    |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | 5,000      |             |       |             | 1,392      |   |   |   | (9,069 | ) |   |   | (635 | ) |   |   | (3,312 | ) |   |
| Effect of exchange rate changes on cash                                                |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | —     |             |       |             | —     |   |   |   | 122 |   |   |   | — |   |   |   | 122 |   |   |
| Change in cash and cash equivalents                                                    |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | —     |             |       |             | (19,902    | ) |   |   | (2,892 | ) |   |   | — |   |   |   | (22,794 | ) |   |
| Cash and cash equivalents:                                                             |       |                   |       |                             |       |                         |       |                                  |       |                                            |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                                                    |       |                   | —     |                             |       |                         | —     |                                  |       |                                            | 1          |             |       |             | 25,387     |   |   |   | 11,166 |   |   |   | — |   |   |   | 36,554 |   |   |
| End of period                                                                          |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                            |       |             | $          | 1                |       |   |   | $ | 5,485 |   |   |   | $ | 8,274 |   |   |   | $ | — |   |   |   | $ | 13,760 |   |   |

 

23

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**SEALY CORPORATION**

**Item 2.   *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations***

*The following management’s discussion and analysis isprovided as a supplement to, and should be read in conjunction with, ourCondensed Consolidated Financial Statements and accompanying notes included inthis Quarterly Report on Form 10-Q as well as our management’sdiscussion and analysis included in our Annual Report on Form 10-K(File No. 001-08738). Except where the context suggests otherwise,the terms “we,” “us” and “our” refer to Sealy Corporation and its subsidiaries.*

***BUSINESS OVERVIEW***

Our conventional bedding products include the *Sealy, Sealy Posturepedic, Stearns & Foster,*and*Bassett* brands and accounted forapproximately 92% of our total net sales for the year ended November 26,2006. In addition to our innerspring bedding, we also produce a variety ofvisco-elastic (memory foam) and latex foam bedding products.

In the first quarter of fiscal 2007, we introduced anew line of *Stearns & Foster* brandedmattresses and boxsprings that incorporates the features we determined were themost desired by the consumer during our intensive market and consumer research.We expect that this launch will be completed in the third quarter of fiscal2007. In addition, we introduced new *Sealy-*brandedproducts that are compliant with the new Federal flame retardant standardswhich become effective July 1, 2007. As with earlier major productlaunches, we expect our sales and profitability growth to be limited during theperiod in which our customers complete the transition to the new product lines.

Our industry continues tobe challenged by the volatility in the price of petroleum and steel products,which affects the cost of our polyurethane foam, polyethylene foam and steelinnerspring component parts. During fiscal 2006 and into the first quarter offiscal 2007, the cost of these components has continued to remain elevatedabove their recent historical averages, and we expect these costs to continue atcurrent levels over the remainder of fiscal 2007.

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***RESULTS OF OPERATIONS***

***Tabular Information***

Thefollowing table sets forth our summarized results of operations for the threemonths ended February 25, 2007 and February 26, 2006, expressed inthousands of dollars as well as a percentage of each period’s net sales:

| ** **                                                         | ** ** | **For the three months ended:** | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                         | ** ** | **February 25, 2007**                     | ** ** | **February 26, 2006** | ** ** |
| ** **                                                         | ** ** | **(in thousands)**                             | ** ** | **(percentage  of net sales)** | ** ** | **(in thousands)** | ** ** | **(percentage  of net sales)** | ** ** |
| Total net sales                                                    |       |                                                | $          | 412,567 |   |   |   | 100.0 | % |   |   | $ | 395,735 |   |   |   | 100.0 | % |   |
| Total cost of  goods sold                                          |       |                                                | 235,293    |   |   |   | 57.0 |   |   |   | 219,038 |   |   |   | 55.3 |   |   |
| Gross profit                                                       |       |                                                | 177,274    |   |   |   | 43.0 |   |   |   | 176,697 |   |   |   | 44.7 |   |   |
| Selling, general  and administrative expenses                      |       |                                                | 126,913    |   |   |   | 30.8 |   |   |   | 123,604 |   |   |   | 31.2 |   |   |
| Amortization of  intangibles                                       |       |                                                | 783        |   |   |   | 0.2 |   |   |   | 122 |   |   |   | — |   |   |
| Royalty income,  net of royalty expense                            |       |                                                | (5,292     | ) |   |   | (1.3 | ) |   |   | (3,689 | ) |   |   | (0.9 | ) |   |
| Income from operations                                             |       |                                                | 54,870     |   |   |   | 13.3 |   |   |   | 56,660 |   |   |   | 14.3 |   |   |
| Interest expense                                                   |       |                                                | 15,905     |   |   |   | 3.8 |   |   |   | 18,736 |   |   |   | 4.7 |   |   |
| Other income, net                                                  |       |                                                | (80        | ) |   |   | — |   |   |   | (187 | ) |   |   | — |   |   |
| Income before  income taxes and cumulative effect                  |       |                                                | 39,045     |   |   |   | 9.5 |   |   |   | 38,111 |   |   |   | 9.6 |   |   |
| Income taxes                                                       |       |                                                | 14,411     |   |   |   | 3.5 |   |   |   | 14,852 |   |   |   | 3.8 |   |   |
| Income before cumulative effect of change in  accounting principle |       |                                                | 24,634     |   |   |   | 6.0 |   |   |   | 23,259 |   |   |   | 5.9 |   |   |
| Cumulative effect  of change in accounting principle               |       |                                                | —     |   |   |   | — |   |   |   | 287 |   |   |   | 0.1 |   |   |
| Net income                                                         |       |                                                | $          | 24,634 |   |   |   | 6.0 | % |   |   | $ | 22,972 |   |   |   | 5.8 | % |   |
| Effective tax rate                                                 |       |                                                | 36.9       | % |   |   |   |   |   |   | 39.0 | % |   |   |   |   |   |

