UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWashington, D.C. 20549



FORM 10-Q

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended: May 29, 2011o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the Transition Period
from                        to


Commission file number 001-08738



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

Delaware(State or other jurisdiction of incorporation)

36-3284147(I.R.S. Employer Identification No.)Sealy Drive One Office Parkway
Trinity, North Carolina(Address of principal executive offices)

27370(Zip Code)(336) 861-3500Registrant's telephone number, including area code




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

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

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

Large accelerated filer o

Accelerated filer ý

Non-accelerated filer o (Do not check if a
smaller reporting company)

Smaller reporting company o


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

The number of shares of the registrant's common stock outstanding as of June 21, 2011 is approximately: 98,184,056.



---





PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

SEALY CORPORATION        Condensed Consolidated Statements of Operations        (in thousands, except per share data)        (unaudited)

Three Months EndedMay 29,
2011

May 30,
2010Net sales

$
321,296

$
290,525Cost of goods sold


196,222


168,951Gross profit


125,074


121,574Selling, general and administrative expenses


107,447


98,297Amortization expense


72


72Royalty income, net of royalty expense


(4,804
)

(3,807
)Income from operations


22,359


27,012Interest expense


21,666


21,237Refinancing and extinguishment of debt


1,236


3,759Other income, net


(102
)

(52
)(Loss) income before income taxes


(441
)

2,068Income tax provision


(568
)

(552
)Equity in earnings of unconsolidated affiliates


623


1,047Income from continuing operations


750


3,667Loss from discontinued operations


(1,127
)

(2,818
)Net (loss) income

$
(377
)
$
849Earnings (loss) per common shareBasicIncome from continuing operations per common share

$
0.01

$
0.04Loss from discontinued operations per common share


(0.01
)

(0.03
)Earnings (loss) per common shareBasic

$


$
0.01Earnings (loss) per common shareDilutedIncome from continuing operations per common share

$
0.01

$
0.03Loss from discontinued operations per common share


(0.01
)

(0.01
)Earnings (loss) per common shareDiluted

$


$
0.02Weighted average number of common shares outstanding:Basic


98,040


94,604Diluted


107,933


287,714


See
accompanying notes to Condensed Consolidated Financial Statements.

1

---





SEALY CORPORATION        Condensed Consolidated Statements of Operations        (in thousands, except per share data)        (unaudited)

Six Months EndedMay 29,
2011

May 30,
2010Net sales

$
626,825

$
602,413Cost of goods sold


383,247


347,957Gross profit


243,578


254,456Selling, general and administrative expenses


211,181


198,585Amortization expense


144


144Royalty income, net of royalty expense


(9,775
)

(7,929
)Income from operations


42,028


63,656Interest expense


43,374


42,970Refinancing and extinguishment of debt


1,236


3,759Other income, net


(207
)

(102
)(Loss) income before income taxes


(2,375
)

17,029Income tax (benefit) provision


(1,777
)

7,075Equity in earnings of unconsolidated affiliates


1,478


1,990Income from continuing operations


880


11,944(Loss) from discontinued operations


(2,159
)

(5,380
)Net (loss) income

$
(1,279
)
$
6,564(Loss) earnings per common shareBasicIncome from continuing operations per common share

$
0.01

$
0.13(Loss) from discontinued operations per common share


(0.02
)

(0.06
)(Loss) earnings per common shareBasic

$
(0.01
)
$
0.07(Loss) earnings per common shareDilutedIncome from continuing operations per common share

$
0.01

$
0.07(Loss) from discontinued operations per common share


(0.02
)

(0.02
)(Loss) earnings per common shareDiluted

$
(0.01
)
$
0.05Weighted average number of common shares outstanding:Basic


97,928


94,563Diluted


107,298


286,092


See
accompanying notes to Condensed Consolidated Financial Statements.

2

---





SEALY CORPORATION        Condensed Consolidated Balance Sheets        (in thousands, except per share amounts)        (unaudited)

May 29,
2011

November 28,
2010ASSETSCurrent assets:Cash and equivalents

$
79,292

$
109,255Accounts receivable (net of allowance for doubtful accounts, discounts and returns, 2011$26,665; 2010$25,812)


151,755


140,778Inventories


61,443


57,178Other current assets


30,439


19,543Deferred income tax assets


20,170


19,127Total current assets


343,099


345,881Property, plant and equipmentat cost


398,925


385,470Less accumulated depreciation


(229,905
)

(217,398
)169,020


168,072Goodwill


363,498


361,958Intangible assets, net


1,253


1,387Deferred income tax assets


5,125


6,140Other assets, including debt issuance costs, net


50,657


53,319420,533


422,804Total assets

$
932,652

$
936,757LIABILITIES AND STOCKHOLDERS' DEFICITCurrent liabilities:Current portionlong-term obligations

$
2,069

$
2,166Accounts payable


74,046


66,507Accrued incentives and advertising


26,028


34,510Accrued compensation


17,710


22,390Accrued interest


14,205


14,359Other accrued liabilities


32,333


37,198Total current liabilities


166,391


177,130Long-term obligations, net of current portion


784,776


793,084Other liabilities


51,190


53,357Deferred income tax liabilities


842


825Stockholders' deficit:Common stock, $0.01 par value; Authorized 600,000 shares
Issued and outstanding: 201198,083; 201097,688


982


979Additional paid-in capital


924,615


911,066Accumulated deficit


(1,007,968
)

(1,006,689
)Accumulated other comprehensive income, net


11,824


7,005Total stockholders' deficit


(70,547
)

(87,639
)Total liabilities and stockholders' deficit

$
932,652

$
936,757


See
accompanying notes to Condensed Consolidated Financial Statements.

3

---





SEALY CORPORATION        Condensed Consolidated Statement of Stockholders' Deficit        (in thousands)        (unaudited)

Common Stock





Accumulated
Other
Comprehensive
Income (Loss)Comprehensive
Income (Loss)

Additional
Paid-in
Capital

Accumulated
DeficitShares

Amount

TotalBalance at November 28, 2010





97,688

$
979

$
911,066

$
(1,006,689
)
$
7,005

$
(87,639
)Net loss


(1,279
)










(1,279
)




(1,279
)Foreign currency translation adjustment


5,100














5,100


5,100Adjustment to defined benefit plan liability, net of tax of $136


152














152


152Change in fair value of cash flow hedges, net of tax of $(242)


(433
)













(433
)

(433
)Share-based compensation











5,773








5,773Exercise of stock options





340


2


581








583Vesting of restricted share units, net





55


1


(67
)







(66
)Excess tax benefit on share based awards











(301
)







(301
)Beneficial conversion feature on Convertible paid in kind Notes











7,563








7,563Balance at May 29, 2011

$
3,540


98,083

$
982

$
924,615

$
(1,007,968
)
$
11,824

$
(70,547
)


See
accompanying notes to Condensed Consolidated Financial Statements.

4

---





SEALY CORPORATION        Condensed Consolidated Statements of Cash Flows        (in thousands)        (unaudited)

Six Months EndedMay 29,
2011

May 30,
2010Operating activities:Net (loss) income

$
(1,279
)
$
6,564Adjustments to reconcile net income to cash used in operating activities:Depreciation and amortization


12,262


14,736Deferred income taxes


672


3,891Bad debt expense


1,783


(902
)Amortization of deferred gain on sale-leaseback


(345
)

(327
)Paid in kind interest on convertible notes


9,312


6,980Amortization of discount on new senior secured notes


728


1,030Amortization of debt issuance costs and other


2,351


2,889Impairment charges


288


Share-based compensation


5,773


9,215Loss on sale of assets


1


262Write-off of debt issuance costs related to debt extinguishments


326


2,709Loss on repurchase of senior notes


617


1,050Dividends received from unconsolidated affiliates


1,011


Equity in earnings of unconsolidated affiliates


(1,478
)

(1,990
)Loss on disposition of subsidiary


206


Other, net


(291
)

2,146Changes in operating assets and liabilities:Accounts receivable


(10,124
)

(11,105
)Inventories


(3,983
)

(13,123
)Other current assets


(8,718
)

1,188Other assets


663


(282
)Accounts payable


7,068


3,311Accrued expenses


(22,474
)

(33,472
)Other liabilities


(2,015
)

800Net cash used in operating activities


(7,646
)

(4,430
)Investing activities:Purchase of property, plant and equipment


(13,239
)

(6,678
)Proceeds from sale of property, plant and equipment


22


67Net cash used in investing activities


(13,217
)

(6,611
)Financing activities:Proceeds from issuance of long-term obligations


1,643


1,806Repayments of long-term obligations


(2,506
)

(5,107
)Repayment of senior secured notes, including premium of $300 and $1,050


(10,300
)

(36,050
)Repurchase of common stock associated with vesting of employee share-based awards


(67
)

Exercise of employee stock options, including related excess tax benefits


583


145Debt issuance costs


(147
)

2Other


(34
)

(77
)Net cash used in financing activities


(10,828
)

(39,281
)Effect of exchange rate changes on cash


1,728


(1,548
)Change in cash and equivalents


(29,963
)

(51,870
)Cash and equivalents:Beginning of period


109,255


131,427End of period

$
79,292

$
79,557


See accompanying notes to Condensed Consolidated Financial Statements.

5

---





SEALY CORPORATION        Notes to Condensed Consolidated Financial Statements        (unaudited)

Note 1: Basis of Presentation and Significant Accounting Policies

The interim Condensed Consolidated Financial Statements are unaudited, and certain related information and footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of America have been omitted in accordance with Rule 10-01 of Regulation S-X. The
accompanying interim Condensed Consolidated Financial Statements were prepared following the same policies and procedures used in the preparation of the annual financial statements and reflect all
adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of Sealy Corporation and its subsidiaries (collectively, the "Company"). The results of
operations for the interim periods are not necessarily indicative of the results for the fiscal year. Our third fiscal quarter sales are typically 5% to 15% higher than other fiscal quarters. These
Condensed Consolidated Financial Statements should be read in conjunction with the annual consolidated financial statements for the year ended November 28, 2010 included within the Company's
Annual Report on Form 10-K (File No. 001-08738).

As
discussed in Note 12, in the fourth quarter of fiscal 2010, the Company divested its European manufacturing operations in France and Italy, which represented our Europe
segment, and also discontinued its operations in Brazil. The Company has transitioned to a license arrangement with third parties in these markets. These businesses have been accounted for as
discontinued operations, and, accordingly, the Condensed Consolidated Statements of Operations for all periods presented have been reclassified to reflect them as such. The Condensed Consolidated
Balance Sheet and Statements of Cash Flows have not been adjusted for discontinued operations presentation. Unless otherwise noted, discussions in these notes pertain to our continuing operations

At
May 29, 2011, affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") controlled approximately 47.6% of the issued and outstanding common stock of the
Company.

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

The
Company's significant accounting policies are described in Note 1 to the annual consolidated financial statements for the year ended November 28, 2010 included within
the Company's Annual Report on Form 10-K. In accordance with the adoption of recently issued authoritative guidance surrounding the credit quality of an entity's financing
receivables and its allowance for credit losses, we have provided the additional disclosure below:

Allowance for Doubtful Accounts

The Company continues to actively monitor the financial condition of its customers to determine the potential for nonpayment of trade
receivables. In determining its allowance for doubtful accounts, the Company considers the current financial condition of its customers as well as other general economic factors. The Company's
management believes that its process of specific review of customers, combined with its overall analytical review, provides a reliable evaluation of ultimate collectability of trade receivables. The
receivables related to leasing activities were not significant to either period.

6

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Authoritative Accounting Guidance

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

In
July 2010, the FASB issued authoritative guidance that requires expanded disclosures about the credit quality of an entity's financing receivables and its allowance for credit losses
on a disaggregated basis. The Company has adopted this guidance and has provided the required disclosures herein.

In
December 2010, the FASB issued authoritative guidance that modifies the requirements of step 1 of the goodwill impairment test for reporting units with zero or negative
carrying amounts. The Company will adopt this guidance in the first quarter of fiscal 2012. The Company is still assessing the potential impact of adoption.

