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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549



FORM 10-Q


ý

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: May 30, 2010

o

 

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from                        to                       

Commission file number 001-08738



SEALY CORPORATION
(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of incorporation)
  36-3284147
(I.R.S. Employer Identification No.)

Sealy Drive One Office Parkway
Trinity, North Carolina

(Address of principal executive offices)

 

27370
(Zip Code)

(336) 861-3500
Registrant's telephone number, including area code



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

        Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o    No o

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer," and "smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o
(Do not check if a
smaller reporting company)
  Smaller reporting company o

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

        The number of shares of the registrant's common stock outstanding as of June 22, 2010 is approximately: [97,520,424].



PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements


SEALY CORPORATION

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 
  Three Months Ended  
 
  May 30,
2010
  May 31,
2009
 

Net sales

  $ 316,528   $ 298,455  

Cost of goods sold

    188,290     176,509  
           
 

Gross profit

    128,238     121,946  

Selling, general and administrative expenses

   
107,182
   
95,581
 

Amortization expense

    115     778  

Restructuring expenses and asset impairment

        1,335  

Royalty income, net of royalty expense

    (3,785 )   (4,600 )
           
   

Income from operations

    24,726     28,852  

Interest expense

    21,765     16,876  

Loss on rights for convertible notes

        2,729  

Refinancing and extinguishment of debt and interest rate derivatives

    3,759     17,422  

Other income, net

    (50 )   (13 )
           
   

Loss before income taxes

    (748 )   (8,162 )

Income tax provision

    (550 )   (2,773 )

Equity in earnings of unconsolidated affiliates

    1,047      
           
   

Net income (loss)

  $ 849   $ (5,389 )
           

Earnings (loss) per common share—Basic

  $ 0.01   $ (0.06 )
           

Earnings (loss) per common share—Diluted

  $ 0.01   $ (0.06 )
           

Weighted average number of common shares outstanding:

             
 

Basic

    94,604     91,819  
 

Diluted

    106,842     91,819  

See accompanying notes to Condensed Consolidated Financial Statements.

1



SEALY CORPORATION

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

 
  Six Months Ended  
 
  May 30,
2010
  May 31,
2009
 

Net sales

  $ 656,155   $ 608,431  

Cost of goods sold

    387,797     368,845  
           
 

Gross profit

    268,358     239,586  

Selling, general and administrative expenses

   
216,138
   
192,277
 

Amortization expense

    454     1,593  

Restructuring expenses and asset impairment

        1,448  

Royalty income, net of royalty expense

    (7,808 )   (7,970 )
           
   

Income from operations

    59,574     52,238  

Interest expense

   
44,106
   
34,424
 

Loss on rights for convertible notes

        2,729  

Refinancing and extinguishment of debt and interest rate derivatives

    3,759     17,422  

Gain on sale of subsidiary stock

        (1,292 )

Other income, net

    (104 )   (46 )
           
   

Income (loss) before income taxes

    11,813     (999 )

Income tax provision

    7,240     46  

Equity in earnings of unconsolidated affiliates

    1,990      
           
   

Net income (loss)

  $ 6,563   $ (1,045 )
           

Earnings (loss) per common share—Basic

  $ 0.07   $ (0.01 )
           

Earnings (loss) per common share—Diluted

  $ 0.05   $ (0.01 )
           

Weighted average number of common shares outstanding:

             
 

Basic

    94,563     91,813  
 

Diluted

    286,092     91,813  

See accompanying notes to Condensed Consolidated Financial Statements.

2



SEALY CORPORATION

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)

(unaudited)

 
  May 30,
2010
  November 29,
2009
 

ASSETS

             

Current assets:

             
 

Cash and equivalents

  $ 79,557   $ 131,427  
 

Accounts receivable, less allowances for bad debts, cash discounts and returns

    164,769     156,850  
 

Inventories

    67,276     56,810  
 

Other current assets

    22,069     21,080  
 

Deferred income tax assets

    14,669     20,222  
           

Total current assets

    348,340     386,389  
           

Property, plant and equipment—at cost

    432,869     446,989  

Less accumulated depreciation

    (238,748 )   (239,508 )
           

    194,121     207,481  
           

Goodwill

    360,893     360,583  

Intangible assets, net

    1,528     1,937  

Deferred income tax assets

    9,425     6,874  

Other assets, including debt issuance costs, net

    51,094     52,206  
           

    422,940     421,600  
           

Total assets

  $ 965,401   $ 1,015,470  
           

LIABILITIES AND STOCKHOLDERS' DEFICIT

             

Current liabilities:

             
 

Current portion—long-term obligations

  $ 10,400   $ 13,693  
 

Accounts payable

    88,371     88,971  
 

Accrued incentives and advertising

    27,808     31,804  
 

Accrued compensation

    22,801     43,105  
 

Accrued interest

    14,659     15,230  
 

Other accrued liabilities

    31,785     36,436  
           

Total current liabilities

    195,824     229,239  
           

Long-term obligations, net of current portion

    798,122     833,766  

Other liabilities

    58,754     59,625  

Deferred income tax liabilities

    871     832  

Stockholders' deficit:

             
 

Common stock, $0.01 par value; Authorized shares: 2010 and 2009—600,000 Issued and outstanding: 2010—94,654; 2009—94,417

    950     947  
 

Additional paid-in capital

    900,932     885,064  
 

Accumulated deficit

    (986,387 )   (992,950 )
 

Accumulated other comprehensive income, net

    (3,665 )   (1,053 )
           

Total shareholders' deficit

    (88,170 )   (107,992 )
           

Total liabilities and shareholders' deficit

  $ 965,401   $ 1,015,470  
           

See accompanying notes to Condensed Consolidated Financial Statements.

3



SEALY CORPORATION

Condensed Consolidated Statement of Stockholders' Deficit

(in thousands)

(unaudited)

 
   
  Common Stock    
   
  Accumulated
Other
Comprehensive
Income (Loss)
   
 
 
  Comprehensive
Income (Loss)
  Additional
Paid-in
Capital
  Accumulated
Deficit
   
 
 
  Shares   Amount   Total  

Balance at November 29, 2009

  $ 32,143     94,417   $ 947   $ 885,064   $ (992,950 ) $ (1,053 ) $ (107,992 )

Net income

    6,563                       6,563           6,563  

Foreign currency translation adjustment

    (2,713 )                           (2,713 )   (2,713 )

Adjustment to defined benefit plan liability, net of tax of $127

    367                             367     367  

Change in fair value of cash flow hedges, net of tax of $177

    (266 )                           (266 )   (266 )

Share-based compensation

                      9,215                 9,215  

Exercise of stock options

          237     3     142                 145  

Excess tax deficiency on options exercised

                      (480 )               (480 )

Beneficial conversion feature on Convertible paid-in-kind Notes

                      6,991                 6,991  
                               

Balance at May 30, 2010

  $ 3,951     94,654   $ 950   $ 900,932   $ (986,387 ) $ (3,665 ) $ (88,170 )
                               

See accompanying notes to Condensed Consolidated Financial Statements.

4



SEALY CORPORATION

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

 
  Six Months Ended  
 
  May 30,
2010
  May 31,
2009
 

Operating activities:

             
 

Net income (loss)

  $ 6,563   $ (1,045 )
 

Adjustments to reconcile net income to cash provided by operating activities:

             
   

Depreciation and amortization

    14,736     16,553  
   

Deferred income taxes

    3,891     (5,786 )
   

Impairment charges

        1,326  
   

Amortization of deferred gain on sale-leaseback

    (327 )   (324 )
   

Paid in kind interest on convertible notes

    6,980      
   

Amortization of discount on new senior secured notes

    1,030      
   

Amortization of debt issuance costs and other

    2,889     579  
   

Loss on rights for convertible notes

        2,729  
   

Share-based compensation

    9,215     2,229  
   

Loss on sale of assets

    262     451  
   

Write-off of debt issuance costs related to debt extinguishments

    2,709     2,113  
   

Loss on repurchase of senior notes

    1,050     15,232  
   

Payment to terminate interest rate swaps

        (15,232 )
   

Gain on sale of subsidiary stock

        (1,292 )
   

Other, net

    157     (661 )
 

Changes in operating assets and liabilities:

             
   

Accounts receivable

    (12,007 )   (9,747 )
   

Inventories

    (13,123 )   6,125  
   

Other current assets

    1,188     14,136  
   

Other assets

    (282 )   1,262  
   

Accounts payable

    3,311     1,303  
   

Accrued expenses

    (33,472 )   (15,757 )
   

Other liabilities

    800     1,126  
           
     

Net cash (used in) provided by operating activities

    (4,430 )   15,320  
           

Investing activities:

             
 

Purchase of property, plant and equipment

    (6,678 )   (4,592 )
 

Proceeds from sale of property, plant and equipment

    67     10,149  
 

Net proceeds from sale of subsidiary stock

        1,237  
 

Investments in and loans to unconsolidated affiliate

        (2,322 )
           
     

Net cash (used in) provided by investing activities

    (6,611 )   4,472  
           

Financing activities:

             
 

Proceeds from issuance of long-term obligations

    1,806     2,830  
 

Repayments of long-term obligations

    (5,107 )   (8,995 )
 

Repayment of senior term loans

        (377,181 )
 

Proceeds from issuance of new senior secured notes

        335,916  
 

Proceeds from issuance of related party notes

        177,132  
 

Repayment of senior secured notes, including premium of $1,050

    (36,050 )    
 

Borrowings under revolving credit facilities

        140,616  
 

Repayments under revolving credit facilities

        (205,016 )
 

Exercise of employee stock options, including related excess tax benefits

    145     (295 )
 

Debt issuance costs

    2     (20,553 )
 

Other

    (77 )    
           
     

Net cash (used in) provided by financing activities

    (39,281 )   44,454  
           

Effect of exchange rate changes on cash

    (1,548 )   1,656  
           

Change in cash and equivalents

    (51,870 )   65,902  

Cash and equivalents:

             
 

Beginning of period

    131,427     26,596  
           
 

End of period

  $ 79,557   $ 92,498  
           

See accompanying notes to Condensed Consolidated Financial Statements.

5



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1: Basis of Presentation

        The accompanying interim Condensed Consolidated Financial Statements are unaudited, and certain related information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted in accordance with Rule 10-01 of Regulation S-X. The accompanying interim Condensed Consolidated Financial Statements were prepared following the same policies and procedures used in the preparation of the annual financial statements and reflect all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of Sealy Corporation and its subsidiaries (the "Company"). The results of operations for the interim periods are not necessarily indicative of the results for the fiscal year. Our third fiscal quarter sales are typically 5% to 15% higher than other fiscal quarters. These Condensed Consolidated Financial Statements should be read in conjunction with the annual consolidated financial statements for the year ended November 29, 2009 included within the Company's Annual Report on Form 10-K (File No. 001-08738).

        At May 30, 2010, affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") controlled approximately 49.1% of the issued and outstanding common stock of the Company.

        The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America ("GAAP") requires management to make estimates and assumptions that affect the amount of assets and liabilities and disclosures on contingent assets and liabilities at period end and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from these estimates.

Note 2: Recently Issued Accounting Pronouncements

        In December 2007, the Financial Accounting Standards Board ("FASB") issued authoritative guidance on noncontrolling interests in consolidated financial statements. This guidance establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The Company adopted this guidance in the first quarter of fiscal 2010 and it did not have a material impact on its financial statements.

        In December 2007, the FASB issued authoritative guidance on business combinations, which significantly changes the principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree. Guidance was also issued for recognizing and measuring goodwill acquired in a business combination and what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The Company adopted this guidance in the first quarter of fiscal 2010 and it did not have a material impact on its financial statements.

        In April 2008, the FASB issued authoritative guidance on the determination of the useful lives of intangible assets, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of an intangible asset. The Company adopted this guidance in the first quarter of fiscal 2010 and it did not have a material impact on its financial statements.