 

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

| ** **         | ** ** | **Three Months Ended:** | ** ** |
|--------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | **February 25,**             | ** ** | **February 26,** | ** ** |
| ** **         | ** ** | **2007**                          | ** ** | **2006** | ** ** |
| **US  Domestic**   |       |                              | 76.8       | % |   |   | 79.5 | % |   |
| **International:** | ** ** | ** **                        | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Canada             |       |                              | 9.8        |   |   |   | 9.2 |   |   |
| Europe             |       |                              | 7.8        |   |   |   | 6.1 |   |   |
| Other              |       |                              | 5.6        |   |   |   | 5.2 |   |   |
| **Total**          | ** ** | ** **                        | **100.0**  | **%** | ** ** | ** ** | **100.0** | **%** | ** ** |

 

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

| ** **                            | ** ** | **For the Three Months Ended** | ** ** |
|---------------------------------------|------------|----------------------------------------------------|------------|
| ** **                            | ** ** | **February 25,**                              | ** ** | **February 26,** | ** ** |
| ** **                            | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                            | ** ** | **(in thousands)**                            | ** ** | **(percentage  of net sales)** | ** ** | **(in thousands)** | ** ** | **(percentage  of net sales)** | ** ** |
| **Total Domestic (US Dollars):**      | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | $          | 316,707 | ** ** |   |   | 100.0 | % |   |   | $ | 314,554 | ** ** |   |   | 100.0 | % |   |
| Total cost of goods sold              |       |                                               | 176,016    | ** ** |   |   | 55.6 |   |   |   | 169,408 | ** ** |   |   | 53.9 |   |   |
| Gross profit                          |       |                                               | 140,691    | ** ** |   |   | 44.4 |   |   |   | 145,146 | ** ** |   |   | 46.1 |   |   |
| **Total International (US Dollars):** | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | 95,860     | ** ** |   |   | 100.0 |   |   |   | 81,181 | ** ** |   |   | 100.0 |   |   |
| Total cost of goods sold              |       |                                               | 59,277     | ** ** |   |   | 61.8 |   |   |   | 49,630 | ** ** |   |   | 61.1 |   |   |
| Gross profit                          |       |                                               | 36,583     | ** ** |   |   | 38.2 |   |   |   | 31,551 | ** ** |   |   | 38.9 |   |   |
| **Canada:**                           | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US  Dollars:**                      | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | 40,446     | ** ** |   |   | 100.0 |   |   |   | 36,296 | ** ** |   |   | 100.0 |   |   |
| Total cost of goods sold              |       |                                               | 23,041     | ** ** |   |   | 57.0 |   |   |   | 20,205 | ** ** |   |   | 55.7 |   |   |
| Gross profit                          |       |                                               | 17,405     | ** ** |   |   | 43.0 |   |   |   | 16,091 | ** ** |   |   | 44.3 |   |   |
| **Canadian Dollars:**                 | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | 46,880     | ** ** |   |   | 100.0 |   |   |   | 42,048 | ** ** |   |   | 100.0 |   |   |
| Total cost of goods sold              |       |                                               | 26,689     | ** ** |   |   | 56.9 |   |   |   | 23,394 | ** ** |   |   | 55.6 |   |   |
| Gross profit                          |       |                                               | 20,191     | ** ** |   |   | 43.1 |   |   |   | 18,654 | ** ** |   |   | 44.4 |   |   |
| **Europe:**                           | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US  Dollars:**                      | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | 32,005     | ** ** |   |   | 100.0 |   |   |   | 24,068 | ** ** |   |   | 100.0 |   |   |
| Total cost of goods sold              |       |                                               | 22,520     | ** ** |   |   | 70.4 |   |   |   | 16,818 | ** ** |   |   | 69.9 |   |   |
| Gross profit                          |       |                                               | 9,485      | ** ** |   |   | 29.6 |   |   |   | 7,250 | ** ** |   |   | 30.1 |   |   |
| **Euros:**                            | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | 24,480     | ** ** |   |   | 100.0 |   |   |   | 20,149 | ** ** |   |   | 100.0 |   |   |
| Total cost of goods sold              |       |                                               | 17,227     | ** ** |   |   | 70.4 |   |   |   | 14,128 | ** ** |   |   | 70.1 |   |   |
| Gross profit                          |       |                                               | 7,253      | ** ** |   |   | 29.6 |   |   |   | 6,021 | ** ** |   |   | 29.9 |   |   |
| **Other International (US Dollars):** | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Total net sales                       |       |                                               | 23,409     | ** ** |   |   | 100.0 |   |   |   | 20,817 | ** ** |   |   | 100.0 |   |   |
| Total cost of goods sold              |       |                                               | 13,716     | ** ** |   |   | 58.7 |   |   |   | 12,607 | ** ** |   |   | 60.6 |   |   |
| Gross profit                          |       |                                               | $          | 9,693 | ** ** |   |   | 41.3 | % |   |   | $ | 8,210 | ** ** |   |   | 39.4 | % |   |