In
May 2011, the FASB issued authoritative guidance to improve the consistency of fair value measurement and disclosure requirements between US GAAP and International Financial
Reporting Standards ("IFRS"). The provisions of this guidance change certain of the fair value principles related to the highest and best use premise, the consideration of blockage factors and other
premiums and discounts, the measurement of financial instruments held in a portfolio and instruments classified within shareholders' equity. Further, the guidance provides additional disclosure
requirements surrounding Level 3 fair value measurements, the uses of nonfinancial assets in certain circumstances and identification of the level in the fair value hierarchy used for assets
and liabilities which are not recorded at fair value, but where fair value is disclosed. The Company will adopt this guidance in the second quarter of fiscal 2012. The Company is still assessing the
potential impact of adoption.

Note 3: Share-Based Compensation

The Company maintains the 1998 Stock Option Plan ("1998 Plan") and the 2004 Stock Option Plan for Key Employees of Sealy Corporation and its Subsidiaries ("2004 Plan") which are
collectively referred to as the "Option Plans". The Company accounts for all new share-based awards granted and outstanding using the fair value based method under FASB authoritative guidance
surrounding share-based payments. Total share-based compensation recognized during the three and six months ended May 29, 2011 and May 30, 2010 was $2.9 million and
$5.8 million, respectively, for fiscal 2011 and $5.1 million and $9.2 million, respectively, for fiscal 2010.

Stock Option Awards

During the three and six months ended May 29, 2011 and May 30, 2010, the Company granted no new options to purchase
shares of its common stock.

7

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

A
summary of option activity under the 1998 Plan for the six months ended May 29, 2011, is presented below:

Shares Subject to Options

Weighted Average
Exercise Price Per ShareOutstanding November 28, 2010


1,776,804

$
1.17Exercised


(231,791
)

2.28Forfeited


(22,000
)

2.12Outstanding May 29, 2011 (all fully vested and exercisable)


1,523,013

$
0.99Weighted average remaining contractual term


2.9 yearsAggregate intrinsic value of in-the-money options at May 29, 2011 (in thousands)

$
2,425


A
summary of option activity under the 2004 Plan for the six months ended May 29, 2011, is presented below:

Shares Subject to Options

Weighted Average
Exercise Price Per ShareOutstanding November 28, 2010


6,420,012

$
5.50Exercised


(35,365
)
$
1.67Forfeited


(929,249
)
$
6.11Outstanding May 29, 2011


5,455,398

$
5.42Weighted average remaining contractual term


4.1 yearsAggregate intrinsic value of in-the-money options (in thousands)

$
1,402Exercisable at May 29, 2011


4,447,377Weighted average remaining contractual term


4.1 yearsAggregate intrinsic value of in-the-money options (in thousands)

$
1,172


As
of May 29, 2011, the Company had approximately $0.9 million of unrecognized compensation expense related to stock option awards, which is expected to be recognized over
a weighted average period of 2.6 years.

The
Company has granted stock options to employees that have accelerated vesting provisions which take effect if certain performance levels are achieved by the Company. If the Company
does not meet these performance targets, then the vesting of the options occurs over the remainder of the requisite service period. As of May 29, 2011, the performance targets for certain of
these stock options have not been met. As such, the related unrecognized compensation cost is being recognized over the remainder of the requisite service period. Further, the Company did not
recognize compensation cost for certain options that contain performance targets for fiscal years through 2010 which did not vest due to the related performance targets not being met. These options
will not vest over a remaining requisite service period and were cancelled during the three and six months ended May 29, 2011.

8

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

Restricted Shares and Share Unit Awards

The Company has outstanding 97,324 restricted shares that are considered to be non-vested shares, and have the same rights
as the Company's outstanding common shares, including dividend participation rights, except that they cannot be sold by the holder until the end of the vesting period. As of May 29, 2011, the
remaining unrecognized compensation cost related to restricted share awards was $0.1 million which is expected to be recognized in the third quarter of fiscal 2011. None of these awards vested
during the three and six months ended May 29, 2011 or May 30, 2010.

During
the three and six months ended May 29, 2011, the Company approved grants of 1,955,056 and 2,070,156 time-based restricted stock units ("RSUs"), respectively.
The weighted average grant date fair value of the awards granted during the three and six months ended May 29, 2011 was $2.65. During the three and six months ended May 30, 2010, the
Company approved grants of 250,000
RSUs which have a grant date fair value of $3.66 per unit. The awards granted in fiscal 2011 and 2010 vest ratably over a requisite service period and do not contain an accretion factor. The fair
value of the Company's RSU awards is based on the closing price of the Company's common stock as of the grant date. The Company has outstanding RSU awards of several types:
1) 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;
2) Time-based RSU awards that vest ratably over a requisite service period; and 3) Performance-based RSUs which do not vest unless certain targets that are tied to the
Company's earnings performance are met. None of the Company's outstanding RSUs contain dividend participation rights.

A
summary of the outstanding unvested RSU awards by type as of May 29, 2011 follows:

Number of Awards

Unrecognized
Compensation Expense
(in thousands)Time-based vesting awards with accretion factor


11,558,576

$
5,601Time-based vesting awards without accretion factor


2,722,823


5,799Performance-based awards outstanding


430,968


13Total


14,712,367

$
11,413Performance-based awards where targets are not expected to be met


114,800

$
88


9

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

A
summary of restricted share unit award activity for the six months ended May 29, 2011, is presented below:

Unvested Restricted
Share Units

Weighted Average Grant
Date Fair ValueOutstanding November 28, 2010


12,811,956

$
2.07Granted


2,070,156


2.65Vested


(157,230
)

3.20Forfeited


(12,515
)

2.15Outstanding May 29, 2011


14,712,367

$
2.14Weighted average remaining vesting period


1.3 years


Note 4: Inventories

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

May 29, 2011

November 28, 2010Raw materials

$
26,251

$
26,449Work in process


25,093


22,629Finished goods


10,099


8,100$
61,443

$
57,178


Note 5: Warranty Costs

The Company's warranty policy provides a 10-year non-prorated warranty service period on all currently manufacturedSealy Posturepedic,
Stearns & FosterandBassettbedding products and certain otherSealybranded products. In addition, the Company has a 20-year warranty on the major components of itsTrueFormand MirrorFormvisco-elastic products and itsSpringFreelatex product, the last ten years of which are
prorated on a straight-line basis. Though discontinued in 2008, the Company also offered a 20-year limited warranty on its RightTouchproduct line which covered only certain parts of the product and
will be 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. The estimate involves an average
lag time in days between the sale of a bed and the date of its return, applied to the current rate of the warranty returns.

10

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 5: Warranty Costs (Continued)

The
change in the Company's accrued warranty obligations for each of the six months ended May 29, 2011 and May 30, 2010 was as follows (in thousands):

May 29, 2011

May 30, 2010Accrued warranty obligations at beginning of period

$
17,584

$
16,464Warranty claims


(7,897
)

(9,865
)Warranty provisions


8,064


9,577Accrued warranty obligations at end of period

$
17,751

$
16,176


As
of May 29, 2011 and November 28, 2010, $10.7 million and $10.5 million is included as a component of other accrued liabilities and $7.1 million and
$7.1 million is included as a component of other noncurrent liabilities within the accompanying Condensed Consolidated Balance Sheet, respectively. In estimating its warranty obligations, the
Company considers the impact of recoverable salvage value on warranty cost in determining its estimate of future warranty obligations. Warranty claims and provisions shown above do not include
estimated salvage recoveries that reduced cost of sales by $2.9 million and $3.3 million for the six months ended May 29, 2011 and the six months ended May 30, 2010,
respectively.

Note 6: Goodwill and Other Intangible Assets

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

The
changes in the carrying amount of goodwill for the six months ended May 29, 2011 are as follows (in thousands):

Balance as of November 28, 2010

$
361,958Increase due to foreign currency translation


1,540Balance as of May 29, 2011

$
363,498


Total
other intangibles of $1.3 million (net of accumulated amortization of $3.3 million) as of May 29, 2011 consist primarily of licenses, which are amortized using
a straight-line method over periods ranging from 5 to 15 years. Costs to renew or extend the term of a recognized intangible asset are expensed as incurred. During the three and six
months ended May 29, 2011 and May 30, 2010, the Company recognized amortization expense associated with intangibles of $0.1 million and $0.1 million, respectively, for
fiscal 2011 and $0.1 million and $0.1 million, respectively, for fiscal 2010. The Company expects to recognize amortization expense relating to these intangibles of $0.1 million
for the remainder of 2011, $0.3 million in 2012, $0.3 million in 2013, $0.3 million in 2014 and $0.2 million in 2015.

11

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 7: Debt Issuance Costs

On May 27, 2011 and March 16, 2010, the Company redeemed $10.0 million and $35.0 million, respectively, of the principal amount of its outstanding senior
secured notes due April 2016 (the "Senior Notes") at a redemption price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date. In connection with the
repurchases, the Company recognized the following charges which were recorded as a component of refinancing and extinguishment of debt in the Condensed Consolidated Statements of Operations:

May 29, 2011

May 30, 2010Premium paid to repurchase the notes

$
300

$
1,050Write-off of related debt issuance costs and original issue discount


643


2,709


Note 8: Unconsolidated Affiliate Companies

The Company is involved in a group of joint ventures to develop markets forSealybranded products in Asia. Our ownership interest in
these joint ventures is 50% and is accounted for under the equity method. The Company's share of earnings is recorded in equity in earnings of unconsolidated affiliates in the Condensed Consolidated
Statements of Operations.

Summarized
statements of operations for these joint ventures for each of the three and six month periods ended May 29, 2011 and May 30, 2010 are as follows (in thousands):

Three months

Six monthsMay 29, 2011

May 30, 2010

May 29, 2011

May 30, 2010Revenues

$
13,103

$
10,191

$
25,421

$
21,743Gross profit


7,827


6,109


15,622


12,621Income from operations


1,708


2,595


3,664


4,859Net income


1,246


2,094


2,955


3,980


12

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations

Long-term obligations as of May 29, 2011 and November 28, 2010 consisted of the following (in thousands):

May 29, 2011

November 28, 2010Asset-based revolving credit facility

$


$
Senior secured notes


295,362


304,318Convertible notes(1)


182,770


181,341Senior subordinated notes


268,945


268,945Financing obligations


39,208


39,896Other


560


750786,845


795,250Less current portion


(2,069
)

(2,166
)$
784,776

$
793,084


(1)Includes
paid in kind ("PIK") interest of $5.8 million from January 16, 2011 through May 29, 2011 for which the principal balance of
the Convertible Notes has not yet been increased.


The
Company's outstanding debt primarily consists of the following: 1) an asset-based revolving credit facility (the "ABL Revolver") which provides commitments of up to
$100.0 million maturing in May 2013; 2) $350.0 million in original aggregate principal amount of Senior Notes; 3) $177.1 million in aggregate principal amount of
senior secured convertible PIK notes due June 2016 which are convertible into shares of the Company's common stock (the "Convertible Notes") and 4) senior subordinated notes which consist of an
original $314 million aggregate principal amount maturing June 15, 2014, bearing interest at 8.25% per annum payable semi annually (the "2014 Notes").

ABL Revolver

The ABL Revolver provides for revolving credit financing of up to $100.0 million, subject to borrowing base availability, and
matures in May 2013. As of May 29, 2011, there were no amounts outstanding under the ABL Revolver. At May 29, 2011, the Company had approximately $61.0 million available under the
ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $16.6 million.

The
ABL Revolver agreement requires the Company to maintain a fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two
consecutive calendar days is less than the greater of 1) 15% of the total commitment under the ABL Revolver and 2) $15.0 million. As of May 29, 2011, the Company was not in
a minimum availability period under the ABL Revolver.

13

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

Senior Secured Notes

The Senior Notes mature in April 2016 and bear interest at 10.875% per annum payable semi-annually in arrears on
April 15 and October 15. The total proceeds received by the Company from the issuance of these notes was $335.9 million, resulting in an original issue discount ("OID") of
$14.1 million which will be accreted over the life of the agreement with the related expense recognized as a component of interest expense in the Condensed Consolidated Statement of Operations.
For each of the three and six months ended May 29, 2011 and May 30, 2010, the Company recognized additional interest expense of $0.3 and $0.7 million, respectively related to the
accretion of the OID.

