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



FORM 10-K

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

For the fiscal year ended November 29, 2009

o

 

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

For the Transition Period from                                    to                                     

Commission file number 333-117081-27



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

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

Sealy Drive
One Office Parkway
Trinity, North Carolina

 

27370
(Address of principal executive offices)   (Zip Code)

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

Securities registered pursuant to Section 12(b) of the Act:

 

 

Title of Each Class

 

Name of Each Exchange
on which Registered
Common Stock, par value $0.01 per share   New York Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None



         Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act Yes o    No ý

         Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o    No ý

         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 Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months or(or for such shorter period that the registrant was required to submit and post such files). Yes o    No o

         Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

         Indicated 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 registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o    No ý

         The aggregate market value of the registrant's voting and non-voting common equity held by non-affiliates as of May 31, 2009 was $86,431,851.

         The number of shares of the registrant's common stock outstanding as of January 2, 2010 is approximately: 94,709,443.


DOCUMENTS OR PARTS THEREOF INCORPORATED BY REFERENCE:

         Portions of the Registrant's proxy statement for the 2010 Annual Meeting of Stockholders are incorporated by reference in Part III of this Form 10-K to the extent described herein.



PART I

Item 1.    Business

General

        Sealy Corporation (hereinafter referred to as the "Company", "Sealy", "we", "our", or "us"), a Delaware corporation organized in 1984, is the largest bedding manufacturer in the world. Based on Furniture/Today, a furniture industry publication, we are also the leading bedding manufacturer in the United States with a wholesale market share of approximately 19.5% in 2008, 1.23 times greater than that of our next largest competitor.

        We manufacture and market a complete line of bedding products, including mattresses and mattress foundations. Our conventional (innerspring) bedding products are manufactured and marketed in the Americas under our Sealy, Sealy Posturepedic, Stearns & Foster and Bassett brand names. In addition, we manufacture and market specialty (non-innerspring) latex and visco-elastic bedding products under the PurEmbrace, TrueForm, SpringFree, Stearns & Foster, Reflexions, Carrington Chase, and MirrorForm brand names, which we sell in the specialty bedding category in the United States and internationally. Through fiscal 2009, we also sold bedding products under the Pirelli brand name primarily in Europe, but have elected to discontinue this licensing contract effective December 31, 2009.

        We believe that our Sealy brand name has been the number one selling brand in the domestic bedding industry for over 25 years and our Stearns & Foster brand name is one of the leading brands devoted to the attractive luxury category which sells at higher price points in the industry. We believe that going to market with the best selling and most recognized brand in the domestic bedding industry (Sealy), one of the leading luxury brands (Stearns & Foster), and differentiated specialty bedding offerings gives us a competitive advantage and strengthens our relationships with our customers by allowing us to offer sleep solutions to a broad group of consumers.

        We maintain an internet website at www.sealy.com. We make available on our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Proxy Statements, and other reports, as soon as reasonably practicable after they are electronically filed or furnished to the Securities and Exchange Commission ("SEC").

Debt Refinancing

        On May 13, 2009, we announced a comprehensive plan to refinance our 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, we have: 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 pursuant to a rights offering to all existing shareholders of the Company (the "Convertible Notes"). The proceeds from the Refinancing were used to repay all of the outstanding amounts due under our 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.

        Through a merger with affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") in 2004, KKR acquired approximately 92% of the Company's capital stock. Subsequent to the initial public offering in 2006, KKR's ownership decreased. At November 29, 2009, affiliates of KKR controlled approximately 49.2% of our issued and outstanding common stock.

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Our Segments

        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 of our reportable segments manufacture and market conventional and specialty bedding products. The Americas segment operations are concentrated in the United States, Canada, Mexico, Argentina, Uruguay, Brazil, and Puerto Rico, with our dominant operations being in the United States (also referred to as "Domestic" herein). Europe's operations are concentrated in western Europe. We derived approximately 8.7% of our fiscal 2009 net sales from our Europe segment, with the remainder of our net sales coming from the Americas segment. For more information regarding revenues, income and assets by reportable segment, see Note 20 to our Consolidated Financial Statements in Item 8.

Products

        We produce sleep sets across a range of technologies, including innerspring, latex foam and visco-elastic "memory foam", and sell them in diverse geographies in the Americas and Europe. While our strategy is to drive sales growth through domestic specialty products, the majority of our products continue to be in the domestic innerspring market where we offer a complete line of innerspring bedding products in sizes ranging from twin to king size, selling at retail price points from under $300 to approximately $5,000 per queen set domestically. While we sell conventional innerspring products at all retail price points, we focus our product development and sales efforts toward mattress and box spring sets that sell at retail price points above $750 domestically. Though the higher priced market sectors have shown more of a downturn due to the slowdown of the global economy in 2008 and 2009 than the lower priced sectors, we believe that the higher priced sectors of the market will return to their historical growth trends, offering faster growth and greater profitability in the long-term. In order to capture this growth potential, we have introduced new products in fiscal 2009 which are focused on the luxury price points and we believe that these products have been well received by customers. For fiscal 2009, we derived approximately 63% of our total domestic sales from products with retail price points of $750 and above.

        Our product development efforts include regular introductions across our product lines in order to maintain the competitiveness and the profitability of our products. In the past two years alone, we have introduced several new products including: 1) an innovative new Sealy Posturepedic innerspring line, 2) the Sealy Posturepedic PurEmbrace mattress featuring our proprietary SmartLatex, 3) our redesigned Stearns & Foster product line which features our Variable Response Technology foam to provide a softer, more indulgent sleep surface, 4) three new Stearns & Foster models to target the upper-end luxury price points and 5) new Posturepedic beds with price points above $1,000.

        In the Americas and Europe, we also produce a variety of innovative latex foam, and visco-elastic "memory foam" bedding products for the specialty bedding category. The specialty bedding category has seen a significant downturn in 2009 sales as the economic environment has shifted the consumer's focus to, often lower priced, innerspring products. For the first nine months of calendar 2009, specialty bedding sales reported by International Sleep Products Association ("ISPA") were down 21.6% compared to a decrease of 10.5% for conventional mattress sales. Given their higher price points, specialty products are often sold with financing terms provided by retailers. The decrease in the availability of financing by the retailers due to the effects of the recent credit environment has put pressure on the high-end price points. While we have continued to introduce new specialty products in the past year, we have seen significant slowdowns in the sales of these products consistent with the overall trend of the market. However, we believe that the potential to increase market share continues to exist for future periods in this area as the economic environment improves. In our other international markets within the Americas, we also offer a wide range of products. In each market, we offer a full line of innerspring and specialty products under the Sealy and local brand names.

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        In Europe, we produce, market and distribute latex products that are produced through a proprietary, continuous production process and sold to customers in the European retail market. Through fiscal 2009, these sales have been made primarily under the Pirelli brand name. However, we have strategically decided to discontinue our licensing arrangement with Pirelli effective December 31, 2009 and will transition to selling product in the European market primarily under the Sealy brand. While the main focus will continue to be latex products, we will also continue to focus on maintaining a diverse portfolio of product offerings in this market. In addition to its retail focus, our Europe segment sells latex components to other mattress, furniture and automotive manufacturers worldwide.

Customers

        Our five largest customers on a consolidated basis accounted for approximately 25.5% of our net sales for fiscal 2009 and no single customer represented more than 10% of our net sales during fiscal 2009. While we believe our relationships with these customers are stable, many arrangements are made by purchase order or are terminable at will at the option of either party. In the U.S., we serve a large and well diversified base of approximately 3,000 customers, including furniture stores, specialty bedding stores, department stores and warehouse club stores. During 2008 and the first quarter of 2009, the economic environment became more challenging and caused a higher occurrence of bankruptcies for mattress retailers. However, we have seen a decrease in the frequency of bankruptcies of our customers in the second through fourth quarter of fiscal 2009. These economic conditions have also caused some smaller mattress retailers to exit the market. We continue to remain focused on monitoring our customer relationships and working with our customers during these unpredictable and difficult times. We have been able to maintain a leading market share among the top 25 U.S. bedding retailers by wholesale sales dollars even through this uncertain economic environment. We believe this is due, in part, to the strength of our customer relationships, our large and well trained sales force, effective marketing, leading brand names and a broad portfolio of quality product offerings.

        We believe our sales force is the largest and best trained in the U.S. bedding industry, as evidenced by our high market share among our major retail accounts, new account growth and strong customer retention rates. Our sales strategy supports strong retail relationships through the use of cooperative advertising programs, in-store product displays, sales associate training and a national advertising campaign to support our multiple brand platforms. A key component of our sales strategy is the leveraging of our portfolio of multiple leading brands across the full range of retail price points to capture and retain profitable long term customer relationships.

        In Europe, we sell finished mattresses to approximately 4,000 customers including furniture stores, specialty bedding stores and department stores. Additionally, Europe sells latex components to original equipment manufacturers (OEMs) in a variety of industries, though the primary focus is bedding or furniture applications. One customer comprises approximately 30.3% of total sales within Europe in fiscal 2009.

Sales and Marketing

        Our sales depend primarily on our ability to provide quality products with recognized brand names at competitive prices. Additionally, we work to build brand loyalty with our end-use consumers, principally through cooperative advertising with our dealers, along with superior "point-of-sale" materials designed to emphasize the various features and benefits of our products that differentiate them from other brands and targeted in-country national advertising.

        In 2008, we launched our first national advertising campaign in over a decade, "Get a Better Six", which was designed not only to deliver a strong direct-to-consumer message but also to serve as a platform for our retailers to better leverage their cooperative advertising dollars. The objective of this campaign is to motivate consumers to ask for Sealy Posturepedic products by name by achieving over

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one billion impressions through an integrated marketing campaign including television, print and the Internet. After its initial release in 2008, spending for this campaign has decreased in fiscal 2009.

        In the U.S., we manage all aspects of our sales force centrally in order to enable us to operate in a more coordinated and effective fashion. Our national account and regional account sales forces are organized along customer lines, and our field sales force is generally structured based on regions of the country and districts within those regions. These sales forces are measured on sales and customer profitability performance. We have a comprehensive training and development program for our sales force, including our University of Sleep curriculum, which provides ongoing training sessions with programs focusing on advertising, merchandising and sales education, including techniques to help optimize a dealer's business and profitability.

        Our sales force emphasizes follow-up service to retail stores and provides retailers with promotional and merchandising assistance, as well as extensive specialized professional training and instructional materials. Training for retail sales personnel focuses on several programs designed to assist retailers in maximizing the effectiveness of their own sales personnel, store operations, and advertising and promotional programs, thereby creating loyalty to, and enhanced sales of, our products.

Operations

        We manufacture and distribute products to our customers primarily on a just-in-time basis from our network of 30 company-operated bedding and component manufacturing facilities located around the world. We manufacture most bedding to order and employ just-in-time inventory techniques in our manufacturing process to more efficiently serve our dealers' needs and to minimize their inventory carrying costs. Most bedding orders are scheduled, produced and shipped within five business days of receipt from our plants located in close proximity to a majority of our customers. We believe there are a number of important advantages to this operating model such as the ability to provide superior service and custom products to regional, national and global accounts, a significant reduction in our required inventory investment and short delivery times. We believe these operating capabilities, and the ability to serve our customers, provide us with a competitive advantage.

        We believe we are the most vertically integrated U.S. manufacturer of innerspring and latex components. We distinguish ourselves from our major competitors by maintaining our own component parts manufacturing capability for producing substantially all of our mattress innerspring and latex component parts requirements. This vertical integration lessens our reliance upon certain key suppliers to the innerspring bedding manufacturing industry and provides us with the following competitive advantages:

    procurement advantage by lessening our reliance upon industry suppliers and thus increasing our flexibility in production;

    production cost advantage via cost savings directly related to our vertically integrated components production capabilities; and

    response time advantage by improving our ability to react to shifts in market demands, thus improving time to market.

        Our Europe segment is a leading manufacturer of latex bedding products in Europe, with manufacturing operations in France and Italy. The Europe segment has a proprietary, low cost, high quality continuous latex production capability. This same process exists at our domestic production facility in Pennsylvania. We believe that these processes position us well so that we can offer differentiated products at lower cost.

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Sources and Availability of Raw Materials and Suppliers

        Our primary raw materials consist of polyurethane foam, polyester, polyethylene foam and steel innerspring components which we purchase from various suppliers. In the U.S., we rely upon a single supplier for certain polyurethane foam components in our mattress units. Such components are purchased under a supply agreement. We continue to develop alternative supply sources, allowing acquisition of similar component parts that meet the functional requirements of various product lines. We also purchase a significant portion of our box spring parts from third party sources under supply agreements which require that we maintain certain volume requirements based on a proportional amount of the material purchases. These volume requirements do not represent fixed purchase commitments. We are also dependent on a single supplier for the visco-elastic components and assembly of our TrueForm product line. Except for our dependence regarding polyurethane foam, visco-elastic components and assembly of our TrueForm product line, we do not consider ourselves to be dependent upon any single outside vendor as a source of supply to our bedding business, and we believe that sufficient alternative sources of supply for the same, similar or alternative components are available.

International

        We derived approximately 26.6% of our fiscal 2009 net sales internationally, primarily from Canada and Europe. We also generate income from royalties by licensing our brands, technology and trademarks to other manufacturers, including twelve international independent licensees.

        We have 100% owned subsidiaries in Canada, Mexico, Puerto Rico, Argentina, Uruguay, Brazil, France and Italy, which have marketing and manufacturing responsibilities for those markets. We have three manufacturing and distribution center facilities in Canada and one each in Mexico, Puerto Rico, Argentina, Uruguay, Brazil, France and Italy, which comprise all of the company-owned manufacturing operations outside of the U.S. at November 29, 2009. As discussed above, our Europe operations have primarily sold product under the Pirelli tradename under a license agreement that expired in December 2009. We have made the strategic decision not to renew this agreement and will shift our focus in these markets primarily to Sealy products.

        We also participate in a group of joint ventures with our Australian licensee to import, manufacture, distribute and sell Sealy products in Southeast Asia. On December 1, 2008, we sold a 50% interest in our operations in South Korea for $1.4 million to our Australian licensee and these operations became part of the group of joint ventures. The South Korean operation principally consists of a sales office that uses a contract manufacturer to service the South Korean market. On December 4, 2008, we acquired a 50% interest in a joint venture with our Australian licensee which owns the assets of our New Zealand licensee for $1.9 million. In addition to the above, we also ship products directly into many small international markets.

        Our international operations are subject to the risks of operating in an international environment, including the potential imposition of trade or foreign exchange restrictions, tariff and other tax increases, fluctuations in exchange rates, inflation and unstable political situations, see "Risk Factors" in Item 1A.

        For information regarding revenues and long lived assets by geographic area, see "Management's Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations" in Item 7 as well as Note 20 to our Consolidated Financial Statements in Item 8.

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Bedding Industry

General

        Our U.S. business within our Americas segment represents the dominant portion of our operations. The U.S. bedding industry generated wholesale revenues of approximately $6.2 billion during the calendar year 2008, according to ISPA. Based on a sample of leading mattress manufacturers, including Sealy, ISPA estimates that wholesale revenues for these manufacturers decreased approximately 9.1% in 2008. This trend has continued into 2009 and based on information published by ISPA, during the first nine months of calendar 2009, the sample of leading mattress manufacturers has seen a significant slowdown in volume, which has caused wholesale revenues to decrease approximately 13.4% from the revenues experienced in the first nine months of 2008.

        Our strategy to weather the current economic environment has been based on our breadth of product offerings at various price points. Through this period, bedding industry retailers have seen that increased traffic flow has become even more dependent on the introduction of new product. In response, we have continued our new product introductions during 2009 and plan to continue to introduce new and innovative products in future periods. We believe that there continues to be significant growth opportunities at the premium end of the market (that is, retail prices greater than $1,000 per queen size set) and as consumer demand returns, we believe that we are well positioned to take advantage of this growth. According to ISPA, mattress units sold in the United States by manufacturers at retail price points of at least $1,000, as a percentage of total industry mattress units sold, rose from 16.3% in 2003 to 26.6% in 2008. Even with the downturn of the economy in late 2008, this portion of the market has shown modest growth of 0.3% between 2007 and 2008. For 2008, this data was based on data representing 40.7% of total industry units shipped. Additionally, queen and king size mattress units sold in the United States, as a percentage of total mattress units sold, rose from 43.3% in 2000 to 47.4% in 2008, according to ISPA. The recent slowdown of the global economy has caused wholesale domestic innerspring revenue levels to decrease 10.5% from 2008 levels through the first nine months of 2009 based on information provided by ISPA. We have also seen a shift to products at lower price points during this timeframe.

        The specialty bedding category, which represents non-innerspring bedding products including visco-elastic ("memory foam"), latex foam and other mattress products, accounted for approximately 17.1% of the overall U.S. mattress market revenue in 2008 according to ISPA. Though we have seen significant historical growth in this sector, through the first nine months of 2009, wholesale revenue for specialty bedding from a sample of leading manufacturers decreased 21.6% from the levels experienced in the first nine months of 2008. We believe that once the retail environment begins to strengthen, consumers will return to purchases of specialty product and we are positioning ourselves to take advantage of this through continued new product introductions.

Competition

        The bedding industry is highly competitive and we encounter competition from many manufacturers in both domestic and foreign markets. Manufacturers in the industry principally compete by developing new products and distributing these new products in retail outlets. While many bedding manufacturers, including Sealy, offer multiple types of bedding products, some of our competitors focus on single product types. The single product focus of these competitors may afford them with a competitive advantage, particularly in the specialty bedding market, but we believe going to market with the best selling and most recognized brand in the domestic bedding industry (Sealy) and differentiated specialty bedding offerings provides us a competitive advantage. We, together with Simmons Company and Serta, Inc., collectively accounted for approximately 50.9% of wholesale bedding industry revenues in 2008, based on figures obtained from ISPA and Furniture/Today industry publications. See "Risk Factors—The bedding industry is highly competitive, and if we are unable to compete effectively, we may lose customers and our sales may decline" in Item 1A below.

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Our Strategy

        We expect to deliver profitable sales growth from three sources: U.S. innerspring products, U.S. specialty products and our International markets. To accomplish this, we intend to leverage our intellectual property, scale and vertical integration to develop innovative products, aggressively manage our cost structure and deliver superior execution in the market place. We believe these actions will allow us to maintain our leading position with bedding retailers and generate strong earnings growth.

Develop innovative products

        We continue to focus on the development of innovative products that are preferred by consumers and our retail customers. With superior, innovative product, we intend to maintain a disproportionate share of the premium-priced products in the market. Our New Product Development ("NPD") process emphasizes three key areas to improve the probability of success with each product that we launch.

    designing unique product attributes;

    testing the durability and quality of individual materials, components and complete system designs; and

    conducting extensive consumer, retail customer and manufacturability tests.

        In designing our products, we use a cross-functional team of Sealy resources supported on an as-needed basis by external industrial design firms and development teams from current and prospective suppliers as well as an independent Orthopedic Advisory Board comprised of orthopedic surgeons, researchers and clinicians. These teams work to develop proprietary attributes that distinguish our products in the minds of the consumers and retailers from others in the market. By developing attributes that provide demonstrable performance and quality benefits, we expect retail sales associates to be better able to sell our products and end consumers to find them more desirable.

        The development of unique product attributes often involves the use of new materials and components. Before settling on specific materials or components that have the desired performance characteristics, the teams test the performance characteristics and durability of the individual materials, then as components and finally as a complete system. We are the only manufacturer with its own pressure mapping laboratory, which allows us to quantify the pressure management efficacy of each mattress that we design. We also perform other extensive quantitative tests in our own labs to predict the expected performance profile of the design over the life of the mattress.

        At various stages throughout the development process, we evaluate the look, feel and performance of prototypes with consumer and retailer focus groups. These tests allow us to identify preferences for specific attributes and designs. In parallel with these efforts, each design is evaluated for manufacturability to ensure that the ultimate design can be made efficiently and consistent with our quality standards.

        During fiscal 2009, we utilized the above NPD process to introduce a newly designed Stearns & Foster product line, which targets the luxury retail price points beginning at $1,199 per queen set. The top-of-the-line Stearns & Foster Estate models, with retail price points starting at $1,499, feature our exclusive IntelliCoil ® for optimal comfort and fabric infused with cashmere for an extra soft touch. These new products have helped us to strengthen our position in the luxury price points of the market. Based on industry data and feedback from retailers, we believe this new line has enabled us to grow market share in the United States and we are launching a similar line of products in our Canada market.

Aggressive cost structure management

        Over the past few years, we have implemented actions designed to reduce our fixed operating, selling, logistics and infrastructure costs, as well as product launch costs. In fiscal 2009 alone, we

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reduced our selling, general and administrative costs by more than $65 million compared to fiscal year 2008. Our actions have focused primarily on controlling costs, organizational realignments, reduced national advertising and more efficient product launches in the U.S. Through these actions, we have streamlined our workforce and have worked to reduce costs in areas such as travel and entertainment and professional fees without sacrificing our execution or performance. During the global recession of 2008 and 2009, we remained committed to aligning our cost structure with the existing retail environment. We have implemented new processes and selectively automated others to improve process quality and the productivity of our associates.

        We have also implemented many of these same types of initiatives in our international locations.

        We continue to leverage our vertical integration into the manufacturing of innersprings and latex foam to better control the design and costs of these components. Our expertise in these areas enables us to refine existing component designs and develop and manufacture proprietary designs, such as the IntelliCoil ®, while better controlling related costs.

        We will also continue to leverage our scale and purchasing power to source technology and materials globally, acquire best-in-class equipment and buy in quantities sufficient to obtain the best pricing possible.

Superior execution in the market place

        After we have developed what we believe to be innovative product at a competitive value, we intend to bring those products to market in a superior fashion. We will leverage the strength of the Sealy brands, the size of our sales force and our expertise in marketing strategies to deliver best-in-class execution in the market place.

        As the largest bedding manufacturer in the world, the Sealy brand is well known by retailers and consumers in the United States, Canada and Mexico. In the United States, Sealy is the most recognized mattress brand in the industry.

        We have the largest sales and training team in the United States bedding industry. We utilize that team to provide training and support at the store level for large and small customers. Effective training of the retail sales associates allows them to better educate consumers, who can in turn make more informed decisions when purchasing a Sealy product.

        In order to better connect directly with consumers and motivate them to visit our retail partners while delivering a strong and compelling brand message, we intend to continue developing new advertising and marketing strategies for our brands. We develop and distribute simplified point-of-sale and advertising materials to our retail partners. Our sales force works with retailers to develop successful promotional programs and leverage media assets made available to them for their own advertisements. We will continue to evaluate the use of national advertising campaigns and the internet to deliver a strong direct-to-consumer message and to serve as a platform for our retailers to better leverage their cooperative advertising dollars. The objective of these campaigns will be to motivate consumers to ask for our products by name.

Commitment to specialty products

        The specialty bedding category includes visco-elastic "memory foam" and latex foam and has experienced substantial historical growth both domestically and internationally. During the global recession, we have seen consumers focus more on value priced products. This has had a disproportionately negative impact on the specialty category. We believe that by successfully leveraging our strong brand advantage, proprietary latex manufacturing technology, and marketing and distribution capabilities, we have the potential to make significant market share gains in the specialty bedding category, which according to consumer and market research, will continue to be a significant category of the market in future years.

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        We have a dedicated latex production facility in Mountain Top, Pennsylvania utilizing the proprietary technology employed in our European manufacturing facilities. We continue to focus on optimizing the efficiency of the production process and developing innovative new formulations for use in our specialty product.