 

***Quarter Ended February 25, 2007 compared withQuarter Ended February 26, 2006***

*NetSales.**  *Ournet sales for the quarter ended February 25,2007, were $412.6 million, an increase of $16.8 million, or 4.3% fromthe quarter ended February 26,2006. Total domestic net sales were $316.7 million for the first quarterof fiscal 2007 compared to $314.6 million for the first quarter of fiscal 2006.The domestic net sales increase of $2.1 million was attributable to a 4.5%increase in volume partially offset by a 3.7% decrease in average unit sellingprice. The increase in volume is primarily attributable to the strongperformance of our promotional products such as our 125th Anniversary beds as well as our specialtybedding products. The decrease in average unit selling price is primarily dueto the higher volume 

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of promotional beddingsales. In addition strategic pricing actions were taken on selected productssuch as the *Stearns & Foster*and *TrueForm *lines. Total international sales increased$14.7 million, or 18.1%. Excluding the effect of currency fluctuations,international sales increased 14.8%. The increase represents a 33.2% increasein unit volume, partially offset by a decrease in average unit selling price. Inthe Canadian market, local currency sales gains of 11.5% translated into gainsof 11.4%  in US dollars. Local currencygains in the Canadian market were driven by a 25.2% increase in volume, whichwas partially offset by a 10.9% decline in average unit selling price. Thechanges in volume and average unit selling price were a result of strategicpricing actions on selected products and increases in lower margin promotionalproduct sales. In our European market, local currency gains of 21.5%, or 33.0%in US dollars were driven by a 52.6% increase in volume, partially offset by a20.4% decrease in local currency average unit selling price. The decrease inaverage unit selling price is attributed to increased sales of lower pricedlatex bed cores to other manufacturers. Finished goods sales in Europeincreased 18.6%.

*GrossProfit.**  *Ourgross profit for the quarter was $177.3 million, an increase of $0.6 millionover the comparable prior year period. As a percentage of net sales, grossprofit decreased 1.7 percentage points to 43.0%. This was due primarily to adecrease in our domestic gross profit margin. Domestic gross profit decreased $4.5million to $140.7 million, which, as a percentage of sales, represented adecrease of 1.7 percentage points to 44.4% of net sales. This decrease isdriven by an increase in sales of lower margin promotional products, strategic  pricing actions, the addition of flameretardant materials to most of our products, as well as startup costsassociated with the new latex facility in Mountain Top, PA. Partiallyoffsetting this decrease were the continued improvements in our manufacturingefficiencies as well as lower employee health insurance costs arising from ourtransition to a new, third party administrator. On a per unit basis, materialcosts increased 2.8% relative to the first quarter of 2006 primarily due toadditional costs to make our products compliant with the 2007 federal flameretardancy regulations, partially offset by product mix as well as improvedyield on raw materials. Gross profit for the international business increased$5.0 million to $36.6 million, which as a percentage of sales represents adecrease of 0.7 percentage points to 38.2% of net sales. This decrease isprimarily due to strategic pricing actions and sales of lower marginpromotional products in Canada, partially offset by a decrease in materialcosts in Canada resulting from favorable exchange rates on imported rawmaterials.