As
discussed in Note 7, on May 27, 2011 and March 16, 2010, the Company redeemed a portion of the principal amount of its outstanding Senior Notes at a redemption
price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date.

Convertible PIK Notes

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

During
the three and six months ended May 29, 2011, there were no conversions of Convertible Notes into common shares.

The
Company accounts for the PIK interest on the Convertible Notes in accordance with the applicable FASB authoritative guidance pertaining to convertible instruments and derivative
financial instruments indexed to, and potentially settled in, a company's own stock. This guidance requires an allocation of a portion of the issuance amount to an embedded beneficial conversion
feature based on the difference between the effective conversion price of the convertible debt and the fair value of the underlying common stock. Upon the
January 15th interest payment dates in both fiscal 2011 and 2010, the fair value of the underlying common stock was more than double the conversion price of the Convertible
Notes. Therefore, a beneficial conversion feature was recognized for the entire amount of the PIK interest payment of $7.6 million during the six months ended May 29, 2011. The
recognition of the beneficial
conversion feature resulted in the recognition of a discount, which was reflected as a reduction of the balance of the Convertible Notes with an offsetting increase to additional paid-in
capital. The recognized discount will be accreted through interest expense over the remaining term of the Convertible Notes.

The
indentures and agreements governing the ABL Revolver, Senior Notes, Convertible Notes and the 2014 Notes also impose certain restrictions including, but not limited to, the payment
of dividends or other equity distributions and the incurrence of debt or liens upon the assets of the Company or its subsidiaries. For instance, the agreement governing Sealy Mattress Company's ABL
Revolver contains restrictions on the ability of Sealy Corporation's subsidiaries to pay dividends or make other distributions to Sealy Corporation subject to specified exceptions including the
satisfaction of a

14

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

minimum
fixed charge coverage ratio and average daily availability levels. Likewise, under the indentures governing Sealy Mattress Company's Senior Notes and 2014 Notes, Sealy Mattress Company is
restricted from paying dividends or making other distributions to Sealy Corporation unless Sealy Mattress Company is able to satisfy certain requirements or use an available exception from the
limitation. As of May 29, 2011, Sealy Mattress Company is restricted in distributing the net assets of its subsidiaries in the amount of $240.3 million to its parent due to the
provisions in its long-term debt agreements. However, $30.0 million would be available for distribution without restriction. At May 29, 2011, the Company was in compliance
with the covenants contained within the related note indentures and agreements.

Note 10: Derivative Instruments and Hedging Strategies

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

Interest Rate Risk

Prior to the disposition of the European operations, the Company was exposed to interest rate risk associated with fluctuations in the
interest rates on its variable interest rate debt. However, the Company now has predominantly fixed rate debt outstanding. In order to manage the risk of variable interest rates prior to this event,
the Company had entered into several interest rate swap agreements that converted the debt's variable interest rate to a fixed interest rate. The swap agreements pertaining to the Company's European
debt were considered to be economic hedges which were not designated as hedging instruments. The gains and losses on both designated and undesignated swap agreements offset losses and gains on the
transactions being hedged. The fair values of the interest rate agreements were estimated as described in Note 11, taking into consideration current interest rates and the current
creditworthiness of the counterparties or the Company, as applicable.

As
of May 29, 2011 and November 28, 2010, the Company did not have any outstanding interest rate swap agreements.

Foreign Currency Exposure

The Company is exposed to foreign currency risk related to purchases of materials and certain equipment made in a foreign currency. To
manage the risk associated with fluctuations in foreign currencies, the Company enters into foreign currency forward and option contracts. As with its interest rate swap instruments, the Company
designates certain of these contracts as hedging instruments and enters into some contracts that are considered to be economic hedges which are not designated as hedging instruments. Whether
designated or undesignated, these contracts protect against the reduction in value of forecasted foreign currency cash flows resulting from payments in a foreign currency. The fair values of foreign
currency agreements are estimated as described in Note 11, taking into consideration current interest rates and the current creditworthiness of the counterparties or the

15

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

Company,
as applicable. Details of the specific instruments used by the Company to hedge its exposure to foreign currency fluctuations are as follows:

At
May 29, 2011, the Company had outstanding 55 forward foreign currency contracts and 1 foreign currency option contract to sell a total of 36.6 million Canadian dollars
and receive U.S. dollars at specified exchange rates with expiration dates ranging from June 2011 through May 2012. These hedges were entered into to protect against the fluctuation in the Canadian
subsidiary's U.S. dollar
denominated purchases of raw materials. Further, the Company had outstanding one foreign currency forward contract to purchase a total of 0.1 million Swiss francs for U.S. dollars at a
specified exchange rate with an expiration date of June 2011. This hedge was entered into to protect against the fluctuations in the scheduled payments to be made for certain equipment denominated in
Swiss francs. The Company has formally designated these contracts as cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in the forecasted purchases of these raw
materials and equipment related to changes in the foreign currency exchange rates.

The
Company also enters into foreign currency contracts that are not designated as hedges for accounting purposes. The changes in fair value of these foreign currency hedges are included
as a part of cost of goods sold in the Condensed Consolidated Statements of Operations. At May 29, 2011 and November 28, 2010, the Company did not have any outstanding foreign currency
contracts that were not designated as hedges for accounting purposes.

At
May 29, 2011, the maximum length of time over which the Company is hedging its exposure to the reduction in value of forecasted foreign currency cash flows through foreign
currency forward agreements is through May 2012. Over the next 12 months, the Company expects to reclassify $0.5 million of deferred losses from accumulated other comprehensive income to
cost of goods sold as related forecasted foreign currency payments are made.

For
the three and six months ended May 29, 2011, the Company recognized foreign currency transaction gains of $0.9 million and $1.2 million, respectively compared
with gains of $0.6 million and $1.8 million, respectively for the three and six months ended May 30, 2010. These gains are recognized in cost of goods sold or selling, general and
administrative expenses at the time they occur.

Commodity Price Exposure

The Company is exposed to risk associated with fluctuations in the prices of diesel fuel used in the transportation of its finished
product to its customers. To manage this risk, the Company enters into fixed price swap agreements. The Company designates these fixed price swap contracts as hedging instruments. These contracts
protect against the reduction in value of forecasted cash flows resulting from the purchases of diesel fuel. The fair values of the fixed price swap agreements are estimated as described in
Note 11, taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable. Details of the specific instruments used by the
Company to hedge its exposure to foreign currency fluctuations are as follows:

At
November 28, 2010, the Company had outstanding two fixed price swap contracts to purchase 0.2 million gallons of diesel fuel at specified prices. These hedges were
entered into to protect against the fluctuations in the prices of diesel fuel purchased by certain of the Company's U.S. manufacturing facilities. The Company formally designated these contracts as
cash flow hedges, and they are expected

16

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

to
be highly effective in offsetting fluctuations in the forecasted purchases of diesel fuel related to changes in the underlying diesel fuel prices. No such contracts were outstanding at
May 29, 2011.

Embedded Derivatives

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

The
Company concluded that the floor on the foreign exchange rate related to the payments to be made associated with the lease of its former Brazilian manufacturing facility and the
related purchase option qualifies as an embedded derivative instrument that should be bifurcated from the lease agreement and recorded at fair value at the end of each reporting period. As of
May 29, 2011 and November 28, 2010, the fair value of this derivative was an insignificant amount and $0.4 million, respectively and is recorded as a component of debt issuance
costs, net, and other assets in the Consolidated Balance Sheet. The initial fair value of the embedded derivative was recorded as deferred lease income and is being amortized over the term of the
lease.

17

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

At
May 29, 2011 and November 28, 2010, the fair value carrying amount of the Company's derivative instruments was recorded as follows (in thousands):

Asset Derivatives

Liability DerivativesMay 29, 2011

May 29, 2011Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair ValueDerivatives designated as hedging instrumentsForeign exchange contracts

Other current assets

$
134

Other current liabilities

$
(930
)Total derivatives designated as hedging instruments




134




(930
)Derivatives not designated as hedging instrumentsEmbedded foreign currency derivative

Other noncurrent assets




Other noncurrent liabilities


Total derivatives not designated as hedging instruments









Total derivatives



$
134



$
(930
)




Asset Derivatives

Liability DerivativesNovember 28, 2010

November 28, 2010Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair ValueDerivatives designated as hedging instrumentsForeign exchange contracts

Other current assets

$
85

Other current liabilities

$
(163
)Diesel fixed price swap contracts

Other current assets


44

Other current liabilities


Total derivatives designated as hedging instruments




129




(163
)Derivatives not designated as hedging instruments:Embedded foreign currency derivative

Other noncurrent assets


380

Other noncurrent liabilities


Total derivatives



$
509



$
(163
)


18

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

The effect of derivative instruments on the Condensed Consolidated Statement of Operations, net of tax, for the three and six months ended
May 29, 2011 and May 30, 2010, was as follows (in thousands):

Three Months Ended May 29, 2011Derivatives in Designated
Cash Flow Hedging
Relationships

Amount of
Gain/(Loss)
Recognized
in OCI on
Derivatives
(Effective Portion)

Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Location of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)

Amount of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)Diesel fixed price swap contracts




Selling, general and administrative expenses




Selling, general and administrative expenses


Foreign exchange contracts


244

Cost of goods sold


(504
)
Cost of goods sold


Total

$
244



$
(504
)


$





Six Months Ended May 29, 2011Derivatives in Designated
Cash Flow Hedging
Relationships

Amount of
Gain/(Loss)
Recognized
in OCI on
Derivatives
(Effective Portion)

Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Location of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)

Amount of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)Diesel fixed price swap contracts




Selling, general and administrative expenses


63

Selling, general and administrative expenses


Foreign exchange contracts


(502
)
Cost of goods sold


(610
)
Cost of goods sold


Total

$
(502
)


$
(547
)


$





Three Months Ended May 30, 2010Derivatives in Designated
Cash Flow Hedging
Relationships

Amount of
Gain/(Loss)
Recognized
in OCI on
Derivatives
(Effective Portion)

Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Location of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)

Amount of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)Diesel fixed price swap contracts


(11
)
Selling, general and administrative expenses


32

Selling, general and administrative expenses


(16
)Foreign exchange contracts


(39
)
Cost of goods sold


(5
)
Cost of goods sold


Total

$
(50
)


$
27



$
(16
)




Six Months Ended May 30, 2010Derivatives in Designated
Cash Flow Hedging
Relationships

Amount of
Gain/(Loss)
Recognized
in OCI on
Derivatives
(Effective Portion)

Location of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Amount of Gain/(Loss)
Reclassified from
Accumulated
OCI into Income
(Effective Portion)

Location of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)

Amount of Gain/(Loss)
Recognized in Income on
Derivatives (Ineffective
Portion and Amount
Excluded from
Effectiveness Testing)Diesel fixed price swap contracts


6

Selling, general and administrative expenses


32

Selling, general and administrative expenses


Foreign exchange contracts


(175
)
Cost of goods sold


52

Cost of goods sold


Total

$
(169
)


$
84



$



19

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)



Three Months EndedMay 29, 2011

May 30, 2010Derivatives Not Designated as
Hedging Instruments

Location of Gain/(Loss)
Recognized in Income
on Derivatives

Amount of Gain/(Loss)
Recognized in Income
on Derivatives

Amount of Gain/(Loss)
Recognized in Income
on DerivativesInterest rate contracts

Loss from discontinued operations

$


$
(9
)Total



$


$
(9
)




Six Months EndedMay 29, 2011

May 30, 2010Derivatives Not Designated as
Hedging Instruments

Location of Gain/(Loss)
Recognized in Income
on Derivatives

Amount of Gain/(Loss)
Recognized in Income
on Derivatives

Amount of Gain/(Loss)
Recognized in Income
on DerivativesInterest rate contracts

Loss from discontinued operations

$


$
21Total



$


$
21


Note 11: Fair Value of Financial Instruments

For assets and liabilities measured at fair value on a recurring basis during the period, the Company uses an income approach to value the assets and liabilities for outstanding interest
rate swaps, foreign currency derivative contracts and diesel fixed price swap contracts discussed above in Note 10. These contracts are valued using an income approach, which consists of a
discounted cash flow model that takes into account the present value of future cash flows under the terms of the contracts by using current market information available as of the reporting date such
as prevailing interest rates and foreign currency and diesel spot and forward rates. We mitigate derivative credit risk by transacting with highly rated counterparties. There were no
non-financial assets or liabilities
requiring initial measurement or subsequent remeasurement during the second quarter of fiscal 2011 or 2010. The following table provides a summary of the fair values of assets and liabilities (in
thousands):