Drive disproportionate growth in our international markets

        We plan to grow our international business through market-oriented strategies. In Canada, where we have the leading market share position, we also intend to expand our presence by executing a strategy which is similar to that utilized in the U.S. market. In Europe, we seek to gain market share from regional competition in a fragmented market by building on our foundation of OEM business and leveraging our sales, marketing and proprietary manufacturing expertise to gain market share with Sealy and Sealy Posturepedic branded finished goods. In Mexico, where we recently launched specialty products for the first time, we have placed more of an emphasis on consumer promotional spending in order to drive sales higher. In Argentina and Uruguay, we plan to profitably grow our positions by leveraging our sales, marketing and product development capabilities. In Brazil, we have moved to a business model under which significantly more product will be supplied by production from other Sealy manufacturing facilities. In addition, we anticipate further growth from international licensees.

Generate strong earnings growth

        We intend to increase our operating profit margins over time. We seek to accomplish this through the strategies discussed above and in the following principal ways:

    Increasing the productivity and amount of retailer floor space with Sealy products by introducing successful, new products and working with retailers to effectively merchandise their floors;

    Prospecting for new business with retailers not currently selling Sealy products;

    Utilizing our value-engineering expertise to reduce our exposure to the highest cost materials and identifying and removing non-value added production costs while still enhancing product quality and feel to optimize flow and first pass yields;

    Using management metrics to benchmark functional performance on key measures and drive comparative best practices across all disciplines;

    Driving efficiency in our supply chain including strategic sourcing initiatives;

    Increasing the focus on higher margin, premium and specialty bedding categories and providing compelling reasons to our customers and consumers to invest in these products; and

    Managing our fixed cost base consistent with the retail market environment.

Other Company Information

Licensing

        At November 29, 2009, there were 17 separate license arrangements in effect with 6 domestic and 11 foreign independent licensees. Sealy New Jersey (a bedding manufacturer), Klaussner Corporation Services (a furniture manufacturer), Kolcraft Enterprises, Inc. (a crib mattress manufacturer), Pacific Coast Feather Company (a pillow, comforter and mattress pad manufacturer), Chairworks Manufacturing Group Limited (an office seating manufacturer), and Mantua Manufacturing Co. (a bed frame manufacturer) are the only domestic manufacturers that are licensed to use the Sealy trademark, subject to the terms of license agreements. Pacific Coast Feather also has a license to use the Stearns & Foster brand on certain approved products. Under license agreements between Sealy New Jersey and

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us, Sealy New Jersey has the perpetual right to use certain of our trademarks in the manufacture and sale of Sealy brand and Stearns & Foster brand products in selected markets in the United States.

        Our 11 foreign license agreements provide exclusive rights to market the Sealy brand in Thailand, Japan, the United Kingdom, Spain, Australia, South Africa, Israel, Saudi Arabia, Jamaica, Bahamas and the Dominican Republic. These licensing agreements allow us to reduce our exposure to political and economic risk abroad by minimizing investments in those markets. On December 4, 2008, we acquired a 50% interest in a joint venture with our Australian licensee which owns the assets of our New Zealand licensee for $1.9 million.

        Our licensing group generates royalties by licensing Sealy brand technology and trademarks to manufacturers located throughout the world. We also provide our licensees with product specifications, research and development, statistical services and marketing programs. In the fiscal years ended November 29, 2009, November 30, 2008 and December 2, 2007, the licensing group as a whole generated unaffiliated gross royalties of approximately $16.5 million, $17.6 million and $19.2 million, respectively.

Intellectual Property

        We have approximately 200 worldwide patents, of which the patents and pending patent applications relating to our UniCased technology, those patents that protect our proprietary spring and coil designs and our latex production process, are believed by us to be our most valuable. These patents, having been just recently issued or still pending, afford us multiple years of continuing protection of certain mattress designs. We have filed for patent protection for the core UniCased technology in 30 countries to date and expect similar competitive benefits from the issuance of those patents in those countries. The patents covering our proprietary spring and coil designs also provide Sealy with a competitive advantage in the U.S. and in other countries where we have a presence, and these patents have a remaining enforceable period of at least 13 years.

        We own thousands of trademarks, tradenames, service marks, logos and design marks, including Sealy, Stearns & Foster and Posturepedic. We also license the Bassett tradename in various territories under a long term agreement. Through fiscal 2009, we licensed the Pirelli tradename in certain territories under an agreement that expired in December 2009. We strategically decided not to renew this contract upon its expiration and transition to sales under our Sealy brand in these territories, which are primarily concentrated in western Europe. With the exception of the Sealy New Jersey license, the domestic licenses are predominantly trademark licenses. Also, with the exception of the Sealy New Jersey license (which is of perpetual duration), each domestic license is limited by a period of years, all of which are for a length of five years or less.

        Of our over 1,200 worldwide trademarks, we believe that our Sealy, Posturepedic, and Stearns & Foster marks and affiliated logos (the Sealy script, the "butterfly logo" and the Stearns & Foster "seal") are the most well known. We have registered the Sealy, Posturepedic and Stearns & Foster marks in over 101 countries.

        Our licenses include rights for the licensees to use trademarks as well as current proprietary or patented technology utilized by us. We also provide our licensees with product specifications, quality control inspections, research and development, statistical services and marketing programs. Only the New Jersey, Australia, United Kingdom and Jamaica licenses are of perpetual duration (with some rights of termination), while the other licenses are for a set duration or are indeterminate in length and subject to reasonable notice provisions. All licenses have provisions for termination for cause (such as bankruptcy, misuse of the mark or violation of standards), approval of marketing materials, audit rights and confidentiality of proprietary data.

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Warranties and Product Returns

        Sealy, Stearns & Foster and Bassett bedding offer limited warranties on our manufactured products. The periods for "no-charge" warranty service vary among products. Prior to fiscal year 1995, such warranties ranged from one year on promotional bedding to 20 years on certain Posturepedic and Stearns & Foster bedding. All currently manufactured Sealy Posturepedic models, Stearns & Foster bedding, Bassett and some other Sealy branded products offer a ten year non-prorated warranty service period. Our TrueForm and MirrorForm visco-elastic line of bedding as well as our SpringFree latex line of bedding, carry a twenty year warranty on the major component, the last ten years of which are prorated on a straight-line basis. In 2006, we introduced Right Touch (which was discontinued in the third quarter of fiscal 2008), that had a twenty year limited warranty that covers only certain parts of the product and is prorated for part of the twenty years. We amended our warranty policy on Sealy brand value-priced bedding to three years beginning with our new line introduced in fiscal 2007. The impact of the changes to the warranty policies did not have a significant impact on our financial results or position.

Employees

        As of November 29, 2009 we had 4,848 full time employees. Approximately 68% of our employees at our 25 North American plants are represented by various labor unions with separate collective bargaining agreements. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We consider our overall relations with our work force to be satisfactory. We have only experienced two work stoppages by some of our employees in the last ten years due to labor disputes. Due to the ability to shift production from one plant to another, these lost workdays have not had a material adverse effect on our financial results. The only significant organizing activity at our non-union plants during the last ten years was a petition filed by the Teamsters seeking to organize the production employees at our Mountain Top, Pennsylvania facility. At the subsequent election, the union was defeated by a wide margin. Our current collective bargaining agreements, which are typically three years in length, expire at various times beginning in 2010 through 2012. As of November 29, 2009, our domestic manufacturing plants employed 967, 462 and 498 employees covered under collective bargaining agreements expiring in fiscal 2010, 2011, and 2012, respectively. At our international facilities, there were 685, 765 and 789 employees covered under collective bargaining agreements expiring in fiscal 2010, 2011 and 2012, respectively.

Seasonality and Production Cycle

        Our third fiscal quarter sales are typically 5% to 15% higher than other fiscal quarters. See Note 18 to our Consolidated Financial Statements in Item 8.

        Most of our sales are by short term purchase orders. Since the level of production of products is generally promptly adjusted to meet customer order demand, we have a negligible backlog of orders. Most finished goods inventories of bedding products are physically stored at manufacturing locations until shipped (usually within five business days of accepting the order). See "Risk Factors—We may experience fluctuations in our operating results due to seasonality, which could make sequential quarter to quarter comparison an unreliable indication of our performance." in Item 1A below.

Regulatory Matters

        Our conventional bedding product lines are subject to various federal and state laws and regulations relating to flammability and other standards. We believe that we are in compliance with all such laws and regulations.

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        Our principal waste products in North America are foam and fabric scraps, wood, cardboard and other non-hazardous materials derived from product component supplies and packaging. We also periodically dispose of (primarily by recycling) small amounts of used machine lubricating oil and air compressor waste oil. In the United States, we are subject to federal, state and local laws and regulations relating to environmental health and safety, including the Federal Water Pollution Control Act and the Comprehensive Environmental Response, Compensation and Liability Act. In our facilities in Mountain Top, Pennsylvania, Argentina, France and Italy, we also manufacture foam. We believe that we are in compliance with all applicable international, federal, state and local environmental statutes and regulations. Except as set forth in "Item 3—Legal Proceedings" below, compliance with international, federal, state or local provisions that have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, should not have any material effect upon our capital expenditures, earnings or competitive position. We are not aware of any pending federal environmental legislation which would have a material impact on our operations. Except as set forth in "Item 3—Legal Proceedings" below, we have not been required to make and do not expect to make any material capital expenditures for environmental control facilities in the foreseeable future.

Item 1A.    Risk Factors

The bedding industry is highly competitive, and if we are unable to compete effectively, we may lose customers and our sales may decline.

        The bedding industry is highly competitive, and we encounter competition from many manufacturers in both domestic and foreign markets. We, along with Simmons Company and Serta, Inc., accounted for approximately 50.9% of U.S. wholesale revenues in 2008, according to figures obtained from ISPA and Furniture/Today industry publications. The highly competitive nature of the bedding industry means we are continually subject to the risk of loss of our market share, loss of significant customers, reduction in margins, the inability for us to gain market share or acquire new customers, and difficulty in raising our prices. Some of our principal competitors have less debt than we have and may be better able to withstand changes in market conditions within the bedding industry. Additionally, we may encounter increased future competition and further consolidation in our industry which could magnify the competitive risks previously outlined.

Our new product launches may not be successful due to development delays, failure of new products to achieve anticipated levels of market acceptance and significant costs associated with failed product introductions, which could adversely affect our revenues and profitability.

        Each year we invest significant time and resources in research and development to improve our product offerings. There are a number of risks inherent in our new product line introductions, such as the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, introduction costs and manufacturing inefficiencies may be greater than anticipated, which could impact our profitability.

We may experience fluctuations in our operating results due to seasonality, which could make sequential quarter to quarter comparison an unreliable indication of our performance.

        We have historically experienced, and we expect to continue to experience, seasonal and quarterly fluctuations in net sales and operating income. As is the case with many bedding customers, the retail business is subject to seasonal influences, characterized by strong sales for the months of June through September, which impacts our third fiscal quarter results. Our third fiscal quarter sales are typically 5% to 15% higher than other fiscal quarters. Our first fiscal quarter cash flows are typically the most unfavorable due to working capital demands and coupon payments on our 2014 Notes. This seasonality

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means that a sequential quarter to quarter comparison may not be a good indication of our performance or of how we will perform in the future.

A substantial decrease in business from our significant customers could have a material adverse effect on our sales and market share.

        Our top five customers on a consolidated basis accounted for approximately 25.5% of our net sales for fiscal 2009 and no single customer represented more than 10% of net sales for fiscal 2009. While we believe our relationships with these customers are stable, many arrangements are made by purchase order or are terminable at will at the option of either party. A substantial decrease or interruption in business from our significant customers could result in material write offs or loss of future business. Beginning in 2008 and continuing through the first quarter of fiscal 2009, the economic environment became more challenging and caused a higher occurrence of bankruptcies for mattress retailers. However, we have seen a decrease in the frequency of bankruptcies of our customers in the second through fourth quarter of fiscal 2009. These economic conditions have also caused some smaller mattress retailers to exit the market. Furthermore, many of our customers rely in part on consumers' ability to finance their mattress purchases with credit from third parties. If consumers are unable to obtain financing, they may defer their purchases.

        In the future, retailers may consolidate, restructure, reorganize or realign their affiliations, any of which could decrease the number of stores that carry our products or increase the ownership concentration in the retail industry. Some of these retailers may decide to carry only one brand of mattress products which could affect our ability to sell our products on favorable terms or to maintain or increase market share. As a result, our sales and profitability may decline.

Unfavorable economic conditions could continue to negatively affect our revenues and profitability.

        Our business, financial condition and results of operations have and may continue to be affected by various economic factors. The global economy is undergoing a period of slowdown, which is characterized as a recession, and the future economic environment may continue to be less favorable than that of recent years. The U.S. economy, which contains our largest market, has been in a recession throughout much of fiscal 2008 and 2009. This slowdown has, and could further lead to, reduced consumer and business spending in the foreseeable future, including by our customers, and the purchasers of their products. Reduced access to credit has and may continue to adversely affect the ability of consumers to purchase our products from retailers. It has and may continue to adversely affect the ability of our customers to pay us. If such conditions continue or further deteriorate in fiscal 2010, our industry, business and results of operations may be severely impacted.

Our profitability may be materially and adversely affected by increases in the cost of petroleum-based products, steel and other raw materials.

        Our industry has been challenged by 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. due to the weakened dollar and other forces beyond our control. During fiscal 2007 and 2008, the cost of these components saw significant increases above their recent historical averages due to volatility in prices. However, these prices were more stable in fiscal 2009. The manufacturers of products such as petro-chemicals and wire rod, which are the materials purchased by our suppliers of foam and drawn wire, may reduce supplies in an effort to maintain higher prices. These actions would delay or eliminate price reductions from our suppliers.

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Our profitability may be materially and adversely affected by any interruption in supply from third party vendors.

        We purchase our raw materials and certain components from a variety of suppliers, including box spring components from Leggett & Platt Inc., foam materials from Carpenter Co., and various subassemblies and components from national raw material and component suppliers. If we experience a loss or disruption in our supply of these components, we may have difficulty sourcing substitute components on terms favorable to us. In addition, any alternate source may impair product performance or require us to alter our manufacturing process, which could have an adverse effect on our profitability.

We are dependent upon a single supplier for certain polyurethane foam components in our mattress units. A disruption in the supply of these products and services could adversely affect our operations.

        We are dependent upon a single supplier for certain key polyurethane foam components which make up our various mattress brands. Such components are purchased under a supply agreement and are manufactured in accordance with proprietary process designs exclusive to the supplier. If we experience a loss or disruption in our supply of these components, we may have difficulty sourcing substitute components on terms favorable to us. In addition, any alternative source may impair product performance or require us to alter our manufacturing process, which could have an adverse effect on our profitability.

We are dependent upon a single supplier for the visco-elastic components and assembly of our TrueForm product line. A disruption in the supply of these products and services could adversely affect our operations.

        We are dependent upon a single supplier for certain structural components and assembly of our TrueForm product line. These products are purchased under a supply agreement and are manufactured in accordance with proprietary designs jointly owned by us and the supplier. If we experience a loss or disruption in our supply of these products, we may have difficulty sourcing substitute components on terms favorable to us. In addition, any alternative source may impair product performance or require us to alter our manufacturing process, which could have an adverse effect on our profitability. The related product in which these components and assembly processes are used does not represent a significant portion of our overall sales.

Our significant international operations are subject to foreign exchange, tariff, tax, inflation and political risks and our ability to expand in certain international markets is limited by the terms of licenses we have granted to manufacture and sell Sealy products.

        We currently conduct significant international operations and may pursue additional international opportunities. Our international operations are subject to the risks of operating in an international environment, including the potential imposition of trade or foreign exchange restrictions, tariff and other tax increases, fluctuations in exchange rates, inflation and unstable political situations. We have also limited our ability to independently expand in certain international markets where we have granted licenses to manufacture and sell Sealy bedding products. Our licensees in Australia, Jamaica and the United Kingdom have perpetual licenses, subject to limited termination rights. Our licensees in the Dominican Republic, the Bahamas, Israel, Japan, Saudi Arabia, Spain, South Africa and Thailand hold licenses for fixed terms with limited renewal rights. Fluctuations in the rate of exchange between the U.S. dollar and other currencies may affect stockholders' equity and our financial condition or results of operations.

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The loss of the services of one or more members of our senior management team could impair our ability to execute our business strategy and adversely affect our business.

        We are dependent on the continued services of our senior management team, most of whom have substantial industry specific experience. For example, Lawrence J. Rogers, our current President and Chief Executive Officer (former President, Sealy North America from December 2006 through March 2008), has served in numerous capacities within our operations since joining us in 1979. The loss of key personnel could impair our ability to execute our business strategy and have a material adverse effect on our business.

Our substantial level of indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our outstanding indebtedness

        After the completion of the Refinancing, we continue to have substantial indebtedness. As of November 29, 2009, we had a total of $847.5 million of debt outstanding, including $336.6 million Senior Notes, $180.1 million Convertible Notes and $268.9 million Senior Subordinated Notes. We also have approximately $36.8 million of undrawn availability under the ABL Revolver, after taking into account $24.1 million of outstanding letters of credit and borrowing base limitations.

        Our outstanding indebtedness could have important consequences. For example, it could:

    limit our ability to pay dividends on our common stock;

    make it more difficult for us to satisfy our obligations with respect to our outstanding debt, including any repurchase obligations that may arise thereunder;

    limit our ability to obtain additional financing for working capital, capital expenditures, product development, debt service requirements, restructuring, acquisitions or general corporate purposes, which could be exacerbated by further volatility in the credit markets;

    require us to use a substantial portion of our cash flow from operations to pay interest on our outstanding debt which will reduce the funds available to us for operations and other purposes;

    place us at a competitive disadvantage compared to our competitors that may have proportionally less debt;

    limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

    make us more vulnerable to economic downturns and adverse developments in our business; and

    make us vulnerable to interest rate increases, as certain of our borrowings are at variable interest rates.

        Any of the above listed factors could materially and adversely affect our business, financial condition or results of operations.

Despite our current leverage, we may still be able to incur substantially more debt. This could further exacerbate the risks that we and our subsidiaries face

        The terms of the ABL Revolver agreement and the indentures governing our Senior Notes, Convertible Notes and 2014 Notes will restrict us and our subsidiaries from incurring substantial additional indebtedness in the future, but will not completely prohibit us from doing so. Our ABL Revolver provides for revolving credit financing of up to $100.0 million, subject to borrowing base availability. At November 29, 2009, we have $36.8 million of undrawn availability under the ABL Revolver, after taking into account $24.1 million of letters of credit and borrowing base limitations. These restrictions are subject to a number of important qualifications and exceptions and the indebtedness incurred in compliance with these restrictions could be substantial. If new debt is added to our existing debt levels, the related risks that we now face, including those described above, could intensify.

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The terms of our debt covenants could limit how we conduct our business and our ability to raise additional funds.

        The agreements that govern the terms of our debt, including the indentures that govern the Senior Notes, Convertible Notes, and 2014 Notes and the credit agreement that governs our ABL Revolver, contain, and the agreements that govern our future indebtedness may contain, covenants that restrict our ability and the ability of our subsidiaries to:

    incur and guarantee indebtedness or issue preferred stock;

    repay certain subordinated indebtedness prior to its stated maturity;

    pay dividends or make other distributions on or redeem or repurchase our stock;

    issue capital stock;

    make certain investments or acquisitions;

    create liens;

    engage in most asset sales;

    merge with or into other companies;

    enter into certain transactions with stockholders and affiliates;

    make capital expenditures;

    make certain investments or acquisitions; and

    restrict dividends, distributions or other payments from our subsidiaries.

        In addition, under the ABL Revolver, if our borrowing availability falls below the greater of 15% of the aggregate commitments thereunder and $15.0 million, we will be required to satisfy and maintain a fixed charge coverage ratio of not less than 1.1 to 1.0. Our ability to meet the required fixed charge coverage ratio can be affected by events beyond our control, and we may not be able to meet this ratio. A breach of any of these covenants could result in a default under the ABL Revolver.

        A breach of the covenants or restrictions under our debt agreements and indentures governing our outstanding notes could result in a default under the applicable indebtedness. Such default may allow the creditors to accelerate the related debt and may result in the acceleration of any other debt to which a cross-acceleration or cross-default provision applies. In addition, an event of default under our ABL Revolver would permit the lenders under our ABL Revolver to terminate all commitments to extend further credit under that facility. Furthermore, if we were unable to repay the amounts due and payable under our ABL Revolver, those lenders could proceed against the Collateral granted to them to secure that indebtedness. In the event our lenders and noteholders accelerate the repayment of our borrowings, we cannot assure that we and our subsidiaries would have sufficient assets to repay such indebtedness. As a result of these restrictions we may be:

    limited in how we conduct our business;

    unable to raise additional debt or equity financing to operate during general economic or business downturns; or

    unable to compete effectively or to take advantage of new business opportunities.

        These restrictions may affect our ability to grow in accordance with our plans.

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We are a holding company and rely on dividends, interest and other payments, advances and transfers of funds from our subsidiaries to enable us to pay dividends.

        We are a holding company and conduct all of our operations through our subsidiaries and currently have no significant assets other than the capital stock of Sealy Mattress Corporation and the license to use the Pirelli brand name in European territories, which expired in December 2009. As a result, we rely on dividends and other payments or distributions from our subsidiaries to enable us to pay dividends. The ability of our subsidiaries to pay dividends or make other payments or distributions to us will depend on their respective operating results and may be restricted by, among other things, the laws of their jurisdiction of organization (which may limit the amount of funds available for the payment of dividends), agreements of those subsidiaries and the covenants of any existing and future outstanding indebtedness we or our subsidiaries incur, including Sealy Mattress Company's ABL revolver agreement and the indentures governing the Senior Notes, Convertible Notes and 2014 Notes. For instance, the agreement governing Sealy Mattress Company's ABL Revolver contains restrictions on the ability of Sealy Mattress Corporation to pay dividends or make other distributions to us subject to specified exceptions including the satisfaction of a minimum fixed charge coverage ratio and average daily availability levels. We currently do not meet this requirement and therefore are not able to pay a dividend. In addition, the indentures governing the Senior Notes and the 2014 Notes contain restrictions on the ability of Sealy Mattress Company to pay dividends or make other distributions to Sealy Mattress Corporation subject to specified exceptions including an amount based upon 50% of cumulative consolidated net income from the issue date of the notes.

We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful

        Our ability to make scheduled payments or to refinance our debt obligations depends on our financial and operating performance, which is subject to prevailing economic and competitive conditions and to certain financial, business and other factors beyond our control. We may not be able to maintain a level of cash flow from operating activities sufficient to permit us to pay the principal, premium, if any, and interest on our indebtedness.

        If our cash flows and capital resources are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, seek additional capital, or seek to restructure or refinance our indebtedness. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial liquidity problems and might be required to sell material assets or operations to attempt to meet our debt service and other obligations. The ABL Revolver agreement and the indentures governing our Senior Notes, Convertible Notes and 2014 Notes will restrict our ability to use the proceeds from asset sales. We may not be able to consummate those asset sales to raise capital or sell assets at prices that we believe are fair and proceeds that we do receive may not be adequate to meet any debt service obligations then due.

Changes in tax laws and regulations or other factors could cause our income tax rate to increase, potentially reducing our net income and adversely affecting our cash flows.

        We are subject to taxation in various jurisdictions around the world. In preparing our financial statements, we calculate our effective income tax rate based on current tax laws and regulations and the estimated taxable income within each of these jurisdictions. Our effective income tax rate, however, may be higher due to numerous factors, including changes in tax laws or regulations. A significantly higher effective income tax rate could have an adverse effect on our business, results of operations and liquidity.

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        Officials in some of the jurisdictions in which we do business, including the United States, have proposed, or announced that they are reviewing tax increases and other revenue raising laws and regulations. Any resulting changes in tax laws or regulations could impose new restrictions, costs or prohibitions on our current practices and reduce our net income and adversely affect our cash flows.