*Selling,General, Administrative.**  *Our selling, general, and administrative expenseincreased $3.3 million to $126.9 million. This increase is dueprimarily to a $2.2 million increase in cooperative advertising costs, a$2.1 million increase in delivery costs due to higher unit volume and a$1.5 million increase in other sales and administration costs. Thisincrease is partially offset by a reduction of $2.5 million in promotionalexpenses in the U.S. associated with the 2006 roll out of our new *Stearns & Foster* product lines. As a percent of netsales this expense was 30.8% and 31.2% for the quarters ended February 25,2007 and February 26, 2006, respectively, a decrease of 0.4 percentagepoints.

*Royaltyincome, net of royalty expense.*   Our royaltyincome, net of royalty expenses, for the three months ended February 25,2007 was $5.3 million, an increase of $1.6 million compared with the threemonths ended February 26, 2006, primarily due to a $0.5 million decreasein royalty expense as a result of capitalizing the Pirelli lease agreement inthe fourth quarter of fiscal 2006 as well as a $0.7 million increase ininternational royalty revenue.

*InterestExpense.**  *Our interest expense for the first quarter offiscal 2007 decreased $2.8 million from the prior year period to $15.9million, primarily due to lower debt levels resulting from the retirement ofthe $89.1 million of senior subordinated Pay-In-Kind Notes (“PIK Notes”) and$47.5 million of the 8.25% Senior Subordinated Notes due June 2014 (“2014Notes”) in the second quarter of fiscal 2006 using proceeds from the initialpublic offering (“IPO”) as well as $35 million in voluntary prepayments of oursenior term debt since February 26, 2006. Our weighted average borrowingcosts for the first quarter of fiscal 2007 and 2006 remained unchanged at 7.7%.Our borrowing costs remained flat due to higher interest rates on the unhedgedvariable rate of our floating rate debt being offset by lower interest rates on

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the fixed component of oursenior secured term debt as a result of the August 2006 amendment of oursenior secured credit agreement.

*Income Tax.**  *Our effective income tax ratesdiffer from the Federal statutory rate principally because of the effect ofcertain foreign tax rate differentials and state and local income taxes. Oureffective tax rate for the three months ended February 25, 2007 is 36.9%compared to 39.0% for the three months ended February 26, 2006.

***LIQUIDITY AND CAPITAL RESOURCES***

***Principal Sources of Funds***

Our principal sources offunds are cash flows from operations and borrowings under our senior securedrevolving credit facility. Our principal use of funds consists of operatingexpenditures, payments of principal and interest on our senior creditagreements, capital expenditures, interest payments on our outstanding seniorsubordinated notes, and dividend payments to shareholders. Capital expenditurestotaled $12.9 million for the three months ended February 25, 2007. Weexpect total 2007 capital expenditures to be approximately $40 million. Webelieve that annual capital expenditure limitations in our current debtagreements will not prevent us from meeting our ongoing capital needs. Ourintroductions of new products typically require us to make initial cashinvestments in inventory, promotional supplies and employee training which maynot be immediately recovered through new product sales. However, we believethat we have sufficient liquidity to absorb such expenditures related to newproducts and that these expenses will not have a significant adverse impact onour operating cash flow. At February 25, 2007, we had approximately $82.3 millionavailable under our revolving credit facility after taking into account lettersof credit issued totaling $31.5 million. Our net weighted averageborrowing cost remained unchanged at 7.7% for the three months ended February 25, 2007 and February 26,2006. Our borrowing cost remained flat due to higher interest rates on theunhedged variable rate component of our floating rate debt being offset bylower interest rates on the fixed component of our senior secured term debt asa result of the August 2006 amendment of our senior credit agreement.  As a result of the IPO completed April 12,2006, approximately $90 million of the net proceeds were used to retire the PIKNotes including accrued interest and prepayment penalties thereon, andapproximately $52 million was used to repurchase and retire $47.5 million ofthe aggregate principal amount outstanding under our 2014 Notes along withaccrued interest and market premiums thereon. In addition, on August 25,2006, we amended our senior secured credit agreement which reduced theapplicable interest rate margins charged on the senior secured term loans, asdiscussed below.

***Debt***

We have incurred substantial debt, including seniorcredit facilities consisting of a $125 million senior secured revolving creditfacility maturing in 2010 and senior secured term loan facilities maturing in August 2011and August 2012 with an outstanding balance of $415 million at February 25,2007. We also have an outstanding principal balance of $342 million at February 25,2007 on the 2014 Notes.