        In June 2008, the FASB issued authoritative guidance which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to

6



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Accounting Pronouncements (Continued)


be included in the earnings allocation in computing earnings per share. The Company adopted this guidance in the first quarter of fiscal 2010 and retrospectively restated its earnings per share for previous periods in accordance with this guidance. The adoption did not have a material impact on the current or prior period financial statements presented herein.

        In November 2008, the Emerging Issues Task Force ("EITF") of the FASB issued authoritative guidance which clarifies the accounting for certain transactions involving equity method investments. The Company adopted this guidance in the first quarter of fiscal 2010 and it did not have a material impact on its financial statements.

        In December 2008, the FASB issued authoritative guidance on an employers' disclosures about plan assets of a defined benefit pension or other postretirement plan. This interpretation is effective for financial statements issued for fiscal years ending after December 15, 2009. The Company will adopt this interpretation in the fourth quarter of fiscal 2010. The adoption of this interpretation will increase the disclosures in the financial statements related to the assets of the Company's defined benefit pension plans.

        In June 2009, the FASB issued authoritative guidance on the consolidation of variable interest entities ("VIE"). This new guidance significantly affects the overall consolidation analysis. The Company adopted this guidance in the first quarter of fiscal 2010. The Company has evaluated the guidance and does not have a VIE for which it is currently required to evaluate whether it is the primary beneficiary. As such, the adoption of this guidance did not have a material impact on the Company's financial statements.

        In January 2010, the FASB issued authoritative guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires new disclosures on the transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy, including the reasons and timing of the transfers, which the Company adopted in the second quarter of fiscal 2010. Additionally, the guidance requires a rollforward of activities related to the purchases, sales, issuance and settlements of assets and liabilities measured using Level 3 fair value measurements. The Company will adopt this guidance in the first quarter of fiscal 2012. The adoption of this guidance will increase the level of disclosures in the financial statements related to fair value measurements.

        In January 2010, the FASB issued authoritative guidance to amend the accounting and reporting requirements for decreases in ownership of a subsidiary. This guidance requires that a decrease in the ownership interest of a subsidiary that does not result in a change of control be treated as an equity transaction. The guidance also expands the disclosure requirements about the deconsolidation of a subsidiary. The Company adopted this guidance in the first quarter of fiscal 2010 and it did not have a material impact on its financial statements.

Note 3: Restatement of Previous Periods

        During the year-end financial close process of fiscal 2009, the Company discovered an error related to the depreciation of the assets acquired through the purchase of certain of its European subsidiaries in fiscal 2001. The Company also discovered an error related to the deferred income tax liabilities recorded on these assets. The errors, which were immaterial to the prior periods, resulted in

7



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Restatement of Previous Periods (Continued)


an understatement of depreciation expense, recorded as a component of cost of goods sold and an overstatement of the income tax provision in the Condensed Consolidated Statements of Operations for prior periods. The recorded balances of accumulated depreciation and deferred tax liabilities were, likewise, understated and overstated, respectively in the Condensed Consolidated Balance Sheets for prior periods. The Company evaluated the effects of these errors on prior periods' consolidated financial statements, individually and in the aggregate, in accordance with the guidance provided by SEC Staff Accounting Bulletin ("SAB") No. 108, codified as Topic 1.N, "Considering the Effects of Prior Year Misstatements When Quantifying Misstatements in Current Year Financial Statements," and concluded that no prior period is materially misstated. However, in accordance with the provisions of this SAB Topic, the Company is restating its Condensed Consolidated Financial Statements for the three and six months ended May 31, 2009 as follows (in thousands):

 
  Condensed Consolidated Statements of Operation Information  
 
  Three Months Ended
May 31, 2009
  Six Months Ended
May 31, 2009
 
 
  As Previously
Reported
  Adjustments   Restated   As Previously
Reported
  Adjustments   Restated  

Cost of goods sold

  $ 176,304   $ 205   $ 176,509   $ 368,030   $ 815   $ 368,845  

Gross profit

    122,151     (205 )   121,946     240,401     (815 )   239,586  

Income from operations

    29,057     (205 )   28,852     53,053     (815 )   52,238  

Loss before income taxes

    (7,957 )   (205 )   (8,162 )   (184 )   (815 )   (999 )

Income tax provision

    (2,719 )   (54 )   (2,773 )   308     (262 )   46  

Net loss

    (5,238 )   (151 )   (5,389 )   (492 )   (553 )   (1,045 )

Loss per common share—Basic

    (0.06 )       (0.06 )   (0.01 )       (0.01 )

Loss per common share—Diluted

    (0.06 )       (0.06 )   (0.01 )       (0.01 )

Basic shares

   
91,819
         
91,819
   
91,813
         
91,813
 

Diluted shares

    91,819           91,819     91,813           91,813  

 

 
  Condensed Consolidated Statements of Cash Flow
Information for the Six Months Ended
May 31, 2009
 
 
  As Previously
Reported
  Adjustments   Restated  

Net loss

  $ (492 ) $ (553 ) $ (1,045 )

Adjustments to reconcile net income to cash provided by operating activities:

                   

Depreciation and amortization

    15,738     815     16,553  

Deferred income taxes

    (5,524 )   (262 )   (5,786 )

8



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation

        The Company maintains the 1998 Stock Option Plan ("1998 Plan") and the 2004 Stock Option Plan for Key Employees of Sealy Corporation and its Subsidiaries ("2004 Plan") which are collectively referred to as the "Option Plans". The Company accounts for all new stock options granted and outstanding options using the fair value based method under FASB authoritative guidance surrounding share-based payments. Total share-based compensation recognized during the three and six months ended May 30, 2010 and May 31, 2009 was $5.1 million and $9.2 million, respectively, for fiscal 2010 and $1.4 million and $3.1 million, respectively, for fiscal 2009.

Stock Option Awards

        During the three and six months ended May 30, 2010, the Company granted no new options to purchase shares of common stock. During the three and six months ended May 31, 2009, the Company granted options to purchase 7,320 and 58,487 shares of common stock and recognized an insignificant amount of compensation expense associated with these grants during the three and six months ended May 31, 2009. The options granted during the second quarter of fiscal 2009 had a weighted average grant-date fair value of $1.82, per option.

        The Company valued these stock option grants using the trinomial lattice valuation model with the following assumptions:

 
  Three Months
Ended
May 31, 2009
 

Expected volatility

    60 %

Expected dividend yield

    0.00 %

Expected term (in years)

    5.63  

Risk-free rate

    1.92 %

        Due to the lack of sufficient historical trading information with respect to its own shares, the Company estimated expected volatility based on its own shares weighted with a portfolio of selected stocks of companies believed to have market and economic characteristics similar to its own. The expected dividend yield is assumed to be zero based on restrictions to pay a dividend under the provisions of the Company's debt agreements. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The expected term is based on an analysis of the early exercise behavior of employees.

9



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

        A summary of option activity under the 1998 Plan for the six months ended May 30, 2010, is presented below:

 
  Shares Subject to Options   Weighted Average
Exercise Price Per Share
 

Outstanding November 29, 2009

    2,102,162   $ 1.09  
 

Exercised

    (208,507 )   0.51  
             

Outstanding May 30, 2010 (all fully vested and exercisable)

    1,893,655   $ 1.15  
 

Weighted average remaining contractual term

   
4.9 years
       
 

Aggregate intrinsic value of in-the-money options at May 30, 2010 (in thousands)

  $ 2,649        

        A summary of option activity under the 2004 Plan for the six months ended May 30, 2010, is presented below:

 
  Shares Subject to Options   Weighted Average
Exercise Price Per Share
 

Outstanding November 29, 2009

    9,568,777   $ 5.20  
 

Exercised

    (23,901 ) $ 1.64  
 

Forfeited

    (2,618,327 ) $ 4.61  
             

Outstanding May 30, 2010

    6,926,549   $ 5.44  
 

Weighted average remaining contractual term

   
6.0 years
       
 

Aggregate intrinsic value of in-the-money options (in thousands)

  $ 1,482        

Exercisable at May 30, 2010

    3,460,186        
 

Weighted average remaining contractual term

    5.8 years        
 

Aggregate intrinsic value of in-the-money options (in thousands)

  $ 257        

        As of May 30, 2010, the Company had approximately $2.5 million of unrecognized compensation expense related to stock option awards, which is expected to be recognized over a weighted average period of 3.6 years.

        The Company has granted stock options to employees that have accelerated vesting provisions which take effect if certain performance levels are achieved by the Company. If the Company does not meet these performance targets, then the vesting of the options occurs over the remainder of the requisite service period. As of May 30, 2010, it is the Company's expectation that the performance targets for these stock options will not be met. As such, the related unrecognized compensation cost is being recognized over the remainder of the requisite service period for those options that vest over the remaining service period. Further, the Company has not recognized compensation cost in the current period for certain options to purchase 667,532 shares of common stock that do not vest unless the performance targets are achieved. Total unrecognized compensation cost related to these options is $1.3 million.

10



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

Restricted Shares

        The Company has outstanding 291,971 restricted shares that are considered to be non-vested shares, and have the same rights as the Company's outstanding common shares, including dividend participation rights, except that they cannot be sold by the holder until the end of the vesting period. As of May 30, 2010, the remaining unrecognized compensation cost related to restricted stock awards was $0.8 million which is expected to be recognized over the remaining vesting period of 1.1 years. As of May 30, 2010, none of the outstanding restricted stock awards have vested.

Restricted Share Unit ("RSU") Awards

        As of May 30, 2010, the Company has outstanding 440,660 restricted share units (RSUs) which vest based on the attainment of certain performance targets that are tied to the Company's earnings performance and a three-year service requirement. None of these RSUs were granted in the three or six months ended May 30, 2010. During the three and six months ended May 31, 2009, the Company approved grants of 344,400 performance-based RSUs. If the performance targets are not met, then the RSUs will not vest. As of May 30, 2010, the first of the related performance targets have been met indicating that one-third of the awards will vest upon the completion of the service requirement. The RSUs granted during the six months ended May 31, 2009 have a grant date fair value of $0.87 based on the closing price of the Company's common stock as of the grant date.

        As of May 30, 2010, the Company also has outstanding, 16,351,935 time-based RSUs that vest based on the passage of time and do not contain performance requirements. During the three and six months ended May 30, 2010, the Company approved grants of 250,000 RSUs that vest ratably over three years and do not contain an accretion factor. These RSUs have a grant date fair value of $3.66 per unit based on the closing price of the Company's common stock as of the grant date. The awards granted prior to the three and six months ended May 30, 2010 accrete in the number of RSUs at an annual rate of 8% payable semi-annually until the RSUs are vested or forfeited. The number of awards outstanding above gives effect to this accretion.

        None of the Company's outstanding RSUs contain dividend participation rights.

        As of May 30, 2010, the remaining unrecognized compensation cost related to the total outstanding RSUs was $14.9 million which will be recognized based on the Company's forecasted attainment of the performance targets or over time depending upon the vesting criteria of the award. As of May 30, 2010, it is the Company's expectation that the performance targets for RSUs with performance targets will be met.

11



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

        A summary of restricted share unit award activity for the six months ended May 30, 2010, is presented below:

 
  Unvested Restricted
Share Units
  Weighted Average Grant
Date Fair Value
 

Outstanding November 29, 2009

    16,954,906   $ 2.02  
 

Granted

    250,000     3.66  
 

Vested

    (4,179 )   2.00  
 

Forfeited

    (408,132 )   1.97  
             

Outstanding May 30, 2010

    16,792,595   $ 2.04  
 

Weighted average remaining vesting period

    3.6 years        

Note 5: Inventories

        The major components of inventories were as follows (in thousands):

 
  May 30, 2010   November 29, 2009  

Raw materials

  $ 32,367   $ 29,700  

Work in process

    25,335     19,158  

Finished goods

    9,574     7,952  
           

  $ 67,276   $ 56,810  
           

Note 6: Warranty Costs

        The Company's warranty policy provides a 10-year non-prorated warranty service period on all currently manufactured Sealy Posturepedic, Stearns & Foster and Bassett bedding products and certain other Sealy-branded products. In addition, the Company has a 20-year warranty on the major components of its TrueForm and MirrorForm visco-elastic products and its SpringFree latex product, the last ten years of which are prorated on a straight-line basis. The Company also offers a 20-year limited warranty on its RightTouch product line which covers only certain parts of the product and is prorated for part of the twenty years. The RightTouch line was discontinued in the third quarter of fiscal 2008. The Company's policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded. The estimate involves an average lag time in days between the sale of a bed and the date of its return, applied to the current rate of the warranty returns.

