UNITED STATESSECURITIES 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: August 30, 2009o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the Transition Period
from                        toCommission file number 001-08738




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

Delaware

36-3284147(State or other jurisdiction of incorporation)

(I.R.S. Employer Identification No.)Sealy Drive One Office Parkway
Trinity, North Carolina

27370(Address of principal executive offices)

(Zip Code)


(336) 861-3500Registrant'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 September 23, 2009 is approximately: 92,324,987.



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PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

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

Three Months EndedAugust 30,
2009

August 31,
2008Net sales

$
349,573

$
404,963Cost of goods sold


203,508


240,843Gross profit


146,065


164,120Selling, general and administrative expenses


110,256


132,892Amortization expense


842


981Restructuring expenses and asset impairment





2,448Royalty income, net of royalty expense


(4,216
)

(4,422
)Income from operations


39,183


32,221Interest expense


22,127


14,379Loss on rights for convertible notes


1,820


Refinancing and extinguishment of debt and interest rate derivatives


39


Other income, net


(14
)

(117
)Income before income taxes


15,211


17,959Income tax provision


3,155


7,017Net income

$
12,056

$
10,942Earnings per common shareBasic

$
0.13

$
0.12Earnings per common shareDiluted

$
0.05

$
0.12Weighted average number of common shares outstanding:Basic


91,884


91,269Diluted


279,156


93,538


See
accompanying notes to Condensed Consolidated Financial Statements.

1

---





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

Nine Months EndedAugust 30,
2009

August 31,
2008Net sales

$
958,004

$
1,172,267Cost of goods sold


571,538


706,579Gross profit


386,466


465,688Selling, general and administrative expenses


302,533


365,536Amortization expense


2,435


2,850Restructuring expenses and asset impairment


1,448


2,907Royalty income, net of royalty expense


(12,186
)

(13,558
)Income from operations


92,236


107,953Interest expense


56,551


45,124Loss on rights for convertible notes


4,549


Refinancing and extinguishment of debt and interest rate derivatives


17,461


Gain on sale of subsidiary stock


(1,292
)

Other income, net


(60
)

(297
)Income before income taxes


15,027


63,126Income tax provision


3,463


24,013Net income

$
11,564

$
39,113Earnings per common shareBasic

$
0.13

$
0.43Earnings per common shareDiluted

$
0.09

$
0.42Weighted average number of common shares outstanding:Basic


91,836


91,044Diluted


153,602


94,066


See
accompanying notes to Condensed Consolidated Financial Statements.

2

---





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

August 30,
2009

November 30,
2008ASSETSCurrent assets:Cash and equivalents

$
99,840

$
26,596Accounts receivable, less allowances for bad debts, cash discounts and returns


189,446


156,583Inventories


57,619


64,634Other current assets


23,726


30,969Deferred income tax assets


18,724


16,775Total current assets


389,355


295,557Property, plant and equipmentat cost


440,003


449,308Less accumulated depreciation


(220,656
)

(218,560
)219,347


230,748Goodwill


360,817


357,149Intangible assets, net


2,774


4,945Deferred income tax assets


5,650


3,392Other assets, including debt issuance costs, net


53,740


29,083422,981


394,569Total assets

$
1,031,683

$
920,874LIABILITIES AND STOCKHOLDERS' DEFICITCurrent liabilities:Current portionlong-term obligations

$
11,591

$
21,243Accounts payable


105,914


97,084Accrued incentives and advertising


31,610


34,542Accrued compensation


33,730


24,797Accrued interest


14,843


16,432Other accrued liabilities


45,178


44,363Total current liabilities


242,866


238,461Long-term obligations, net of current portion


837,836


762,162Other liabilities


59,585


71,257Deferred income tax liabilities


6,538


4,962Common stock and options subject to redemption





8,856Stockholders' deficit:Common stock, $0.01 par value; Authorized shares: 2009600,000; 2008200,000 Issued and outstanding: 200992,321; 200891,800
(including shares classified above as subject to redemption: 20090; 2008282)


922


917Additional paid-in capital


878,003


668,547Accumulated deficit


(991,572
)

(814,298
)Accumulated other comprehensive income, net


(2,495
)

(19,990
)Total shareholders' deficit


(115,142
)

(164,824
)Total liabilities and shareholders' deficit

$
1,031,683

$
920,874


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
IncomeComprehensive
Income

Additional
Paid-in
Capital

Accumulated
DeficitShares

Amount

TotalBalance at November 30, 2008





91,800

$
917

$
668,547

$
(814,298
)
$
(19,990
)
$
(164,824
)Net income


11,564











11,564





11,564Foreign currency translation adjustment


8,360














8,360


8,360Adjustment to defined benefit plan liability, net of tax of $128


151














151


151Change in fair value of cash flow hedges, net of tax of $286


(460
)













(460
)

(460
)Loss on termination of interest rate swaps, net of tax of $5,834


9,444














9,444


9,444Share-based compensation:Compensation associated with stock option grants











3,917








3,917Directors' deferred stock compensation











320








320Compensation associated with restricted stock awards











500








500Compensation associated with restricted stock units











2,646








2,646Exercise of stock options





59





26








26Excess tax benefit on options exercised











(357
)







(357
)Distribution of rights to purchase convertible notes














(188,838
)




(188,838
)Settlement of rights to purchase Convertible Notes











193,388








193,388Conversion of Convertible Notes





171


2


164








166Adjustment of common stock and options subject to redemption








3


8,852








8,855Balance at August 30, 2009

$
29,059


92,030

$
922

$
878,003

$
(991,572
)
$
(2,495
)
$
(115,142
)


See accompanying notes to Condensed Consolidated Financial Statements.