On August 25, 2006, we amended our senior securedcredit agreement to provide for two senior secured term loans, one for $300million maturing August 25, 2011 and one for $140 million maturing August 25,2012. This amendment reduced the applicable interest rate margins charged onthe senior secured term loans, provided certain financial leverage ratio testsare met, by 50 basis points on the $300 million loan and 25 basis points on the$140 million loan. In addition, this amendment provides us with greaterflexibility for Sealy Mattress Company to make dividend payments to us, or torepay certain subordinated debt, provided certain leverage ratio tests andother conditions are met. The terms and conditions of our $125 million seniorrevolving credit facility were unchanged by the amendment. Since 

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August 25, 2006 wehave repaid $25 million of the original $140 million outstanding on our termloan maturing August 25, 2012.

Future principal debt payments are expected to be paidout of cash flows from operations and borrowings on our revolving creditfacility. As of March 29, 2007, we had $85.7 million outstanding under ourrevolving credit facility.

Borrowings under our new senior secured creditfacilities bear interest at our choice of the Eurodollar rate or adjusted baserate (‘‘ABR’’), in each case, plus an applicable margin, subject to adjustmentbased on a pricing grid. Annually, we may be required to make principalprepayments equal to 25% of excess cash flow for the preceding fiscal year, asdefined in our senior secured credit agreement, if our leverage ratio is lessthan 4.00 to 1.00 reducing to 0% if our leverage ratio is less than 3.25 to1.00. At February 25, 2007, we are unable to determine the amount of suchrequired payment, if any, that would be due following the first quarter offiscal 2008 with respect to excess cash flow for the 2007 fiscal year.

On June 3, 2004, we entered into an interest rateswap agreement effective July 6, 2004 effectively fixing the floatingportion of the interest rate at 3.725% on $200 million of the outstandingbalance under the senior secured term loan through November 2005,declining to $150 million from December 2005 through November 2007.Concurrent with the refinancing of our senior secured term loan, wede-designated $13 million of this swap as a hedging instrument and recorded areduction of interest expense of $0.2 million related to this de-designation.To retain the designation of this swap as a hedging instrument, we must selectthe Eurodollar rate on the hedged portion of the senior secured term loanduring the term of the swap.

The outstanding 2014 Notes consist of$342 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 an exchange offer whereby all of the 2014 Notes wereexchanged for publicly traded, registered securities with identical terms(other than certain terms relating to registration rights and certain interestrate provisions otherwise applicable to the original senior subordinatednotes). During the second quarter of fiscal 2006, we used a portion of theproceeds from the IPO to retire approximately $47.5 million aggregate principalamount of the 2014 Notes.

On July 16, 2004, we issued $75.0 millionaggregate principal amount of PIK Notes to certain institutional investors intransactions exempt from registration under the Securities Act of 1933. The PIKnotes accrue interest in-kind at 10% per year, compounded semi-annually, andmature on July 15, 2015. On April 21, 2006, we used approximately$90 million of the proceeds from the IPO to redeem the outstandingprincipal amount of the PIK notes and pay accrued interest thereon through thedate of the redemption, along with a related redemption premium.

At February 25, 2007, we were in compliance withthe covenants contained within our senior credit agreements and indenturegoverning the 2014 Notes.

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

Our ability to make scheduled payments of principal,or to pay the interest or liquidated damages, if any, on or to refinance ourindebtedness, or to fund planned capital expenditures will depend on our futureperformance, which, to a certain extent, is subject to general economic,financial, competitive, legislative, regulatory and other factors that arebeyond our control. Based upon the current level of operations, we believe thatcash flow from operations and available cash, together with availableborrowings under the senior credit agreement, will be adequate to meet thefuture liquidity needs during the one year following February 25, 2007. Wewill be required to make scheduled principal payments of $23.0 million duringthe 

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next twelve months, with$7.5 million for our senior secured term loans, $2.1 million for our financingobligations and capital leases and the remainder for debt owed by ourinternational subsidiaries. However, as we continually evaluate our ability tomake additional prepayments as permitted under our senior credit agreements, itis possible that we will make additional voluntary prepayments on our seniordebt during that time.

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

On February 19, 2007,our Board of Directors approved a share repurchase program authorizing us torepurchase up to $100 million of our Company’s common stock.

***Dividend***

On April 3, 2007, our Board of Directors declareda cash dividend in the amount of $0.075 per share of common stock payable on May 1,2007 to stockholders of record as of April 19, 2007. This will result in adividend distribution of approximately $6.9 million to be paid during thesecond quarter of fiscal 2007.