The time and expense of defending against challenges to our trademarks, patents and other intellectual property could divert our management's attention and substantial financial resources from our business. Our goodwill and ability to differentiate our products in the marketplace could be negatively affected if we were unsuccessful in defending against such challenges.

        We hold over 1,200 worldwide trademarks, which we believe have significant value and are important to the marketing of our products to customers. We own 43 U.S. patents, a number of which have been registered in a total of 31 countries, and we have 4 domestic patents pending. In addition, we own U.S. and foreign registered trade names and service marks and have applications for the registration of trade names and service marks pending domestically and abroad. We also own several U.S. copyright registrations, and a wide array of unpatented proprietary technology and know-how. We also license certain intellectual property rights from third parties.

        Our ability to compete effectively with other companies depends, to a significant extent, on our ability to maintain the proprietary nature of our owned and licensed intellectual property. Although our trademarks are currently registered in the United States and registered or pending in 101 foreign countries, we still face risks that our trademarks may be circumvented or violate the proprietary rights of others and we may be prevented from using our trademarks if challenged. A challenge to our use of our trademarks could result in a negative ruling regarding our use of our trademarks, their validity or their enforceability, or could prove expensive and time consuming in terms of legal costs and time spent defending against it. In addition, we may not have the financial resources necessary to enforce or defend our trademarks. We also face risks as to the degree of protection offered by the various patents, the likelihood that patents will be issued for pending patent applications or, with regard to the licensed intellectual property, that the licenses will not be terminated. If we were unable to maintain the proprietary nature of our intellectual property and our significant current or proposed products, our goodwill and ability to differentiate our products in the marketplace could be negatively affected and our market share and profitability could be materially and adversely affected.

Regulatory requirements relating to our products may increase our costs, alter our manufacturing processes and impair our product performance.

        Our products and raw materials are and will continue to be subject to regulation in the United States by various federal, state and local regulatory authorities. In addition, other governments and agencies in other jurisdictions regulate the sale and distribution of our products and raw materials. These rules and regulations may change from time to time. Compliance with these regulations may negatively impact our business. There may be continuing costs of regulatory compliance including continuous testing, additional quality control processes and appropriate auditing of design and process compliance.

        In February 2005, the U.S. Consumer Product Safety Commission ("CPSC") passed 16 CFR Part 1633 that effectively applies the California open flame standard, but added significant quality control, record keeping and testing requirements on mattress manufacturers, including Sealy. This rule became effective on July 1, 2007. Further, some states and the U.S. Congress continue to consider open flame regulations for mattresses and bed sets or integral components that may be different or more stringent than the CPSC standard and we may be required to make different products for different states or change our processes or distribution practices nationwide. It is possible that some states' more stringent standards, if adopted and enforceable, could make it difficult to manufacture a cost effective

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product in those jurisdictions and compliance with proposed new rules and regulations may increase our costs, alter our manufacturing processes and impair the performance of our products.

        In addition, our marketing and advertising practices could become the subject of proceedings before regulatory authorities or the subject of claims by other parties, which could require us to alter or end these practices or adopt new practices that are not as effective or are more expensive.

Environmental, health and safety requirements could expose us to material liabilities and changes in our operations as a result of environmental contamination, among other things.

        As a manufacturer of bedding and related products, we use and dispose of a number of substances, such as glue, lubricating oil, solvents and other petroleum products, as well as certain foam ingredients that may subject us to regulation under numerous federal and state statutes governing the environment (including those environmental regulations that are applicable to our foreign operations such as Argentina, Brazil, Canada, France, Italy, Mexico, Uruguay and other jurisdictions). Among other statutes, we are subject to the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation and Liability Act, the Resource Conservation and Recovery Act, the Clean Air Act and related state statutes and regulations. As we abide by certain new open flame regulations, our products and processes may be governed more rigorously by certain state and federal environmental and OSHA standards as well as the provisions of California Proposition 65 and 16 CFR Part 1633.

        We have made and will continue to make capital and other expenditures to comply with environmental requirements. We also have incurred and will continue to incur costs related to certain remediation activities. Under various environmental laws, we may be held liable for the costs of remediating releases of hazardous substances at any properties currently or previously owned or operated by us or at any site to which we sent hazardous substances for disposal. We are currently addressing the clean-up of environmental contamination at our former facility in Oakville, Connecticut and our former facility in South Brunswick, New Jersey. At November 29, 2009, we have accrued approximately $0.2 million and $2.3 million for the Oakville and South Brunswick clean-ups, respectively, and we believe that these reserves are adequate. While uncertainty exists as to the ultimate resolution of these two environmental matters and we believe that the accruals recorded are adequate, in the event of an adverse decision by one or more of the governing environmental authorities or if additional contamination is discovered, these matters could have a material effect on our profitability.

A change or deterioration in labor relations could disrupt our business or increase costs, which could lead to a material decline in sales or profitability.

        As of November 29, 2009, we had 4,848 full time employees. Approximately 68% of our employees at our 25 North American plants are represented by various labor unions with separate collective bargaining agreements. Our current collective bargaining agreements, which are typically three years in length, expire at various times beginning in 2010 through 2012. Due to the large number of collective bargaining agreements, we are periodically in negotiations with certain of the unions representing our employees. We may at some point be subject to work stoppages by some of our employees and, if such events were to occur, there may be a material adverse effect on our operations and profitability. Further, we may not be able to renew the various collective bargaining agreements on a timely basis or on favorable terms, or at all.

Our pension plans are currently underfunded and we will be required to make cash payments to the plans, reducing the cash available for our business.

        We have noncontributory, defined benefit pension plans covering current and former hourly employees at four of our active plants and eight previously closed facilities as well as the employees of

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a facility of our Canadian operations and our manufacturing facility in France. We record a liability associated with these plans equal to the excess of the benefit obligation over the fair value of plan assets. The benefit liability recorded at November 29, 2009 was $12.1 million, and we expect to make estimated minimum funding contributions totaling approximately $1.1 million in 2010. If the performance of the assets in these pension plans does not meet our expectations, or if other actuarial assumptions are modified, our future cash payments to the plans could be higher than we expect. The domestic pension plan is subject to the Employee Retirement Income Security Act of 1974, or ERISA. Under ERISA, the Pension Benefit Guaranty Corporation, or PBGC, has the authority to terminate an underfunded pension plan under limited circumstances. In the event our pension plan is terminated for any reason while it is underfunded, we will incur a liability to the PBGC that may be equal to the entire amount of the underfunding.

Item 1B.    Unresolved Staff Comments

        None.

Item 2.    Properties

        Our principal executive offices are located on Sealy Drive at One Office Parkway, Trinity, North Carolina, 27370. Corporate and administrative services are provided to us by Sealy, Inc. (our 100%-owned subsidiary).

        We administer our component operations at our Rensselaer, Indiana facility. Our leased facilities are occupied under operating leases, which expire from fiscal 2010 to 2043, including renewal options.

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        The following table sets forth certain information regarding manufacturing and distribution facilities operated by us at January 2, 2010:

Location
   
  Approximate
Square
Footage
  Title

United States

             
 

Arizona

  Phoenix     76,000   Owned(a)
 

California

  Richmond     238,000   Owned(a)

  South Gate     185,000   Leased
 

Colorado

  Colorado Springs     70,000   Owned(a)

  Denver     92,900   Owned(a)
 

Florida

  Orlando     225,000   Owned(b)
 

Georgia

  Atlanta     292,500   Owned(a)
 

Illinois

  Batavia     212,700   Leased
 

Indiana

  Rensselaer     131,000   Owned(a)

  Rensselaer     124,000   Owned(a)
 

Kansas

  Kansas City     102,600   Leased
 

Maryland

  Williamsport     144,000   Leased
 

Minnesota

  St. Paul     93,600   Owned(a)
 

New York

  Green Island     257,000   Owned(b)
 

North Carolina

  High Point     151,200   Owned(a)
 

Ohio

  Medina     140,000   Owned(a)
 

Oregon

  Portland     140,000   Owned(a)
 

Pennsylvania

  Delano     143,000   Owned(a)

  Mountain Top     210,000   Owned(b)
 

Texas

  Brenham     220,000   Owned(a)

  North Richland Hills     124,500   Owned(a)

Canada

             
 

Alberta

  Edmonton     144,500   Owned(a)
 

Quebec

  Saint Narcisse     76,000   Owned(a)
 

Ontario

  Toronto     130,200   Leased

Argentina

  Buenos Aires     85,000   Owned

Brazil

  Sorocaba     92,000   Owned

Puerto Rico

  Carolina     58,600   Owned(a)

Italy

  Silvano d'Orba     170,600   Owned(a)(c)

France

  Saleux     239,400   Owned(c)

Mexico

  Toluca     157,100   Owned

Uruguay

  Montevideo     39,500   Leased
             

        4,565,900    
             

(a)
We have granted a mortgage or otherwise encumbered our interest in this facility as collateral for secured indebtedness.

(b)
We engaged third parties to construct these facilities to be leased by us. The FASB's authoritative guidance requiring the Company to be considered the owner, for accounting purposes of certain leased facilities, is applied to entities involved with certain structural elements of the construction of an asset that will be leased when construction of the asset is completed.

(c)
These properties are in our Europe segment. All other properties are included in our Americas segment.

21


        In addition to the locations listed above, we maintain additional warehousing facilities in several of the states and countries where our manufacturing facilities are located. We consider our present facilities to be generally well maintained and in sound operating condition.

Item 3.    Legal Proceedings

        We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. Management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

        We are currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. We and one of our subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, we and our subsidiary agreed to conduct soil and groundwater remediation at the property. We do not believe that our manufacturing processes were the source of contamination. We sold the property in 1997. We and our subsidiary retained primary responsibility for the required remediation. We have completed essentially all soil remediation with the New Jersey Department of Environmental Protection's approval, and have installed a groundwater remediation system on the site. During 2005, with the approval from the New Jersey Department of Environmental Protection, we removed and disposed of sediment in Oakeys Brook adjoining the site. We continue to monitor groundwater remediation at this site. We have recorded a reserve as of November 29, 2009 of $2.3 million ($2.4 million prior to discounting at 4.75%) associated with this remediation project.

        We are also remediating soil and groundwater contamination at an inactive facility located in Oakville, Connecticut. Although we are conducting the remediation voluntarily, we obtained Connecticut Department of Environmental Protection approval of the remediation plan. We have completed essentially all soil remediation under the remediation plan and are currently monitoring groundwater at the site. We identified cadmium in the soil and ground water at the site and removed the cadmium contaminated soil and rock from the site during fiscal 2007. At November 29, 2009, we have recorded a reserve of approximately $0.2 million associated with the additional work and ongoing monitoring. We believe the contamination is attributable to the manufacturing operations of previous unaffiliated occupants of the facility.

        While we cannot predict the ultimate timing or costs of the South Brunswick and Oakville environmental matters, based on facts currently known, we believe that the accruals recorded are adequate and do not believe the resolution of these matters will have a material adverse effect on our financial position or our future operations; 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.

        On June 15, 2009, Sealy was served with a lawsuit filed by Tempur-Pedic, LLC North America in the Western District of Virginia. In the lawsuit, Tempur-Pedic alleges that Sealy and sixteen other defendants are infringing a patent issued to Tempur-Pedic in March of 2009, requesting injunctive relief and unspecified damages against all of the defendants. In November 2009, Tempur-Pedic dismissed this suit without prejudice.

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

    None

22



PART II

Item 5.    Market for Registrant's Common Equity, Related Stockholder Matters, and Issuer Purchases of Equity Securities

        Our common stock trades on the New York Stock Exchange under the symbol "ZZ." The table below highlights quarterly stock market information and the amount of cash dividends declared per share of our common stock for the past two fiscal years.

 
  Sales Price ($)    
 
 
  Cash Dividend
Declared ($)
 
 
  High   Low  

Fiscal 2009

                   

First quarter

    3.68     0.80      

Second quarter

    5.83     0.43      

Third quarter

    2.80     2.02      

Fourth quarter

    3.83     2.45      

 

 
  Sales Price ($)    
 
 
  Cash Dividend
Declared ($)
 
 
  High   Low  

Fiscal 2008

                   

First quarter

    13.39     8.87     0.075  

Second quarter

    9.14     5.63      

Third quarter

    7.90     5.12      

Fourth quarter

    8.41     1.62      

        Our ability to pay dividends is restricted by our debt agreements. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7.

        As of January 2, 2010, there were approximately 153 holders of record of our common stock.

Issuer Purchases of Equity Securities

        Our common stock repurchase program, which authorizes us to repurchase up to $100 million of our Company's common stock, was initially approved by our Board of Directors on February 19, 2007. During the fourth quarter of fiscal 2009, no shares were repurchased under this program. However, during the fourth quarter of fiscal 2009, 161,275 shares were surrendered or withheld to cover the exercise price and/or tax withholding obligations in stock option exercises, as permitted under our 1998 and 2004 Stock Option Plans. See table below:

Period
  Total number
of shares
purchased
  Average
price paid
per share
  Total number of
shares purchased
during quarter as
part of publicly
announced program
  Approximate
dollar value of
shares that may
yet be purchased
under program
 

August 31 - September 27, 2009

    45,663   $ 3.24       $ 83,746,985  

September 28 - October 25, 2009

    115,612     3.19         83,746,985  

October 26 - November 29, 2009

                  83,746,985  
                       
 

Total

    161,275                  
                       

Performance Graph

        The following graph compares the performance through November 29, 2009 of a hypothetical $100 investment made on April 7, 2006 in (a) our common stock, (b) the S&P 500 Composite Index® and (c) an index of certain companies by the company as comparable to Sealy (the "Peer Group Index").

23



The companies selected to form the Peer Group Index are: Brunswick Corp., Church & Dwight Co, Chattem Inc., Energizer Holdings Inc., Ethan Allen Interiors Inc., Fortune Brands, Inc., Furniture Brands International, Harman International, Leggett & Platt Inc., La-Z-Boy Inc, Masco Corp., Mohawk Industries Inc., Nautilus Inc., Prestige Brands Holdings Inc., Polaris Industries Inc., Select Comfort Corp., Spectrum Brands, Inc., Tempur-pedic International Inc., The Scotts Miracle-Gro Co. Playtex Products Inc. which had been part of the Peer Group Index in 2006 was acquired in 2007 and is no longer a public company. As a result, Playtex Products Inc. has been removed from the Peer Group Index and Stock Performance Graph. This peer group was determined at the time that Sealy became a public company with the assistance of the investment banking firms involved in taking Sealy public. The group includes public companies in home furnishings and consumer products industries. This graph is calculated assuming that all stock dividends are reinvested during the relevant period.

GRAPHIC

24


Item 6.    Selected Financial Data

        The following table presents selected historical financial and other data about us. The selected historical financial data for the years ended and as of November 29, 2009, November 30, 2008, December 2, 2007, November 26, 2006 and November 27, 2005 are derived from our audited Consolidated Financial Statements and the notes thereto. However, certain of the amounts presented for periods prior to fiscal 2009 have been restated from the amounts previously presented. See Note 2 to the Consolidated Financial Statements included in Item 8 below. The consolidated financial statements for the three years ended November 29, 2009 have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, and are included in "Financial Statements and Supplementary Data" in Item 8 below.

        The selected historical financial and other data set forth below should be read together with the information contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in Item 7 below and our financial statements and the notes thereto, appearing elsewhere in this report.

 
  Fiscal Year(1)  
 
  2009   2008   2007   2006   2005  
 
  (in millions, except per share data)
 

Statement of Operations Data:

                               
 

Net sales

  $ 1,290.1   $ 1,498.0   $ 1,702.1   $ 1,582.8   $ 1,469.6  
 

Cost of goods sold

    773.3     916.0     994.7     876.6     819.6  
 

Selling, general and administrative expenses

    416.4     482.6     545.6     499.6     456.3  
 

Other (income) expense(2)

    (10.7 )   17.0     (15.2 )   15.4     (12.7 )
                       
 

Income from operations

    111.1     82.4     177.0     191.2     206.4  
 

Interest expense

    79.1     60.5     64.0     72.0     79.6  
 

Other expense, net(3)

    20.6     4.9     0.7     9.1     5.4  
                       
 

Income before provision for income taxes

    11.4     17.0     112.3     110.1     121.4  
 

Provision for income tax expense

    (2.1 )   20.9     34.9     37.0     53.9  
                       
 

Income (loss) before cumulative effect of change in accounting principle

    13.5     (3.9 )   77.4     73.1     67.5  
 

Cumulative effect of change in accounting principle, net of tax

                0.3      
                       
 

Income (loss) available to common shareholders

  $ 13.5   $ (3.9 ) $ 77.4   $ 72.8   $ 67.5  
                       

Basic net income (loss) per share:

                               
 

Net income (loss) per share

  $ 0.15   $ (0.04 ) $ 0.85   $ 0.87   $ 0.96  
 

Cumulative effect of change in accounting principle

                     
                       
   

Earnings per common share—Basic

  $ 0.15   $ (0.04 ) $ 0.85   $ 0.87   $ 0.96  
                       

Weighted average shares

    92.3     91.2     91.3     83.6     70.4  

Diluted net income (loss) per share:

                               
 

Net income (loss) per share

  $ 0.10   $ (0.04 ) $ 0.80   $ 0.82   $ 0.89  
 

Cumulative effect of change in accounting principle

                     
                       
   

Earnings per common share—Diluted

  $ 0.10   $ (0.04 ) $ 0.80   $ 0.82   $ 0.89  
                       
 

Weighted average shares

    185.6     91.2     96.3     89.6     75.4  

25


 
  Fiscal Year(1)  
 
  2009   2008   2007   2006   2005  
 
  (in millions, except per share data)
 

Balance Sheet Data (at end of period):

                               
 

Current assets

  $ 386.4   $ 295.6   $ 343.7   $ 345.3   $ 304.4  
 

Total assets

    1,015.5     913.5     1,019.0     999.1     914.4  
 

Current liabilities

    229.2     238.5     321.9     288.2     282.0  
 

Long term debt, net of current portion

    833.8     762.2     757.3     814.2     959.8  
 

Total debt

    847.5     783.4     793.8     832.5     972.8  
 

Common stock and options subject to redemption

        8.9     16.2     20.3     21.6  
 

Stockholders' deficit

    (108.0 )   (167.8 )   (131.8 )   (173.1 )   (411.5 )

Other Financial Data:

                               
 

Dividends per common share

  $   $ 0.08   $ 0.30     0.23   $  
 

Depreciation and amortization

    33.4     35.9     32.7     31.9     23.5  
 

Capital expenditures

    (12.4 )   (25.0 )   (42.4 )   (30.9 )   (29.4 )
 

Cash flows provided by (used in):

                               
   

Operating activities

    79.3     53.7     94.4     58.2     135.0  
   

Investing activities

    (3.3 )   (24.9 )   (37.4 )   (30.3 )   (19.4 )
   

Financing activities

    25.8     (18.7 )   (86.2 )   (18.9 )   (101.5 )

(1)
We use a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal years ended November 29, 2009, November 30, 2008, November 26, 2006, and November 27, 2005 were all 52-week years. The fiscal year ended December 2, 2007 was a 53-week year. All stock share amounts have been restated to reflect the 0.7595 to 1 reverse stock split, which became effective on March 23, 2006.

(2)
Also includes the following items to the extent applicable for the periods presented: IPO expenses, recapitalization expenses, stock based compensation, goodwill impairment charges, business closure charges, plant closing and restructuring charges, amortization of intangibles, asset impairment charges and net royalty income.

(3)
Includes $17.4 million of charges related to the Refinancing and extinguishment of debt and interest rate derivatives in fiscal 2009.

26


Item 7.    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 Consolidated Financial Statements and accompanying notes included in this filing. Except where the context suggests otherwise, the terms "we," "us" and "our" refer to Sealy Corporation and its subsidiaries.

Business Overview

        We believe we are the largest bedding manufacturer in the world, with a wholesale domestic market share of approximately 19.5% in 2008. We believe our market share in 2009 is comparable to 2008. We manufacture and market a complete line of bedding (innerspring and non-innerspring) products, including mattresses and box springs, holding leading positions in key market categories such as luxury bedding products and among leading retailers. Our conventional bedding products include the Sealy, Sealy Posturepedic, Stearns & Foster and Bassett brands and account for approximately 91% of our total domestic net sales for the year ended November 29, 2009. In addition to our innerspring bedding, we also produce a variety of visco-elastic ("memory foam") and latex foam bedding products. We expect to gain market share in these product lines as we seek to strengthen our competitive position in the specialty bedding (non-innerspring mattress) market. We distinguish ourselves from our major competitors by maintaining our own component parts manufacturing capability and producing substantially all of our mattress innerspring and latex mattress components requirements. During fiscal 2009, we made the strategic decision to outsource the production of our box spring components to a third party as we expect this to be more cost-advantageous for us in the current and future periods.

        The current economic and weak retail environments have affected the level of spending by end consumers and have caused a decrease in mattress sales across the industry. From January 2009 through September 2009, the total decrease in sales levels was 10.5% as reported by the International Sleep Products Association ("ISPA") sample of leading manufacturers. We expect the business environment to remain challenging in 2010.

        We continue to focus on the development of innovative products that are preferred by consumers and our retail customers. With superior, innovative product, we intend to maintain a disproportionate share of the premium-priced products in the market. In fiscal 2009, we introduced our redesigned Stearns & Foster product line which features our Variable Response Technology foam to provide a softer, more indulgent sleep surface. Additionally, we introduced three new Stearns & Foster models to target the upper-end luxury price points and new Posturepedic beds with price points above $1,000.

        Our industry continues to recover from 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 2008, the cost of these components saw significant increases above their recent historical averages. These costs, particularly those related to steel and polyurethane and latex foams, decreased during the third quarter of fiscal 2009 and we have seen some stabilization of these prices during the fourth quarter of fiscal 2009, due to reduced volatility in related commodity prices. 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 reduce supplies in an effort to maintain higher prices. These actions would delay or eliminate price reductions from our suppliers.

        Our foreign subsidiaries contributed 26.6% of our total revenues during fiscal 2009 compared to 29.5% in fiscal 2008. This decrease from the prior year has been primarily driven by greater percentage decreases in sales volumes for the Canada and Europe business units during 2009, which has been driven by a combination of weaker retail sales environments and the declines in local currencies relative to the U.S. dollar.

27


Raw Materials

        The cost of our steel innerspring, polyurethane foam, polyester, and polyethlylene component parts were impacted sharply by the volatility in the prices of steel and petroleum in fiscal 2008. During fiscal 2009, the prices paid for steel and latex foam decreased from prior year levels and stabilized somewhat due to a reduction in the volatility in the related commodity prices. We periodically enter into commodity-based physical contracts to buy natural gas at agreed-upon fixed prices. These contracts are entered into in the normal course of business. We do not engage in commodity hedging programs, but continue to evaluate opportunities to reduce our risk associated with price volatility.