12



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 6: Warranty Costs (Continued)

        The change in the Company's accrued warranty obligations for each of the six months ended May 30, 2010 and May 31, 2009 was as follows (in thousands):

 
  May 30, 2010   May 31, 2009  

Accrued warranty obligations at beginning of period

  $ 16,464   $ 16,487  

Warranty claims

    (9,865 )   (9,348 )

Warranty provisions

    9,577     9,400  
           

Accrued warranty obligations at end of period

  $ 16,176   $ 16,539  
           

        As of May 30, 2010 and November 29, 2009, $10.4 million and $10.6 million is included as a component of other accrued liabilities and $5.8 million and $5.9 million is included as a component of other noncurrent liabilities within the accompanying Condensed Consolidated Balance Sheet, respectively. In estimating its warranty obligations, the Company considers the impact of recoverable salvage value on warranty cost in determining its estimate of future warranty obligations. Warranty claims and provisions shown above do not include estimated salvage recoveries that reduced cost of sales by $3.3 million and $3.0 million for the six months ended May 30, 2010 and the six months ended May 31, 2009, respectively.

Note 7: Goodwill and Other Intangible Assets

        The Company performs an annual assessment of its goodwill for impairment as of the beginning of the fiscal fourth quarter. The Company also assesses its goodwill and other intangible assets for impairment when events or circumstances indicate that their carrying value may not be recoverable from future cash flows.

        The changes in the carrying amount of goodwill, which relates entirely to the Americas segment, for the six months ended May 30, 2010 are as follows (in thousands):

Balance as of November 29, 2009

  $ 360,583  

Increase due to foreign currency translation

    310  
       

Balance as of May 30, 2010

  $ 360,893  
       

        Total other intangibles of $1.5 million (net of accumulated amortization of $3.1 million) as of May 30, 2010 consist primarily of licenses, which are amortized using a straight-line method over periods ranging from 5 to 15 years. Costs to renew or extend the term of a recognized intangible asset are expensed as incurred. During the three and six months ended May 30, 2010 and May 31, 2009, the Company recognized amortization expense associated with intangibles of $0.1 million and $0.5 million, respectively, for fiscal 2010 and $0.8 and $1.6 million, respectively for fiscal 2009. The Company expects to recognize amortization expense relating to these intangibles of $0.1 million for the remainder of 2010, $0.3 million in 2011, $0.3 million in 2012, $0.3 million in 2013, $0.3 million in 2014 and $0.3 million thereafter.

13



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 8: Debt Issuance Costs

        On March 16, 2010, the Company redeemed 10%, or $35.0 million, of the principal amount of its outstanding Senior Notes at a redemption price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date. In connection with the repurchase, the Company recognized charges of $1.1 million related to the premium paid to repurchase the notes and $2.7 million related to write-off of related debt issuance costs and original issue discount. These charges were recorded as a component of refinancing and extinguishment of debt and interest rate derivatives in the Condensed Consolidated Statements of Operations.

        The Company capitalizes costs associated with the issuance of debt and amortizes them as additional interest expense over the lives of the debt on a straight-line basis which approximates the effective interest method. In connection with the refinancing of the Company's senior secured credit facilities in May 2009, the Company recorded fees in the amount of $24.1 million which were deferred and will be amortized over the life of the new agreements. Since the previously existing senior secured term loans were considered terminated under the provisions of the applicable authoritative accounting guidance, the remaining unamortized debt issuance costs of $2.1 million were expensed and recognized as a component of debt extinguishment and refinancing expenses in the Condensed Consolidated Statements of Operations. The remaining unamortized debt issuance costs of $0.4 million associated with the previously existing senior revolving credit facility will continue to be amortized over the life of the Company's new asset-based revolving credit facility in accordance with the provisions of the applicable authoritative accounting guidance.

Note 9: Long-Term Obligations

        Long-term obligations as of May 30, 2010 and November 29, 2009 consisted of the following (in thousands):

 
  May 30, 2010   November 29, 2009  

Asset-based revolving credit facility

  $   $  

Senior secured notes

    303,638     336,625  

Convertible notes(1)

    180,409     180,109  

Senior subordinated notes

    268,945     268,945  

Financing obligations

    40,635     41,296  

Other

    14,895     20,484  
           

    808,522     847,459  

Less current portion

    (10,400 )   (13,693 )
           

  $ 798,122   $ 833,766  
           

(1)
Includes PIK interest of $5.5 million and $5.3 million for which the principal balance of the Convertible Notes has not yet been increased at May 30, 2010 and November 29, 2009, respectively.

14



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

Debt Refinancing

        On May 13, 2009, the Company announced a comprehensive plan to refinance its existing senior secured credit facilities and replace them with indebtedness that has longer-dated maturities and eliminates quarterly financial ratio based maintenance covenants (the "Refinancing"). Through the Refinancing, the Company has: 1) entered into a new asset-based revolving credit facility (the "ABL Revolver") which provides commitments of up to $100.0 million maturing in May 2013; 2) issued $350.0 million in aggregate principal amount of senior secured notes due April 2016 (the "Senior Notes"); and 3) issued $177.1 million in aggregate principal amount of senior secured convertible paid in kind ("PIK") notes due July 2016 which are convertible into shares of the Company's common stock (the "Convertible Notes").

        At May 31, 2009, the rights offering (discussed below) related to the Convertible Notes had not yet expired, and therefore, none of the Convertible Notes were issued as of this date. However, the Company had entered into a forward purchase agreement with a related party, Sealy Holding LLC (the "Purchaser") an affiliate of KKR, in connection with the distribution of the subscription rights through which the Purchaser provided $177.1 million in cash to support its obligation to exercise its rights as well as an oversubscription for those rights that are not exercised by other common shareholders.

        The proceeds from the Refinancing were used to repay all of the outstanding amounts due under the Company's previously existing senior secured credit facilities, which consisted of a $125 million senior revolving credit facility and senior secured term loans, and to increase cash for general operating purposes.

ABL Revolver

        The ABL Revolver provides for revolving credit financing of up to $100.0 million, subject to borrowing base availability, and matures in May 2013. As of May 30, 2010, there were no amounts outstanding under the ABL Revolver. At May 30, 2010, the Company had approximately $57.7 million available under the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $15.7 million.

        The ABL Revolver agreement requires the Company to maintain a fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two consecutive calendar days is less than the greater of 1) 15% of the total commitment under the ABL Revolver and 2) $15.0 million. As of May 30, 2010, the Company is not in a minimum availability period under the ABL Revolver.

Senior Secured Notes

        On May 29, 2009, the Company issued $350.0 million aggregate principal amount of Senior Notes maturing April 2016 bearing interest at 10.875% per annum payable semi-annually in arrears on April 15 and October 15. The total proceeds received by the Company from the issuance of these notes was $335.9 million, resulting in an original issue discount ("OID") of $14.1 million which will be accreted over the life of the agreement with the related expense recognized as a component of interest expense in the Condensed Consolidated Statement of Operations. For the three and six months ended

15



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)


May 30, 2010, the Company recognized additional interest expense of $0.3 million and $0.7 million, respectively, related to the accretion of the OID.

        As discussed further in Note 8, on March 16, 2010, the Company redeemed 10%, or $35.0 million, of the principal amount of its outstanding Senior Notes at a redemption price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date.

Convertible PIK Notes

        On May 13, 2009, the Company announced a rights offering pursuant to which rights to subscribe for Convertible Notes were issued at no charge to all holders of the Company's common stock at the close of business on May 26, 2009 at a rate of one right per share of common stock. Each 13 rights entitled its holder to purchase a Convertible Note at a subscription price of $25.00 and each Convertible Note is initially convertible into 25 shares of common stock. The rights offering expired on July 2, 2009 and the related Convertible Notes were issued on July 10, 2009.

        The issuance of the 92,116,369 rights to purchase the Convertible Notes was considered a non-reciprocal transfer with owners and was therefore treated as a dividend of $188.8 million in the second quarter of fiscal 2009. The amount recorded as a dividend was calculated based on the initial fair value of the rights issued of $2.05 per right based on the initial trading value of the rights on the active market on which they traded. See Note 11. The rights were considered to constitute written options which are accounted for as derivative instruments and were adjusted, prior to exercise or expiration, to fair value through earnings. See Note 10.

        On May 15, 2009, the Company entered into a forward purchase agreement (the "Forward Contract") with the Purchaser in connection with the distribution of the subscription rights discussed above. The Forward Contract required the Purchaser to purchase up to $177.1 million aggregate principal amount of Convertible Notes which represents the maximum number of Convertible Notes that the Purchaser could have been obligated to purchase. The Forward Contract was settled upon the expiration of the rights offering. Upon settlement, the Company delivered to the Purchaser the Convertible Notes that were not subscribed for by the Company's shareholders (other than the Purchaser) and cash in an amount equal to the purchase price of the Convertible Notes that were subscribed to by the Company's shareholders (other than the Purchaser) along with accrued interest. In consideration of the Forward Contract, the Purchaser posted cash of $177.1 million on May 29, 2009 which bore interest during the rights offering period at the rate of LIBOR plus 3.00%. On July 10, 2009, the forward contract was settled resulting in a repayment to the Purchaser of $84.0 million which represented $83.3 million related to rights exercised by shareholders other than the Purchaser and an interest payment of $0.7 million. Under the terms of the Forward Contract, the Company paid the Purchaser a forward contract payment of $1.0 million which was recorded as a component of debt issuance costs, net, and other assets in the Condensed Consolidated Balance Sheet as of November 29, 2009 and is being amortized as a component of interest expense within the Condensed Consolidated Statements of Operations.

        Due to the agreement by the Purchaser to exercise all of the rights distributed to it under the terms of the Forward Contract, the 46,625,921 rights allocable to the Purchaser have been considered to be exercised at issuance of the rights. The fair value of these rights was considered to represent a

16



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)


substantial premium related to the issuance of the Convertible Notes. As such, $95.6 million of this premium was recorded as a component of additional paid-in capital upon issuance of the rights. The amount of the premium recognized was based upon the $2.05 initial fair value of the rights. The 45,490,448 rights issued to the Company's other shareholders remained outstanding through the rights period and were adjusted to their fair value (See Note 12) until the issuance of the Convertible Notes on July 10, 2009 as the rights were considered to be written options and were accounted for as derivative liabilities while they were outstanding. Upon issuance of the Convertible Notes, the current fair value of these rights were also considered to represent a substantial premium related to the issuance of the Convertible Notes and $97.8 million of premium was recorded as a component of additional paid-in capital within the Consolidated Balance Sheets.

        The Company accounts for the PIK interest on the Convertible Notes in accordance with the applicable FASB authoritative guidance pertaining to convertible instruments and derivative financial instruments indexed to, and potentially settled in a company's own stock. This guidance requires an allocation of a portion of the issuance amount to an embedded beneficial conversion feature based on the difference between the effective conversion price of the convertible debt and the fair value of the underlying common stock. Upon the January 15, 2010 interest payment date, the fair value of the underlying common stock was more than double the conversion price of the Convertible Notes. Therefore, a beneficial conversion feature was recognized for the entire amount of the PIK interest payment of $7.0 million. The recognition of the beneficial conversion feature resulted in the recognition of a discount of $7.0 million, which was reflected as a reduction of the balance of the Convertible Notes with an offsetting increase to additional paid-in capital. The recognized discount will be accreted through interest expense over the remaining term of the Convertible Notes.