Fair Value Measurements at May 29, 2011 UsingMay 29, 2011

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable Inputs
(Level 3)Foreign exchange and commodity derivative assets

$
134

$


$
134

$
Foreign exchange and commodity derivative liabilities


(930
)




(930
)

Embedded foreign currency derivative in lease agreement











Total

$
(796
)
$


$
(796
)
$



20

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 11: Fair Value of Financial Instruments (Continued)



Fair Value Measurements at November 28, 2010 UsingNovember 28, 2010

Quoted Prices in
Active Markets for
Identical Assets
(Level 1)

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable Inputs
(Level 3)Foreign exchange and commodity derivative assets

$
129

$


$
129

$
Foreign exchange and commodity derivative liabilities


(163
)




(163
)

Embedded foreign currency derivative in lease agreement


380








380Total

$
346

$


$
(34
)
$
380


Due
to the short maturity of cash and equivalents, accounts receivable, accounts payable and accrued expenses, their carrying values approximate fair value. The carrying amounts of long
term debt, based on quoted market prices, at May 29, 2011 were as follows (in thousands):

Senior Secured Notes

$
343,125Convertible Notes


524,432Senior Subordinated Notes


270,626


Note 12: Discontinued Operations

In the fourth quarter of fiscal 2010, management divested the assets of its European manufacturing operations in France and Italy and ceased manufacturing operations in Brazil. These
businesses have been accounted for as discontinued operations. During the three and six months ended May 29, 2011, the Company continued the liquidation of certain of its assets related to its
Brazil operations. The charges related to these activities were recorded as a component of discontinued operations. The remaining current assets and liabilities of the Brazilian operations reflected
within the Consolidated Balance Sheet at May 29, 2011 and November 28, 2010 were immaterial. The Company also recognized additional expenses related to the disposition of its European
manufacturing operations which were primarily related to services rendered in connection with the disposition.

21

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 12: Discontinued Operations (Continued)

The operating results of the discontinued operations in total are summarized below (in thousands):

Three months ended

Six months endedMay 29, 2011

May 30, 2010

May 29, 2011

May 30, 2010Net sales

$


$
26,002

$


$
53,741Loss before income taxes


(746
)

(2,816
)

(1,164
)

(5,215
)Income tax provision (benefit)





2





165Loss from operations of discontinued operations


(746
)

(2,818
)

(1,164
)

(5,380
)Loss on disposition of business, net of tax


(381
)




(995
)

Loss from discontinued operations

$
(1,127
)
$
(2,818
)
$
(2,159
)
$
(5,380
)


In
connection with the sale of the Company's European manufacturing operations, the Company made certain guarantees with respect to the existence of liabilities and deficiencies related
to assets as of the closing date that were not reflected in the European business' financial statements as of the closing date. Further, certain guarantees were made with respect to losses or damages
incurred by the purchaser related to any misrepresentations or warranties made by the Company, outstanding disputes or judicial proceedings. Such guarantees are limited to an aggregate amount of
3.5 million Euro under the terms of the contract. As of May 29, 2011, the Company has been notified of several outstanding contingencies that would be covered by this guarantee.

Note 13: Defined Benefit Pension Expense

The components of net periodic pension cost recognized for the Company's defined benefit pension plans in the U.S. and Canada for the three and six months ended May 29,
2011 and May 30, 2010 are as follows (in thousands):

Three Months Ended

Six Months EndedMay 29, 2011

May 30, 2010

May 29, 2011

May 30, 2010Service cost

$
199

$
179

$
398

$
359Interest cost


360


337


719


674Expected return on plan assets


(367
)

(305
)

(733
)

(611
)Amortization of unrecognized losses


35


37


71


74Amortization of unrecognized prior service cost


144


129


288


259Net periodic pension cost*

$
371

$
377

$
743

$
755Cash contributions

$
538

$
636

$
758

$
636Weighted average expected return on plan assets


7.85
%

7.85
%

7.85
%

7.85
%


*Net
periodic pension cost recognized for the three and six months ended May 29, 2011 is based upon preliminary estimates pending the final
actuarial determination of such costs for fiscal 2010. Similarly, net periodic pension cost for the three and six months ended May 30, 2010 is based upon preliminary estimates.


22

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 13: Defined Benefit Pension Expense (Continued)




The
Company expects to make additional cash contributions to the defined benefit pension plans of approximately $1.4 million during the remainder of fiscal 2011.

Note 14: Income Taxes

The Company's effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of non-deductible paid in kind interest, certain
foreign tax rate differentials and state and local income taxes. The effective tax rate for the three and six months ended May 29, 2011 was approximately 128.8% and 74.8%, respectively,
compared to approximately (26.7)% and 41.5%, for the three and six months ended May 30, 2010, respectively. The effective rate for the three months ended May 29, 2011 was higher than the
rate for the three months ended May 30, 2010, primarily due to the decrease in income before income taxes.

The
Condensed Consolidated Balance Sheet as of May 29, 2011 includes accrued interest of $3.8 million and penalties of $2.0 million due to unrecognized tax benefits.
As of November 28, 2010, the Company had recorded accrued interest of $3.7 million and penalties of $2.2 million due to unrecognized tax benefits.

The
Company expects the liability for uncertain tax positions to decrease by approximately $1.4 million within the succeeding twelve months due to expiration of income tax
statutes of limitations. Federal years open to examination are fiscal year 2004 and forward. State and international jurisdictions remain open to examination for fiscal year 2000 and forward.

Significant
judgment is required in evaluating the Company's federal, state and foreign tax positions and in the determination of its tax provision. Despite the Company's belief that its
liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of any particular tax matter. The Company may adjust these
liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, or resolution of issues in the courts. These adjustments are recognized as a component of income tax
expense entirely in the period in which they are identified. The Company is currently undergoing examinations of certain of its corporate income tax returns by tax authorities. Issues related to
certain of these reserves have been presented to the Company and the Company believes that such audits will not result in a material assessment or payment of taxes related to these positions during
the one year period following May 29, 2011. The Company also cannot predict when or if any other future tax payments related to these tax positions may occur.

Note 15: Comprehensive Income

Comprehensive (loss) income for the three and six months ended May 29, 2011 was $0.7 million and $3.5 million, respectively and for the three and six months
ended May 30, 2010 was $(0.7) million and $4.0 million, respectively. The increase in comprehensive income for the three months ended May 29, 2011 compared to the three months
ended May 30, 2010, was driven primarily by an increase in gains from foreign exchange translation. The decrease in comprehensive income for the six months ended May 29, 2011 compared to
the six months ended May 30, 2010 was driven by decreases in net income offset by increases in gains from foreign exchange translations.

23

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 15: Comprehensive Income (Continued)

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

May 29, 2011

November 28, 2010Unrealized gain (loss) on cash flow hedges, net of tax of $(319) and $(64), respectively

$
(502
)
$
(69
)Unrealized actuarial loss and prior service credit for pension liability, net of tax of $4,592 and $4,717, respectively


(7,235
)

(7,387
)Accumulated foreign currency translation adjustment


19,561


14,461$
11,824

$
7,005


Note 16: Commitments and Contingencies

Commitments

The Company has employment agreements with certain of its executive officers and key employees which, among other things, provide
severance benefits to those employees. For the three and six months ended May 30, 2011, severance costs of $0.1 million and $0.3 million were recorded as a component of
operating income within the accompanying Condensed Consolidated Statements of Operations. For the three and six months ended May 30, 2010, severance costs of $0.1 million and
$1.4 million were recorded as a component of operating income within the accompanying Condensed Consolidated Statements of Operations. Severance benefits of $0.3 million and
$0.5 million have been accrued as of May 29, 2011 and November 28, 2010, respectively. The entire liability has been recorded as a component of accrued compensation within the
accompanying Condensed Consolidated Balance Sheets as of May 29, 2011 and November 28, 2010, respectively.

Contingencies

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

The
Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. The
Company and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, the Company and its
subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the
property in 1997. The Company and its subsidiary retained primary responsibility for the required remediation. The Company has completed essentially all soil remediation with the approval of the New
Jersey Department of Environmental Protection and continues to operate a groundwater remediation system on the site. During 2005, with the approval of the New Jersey Department of Environmental
Protection, the Company removed and disposed of sediment in Oakeys Brook adjoining the site. The

24

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 16: Commitments and Contingencies (Continued)

Company
continues to monitor ground water at the site. The Company has recorded a reserve as a component of other accrued liabilities and other noncurrent liabilities in the accompanying Condensed
Consolidated Balance Sheets as of May 29, 2011 for $1.9 million ($2.1 million prior to discounting at 4.75%) associated with this remediation project.

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

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

During
fiscal 2010, the Company was assessed $8.0 million by the Brazilian government for the failure to provide certain income tax filings. Due to the accumulated net operating
losses in this jurisdiction, the Company's exposure is expected to be limited. At May 29, 2011, the Company has recorded a reserve of $1.2 million related to the expected requirement to
pay certain sales tax, fees and penalties associated with this assessment as a component of accrued expenses.

Note 17: Related Party Transactions

During the three and six months ended May 29, 2011 and May 30, 2010, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC
(a consulting company that works exclusively with KKR's portfolio companies) of $0.3 million and $0.7 million, respectively for fiscal 2011 and $0.5 million and
$1.0 million, respectively for fiscal 2010. As of May 29, 2011 and November 28, 2010, $0.2 million of the costs incurred for these services was accrued as a component of
other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. The Company also participates
in a lease arrangement with a KKR affiliate for our Clarion facility for a six month initial term with two six month renewal options available. The Company has received lease income on this
property of an insignificant amount during the three and six months ended May 29, 2011 and May 30, 2010.

Sealy
Holding LLC, an affiliate of KKR, holds an aggregate amount of $105.6 million of the Company's Convertible Notes. In connection with the PIK interest payment on the
Convertible Notes, the par value of the notes held by KKR was increased by $4.1 million, representing interest from July 15, 2010 to January 15, 2011.

25

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 17: Related Party Transactions (Continued)

During
the six months ended May 29, 2011 and May 30, 2010, the Company's joint ventures made a distribution to the Company of $1.0 million. These amounts have been
reflected as a reduction of the investment in these joint ventures in the accompanying Condensed Consolidated Balance Sheets as of May 29, 2011 and November 28, 2010.

Note 18: Geographical Information

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

Three Months Ended

Six Months EndedMay 29, 2011

May 30, 2010

May 29, 2011

May 30, 2010United States

$
253,443

$
229,131

$
492,187

$
475,505Canada


44,579


42,091


88,085


86,818Other International


23,274


19,303


46,553


40,090Total

$
321,296

$
290,525

$
626,825

$
602,413Total International

$
67,853

$
61,394

$
134,638

$
126,908


Long
lived assets (principally property, plant and equipment) outside the United States were $34.8 million and $34.4 million as of May 29, 2011 and
November 28, 2010, respectively.

26

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 19: Earnings per Share

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

Three Months Ended

Six Months EndedMay 29, 2011

May 30, 2010

May 29, 2011

May 30, 2010(in thousands)

(in thousands)Numerator:Net income from continuing operations, as reported

$
750

$
3,667

$
880

$
11,944Net income attributable to participating securities


(1
)

(11
)

(1
)

(37
)Interest on convertible notes





4,075





7,610Net income from continuing operations available to common shareholders

$
749

$
7,731

$
879

$
19,517Denominator:Denominator for basic earnings per shareweighted average shares


98,040


94,604


97,928


94,563Effect of dilutive securities:Convertible debt





181,776





180,000Stock options


796


1,094


841


1,217Restricted share units


8,669


9,895


8,112


9,977Other


428


345


417


335Denominator for diluted earnings per shareadjusted weighted average shares and assumed conversions


107,933


287,714


107,298


286,092


Options
and share units (in thousands) not included in the computation of diluted earnings per share because their impact is antidilutive for the three and six months ended
May 29, 2011 were 4,012 and 4,004, respectively. Additionally, for the three and six months ended May 29, 2011, the outstanding Convertible Notes were excluded from the computation of
diluted earnings per share since their inclusion would be antidilutive. The Convertible Notes not included in the computation of diluted earnings per share for the three and six months ended
May 29, 2011 convert into a weighted average 196,610 and 194,646 shares (in thousands), respectively. Options and share units (in thousands) not included in the calculation of diluted earnings
per share because their impact is antidilutive for the three and six months ended May 30, 2010 were 5,315 and 5,332, respectively.