Critical Accounting Estimates

        Our discussion and analysis of our financial condition and results of operations are based upon our Consolidated Financial Statements that have been prepared in accordance with generally accepted accounting principles in the United States of America ("US GAAP"). The preparation of financial statements in accordance with US GAAP requires our management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. US GAAP provides the framework from which to make these estimates, assumptions and disclosures. We choose accounting policies within US GAAP that our management believes are appropriate to accurately and fairly report our operating results and financial position in a consistent manner. Our management regularly assesses these policies in light of current and forecasted economic conditions. Our accounting policies are stated in Note 1 to our Consolidated Financial Statements included in Item 8. We believe the following accounting estimates are critical to understanding our results of operations and affect the more significant judgments and estimates used in the preparation of our Consolidated Financial Statements:

        Cooperative Advertising, Rebate and Other Promotional Programs—We enter into agreements with our customers to provide funds to the customer for advertising and promotion of our products. We also enter into volume and other rebate programs with our customers whereby funds may be rebated to the customer. When sales are made to these customers, we record liabilities pursuant to these agreements. We periodically assess these liabilities based on actual sales and claims to determine whether all of the cooperative advertising earned will be used by the customer or whether the customers will meet the requirements to receive rebate funds. We generally negotiate these agreements on a customer-by-customer basis. Some of these agreements extend over several periods and are linked with supply agreements. Most of these agreements coincide with our fiscal year; however, our customers typically have ninety days following the end of a period to submit claims for reimbursement of advertising and promotional costs. Therefore, significant estimates are required at any point in time with regard to the ultimate reimbursement to be claimed by our customers. Subsequent revisions to such estimates are recorded and charged to earnings in the period in which they are identified. Changes in underlying spending patterns related to these incentive programs could impact our margins. Costs of these programs totaled $219.5 million, $235.0 million and $275.7 million in fiscal 2009, 2008 and 2007, respectively. Of these costs, amounts associated with volume rebates, supply agreement amortization, slotting fees, end consumer rebates and other customer allowances which were recorded as a reduction of sales were $99.3 million, $101.4 million and $104.4 million in fiscal 2009, 2008 and 2007, respectively. The costs associated with cooperative advertising were recorded as selling, general and administrative expenses and were $120.2 million, $133.6 million and $171.2 million in fiscal 2009, 2008 and 2007, respectively.

        Allowance for Doubtful Accounts—Beginning in 2008 and continuing through the first quarter of fiscal 2009, the economic environment became more challenging and caused a higher occurrence of bankruptcies for mattress retailers. However, we have seen a decrease in the frequency of bankruptcies of our customers in the second through fourth quarter of fiscal 2009. These economic conditions have also caused some smaller mattress retailers to exit the market. We continue to actively monitor the

28



financial condition of our customers to determine the potential for any nonpayment of trade receivables. In determining our reserve for bad debts, we also consider other general economic factors. Our management believes that our process of specific review of customers, combined with overall analytical review provides a reliable evaluation of ultimate collectibility of trade receivables. We recorded a bad debt provision of $5.5 million, or approximately 0.4% percent of sales, in fiscal 2009. Provisions for bad debts recorded in fiscal 2008 and 2007 were $10.3 million (approximately 0.7% of sales) and $6.6 million (approximately 0.4% of sales), respectively.

        Warranties and Product Returns—Our warranty policy provides a 10 year non-prorated warranty service period on all currently manufactured Sealy Posturepedic, Stearns & Foster and Bassett bedding products and some other Sealy branded products and a 20 year warranty period on the major components of our TrueForm and MirrorForm visco-elastic products as well as our SpringFree latex product, introduced in 2005, the last ten years of which are prorated on a straight-line basis. In 2006, we introduced and subsequently discontinued Right Touch, which has a twenty year limited warranty that covers only certain parts of the product and is prorated for part of the twenty years. We amended our warranty policy on Sealy brand value-priced bedding to three years beginning with our new line introduced in fiscal 2007. The impact of the changes to the warranty policies did not have a significant impact on our financial results or position. Our policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded based on historical trends of warranty costs. We utilize warranty trends on existing similar product in order to estimate future warranty claims associated with newly introduced product. Changes in the historical trends of these returns could impact the estimates for future periods. Our accrued warranty liability totaled $16.5 million as of November 29, 2009 and November 30, 2008.

        In fiscal 2008, we completed an analysis of our returns claims experience for the U.S. business within the Americas segment based on historical return trends using new information that is available which allows us to better track and match claims received to the sales for which those claims were initially recorded. This change in estimate resulted in a reduction of cost of sales of approximately $2.5 million for fiscal 2008 as well as a corresponding reduction in the accrued returns obligation. Our estimate involves an application of the lag time in days between the sale date and the date of its return applied to the current rate of returns.

        Share-Based Compensation Plans—We have two share based compensation plans, as described more fully in Note 3 to our Consolidated Financial Statements included in Item 8. For new awards issued and awards modified, repurchased, or cancelled, the cost is equal to the fair value of the award at the date of the grant, and compensation expense is recognized for those awards earned over the service period. Certain of the equity awards vest based upon the Company achieving certain EBITDA performance targets. During the service period, management estimates whether or not the EBITDA performance targets will be met in order to determine the vesting period for those awards and what amount of compensation cost should be recognized related to these awards. At the date of grant, we determine the fair value of the awards using the Black-Scholes option pricing formula, the trinomial lattice model or the closing price of the Company's common stock, as appropriate under the circumstances. Management estimates the period of time the employee will hold the option prior to exercise and the expected volatility of Sealy Corporation's stock, each of which impacts the fair value of the stock options. The fair value of restricted shares and restricted share units is based upon the closing price of the Company's common stock as of the grant date. We also estimate the amount of share-based awards that are expected to be forfeited based on the historical forfeiture rates experienced for our outstanding awards.

        Self-Insurance Liabilities—We are self-insured for certain losses related to medical claims with excess loss coverage of $375,000 per claim per year. We also utilize large deductible policies to insure claims related to general liability, product liability, automobile, and workers' compensation. Our

29



recorded liability represents an estimate of the ultimate cost of claims incurred as of the balance sheet date. The estimated workers' compensation liability is discounted and is established based upon analysis of historical data and actuarial estimates, and is reviewed by us and third-party actuaries on a quarterly basis to ensure that the liability is appropriate. While management believes these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation, or fluctuations in premiums, differ from our estimates, our results of operations could be impacted.

        Impairment of Goodwill—We assess goodwill at least annually for impairment as of the beginning of the fiscal fourth quarter or whenever events or circumstances indicate that the carrying value of goodwill may not be recoverable from future cash flows. We assess recoverability using several methodologies, including the present value of estimated future cash flows and comparisons of multiples of enterprise values to earnings before interest, taxes, depreciation and amortization ("EBITDA"). The analysis is based upon available information regarding expected future cash flows of each reporting unit discounted at rates consistent with the cost of capital specific to the reporting unit. If the carrying value of the reporting unit exceeds the indicated fair value of the reporting unit, a second analysis is performed to allocate the fair value to all assets and liabilities. If, based on the second analysis, it is determined that the implied fair value of the goodwill of the reporting unit is less than the carrying value, goodwill is considered impaired.

        Our fiscal 2009 annual evaluation for goodwill impairment indicated a potential impairment of the goodwill for our Argentina reporting unit. As a result, we estimated the implied fair value of the goodwill in this reporting unit compared to carrying amounts and recorded an impairment charge of $1.2 million to impair the entire balance of goodwill recorded in the Argentina reporting unit. The impairment charge is based upon the fair value of the assets and liabilities of the reporting unit.

        In the fourth quarter of fiscal 2008, market conditions deteriorated significantly. This deterioration resulting from the global economic downturn had not yet matured or been considered in our annual test of goodwill. Because of the potential impact of these conditions on our projections and the indicated fair value of our reporting units, we performed an interim evaluation of goodwill in the fourth quarter of 2008 reflecting our current views regarding the impact of the changed economic environment. This analysis indicated potential impairment in the goodwill of our Europe and Puerto Rico reporting units. As a result, we estimated the implied fair value of the goodwill in those reporting units compared to carrying amounts and recorded an impairment charge of $27.5 million to impair goodwill, including $2.8 million recorded in the Puerto Rico reporting unit and $24.7 million in the Europe reporting unit. The impairment charge recorded in fiscal 2008 was based upon estimates of the fair value of property and equipment and certain intangible assets, including customer relationships. During fiscal 2009, we completed our measurement of the impairment loss for the Europe reporting unit and concluded that the entire balance of the goodwill of this reporting unit was determined to be impaired. Thus, the $24.7 million impairment charge recognized in the fourth quarter of fiscal 2008 as an estimate required no adjustment in fiscal 2009.

        The total carrying value of our goodwill was $360.6 million and $357.1 million at November 29, 2009 and November 30, 2008, respectively. Based on the results of our annual impairment testing, the fair value of the reporting units that maintain goodwill balances at November 30, 2009 significantly exceeded their carrying value.

        Commitments and Contingencies—We are subject to legal proceedings, claims, and litigation arising in the ordinary course of business. A negative outcome of these matters is considered remote, and management does not expect that the ultimate costs to resolve these matters will have a material adverse effect on our consolidated financial position, results of operations or cash flows.

30


        Income Taxes—We record an income tax valuation allowance when the realization of certain deferred tax assets, including net operating losses, is not more likely than not. These deferred tax items represent expenses recognized for financial reporting purposes, which may result in tax deductions in the future. Certain judgments, assumptions and estimates may affect the carrying value of the valuation allowance and income tax expense in the Consolidated Financial Statements. Our net deferred tax assets at November 29, 2009 were $26.3 million, net of a $34.3 million valuation allowance.

        Significant judgment is required in evaluating our federal, state and foreign tax positions and in the determination of our tax provision. Despite our belief that our 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 matters. We may adjust these liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, our tax advisors, 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.

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. The recorded balances of accumulated depreciation and deferred tax liabilities were likewise understated and overstated, respectively in the Consolidated Balance Sheets for prior periods.

        As further discussed in Note 2 of our Consolidated Financial Statements in Item 8, 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 as of and for the years ended November 30, 2008 and December 2, 2007, which restated periods are discussed below. Such restatement had no impact on our compliance with the indentures governing our Senior Notes, our 2014 Notes or our Convertible Notes or our ABL Revolver agreement.

31


Tabular Information

        The following table sets forth our summarized results of operations for fiscal years 2009, 2008 and 2007, expressed in thousands of dollars as well as a percentage of each year's net sales:

 
  Fiscal year(1)  
 
  2009   2008   2007  
 
  (in thousands)
  (percentage of
net sales)

  (in thousands)
  (percentage of
net sales)

  (in thousands)
  (percentage of
net sales)

 

Net sales

  $ 1,290,064     100.0 % $ 1,498,023     100.0 % $ 1,702,065     100.0 %

Cost of goods sold(2)

    773,279     59.9     915,977     61.1     994,700     58.4  
                           
 

Gross profit

    516,785     40.1     582,046     38.9     707,365     41.6  

Selling, general and administrative expenses(2)

    416,420     32.3     482,566     32.2     545,608     32.1  

Goodwill impairment loss

    1,188     0.1     27,475     1.8          

Amortization expense

    3,308     0.3     3,692     0.2     3,356     0.2  

Restructuring expenses and asset impairment

    1,256     0.1     3,126     0.2          

Royalty income, net of royalty expense

    (16,442 )   (1.3 )   (17,327 )   (1.2 )   (18,562 )   (1.1 )
                           
 

Income from operations

    111,055     8.6     82,514     5.7     176,963     10.4  

Interest expense

    79,092     6.1     60,464     4.0     63,976     3.8  

Loss on rights for convertible notes

    4,549     0.4                  

Refinancing and extinguishment of debt and interest rate derivatives

    17,423     1.4     5,378     0.4     1,222     0.1  

Gain on sale of subsidiary stock

    (1,292 )   (0.1 )                

Other income, net

    (77 )       (397 )       (421 )    
                           
 

Income before income tax expense

    11,360     0.8     17,069     1.3     112,186     6.5  

Income tax provision

    (2,125 )   (0.2 )   20,872     1.4     34,865     2.0  
                           
 

Net income (loss)

  $ 13,485     1.0 % $ (3,803 )   (0.1 )% $ 77,321     4.5 %
                           

Effective tax rate

    (18.7 )%         122.3 %         31.1 %      

(1)
We use a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal years ended November 29, 2009 and November 30, 2008 were 52-week years. The fiscal year ended December 2, 2007 was a 53-week year.

(2)
Included in our selling, general and administrative expenses for fiscal years 2009, 2008 and 2007 were $75.1 million, $91.2 million and $91.2 million, respectively, in shipping and handling costs associated with the delivery of finished mattress products to our customers, including approximately $5.7 million, $7.3 million and $8.4 million, respectively, of costs associated with internal transfers between our plant locations. With respect to these costs, our cost of goods sold may not be comparable with that reported by other entities.

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

Geographic distribution of sales:

 
  Fiscal year(1)  
 
  2009   2008   2007  

Americas:

                   
 

United States

    73.4 %   70.5 %   74.5 %
 

Canada

    11.7     12.5     11.5  
 

Other

    6.2     7.1     5.8  
               
   

Total Americas

    91.3     90.1     91.8  

Europe

    8.7     9.9     8.2  
               
   

Total

    100.0 %   100.0 %   100.0 %
               

(1)
We use a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal years ended November 29, 2009 and November 30, 2008 were 52-week years. The fiscal year ended December 2, 2007 was a 53-week year.

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        The following table shows our net sales and margin profitability for the major geographic regions of our operations, including local currency results for the significant international operations:

 
  Fiscal year(1)  
 
  2009   2008   2007  
 
  (in thousands)
  (percentage of
net sales)

  (in thousands)
  (percentage of
net sales)

  (in thousands)
  (percentage of
net sales)

 

Total Americas (US Dollars):

                                     
 

Net sales

  $ 1,178,464     100.0 % $ 1,349,283     100.0 % $ 1,561,739     100.0 %
 

Cost of goods sold

    689,743     58.5     799,026     59.2     887,975     56.9  
                           
   

Gross profit

    488,721     41.5     550,257     40.8     673,764     43.1  

United States (US Dollars):

                                     
 

Net sales

    946,951     100.0     1,055,682     100.0     1,266,355     100.0  
 

Cost of goods sold

    546,487     57.7     626,678     59.4     719,537     56.8  
                           
   

Gross profit

    400,464     42.3     429,004     40.6     546,818     43.2  

Total International (US Dollars):

                                     
 

Net sales

    343,113     100.0     442,341     100.0     435,710     100.0  
 

Cost of goods sold

    229,784     67.0     287,304     65.0     272,918     62.6  
                           
   

Gross profit

    113,329     33.0     155,037     35.0     162,792     37.4  

Canada:

                                     
 

US Dollars:

                                     
   

Net sales

    151,387     100.0     187,672     100.0     196,264     100.0  
   

Cost of goods sold

    95,004     62.8     108,795     58.0     111,737     56.9  
                           
     

Gross profit

    56,383     37.2     78,877     42.0     84,527     43.1  
 

Canadian Dollars:

                                     
   

Net sales

    173,121     100.0     195,373     100.0     210,724     100.0  
   

Cost of goods sold

    108,868     62.9     113,431     58.1     120,004     56.9  
                           
     

Gross profit

    64,253     37.1     81,942     41.9     90,720     43.1  

Other Americas (US Dollars):

                                     
 

Net sales

    80,126     100.0     105,929     100.0     99,120     100.0  
 

Cost of goods sold

    48,252     60.2     63,553     60.0     56,701     57.2  
                           
   

Gross profit

    31,874     39.8     42,376     40.0     42,419     42.8  

Europe:

                                     
 

US Dollars:

                                     
   

Net sales

    111,600     100.0     148,740     100.0     140,326     100.0  
   

Cost of goods sold

    83,536     74.9     116,951     78.6     106,725     76.1  
                           
     

Gross profit

    28,064     25.1     31,789     21.4     33,601     23.9  
 

Euros:

                                     
   

Net sales

    80,083     100.0     99,699     100.0     103,350     100.0  
   

Cost of goods sold

    59,895     74.8     78,518     78.8     78,420     75.9  
                           
     

Gross profit

    20,188     25.2 %   21,181     21.2 %   24,930     24.1 %

(1)
We use a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal years ended November 29, 2009 and November 30, 2008 were 52-week years. The fiscal year ended December 2, 2007 was a 53-week year.

Year Ended November 29, 2009 Compared With Year Ended November 30, 2008

        Net Sales.    Our consolidated net sales for the year ended November 29, 2009 were $1,290.1 million, a decrease of $208.0 million, or 13.9% from the year ended November 30, 2008. Total

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Americas net sales were $1,178.5 million for fiscal 2009, a decrease of 12.7% from fiscal 2008. This decrease was primarily related to our U.S. operations within the Americas segment. Total U.S. net sales of $947.0 million for fiscal 2009 decreased $108.7 million from $1,055.7 million in fiscal 2008, a decrease of 10.3%. The U.S. net sales decrease of $108.7 million was attributable primarily to a 9.8% decrease in wholesale unit volume, coupled with a 0.2% decrease in wholesale average unit selling price. The decrease in unit volume resulted from weak retail demand throughout the year. The slight decrease in average unit selling price was due to increased interest in our value-priced Sealy brand product as a result of its appeal to more price conscious consumers in this economic environment. However, those decreases were partially offset by increased interest in our newly designed Stearns & Foster product line which was introduced in the second quarter of fiscal 2009, the favorable impact of the July 2008 price increase, increased delivery revenue and fewer discounted floor samples in fiscal 2009 as the Stearns & Foster product launch was not distributed as widely as the Posturepedic product launched in fiscal 2008. International net sales decreased $99.2 million, or 22.4% from fiscal 2008 to $343.1 million. Excluding the effects of currency fluctuations, net sales declined 13.7% from fiscal 2008. This decline was due to the weak retail environment in all of our major markets. In Canada, local currency sales decreases of 11.4% translated into decreases of 19.3% in U.S. dollars due to a lower average value of the Canadian dollar versus the U.S. dollar. Local currency sales decreases in our Canadian market were driven by a 10.3% decrease in unit volume and a 1.2% decrease in average unit selling price. The decrease in unit volume is primarily attributable to weak Canadian retail demand while the decrease in average unit selling price is due to increased sales of value oriented beds. Elsewhere in the Americas, we have experienced sales decreases in our Mexico and South American markets. In our Europe segment, local currency sales decreases of 19.7% translated into a decrease of 25.0% in U.S. dollars due to a decline in the value of the Euro relative to the U.S. dollar. Local currency sales decreases in the European market were attributable to decreased sales of latex bed cores to other manufacturers associated with a shift in mix away from higher-priced finished product. Finished goods sales in Europe decreased 10.8% in local currency in fiscal 2009.

        Gross Profit.    Gross profit for fiscal 2009 was $516.8 million, a decrease of $65.3 million compared to fiscal 2008. As a percentage of net sales, gross profit in fiscal 2009 increased 1.2 percentage points to 40.1%. This was due to an increase in gross profit margins within the Americas segment. Total Americas gross profit in fiscal 2009 decreased $61.5 million to $488.7 million, which as a percentage of sales, represented an increase of 0.7 percentage points to 41.5%. The increase as a percentage of net sales was driven by improvements in the U.S., partially offset by decreases in Canada and the Other Americas business. U.S. gross profit decreased $28.5 million to $400.5 million or 42.3% of net sales, which is an increase of 1.7 percentage points of net sales from the prior year period. The increase in percentage of net sales was driven primarily by the continued favorable impact of operations efficiencies and lower material costs. Partially offsetting these improvements was a decrease in absorption of fixed costs. The local currency gross profit margin in Canada was 37.1% as a percentage of net sales which represents a decrease of 4.8 percentage points from fiscal 2008. This decrease as a percentage of sales was driven by the impact of currency fluctuations on raw materials purchases. In our Europe segment, the local currency gross profit margin increase of 2.4 percentage points was due to the shift in product sales mix towards more finished goods sales coupled with decreased prices of raw materials due to the deflation in the prices of the underlying commodities.

        Selling, General, and Administrative.    Selling, general, and administrative expenses decreased $66.1 million to $416.4 million for fiscal 2009 compared to $482.6 million for fiscal 2008. As a percentage of net sales, selling, general, and administrative expenses were 32.3% for fiscal 2009 compared to 32.2% for fiscal 2008. The slight increase as a percent of sales is primarily due to lower sales volumes. The decrease in absolute dollars is primarily due to a $39.6 million reduction in volume driven variable expenses including an $18.7 million decrease in cooperative advertising and promotional costs, a $16.1 million decrease in delivery costs due primarily to a decrease in unit volume shipped and a $4.8 million decrease in bad debt expense. Fixed operating costs, exclusive of compensation expense,

35



decreased $44.3 million from the prior year period primarily due to reductions in national advertising expenses of $14.8 million and discretionary expenditures such as professional fees and travel and entertainment. Compensation expense increased $17.7 million compared to fiscal 2008. This increase is primarily due to increases of $15.3 million for incentive-based payments and expected defined contribution plan payments, coupled with the recognition of share-based compensation expense of $9.3 million, which is non-cash in nature and the effects of which were partially offset by lower compensation expense due to reduced headcount. In addition, foreign exchange transaction and severance related costs improved $7.4 million and $5.1 million, respectively from fiscal 2008.

        Goodwill impairment loss.    During fiscal 2009, we recognized a total non-cash charge of $1.2 million related to the impairment of goodwill of our Argentina reporting unit. The impairment was indicated by our fiscal 2009 annual impairment testing of goodwill performed in the fourth quarter of fiscal 2009. The goodwill impairment reflected a reduction in the fair value of Argentina as a result of lower expected cash flows for the business and represents the entire goodwill balances for this reporting unit.

        During fiscal 2008, we recognized a total non-cash charge of $27.5 million related to the impairment of goodwill of our Puerto Rico and Europe reporting units. The impairment was indicated by an update to our fiscal 2008 annual impairment testing of goodwill performed in the fourth quarter of fiscal 2008. The goodwill impairment reflected a reduction in the fair value of Puerto Rico and Europe as a result of lower expected cash flows for the business and represents the entire goodwill balances for those reporting units.

        Restructuring expenses and asset impairment.    We recognized pretax restructuring costs of $1.3 million during fiscal 2009 as compared with costs of $3.1 million recognized in fiscal 2008. These charges primarily relate to the following actions:

        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, we incurred certain insignificant costs related to one-time terminations of employees. Additionally, we recognized an impairment charge of approximately $1.2 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.

        In the first quarter of fiscal 2008, management made the decision to cut back the manufacturing operations in Brazil and move to a business model under which significantly more product will be supplied by production from other Sealy manufacturing facilities. As a result, we incurred charges of $0.4 million related to employee severance and related benefits. We do not expect to incur additional restructuring charges related to this activity. The plan was completed in the fourth quarter of fiscal 2008.

        In the third quarter of fiscal 2008, management elected to close its administrative offices near Milan, Italy and relocate these activities to its manufacturing facility in Silvano, Italy. This closure resulted in the elimination of approximately 10 employees who elected not to relocate in the fourth quarter of fiscal 2008. We recorded a pre-tax restructuring charge related to this action of $0.2 million during the year ended November 30, 2008, the majority of which related to employee severance and benefits. An insignificant amount of this charge was related to relocation costs. This plan was completed in the fourth quarter of fiscal 2008.

        In the third quarter of fiscal 2008, management also made the decision to close its manufacturing facility in Clarion, Pennsylvania. We recorded a pre-tax restructuring and impairment charge related to this action of $2.5 million during fiscal 2008, of which $1.6 million was related to employee severance and benefits and other exit costs, and $0.9 million of which was non-cash in nature, related to fixed asset impairment charges. During fiscal 2009, we incurred additional charges related to this action of

36



$0.1 million primarily related to relocation costs. This plan was completed in the first quarter of fiscal 2009.

        Royalty Income, net of royalty expense.    Our consolidated royalty income, net of royalty expense, for fiscal 2009 decreased $0.9 million to $16.4 million from fiscal 2008 primarily due to the decreased domestic license sales along with unfavorable fluctuations in international currency rates.

        Interest Expense.    Our consolidated interest expense in fiscal 2009 increased by $18.6 million from the prior year period to $79.1 million which includes $5.3 million of non-cash interest expense related to our Convertible Notes. Our weighted average borrowing costs for fiscal 2009 and 2008 were 9.6% and 7.5%, respectively. Our borrowing cost was unfavorably impacted by our 2009 refinancing of our existing senior secured credit facilities (the "Old Senior Credit Facility") to replace them with indebtedness that has longer-dated maturities and eliminates quarterly financial ratio based maintenance covenants (the "Refinancing") which resulted in increased interest rates and outstanding debt balances.