        The Convertible Notes mature in July 2016 and bear interest at 8.00% per annum payable semi-annually in arrears on January 15 and July 15. The Company does not pay interest in cash related to the Convertible Notes, but instead increases the amount of the Convertible Notes by an amount equal to the interest payable for the interest period ending immediately prior. The amount of interest payable for each interest period is calculated on the basis of the accreted principal amount as of the first day of such interest period. The Convertible Notes are convertible into shares of the Company's common stock at an initial conversion price of $1.00 per share.

        During the three and six months ended May 30, 2010, there were no conversions of Convertible Notes into common shares.

        The indentures and agreements governing the ABL Revolver, Senior Notes, Convertible Notes and the 2014 Notes also impose certain restrictions including, but not limited to, the payment of dividends or other equity distributions and the incurrence of debt or liens upon the assets of the Company or its subsidiaries. For instance, the agreement governing Sealy Mattress Company's ABL Revolver contains restrictions on the ability of Sealy Corporation's subsidiaries to pay dividends or make other distributions to Sealy Corporation subject to specified exceptions including the satisfaction of a minimum fixed charge coverage ratio and average daily availability levels. Likewise, under the indentures governing our Senior Notes and the 2014 Notes we are restricted from paying dividends or making other distributions to Sealy Corporation unless we are able to satisfy certain requirements or use an available exception from the limitation. As of May 30, 2010, the net assets of Sealy Mattress Company and its subsidiaries of $251.7 million are restricted from being distributed to its parent due to

17



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)


the provisions in its long-term debt agreements. However, these agreements would allow $40.6 million of these assets to be distributed without restriction as restricted payments. At May 30, 2010, the Company was in compliance with the covenants contained within the related note indentures and agreements.

Note 10: Derivative Instruments and Hedging Strategies

        The Company uses hedging contracts to manage the risk of its overall exposure to changes in interest rates, commodity prices and foreign currency exchange rates. All of the Company's designated hedging instruments are considered to be cash flow hedges.

Interest Rate Risk

        The Company is exposed to interest rate risk associated with fluctuations in the interest rates on its variable interest rate debt. In order to manage this risk, the Company has entered into several interest rate swap agreements that convert the debt's variable interest rate to a fixed interest rate. These swap agreements are either designated as hedging instruments or are considered to be economic hedges which are not designated as hedging instruments. The gains and losses on both designated and undesignated swap agreements will offset losses and gains on the transactions being hedged. The Company formally documents qualifying hedged transactions and hedging instruments. The Company assesses, both at inception of the contract and on an ongoing basis, whether the hedging instruments are effective in offsetting changes in cash flows of the hedged transaction. The fair values of the interest rate agreements are estimated as described in Note 10, taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable. Details of the specific instruments used by the Company to hedge its exposure to interest rate fluctuations are as follows:

        Prior to the Refinancing, the Company had three interest rate swap agreements related to term debt under our Old Senior Credit Facility which were formally designated as cash flow hedges. These interest rate swaps consisted of: 1) an agreement fixing the floating portion of the interest rate at 5.495% on $242 million of the outstanding balance through November 2008, declining to $240 million from December 2008 through November 2009, and further declining to $180 million from December 2009 through November 2010; 2) an agreement fixing the floating portion of the interest rate at 1.952% on $20.0 million of the outstanding balance through November 4, 2009; and 3) an agreement fixing the floating portion of the interest rate at 1.991% on $107.0 million of the outstanding balance through February 4, 2010. In connection with the Refinancing, the Company paid $15.2 million to terminate these interest rate swap agreements which was recorded as refinancing expense in the second quarter of fiscal 2009.

        Additionally, the Company has three interest rate swaps outstanding for notional amounts of 2.3 million Euros, 2.9 million Euros and 3.5 million Euros which fix the floating interest rates on the Company's debt of its Europe segment at 4.92%, 4.85% and 4.50%, respectively. The notional amounts of these contracts amortize over the life of the agreement and the agreements expire in May 2019, January 2013 and October 2013. The Company has not formally documented these interest rate swaps as hedges.

18



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

        As of May 30, 2010, the total notional amount of the Company's interest rate swap agreements was $0.5 million, which relates to agreements that have not been designated as hedging instruments. The maximum length of time over which the Company is hedging its exposure to the variability of future cash flows related to forecasted interest payments through interest rate swap agreements is through May 2019.

Foreign Currency Exposure

        The Company is exposed to foreign currency risk related to purchases of materials and royalty payments made in a foreign currency. To manage the risk associated with fluctuations in foreign currencies, the Company enters into foreign currency forward and option contracts. As with its interest rate swap instruments, the Company designates certain of these contracts as hedging instruments and enters into some contracts that are considered to be economic hedges which are not designated as hedging instruments. Whether designated or undesignated, these contracts protect against the reduction in value of forecasted foreign currency cash flows resulting from payments in a foreign currency. The fair values of foreign currency agreements are estimated as described in Note 10, taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable. Details of the specific instruments used by the Company to hedge its exposure to certain foreign currency fluctuations are as follows:

        At May 30, 2010, the Company had 15 forward foreign currency contracts and 12 foreign currency option contracts to sell a total of 24.8 million Canadian dollars and receive US dollars at specified exchange rates with expiration dates ranging from June 15, 2010 through February 15, 2011. These hedges were entered into to protect against the fluctuation in the Canadian subsidiary's US dollar denominated purchases of raw materials. The Company has formally designated these contracts as cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in the forecasted purchases of these raw materials related to changes in the foreign currency exchange rates.

        The Company also enters into foreign currency contracts that are not designated as hedges for accounting purposes. The changes in fair value of these foreign currency hedges are included as a part of cost of goods sold or selling, general and administrative expenses in the Condensed Consolidated Statements of Operations. At May 30, 2010 and November 29, 2009, the Company did not have any outstanding foreign currency contracts that were not designated as hedges for accounting purposes.

        At May 31, 2009, the Company had three forward foreign currency contracts outstanding to purchase a total of 1.4 million Euros with expiration dates ranging from June 30, 2009 through December 31, 2009. These hedges were entered into to protect against the fluctuation in the Euro denominated royalty payments related to a third party license held by the Company. The Company formally designated these contracts as cash flow hedges, and they were expected to be highly effective in offsetting fluctuations in these royalty payments related to changes in the foreign currency exchange rates. These hedges were no longer outstanding at May 31, 2010.

        At May 30, 2010, the maximum length of time over which the Company is hedging its exposure to the reduction in value of certain forecasted foreign currency cash flows through foreign currency forward agreements is through February 15, 2011. Over the next 12 months, the Company expects to

19



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)


reclassify $0.6 million of deferred gains from accumulated other comprehensive income to selling, general and administrative expense as related forecasted foreign currency payments are made.

        For the three and six months ended May 30, 2010, the Company recognized foreign currency transaction (gains) of $(0.6 million) and $(1.8 million), respectively compared with losses of $0.4 million and $0.8 million, respectively for the three and six months ended May 31, 2009. These gains are recognized in cost of goods sold or selling, general and administrative expenses at the time they occur.

Commodity Price Exposure

        The Company is exposed to risk associated with fluctuations in the prices of diesel fuel used in the transportation of its finished product to its customers. To manage this risk, the Company enters into fixed price swap agreements. The Company designates these fixed price swap contracts as hedging instruments. These contracts protect against the reduction in value of forecasted cash flows resulting from the purchases of diesel fuel. The fair values of the fixed price swap agreements are estimated as described in Note 10, taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable. Details of the specific instruments used by the Company to hedge its exposure to diesel price fluctuations are as follows:

        At May 30, 2010, the Company had 8 fixed price swap contracts outstanding to purchase 1.0 million gallons of diesel fuel at specified prices with expiration dates ranging from May 31, 2010 through January 31, 2011. These hedges were entered into to protect against the fluctuations in the prices of diesel fuel purchased by certain of the Company's U.S. manufacturing facilities. The Company has formally designated these contracts as cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in the forecasted purchases of diesel fuel related to changes in the underlying diesel fuel prices.

Embedded Derivatives

        The Company evaluates its outstanding debt arrangements in accordance with the FASB's authoritative guidance on derivative instruments and hedging, which requires bifurcation of embedded derivative instruments and measurement of fair value for accounting purposes. The Company concluded that the contingent redemption option upon a change of control or a qualifying asset sale within its Senior Notes qualifies as an embedded derivative instrument which should be bundled as a compound embedded derivative and bifurcated from the Senior Notes. Due to the low probability of the occurrence of the contingent events requiring redemption, the fair value of this embedded derivative instrument was determined to be immaterial.

Rights to Purchase Convertible Notes

        During the second quarter of fiscal 2009, the Company issued rights to holders of its common stock at the close of business on May 26, 2009. As described in Note 10, these rights entitle holders to purchase the Company's Convertible Notes issued in connection with the Refinancing. These rights are considered to be written options and therefore are treated as derivatives and must be adjusted, after issuance, to fair value through earnings. Based on the terms of the forward purchase agreement with

20



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)


the Purchaser, the rights related to the Purchaser's then approximate 50.6% ownership are considered to be exercised as of the date of the issuance of the right.

        Therefore, the fair value of the rights attributable to the Purchaser, which was $95.6 million at May 27, 2009, was recorded as additional paid-in capital upon issuance. The rights issued to other shareholders remained outstanding at May 31, 2009, and were adjusted to their market value at that date resulting in a $2.7 million loss.

        At May 30, 2010 and November 29, 2009, the fair value carrying amount of the Company's derivative instruments was recorded as follows (in thousands):

 
  Asset Derivatives   Liability Derivatives  
 
  May 30, 2010   May 30, 2010  
 
  Balance Sheet
Location
  Fair
Value
  Balance Sheet
Location
  Fair
Value
 

Derivatives designated as hedging instruments

                     
 

Foreign exchange contracts

  Other current assets   $ 568   Other current liabilities   $  
 

Commodity fixed price swap contracts

  Other current assets     30   Other current liabilities     (20 )
                   

Total derivatives designated as hedging instruments

        598         (20 )

Derivatives not designated as hedging instruments

                     
 

Interest rate contracts

  Other noncurrent assets     496   Other noncurrent liabilities      
                   

Total derivatives not designated as hedging instruments

        496          
                   

Total derivatives

      $ 1,094       $ (20 )
                   

 

 
  Asset Derivatives   Liability Derivatives  
 
  November 29, 2009   November 29, 2009  
 
  Balance Sheet
Location
  Fair
Value
  Balance Sheet
Location
  Fair
Value
 

Derivatives designated as hedging instruments

                     
 

Foreign exchange contracts

  Other current assets   $ 1,133   Other current liabilities   $  
                   

Total derivatives designated as hedging instruments

        1,133          

Derivatives not designated as hedging instruments

                     
 

Interest rate contracts

  Other noncurrent assets     475   Other noncurrent liabilities      
                   

Total derivatives not designated as hedging instruments

        475          
                   

Total derivatives

      $ 1,608       $  
                   

21



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

        The effect of derivative instruments on the Condensed Consolidated Statement of Operations for the three and six months ended May 30, 2010 and May 31, 2009, was as follows (in thousands):

Three Months Ended May 30, 2010  
Derivatives in Designated
Cash Flow Hedging
Relationships
  Amount of
Gain/(Loss)
Recognized
in OCI on
Derivatives
(Effective Portion)
  Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Location of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
  Amount of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
 

Diesel fixed price swap contracts

    (11 )

Selling, general and administrative expenses

    32  

Selling, general and administrative expenses

    (16 )

Foreign exchange contracts

    (39 )