Note 20: Guarantor/Non-Guarantor Financial Information

Sealy Corporation, Sealy Mattress Corporation (a 100% owned subsidiary of Sealy Corporation) and each of the subsidiaries of Sealy Mattress Company (the "Issuer") that guarantee the
Senior Notes, the Convertible Notes and the 2014 Notes (the "Guarantor Subsidiaries"), and are 100% owned subsidiaries of the Issuer, have fully and unconditionally guaranteed, on a joint and several
basis, the obligation to pay principal and interest with respect to the Senior Notes, the Convertible Notes and the 2014 Notes (collectively, the "Guaranteed Notes") of the Issuer. Substantially all
of the Issuer's

27

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

operating
income and cash flow is generated by its subsidiaries. As a result, funds necessary to meet the Issuer's debt service obligations are provided, in part, by distributions or advances from its
subsidiaries. Under certain circumstances, contractual and legal restrictions, as well as the financial condition and operating requirements of the Issuer's subsidiaries, could limit the Issuer's
ability to obtain cash from its subsidiaries for the purpose of meeting its debt service obligations, including the payment of principal and interest on the Guaranteed Notes. Although holders of the
Guaranteed Notes will be direct creditors of the Issuer's principal direct subsidiaries by virtue of the guarantees, the Issuer has subsidiaries ("Non-Guarantor Subsidiaries") that are not
included among the Guarantor Subsidiaries, and such subsidiaries will not be obligated with respect to the Guaranteed Notes. As a result, the claims of creditors of the Non-Guarantor
Subsidiaries will effectively have priority with respect to the assets and earnings of such companies over the claims of creditors of the Issuer, including the holders of the Guaranteed Notes.

The
following supplemental Condensed Consolidating Financial Statements present:



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

28

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Balance Sheets        May 29, 2011        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
1,655

$


$
9,234

$
16,092

$
52,311

$


$
79,292Accounts receivable, net








18


95,719


56,018





151,755Inventories








1,673


51,530


8,382


(142
)

61,443Other current assets and deferred income taxes


400





686


41,907


7,616





50,609Total current assets


2,055





11,611


205,248


124,327


(142
)

343,099Property, plant and equipment, at cost








9,591


351,549


37,785





398,925Less accumulated depreciation








(5,607
)

(202,986
)

(21,312
)




(229,905
)





3,984


148,563


16,473





169,020Other assets:Goodwill








24,741


301,942


36,815





363,498Intangible assets, net











1,233


20





1,253Net investment in subsidiaries


(176,298
)

240,323


380,458


152,334





(596,817
)

Due from (to) affiliates


286,466


(416,621
)

550,631


(136,615
)

(100,498
)

(183,363
)

Debt issuance costs, net and other assets








19,292


19,120


17,370





55,782110,168


(176,298
)

975,122


338,014


(46,293
)

(780,180
)

420,533Total assets

$
112,223

$
(176,298
)
$
990,717

$
691,825

$
94,507

$
(780,322
)
$
932,652Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$


$
1,636

$
433

$


$
2,069Accounts payable








461


51,420


22,165





74,046Accrued customer incentives and advertising











19,207


6,821





26,028Accrued compensation








393


14,220


3,097





17,710Accrued interest








1,273


12,932








14,205Other accrued liabilities








1,501


25,255


5,577





32,333Total current liabilities








3,628


124,670


38,093





166,391Long-term obligations


182,770





747,077


37,699





(182,770
)

784,776Other liabilities











45,071


6,119





51,190Deferred income tax liabilities








(311
)

524


629





842Stockholders' equity (deficit)


(70,547
)

(176,298
)

240,323


483,861


49,666


(597,552
)

(70,547
)Total liabilities and stockholders' equity (deficit)

$
112,223

$
(176,298
)
$
990,717

$
691,825

$
94,507

$
(780,322
)
$
932,652


29

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Balance Sheets        November 28, 2010        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
1,010

$


$
9,234

$
59,108

$
39,903

$


$
109,255Accounts receivable, net


7





23


80,202


60,546





140,778Inventories








1,605


47,230


8,684


(341
)

57,178Other current assets and deferred income taxes


410





448


32,541


5,271





38,670Total current assets


1,427





11,310


219,081


114,404


(341
)

345,881Property, plant and equipment, at cost








9,452


340,077


35,941





385,470Less accumulated depreciation








(5,326
)

(192,881
)

(19,191
)




(217,398
)





4,126


147,196


16,750





168,072Other assets:Goodwill








24,741


301,942


35,275





361,958Intangible assets, net











1,377


10





1,387Net investment in subsidiaries


(179,840
)

236,674


383,319


114,072





(554,225
)

Due from (to) affiliates


272,114


(416,514
)

547,919


(124,622
)

(97,023
)

(181,874
)

Debt issuance costs, net and other assets








22,142


20,522


16,795





59,45992,274


(179,840
)

978,121


313,291


(44,943
)

(736,099
)

422,804Total assets

$
93,701

$
(179,840
)
$
993,557

$
679,568

$
86,211

$
(736,440
)
$
936,757Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$


$
1,724

$
442

$


$
2,166Accounts payable








446


44,406


21,655





66,507Accrued customer incentives and advertising











24,446


10,064





34,510Accrued compensation








383


17,840


4,167





22,390Accrued interest








1,239


13,120








14,359Other accrued liabilities


(1
)




530


28,198


8,471





37,198Total current liabilities


(1
)




2,598


129,734


44,799





177,130Long-term obligations


181,341





754,603


38,481





(181,341
)

793,084Other liabilities











46,746


6,611





53,357Deferred income tax liabilities








(318
)

530


613





825Stockholders' equity (deficit)


(87,639
)

(179,840
)

236,674


464,077


34,188


(555,099
)

(87,639
)Total liabilities and stockholders' equity (deficit)

$
93,701

$
(179,840
)
$
993,557

$
679,568

$
86,211

$
(736,440
)
$
936,757


30

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Three Months Ended May 29, 2011        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
22,963

$
236,852

$
66,525

$
(5,044
)
$
321,296Cost and expenses:Cost of goods sold








12,878


149,552


38,897


(5,105
)

196,222Selling, general and administrative








2,162


86,658


18,627





107,447Amortization expense











72








72Royalty (income) expense, net











(4,804
)







(4,804
)Income from operations








7,923


5,374


9,001


61


22,359Interest expense





77


20,787


530


272





21,666Refinancing and extinguishment of debt








1,236











1,236Other (income) expense, net














(102
)




(102
)Loss (income) from equity investees


377


322


3,745








(4,444
)

Loss (income) from non- guarantor equity investees











(5,121
)




5,121


Capital charge and intercompany interest allocation








(18,858
)

17,185


1,673





Income (loss) before income taxes


(377
)

(399
)

1,013


(7,220
)

7,158


(616
)

(441
)Income tax provision (benefit)





(22
)

1,335


(3,604
)

1,708


15


(568
)Equity in earnings of unconsolidated affiliates














623





623Income (loss) from continuing operations


(377
)

(377
)

(322
)

(3,616
)

6,073


(631
)

750Loss from discontinued operations











(175
)

(952
)




(1,127
)Net income (loss)

$
(377
)
$
(377
)
$
(322
)
$
(3,791
)
$
5,121

$
(631
)
$
(377
)


31

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Three Months Ended May 30, 2010        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
18,676

$
218,859

$
59,904

$
(6,914
)
$
290,525Cost and expenses:Cost of goods sold








11,310


130,484


34,155


(6,998
)

168,951Selling, general and administrative


369





1,770


80,108


16,050





98,297Amortization of intangibles











72








72Royalty (income) expense, net











(3,807
)







(3,807
)Income from operations


(369
)




5,596


12,002


9,699


84


27,012Interest expense





79


20,332


571


255





21,237Refinancing and extinguishment of debt and interest rate derivatives








3,759











3,759Other (income) expense, net














(52
)




(52
)Loss (income) from equity investees


(2,454
)

(3,343
)

23,918








(18,121
)

Loss (income) from non- guarantor equity investees











(3,879
)




3,879


Capital charge and intercompany interest allocation








(18,627
)

17,959


668





Income (loss) before income taxes


2,085


3,264


(23,786
)

(2,649
)

8,828


14,326


2,068Income tax expense (benefit)


1,236


810


(27,129
)

21,254


3,178


99


(552
)Equity in earnings of unconsolidated affiliates














1,047





1,047Income (loss) from continuing operations


849


2,454


3,343


(23,903
)

6,697


14,227


3,667Loss from discontinued operations














(2,818
)




(2,818
)Net income (loss)

$
849

$
2,454

$
3,343

$
(23,903
)
$
3,879

$
14,227

$
849


32

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Six Months Ended May 29, 2011        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
44,121

$
461,477

$
131,554

$
(10,327
)
$
626,825Cost and expenses:Cost of goods sold








25,008


292,207


76,558


(10,526
)

383,247Selling, general and administrative








4,116


170,415


36,650





211,181Amortization expense











144








144Royalty (income) expense, net











(9,775
)







(9,775
)Income from operations








14,997


8,486


18,346


199


42,028Interest expense





154


41,432


1,102


686





43,374Refinancing and extinguishment of debt








1,236











1,236Other (income) expense, net














(207
)




(207
)Loss (income) from equity investees


1,279


1,172


8,115








(10,566
)

Loss (income) from non- guarantor equity investees











(10,732
)




10,732


Capital charge and intercompany interest allocation








(37,628
)

35,159


2,469





Income (loss) before income taxes


(1,279
)

(1,326
)

1,842


(17,043
)

15,398


33


(2,375
)Income tax provision (benefit)





(47
)

3,014


(9,145
)

4,341


60


(1,777
)Equity in earnings of unconsolidated affiliates














1,478





1,478Income (loss) from continuing operations


(1,279
)

(1,279
)

(1,172
)

(7,898
)

12,535


(27
)

880Loss from discontinued operations











(356
)

(1,803
)




(2,159
)Net income (loss)

$
(1,279
)
$
(1,279
)
$
(1,172
)
$
(8,254
)
$
10,732

$
(27
)
$
(1,279
)


33

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Six Months Ended May 30, 2010        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
40,259

$
452,279

$
123,789

$
(13,914
)
$
602,413Cost and expenses:Cost of goods sold








24,237


267,826


69,802


(13,908
)

347,957Selling, general and administrative


388





3,729


161,209


33,259





198,585Amortization of intangibles











144








144Royalty (income) expense, net











(7,928
)

(1
)




(7,929
)Income from operations


(388
)




12,293


31,028


20,729


(6
)

63,656Interest expense





159


41,048


1,235


528





42,970Refinancing and extinguishment of debt and interest rate derivatives








3,759











3,759Other (income) expense, net














(102
)




(102
)Loss (income) from equity investees


(8,149
)

(9,055
)

19,249








(2,045
)

Loss (income) from non- guarantor equity investees











(8,303
)




8,303


Capital charge and intercompany interest allocation








(37,483
)

34,579


2,904





Income (loss) before income taxes


7,761


8,896


(14,280
)

3,517


17,399


(6,264
)

17,029Income tax expense (benefit)


1,307


747


(23,335
)

22,732


5,596


28


7,075Equity in earnings of unconsolidated affiliates














1,990





1,990Income (loss) from continuing operations


6,454


8,149


9,055


(19,215
)

13,793


(6,292
)

11,944Loss from discontinued operations


110











(5,490
)




(5,380
)Net income (loss)

$
6,564

$
8,149

$
9,055

$
(19,215
)
$
8,303

$
(6,292
)
$
6,564


34

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Cash Flows        Six Months Ended May 29, 2011        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by (used in) operating activities

$


$


$
20,882

$
(36,254
)
$
7,726

$


$
(7,646
)Investing activities:Purchase of property, plant and equipment








(126
)