***Cash Flow Analysis***

Thefollowing table summarizes our changes in cash:

| ** **                              | ** ** | **Three Months Ended:** | ** ** |
|-----------------------------------------|------------|-----------------------------------|------------|
| ** **                              | ** ** | **February 25,  2007**       | ** ** | **February 26,  2006** | ** ** |
| ** **                              | ** ** | **(in thousands)**           | ** ** |
| Statement of Cash Flow  Data:           |       |                              |       |   |   |   |   |   |   |
| Cash flows  provided by (used in):      |       |                              |       |   |   |   |   |   |   |
| Operating activities                    |       |                              | $          | 4,253 |   |   |   | $ | (14,056 | ) |   |
| Investing activities                    |       |                              | (12,836    | ) |   |   | (5,548 | ) |   |
| Financing activities                    |       |                              | (5,230     | ) |   |   | (3,312 | ) |   |
| Effect of exchange rate changes on cash |       |                              | (57        | ) |   |   | 122 |   |   |
| Change in cash and cash equivalents     |       |                              | (13,870    | ) |   |   | (22,794 | ) |   |
| Cash and cash equivalents:              |       |                              |       |   |   |   |   |   |   |
| Beginning of period                     |       |                              | 45,620     |   |   |   | 36,554 |   |   |
| End of period                           |       |                              | $          | 31,750 |   |   |   | $ | 13,760 |   |   |

 

***Three Months Ended February 25, 2007 ComparedWith Three Months Ended February 26, 2006***

*CashFlows from Operating Activities.**  *Ourcash flow from operations increased $18.3 million to $4.3 million netcash provided for the three months ended February 25, 2007, compared to a$14.1 million net use of cash for the three months ended February 25,2006. This change was primarily the result of changes in working capital andtiming of various payments.

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*CashFlows from Investing Activities.**  *Ourcash flows used in investing activities increased approximately $7.3 million to$12.8 million net use of cash for the three months ended February 25,2007, compared to a $5.5 million net use of cash for three months ended February 26,2006 due to higher capital expenditures for the first three months of fiscal2007 as compared with the prior year period. The increased capital expenditureswere primarily due to the construction of our new facility in Mountain Top, PA.

*Cash Flows from FinancingActivities.**  *Our cashflow used in financing activities for the three months ended February 25,2007 increased $1.9 million to a $5.2 million net use of cash from anet use of $3.3 million for the three months ended February 26, 2006. Thisincrease is primarily due to a $6.9 million cash dividend paid in the firstquarter of fiscal 2007 partially offset by $4.6 million related to theexercise of employee stock options in the first three months of fiscal 2007.

***Income Taxes***

Significant judgment isrequired in evaluating our federal, state and foreign tax positions and in thedetermination of our tax provision. Despite our belief that our tax returnpositions are fully supportable, we have established reserves where we believethat certain tax positions are likely to be challenged and we may not fullyprevail in overcoming these challenges. We may adjust these reserves asrelevant circumstances evolve, such as guidance from the relevant taxauthority, our tax advisors, or resolution of issues in the courts. In addition, the FASB recently issuedInterpretation No. 48 “Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement No. 109” (“FIN 48”), as described in Note2 to the Condensed Consolidated Financial Statements, Part I, Item 1,included herein. We are still assessing the potential impact of adopting thisinterpretation. Our tax expense includes the impact of reserve positionsand changes to reserves that we consider appropriate, as well as relatedinterest. While the Company is currently undergoing examinations of itscorporate income tax returns by tax authorities, no issues related to thesereserved positions have been presented to the Company. The Company believesthat such audits will not result in assessment and payment of taxes related tothese positions during one year following February 25, 2007. We alsocannot predict when or if any other future tax payments related to these taxpositions may occur.

***Debt Covenants***

Our long-term obligations contain various financialtests and covenants. Our senior secured credit facilities require us to meet aminimum interest coverage ratio and a maximum leverage ratio. The indenturegoverning our senior subordinated notes also requires us to meet a fixed chargecoverage ratio in order to incur additional indebtedness, subject to certainexceptions. We are currently in compliance with all debt covenants. Thespecific covenants and related definitions can be found in the applicable debtagreements, each of which we have previously filed with the Securities andExchange Commission.

The covenants contained in our senior secured creditfacilities are based on what we refer to herein as “Adjusted EBITDA”. In thesenior secured credit facilities, EBITDA is defined as net income plusinterest, taxes, depreciation and amortization and Adjusted EBITDA is definedas EBITDA further adjusted to exclude unusual items and other adjustmentspermitted in calculating covenant compliance as discussed above. AdjustedEBITDA is presented herein as it is a material component of these covenants.Non-compliance with such covenants could result in the requirement toimmediately repay all amounts outstanding under such facilities. While thedetermination of “unusual items” is subject to interpretation and requires judgment,we believe the adjustments listed below are in accordance with the covenants.