Cost of goods sold

    (5 )

Cost of goods sold

     
                       
 

Total

  $ (50 )     $ 27       $ (16 )
                       

 

Six Months Ended May 30, 2010  
Derivatives in Designated
Cash Flow Hedging
Relationships
  Amount of
Gain/(Loss)
Recognized
in OCI on
Derivatives
(Effective Portion)
  Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Location of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
  Amount of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
 

Diesel fixed price swap contracts

    6  

Selling, general and administrative expenses

    32  

Selling, general and administrative expenses

     

Foreign exchange contracts

    (175 )

Cost of goods sold

    52  

Cost of goods sold

     
                       
 

Total

  $ (169 )     $ 84       $  
                       

 

Three Months Ended May 31, 2009  
Derivatives in FAS 133 Cash
Flow Hedging Relationships
  Amount of
Gain/(Loss)
Recognized
in OCI on
Derivative
(Effective Portion)
  Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Location of Gain/(Loss)
Recognized in Income on
Derivative (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
  Amount of Gain/(Loss)
Recognized in Income on
Derivative (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
 

Interest rate contracts

    (2,484 )

Interest income (expense)

    (2,967 )

Interest income (expense)

     

Interest rate contracts

     

Refinancing expense

     

Refinancing expense

    (15,232 )

Foreign exchange contracts

    192  

Selling, general and administrative expenses

    19  

Selling, general and administrative expenses

     
                       
 

Total

  $ (2,292 )     $ (2,948 )     $ (15,232 )
                       

 

Six Months Ended May 31, 2009  
Derivatives in FAS 133 Cash
Flow Hedging Relationships
  Amount of
Gain/(Loss)
Recognized
in OCI on
Derivative
(Effective Portion)
  Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)
  Location of Gain/(Loss)
Recognized in Income on
Derivative (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
  Amount of Gain/(Loss)
Recognized in Income on
Derivative (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)
 

Interest rate contracts

    (3,864 )

Interest income (expense)

    (5,266 )

Interest income (expense)

     

Interest rate contracts

     

Refinancing expense

     

Refinancing expense

    (15,232 )

Foreign exchange contracts

    189  

Selling, general and administrative expenses

    108  

Selling, general and administrative expenses

     
                       
 

Total

  $ (3,675 )     $ (5,158 )     $ (15,232 )
                       

22



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

 

Three Months Ended  
 
   
  May 30, 2010   May 31, 2009  
Derivatives Not Designated as
Hedging Instruments
  Location of Gain/(Loss)
Recognized in Income
on Derivatives
  Amount of Gain/(Loss)
Recognized in Income
on Derivatives
  Amount of Gain/(Loss)
Recognized in Income
on Derivatives
 

Interest rate contracts

  Interest income (expense)   $ (9 ) $ 108  

Rights to purchase convertible notes

  Loss on rights for convertible notes         (2,729 )
               
 

Total

      $ (9 ) $ (2,621 )
               

 

Six Months Ended  
 
   
  May 30, 2010   May 31, 2009  
Derivatives Not Designated as
Hedging Instruments
  Location of Gain/(Loss)
Recognized in Income
on Derivatives
  Amount of Gain/(Loss)
Recognized in Income
on Derivatives
  Amount of Gain/(Loss)
Recognized in Income
on Derivatives
 

Interest rate contracts

  Interest income (expense)   $ 21   $ 319  

Rights to purchase convertible notes

  Loss on rights for convertible notes         (2,729 )
               
 

Total

      $ 21   $ (2,410 )
               

Note 11: Fair Value of Financial Instruments

        For assets and liabilities measured at fair value on a recurring basis during the period, the Company uses an income approach to value the assets and liabilities for outstanding interest rate swaps, foreign currency derivative contracts and diesel fixed price swap contracts discussed above. See Note 10. These contracts are valued using an income approach which consists of a discounted cash flow model that takes into account the present value of future cash flows under the terms of the contracts by using current market information available as of the reporting date such as prevailing interest rates and foreign currency and diesel spot and forward rates. We mitigate derivative credit risk by transacting with highly rated counterparties. The fair value of the Company's rights for convertible notes is determined based on the closing price reported on the active market on which the related rights trade. There were no non-financial assets or liabilities requiring initial measurement or subsequent remeasurement during the first six months of fiscal 2010 or 2009. Further, there were no transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy during the six months ended May 30, 2010 and May 31, 2009. The following table provides a summary of the fair values of assets and liabilities (in thousands):

 
   
  Fair Value Measurements at May 30, 2010 Using  
 
  May 30, 2010   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
  Significant Other
Observable Inputs
(Level 2)
  Significant
Unobservable Inputs
(Level 3)
 

Interest rate, foreign exchange and commodity derivatives

  $ 1,074   $   $ 1,074   $  
                   

23



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 11: Fair Value of Financial Instruments (Continued)

 
   
  Fair Value Measurements at November 29, 2009 Using  
 
  November 29, 2009   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
  Significant Other
Observable Inputs
(Level 2)
  Significant
Unobservable Inputs
(Level 3)
 

Interest rate and foreign exchange derivatives

  $ 1,608   $   $ 1,608   $  
                   

        Due to the short maturity of cash and equivalents, accounts receivable, accounts payable and accrued expenses, their carrying values approximate fair value. The carrying amounts of long term debt, based on quoted market prices, at May 30, 2010 were as follows (in thousands):

Senior Secured Notes

  $ 387,170  

Convertible Notes

    650,203  

Senior Subordinated Notes

    266,928  

Note 12: Debt Extinguishment and Refinancing Expense

        Debt extinguishment and refinancing expenses for the three and six months ended May 30, 2010 includes non-cash charges of $2.7 million related to the write-off of debt issuance costs and original issue discount associated with the $35.0 million of principal amount of the Senior Notes that were repurchased during the six months ended May 30, 2010. Also included is a cash charge of $1.1 million which represents the premium that was paid to repurchase these notes. See Note 8.

        Debt extinguishment and refinancing expenses for the three and six months ended May 31, 2009 includes non-cash charges of $2.1 million relating to the write-off of debt issuance costs associated with the previously existing senior term loans as well as $15.2 million of cash charges associated with the termination of the interest rate swap agreements that were associated with the old senior credit facility. See Note 9.

Note 13: Other Income, Net

        Other income, net, includes interest income of $0.1 million and $0.1 million, for the three and six months ended May 30, 2010, respectively, and an insignificant amount for the three and six months ended May 31, 2009.

Note 14: Acquisitions and Dispositions

        On December 1, 2008, the Company sold fifty percent of its ownership interest in its 100% owned subsidiary Sealy Korea Company to the Company's Australian licensee and these operations became part of the group of joint ventures that we participate in with the Australian licensee. In consideration of the sale of the fifty percent interest, the Company received net cash of $1.2 million and recognized a gain on the sale of the subsidiary of $1.3 million which has been recorded as a gain on sale of subsidiary stock in the accompanying Condensed Consolidated Statements of Operations. Upon the close of this transaction, the subsidiary was deconsolidated. The joint venture to which these operations were added is not considered to be a variable interest entity for which the Company is a primary

24



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 14: Acquisitions and Dispositions (Continued)


beneficiary and is, therefore, not consolidated for financial statement purposes. The Company accounts for its interest in this joint venture under the equity method.

        On December 4, 2008, the Company and its Australian licensee each acquired a 50% interest in a joint venture that owns the assets of the Company's former New Zealand licensee. The purchase price for the 50% ownership was $1.9 million. Additional contributions of $0.4 million were made by each party to the joint venture to fund the initial working capital of this entity. The New Zealand joint venture is not considered to be a variable interest entity for which the Company is a primary beneficiary and is, therefore, not consolidated for financial statement purposes. The Company accounts for its interest in this joint venture under the equity method.

Note 15: Defined Benefit Pension Expense

        The components of net periodic pension cost recognized for the Company's defined benefit pension plans in the U.S., Canada and France for the three and six months ended May 30, 2010 and May 31, 2009 are as follows (in thousands):

 
  Three Months Ended   Six Months Ended  
 
  May 30, 2010   May 31, 2009   May 30, 2010   May 31, 2009  

Service cost

  $ 244   $ 184   $ 488   $ 551  

Interest cost

    383     352     766     1,057  

Expected return on plan assets

    (305 )   (235 )   (611 )   (705 )

Amortization of unrecognized losses

    37     91     74     274  

Amortization of unrecognized prior service cost

    143     63     287     188  
                   

Net periodic pension cost*

  $ 502   $ 455   $ 1,004   $ 1,365  
                   

Cash contributions

  $ 636   $ 0   $ 636   $ 1,447  
                   

*
Net periodic pension cost recognized for the three and six months ended May 30, 2010 is based upon preliminary estimates pending the final actuarial determination of such costs for fiscal 2010. Similarly, net periodic pension cost for the three and six months ended May 31, 2009 is based upon preliminary estimates.

        The Company expects to make additional cash contributions to the plans of approximately $0.4 million during the remainder of fiscal 2010.

Note 16: Income Taxes

        The Company's effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of non-deductible paid in kind interest, certain foreign tax rate differentials and state and local income taxes. The effective tax rate for the three and six months ended May 30, 2010 was approximately 73.5% and 61.3%, respectively, compared to approximately (4.6)% and 34.0%, for the three and six months ended May 31, 2009, respectively. The effective rate for the three and six months ended May 30, 2010 was higher than the rate for the three and six months ended

25



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 16: Income Taxes (Continued)


May 31, 2009, primarily due to the effect of non-deductible paid in kind interest which resulted from the Refinancing in the second quarter of fiscal 2009.

        The Condensed Consolidated Balance Sheet as of May 30, 2010 includes accrued interest of $4.1 million and penalties of $3.1 million due to unrecognized tax benefits. As of November 29, 2009, the Company had recorded accrued interest of $3.6 million and penalties of $3.1 million due to unrecognized tax benefits.

        The Company expects the liability for uncertain tax positions to decrease by approximately $2.9 million within the succeeding twelve months due to expiration of income tax statutes of limitations. Federal years open to examination are fiscal year 2006 and forward. State and international jurisdictions remain open to examination for fiscal year 2000 and forward.

        Significant judgment is required in evaluating the Company's federal, state and foreign tax positions and in the determination of its tax provision. Despite the Company's belief that its liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of any particular tax matter. The Company may adjust these liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, or resolution of issues in the courts. These adjustments are recognized as a component of income tax expense entirely in the period in which they are identified. The Company is currently undergoing examinations of certain of its corporate income tax returns by tax authorities. Issues related to certain of these reserves have been presented to the Company and the Company believes that such audits will not result in a material assessment or payment of taxes related to these positions during the one year period following May 30, 2010. The Company also cannot predict when or if any other future tax payments related to these tax positions may occur.

Note 17: Comprehensive Income

        Comprehensive (loss) income for the three and six months ended May 30, 2010 and May 31, 2009 was $(0.7) million and $4.0 million, respectively for fiscal 2010 and $15.6 million and $16.3 million, respectively for fiscal 2009. The decrease in comprehensive income for the three and six months ended May 30, 2010 compared to the three and six months ended May 31, 2009, has been driven primarily by a decrease in gains from foreign currency translation and the change in cash flow derivatives offset by increased net income.

        The following table provides the components of accumulated other comprehensive income in the Condensed Consolidated Balance Sheets (in thousands):

 
  May 30, 2010   November 29, 2009  

Unrealized gain on cash flow hedges, net of tax

  $ 197   $ 463  

Unrealized actuarial loss and prior service credit for pension liability, net of tax

    (7,567 )   (7,936 )

Accumulated foreign currency translation adjustment

    3,705     6,420  
           

  $ (3,665 ) $ (1,053 )
           

26



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 18: Commitments and Contingencies

Contingencies

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

        The Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. The Company and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, the Company and its subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the property in 1997. The Company and its subsidiary retained primary responsibility for the required remediation. The Company has completed essentially all soil remediation with the approval of the New Jersey Department of Environmental Protection and continues to operate a groundwater remediation system on the site. During 2005, with the approval of the New Jersey Department of Environmental Protection, the Company removed and disposed of sediment in Oakeys Brook adjoining the site. The Company continues to monitor ground water at the site. The Company has recorded a reserve as a component of other accrued liabilities and other noncurrent liabilities in the accompanying Condensed Consolidated Balance Sheets as of May 30, 2010 for $2.1 million ($2.5 million prior to discounting at 4.75%) associated with this remediation project.