(12,569
)

(544
)




(13,239
)Proceeds from the sale of property, plant, and equipment














22





22Net activity in investment in and advances from (to) subsidiaries and affiliates


62





(10,275
)

6,738


3,475





Net cash provided by (used in) investing activities


62





(10,401
)

(5,831
)

2,953





(13,217
)Financing activities:Equity received upon exercise of stock including related excess tax benefits


583

















583Repurchase of common stock











(67
)







(67
)Proceeds from issuance of long term obligations














1,643





1,643Repayments of long-term obligations











(864
)

(1,642
)




(2,506
)Repayment of senior secured notes








(10,300
)










(10,300
)Debt issuance costs








(147
)










(147
)Other








(34
)










(34
)Net cash provided by (used in) financing activities


583





(10,481
)

(931
)

1





(10,828
)Effect of exchange rate changes on cash














1,728





1,728Change in cash and equivalents


645








(43,016
)

12,408





(29,963
)Cash and equivalents:Beginning of period


1,010





9,234


59,108


39,903





109,255End of period

$
1,655

$


$
9,234

$
16,092

$
52,311

$


$
79,292


35

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Guarantor/Non-Guarantor Financial Information (Continued)

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Cash Flows        Six Months Ended May 30, 2010        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by operating activities

$


$


$
43,214

$
(52,628
)
$
4,984

$


$
(4,430
)Investing activities:Purchase of property, plant and equipment








(116
)

(5,121
)

(1,441
)




(6,678
)Proceeds from the sale of property, plant, and equipment








26





41





67Net activity in investment in and advances from (to) subsidiaries and affiliates


267





(11,999
)

9,609


2,123





Net cash provided by (used in) investing activities


267





(12,089
)

4,488


723





(6,611
)Financing activities:Equity received upon exercise of stock including related excess tax benefits


145

















145Proceeds from issuance of long term obligations














1,806





1,806Repayments of long-term obligations











(1,441
)

(3,666
)




(5,107
)Repayment of senior secured notes








(36,050
)










(36,050
)Debt issuance costs








2











2Other








(77
)










(77
)Net cash used in financing activities


145





(36,125
)

(1,441
)

(1,860
)




(39,281
)Effect of exchange rate changes on cash














(1,548
)




(1,548
)Change in cash and equivalents


412





(5,000
)

(49,581
)

2,299





(51,870
)Cash and equivalents:Beginning of period


357





29,234


67,950


33,886





131,427End of period

$
769

$


$
24,234

$
18,369

$
36,185

$


$
79,557


36

---





SEALY CORPORATION

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

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

We
have reclassified the financial data for all periods presented below to reflect the operations of our European manufacturing operations in France and Italy and our operations in
Brazil as discontinued operations. See "Results of OperationsDiscontinued Operations" later in this Item 2 for more information. Unless otherwise noted, discussions below pertain
to our continuing operations.

BUSINESS OVERVIEW

Our mattress and foundation products include theSealy, Sealy Posturepedic, Embody by Sealy, Stearns &
Foster,andBassettbrands. We produce a variety of innerspring, visco-elastic (memory foam) and latex foam products.

During
2010, we saw the weak economic and retail environments begin to turn around and saw an increase in mattress sales across the industry in the fourth quarter of 2010. However, we
are beginning to see some weakness in the mattress industry based on the current economic slowdown that is being experienced worldwide.

In
2011, we launched our Next GenerationPosturepedicline which is the single largest product line in our portfolio. This line of
products incorporates the knowledge gained from our consumer research and product reviews with key retail partners as well as new benefits and technologies developed specifically for the line. Through
the end of the second quarter of 2011, the Next GenerationPosturepedicline has been distributed to a majority of our customers. In conjunction with
the release of our Next GenerationPosturepedicline, we also introduced a new national advertising campaign which is being communicated across a
variety of mediums including television, print, digital outlets and the retail environment. The three and six months ended May 29, 2011 include approximately $12.7 million and
$23.9 million, respectively, of incremental costs associated with the launch of the Next Generation Posturepedic line, including price discounting for the old line, manufacturing start-up,
launch related costs and national advertising expense.

Our
industry has experienced significant volatility in the price of petroleum-based and steel products, which affects the cost of our polyurethane foam, polyester, polyethylene foam and
steel innerspring component parts. Domestic supplies of these raw materials are being limited by supplier consolidation, the exporting of these raw materials outside of the U.S. and other forces
beyond our control. During fiscal 2010, the cost of these components became more stable, but began increasing in the latter part of the year. Through the first half of fiscal 2011, we have experienced
some inflation in the cost of raw materials and expect that the cost of raw materials may continue to increase and experience volatility through the remainder of the year. 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, have enacted cost increases that have had an effect on the prices of our raw
materials. We have recently introduced price increases and a fuel surcharge to our customers in order to mitigate the impact of the inflation we have seen, but these price increases may not
sufficiently offset additional inflation during the remainder of the fiscal year.

37

---



RESULTS OF OPERATIONS



The following table sets forth our summarized results of operations for the three months ended May 29, 2011 and May 30,
2010, expressed in thousands of dollars, as well as a percentage of each period's net sales:

For the three months ended:May 29, 2011

May 30, 2010(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)Net sales

$
321,296


100.0
%
$
290,525


100.0
%Cost of goods sold


196,222


61.1


168,951


58.2Gross profit


125,074


38.9


121,574


41.8Selling, general and administrative expenses


107,447


33.4


98,297


33.8Amortization expense


72





72


Royalty income, net of royalty expense


(4,804
)

(1.5
)

(3,807
)

(1.3
)Income from operations


22,359


7.0


27,012


9.3Interest expense


21,666


6.7


21,237


7.3Refinancing and extinguishment of debt


1,236


0.4


3,759


1.3Other income, net


(102
)




(52
)

(Loss) income before income taxes


(441
)

(0.1
)

2,068


0.7Income tax provision


(568
)

(0.2
)

(552
)

(0.2
)Equity in earnings of unconsolidated affiliates


623


0.2


1,047


0.4Income from continuing operations


750


0.2


3,667


1.3Loss from discontinued operations


(1,127
)

(0.4
)

(2,818
)

(1.0
)Net (loss) income

$
(377
)

(0.2
)%
$
849


0.3
%Effective tax rate


128.8
%




(26.7
)%


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

Three Months
Ended:May 29,
2011

May 30,
2010United States


78.9
%

78.9
%Canada


13.9


14.5Other


7.2


6.6Total


100.0
%

100.0
%


38

---



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:

For the three months endedMay 29, 2011

May 30, 2010(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)United States (U.S. Dollars):Net sales


253,443


100.0


229,131


100.0Cost of goods sold


156,342


61.7


133,843


58.4Gross profit


97,101


38.3


95,288


41.6Total International (U.S. Dollars):Net sales


67,853


100.0


61,394


100.0Cost of goods sold


39,880


58.8


35,108


57.2Gross profit


27,973


41.2


26,286


42.8Canada:U.S. Dollars:Net sales


44,579


100.0


42,091


100.0Cost of goods sold


26,476


59.4


23,684


56.3Gross profit


18,103


40.6


18,407


43.7Canadian Dollars:Net sales


43,264


100.0


43,132


100.0Cost of goods sold


25,697


59.4


24,272


56.3Gross profit


17,567


40.6


18,860


43.7Other International (U.S. Dollars):Net sales


23,274


100.0


19,303


100.0Cost of goods sold


13,404


57.6


11,424


59.2Gross profit


9,870


42.4


7,879


40.8




Net Sales.Our consolidated net sales for the quarter ended May 29, 2011, were $321.3 million, an increase of
$30.8 million, or
10.6%, from the quarter ended May 30, 2010. This increase was driven primarily by growth in our domestic market. Total U.S. net sales were $253.4 million for the second quarter of fiscal
2011, an increase of 10.6% from the second quarter of fiscal 2010. The U.S. net sales increase of $24.3 million was attributable to a 12.2% increase in wholesale unit volume, offset by a 1.2%
decrease in wholesale average unit selling price, which excludes third party sales from our component plants. The increase in unit volume is attributable to higher sales of our Next Generation Posturepedicline which had been distributed to the majority of our customers by the end of the second quarter as well as increased sales of Sealybranded products. The decrease in our average unit selling
price was driven by the heavy mix of Next Generation Posturepedicfloor samples which typically carry a significant discount during the line's initial distribution. International net sales increased
$6.5 million, or 10.5%, from the second quarter of fiscal 2010 to $67.9 million. This increase was primarily due to increased sales in the Argentina, Mexico and Canada markets. In
Canada, local currency sales increases of 0.3% translated into increases of 5.9% in U.S. dollars due to an increase in the average value of the Canadian dollar versus the U.S. dollar. Local currency
sales performance in Canada was driven by a 6.3% increase in unit volume, offset by a 5.6% decrease in average unit selling price. The increase in

39

---



unit
volume was attributable to higher promotional and specialty bedding sales. The lower average unit selling price was driven primarily by strategic merchandising and promotional activity.

Gross Profit.Our consolidated gross profit for the quarter was $125.1 million, an increase of $3.5 million from the
comparable prior
year period. As a percentage of net sales, gross profit decreased 2.9 percentage points to 38.9%. While margin decreases were experienced in both the U.S. and Canadian markets, the decrease in
percentage of net sales was primarily due to a decrease in gross profit margin in our U.S. operations. U.S. gross profit increased $1.8 million to $97.1 million, which, as a percentage
of net sales, represents a decrease of 3.3 percentage points to 38.3% of net sales. The increase in absolute dollars was driven by increased sales levels. The decrease in percentage of net
sales was driven primarily by the launch of the Next GenerationPosturepedicline, which had been distributed to most customers by the end of the second
quarter of fiscal 2011. The launch included costs related to the heavy mix of discounted floor samples and start up efforts of the new line. These combined actions negatively impacted U.S. gross
profit margin by approximately 2.0 percentage points. Higher material costs related to increased commodity prices and other inflation contributed 1.2 percentage points of the decrease in
U.S. gross profit margin. Additionally, the increased sales ofSealybranded product discussed above contributed to the lower margins in the current
quarter as these value priced products carry a lower gross margin. In local currency, the gross profit margin in Canada was 40.6% as a percentage of net sales which represents a decrease of
3.1 percentage points. This decrease was primarily driven by the impact of the lower average unit selling price discussed above coupled with higher material costs.

Selling, General, Administrative.Our consolidated selling, general and administrative expense increased $9.2 million to
$107.4 million. As a percentage of net sales, this expense was 33.4% and 33.8% for the quarters ended May 29, 2011 and May 30, 2010, respectively, a decrease of
0.4 percentage points. The increase in absolute dollars was primarily driven by a $7.3 million increase in volume driven variable expenses, consisting of a $3.0 million increase
in delivery costs due to higher fuel costs, a $2.9 million increase in cooperative advertising and promotional costs, and a $1.4 million increase in bad debt expenses. Fixed operating
costs, exclusive of non-cash compensation expense, increased $4.4 million from the prior year period. This increase is primarily due to an increase of $4.0 million in costs
incurred to support the launch of the Next GenerationPosturepedicline and $1.8 million in costs related to our new advertising campaign. These
costs were offset by a $2.4 million decrease in expected incentive based compensation for fiscal 2011. Non-cash compensation expense decreased by $2.2 million compared to the
second quarter of fiscal 2010 due primarily to the recognition of expense related to the vesting of restricted share unit grants.

Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, of $4.8 million for the three
months ended
May 29, 2011 increased $1.0 million from the prior year period due to increased royalties recognized related to international licenses including the new Europe and Brazil license
arrangements.

Interest Expense.Our consolidated interest expense for the second quarter of fiscal 2011 remained relatively consistent with the prior
year period.
Our net weighted average borrowing cost was 10.9% and 10.6% for the three months ended May 29, 2011 and May 30, 2010, respectively. Our net weighted average borrowing cost was
unfavorably impacted by increases in non-cash interest expense which was driven by the accretion of the beneficial conversion features in our Convertible Notes.