        Refinancing and extinguishment of debt and interest rate derivatives.    Debt extinguishment and refinancing expenses for fiscal 2009 includes non-cash charges of $2.1 million relating to the write-off of debt issuance costs related to our old senior term loans. Additionally, we incurred $15.2 million of charges associated with termination payments on our interest rate swap agreements that were associated with the old senior credit facility. During fiscal 2008, we incurred cash charges of $5.4 million related to the amendment of our senior credit facility which represents amounts paid to the creditors in connection with the amendment.

        Income Tax.    Our effective income tax rate generally differs from the federal statutory rate due to the effects of certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for fiscal 2009 and fiscal 2008 was (18.7)% and 122.3%, respectively. The effective rate for the fiscal 2009 period was decreased primarily due to the reversal of $11.4 million of the liability for uncertain tax positions and related interest (net) and penalties due to the expiration of statutes of limitations offset by lower pre-tax income in fiscal 2009. The effective rate for the fiscal 2008 period was increased by 91.2% due to lower pre-tax income and the impairment of goodwill for our Puerto Rico and Europe reporting units which is not tax deductible.

Year Ended November 30, 2008 Compared With Year Ended December 2, 2007

        Net Sales.    Our consolidated net sales for the year ended November 30, 2008 were $1,498.0 million, a decrease of $204.0 million, or 12.0% from the year ended December 2, 2007. Fiscal year 2007 was a 53 week year, while fiscal year 2008 was a 52 week year. The decrease in net sales attributable to the 53rd week in fiscal 2007 was $32.3 million or 1.9% of fiscal 2007 net sales. Total Americas net sales were $1,349.3 million for fiscal 2008, a decrease of 13.6% from fiscal 2007. This decrease was primarily related to our U.S. operations within the Americas segment. Total U.S. net sales of $1,055.7 million for fiscal 2008 declined $210.7 million from $1,266.4 million in fiscal 2007, a decrease of 16.6%. The net sales attributable to the 53rd week in 2007 for the U.S. were $26.2 million. The U.S. net sales decrease of $210.7 million was attributable primarily to a 19.0% decrease in wholesale unit volume, partially offset by a 1.6% increase in wholesale average unit selling price. The decrease in unit volume was affected by weak retail demand, which intensified in our fiscal fourth quarter. Sales of our new Posturepedic, SmartLatex and Sealy branded products outperformed the rest of the portfolio. The slight increase in average unit selling price was due in part to the price increases taken in December 2007 and July 2008. Average unit selling price was also favorably impacted by the $3.7 million favorable impact from the change in the estimated reserve for non-warranty product returns. Partially offsetting these favorable effects was the impact of increased floor sample discounts related to new product introductions as well as softer sales of higher price point products such as Stearns & Foster. In Canada, local currency sales decreases of 7.3% translated into decreases of 4.4% in

37


U.S. dollars as retail demand in this market increasingly deteriorated during the year. Local currency sales decreases in our Canadian market were driven by a 7.5% decrease in unit volume, offset by a 0.2% increase in average unit selling price. The decrease in unit volume is primarily attributable to declines brought about because of a weak retail environment in this market. Elsewhere in the Americas, we experienced sales gains in our Mexico and Argentina markets. However, retail demand in these markets has also begun to decline. In our Europe segment, local currency sales decreases of 3.5% translated into an increase of 6.0% in U.S. dollars. Local currency sales decreases in the European market were attributable to an 11.5% decrease in unit volume driven by decreased sales of latex bed cores to other manufacturers, partially offset by a 9.0% increase in average unit selling price associated with price increases to our customers to offset some of the increased cost of raw materials. Finished goods sales in Europe decreased 3.4% in local currency in fiscal 2008.

        Gross Profit.    Gross profit for fiscal 2008 was $582.0 million, a decrease of $125.3 million compared to fiscal 2007. The 2007 results include the impact of the 53rd week, which represented $13.1 million. As a percentage of net sales, gross profit in fiscal 2008 decreased 2.7 percentage points to 39.0%. This was due to a decrease in gross profit margins within both of our segments. Total Americas gross profit in fiscal 2008 decreased $123.5 million to $550.3 million, which as a percentage of sales, represented a decrease of 2.3 percentage points to 40.8%. The decrease in gross profit for the Americas segment was primarily driven by a decrease in the U.S. gross profit in fiscal 2008. U.S. gross profit decreased $117.8 million to $429.0 million or 40.6% of net sales, which is a decrease of 2.6 percentage points of net sales from the prior year period. The decrease in percentage of net sales was driven primarily by higher inflation on core inputs such as steel and foam. In addition, the domestic gross profit margin relative to the prior year was negatively impacted by less absorption of overhead expenses due to lower volume and reduced sales of higher price point products such as Stearns & Foster. Additionally, incremental costs of approximately $8.1 million were incurred in fiscal 2008 as compared to fiscal 2007 related to compliance with July 2007 federal flame retardant regulations. The U.S. gross profit was positively impacted by a change in accounting estimate related to our warranty returns reserves recorded in the second quarter of fiscal 2008 which resulted in a reduction of cost of sales of approximately $2.5 million. Also, U.S. gross profit was positively impacted by continued improvements in manufacturing efficiencies, particularly factory labor and product scrap costs. The results of fiscal 2007 include $2.5 million of refunds on lumber tariffs received from Canadian suppliers as well as $2.1 million more startup costs associated with the latex facility in Mountain Top, Pennsylvania. In Canada, our gross profit margin decreased 1.1 percentage points to 42.0% of net sales primarily due to less absorption of overhead expenses due to lower sales volumes and rising material costs. In our Europe segment, the gross profit margin decrease resulted from manufacturing ineffiencies experienced related to lower production volume and price competition experienced in the OEM business.

        Selling, General, and Administrative.    Selling, general, and administrative expenses decreased $63.0 million to $482.6 million for fiscal 2008 compared to $545.6 million for fiscal 2007. As a percentage of net sales, selling, general, and administrative expenses was 32.2% for fiscal 2008 compared to 32.1% for fiscal 2007. The decrease in selling, general and administrative expenses is primarily due to $41.3 million of lower volume driven variable expenses and reductions in fixed costs. Actions taken to reduce fixed costs included $14.4 million of reductions in compensation related expenses, and $12.9 million less promotional expenses related to more efficient launches of new products in the U.S. as compared to fiscal 2007. In addition, spending on professional services and other discretionary items declined relative to fiscal 2007. Reduced sales drove a reduction of $41.3 million in volume variable expenses comprised of a $37.6 million decrease in cooperative advertising costs partially offset by higher transportation costs, a $3.7 million increase in bad debt costs and the impact of significantly higher foreign currency valuations relative to the U.S. dollar. The fixed cost reductions were partially offset by $6.6 million of costs associated with a reduction in personnel and executive search costs. The selling, general and administrative expense recorded in fiscal 2007 also

38



reflected the gain on the sale of our Orlando facility of $2.6 million as well as $3.9 million of costs associated with an organizational realignment.

        Goodwill impairment loss.    During fiscal 2008, we recognized a total non-cash charge of $27.5 million related to the impairment of goodwill of our Puerto Rico and Europe reporting units. The impairment was indicated by an update to our fiscal 2008 annual impairment testing of goodwill performed in the fourth quarter of fiscal 2008. The goodwill impairment reflected a reduction in the fair value of Puerto Rico and Europe as a result of lower expected cash flows for the business and represents the entire goodwill balances for those reporting units. No such impairments were identified in fiscal 2007.

        Restructuring expenses and asset impairment.    We recognized pretax restructuring costs of $3.1 million during the year ended November 30, 2008. No such costs were recognized during the year ended December 2, 2007. These charges primarily relate to the following actions:

        In the first quarter of fiscal 2008, management made the decision to cut back the manufacturing operations in Brazil and move to a business model under which significantly more product will be supplied by production from other Sealy manufacturing facilities. As a result, we incurred charges of $0.5 million related to employee severance and related benefits. We do not expect to incur additional restructuring charges related to this activity. The plan was completed in the fourth quarter of fiscal 2008.

        In the third quarter of fiscal 2008, management elected to close its administrative offices near Milan, Italy and relocate these activities to its manufacturing facility in Silvano, Italy. This closure resulted in the elimination of approximately 10 employees who elected not to relocate in the fourth quarter of fiscal 2008. We recorded a pre-tax restructuring charge related to this action of $0.2 million during the year ended November 30, 2008, the majority of which related to employee severance and benefits. An insignificant amount of this charge was related to relocation costs. This plan was completed in the fourth quarter of fiscal 2008.

        In the third quarter of fiscal 2008, management also made the decision to close its manufacturing facility in Clarion, Pennsylvania. This facility was closed on October 17, 2008. This closure resulted in the elimination of approximately 114 positions, the majority of which occurred in the fourth quarter of fiscal 2008. We recorded a pre-tax restructuring and impairment charge related to this action of $2.5 million during fiscal 2008, of which $1.6 million was related to employee severance and benefits and other exit costs, and $0.9 million of which was non-cash in nature, related to fixed asset impairment charges. The impairment charges were recognized based on the difference between the carrying value and the amount expected to be recovered through sale of the property, plant and equipment. During fiscal 2009, we incurred additional charges related to this action of $0.1 million primarily related to relocation costs. This plan was completed in the first quarter of fiscal 2009.

        Royalty Income, net of royalty expense.    Our consolidated royalty income, net of royalty expense, for fiscal 2008 decreased $1.2 million to $17.3 million from fiscal 2007, primarily due to a decrease in international licensee sales.

        Interest Expense.    Our consolidated interest expense in fiscal 2008 decreased $3.5 million from fiscal 2007. Our weighted average borrowing costs for fiscal 2008 and 2007 were 7.5% and 7.8%, respectively. Our borrowing cost and the related interest expense decreased because of lower interest rates on the unhedged variable rate component of our floating rate debt offset partially by an increase in the outstanding amount on our revolving credit facility. The borrowing cost was also reduced because of the retirement of $68.1 million of our 2014 Notes late in fiscal 2007.

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        Refinancing and extinguishment of debt and interest rate derivatives.    During fiscal 2008, we incurred cash charges of $5.4 million related to the amendment of our senior credit facility which represents amounts paid to the creditors in connection with the amendment. During fiscal 2007, we incurred $1.2 million of debt extinguishment costs consisting of $1.7 million of non-cash charges offset by a $0.5 million gain related to the retirement of $68.1 million of our 2014 Notes.

        Income Tax.    Our effective income tax rate generally differs from the federal statutory rate due to the effects of certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for fiscal 2008 and fiscal 2007 was 122.3% and 31.1%, respectively. The effective rate for the fiscal 2008 period was increased by 91.2% due to lower pre-tax income and the impairment of goodwill for our Puerto Rico and Europe reporting units which is not tax deductible. The effective rate for the fiscal 2007 period was reduced by a benefit of approximately $4.4 million resulting from a reduction in our income tax reserve as a result of the elimination of certain federal and state tax exposures due to the expiration of statutes of limitations and approximately $1.8 million from the reduction of the valuation allowance on capital loss carryforwards due to the availability of capital gains, and the reversal of previously established valuation allowances for Mexican deferred tax assets, partially offset by valuation allowances established during the year.

Liquidity and Capital Resources

Principal Sources of Funds

        Our principal sources of funds are cash flows from operations and borrowings under our asset-based revolving credit facility which provides commitments of up to $100.0 million maturing in May 2013 (the "ABL Revolver"). Our principal use of funds consists of operating expenditures, payments of interest on our senior debt, capital expenditures, and interest payments on our outstanding senior subordinated notes. Capital expenditures totaled $12.4 million for fiscal 2009. During fiscal 2009, there was no significant spending for additional production capacity. We believe that annual capital expenditure limitations in our current debt agreements will not prevent us from meeting our ongoing capital needs. Our introductions of new products typically require us to make initial cash investments in inventory, promotional supplies and employee training which may not be immediately recovered through new product sales. However, we believe that we have sufficient liquidity to absorb such expenditures related to new products and that these expenses will not have a significant adverse impact on our operating cash flow. At November 29, 2009, we had approximately $36.8 million available for borrowing under the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $24.1 million. We currently believe that our liquidity is adequate to meet our anticipated cash requirements. The calculated borrowing base under the ABL Revolver is determined based on our domestic accounts receivable and inventory balances. Our net weighted average borrowing cost was 9.6% and 7.5% for fiscal 2009 and 2008, respectively. As of January 2, 2010, we had no borrowings outstanding under the ABL Revolver.

        On May 13, 2009, we announced a comprehensive plan to refinance our existing senior secured credit facilities (the "Old Senior Credit Facility") and replace them with indebtedness that has longer-dated maturities and eliminates quarterly financial ratio based maintenance covenants. The Refinancing converted much of the existing senior debt from debt bearing interest at variable rates to debt bearing interest at fixed rates. Due to increases in the interest rates associated with our senior debt, the amount of debt outstanding and increases in the amortization of debt issuance costs, our interest expense in future periods is expected to increase significantly. However, we do not expect cash interest payments to change significantly due to the payment in kind interest associated with the Convertible Notes (as discussed below). Based on our current cash position and the availability of funds through our ABL Revolver, we believe that we will be able to obtain additional funds as necessary during fiscal 2010 in order to support our operations.

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Debt

        In connection with the Refinancing, we have: 1) entered into a new asset-based revolving credit facility which provides commitments of up to $100.0 million maturing in May 2013, which bears interest at our choice of either a base rate (determined by reference to the higher of several rates as defined by the ABL Revolver agreement) or a LIBOR rate for U.S. dollar deposits plus an applicable margin of 4.00%; 2) issued $350.0 million in aggregate principal amount of senior secured notes due April 2016 (the "Senior Notes"), which bear interest at 10.875% per annum payable semi-annually; 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") and bear interest at 8.00% per annum payable semi-annually in the form of additional Convertible Notes.

        At November 29, 2009, there were no amounts outstanding under the ABL Revolver. The Senior Notes have an outstanding balance of $336.6 million at November 29, 2009 which gives effect to an unamortized original issue discount of $13.4 million. As of November 29, 2009, the Convertible Notes have an outstanding principal balance of $180.1 million. We also have an outstanding principal balance of $268.9 million at November 29, 2009 on the 8.25% Senior Subordinated Notes due 2014 (the "2014 Notes").

        Future interest payments are expected to be paid out of cash flows from operations and borrowings on our ABL Revolver. The ABL Revolver provides for revolving credit financing, subject to borrowing base availability. The borrowing base consists of the following: 1) 85% of the net amount of eligible accounts receivable and 2) the lesser of (i) 85% of the net orderly liquidation value of eligible inventory or (ii) 65% of the net amount of eligible inventory. These amounts are reduced by reserves deemed necessary by the lenders. At November 29, 2009, there were no amounts outstanding under the ABL Revolver.

        Prior to the Refinancing, we had outstanding three interest rate swap agreements related to term debt under our Old Senior Credit Facility. In connection with the Refinancing, we paid $15.2 million to terminate these interest rate swap agreements. As the future variable interest rate payments are no longer likely to be made, the amounts which had previously been recorded in accumulated other comprehensive income were charged to refinancing expense for the year ended November 29, 2009.

        We are also party to three interest rate swaps for 2.3 million Euros, 2.9 million Euros and 3.5 million Euros which fix the floating interest rates on the debt of our 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. We have not formally documented these interest rate swaps as hedges. Therefore, changes in the fair value of these interest rate swaps are recorded as a component of interest expense.

        The outstanding 8.25% Senior Subordinated Notes due 2014 (the "2014 Notes") consist of an original $314 million aggregate principal amount maturing June 15, 2014, bearing interest at 8.25% per annum payable semiannually in arrears on June 15 and December 15, commencing on December 15, 2004. At November 29, 2009, the outstanding balance of the 2014 Notes was $268.9 million.

        At November 29, 2009, we were in compliance with the covenants contained within our ABL Revolver agreement and the indentures governing the Senior Notes, the Convertible Notes and the 2014 Notes. These agreements also restrict our ability to pay dividends and repurchase common stock.

        As part of our ongoing evaluation of our capital structure, we continually assess opportunities to reduce our debt, which opportunities may from time to time include the redemption or repurchase of a portion of our Senior Notes, the 2014 Notes or the Convertible Notes to the extent permitted by our debt covenants. During the fourth quarter of fiscal 2009, the Company repurchased and retired $5.0 million aggregate principal amount of the 2014 notes on the open market at 99.06% of par, plus accrued interest. In addition, our Board authorized a common stock repurchase program under which

41



we may repurchase up to $100 million of our common stock. As of November 29, 2009, we have repurchased shares for $16.3 million under this program, none of which was repurchased during fiscal 2009. From November 29, 2009 through January 2, 2010, we did not repurchase any additional shares under this program.

        Our ability to make scheduled payments of principal, or to pay the interest or liquidated damages, if any, on or to refinance our indebtedness, or to fund planned capital expenditures will depend on our future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We will be required to make scheduled principal payments of $13.7 million during the next twelve months, with $1.3 million for our financing obligations and capital leases and the remainder for debt owed by our international subsidiaries. However, as we continually evaluate our ability to make additional prepayments as permitted under our ABL Revolver agreement and the indentures governing the Senior Notes, the Convertible Notes and the 2014 Notes, it is possible that we will redeem or repurchase portions of our senior or subordinated debt during that time.

Dividend

        The indentures governing the Senior Notes, the 2014 Notes and the Convertible Notes contain restrictions on our ability to pay dividends which we do not currently meet and until we do so, we will not be able to declare a dividend. Additionally, our ABL Revolver agreement includes a requirement that we meet a minimum fixed charge coverage ratio for the payment of dividends. Although we meet the minimum fixed charge coverage ratio requirement as of November 29, 2009 because we do not meet the other restrictions, we will not be able to declare a dividend.

Cash Flow Analysis

        The following table summarizes our changes in cash:

 
  Fiscal year(1)  
 
  2009   2008   2007  
 
  (in thousands)
 

Statement of Cash Flow Data:

                   
 

Cash flows provided by (used in):

                   
     

Operating activities

  $ 78,653   $ 53,713   $ 94,382  
     

Investing activities

    (3,263 )   (24,913 )   (37,369 )
     

Financing activities

    26,494     (18,669 )   (86,218 )
 

Effect of exchange rate changes on cash

    2,947     1,858     (1,808 )
               
 

Change in cash and cash equivalents

    104,831     11,989     (31,013 )
 

Cash and cash equivalents:

                   
   

Beginning of period

    26,596     14,607     45,620  
               
   

End of period

  $ 131,427   $ 26,596   $ 14,607  
               

(1)
We use a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal years ended November 29, 2009 and November 30, 2008 were 52-week years. The fiscal year ended December 2, 2007 was a 53-week year.

Year Ended November 29, 2009 Compared With Year Ended November 30, 2008

        Cash Flows from Operating Activities.    Our cash flow from operations increased $25.0 million to a $78.7 million net source of cash for the year ended November 29, 2009, compared to a $53.7 million net source of cash for the year ended November 30, 2008. This increase has been driven by an increase in net income from fiscal 2008 of $17.3 million coupled with net cash provided by changes in working

42


capital in fiscal 2009 of $14.9 million compared with a net use of cash for working capital in fiscal 2008 of $17.0 million. This increase has been driven, in part by the receipt of $8.0 million of income tax refunds and improved working capital management during fiscal 2009.

        Cash Flows used in Investing Activities.    Our cash flows used in investing activities decreased approximately $21.7 million from fiscal 2008 primarily due to $8.4 million of proceeds from the sale-leaseback of our South Gate, California facility coupled with $12.5 million lower capital expenditures as compared with fiscal 2008.

        Cash Flows used in Financing Activities.    Our cash flow provided by financing activities for the year ended November 29, 2009 was $26.5 million compared with cash used in financing activities in fiscal 2008 of $18.7 million. This change has been primarily driven by the Refinancing which provided approximately $44.0 million of cash after considering the effects of the payments of costs to issue our new debt.

Year Ended November 30, 2008 Compared With Year Ended December 2, 2007

        Cash Flows from Operating Activities.    Our cash flow from operations decreased $40.7 million to a $53.7 million net source of cash for the year ended November 30, 2008, compared to a $94.4 million net source of cash for the year ended December 2, 2007. This decrease has been primarily driven by a reduction in net income from fiscal 2007 of $81.1 million. This decrease has been partially offset by changes in working capital driven primarily by a reduction in accounts receivable balances.

        Cash Flows used in Investing Activities.    Our cash flows used in investing activities decreased approximately $12.5 million from fiscal 2007 primarily due to $17.5 million lower capital expenditures for fiscal 2008 as compared with the prior fiscal year. The decreased capital expenditures were primarily due to the completion of our new facility in Orlando, Florida, the completion of the Mountain Top, Pennsylvania facility and the commencement of work on a second production line at the same facility and the construction of a warehouse at our production site in Italy in fiscal 2007. These expenditures were partially offset by $5.0 million in lower proceeds on sales of assets. Fiscal 2007 results included $4.8 million received from the sale of our Orlando, Florida facility.

        Cash Flows used in Financing Activities.    Our cash flow used in financing activities for the year ended November 30, 2008 decreased $67.5 million to a net use of $18.7 million from a net use of $86.2 million for the year ended December 2, 2007. This decrease has been driven by $20.6 million less of dividend payments and $4.4 million less net borrowings against our senior revolving credit facility in fiscal 2008. Further, in fiscal 2007, $16.3 million was used to repurchase our common stock, $68.1 million was used to retire a portion of our 2014 Notes and $11.6 million was used for payments on our senior secured term loans.

Debt Covenants

        Our long-term obligations contain various financial tests and covenants, but do not require that we meet quarterly financial ratio targets in order to maintain compliance. Our ABL Revolver requires us to meet a minimum fixed charge coverage ratio in order to incur additional indebtedness and make dividend distributions to holders of our common stock, subject to certain exceptions. Additionally, the ABL Revolver requires us 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 November 29, 2009, we are in compliance with the covenants and are not in a minimum availability period under the ABL Revolver. The indentures governing our Senior Notes, Convertible Notes and Senior Subordinated Notes also require us to meet a fixed charge coverage ratio in order to incur additional indebtedness, subject to certain exceptions. We are in compliance with the fixed charge coverage ratio at November 29, 2009.

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        The covenants contained in our senior debt agreements restricting our ability to enter into certain transactions are based on what we refer to herein as "Adjusted EBITDA". In the senior debt agreements, EBITDA is defined as net income plus interest, taxes, depreciation and amortization and Adjusted EBITDA is defined as EBITDA further adjusted to exclude unusual items and other adjustments permitted in calculating covenant compliance as discussed above. Adjusted EBITDA is presented herein as it is a material component of these covenants. For instance, the indenture governing the Senior Notes, Convertible Notes and 2014 Notes and the ABL Revolver agreement each contain financial covenant ratios, specifically leverage and interest coverage ratios, that are calculated by reference to Adjusted EBITDA. Non-compliance with the covenants contained in the ABL Revolver agreement could result in the requirement to immediately repay all amounts outstanding under this facility, while non-compliance with the debt incurrence ratios contained in the indenture governing the Senior Notes, Convertible Notes and 2014 Notes would prohibit Sealy Mattress Company and its subsidiaries from being able to incur additional indebtedness other than pursuant to specified exceptions. In addition, under the restricted payment covenants contained in the indenture governing the Senior Notes, Convertible Notes and 2014 Notes, the ability of Sealy Mattress Company to pay dividends is restricted by formula based on the amount of Adjusted EBITDA. While the determination of "unusual items" is subject to interpretation and requires judgment, we believe the adjustments listed below are in accordance with the covenants.

        EBITDA and Adjusted EBITDA are not recognized terms under GAAP and do not purport to be alternatives to net income as a measure of operating performance or to cash flows from operating activities as a measure of liquidity. Additionally, they are not intended to be measures of free cash flow for management's discretionary use, as they do not consider certain cash requirements such as interest payments, tax payments and debt service requirements. Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies.