        The Company is also remediating soil and groundwater contamination at an inactive facility located in Oakville, Connecticut. Although the Company is conducting the remediation voluntarily, it obtained Connecticut Department of Environmental Protection approval of the remediation plan. The Company has completed essentially all soil remediation under the remediation plan and is currently monitoring groundwater at the site. The Company identified cadmium in the ground water at the site and removed the contaminated soil and rock from the site during fiscal 2007. The Company has recorded a liability of approximately $0.1 million associated with the additional work and ongoing monitoring. The Company believes the contamination is attributable to the manufacturing operations of previous, unrelated, unaffiliated occupants of the facility.

        The Company cannot predict the ultimate timing or costs of the South Brunswick and Oakville environmental matters. Based on facts currently known, the Company believes that the accruals recorded are adequate and does not believe the resolution of these matters will have a material adverse effect on the financial position or future operations of the Company. However, in the event of an adverse decision by the agencies involved, or an unfavorable result in the New Jersey natural resources damages matter, these matters could have a material adverse effect.

    Commitments

        The Company has employment agreements with certain of its executive officers and key employees which, among other things, provide severance benefits to those employees. For the three and six months ended May 30, 2010, severance costs of $0.1 million and $1.4 million were recorded as a component of operating income within the accompanying Condensed Consolidated Statements of

27



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 18: Commitments and Contingencies (Continued)

Operations. For the three and six months ended May 31, 2009, severance costs of an insignificant amount and $1.2 million, were recorded as a component of operating income within the accompanying Condensed Consolidated Statements of Operations. Severance benefits of $0.5 million and $1.2 million have been accrued as of May 30, 2010 and November 29, 2009, respectively. The entire liability has been recorded as a component of accrued compensation within the accompanying Condensed Consolidated Balance Sheet as of May 30, 2010 and November 29, 2009, respectively.

Note 19: Related Party Transactions

        During the three and six months ended May 30, 2010, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC (a consulting company that works exclusively with KKR's portfolio companies) of $0.5 million and $1.0 million, respectively. As of May 30, 2010, $0.3 million of this amount was accrued as a component of other accrued liabilities and accounts payable in the accompanying Condensed Consolidated Balance Sheets. We also participate in a lease arrangement with a KKR affiliate for our Clarion facility for a six month initial term with two six month renewal options available. We have received lease income on this property of an insignificant amount during the first six months of fiscal 2010.

        During the three and six months ended May 31, 2009, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC (a consulting company that works exclusively with KKR's portfolio companies) of $0.9 million and $1.6 million, respectively. As of May 31, 2009, $1.1 million of this amount was accrued as a component of other accrued expenses in the accompanying Condensed Consolidated Balance Sheets. The Company was also billed $0.1 million and $0.2 million for executive search costs incurred by KKR on the Company's behalf for the three and six months ended May 31, 2009, respectively.

        In connection with the Refinancing (Note 9), the Company entered into an agreement with Sealy Holding, LLC, a company which is owned by KKR, whereby the Purchaser provided $177.1 million in cash to support its obligation to exercise its rights as well as an oversubscription for those rights that are not exercised by other common shareholders. Until the conclusion of the rights offering period, the $177.1 million bore interest at a rate of LIBOR plus 3.0%. At the expiration of the rights offering period, the Company repaid the Purchaser an amount equal to the proceeds obtained from the subscription to the Convertible Notes by other shareholders and Convertible Notes were for the remaining amount. For the three and six months ended May 31, 2009, $0.1 million of interest was recognized on this related party debt. As consideration for the forward purchase, the Company paid the Purchaser $1.0 million which was deferred as debt issuance costs and is being amortized as a component of interest expense.

        Certain funds and accounts managed by KKR Asset Management LLC, an affiliate of KKR, also participated in the Senior Notes that were issued in connection with the Refinancing. At May 30, 2010, KKR Financial LLC holds $45.7 million principal amount of the outstanding Senior Notes. Interest expense of $1.2 million and $2.6 million has been recorded during the three and six months ended May 30, 2010, respectively related to KKR Financial LLC's portion of the outstanding Senior Notes and remains accrued at May 30, 2010.

28



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 19: Related Party Transactions (Continued)

        During the first half of fiscal 2010, the Company's joint ventures declared a distribution of $1.0 million which has been reflected as a reduction of our investment in these joint ventures in the accompanying Condensed Consolidated Balance Sheet as of May 30, 2010.

Note 20: Segment Information

        The Company has determined that it has two reportable segments: the Americas and Europe. These segments have been identified and aggregated based on the Company's organizational structure which is organized around geographic areas.

        Both reportable segments manufacture and market conventional and specialty bedding. The Americas segment's operations are concentrated in the United States, Canada, Mexico, Argentina, Uruguay, Brazil, Puerto Rico and Chile. Europe's operations are concentrated in western Europe. The accounting policies of the segments are the same as those described in Note 1. The Company evaluates performance based on profit or loss from operations before interest expense, income taxes, depreciation and amortization ("EBITDA"). The Company accounts for inter-segment sales and transfers as if the sales or transfers were to third parties, that is, at current market prices.

        Sales by geographic area are as follows (in thousands):

 
  Three Months Ended   Six Months Ended  
 
  May 30, 2010   May 31, 2009   May 30, 2010   May 31, 2009  

Americas:

                         
 

United States

  $ 229,131   $ 222,478   $ 475,505   $ 457,233  
 

Canada

    42,091     32,743     86,818     63,782  
 

Other International

    20,133     19,098     42,026     38,989  
                   
   

Total Americas

    291,355     274,319     604,349     560,004  

Europe

    25,173     24,136     51,806     48,427  
                   
   

Total

  $ 316,528   $ 298,455   $ 656,155   $ 608,431  
                   

Total International

  $ 87,397   $ 75,977   $ 180,650   $ 151,198  

        Intersegment sales from the Americas to Europe for the three and six months ended May 30, 2010 were $0.1 million and $0.2 million, respectively. There were no inter-segment sales for the three and six months ended May 31, 2009. Long lived assets (principally property, plant and equipment) outside the United States were $57.7 million and $60.6 million as of May 30, 2010 and November 29, 2009, respectively.

29



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Segment Information (Continued)

 
  Three Months Ended   Six Months Ended  
 
  May 30, 2010   May 31, 2009   May 30, 2010   May 31, 2009  
 
  (in thousands)
  (in thousands)
 

Net sales to external customers:

                         
 

Americas

  $ 291,355   $ 274,319   $ 604,349   $ 560,003  
 

Europe

    25,173     24,136     51,806     48,427  
                   

    316,528     298,455     656,155     608,430  
                   

Capital expenditures:

                         
 

Americas

    4,068     2,129     6,160     4,337  
 

Europe

    161     52     518     190  
                   

    4,229     2,181     6,678     4,527  
                   

EBITDA:

                         
 

Americas

    30,174     20,607     74,430     54,560  
 

Europe

    (921 )   (3,502 )   (1,784 )   (4,515 )
 

Inter-segment eliminations

        (67 )       (68 )
                   

    29,253     17,038     72,646     49,977  
                   

Reconciliation of EBITDA to net income:

                         
 

EBITDA from segments

    29,253     17,038     72,646     49,977  
 

Interest

    21,767     16,876     44,107     34,424  
 

Income taxes

    (550 )   (2,773 )   7,240     46  
 

Depreciation and amortization

    7,187     8,323     14,736     16,552  
                   
   

Net Income

  $ 849   $ (5,388 ) $ 6,563   $ (1,045 )
                   

 

 
  May 30, 2010   November 29, 2009  
 
  (in thousands)
 

Total assets:

             
 

Americas

  $ 913,616   $ 949,051  
 

Europe

    53,338     67,972  
 

Intersegment eliminations

    (1,553 )   (1,553 )
           

  $ 965,401   $ 1,015,470  
           

Note 21: Earnings per Share

        In June 2008, the FASB issued new authoritative guidance that indicates that unvested share-based awards that contain rights to receive non-forfeitable dividends (whether paid or unpaid) are participating securities, and should be included in the two-class method of computing earnings per share. As of May 30, 2010, the Company implemented this guidance which requires the unvested shares of its restricted shares outstanding to be treated as participating securities in accordance with the two-class method in the calculation of both basic and diluted earnings per share. Prior period comparative data has been retrospectively restated below, in accordance with the new guidance.

30



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 21: Earnings per Share (Continued)

        The following table sets forth the computation of basic and diluted earnings per share for the three and six months ended:

 
  Three Months Ended   Six Months Ended  
 
  May 30, 2010   May 31, 2009   May 30, 2010   May 31, 2009  
 
  (in thousands)
  (in thousands)
 

Numerator:

                         

Net income (loss), as reported

  $ 849   $ (5,389 ) $ 6,563   $ (1,045 )

Net income (loss) attributable to participating securities

    (3 )   17     (20 )   3  

Interest on convertible notes

            7,610      
                   

Net income available to common shareholders

  $ 846   $ (5,372 ) $ 14,153   $ (1,042 )
                   

Denominator:

                         

Denominator for basic earnings per share—weighted average shares

    94,604     91,819     94,563     91,813  

Effect of dilutive securities:

                         

Convertible debt

            180,000      

Stock options

    1,233         1,217      

Restricted shares

                 

Restricted share units

    10,660         9,977      

Other

    345         335      
                   

Denominator for diluted earnings per share—adjusted weighted average shares and assumed conversions

    106,842     91,819     286,092     91,813  
                   

        Options and share units (in thousands) not included in the computation of diluted earnings per share because their impact is antidilutive for the three and six months ended May 30, 2010 are 5,315 and 5,332, respectively. Additionally, for the three months ended May 30, 2010, the outstanding Convertible Notes were excluded from the computation of diluted earnings per share since their inclusion would be antidilutive. The Convertible Notes not included in the computation of diluted earnings per share for the three months ended May 30, 2010 convert into a weighted average 181,777 shares (in thousands). Interest expense recognized during the three months ended May 30, 2010 related to these Convertible Notes was $4.1 million. Since the Company reported a net loss for the three and six month periods ending May 31, 2009, the 189,478 outstanding options to purchase common stock, restricted shares, share units and rights for Convertible Notes (in thousands) are considered antidilutive and are not included in the computation of diluted earnings per share.

Note 22: Restructuring Activities

        For the three and six months ended May 31, 2009, the Company recognized restructuring charges related to initiatives including facility closures and organizational changes. There were no such charges incurred during the three and six months ended May 30, 2010. The pretax restructuring charges

31



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 22: Restructuring Activities (Continued)


recognized by the Company during the three and six months ended May 30, 2010 and May 31, 2009 were as follows:

 
  Three Months Ended   Six Months Ended  
 
  May 30, 2010   May 31, 2009   May 30, 2010   May 31, 2009  
 
  (in thousands)
  (in thousands)
 

Americas Segment

  $   $ 1,335   $   $ 1,448  

Europe Segment

                 
                   

  $   $ 1,335   $   $ 1,448  
                   

        The following table summarizes the restructuring activity for the six months ended May 31, 2009 and the related restructuring liabilities balance:

 
  2009 Restructuring Activities  
 
  Liabilities
November 30, 2008
  Charges to
Expense
  Cash
Payments
  Non-cash
Utilized
  Liabilities
May 31, 2009
 
 
  (in thousands)
 

Severance and employee benefits

  $ 393   $ 114   $ (315 ) $   $ 192  

Asset impairment charges

        1,334         (1,334 )    
                       
 

Total

  $ 393   $ 1,448   $ (315 ) $ (1,334 ) $ 192  
                       

        In the first half of fiscal 2009, the Company incurred restructuring charges of $0.1 million representing costs incurred to relocate machinery and equipment associated with the closure of its Clarion, Pennsylvania manufacturing facility which occurred in October 2008. Additionally, in the second quarter of fiscal 2009, management made the decision to cease manufacturing of certain foundation components and begin purchasing all of these components from third party suppliers. As a result, the Company incurred certain costs which were insignificant related to one-time terminations of employees. Additionally, the Company recognized an impairment charge of approximately $1.3 million for the related equipment used in this manufacturing process that was not sold. This plan was completed in the second quarter of fiscal 2009 and we do not expect to incur additional costs related to this restructuring activity.