We
recognize non-cash interest related to the PIK interest on our outstanding Convertible Notes and the accretion or amortization of original issue discount and deferred debt
issuance costs. The table

40

---



below
provides a breakout of cash and non-cash interest for the three month periods ended May 29, 2011 and May 30, 2010:

Three Months Ended:May 29, 2011

May 30, 2010Cash interest expense

$
15,419

$
15,581Non-cash interest expense


6,247


5,656$
21,666

$
21,237


Income Tax.Our effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of
non-deductible paid in kind interest, certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for the three months ended May 29, 2011 was
128.8% compared to (26.7)% for the three months ended May 30, 2010. The effective rate for the fiscal 2011 period was higher than the fiscal 2010 period primarily due to lower income before
income taxes.

Equity in Earnings of Unconsolidated Affiliates.Earnings related to our joint ventures have decreased $0.4 million from the second
quarter of
fiscal 2010 primarily due to decreased profitability in the China and Hong Kong markets.

Discontinued Operations.During the fourth quarter of fiscal 2010, we divested the assets of our European manufacturing operations in
France and
Italy. Also during the fourth quarter of fiscal 2010, we discontinued our operations in Brazil and transitioned to a license arrangement with third parties in this market. We accounted for these
businesses as discontinued operations, and accordingly, we have reclassified the results of operations and any losses resulting from disposition for all periods presented to reflect them as such.
Amounts recognized in fiscal 2011 primarily include charges related to the continued liquidation of certain of the assets related to our Brazil operations as well as charges for services performed in
connection with the discontinuance of these operations.

41

---





The following table sets forth our summarized results of operations for the six months ended May 29, 2011 and May 30,
2010, expressed in thousands of dollars, as well as a percentage of each period's net sales:

For the six months ended:May 29, 2011

May 30, 2010(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)Net sales

$
626,825


100.0
%
$
602,413


100.0
%Cost of goods sold


383,247


61.1


347,957


57.8Gross profit


243,578


38.9


254,456


42.2Selling, general and administrative expenses


211,181


33.7


198,585


33.0Amortization expense


144





144


Royalty income, net of royalty expense


(9,775
)

(1.6
)

(7,929
)

(1.3
)Income from operations


42,028


6.8


63,656


10.5Interest expense


43,374


6.9


42,970


7.1Refinancing and extinguishment of debt


1,236


0.2


3,759


0.6Other income, net


(207
)




(102
)

(Loss) income before income taxes


(2,375
)

(0.3
)

17,029


2.8Income tax (benefit) provision


(1,777
)

(0.3
)

7,075


1.2Equity in earnings of unconsolidated affiliates


1,478


0.2


1,990


0.3Income (loss) from continuing operations


880


0.1


11,944


2.0Loss from discontinued operations


(2,159
)

(0.3
)

(5,380
)

(0.9
)Net (loss) income

$
(1,279
)

(0.2)
%
$
6,564


1.1
%Effective tax rate


74.8
%




41.5
%


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

Six Months
Ended:2011

2010United States


78.5
%

78.9
%Canada


14.1


14.4Other


7.4


6.7Total


100.0
%

100.0
%


42

---



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:



For the six months ended:May 29, 2011

May 30, 2010(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)United States (U.S. Dollars):Net sales


492,187


100.0


475,505


100.0Cost of goods sold


304,516


61.9


276,104


58.1Gross profit


187,671


38.1


199,401


41.9Total International (U.S. Dollars):Net sales


134,638


100.0


126,908


100.0Cost of goods sold


78,731


58.5


71,853


56.6Gross profit


55,907


41.5


55,055


43.4Canada:US Dollars:Net sales


88,085


100.0


86,818


100.0Cost of goods sold


51,777


58.8


48,464


55.8Gross profit


36,308


41.2


38,354


44.2Canadian Dollars:Net sales


86,770


100.0


90,319


100.0Cost of goods sold


50,989


58.8


50,416


55.8Gross profit


35,781


41.2


39,903


44.2Other International (U.S. Dollars):Net sales


46,553


100.0


40,090


100.0Cost of goods sold


26,954


57.9


23,389


58.3Gross profit


19,599


42.1


16,701


41.7


Net Sales.Our consolidated net sales for the six months ended May 29, 2011, were $626.8 million, an increase of
$24.4 million,
or 4.1%, from the six months ended May 30, 2010. This increase was due to increases in the U.S. and Other International businesses. Total U.S. net sales were $492.2 million for the first
half of fiscal 2011, an increase of 3.5% from the first half of fiscal 2010. The U.S. net sales increase of $16.7 million was attributable to a 5.2% increase in wholesale unit volume, which
excludes third party sales from our component plants, offset by a 1.6% decrease in wholesale average unit selling price. The increases in unit volume and decreases in average unit selling price are
primarily attributable to the growth of ourSealybranded products which have seen significant increases over the first half of fiscal 2010. These
products have also contributed to the lower average unit selling price as these value priced products made up an increased portion of total sales. International net sales increased $7.7 million
or 6.1%, from the first quarter of fiscal 2010 to $134.6 million. This increase was primarily due to increased sales in the Argentina and Mexico markets. In Canada, local currency sales
decreases of 3.9% translated into increases of 1.5% in U.S. dollars due to an increase in the average value of the Canadian dollar versus the U.S. dollar. Local currency sales performance in Canada
was driven by a 4.3% decrease in average unit selling price, offset by a 0.4% increase in unit volume. The lower average unit selling price was driven by the overall decrease in sales of premium
products and stronger sales of products at lower price points. The increase in unit volume was driven by promotional activity.

43

---



Gross Profit.Our consolidated gross profit for the six months was $243.6 million, a decrease of $10.9 million from the
comparable
prior year period. As a percentage of net sales, gross profit decreased 3.3 percentage points to 38.9%. While margin decreases were experienced in both the U.S. and Canadian markets, the
decrease in percentage of net sales was primarily due to a decrease in gross profit margin in our U.S. operations. U.S. gross profit decreased $11.7 million to $187.7 million, which, as
a percentage of net sales, represents a decrease of 3.8 percentage points to 38.1% of net sales. The decrease in percentage of net sales was driven primarily by the launch of the Next
GenerationPosturepedicline which had been distributed to the majority of our customers by the end of the second quarter. The launch included costs
related to the discounting of floor samples and start up efforts of the new line. These combined actions negatively impacted U.S. gross profit margin by approximately 2.0 percentage points.
Higher material costs related to increased commodity prices and other inflation contributed 1.4 percentage points of the decrease in U.S. gross profit margin. Additionally, the increased sales
ofSealybranded product discussed above contributed to the lower margins in the current quarter as these value priced products carry a lower gross
margin. In local currency, the gross profit margin in Canada was 41.2% as a percentage of net sales which represents a decrease of 3.0 percentage points. This decrease was primarily driven by
the impact of the lower average unit selling price discussed above coupled with higher material costs.

Selling, General, Administrative.Our consolidated selling, general and administrative expense increased $12.6 million to
$211.2 million. As a percentage of net sales, this expense was 33.7% and 33.0% for the six months ended May 29, 2011 and May 30, 2010, respectively, an increase of
0.7 percentage points. The increase in absolute dollars and as a percentage of net sales was primarily driven by an increase in fixed operating costs. Fixed operating costs, exclusive of
non-cash compensation expense, increased $10.4 million from the prior year period. This increase is primarily due to an increase of $4.0 million related to our new
advertising campaign and $5.2 million in costs incurred to support the launch of the Next GenerationPosturepedicline. Volume driven variable
expenses increased from the first half of fiscal 2010 by $7.5 million. This increase consists of a $3.8 million increase in delivery costs due to higher fuel costs, a $1.9 million
increase in bad debt expense and a $1.8 million increase in cooperative advertising and promotional costs. Non-cash compensation expense decreased by $3.4 million compared to
the first half of fiscal 2010 due primarily to the recognition of expense related to the vesting of restricted share unit grants. Additionally, one-time severance costs related to employee
terminations decreased by $1.1 million from fiscal 2010.

Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, of $9.8 million for the six
months ended
May 29, 2011 increased $1.8 million from the prior year period due
to increased royalties recognized related to international licenses including the new Europe and Brazil license arrangements.

Interest Expense.Our consolidated interest expense for the first six months of fiscal 2011 remained consistent with the prior year
period. Our net
weighted average borrowing cost was 10.9% and 10.6% for the six months ended May 29, 2011 and May 30, 2010, respectively. Our net weighted average borrowing cost was unfavorably impacted
by increases in non-cash interest expense which was driven by the accretion of the beneficial conversion features in our Convertible Notes.

We
recognize non-cash interest related to the PIK interest on our outstanding Convertible Notes and the accretion or amortization of original issue discount and deferred debt
issuance costs. The table

44

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below
provides a breakout of cash and non-cash interest for the three month periods ending May 29, 2011 and May 30, 2010:

Six Months Ended:May 29, 2011

May 30, 2010Cash interest expense

$
30,984

$
32,032Non-cash interest expense


12,390


10,938$
43,374

$
42,970


Income Tax.Our effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of
non-deductible paid in kind interest, certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for the six months ended May 29, 2011 was 74.8%
compared to 41.5% for the six months ended May 30, 2010. The effective rate for the fiscal 2011 period was higher than the fiscal 2010 period primarily due to lower income before income taxes.

Equity in Earnings of Unconsolidated Affiliates.Earnings related to our joint ventures have decreased $0.5 million from the first
six months
of fiscal 2010 due to decreased profitability in the China and Hong Kong markets.

Discontinued Operations.During the fourth quarter of fiscal 2010, we divested the assets of our European manufacturing operations in
France and
Italy. Also during the fourth quarter of fiscal 2010, we discontinued our operations in Brazil and transitioned to a license arrangement with third parties in this market. We accounted for these
businesses as discontinued operations, and accordingly, we have reclassified the results of operations and any losses resulting from disposition for all periods presented to reflect them as such.
Amounts recognized in the first half of fiscal 2011 primarily include charges related to the continued liquidation of certain of the assets related to our Brazil operations as well as charges for
services performed in connection with the discontinuance of these operations.

LIQUIDITY AND CAPITAL RESOURCES



Our principal source of funds is cash flows from operations. However, we also have the ability to borrow under our asset-based
revolving credit facility (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 $13.2 million for the six months ended May 29, 2011. We expect total 2011 capital expenditures to be approximately
$25.0 million. 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, machinery and equipment, 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 May 29, 2011, the Company had approximately $61.0 million available under the ABL Revolver which represents the calculated borrowing base reduced by outstanding
letters of credit of $16.6 million, and certain reserves related to our outstanding derivative contracts. The calculated borrowing base under the ABL Revolver is determined based on our U.S.
accounts receivable and inventory balances. Our net weighted average borrowing cost was 10.9% and 10.6% for the six months ended May 29, 2011 and May 30, 2010, respectively. As of
June 21, 2011, we had no borrowings outstanding under the ABL Revolver.

45

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Our outstanding debt primarily consists of the following: 1) the ABL Revolver 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) $350.0 million in original aggregate principal amount of senior secured notes due
April 2016 (the "Senior Notes"), which bear interest at 10.875% per annum payable semi-annually; 3) $177.1 million in initial 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; and 4) senior subordinated notes which consist of an original $314 million aggregate principal amount maturing
June 15, 2014, bearing interest at 8.25% per annum payable semi annually (the "2014 Notes").

At
May 29, 2011, there were no amounts outstanding under the ABL Revolver. The Senior Notes have an outstanding balance of $295.4 million at May 29, 2011 which gives
effect to an unamortized original issue discount of $9.6 million. As of May 29, 2011, the Convertible Notes have an outstanding balance of $182.8 million. We also have an
outstanding principal balance of $268.9 million at May 29, 2011 on 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 May 29,
2011, there were no amounts outstanding under the ABL Revolver.

At
May 29, 2011, the Company was in compliance with the covenants contained within its 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 may from time to time include the redemption or repurchase of
part or all of our Senior Notes, the 2014 Notes or the Convertible Notes to the extent permitted by our debt covenants. In addition, our Board authorized a common stock repurchase program under which
we may repurchase up to $100 million of our common stock. As of May 29, 2011, we have repurchased shares for $16.3 million under this program, none of which was repurchased during
the second quarter of fiscal 2011. From May 29, 2011 through June 21, 2011, 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 $2.1 million during the next twelve months, with $1.6 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 additional portions of our Senior Notes, 2014 Notes or the Convertible Notes during that time.