        The following table sets forth a reconciliation of net income to EBITDA and EBITDA to Adjusted EBITDA for the year ended November 29, 2009, November 30, 2008 and December 2, 2007 (in thousands):

 
  2009   2008   2007  

Net income (loss)

  $ 13,485   $ (3,803 ) $ 77,321  
 

Interest expense

    79,092     60,464     63,976  
 

Income taxes

    (2,125 )   20,872     34,865  
 

Depreciation and amortization

    33,401     35,949     32,738  
               

EBITDA

    123,853     113,482     208,900  

Adjustments for debt covenants:

                   
 

Refinancing charges

    17,488     5,378     0  
 

Non-cash compensation

    12,638     3,375     0  
 

KKR consulting fees

    2,862     2,195     0  
 

Severance charges

    2,502     6,019     0  
 

Goodwill impairment

    1,188     27,475     0  
 

Restructuring and impairment related charges

    3,623     3,402     0  
 

Loss on written option derivative

    4,549     0     0  
 

North American realignment

    0     0     3,898  
 

Other (various)(a)

    (967 )   5,600     4,048  
               

Adjusted EBITDA

  $ 167,736   $ 166,926   $ 216,846  
               

(a)
Consists of various immaterial adjustments.

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        As of and during the fiscal years ended November 29, 2009, November 30, 2008 and December 2, 2007, we were in compliance with the covenants contained within our debt instruments.

Off-Balance Sheet Arrangements

        We occupy premises and utilize equipment under operating leases that expire at various dates through 2023. In accordance with generally accepted accounting principles, the obligations under those leases are not recorded on our balance sheet. Many of these leases provide for payment of certain expenses and contain renewal and purchase options. During the fiscal years ended November 29, 2009, November 30, 2008 and December 2, 2007, we recognized lease expenses of $21.6 million, $21.6 million and $20.7 million, respectively.

        We are involved in a joint venture to develop markets for Sealy branded products in Asia. The joint venture is not considered to be a variable interest entity and is therefore not consolidated for financial statement purposes. We account for our interest in the joint venture under the equity method, and our net investment of $4.5 million is recorded as a component of other assets including debt issuance costs, net within the Consolidated Balance Sheet at November 29, 2009. We believe that any possible commitments arising from this joint venture will not be significant to our consolidated financial position or results of operations.

Contractual Obligations and Commercial Commitments

        As previously discussed, our debt at November 29, 2009 consists of an asset-based revolving credit facility, under which no amounts are outstanding, $336.6 million aggregate principal amount of senior notes due 2016, $180.1 million aggregate principal amount of convertible paid-in kind notes due 2016, $268.9 million outstanding aggregate principal amount of senior subordinated notes due 2014, $41.3 million due on our financing obligations and an additional $20.5 million of other borrowings, most of which are owed by our international subsidiaries.

        We engage in various hedging activities in order to mitigate the risk of variability in future cash flows resulting from floating interest rates on our debt and projected foreign currency purchase requirements. Accordingly, we have entered into contractual arrangements for interest rate swaps and forward purchases of foreign currency. The related assets and liabilities associated with the fair value of such derivative instruments are recorded on our balance sheet. Changes in the fair value of these derivatives are recorded in our income statement, except for those associated with those agreements which have been designated as cash flow hedges for accounting purposes.

        Significant judgment is required in evaluating our federal, state and foreign tax positions and in the determination of its tax provision. Despite our belief that the 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. We 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. While we are currently undergoing examinations of certain of its corporate income tax returns by tax authorities, no issues related to these liabilities for uncertain tax positions have been presented to us and we have not been informed that such audits will result in an assessment or payment of taxes related to these positions during the one year period following November 29, 2009.

        In accordance with FASB authoritative guidance on accounting for uncertainty in income taxes, we maintain a reserve for uncertain tax positions. At November 29, 2009, the entire net reserve for uncertain tax positions is $20.9 million and $2.4 million as a reduction of non current deferred tax asset (including penalties and interest). At this time, we are unable to make a reasonably reliable estimate of the timing of payments in individual years beyond 12 months due to uncertainties in the timing of the effective settlement of tax positions. As such, the unrecognized tax benefit liabilities are not included in the table below.

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        Our contractual obligations and other commercial commitments as of November 29, 2009 are summarized below (in thousands):

Contractual Obligations
  2010   2011   2012   2013   2014   After 2015   Total
Obligations
 

Principal maturities of long-term debt

  $ 13,693   $ 3,598   $ 3,668   $ 3,533   $ 271,457   $ 551,510   $ 847,459  

Projected interest on long-term debt(1)

    82,032     83,588     85,793     88,262     91,030     117,267     547,972  

Projected cash flows on derivatives(2)

                             

Operating leases(3)

    13,896     12,520     10,520     8,648     6,695     21,854     74,133  

Obligations under license agreements(4)

    953                         953  
                               

Total

  $ 110,574   $ 99,706   $ 99,981   $ 100,443   $ 369,182   $ 690,631   $ 1,470,517  
                               

Other Commercial Commitments

 

2010

 

2011

 

2012

 

2013

 

2014

 

After 2015

 

Total
Commitments

 

Standby Letters of Credit(5)

  $ 24,101                       $ 24,101  

(1)
$5.9 million of our outstanding debt at November 29, 2009 is subject to variable interest rates. Interest payments are projected based on rates in effect at November 29, 2009 assuming no variable rate fluctuations going forward. An increase in the interest rates applicable to the unhedged portion of our variable rate debt by 1% would result in approximately $0.1 million in additional annual cash interest expense. Further, these amounts include the paid in kind interest obligation related to our Convertible Notes which does not represent a cash interest payment.

(2)
Our hedging instruments consist of the projected net settlements of our interest rate swaps and foreign currency contracts as of November 29, 2009 based on the expected timing of the net payments to be received under the agreements and have not been included in the above presentation as they do not currently represent obligations of the Company. The fair value of these instruments can fluctuate based on market conditions.

(3)
Obligations under operating leases include only projected payments under current lease terms, excluding renewal options and assuming no exercise of any purchase options.

(4)
Amounts represent minimum guarantees owed under license agreements.

(5)
We issue letters of credit in the ordinary course of business primarily to back our various obligations under workers compensation and other insurance programs, environmental liabilities, and open positions on certain of our derivative instruments. These obligations will renew automatically on an annual basis unless cancelled per our instructions.

        As discussed in Note 17 to our Consolidated Financial Statements included in Item 8, we have a $12.1 million long term obligation arising from underfunded pension plans. Future minimum pension funding requirements are not included in the schedule above as they are not available for all periods presented. During fiscal 2010, we estimate that we will make approximately $1.1 million in contributions to the plans. In fiscal 2009, we contributed $1.9 million into the plans.

        There are no agreements to purchase goods or services with fixed or minimum obligations. The schedule above does not include normal purchases which are made in the ordinary course of business.

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Foreign Operations and Export Sales

        We operate three manufacturing and distribution center facilities in Canada, and one each in Mexico, Argentina, Uruguay and Brazil. In 2000, we formed a joint venture with our Australian licensee to import, manufacture, distribute and sell Sealy branded products in South East Asia. On December 1, 2008, a fifty percent interest in our operations in South Korea was sold for $1.4 million to our Australian licensee and these operations became part of the joint venture. On December 4, 2008, the Company and its Australian licensee each acquired a 50% interest in a joint venture that owns the assets of our 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. (See Note 13 to the Consolidated Financial Statements in Item 8). We also export products directly into many small international markets, and have license agreements in Thailand, Japan, the United Kingdom, Spain, Australia, South Africa, Israel, Jamaica, Saudi Arabia, the Bahamas and the Dominican Republic. The results of these export operations are considered a component of our Americas segment.

        In addition, we own Sapsa Bedding S.A.S., a leading European manufacturer of latex bedding products in Europe, with headquarters in Italy and manufacturing operations in France and Italy and which are components of our Europe segment.

Impact of Recently Issued Authoritative Accounting Guidance

        In December 2007, the 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. This guidance is effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008. This guidance will be effective for us beginning in fiscal 2010. We do not expect the adoption of this guidance to have a material impact on the 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. This guidance is effective prospectively, except for certain retrospective adjustments to deferred tax balances, for fiscal years beginning after December 15, 2008. This guidance will be effective for us beginning in fiscal 2010. This guidance could have a potential impact should we enter into a business combination in future periods.

        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. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. We will adopt this guidance as of the beginning of fiscal 2010 and do not expect the adoption of this guidance to have a material impact on the financial statements.

        In June 2008, the FASB issued authoritative guidance that addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. We will adopt this guidance as of the beginning of fiscal 2010 and do not expect the adoption of this guidance to have a material impact on the financial statements.

        In November 2008, the Emerging Issued Task Force ("EITF") issued authoritative guidance which clarifies the accounting for certain transactions involving equity method investments. This guidance is

47



effective for financial statements issued for fiscal years beginning on or after December 15, 2008 and interim periods within those years. We will adopt this guidance as of the beginning of fiscal 2010 and do not expect the adoption of this guidance to have a material impact on the financial statements.

        In June 2009, the FASB issued authoritative guidance on the consolidation of variable interest entities. This new guidance will significantly affect the overall consolidation analysis. This guidance is effective as of the beginning of the first fiscal year that begins after November 15, 2009. This guidance will be effective for us beginning in fiscal 2010. We are still assessing the potential impact of adoption.

General Business Risk

        Our customers include furniture stores, specialty sleep shops, department stores, membership warehouse clubs, hospitality customers and other stores. In the future, these customers may consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of locations that carry our products. These customers are also subject to changes in consumer spending and the overall state of the economy, both domestically and internationally. As we have seen in fiscal 2008 and 2009, our business, financial condition and results of operations may be affected by various economic factors. Unfavorable economic conditions such as the global economic downturn we have experienced have made it more difficult for us to maintain and continue our revenue growth. In an economic recession or under other adverse economic conditions, customers and vendors may be more likely to be unable to meet contractual terms or their payment obligations. Any of these factors could have a material adverse effect on our business, financial condition or results of operations.

Fiscal Year

        We use a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal years ended November 29, 2009 and November 30, 2008 were 52-week years. The fiscal year ended December 2, 2007 was a 53-week year.

Forward Looking Statements

        "Safe Harbor" Statement Under the Private Securities Litigation Reform Act of 1995. When used in this Annual Report on Form 10-K, the words "believes," "anticipates," "expects," "intends," "projects" and similar expressions are used to identify forward-looking statements within the meaning of Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to future financial and operation results. Any forward-looking statements contained in this report represent our management's current expectations, based on present information and current assumptions, and are thus prospective and subject to risks and uncertainties which could cause actual results to differ materially from those expressed in such forward-looking statements. Actual results could differ materially from those anticipated or projected due to a number of factors. These factors include, but are not limited to:

    the level of competition in the bedding industry;

    legal and regulatory requirements;

    the success of new products;

    our relationships with our major suppliers;

    fluctuations in costs of raw materials;

    our relationship with significant customers and licensees;

    our labor relations;

    departure of key personnel;

48


    encroachments on our intellectual property;

    product liability claims;

    the timing, cost and success of opening new manufacturing facilities;

    our level of indebtedness;

    interest rate risks;

    access to financial credit by our customers, vendors or us;

    future acquisitions;

    an increase in return rates; and

    other risks and factors identified from time to time in the Company's reports filed with the Securities and Exchange Commission, or the SEC.

        All forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Annual Report on Form 10-K and are expressly qualified in their entirety by the cautionary statements include in this Annual Report on Form 10-K. Except as may be required by law, we undertake no obligation to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.

Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exposures

        Our earnings are affected by fluctuations in the value of our subsidiaries' functional currency as compared to the currencies of our foreign denominated purchases. Foreign currency forward and option contracts are used to hedge against the earnings and cash flow effects of such fluctuations. The result of a uniform 10% change in the value of the U.S. dollar relative to currencies of countries in which we manufacture or sell our products would have an approximate $0.8 million dollar impact on our financial position for the year ended November 29, 2009. This calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar.

        To protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, we have instituted a forecasted cash flow hedging program. We hedge portions of our purchases denominated in foreign currencies and royalty payments to third parties with forward contracts. At November 29, 2009, we had one forward foreign currency contract outstanding to purchase a total of 0.5 million Euros with an expiration date of December 31, 2009. Additionally, at November 29, 2009, we had outstanding forward and option foreign currency contracts to sell Canadian dollars for a total of 35.5 million US dollars. The expiration dates for the Canadian dollar contracts range from December 15, 2009 to November 15, 2010. At November 29, 2009, the fair value of these contracts was an asset of $1.1 million. The changes in fair value of the foreign currency hedges are included in net income, except for those contracts that have been designated as hedges for accounting purposes. For contracts designated as hedges for accounting purposes, the changes in fair value related to the effective portion of the hedge are recognized as a component of accumulated other comprehensive income.

Interest Rate Risk

        Prior to the Refinancing, we had outstanding three interest rate swap agreements related to term debt under our Old Senior Credit Facility. In connection with the Refinancing, we paid $15.2 million to terminate these interest rate swap agreements. As the future variable interest rate payments are no

49



longer probable of being made, the amounts which had previously been recorded in accumulated other comprehensive income were charged to refinancing expense for fiscal 2009, in accordance with the FASB's authoritative guidance on accounting for derivative instruments.

        No assets or liabilities were recognized related to the above swap instruments at November 29, 2009 due to their termination prior to this date. The fair value of the above swap instruments was a liability of $15.9 million at November 30, 2008.

        Additionally, we have entered into three interest rate swaps for 2.3 million Euro, 2.9 million Euro and 3.5 million Euro which fix the floating interest rates on the debt of our 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 fair value of these swaps was an asset totaling $0.5 million and $0.4 million as of November 29, 2009 and November 30, 2008, respectively.

        A 10% increase or decrease in market interest rates that affect our interest rate derivative instruments would not have a material impact on our earnings during the next fiscal year. Based on the unhedged portion of our variable rate debt outstanding at November 29, 2008, a 12.5 basis point increase or decrease in variable interest rates would have an insignificant impact on our annual interest expense.

Commodity Price Risks

        The cost of our steel innerspring, polyurethane foam, polyester, and polyethlylene component parts were impacted sharply by the volatility in the prices of steel and petroleum in fiscal 2008. During fiscal 2009, the prices paid for steel and latex foam decreased from prior year levels and stabilized somewhat due to a reduction in the volatility in the related commodity prices. We periodically enter into commodity-based physical contracts to buy natural gas at agreed-upon fixed prices. These contracts are entered into in the normal course of business. We do not engage in commodity hedging programs, but continue to evaluate opportunities to reduce our risk associated with price volatility.

50


Item 8.    Financial Statements and Supplementary Data


REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
Sealy Corporation
Trinity, North Carolina

        We have audited the accompanying consolidated balance sheets of Sealy Corporation and subsidiaries (the "Company") as of November 29, 2009 and November 30, 2008 and related consolidated statements of operations, stockholders' deficit, and cash flows for each of the three fiscal years in the period ended November 29, 2009. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.

        We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Sealy Corporation and subsidiaries as of November 29, 2009 and November 30, 2008 and the results of their operations and their cash flows for each of the three fiscal years in the period ended November 29, 2009, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        As discussed in Notes 1 and 16 to the consolidated financial statements, the Company adopted new Financial Accounting Standards Board (FASB) authoritative guidance on accounting for uncertainty in income taxes, effective December 3, 2007. Also, as discussed in Note 1, the fiscal year ended December 2, 2007 included 53 weeks. The fiscal years ended November 29, 2009 and November 30, 2008 included 52 weeks.

        We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of November 29, 2009, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated January 25, 2010 expressed an unqualified opinion on the Company's internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Raleigh, North Carolina
January 25, 2010

51



SEALY CORPORATION

Consolidated Balance Sheets

(in thousands, except per share amounts)

 
  November 29,
2009
  November 30,
2008
 

ASSETS

             

Current assets:

             
 

Cash and cash equivalents

  $ 131,427   $ 26,596  
 

Accounts receivable (net of allowance for doubtful accounts, discounts and returns, 2009—$26,675; 2008—$24,910)

    156,850     156,583  
 

Inventories

    56,810     64,634  
 

Prepaid expenses and other current assets

    21,080     30,969  
 

Deferred income taxes

    20,222     16,775  
           

    386,389     295,557  
           

Property, plant and equipment—at cost:

             
 

Land

    10,555     12,489  
 

Buildings and improvements

    147,415     144,881  
 

Machinery and equipment

    284,468     287,817  
 

Construction in progress

    4,551     4,121  
           

    446,989     449,308  
 

Less accumulated depreciation

    (239,508 )   (225,958 )
           

    207,481     223,350  
           

Other assets:

             
 

Goodwill

    360,583     357,149  
 

Other intangibles—net of accumulated amortization (2009—$18,900; 2008—$13,434)

    1,937     4,945  
 

Deferred income taxes

    6,874     3,392  
 

Debt issuance costs, net, and other assets

    52,206     29,083  
           

    421,600     394,569  
           

Total Assets

  $ 1,015,470   $ 913,476  
           

See accompanying notes to consolidated financial statements.

52



SEALY CORPORATION

Consolidated Balance Sheets (Continued)

(in thousands, except per share amounts)

 
  November 29,
2009
  November 30,
2008
 

LIABILITIES AND STOCKHOLDERS' DEFICIT

             
 

Current liabilities:

             
   

Current portion-long term obligations

  $ 13,693   $ 21,243  
   

Accounts payable

    88,971     97,084  
   

Accrued expenses:

             
     

Customer incentives and advertising

    31,804     34,542  
     

Compensation

    43,105     24,797  
     

Interest

    15,230     16,432  
     

Other

    36,436     44,363  
           

    229,239     238,461  
           
 

Long term obligations, net of current portion

    833,766     762,162  
 

Other noncurrent liabilities

    59,625     71,257  
 

Deferred income taxes

    832     584  
 

Commitments and contingencies (Notes 1, 10 and 19)

             
 

Common stock and options subject to redemption

   
   
8,856
 
 

Stockholders' deficit:

             
   

Preferred stock, $0.01 par value; Authorized 50,000 shares;

             
     

Issued, none

         
   

Common stock, $0.01 par value; Authorized 200,000 shares; Issued and outstanding: 2009—94,417; 2008—91,800 (including shares classified above as subject to redemption: 2009—0; 2008—282)

    947     917  
   

Additional paid-in capital

    885,064     668,547  
   

Accumulated deficit

    (992,950 )   (817,597 )
   

Accumulated other comprehensive loss

    (1,053 )   (19,711 )
           

    (107,992 )   (167,844 )
           
 

Total Liabilities and Stockholders' Deficit

  $ 1,015,470   $ 913,476  
           

See accompanying notes to consolidated financial statements.

53



SEALY CORPORATION

Consolidated Statements of Operations

(in thousands, except per share amounts)

 
  Year Ended  
 
  November 29,
2009
  November 30,
2008
  December 2,
2007
 

Net sales

  $ 1,290,064   $ 1,498,023   $ 1,702,065  

Cost of goods sold

    773,279     915,977     994,700  
               
 

Gross profit

    516,785     582,046     707,365  

Selling, general and administrative expenses

   
416,420
   
482,566
   
545,608
 

Goodwill impairment loss

    1,188     27,475      

Amortization expense

    3,308     3,692     3,356  

Restructuring expenses and asset impairment

    1,256     3,126      

Royalty income, net of royalty expense

    (16,442 )   (17,327 )   (18,562 )
               
   

Income from operations

    111,055     82,514     176,963  

Interest expense

   
79,092
   
60,464
   
63,976
 

Loss on rights for convertible notes

    4,549          

Refinancing and extinguishment of debt and interest rate derivatives

    17,423     5,378     1,222  

Gain on sale of subsidiary stock

    (1,292 )        

Other income, net

    (77 )   (397 )   (421 )
               
   

Income before income tax expense (benefit)

    11,360     17,069     112,186  

Income tax provision (benefit)

    (2,125 )   20,872     34,865  
               
   

Net income (loss)

  $ 13,485   $ (3,803 ) $ 77,321  
               

Earnings (loss) per common share—Basic

  $ 0.15   $ (0.04 ) $ 0.85  
               

Earnings (loss) per common share—Diluted

  $ 0.10   $ (0.04 ) $ 0.80  
               

Weighted average number of common shares outstanding:

                   
 

Basic

    92,258     91,231     91,299  
 

Diluted

    185,639     91,231     96,337  

See accompanying notes to consolidated financial statements.

54



SEALY CORPORATION

Consolidated Statements of Stockholders' Deficit

(in thousands, except per share amounts)

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

Balance at November 26, 2006

  $ 79,122     90,983   $ 904   $ 664,609   $ (846,455 ) $ 7,793   $ (173,149 )
                                           

Net income

    77,321                       77,321           77,321  

Foreign currency translation adjustment

    11,146                             11,146     11,146  

Excess of additional pension liability over unrecognized prior service cost, net of tax of $568

    (1,160 )                           (1,160 )   (1,160 )

Adjustment to adopt certain provisions of ASC Topic 715, net of income taxes of $699

                                  (1,028 )   (1,028 )

Change in fair value of cash flow hedge, net of tax of $4,667

    (7,549 )                           (7,549 )   (7,549 )

Share-based compensation:

                                           
 

Compensation associated with stock option grants

                      2,124                 2,124  
 

Directors' deferred stock compensation

                      281                 281  

Cash dividend

                            (27,389 )         (27,389 )

Repurchase of common stock

          (1,057 )   (11 )   (16,242 )               (16,253 )

Exercise of stock options

          888     9     (6,888 )               (6,879 )

Excess tax benefit on options exercised

                      6,585                 6,585  

Adjustment of temporary equity subject to redemption

                      4,107                 4,107  

Other

                      50                 50  
                               

Balance at December 2, 2007

  $ 79,758     90,814   $ 902   $ 654,626   $ (796,523 ) $ 9,202   $ (131,793 )
                               

Net loss

    (3,803 )                     (3,803 )         (3,803 )

Foreign currency translation adjustment

    (24,731 )                           (24,731 )   (24,731 )

Adjustment to defined benefit plan liability, net of tax of $1,045

    (1,644 )                           (1,644 )   (1,644 )

Change in fair value of cash flow hedge, net of tax of $1,559

    (2,538 )                           (2,538 )   (2,538 )

Cumulative effect of a change in accounting principle—adoption of certain provisions of ASC Topic 740

                            (10,460 )         (10,460 )

Share-based compensation:

                                         
 

Compensation associated with stock option grants

                      2,981                 2,981  
 

Directors' deferred stock compensation

                      26                 26  
 

Current period expense from restricted stock awards

                      222                 222  

Cash dividend

                            (6,811 )         (6,811 )

Repurchase of common stock

                                         

Exercise of stock options

          986     14     (882 )               (868 )

Excess tax benefit on options exercised

                      407                 407  

Reversal of retiree put liability

                      2,372                 2,372  

Adjustment of common stock and options subject to redemption

                1     8,795                 8,796  
                               

Balance at November 30, 2008

  $ (32,716 )   91,800   $ 917   $ 668,547   $ (817,597 ) $ (19,711 ) $ (167,844 )
                               

Net income

    13,485                       13,485           13,485  

Foreign currency translation adjustment

    11,164                             11,164     11,164  

Adjustment to defined benefit plan liability, net of tax of $680

    (1,814 )                           (1,814 )   (1,814 )

Change in fair value of cash flow hedges, net of tax of $44

    (136 )                           (136 )   (136 )

Loss on termination of interest rate swaps, net of tax of $5,834

    9,444                             9,444     9,444  

Share-based compensation:

                                           
 

Compensation associated with stock option grants

                      4,819                 4,819  
 

Directors' deferred stock compensation

                      371                 371  
 

Compensation associated with restricted stock awards

                      667                 667  
 

Compensation associated with restricted stock units

                      6,776                 6,776  

Exercise of stock options

          271     4     23                 27  

Excess tax deficiency on options exercised

                      (647 )               (647 )

Distribution of rights to purchase convertible notes

                            (188,838 )         (188,838 )

Settlement of rights to purchase Convertible Notes

                      193,388                 193,388  

Conversion of Convertible Notes

          2,346     23     2,267                 2,290  

Adjustment of common stock and options subject to redemption

                3     8,853                 8,856  
                               

Balance at November 29, 2009

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

See accompanying notes to consolidated financial statements.