Note 23: Guarantor/Non-Guarantor Financial Information

        Sealy Corporation, Sealy Mattress Corporation (a 100% owned subsidiary of Sealy Corporation) and each of the subsidiaries of Sealy Mattress Company (the "Issuer") that guarantee the Senior Notes, the Convertible Notes and the 2014 Notes (the "Guarantor Subsidiaries"), and are 100% owned subsidiaries of the Issuer, have fully and unconditionally guaranteed, on a joint and several basis, the obligation to pay principal and interest with respect to the Senior Notes, the Convertible Notes and the 2014 Notes (collectively, the "Guaranteed Notes") of the Issuer. Substantially all of the Issuer's operating income and cash flow is generated by its subsidiaries. As a result, funds necessary to meet the Issuer's debt service obligations are provided, in part, by distributions or advances from its subsidiaries. Under certain circumstances, contractual and legal restrictions, as well as the financial condition and operating requirements of the Issuer's subsidiaries, could limit the Issuer's ability to

32



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)


obtain cash from its subsidiaries for the purpose of meeting its debt service obligations, including the payment of principal and interest on the Guaranteed Notes. Although holders of the Guaranteed Notes will be direct creditors of the Issuer's principal direct subsidiaries by virtue of the guarantees, the Issuer has subsidiaries ("Non-Guarantor Subsidiaries") that are not included among the Guarantor Subsidiaries, and such subsidiaries will not be obligated with respect to the Guaranteed Notes. As a result, the claims of creditors of the Non-Guarantor Subsidiaries will effectively have priority with respect to the assets and earnings of such companies over the claims of creditors of the Issuer, including the holders of the Guaranteed Notes.

        The following supplemental Condensed Consolidating Financial Statements present:

    1.
    Condensed Consolidating Balance Sheets as of May 30, 2010 and November 29, 2009, Condensed Consolidating Statements of Operations for the three and six months ended May 30, 2010 and May 31, 2009, and Condensed Consolidating Statements of Cash Flows for the three and six months ended May 30, 2010 and May 31, 2009.

    2.
    Sealy Corporation, who became a guarantor of the 2014 Notes effective May 25, 2006 and who is guarantor of the Senior Notes and a co-issuer of the Convertible Notes (as "Guarantor Parent"), Sealy Mattress Corporation (a guarantor), the Issuer, combined Guarantor Subsidiaries and combined Non-Guarantor Subsidiaries with their investments in subsidiaries accounted for using the equity method (see Note 1).

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

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

33



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Balance Sheets

May 30, 2010

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-
Guarantor
Subsidiaries
  Eliminations   Consolidated  

Assets

                                           

Current assets:

                                           
   

Cash and equivalents

  $ 769   $   $ 24,234   $ 18,369   $ 36,185   $   $ 79,557  
   

Accounts receivable, net

            22     96,765     67,982         164,769  
   

Inventories

            1,670     44,475     21,491     (360 )   67,276  
   

Other current assets and deferred income taxes

    391         780     30,429     5,138         36,738  
                               

Total current assets

    1,160         26,706     190,038     130,796     (360 )   348,340  

Property, plant and equipment, at cost

            9,415     332,945     90,509         432,869  

Less accumulated depreciation

            (5,066 )   (183,882 )   (49,800 )       (238,748 )
                               

            4,349     149,063     40,709         194,121  

Other assets:

                                           
 

Goodwill

            24,741     301,942     34,210         360,893  
 

Intangible assets, net

                1,522     6         1,528  
 

Net investment in subsidiaries

    (165,380 )   251,721     368,016     196,116     (1 )   (650,472 )    
 

Due from (to) affiliates

    256,603     (417,101 )   558,251     (116,928 )   (100,486 )   (180,339 )    
 

Debt issuance costs, net and other assets

            24,886     19,480     16,153         60,519  
                               

    91,223     (165,380 )   975,894     402,132     (50,118 )   (830,811 )   422,940  
                               
 

Total assets

  $ 92,383   $ (165,380 ) $ 1,006,949   $ 741,233   $ 121,387   $ (831,171 ) $ 965,401  
                               

Liabilities and Stockholders' (Deficit) Equity

                                           

Current liabilities:

                                           
 

Current portion—long-term obligations

  $   $   $   $ 1,741   $ 8,659   $   $ 10,400  
 

Accounts payable

            303     50,139     37,929         88,371  
 

Accrued customer incentives and advertising

                20,789     7,019         27,808  
 

Accrued compensation

            356     15,309     7,136         22,801  
 

Accrued interest

            1,228     13,273     158         14,659  
 

Other accrued liabilities

            287     25,756     5,742         31,785  
                               

Total current liabilities

            2,174     127,007     66,643         195,824  

Long-term obligations

   
180,409
   
   
752,992
   
39,366
   
5,764
   
(180,409

)
 
798,122
 

Other liabilities

                47,765     10,989         58,754  

Deferred income tax liabilities

    144         62     21     644         871  

Stockholders' equity (deficit)

    (88,170 )   (165,380 )   251,721     527,074     37,347     (650,762 )   (88,170 )
                               
 

Total liabilities and stockholders' equity (deficit)

  $ 92,383   $ (165,380 ) $ 1,006,949   $ 741,233   $ 121,387   $ (831,171 ) $ 965,401  
                               

34



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Balance Sheets

November 29, 2009

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-
Guarantor
Subsidiaries
  Eliminations   Consolidated  

Assets

                                           

Current assets:

                                           
 

Cash and equivalents

  $ 357   $   $ 29,234   $ 67,950   $ 33,886   $   $ 131,427  
 

Accounts receivable, net

            6     82,339     74,505         156,850  
 

Inventories

            1,663     37,023     18,478     (354 )   56,810  
 

Other current assets and deferred income taxes

    394         1,169     31,405     8,334         41,302  
                               

Total current assets

    751         32,072     218,717     135,203     (354 )   386,389  

Property, plant and equipment, at cost

            9,337     335,302     102,350         446,989  

Less accumulated depreciation

            (4,802 )   (180,116 )   (54,590 )       (239,508 )
                               

            4,535     155,186     47,760         207,481  

Other assets:

                                           
 

Goodwill

            24,741     301,942     33,900         360,583  
 

Intangible assets, net

    271             1,666             1,937  
 

Net investment in subsidiaries

    (170,794 )   245,511     389,844     75,527         (540,088 )    
 

Due from (to) affiliates

    243,154     (416,305 )   553,243     (102,010 )   (98,073 )   (180,009 )    
 

Debt issuance costs, net and other assets

            29,226     17,902     11,952         59,080  
                               

    72,631     (170,794 )   997,054     295,027     (52,221 )   (720,097 )   421,600  
                               
 

Total assets

  $ 73,382   $ (170,794 ) $ 1,033,661   $ 668,930   $ 130,742   $ (720,451 ) $ 1,015,470  
                               

Liabilities and Stockholders' (Deficit) Equity

                                           

Current liabilities:

                                           
 

Current portion—long-term obligations

  $   $   $   $ 2,159   $ 11,534   $   $ 13,693  
 

Accounts payable

            275     45,413     43,283         88,971  
 

Accrued customer incentives and advertising

                24,175     7,629         31,804  
 

Accrued compensation

            391     32,706     10,008         43,105  
 

Accrued interest

    6         1,343     13,658     223         15,230  
 

Other accrued liabilities

    1,116         401     28,046     6,873         36,436  
                               

Total current liabilities

    1,122         2,410     146,157     79,550         229,239  

Long-term obligations

    180,108         785,678     40,220     7,868     (180,108 )   833,766  

Other liabilities

                48,456     11,169         59,625  

Deferred income tax liabilities

    144         62     21     605         832  

Common stock and options subject to redemption

                             

Stockholders' equity (deficit)

    (107,992 )   (170,794 )   245,511     434,076     31,550     (540,343 )   (107,992 )
                               
 

Total liabilities and stockholders' equity (deficit)

  $ 73,382   $ (170,794 ) $ 1,033,661   $ 668,930   $ 130,742   $ (720,451 ) $ 1,015,470  
                               

35



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Three Months Ended May 30, 2010

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-
Guarantor
Subsidiaries
  Eliminations   Consolidated  

Net sales

  $   $   $ 18,676   $ 218,859   $ 85,907   $ (6,914 ) $ 316,528  

Cost and expenses:

                                           
 

Cost of goods sold

            11,310     130,484     53,494     (6,998 )   188,290  
 

Selling, general and administrative

    369         1,770     80,108     24,935         107,182  
 

Amortization expense

                72     43         115  
 

Restructuring expenses and asset impairment

                             
 

Royalty (income) expense, net

                (3,807 )   22         (3,785 )
                               

Income from operations

    (369 )       5,596     12,002     7,413     84     24,726  
 

Interest expense

        79     20,332     571     783         21,765  
 

Loss on rights for convertible notes

                             
 

Gain on sale of subsidiary stock

                             
 

Refinancing and extinguishment of debt and interest rate derivatives

            3,759                 3,759  
 

Other (income) expense, net

                    (50 )       (50 )
 

Loss (income) from equity investees

    (2,454 )   (3,343 )   23,918             (18,121 )    
 

Loss (income) from non- guarantor equity investees

                (3,879 )       3,879      
 

Capital charge and intercompany interest allocation

            (18,627 )   17,959     668          
                               

Income (loss) before income taxes

    2,085     3,264     (23,786 )   (2,649 )   6,012     14,326     (748 )

Income tax provision (benefit)

    1,236     810     (27,129 )   21,254     3,180     99     (550 )

Equity in earnings of unconsolidated affiliates

                    1,047         1,047  
                               

Net income (loss)

  $ 849   $ 2,454   $ 3,343   $ (23,903 ) $ 3,879   $ 14,227   $ 849  
                               

36



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Three Months Ended May 31, 2009

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-
Guarantor
Subsidiaries
  Eliminations   Consolidated  

Net sales

  $   $   $ 19,327   $ 210,797   $ 74,789   $ (6,458 ) $ 298,455  

Cost and expenses:

                               
 

Cost of goods sold

            11,751     121,595     49,673     (6,510 )   176,509  
 

Selling, general and administrative

    (197 )       1,819     71,506     22,453         95,581  
 

Goodwill impairment loss

                             
 

Amortization of intangibles

    723             72     (17 )       778  
 

Restructuring and related costs

                1,335             1,335  
 

Royalty (income) expense, net

    (999 )           (4,600 )   999         (4,600 )
                               

Income from operations

    473         5,757     20,889     1,681     52     28,852  
 

Interest expense

    27     72     15,951     623     203         16,876  
 

Loss on rights for convertible notes

    2,729                         2,729  
 

Gain on sale of subsidiary stock

                             
 

Refinancing and extinguishment of debt and interest rate derivatives

            17,422                 17,422  
 

Other (income) expense, net

                    (13 )       (13 )
 

Loss (income) from equity investees

    4,786     4,812     (1,109 )           (8,489 )    
 

Loss (income) from non- guarantor equity investees

                309         (309 )    
 