EBITDA and Adjusted EBITDA are not recognized termsunder generally accepted accounting principles (“GAAP”) and do not purport tobe alternatives to net income as a measure of operating performance or to cashflows from operating activities as a measure of liquidity. Additionally, theyare not 

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intended to be measures offree cash flow for management’s discretionary use, as they do not considercertain cash requirements such as interest payments, tax payments and debtservice requirements. Because not all companies use identical calculations,these presentations may not be comparable to other similarly titled measures ofother companies.

Thefollowing table sets forth a reconciliation of net income to EBITDA and EBITDAto Adjusted EBITDA for the three months ended February 25, 2007:

| ** **                        | ** ** | **Three Months Ended  February 25, 2007** | ** ** |
|-----------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                        | ** ** | **(in thousands)**                                       | ** ** |
| Net income                        |       |                                                          | $          | 24,634 |   |   |
| Interest expense                  |       |                                                          | 15,905     |   |   |
| Income taxes                      |       |                                                          | 14,411     |   |   |
| Depreciation and amortization     |       |                                                          | 7,322      |   |   |
| EBITDA                            |       |                                                          | 62,272     |   |   |
| Unusual and  nonrecurring losses: |       |                                                          |       |   |   |
| Other  (various)(a)               |       |                                                          | 1,547      |   |   |
| Adjusted EBITDA                   |       |                                                          | $          | 63,819 |   |   |

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(a)           Consists of variousimmaterial adjustments

Thefollowing table reconciles EBITDA to cash flow from operations:

| ** **                                                     | ** ** | **Three Months Ended  February 25, 2007** | ** ** |
|----------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                                     | ** ** | **(in thousands)**                                       | ** ** |
| EBITDA                                                         |       |                                                          | $          | 62,272 |   |   |
| Adjustments to  EBITDA to arrive at cash flow from operations: |       |                                                          |       |   |   |
| Interest expense                                               |       |                                                          | (15,905    | ) |   |
| Income taxes                                                   |       |                                                          | (14,411    | ) |   |
| Non-cash charges against (credits to) net income               |       |                                                          | (3,463     | ) |   |
| Changes in operating assets & liabilities             |       |                                                          | (24,240    | ) |   |
| Cash flow from  operations                                     |       |                                                          | $          | 4,253 |   |   |

 

***Forward Looking Statements***

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

·       thelevel of competition in the bedding industry;

·       legaland regulatory requirements;

·       thesuccess of new products;

·       ourrelationships with our major suppliers;

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·       fluctuationsin costs of raw materials;

·       ourrelationship with significant customers and licensees;

·       ourlabor relations;

·       departureof key personnel;

·       encroachmentson our intellectual property;

·       productliability claims;

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

·       ourlevel of indebtedness;

·       interestrate risks;

·       futureacquisitions;

·       anincrease in return rates; and

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

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

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

*The information appearing below relating to our marketrisk sensitive instruments by major category should be read in conjunction withthe related disclosure contained in the management’s discussion and analysissection of our Annual Report on Form 10-K (File No. 001-08738).*

***Foreign Currency Exposures***

Our earnings are affected by fluctuations in the valueof our subsidiaries’ functional currency as compared to the currencies of ourforeign denominated purchases. Foreign currency forward, swap and optioncontracts are used to hedge against the earnings effects of such fluctuations.The result of a uniform 10% change in the value of the U.S. dollar relative tocurrencies of countries in which we manufacture or sell our products would havean approximately $0.4 million dollar impact on our financial position. Thiscalculation assumes that each exchange rate would change in the same directionrelative 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 25, 2007, we hadforward contracts to sell a total of 33 million Canadian dollars withexpiration dates ranging from February 28, 2007 through November 30,2007. At February 25, 2007, the fair value of our net asset under theforward contracts was $0.2 million. We do not designate our foreign currencyhedges for accounting purposes, therefore all changes in fair value are chargedto earnings.

***Interest Rate Risk***

On June 3, 2004, we entered into an interest rateswap agreement effective July 6, 2004 effectively fixing the floatingportion of the interest rate at 3.725% on $200 million of our outstandingbalance under 

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the senior secured termloan through November 2005, declining to $150 million through November 2007.The fair value of this swap instrument was an asset of $2.4 million at February 25,2007 and $2.8 million at November 26, 2006.