55



SEALY CORPORATION

Consolidated Statements of Cash Flow

(in thousands)

 
  Year Ended  
 
  November 29,
2009
  November 30,
2008
  December 2,
2007
 

Operating activities:

                   
 

Net income (loss)

  $ 13,485   $ (3,803 ) $ 77,321  
 

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

                   
   

Depreciation and amortization

    33,401     35,949     32,738  
   

Deferred income taxes

    (10,403 )   8,318     (5,207 )
   

Impairment charges

    2,514     28,348      
   

Amortization of deferred gain on sale-leaseback

    (644 )        
   

Paid in kind interest on convertible notes

    5,323          
   

Amortization of discount on new senior secured notes

    709          
   

Amortization of debt issuance costs and other

    4,124     2,395     (469 )
   

Loss on rights for convertible notes

    4,549          
   

Share-based compensation

    12,633     3,392     2,891  
   

Excess tax benefits from share-based payment arrangements

        (406 )   (6,585 )
   

Loss (gain) on sale of assets

    975     625     (1,695 )
   

Write-off of debt issuance costs related to debt extinguishments

    2,195         1,770  
   

Loss on termination of interest rate swap

    15,232          
   

Payment to terminate interest rate swaps

    (15,232 )        
   

Gain on sale of subsidiary stock

    (1,292 )        
   

Other, net

    (3,817 )   (4,104 )   5,980  
 

Changes in operating assets and liabilities:

                   
   

Accounts receivable

    7,242     37,566     (5,285 )
   

Inventories

    7,142     5,844     (5,456 )
   

Other current assets

    16,676     (3,035 )   (2,251 )
   

Other assets

    (1,161 )        
   

Accounts payable

    (13,064 )   (29,922 )   13,243  
   

Accrued expenses

    8,220     (28,529 )   (8,790 )
   

Other liabilities

    (10,154 )   1,075     (3,823 )
               
     

Net cash provided by operating activities

    78,653     53,713     94,382  
               

Investing activities:

                   
 

Purchase of property, plant and equipment

    (12,428 )   (24,975 )   (42,434 )
 

Proceeds from sale of property, plant and equipment

    10,388     62     5,065  
 

Net proceeds from sale of subsidiary stock

    1,237          
 

Investments in and loans to unconsolidated affiliate

    (2,322 )        
 

Repayments of loans and capital from unconsolidated affiliate

    (138 )        
               
     

Net cash used in investing activities

    (3,263 )   (24,913 )   (37,369 )
               

Financing activities:

                   
 

Cash dividends

        (6,811 )   (27,389 )
 

Proceeds from issuance of long-term obligations

    6,280     9,305      
 

Repayments of long-term obligations, including discounts taken of $460 in 2007

    (18,285 )   (44,455 )   (79,202 )
 

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 related party notes

    (83,284 )        
 

Proceeds from issuance of convertible notes, net

    83,284          
 

Repayment of subordinated notes, including discounts taken of $47

    (4,953 )        
 

Borrowings under revolving credit facilities

    141,158     283,527     233,990  
 

Repayments under revolving credit facilities

    (205,558 )   (260,617 )   (206,643 )
 

Repurchase of common stock

            (16,253 )
 

Exercise of employee stock options, including related excess tax benefits

    30     482     7,166  
 

Debt issuance costs

    (27,617 )   (100 )    
 

Other

    (428 )       2,113  
               
     

Net cash provided by (used in) financing activities

    26,494     (18,669 )   (86,218 )
               

Effect of exchange rate changes on cash

    2,947     1,858     (1,808 )
               

Increase in cash and equivalents

    104,831     11,989     (31,013 )

Cash and equivalents:

                   
 

Beginning of period

    26,596     14,607     45,620  
               
 

End of period

  $ 131,427   $ 26,596   $ 14,607  
               

Supplemental disclosures:

                   
 

Taxes paid (net of tax refunds of $8,000, $159 and $94 in fiscal 2009, 2008 and 2007, respectively)

  $ 12,852   $ 22,882   $ 39,944  
 

Interest paid

  $ 69,397   $ 58,164   $ 62,097  

See accompanying notes to consolidated financial statements.

56



SEALY CORPORATION

Notes To Consolidated Financial Statements

Note 1: Basis of Presentation and Significant Accounting Policies

Business

        Sealy Corporation and its subsidiaries (the "Company") are engaged in the consumer products business and manufacture, distribute and sell conventional bedding products including mattresses and box springs, as well as specialty bedding products which include latex and visco-elastic mattresses. The Company's products are manufactured in a number of countries in North and South America and Europe. Substantially all of the Company's trade accounts receivables are from retail customers.

Basis of Presentation and Principles of Consolidation

        The Consolidated Financial Statements include the accounts of Sealy Corporation and its 100%-owned subsidiary companies. Intercompany transactions are eliminated. The equity method of accounting is used for joint ventures and investments in associated companies over which the Company has significant influence, but does not have effective control and consolidation is not otherwise required under the Financial Accounting Standards Board's (the "FASB") authoritative guidance surrounding the consolidation of variable interest entities. Significant influence is generally deemed to exist when the Company has an ownership interest in the voting stock of the investee of between 20% and 50%, although other factors, such as representation on the investee's Board of Directors, voting rights and the impact of commercial arrangements, are considered in determining whether the equity method of accounting is appropriate. The Company's equity in the net income and losses of these investments is reported in selling, general and administrative expenses in the accompanying Consolidated Statements of Operations. Also, based on triggering events, the Company assesses whether it has any primary beneficial interests in any variable interest entity ("VIE") which would require consolidation of such entity. At November 29, 2009, the Company is not a beneficiary in a VIE and does not have a significant variable interest in any variable interest entity for which it is not the primary beneficiary.

        At November 29, 2009, affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") controlled approximately 49.2% of the issued and outstanding common stock of the Company.

        Significant accounting policies used in the preparation of the Consolidated Financial Statements are summarized below.

Fiscal Year

        The Company uses a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal year ended December 2, 2007 was a 53-week year. The fiscal years ended November 29, 2009 and November 30, 2008 were 52-week years. The net sales and gross profit attributable to the 53rd week in fiscal 2007 was $32.3 million and $13.1 million, respectively.

Subsequent Events

        The Company has evaluated subsequent events from the end of the most recent fiscal year through January 25, 2010, the date the consolidated financial statements were issued.

Recently Issued Authoritative Accounting Guidance

        In December 2007, the 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. This guidance is

57



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)


effective prospectively, except for certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008. This guidance will be effective for the Company beginning in fiscal 2010. The Company does not expect the adoption of this guidance to have a material impact on the 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 determining what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This guidance is effective prospectively, except for certain retrospective adjustments to deferred tax balances, for fiscal years beginning after December 15, 2008. This guidance will be effective for the Company beginning in fiscal 2010. This guidance could have a potential impact should the Company enter into a business combination in future periods.

        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. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company will adopt this guidance as of the beginning of fiscal 2010 and does not expect the adoption of this guidance to have a material impact on the financial statements.

        In June 2008, the FASB issued authoritative guidance that addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share. This guidance is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company will adopt this guidance as of the beginning of fiscal 2010 and does not expect the adoption of this guidance to have a material impact on the financial statements.

        In November 2008, the Emerging Issues Task Force ("EITF") issued authoritative guidance which clarifies the accounting for certain transactions involving equity method investments. This guidance is effective for financial statements issued for fiscal years beginning on or after December 15, 2008 and interim periods within those years. The Company will adopt this guidance as of the beginning of fiscal 2010 and does not expect the adoption of this guidance to have a material impact on the financial statements.

        In December 2008, the FASB issued additional authoritative guidance on an employers' disclosures about plan assets of a defined benefit pension or other postretirement plan. This guidance is effective for financial statements issued for fiscal years ending after December 15, 2009. The Company will adopt this guidance in fiscal 2010. The adoption of this guidance 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. This new guidance will significantly affect the overall consolidation analysis. This guidance is effective as of the beginning of the first fiscal year that begins after November 15, 2009. This guidance will be effective for the Company beginning in fiscal 2010. The Company is still assessing the potential impact of adoption.

58



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

Revenue Recognition

        The Company recognizes revenue when realized or realizable and earned, which is when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the sales price is fixed or determinable; and collectibility is reasonably assured. The recognition criteria are met when title and risk of loss have transferred from the Company to the buyer, which is upon delivery to the customer sites or as determined by legal requirements in foreign jurisdictions. At the time revenue is recognized, the Company provides for the estimated costs of warranties and reduces revenue for estimated returns and cash discounts. The Company also records reductions to revenue for customer incentive programs offered including volume discounts, promotional allowances, slotting fees and supply agreement amortization, and records liabilities pursuant to these agreements. The Company periodically assesses these liabilities based on actual sales and claims to determine whether the customers will meet the requirements to receive rebate funds. The Company generally negotiates these agreements on a customer-by-customer basis. Some of these agreements extend over several periods and are linked with supply agreements. Accordingly, $99.3 million, $101.4 million, and $104.4 million were recorded as a reduction of revenue for fiscal 2009, 2008 and 2007, respectively.

Product Delivery Costs

        Included in the Company's selling, general and administrative expenses in the consolidated statement of operations for fiscal 2009, 2008 and 2007 were $75.1 million, $91.2 million and $91.2 million, respectively, in shipping and handling costs associated with the delivery of finished mattress products to its customers, including approximately $5.8 million, $7.3 million and $8.4 million, respectively, of costs associated with internal transfers between plant locations.

Concentrations of Credit and Other Risk

        Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, receivables, foreign currency forward and option contracts and interest rate swap arrangements. The Company places its cash and cash equivalents with major financial institutions and limits the amount of credit exposure to any one institution.

        The Company's accounts receivable arise from sales to numerous customers in a variety of markets, and geographies around the world. Receivables arising from these sales are generally not collateralized. The Company's customers include furniture stores, national mass merchandisers, specialty sleep shops, department stores, contract customers and other stores. The top five customers accounted for approximately 25.5%, 25.4% and 23.5% of the Company's net sales for the years ended November 29, 2009, November 30, 2008 and December 2, 2007, respectively. No single customer accounted for more than 10% of the Company's net sales in fiscal 2009, 2008 or 2007. During 2008 and the first quarter of 2009, the economic environment became more challenging and caused a higher occurrence of bankruptcies for mattress retailers. However, the Company has seen a decrease in the frequency of bankruptcies of its customers in the second through fourth quarter of fiscal 2009. These economic conditions have also caused some smaller mattress retailers to exit the market. The Company performs ongoing credit evaluations of its customers' financial conditions and maintains reserves for estimated credit losses. Such losses, in the aggregate, have not materially exceeded management's estimates.

59



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

        The counterparties to the Company's foreign currency and interest rate swap agreements are major financial institutions. The Company has not experienced non-performance by any of its counterparties nor does the Company expect there to be significant non-performance risks associated with its derivative counterparties at November 29, 2009.

        The Company is presently dependent upon a single supplier for certain polyurethane foam components in its mattress units manufactured in the Americas. Such components are purchased under a supply agreement, and are manufactured in accordance with proprietary process designs exclusive to the supplier. The Company has incorporated these methods of construction into many of its branded products. The Company continually looks to develop alternative supply sources, allowing acquisition of similar component parts which meet the functional requirement of various product lines. The Company also purchases a significant portion of its box spring components from a single supplier and manufactures only a minor amount of these parts. The Company is also dependent on a single supplier for the visco-elastic components and assembly of its TrueForm product line. The related product in which these components and assembly processes are used does not represent a significant portion of overall sales. Except for its dependence regarding certain polyurethane foam and visco-elastic components and assembly of its TrueForm product line, the Company does not consider itself to be dependent upon any single outside vendor as a source of supply to its conventional bedding or specialty businesses, and the Company believes that sufficient sources of supply for the same, similar or alternative components are available.

        Approximately 68% of the employees at the Company's 25 North American plants are represented by various labor unions with separate collective bargaining agreements. The Company's current collective bargaining agreements, which are typically three years in length, expire at various times beginning in fiscal 2010 through 2012. Of the employees covered by collective bargaining agreements, approximately 50% are under contracts expiring in fiscal 2010. Certain employees at the Company's international facilities are also covered by collective bargaining agreements, which expire at various terms between fiscal 2010 and 2012.

Use of Estimates

        The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the amount of assets and liabilities and disclosures on contingent assets and liabilities at year end and the reported amounts of revenue and expenses during the reporting period. Actual results may differ from these estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the accrued warranty obligation, allowance for doubtful accounts, discounts and returns, cooperative advertising and promotional accruals, share-based compensation, valuation of goodwill and intangible assets, reserve for workers' compensation claims, benefit plan obligations and expenses, environmental contingencies and tax assets, liabilities and expense.

        See "Warranties" below regarding the effect of changes in estimates associated with the Company's reserve for product warranties.

        See "Self-Insurance" below regarding estimates associated with the Company's reserve for workers' compensation claims.

60



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

        See "Income Taxes" below regarding estimates associated with the Company's uncertain tax positions and valuation allowances against net deferred tax assets.

Foreign Currency

        Subsidiaries located outside the U.S. use the local currency as the functional currency. Assets and liabilities are translated at exchange rates in effect at the balance sheet date and income and expense accounts at average exchange rates during the year. Resulting translation adjustments are recorded directly to a separate component of stockholders' deficit (accumulated other comprehensive income (loss)) and are not tax effected since they relate to investments which are permanent in nature. At November 29, 2009 and November 30, 2008, accumulated foreign currency translation adjustments were $6.4 million and $(5.0 million), respectively. Foreign currency transaction gains and losses are recognized in cost of goods sold or selling, general and administrative expenses at the time they occur. The Company recorded foreign currency transaction (losses) gains of $(6.0 million), ($1.4 million) and $0.5 million in fiscal 2009, 2008 and 2007, respectively.

Cash and Equivalents

        The Company considers all highly liquid debt instruments with an original maturity at the time of purchase of three months or less to be cash equivalents. Included as cash equivalents are money market funds that are stated at cost, which approximates market value.

Checks Issued In Excess of Funds on Deposit

        Accounts payable and accrued compensation expenses include book overdrafts in the amounts of $7.0 million and $0.8 million at November 29, 2009 and $15.8 million and $0.9 million at November 30, 2008, respectively. The change in the reclassified amount of checks issued in excess of funds on deposit is included in cash flows from operations in the statements of cash flows.

Inventory

        The cost of inventories is determined by the "first-in, first-out" (FIFO) method, which approximates current cost. The cost of inventories includes raw materials, direct labor and manufacturing overhead costs. The Company adjusts the basis of its inventory value for excess, obsolete or slow moving inventory based on changes in customer demand, technology developments or other economic factors.

Supply Agreements

        The Company from time to time enters into long term supply agreements with its customers to sell its branded products to customers in exchange for minimum sales volume or a minimum percentage of the customer's sales or space on the retail floor. Such agreements generally cover a period of two to five years. In these long term agreements, the Company reserves the right to pass on its cost increases to its customers. Other costs such as transportation and warranty costs are factored into the wholesale price of the Company's products and passed on to the customer. Initial cash outlays by the Company for such agreements are capitalized and amortized generally as a reduction of sales over the life of the contract. The majority of these cash outlays are ratably recoverable upon contract termination. Such

61



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)


capitalized amounts are included in "Prepaid expenses and other current assets" and "Debt issuance costs, net, and other assets" in the Company's Consolidated Balance Sheets.

Property, Plant and Equipment

        Property, plant and equipment are recorded at cost less accumulated depreciation. Depreciation expense is provided based on historical cost and estimated useful lives ranging from approximately twenty to forty years for buildings and building improvements and three to fifteen years for machinery and equipment. The Company uses the straight-line method for calculating the provision for depreciation. Depreciation expense for fiscal 2009, 2008 and 2007 was $30.1 million, $32.3 million, $29.4 million, respectively and is primarily recorded in cost of goods sold on the consolidated statements of operations.

        The Company reviews property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset group to future net undiscounted cash flows expected to be generated by the asset group. If such assets are considered to be impaired, the impairment recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.

        Impairment charges recognized related to property, plant and equipment within the Americas segment for fiscal 2009 were $1.3 million and relate to the decision to cease manufacturing of certain foundation components and begin purchasing all of these components from third party suppliers. Impairment charges recognized in fiscal 2008 were $0.9 million and relate to the closure of the Company's manufacturing facility in Clarion, Pennsylvania. These charges have been recorded as a component of restructuring expenses and asset impairments in the Consolidated Statements of Operations (See Note 24). No such charges were recognized in fiscal 2007.

        Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell. Fair value is determined based upon estimates of the amount to be recovered upon disposal of the facility. Such assets which meet the criteria to be reported as "assets held for sale" are shown as such in the accompanying balance sheets, and consist of land and buildings at the Company's closed manufacturing facilities and facilities that the Company is actively marketing for sale and that the Company expects to sell within one year. There were no assets qualifying as held for sale at November 29, 2009 or November 30, 2008. It is Company policy to capitalize certain costs incurred in connection with developing or obtaining internal-use software.

Goodwill

        Goodwill is recorded when the consideration paid for an acquisition exceeds the fair value of the identifiable net tangible and identifiable intangible assets acquired. Goodwill is not amortized but must be reviewed for impairment at least annually and if a triggering event were to occur in an interim period. The Company performs at least an annual assessment of goodwill for impairment as of the beginning of the fiscal fourth quarter or whenever events or circumstances indicate that the carrying value of goodwill may not be recoverable from future cash flows. The Company assesses recoverability using several methodologies to determine fair value of a reporting unit, which include the present value of estimated future cash flows and comparisons of multiples of enterprise values to earnings before interest, taxes, depreciation and amortization ("EBITDA"). The analysis is based upon available

62



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)


information regarding expected future cash flows of each reporting unit and discount rates. Discount rates are based upon the cost of capital specific to the reporting unit. If the carrying value of the reporting unit exceeds the discounted fair value of the reporting unit, a second analysis is performed to allocate the fair value to all assets and liabilities. If, based on the second analysis, it is determined that the fair value of goodwill of the reporting unit is less than the carrying value, the Company would recognize impairment for the excess of carrying value over fair value of goodwill. In connection with its fiscal 2009 annual evaluation for goodwill impairment the Company recorded a non-cash charge of $1.2 million related to the impairment of the goodwill of its Argentina reporting unit. The impairment charge is based upon the fair value of the assets and liabilities of the reporting unit. In connection with an interim evaluation of goodwill in the fourth quarter of 2008, the Company recorded a non-cash charge of $2.8 million and $24.7 million related to the impairment of the goodwill of its Puerto Rico and Europe reporting units, respectively (See Note 8). No impairment charges related to goodwill were recognized in fiscal 2007.

Debt Issuance Costs

        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. Upon the prepayment of the related debt, the Company accelerates the recognition of an appropriate amount of the costs as interest expense. Additional interest expense arising from such prepayments during fiscal 2009, 2008 and 2007 was $0.1 million, $0.0 million and $0.1 million, respectively.

        In connection with the refinancing of the Company's senior secured credit facilities in May 2009, the Company recorded fees in the amount of $27.6 million which were deferred and will be amortized over the life of the new agreements. Since the old senior secured term loans are considered terminated, the remaining unamortized debt issuance costs of $2.1 million were expensed and recognized as a component of refinancing and extinguishment of debt and interest rate derivatives in the Consolidated Statements of Operations. The remaining unamortized debt issuance costs associated with the old senior revolving credit facility will continue to be amortized over the life of the Company's new asset-based revolving credit facility as such credit facility met the criteria for modification treatment rather than extinguishment.

        In connection with the Second Amendment to the Third Amended and Restated Credit Agreement entered into in November 2008, the Company paid fees to the creditor in the amount of $5.4 million, which were recorded as a component of refinancing and extinguishment of debt and interest rate derivatives in the Consolidated Statements of Operations. In accordance with the FASB's authoritative guidance surrounding a debtor's accounting for a modification or exchange of debt instruments, these costs were expensed as incurred. The Company also paid approximately $0.1 million of fees to third parties that were deferred and will be amortized over the life of the amended

63



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)


agreement. The Company has the following amounts recorded in debt issuance costs, net, and other assets (in thousands):

 
  November 29, 2009   November 30, 2008  

Gross cost

  $ 34,008   $ 11,035  

Accumulated amortization

    (4,783 )   (2,395 )
           

Net deferred debt issuance costs

  $ 29,225   $ 8,640  
           

Royalty Income and Expense

        The Company recognizes royalty income based on sales of Sealy, Stearns & Foster, and Bassett branded product by various licensees. The Company recognized gross royalty income of $16.5 million, $17.6 million and $19.2 million in fiscal 2009, 2008, and 2007, respectively. The decrease in royalty income in fiscal 2009 from the levels experienced in fiscal 2008 and fiscal 2007 is due to the decreased domestic licensee sales along with unfavorable fluctuations in international currency rates. The Company also pays royalties to other entities for the use of their names on product produced by the Company. The Company recognized royalty expense of an insignificant amount, $0.3 million and $0.6 million, in fiscal 2009, 2008, and 2007, respectively.

Income Taxes

        Income taxes are accounted for under the asset and liability method in accordance with the FASB's authoritative guidance on accounting for income taxes. Deferred tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. The Company provides valuation allowances against the net deferred tax asset for amounts that are not considered more likely than not to be realized (See Note 16 for disclosure of amounts related to deferred taxes and associated valuation allowances).

        Effective December 3, 2007, the Company adopted new authoritative guidance surrounding accounting for uncertainty in income taxes. Significant judgment is required in evaluating the Company's federal, state and foreign tax positions and in the determination of its tax provision. Despite management's belief that the Company's 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 matters. The Company may adjust these reserves as relevant circumstances evolve, such as guidance from the relevant tax authority, its tax advisors, or resolution of issues in the courts. The Company's tax expense includes the impact of reserve provisions and changes to reserves that it considers appropriate, as well as related interest and penalties. 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 its corporate income tax returns by tax authorities. No issues related to these reserved positions have been presented to the Company. The Company believes that such audits will not result in an assessment and payment of taxes related to these positions during the one year following November 29, 2009.

64



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

Advertising Costs

        The Company expenses all advertising costs as incurred. The estimated fair value of cooperative advertising costs paid to customers is recorded as a component of selling, general and administrative expense within the Consolidated Statements of Operations when the customer provides proof of advertising. The Company periodically assesses the liabilities recorded for cooperative advertising based on actual sales and claims to determine whether all of the cooperative advertising earned will be used by the customer. Advertising expenses, including cooperative advertising, for fiscal 2009, 2008 and 2007 amounted to $127.3 million, $155.5 million and $188.9 million, respectively.

65



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

Warranties

        The Company's warranty policy provides a ten year non-prorated warranty service period on all currently manufactured Sealy Posturepedic, Stearns & Foster and Bassett bedding products and some other Sealy branded products and a twenty year warranty period on the major components of the Company's TrueForm and MirrorForm visco- elastic products as well as the Company's SpringFree latex product, the last ten years of which are prorated on a straight-line basis. Though discontinued in 2008, the Company's Right Touch products have a twenty year limited warranty that covers only certain parts of the product and is prorated for part of the twenty years. The Company's policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded based on historical trends of warranty costs. 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 warranty returns.