Capital charge and intercompany interest allocation

            (14,544 )   14,039     505          
                               

Income (loss) before income taxes

    (7,069 )   (4,884 )   (11,963 )   5,918     986     8,850     (8,162 )

Income tax expense (benefit)

    (1,680 )   (98 )   (7,151 )   4,838     1,362     (44 )   (2,773 )
                               

Net income (loss)

  $ (5,389 ) $ (4,786 ) $ (4,812 ) $ 1,080   $ (376 ) $ 8,894   $ (5,389 )
                               

37



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Six Months Ended May 30, 2010

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-Guarantor
Subsidiaries
  Eliminations   Consolidated  

Net sales

  $   $   $ 40,259   $ 452,279   $ 177,531   $ (13,914 ) $ 656,155  

Cost and expenses:

                                           
 

Cost of goods sold

            24,237     267,826     109,642     (13,908 )   387,797  
 

Selling, general and administrative

    379         3,729     161,209     50,821         216,138  
 

Amortization expense

    266             144     44         454  
 

Restructuring expenses and asset impairment

                             
 

Royalty (income) expense, net

    (368 )           (7,928 )   488         (7,808 )
                               

Income from operations

    (277 )       12,293     31,028     16,536     (6 )   59,574  
 

Interest expense

    1     159     41,048     1,235     1,663         44,106  
 

Refinancing and extinguishment of debt and interest rate derivatives

            3,759                 3,759  
 

Other (income) expense, net

                    (104 )       (104 )
 

Loss (income) from equity investees

    (8,148 )   (9,054 )   19,250             (2,048 )    
 

Loss (income) from non- guarantor equity investees

                (8,302 )       8,302      
 

Capital charge and intercompany interest allocation

            (37,483 )   34,579     2,904          
                               

Income (loss) before income taxes

    7,870     8,895     (14,281 )   3,516     12,073     (6,260 )   11,813  

Income tax provision (benefit)

    1,307     747     (23,335 )   22,732     5,761     28     7,240  

Equity in earnings of unconsolidated affiliates

                    1,990         1,990  
                               

Net income (loss)

  $ 6,563   $ 8,148   $ 9,054   $ (19,216 ) $ 8,302   $ (6,288 ) $ 6,563  
                               

38



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Six Months Ended May 31, 2009

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-Guarantor
Subsidiaries
  Eliminations   Consolidated  

Net sales

  $   $   $ 40,220   $ 433,466   $ 148,334   $ (13,589 ) $ 608,431  

Cost and expenses:

                               
 

Cost of goods sold

            24,124     257,675     100,624     (13,578 )   368,845  
 

Selling, general and administrative

    (3 )       3,752     146,684     41,844         192,277  
 

Goodwill impairment loss

                             
 

Amortization of intangibles

    1,450             144     (1 )       1,593  
 

Restructuring and related costs

                1,448             1,448  
 

Royalty (income) expense, net

    (2,003 )           (8,001 )   2,034         (7,970 )
                               

Income from operations

    556         12,344     35,516     3,833     (11 )   52,238  
 

Interest expense

    63     160     31,853     1,242     1,106         34,424  
 

Loss on rights for convertible notes

    2,729                         2,729  
 

Gain on sale of subsidiary stock

                    (1,292 )       (1,292 )
 

Refinancing and extinguishment of debt and interest rate derivatives

            17,422                 17,422  
 

Other (income) expense, net

                    (46 )       (46 )
 

Loss (income) from equity investees

    478     437     (1,569 )           654      
 

Loss (income) from non- guarantor equity investees

                (303 )       303      
 

Capital charge and intercompany interest allocation

            (29,014 )   27,919     1,095          
                               

Income (loss) before income taxes

    (2,714 )   (597 )   (6,348 )   6,658     2,970     (968 )   (999 )

Income tax expense (benefit)

    (1,669 )   (119 )   (5,911 )   5,069     2,735     (59 )   46  
                               

Net income (loss)

  $ (1,045 ) $ (478 ) $ (437 ) $ 1,589   $ 235   $ (909 ) $ (1,045 )
                               

39



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Cash Flows

Six Months Ended May 30, 2010

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-
Guarantor
Subsidiaries
  Eliminations   Consolidated  

Net cash provided by operating activities

  $   $   $ 43,214   $ (52,628 ) $ 4,984   $   $ (4,430 )
                               

Investing activities:

                                           
 

Purchase of property, plant and equipment

            (116 )   (5,121 )   (1,441 )       (6,678 )
 

Proceeds from the sale of property, plant, and equipment

            26         41         67  
 

Net activity in investment in and advances from (to) subsidiaries and affiliates

    267         (11,999 )   9,609     2,123          
                               
 

Net cash provided by (used in) investing activities

    267         (12,089 )   4,488     723         (6,611 )

Financing activities:

                                           
 

Equity received upon exercise of stock including related excess tax benefits

    145                         145  
 

Proceeds from issuance of long term obligations

                    1,806         1,806  
 

Repayments of long-term obligations

                (1,441 )   (3,666 )       (5,107 )
 

Repayment of senior secured notes

            (36,050 )               (36,050 )
 

Debt issuance costs

            2                 2  
 

Other

            (77 )               (77 )
                               

Net cash used in financing activities

    145         (36,125 )   (1,441 )   (1,860 )       (39,281 )
                               

Effect of exchange rate changes on cash

                    (1,548 )       (1,548 )
                               

Change in cash and equivalents

    412         (5,000 )   (49,581 )   2,299         (51,870 )

Cash and equivalents:

                                           
 

Beginning of period

    357         29,234     67,950     33,886         131,427  
                               
 

End of period

  $ 769   $   $ 24,234   $ 18,369   $ 36,185   $   $ 79,557  
                               

40



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Cash Flows

Six Months Ended May 31, 2009

(in thousands)

 
  Sealy
Corporation
  Sealy
Mattress
Corporation
  Sealy
Mattress
Company
  Combined
Guarantor
Subsidiaries
  Combined
Non-
Guarantor
Subsidiaries
  Eliminations   Consolidated  

Net cash provided by operating activities

  $   $   $ 887   $ 19,742   $ (5,309 ) $   $ 15,320  
                               

Investing activities:

                                           
 

Purchase of property, plant and equipment

            (12 )   (3,946 )   (634 )       (4,592 )
 

Proceeds from the sale of property, plant, and equipment

            46     10,153     (50 )       10,149  
 

Net proceeds from sale of subsidiary

                    1,237         1,237  
 

Investments in and loans to unconsolidated affiliate

                    (2,322 )       (2,322 )
 

Net activity in investment in and advances from (to) subsidiaries and affiliates

    (265 )       (15,739 )   10,665     5,339          
                               
 

Net cash provided by (used in) investing activities

    (265 )       (15,705 )   16,872     3,570         4,472  

Financing activities:

                                           
 

Equity received upon exercise of stock including related excess tax benefits

    (295 )                       (295 )
 

Proceeds from issuance of long term obligations

                    2,830         2,830  
 

Repayments of long-term obligations

                (3,041 )   (5,954 )       (8,995 )
 

Repayment of old senior term loans

            (377,181 )               (377,181 )
 

Proceeds from issuance of new senior secured notes

            335,916                 335,916  
 

Proceeds from issuance of related party debt

            177,132                 177,132  
 

Borrowings under new asset-based revolver

                             
 

Borrowings under old revolving credit facilities

            130,300         10,316         140,616  
 

Repayments on old revolving credit facilities

            (194,700 )       (10,316 )       (205,016 )
 

Debt issuance costs

            (20,553 )               (20,553 )
 

Other

                             
                               

Net cash used in financing activities

    (295 )       50,914     (3,041 )   (3,124 )       44,454  
                               

Effect of exchange rate changes on cash

                    1,656         1,656  
                               

Change in cash and equivalents

    (560 )       36,096     33,573     (3,207 )       65,902  

Cash and equivalents:

                                           
 

Beginning of period

    589         1     2,423     23,583         26,596  
                               
 

End of period

  $ 29   $   $ 36,097   $ 35,996   $ 20,376   $   $ 92,498  
                               

41



SEALY CORPORATION

Item 2.    Management's Discussion and Analysis of Financial Condition and Results of Operations

        The following management's discussion and analysis is provided as a supplement to, and should be read in conjunction with, our Condensed Consolidated Financial Statements and accompanying notes included in this Quarterly Report on Form 10-Q as well as our management's discussion 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 mattress and foundation products include the Sealy, Sealy Posturepedic, Stearns & Foster, and Bassett brands. We produce a variety of innerspring, visco-elastic (memory foam) and latex foam products.

        The current economic and weak retail environments have affected the level of spending by end consumers and have continued to put pressure on U.S. mattress sales, though we have begun to see some stabilization in the retail environment recently. Some of the international markets where we operate are experiencing similar challenges as well. We expect this challenging business environment to potentially continue through 2010. Furthermore, changes in foreign exchange rates contributed favorably to international results and these trends are expected to continue.

        We have continued our focus on new product development to bring new and innovative products to the market. In February 2010, we introduced Embody by Sealy, a single premium specialty brand that encompasses both memory foam and latex technologies. The Embody line features products at retail price levels ranging from $1,999 to $3,299 per queen set. We also introduced new 60th Anniversary Posturepedic mattresses which feature new innerspring product at retail price points ranging from $750 to $1,000 per queen set. We will be shipping these products to retailers in the coming months.

        Our industry has experienced significant volatility in the price of petroleum-based and steel products, which affects the cost of our polyurethane foam, polyester, polyethylene foam and steel innerspring component parts. Domestic supplies of these raw materials are being limited by supplier consolidation, the exporting of these raw materials outside of the U.S. and other forces beyond our control. During fiscal 2009, the cost of these components decreased and ultimately became more stable in the latter part of fiscal 2009. While these costs have remained stable in the first half of fiscal 2010, we expect these costs to increase during the latter half of fiscal 2010. The manufacturers of products such as petro-chemicals and wire rod, which are the feed stocks purchased by our suppliers of foam and drawn wire, may also magnify this by reducing supplies in an effort to maintain higher prices.

        We have two reportable segments: the Americas and Europe. These segments have been identified and aggregated based on our organizational structure which is organized around geographic areas. Both reportable segments manufacture and market conventional and specialty bedding. The Americas segment's operations are concentrated in the United States, Canada, Mexico, Argentina, Uruguay, Brazil, Puerto Rico and Chile. Europe's operations are concentrated in western Europe.

RESULTS OF OPERATIONS

        During the year-end financial close process of fiscal 2009, we discovered an error related to the depreciation of the assets acquired through our purchase of certain of our European subsidiaries in fiscal 2001. We also discovered an error related to the deferred income tax liabilities recorded on these assets. The errors, which were immaterial to the prior periods, resulted in an understatement of depreciation expense and an overstatement of the income tax provision in the Consolidated Statement of Operations for prior periods.

42


        As further discussed in Note 3 of our Condensed Consolidated Financial Statements in Item 1 above, we evaluated the effects of these errors in accordance with applicable SEC guidance and concluded that no prior period is materially misstated. Nonetheless, we decided to restate our Consolidated Financial Statements for the three and six months ended May 31, 2009, which restated periods are discussed below. Such restatement had no impact on our compliance with the indentures governing our Senior Notes, our 2014 Notes, our Convertible Notes or our ABL Revolver agreement.

    Tabular Information—Current Fiscal Quarter

        The following table sets forth our summarized results of operations for the three months ended May 30, 2010 and May 31, 2009, expressed in thousands of dollars, as well as a percentage of each period's net sales:

 
  For the three months ended:  
 
  May 30, 2010   May 31, 2009  
 
  (in thousands)   (percentage of
net sales)
  (in thousands)   (percentage of
net sales)
 

Net sales

  $ 316,528     100.0 % $ 298,455     100.0 %

Cost of goods sold

    188,290     59.5     176,509     59.1