46

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Our ABL Revolver agreement and the indentures governing the Senior Notes, the 2014 Notes and the Convertible Notes contain restrictions
on our ability to pay dividends, including a requirement in the ABL Revolver agreement that we meet a minimum fixed charge coverage ratio and restrictions as to the amount available for payment.
Although we meet the minimum fixed charge coverage ratio requirement as of May 29, 2011, we do not currently expect a dividend will be declared in the second quarter of fiscal 2011.



The following table summarizes our changes in cash:

Six Months Ended:May 29,
2011

May 30,
2010(in thousands)Statement of Cash Flow Data:Cash flows provided by (used in):Operating activities

$
(7,646
)
$
(4,430
)Investing activities


(13,217
)

(6,611
)Financing activities


(10,828
)

(39,281
)Effect of exchange rate changes on cash


1,728


(1,548
)Change in cash and cash equivalents


(29,963
)

(51,870
)Cash and cash equivalents:Beginning of period


109,255


131,427End of period

$
79,292

$
79,557




Cash Flows from Operating Activities.Our cash flow from operations decreased $3.2 million to a use of cash of $7.6 million
for the six
months ended May 29, 2011 from a use of cash of $4.4 million for the six months ended May 30, 2010. The decrease in cash flows from operations for the six months ended
May 29, 2011 compared to the same prior year period was primarily driven by lower net income. The lower net income was offset by decreased use of working capital during the first six months of
fiscal 2011 which was driven primarily by lower incentive and deferred compensation payments and improved inventory management during fiscal 2011.

Cash Flows from Investing Activities.Our cash flows used in investing activities for the six months ended May 29, 2011 were
$13.2 million as compared to net cash used in investing activities of $6.6 million for the six months ended May 30, 2010. This difference of $6.6 million is primarily due
to higher capital expenditures in support of the launch of our Next GenerationPosturepedicline.

Cash Flows from Financing Activities.Our cash flow used in financing activities for the six months ended May 29, 2011 was
$10.8 million compared with cash used in financing activities of $39.3 million for the six months ended May 30, 2010. This change was primarily driven by the decreased level of
Senior Note repurchases in fiscal 2011 compared with fiscal 2010.



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

47

---



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. The Company is currently undergoing examinations of its corporate income tax
returns by tax authorities. Issues related to certain of these reserved positions have been presented to the Company. The Company believes that such audits will not result in a material assessment and
payment of taxes related to these positions during the one year period following May 29, 2011. We also cannot predict when or if any other future tax payments related to these tax positions may
occur.



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 with the terms of the obligations unless we are in a minimum availability period under the terms of our ABL Revolver.

Our
ABL Revolver requires us to maintain a minimum fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two consecutive
calendar days is less than the greater of 1) 15% of the total commitment under the ABL Revolver and 2) $15.0 million. As of May 29, 2011, we were not in a period of minimum
availability and did not have any outstanding borrowings under the ABL Revolver. Non-compliance with the minimum fixed charge coverage ratio in a period of minimum availability could
result in the requirement to immediately repay all amounts outstanding under the ABL Revolver. The fixed charge coverage ratio is defined by the ABL Revolver agreement as the ratio of Adjusted EBITDA
less unfinanced capital expenditures and net cash taxes paid to fixed charges which include cash payments for interest, capital lease obligations, scheduled principal payments on debt and other
restricted payments.



The covenants contained in our senior debt agreements also restrict our ability to enter into certain transactions (the most
significant of which are summarized below). Our ABL Revolver requires us to meet a minimum fixed charge coverage ratio of 1.25 to 1.00 in order to make certain restricted payments including dividend
distributions to holders of our common stock, dividends or distributions to the parent company (Sealy Corporation), and debt repayments, subject to certain exceptions. The fixed charge coverage ratio
is defined by the ABL Revolver agreement as the ratio of Adjusted EBITDA less unfinanced capital expenditures and net cash paid to fixed charges which include cash payments for interest, capital lease
obligations, scheduled principal payments on debt and restricted payments. At May 29, 2011, adjustments to Adjusted EBITDA for cash taxes paid and unfinanced capital expenditures were
$41.0 million. Fixed charges as calculated under the terms of the ABL Revolver agreement were $64.4 million. This results in a fixed charge coverage ratio of 1.70 to 1.00 at
May 29, 2011 under the terms of the ABL Revolver agreement.

The
indentures governing our Senior Notes, Convertible Notes and 2014 Notes also require us to meet a fixed charge coverage ratio of 2.0 to 1.0 in order to incur additional indebtedness
and make certain restricted payments, including dividends or equity distributions, subject to certain exceptions. The fixed charge coverage ratio is defined by the indentures related to these notes as
the ratio of Adjusted EBITDA to fixed charges which include interest expense, and cash dividend payments on certain preferred stock. At May 29, 2011, fixed charges as calculated under the terms
of the indentures governing our Senior Notes, Convertible Notes and 2014 Notes were $79.0 million, resulting in a fixed charge coverage ratio of 1.90 to 1.00.

48

---





Non-compliance with the minimum fixed charge ratio contained in the ABL Revolver agreement and the indentures 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.

The
covenants contained within our debt agreements are based on what we refer to herein as "Adjusted EBITDA". In the senior debt agreements, Adjusted EBITDA is defined as net income plus
interest, taxes, depreciation and amortization adjusted to exclude unusual items and other adjustments permitted in calculating covenant compliance. Adjusted EBITDA is presented herein as it is a
material component of these covenants. Additionally, management uses Adjusted EBITDA to evaluate the Company's operating performance and we believe that this measure provides useful incremental
information to investors regarding our operating performance. 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.

Adjusted
EBITDA is not a recognized term under GAAP and does not purport to be an alternative to net income as a measure of operating performance or to cash flows from operating
activities as a measure of liquidity. Additionally, it is not intended to be a measure of free cash flow for management's discretionary use, as it does 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 Adjusted EBITDA for the three and six months ended May 29, 2011 and May 30, 2010:

Three Months Ended:

Six Months Ended:May 29, 2011

May 30, 2010

May 29, 2011

May 30, 2010(in thousands)

(in thousands)Net (loss) income

$
(377
)
$
849

$
(1,279
)
$
6,564Interest expense


21,666


21,237


43,374


42,970Income taxes


(568
)

(552
)

(1,777
)

7,075Depreciation and amortization


6,208


7,144


12,262


12,84326,929


28,678


52,580


69,452Adjustments for debt covenants:Refinancing charges


1,236


3,759


1,236


3,759Non-cash compensation


2,894


5,098


5,773


9,214KKR consulting fees


293


524


659


1,020Severance charges


227


137


460


1,252Discontinued operations


1,127


2,818


2,159


5,380Other (various)(a)


110


(665
)

(47
)

209Adjusted EBITDA

$
32,816

$
40,349

$
62,820

$
90,286


(a)Consists
of various immaterial adjustments




There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7,
"Management's Discussion and Analysis of Financial Condition and Results of Operations", included in our Annual Report on Form 10-K for the fiscal year ended November 28,
2010.

49

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"Safe Harbor" Statement Under the Private Securities Litigation Reform Act of 1995.When used in this Quarterly Report on
Form 10-Q, the words "believes," "anticipates," "expects," "intends," "projects" and similar expressions are used to identify forward-looking statements within the meaning of the
Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to future financial and operational 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:



All
forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Quarterly Report on Form 10-Q and are expressly
qualified in their entirety by the cautionary statements included in this Quarterly Report on Form 10-Q. 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. For a more detailed
discussion of these factors see the information under the caption "Risk Factors" herein, in "Item 1A. Risk Factors" in the Company's most recent Annual Report on Form 10-K
and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's most recent Annual Report on Form 10-K.

50

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

The information appearing below relating to our market risk sensitive instruments by major category should be
read in conjunction with the related disclosure contained in the management's discussion and analysis section of our Annual Report on Form 10-K (File
No. 001-08738).



Our earnings are affected by fluctuations in the value of our subsidiaries' functional currency as compared to the currencies of our
foreign denominated purchases. 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 $0.5 million and $1.1 million impact on our financial position for the three and six months ended May 29, 2011, respectively. 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 and option contracts. At May 29, 2011, we had outstanding
forward and option foreign currency contracts to sell a total of 36.6 million Canadian dollars for U.S. dollars. The expiration dates for the
Canadian dollar contracts range from June 2011 to May 2012. At May 29, 2011, the fair value of these contracts was a net liability of $0.8 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.



Based on the amount of variable-rate debt outstanding at May 29, 2011, a 12.5 basis point increase or decrease in
variable interest rates would have an insignificant dollar impact on our annual interest expense.



We experienced more stability in the prices of polyurethane foam, polyester, polyethylene foam and steel innerspring component parts in
fiscal 2010, but saw the prices increase in the latter part of the year. In addition, we are now seeing trends that may create inflation in the prices of these products. We expect volatility in the
prices of these commodities through fiscal 2011. Specifically, the prices of polyurethane foam chemicals are accelerating at higher rates whereas polyester and rayon prices have only recently reached
stability. From time to time, we 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. From time to time we also hedge a portion of our expected diesel fuel consumption through the use of fixed price swap contracts. These contracts reduce the Company's exposure to the
volatility in diesel fuel prices. At May 29, 2011 we had no diesel fuel contracts outstanding. At November 28, 2010, there were outstanding contracts to purchase 0.2 million
gallons of diesel fuel. The fair value of the contracts outstanding at November 28, 2010 was an asset of an insignificant amount.

Item 4.    Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered

51

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by
this report (the "Evaluation Date"). Based on this evaluation, our principal executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and
procedures were effective such that the information relating to the Company, including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") reports
(i) is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company's management,
including our principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure.

There
were no changes in our internal control over financial reporting identified in connection with the foregoing evaluation that occurred during the second quarter of fiscal 2011 that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

The information required with respect to this Item can be found in Note 16 to the Condensed Consolidated Financial Statements,
Part I, Item 1 included herein.

Item 1A.    Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I,
"Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended November 28, 2010, which could materially affect our business, financial condition or
future results. The risks described herein and in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to
us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

The table below shows information regarding our repurchases of the Company's common stock during the second quarter of fiscal 2011:

Period

Total number of
shares
purchased(1)

Average price paid
per share

Total number of shares
purchased during
quarter as part of
publicly announced
program(2)

Approximate dollar
value of shares that
may yet be purchased
under programFebruary 28 - March 27, 2011




$





$
83,746,985March 28 - April 24, 2011


27,690


2.45





83,746,985April 25 - May 29, 2011











83,746,985Total


27,690








(1)The
entire amounts presented above are comprised of common stock surrendered or withheld to cover the minimum tax withholding obligations related to the
vesting of restricted stock units as permitted under the 2004 Stock Option Plan.(2)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.


52

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Subsequent
to May 29, 2011, through June 21, 2011, 1,467,367 shares of Sealy Corporation common stock were surrendered by participants in the Company's 1998 and 2004 Stock
Option Plans to cover the individuals' minimum tax withholding obligations related to the vesting of certain restricted stock unit awards that were granted on June 12, 2010. For further details
of these awards and related stock ownership guidelines for the Company's senior management, refer to the Company's definitive Proxy Statement filed on March 4, 2011 and Exhibit 10.34 to
the Company's Annual Report on Form 10-K filed on January 21, 2011.

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

Item 3.    Defaults Upon Senior Securities



Item 4.    (Removed and Reserved)

Item 5.    Other Information



Item 6.    Exhibits

10.42

Restricted Stock Unit Agreement dated May 25, 2011 by and between Sealy Corporation and Lawrence J. Rogers.31.1

Chief Executive Officer Certification of the Quarterly Financial Statements.31.2

Chief Financial Officer Certification of the Quarterly Financial Statements.32

Certification pursuant to 18 U.S.C. Section 1350.


Filed
herewith.


53

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned thereunto duly authorized.

SEALY CORPORATION

Signature

Title/s/ LAWRENCE J. ROGERS Lawrence J. Rogers

President and Chief Executive Officer
(Principal Executive Officer)/s/ JEFFREY C. ACKERMAN Jeffrey C. Ackerman

Executive Vice President and Chief Financial Officer (Principal Financial Officer)


Date:
June 28, 2011

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