        The Company amended its warranty policy on Sealy branded promotional bedding to three years for product produced after fiscal 2007. The impact of this change to the warranty policy did not have a significant impact on the Company's financial results or position.

        During fiscal 2008, the Company completed an analysis of its returns claims experience based on historical return trends for the Company's U.S. business, which resulted in a change in estimate for warranty claims. See Note 4.

        The change in the Company's accrued warranty obligations for the fiscal 2009, 2008 and 2007 was as follows (in thousands):

 
  November 29, 2009   November 30, 2008   December 2, 2007  

Accrued warranty obligations at beginning of period

  $ 16,487   $ 15,964   $ 15,349  

Warranty claims(1)

    (18,082 )   (20,034 )   (17,389 )

Warranty provisions(2)

    18,059     23,032     18,004  

Change in estimate (Note 4)

        (2,475 )    
               

Accrued warranty obligations at end of period

  $ 16,464   $ 16,487   $ 15,964  
               

(1)
Warranty claims for the year ended November 29, 2009 include approximately $9.3 million for claims associated with products sold prior to November 30, 2008 that are still under warranty. 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. The Company utilizes warranty trends on existing similar product in order to estimate future warranty claims associated with newly introduced product. Warranty claims and provisions shown above do not include estimated salvage recoveries that reduced cost of sales by $5.9 million, $5.9 million and $6.2 million for fiscal 2009, 2008 and 2007, respectively.

(2)
The provision for fiscal year 2009 includes a decrease of an insignificant amount relating to increased recoverable salvage value included in the warranty obligation estimate. The provision for fiscal year 2008 includes an increase of approximately $0.5 million relating to decreased recoverable salvage value included in the warranty obligation estimate. The provision for fiscal year 2007 includes a decrease of approximately $2.1 million relating to increased recoverable salvage value included in the warranty obligation estimate.

66



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

        As of November 29, 2009 and November 30, 2008, $10.6 million and $9.9 million is included as a component of other accrued liabilities and $5.9 million and $6.6 million is included as a component of other noncurrent liabilities within the accompanying Consolidated Balance Sheet, respectively.

Self-Insurance

        The Company is self-insured for certain losses related to medical claims with excess loss coverage of $375,000 per claim per year. The Company also utilizes large deductible policies to insure claims related to general liability, product liability, automobile, and workers' compensation. The Company's recorded liability for workers' compensation represents an estimate of the ultimate cost of claims incurred as of the balance sheet date. The estimated workers' compensation liability is discounted and is established based upon analysis of historical data and actuarial estimates, and is reviewed by management and third-party actuaries on a quarterly basis to ensure that the liability is appropriate. The discount rate used to estimate the workers' compensation liability was 3% and 4% for fiscal 2009 and 2008, respectively. While the Company believes these estimates are reasonable based on the information currently available, if actual trends, including the severity or frequency of claims, medical cost inflation, or fluctuations in premiums, differ from the Company's estimates, the Company's results of operations could be impacted. As of November 29, 2009 and November 30, 2008, $6.0 million and $4.6 million of the recorded liability is included as a component of other accrued liabilities and $6.5 million and $6.3 million is included as a component of other noncurrent liabilities within the accompanying consolidated balance sheets, respectively.

Research and Development

        Product development costs are charged to operations during the period incurred and are not considered material.

Environmental Costs

        Environmental expenditures that relate to current operations are expensed or capitalized, as appropriate, under the FASB's authoritative guidance on environmental remediation liabilities. Expenditures that relate to an existing condition caused by past operations and that do not provide future benefits are expensed as incurred. Liabilities are recorded when environmental assessments are made or the requirement for remedial efforts is probable, and the costs can be reasonably estimated. The timing of accruing for these remediation liabilities is generally no later than the completion of feasibility studies. The Company has an ongoing monitoring and identification process to assess how the activities, with respect to the known exposures, are progressing against the accrued cost estimates, as well as to identify other potential remediation sites that are presently unknown.

Conditional Asset Retirement Obligations

        The Company recognizes asset retirement obligations for obligations in certain of the Company's facility leases that require the Company to return those properties to the same or similar condition at the end of the lease as existed when the Company began using those facilities. Although the lease termination dates range from 2010 to 2023, the Company may be able to renegotiate such leases to extend the terms.

67



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

        Additionally, the Company also owns certain factories that contain asbestos. Current regulations require that the Company remove and dispose of asbestos if the factory undergoes major renovations or is demolished. Although the Company is not required to remove the asbestos unless renovation or demolition occurs, it is required to monitor and ensure that it remains stable and is required to notify any potential buyer of its existence. In fiscal 2007, the Company removed asbestos at a European facility. The Company has recognized an asset retirement obligation of $0.2 million for the remaining asbestos in its European facilities. The Company has not recognized asset retirement obligations in its financial statements for asbestos at any other facilities because management believes that there is an indeterminate settlement date for the retirement obligation as the range of time over which the Company may be required to remove and dispose of the asbestos is unknown or cannot be estimated. The Company currently has no plans to demolish a factory or to undertake a major renovation that would require removal of the asbestos at any of these other facilities. Management will continue to monitor this issue and will record an asset retirement obligation when sufficient information becomes available to estimate the obligation.

        Asset retirement obligations recorded as a component of other noncurrent liabilities in the Consolidated Balance Sheets were $1.7 million and $1.5 million at November 29, 2009 and November 30, 2008, respectively. An immaterial amount of accretion and depreciation expense was recognized in fiscal 2009, 2008 and 2007.

Derivative Financial Instruments

        The Company uses financial instruments, including forward, option and swap contracts to manage its exposures to movements in interest rates and foreign exchange rates. The use of these financial instruments allows the Company to reduce its overall exposure to fluctuations in interest rates and foreign exchange rates. The Company's hedging relationships are either designated as hedging instruments or are considered to be economic hedges which are not designated as hedging instruments.

        The Company formally documents its designated hedging relationships by identifying the hedging instruments and the hedged items, as well as its risk management objectives and strategies for undertaking the hedge transaction. The Company also formally assesses, both at inception and at least quarterly thereafter, whether the derivatives that are used in hedging transactions are highly effective in offsetting changes in the cash flows of the hedged item. The effective portion of the change in fair value of a derivative is recorded as a component of accumulated other comprehensive income in the Consolidated Balance Sheets. When the hedged item affects the income statement, the gain or loss included in accumulated other comprehensive income is reported on the same line in the Consolidated Statements of Operations as the hedged item. In addition, any ineffective portion of the changes in the fair value of derivatives used as cash flow hedges and the changes in the fair value related to those hedging instruments that are not designated as hedges for accounting purposes are reported in the Consolidated Statements of Operations as the changes occur. If it is determined that a derivative ceases to be a highly effective hedge, or if the anticipated transaction is no longer likely to occur, the Company discontinues hedge accounting and any deferred gains or losses are recorded in the Consolidated Financial Statements.

        The Company's hedging relationships that are considered to be economic hedges are recorded at their fair value at the end of each period. The resulting changes in fair value are included as a component of earnings in the period that they occur.

68



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

        Derivatives are recorded in the Consolidated Balance Sheets at fair value which is based upon an income approach which consists of a discounted cash flow model that takes into account the present value of the future cash flows under the terms of the contracts using current market information as of the reporting date such as prevailing interest rates and foreign currency spot and forward rates.

Share-Based Compensation

        New share-based compensation awards and awards modified, repurchased, or cancelled are accounted for using the fair value based method under FASB authoritative guidance surrounding share-based payments.

Commitments and 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.

Note 2: 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 an understatement of depreciation expense, recorded as a component of cost of goods sold and an overstatement of the income tax provision in the Consolidated Statement of Operations for prior periods. The recorded balances of accumulated depreciation and deferred tax liabilities were likewise understated and overstated, respectively in the 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 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 Consolidated Financial Statements as of and for the years ended November 30, 2008 and December 2, 2007 as follows (in thousands):

 
  Consolidated Balance Sheet Information
as of November 30, 2008
 
 
  As Previously
Reported
  Adjustments   Restated  

Accumulated depreciation

  $ (218,560 ) $ (7,398 ) $ (225,958 )

Deferred income tax liabilities

    4,962     (4,378 )   584  

Accumulated deficit

    (814,298 )   (3,299 )   (817,597 )

Accumulated other comprehensive income

    (19,990 )   279     (19,711 )

69



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 2: Restatement of Previous Periods (Continued)

 

 
  Consolidated Statements of Operations Information for the Years Ended  
 
  November 30, 2008   December 2, 2007  
 
  As Previously
Reported
  Adjustments   Restated   As Previously
Reported
  Adjustments   Restated  

Cost of goods sold

  $ 913,982   $ 1,995   $ 915,977   $ 992,455   $ 2,245   $ 994,700  

Gross profit

    584,041     (1,995 )   582,046     709,610     (2,245 )   707,365  

Income from operations

    84,509     (1,995 )   82,514     179,208     (2,245 )   176,963  

Income before income taxes

    19,064     (1,995 )   17,069     114,431     (2,245 )   112,186  

Income tax provision

    21,931     (1,059 )   20,872     35,058     (193 )   34,865  

Net income (loss)

    (2,867 )   (936 )   (3,803 )   79,373     (2,052 )   77,321  

Earnings (loss) per common share—Basic

    (0.03 )   (0.01 )   (0.04 )   0.87     (0.02 )   0.85  

Earnings (loss) per common share—Diluted

    (0.03 )   (0.01 )   (0.04 )   0.82     (0.02 )   0.80  

 

 
  Consolidated Statements Stockholders' Deficit for the Years Ended
December 2, 2007 and November 30, 2008
 
 
  Accumulated Deficit   Accumulated Other Comprehensive Income (Loss)  
 
  As Previously
Reported
  Adjustments   Restated   As Previously
Reported
  Adjustments   Restated  

Balance—November 26, 2006

  $ (846,144 ) $ (311 ) $ (846,455 ) $ 7,793   $   $ 7,793  

Net income (for the year ended December 2, 2007)

    79,373     (2,052 )   77,321                    

Foreign currency translation adjustment (for the year ended December 2, 2007)

                11,183     (37 )   11,146  

Balance—December 2, 2007

    (794,160 )   (2,363 )   (796,523 )   9,239     (37 )   9,202  

Net loss (for the year ended November 30, 2008)

    (2,867 )   (936 )   (3,803 )                  

Foreign currency translation adjustment (for the year ended November 30, 2008)

                (25,047 )   316     (24,731 )

Balance—November 30, 2008

    (814,298 )   (3,299 )   (817,597 )   (19,990 )   279     (19,711 )

 

 
  Consolidated Statements of Cash Flow for the Years Ended  
 
  November 30, 2008   December 2, 2007  
 
  As Previously
Reported
  Adjustments   Restated   As Previously
Reported
  Adjustments   Restated  

Net income (loss)

  $ (2,867 ) $ (936 ) $ (3,803 ) $ 79,373   $ (2,052 ) $ 77,321  

Adjustments to reconcile net income (loss) to cash provided by operating activities:

                                     

Depreciation and amortization

    33,954     1,995     35,949     30,493     2,245     32,738  

Deferred income taxes

    8,317     (1,059 )   7,258     (5,207 )   (193 )   (5,400 )

Net cash provided by operating activities

    53,713         53,713     94,382         94,382  

70



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 2: Restatement of Previous Periods (Continued)

 

 
  Segment Information for the Years Ended  
 
  November 30, 2008   December 2, 2007  
 
  As Previously
Reported
  Adjustments   Restated   As Previously
Reported
  Adjustments   Restated  

Total assets:

                                     
 

Europe

  $ 69,784   $ (7,398 ) $ 62,386   $ 122,630   $ (6,223 ) $ 116,407  
 

Total assets

    920,874     (7,398 )   913,476     1,025,079     (6,223 )   1,018,856  

Note 3: Share-Based Compensation

    Share-Based Payment Arrangements

        At November 29, 2009, the Company has share-based compensation plans as described below. Share-based compensation expense, related income tax benefits and cash received from the exercise of stock option awards, were as follows (in thousands):

 
  November 29, 2009   November 30, 2008   December 2, 2007  

Stock option awards

  $ 3,337   $ 2,097   $ 2,128  

Restricted shares

    667     222      

Restricted share units

    6,703          

Directors' deferred stock compensation

    256     26     276  

Adjustment to options and shares subject to redemption

        164     487  

Modifications of share-based awards

    1,670     883      
               
 

Total share-based compensation

  $ 12,633   $ 3,392   $ 2,891  
               

Income tax benefits related to share-based compensation

   
5,372
   
1,310
   
1,241
 
               

Cash received from exercise of stock option awards

    27     75     866  
               

Tax benefits realized upon exercise

    280     3,044     8,133  
               

        Share-based compensation cost has been recorded as a component of selling, general and administrative expense in the Consolidated Statements of Operations. No share based compensation cost has been capitalized and included in any assets in the accompanying Consolidated Balance Sheets.

    Modification of Awards

        During the third quarter of fiscal 2009, the Company undertook a modification to the terms of its outstanding share-based compensation awards to give effect to the dilution caused by the issuance of rights to purchase notes convertible into shares of common stock. For outstanding stock option awards granted under the 1998 Stock Option Plan ("1998 Plan"), the number of awards was increased by 32.7696% and the strike price of the awards was reduced by 24.6815%. For awards granted under the 2004 Stock Option Plan for Key Employees of Sealy Corporation and its Subsidiaries ("2004 Plan"), the number of awards outstanding was not adjusted, but the strike price of the outstanding awards was

71



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 3: Share-Based Compensation (Continued)

reduced by 24.6815%. The increase to the number of outstanding awards has been treated as an additional grant of stock options under the 1998 Plan as disclosed below.

        The Company also modified the terms of its outstanding restricted share unit ("RSU") awards by increasing the number of awards by 32.7696%. This resulted in an additional 112,856 awards being granted. However, since the Company's restricted shares outstanding as of the modification date participated in the rights offering, there was no modification of these awards.

        The number of units outstanding under the Sealy Corporation Directors' Deferred Compensation Plan was also increased by 32.7696% as part of this modification, resulting in an additional 62,953 awards being granted at a grant date fair value of $2.00 per unit.

        In connection with the modification of its outstanding share-based compensation awards, the Company will recognize additional compensation expense of $2.1 million, which will be recorded as a component of selling, general and administrative expenses in the Consolidated Statements of Operations. Of this amount, $1.7 million was recognized in fiscal 2009 which primarily represents the additional compensation cost related to awards that were vested at the date of the modification. Unrecognized compensation cost related to this modification as of November 29, 2009 is $0.4 million and will be recognized over the remaining vesting period of the awards.

        Assumptions used in valuing stock options modified in the third quarter of fiscal 2009 were as follows:

Expected volatility

    60 %

Expected dividend yield

    0.00 %

Expected term (in years)

    0.00 - 7.47  

Risk-free rate

    0.52% - 3.46 %

        Modifications of awards given to certain former executive officers of the Company in fiscal 2008 resulted in charges of approximately $0.9 million. These charges have been recorded as a component of selling, general and administrative expenses in the Consolidated Statements of Operations.

    1998 Plan

        Prior to 2004, all outstanding options were issued under the 1998 Plan. On April 6, 2004, certain members of management who held options elected to rollover their options upon the completion of the merger with KKR (the "Rollover Options"). The expiration dates of the Rollover Options were uniformly extended to ten years from the date of the merger, thus resulting in a new measurement date and recognition of expense for the intrinsic value. Prior to the modification described above, the Rollover Options were accounted for using the intrinsic value method with the minimum value method having been used for disclosure purposes in previously issued financial statements. Therefore, no information was presented in previously issued financial statements with regard to significant assumptions used for fair value estimation purposes or regarding weighted average grant date fair value. Upon modification in 2009, outstanding options under the 1998 Plan were valued using the fair value method and, since these awards are fully vested, compensation expense attributable to the modification was recognized in fiscal 2009 as described above.

72



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 3: Share-Based Compensation (Continued)

        A summary of options outstanding under the 1998 Plan as of November 29, 2009, and the activity for the year then ended, is presented below:

 
  Shares Subject
to Options
  Weighted Average
Exercise Price
Per Share
 

Outstanding November 30, 2008

    1,935,478   $ 1.50  
 

Granted(1)

    620,472     1.12  
 

Exercised

    (435,684 )   1.26  
 

Forfeited

    (18,104 )   2.68  
             

Outstanding November 29, 2009 (all fully vested and exercisable)

    2,102,162   $ 1.09  
 

Weighted average remaining contractual term

   
4.4 years
       
 

Aggregate intrinsic value of in-the-money options at November 29, 2009 (in thousands)

  $ 3,073        

(1)
Granted options represent the additional options awarded through the fiscal 2009 modification discussed above.

    2004 Plan

    Stock Option Awards

        The Company's Board of Directors adopted the 2004 Plan that provides for the grant of cash and cashless exercise stock options, restricted share awards, restricted share unit awards, stock appreciation rights and/or dividend equivalent rights to management, other key employees and non-employee directors on terms and subject to conditions as established by the Compensation Committee of Sealy Corporation's Board of Directors or certain of the committee's designees. Effective May 26, 2009, the Company adopted the Second Amended and Restated Equity Plan for Key Employees of Sealy Corporation and its Subsidiaries which, among other things, increases the number of shares available for issuance under the 2004 Plan from 15,190,000 to 40,190,000. Upon exercise, the Company will issue new shares of common stock.

        Stock options under the 2004 Plan are granted in part as: 1) "time options," which vest and become exercisable ratably on a monthly basis generally over the first three to five years following the date of grant; 2) "old performance options," which were granted prior to fiscal 2008 and vest and become exercisable over the fiscal years through fiscal year 2008 upon the achievement of certain EBITDA performance targets, and in any event by the eighth anniversary of the date of grant; and 3) "new performance options," issued during fiscal 2008, which vest and become exercisable only upon achievement of certain EBITDA performance targets and do not have a time vesting component. As of November 29, 2009, approximately 5.9 million time options and 3.7 million performance options were issued and outstanding. The Company has not met the EBITDA performance targets for fiscal 2008 and 2007 for the old performance options; thus, the 2008 and 2007 portions of these options have not become vested based on the accelerated vesting provisions. Since management has determined that certain of the cumulative EBITDA performance targets for the old performance options granted prior to 2008 will not be met, these performance options are being amortized over the first eight years

73



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 3: Share-Based Compensation (Continued)


following the date of grant. Management has also determined that the cumulative EBITDA performance targets for the new performance options granted after fiscal 2008 will not be met and therefore has not recognized any compensation expense related to options to purchase 669,532 shares of common stock since these options do not vest if the performance targets are not achieved. Approximately 50% of the total outstanding performance options are vested as of November 29, 2009.

        Prior to the modification of awards in fiscal 2009 discussed above, all options issued under the 2004 Plan, which were outstanding at August 29, 2005, were accounted for using the intrinsic value method. Subsequent to the modification of these awards, all options granted under the 2004 Plan are accounted for using the fair value method.

        As of November 29, 2009, there was $4.0 million of unrecognized compensation cost associated with grants under the 2004 Plan. That cost is expected to be recognized over a weighted average period of 4.1 years. The Company valued these stock option grants using the trinomial lattice model. The weighted average grant date fair value for all option grants, total intrinsic value of options exercised and assumptions used to value options, excluding those granted through the modification discussed above, for fiscal 2009, 2008 and 2007 were as follows:

 
  Year ended  
 
  November 29,
2009
  November 30,
2008
  December 2,
2007
 

Weighted average grant date fair value of options granted

  $ 0.64   $ 2.04   $ 5.16  

Total intrinsic value of options exercised (in thousands)

  $ 633   $ 8,374   $ 21,038  

Assumptions used to value options:

                   
 

Expected volatility

    60 %   40% - 60 %   30 %
 

Expected dividend yield

    0.00 %   0.00% - 3.35 %   1.76% - 2.24 %
 

Expected term (in years)

    5.63 - 5.90     5.66 - 6.53     6.71 - 8.39  
 

Risk free rate

    1.92% - 2.07 %   1.35% - 3.48 %   4.19% - 4.85 %

        Due to the lack of sufficient historical trading information with respect to its own shares, the Company estimates 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 based on the Company's then current quarterly dividend of $0.075 per share relative to the fair value of the underlying stock at grant date for options granted prior to the suspension of the dividend in the second quarter of fiscal 2008. The expected dividend yield for options granted after the decision was made to suspend the dividend was assumed to be zero. Expected term is based on an analysis of the early exercise behavior of employees. The risk free rate is based on the U.S. Treasury yield curve in effect at the time of grant. The Company also estimates the amount of share-based awards that are expected to be forfeited based on the historical forfeiture rates experienced for its outstanding awards.

74



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 3: Share-Based Compensation (Continued)

        A summary of options outstanding under the 2004 Plan as of November 29, 2009, and the activity for the year then ended, is presented below:

 
  Shares Subject
to Options
  Weighted Average
Exercise Price
Per Share
 

Outstanding November 30, 2008

    9,948,520   $ 6.96  
 

Granted

    58,487   $ 0.89  
 

Forfeited

    (438,230 ) $ 5.38  
             

Outstanding November 29, 2009

    9,568,777   $ 5.20  
 

Weighted average remaining contractual term

    5.3 years        
 

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

  $ 1,554        

Exercisable at November 29, 2009

    6,062,663        
 

Weighted average remaining contractual term

    5.2 years        
 

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

  $ 555        

    Restricted Shares and Share Unit Awards

        The Company has outstanding 291,971 restricted shares that are considered to be non-vested shares. The rights associated with these shares are the same as those of the Company's outstanding common shares (Note 22) except that they cannot be sold by the holder until the end of the vesting period. Two-thirds of such restricted shares will vest on the second anniversary of the grant date, and one-third of such restricted shares will vest on the third anniversary of the grant date. As of November 29, 2009, the remaining unrecognized compensation cost related to restricted stock awards was $1.1 million which is expected to be recognized over the remaining vesting period of 1.6 years. As of November 29, 2009, none of the outstanding restricted stock awards have vested.

        During fiscal 2009, the Company approved grants of 17,084,368 restricted share units (RSUs). The weighted average grant date fair value of these awards is based on the closing price of the Company's common stock as of the grant date. The Company has outstanding 16,627,112 RSUs which vest based on the passage of time and do not contain performance requirements. These time-based RSU awards 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 RSUs granted discussed above give effect to this accretion. The Company also has outstanding 457,256 RSUs which vest based on the attainment of certain performance targets that are tied to the Company's earnings performance. If these performance targets are not met, then the RSUs will not vest. As of November 29, 2009, the remaining unrecognized compensation cost related to these outstanding RSUs on a fully accreted basis was $22.2 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 November 29, 2009, it is the Company's expectation that the performance targets for RSUs with performance targets will be met.

75



SEALY CORPORATION

Notes To Consolidated Financial Statements (Continued)

Note 3: Share-Based Compensation (Continued)

        In connection with the modification of share-based compensation awards discussed above, the RSUs outstanding as of June 12, 2009, which were all performance-based awards, were modified to increase the number of awards by 32.7696%. This resulted in an additional 112,856 awards being granted and additional compensation cost of $0.2 million which will be recognized based on the forecasted attainment of the performance targets over time. The additional awards granted as part of this modification are included as RSUs granted as disclosed below. As the restricted shares outstanding participated in the rights offering, there was no modification of these awards.

        A summary of restricted share unit awards outstanding as of November 29, 2009 and the activity for the year then ended, is presented below:

 
  Unvested Restricted
Share Units
  Weighted Average
Grant Date Fair
Value
 

Outstanding November 30, 2008

      $ 0.00  
 

Granted

    17,084,368     2.01  
 

Vested

    (102,923 )   2.00  
 

Forfeited

    (26,539 )   2.00  
             

Outstanding November 29, 2009

    16,954,906