A 10% increase or decrease in market interest ratesthat affect our interest rate derivative instrument would not have a materialimpact on our earnings during the next fiscal year.

Based on the unhedgedportion of our variable rate debt outstanding at February 25, 2007, a 12.5basis point increase or decrease in variable interest rates would have anapproximately $0.4 million dollar impact on our annual interest expense.

***Commodity Price Risks***

The cost of our steelinnerspring and our polyurethane foam and polyethylene component parts areimpacted by volatility in the price of steel and petroleum. We believe the costof the components could remain slightly elevated above their recent historicalaverages throughout fiscal 2007. Through February 25, 2007, we have beenable to successfully address these cost pressures through price increasesannounced May of 2004 and November of 2005 and through cost reductionefforts. We do not engage in commodity hedging programs

**Item 4.**                        *Internal Control and Procedures*

Under the supervision and with the participation ofour management, including our principal executive officer and principalaccounting officer, we conducted an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended, asof the end of the period covered by this report (the ‘‘Evaluation Date’’).Based on this evaluation, our principal executive officer and principalaccounting officer concluded as of the Evaluation Date that our disclosurecontrols and procedures were effective such that the information relating tothe Company, including our consolidated subsidiaries, required to be disclosedin our Securities and Exchange Commission (‘‘SEC’’) reports (i) isrecorded, processed, summarized and reported within the time periods specifiedin SEC rules and forms, and (ii) is accumulated and communicated tothe Company’s management, including our principal executive and principalaccounting officer, as appropriate to allow timely decisions regarding requireddisclosure.

There were no changes in our internal control overfinancial reporting identified in connection with the foregoing evaluation thatoccurred during the first quarter of fiscal 2007 that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

We are preparing for our first management report oninternal control over financial reporting, as required by Section 404 ofthe Sarbanes-Oxley Act of 2002, for our fiscal year ending December 2,2007, on which our auditors will be required to deliver an attestation reporton management’s assessment of, and operating effectiveness of, internalcontrols over financial reporting. As a result, we expect to continue enhancingour internal controls over financial reporting throughout fiscal 2007.

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**PART II. OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

See Note 16 to theCondensed Consolidated Financial Statements, Part I, Item 1 includedherein.

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

Thetable below shows our repurchases of the Company’s common stock during thefirst quarter of fiscal 2007. These repurchases represent common stocksurrendered or withheld to cover the exercise price and/or tax withholdingobligations in stock option exercises, as permitted under the Company’s 1998and 2004 Stock Option Plans. These shares were not repurchased as part of apublicly announced repurchase plan or program.

| **Period**                                            | ** ** | ** ** | ** ** | **Total number of  shares purchased** | ** ** | **Average price paid  per share** | ** ** |
|-------------------------------------------------------|------------|------------|------------|------------------------------------------------------|------------|--------------------------------------------------|------------|
| November 27,  2006 - December 24, 2006 |       |       | 542,866    |                                                 |       |                                             | $          | 15.55 |   |   |
| December 25,  2006 - January 21, 2007  |       |       | —     |                                                 |       |                                             | —     |   |   |
| January 22,  2007 - February 25, 2007  |       |       | 137,863    |                                                 |       |                                             | 17.40      |   |   |
| Total                                                 |       |       | 680,729    |                                                 |       |                                             | $          | 15.92 |   |   |

 

On February 19, 2007, our Board of Directorsapproved a share repurchase program authorizing us to repurchase up to $100million of our Company’s common stock. No shares were repurchased under thisplan during the quarter ended February 25, 2007. Through March 30,2007 we have has repurchased 84,900 shares of the Company’s common stock for anaggregate purchase price of $1.5 million.

Our ability to paydividends is restricted by our debt agreements. See “Management’s Discussionand Analysis of Financial Condition and Results of Operations.”

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

None

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

None

**Item 5.**                        *Other Information*

None

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

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, Sealy Corporationhas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.

|                                                 |          | SEALY CORPORATION                                     |
|-------------------------------------------------|---------------|-------------------------------------------------------|
| ** **                                      | **Signature** | ** **                                            |   | ** ** | **Title** | ** ** |
| /s/    DAVID J.  MCILQUHAM  |          | Chairman and  Chief Executive Officer                 |
| **David J. McIlquham**                          |          | (Principal Executive  Officer)                        |
| /s/    JEFFREY  C. ACKERMAN |          | Executive Vice  President and Chief Financial Officer |
| **Jeffrey  C. Ackerman**                        |          | (Principal Accounting Officer)                        |
|                                                 |               |                                                       |  |  |  |  |

 

Date: April 4, 2007

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