4

---





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

Nine Months EndedAugust 30,
2009

August 31,
2008Operating activities:Net income

$
11,564

$
39,113Adjustments to reconcile net income to cash provided by operating activities:Depreciation and amortization


23,840


25,763Deferred income taxes


(7,303
)

1,847Impairment charges


1,326


873Amortization of deferred gain on sale-leaseback


(485
)

Paid in kind interest on convertible notes


1,820


Amortization of discount on new senior secured notes


351


Amortization of debt issuance costs and other


2,925


1,761Loss on rights for convertible notes


4,549


Share-based compensation


7,381


2,550Excess tax benefits from share-based payment arrangements





(781
)Loss on sale of assets


383


348Write-off of debt issuance costs related to debt extinguishments


2,113


Loss on termination of interest rate swap


15,232


Payment to terminate interest rate swaps


(15,232
)

Gain on sale of subsidiary stock


(1,292
)

Other, net


(2,458
)

1,083Changes in operating assets and liabilities:Accounts receivable


(27,628
)

(16,538
)Inventories


5,684


715Other current assets


14,080


2,549Other assets


(1,434
)

3,049Accounts payable


5,195


25,731Accrued expenses


6,752


(26,824
)Other liabilities


(7,150
)

3,539Net cash provided by operating activities


40,213


64,778Investing activities:Purchase of property, plant and equipment


(8,669
)

(21,102
)Proceeds from sale of property, plant and equipment


10,385


34Net proceeds from sale of subsidiary stock


1,237


Investments in and loans to unconsolidated affiliate


(2,322
)

Net cash provided by (used in) investing activities


631


(21,068
)Financing activities:Cash dividends





(6,811
)Proceeds from issuance of long-term obligations


3,343


8,114Repayments of long-term obligations


(15,668
)

(23,821
)Repayment of senior term loans


(377,181
)

Proceeds from issuance of new senior secured notes


335,916


Proceeds from issuance of related party notes


177,132


Repayment of related party notes


(83,284
)

Proceeds from issuance of convertible notes, net


83,284


Borrowings under revolving credit facilities


140,904


277,658Repayments under revolving credit facilities


(205,304
)

(281,085
)Exercise of employee stock options, including related excess tax benefits


(330
)

824Debt issuance costs


(27,421
)

Net cash provided by (used in) financing activities


31,391


(25,121
)Effect of exchange rate changes on cash


1,009


(2,497
)Increase in cash and equivalents


73,244


16,092Cash and equivalents:Beginning of period


26,596


14,607End of period

$
99,840

$
30,699


See accompanying notes to Condensed Consolidated Financial Statements.

5

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SEALY CORPORATION        Notes to Condensed Consolidated Financial Statements        (unaudited)

Note 1: Basis of Presentation

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 (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 30, 2008 included within the Company's Annual
Report on Form 10-K (File No. 001-08738).

At
August 30, 2009, affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") controlled approximately 50.9% 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.

In
accordance with Statement of Financial Accounting Standards ("FAS") No. 165, "Subsequent Events", we evaluated subsequent events through the date and time our condensed
consolidated financial statements were issued on September 29, 2009.

Note 2: Recently Issued Accounting Pronouncements

In September 2006, the Financial Accounting Standards Board ("FASB") issued FAS 157, "Fair Value Measurements" ("FAS 157"), which defines fair value, establishes a
framework for measuring fair value in GAAP and expands disclosure about fair value measurements. In February 2008, the FASB issued FASB Staff Position No. FAS 157-2, "Effective Date
of FASB Statement No. 157", which provides a one year deferral of the effective date of FAS 157 for non-financial assets and non-financial liabilities, except
those that are recognized or disclosed in the financial statements at fair value at least annually. In accordance with this interpretation, the Company has adopted the provisions of FAS 157
with respect to its non-financial assets and liabilities that are measured at fair value within the financial statements as of December 1, 2008. See Note 11.

In
June 2007, the Emerging Issues Task Force ("EITF") issued Issue No. 07-3, "Accounting for Nonrefundable Advance Payments for Goods or Services to Be Used in Future
Research and Development Activities," which provides guidance on the accounting for certain nonrefundable advance payments for goods or services that will be used or rendered for future research and
development activities. The provisions of this issue were adopted effective December 1, 2008. The adoption of this issue did not have an impact on the financial statements as the Company had
previously accounted for these types of advance payments in a manner consistent with that required by the interpretation.

6

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Accounting Pronouncements (Continued)

In
December 2007, the FASB issued FAS 160, "Noncontrolling Interests in Consolidated Financial Statementsan amendment of ARB No. 51". This statement
establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This statement is effective prospectively, except for
certain retrospective disclosure requirements, for fiscal years beginning after December 15, 2008. This statement will be effective for the Company beginning in fiscal 2010. The Company is
still assessing the potential impact of adoption.

In
December 2007, the FASB issued FAS 141(R), "Business Combinationsa replacement of FASB Statement No. 141", which significantly changes the principles and
requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the
acquiree. The statement also provides guidance for recognizing and measuring goodwill acquired in a business combination and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business combination. This statement is effective prospectively, except for certain retrospective adjustments to deferred tax balances,
for fiscal years beginning after December 15, 2008. This statement will be effective for the Company beginning in fiscal 2010. The Company is still assessing the potential impact of adoption.

In
March 2008, the FASB issued FAS 161, "Disclosures about Derivative Instruments and Hedging Activitiesan amendment of FASB Statement No. 133", which amends
and expands the disclosure requirements of FAS 133 to require qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of
and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. The Company adopted the provisions of
this statement effective March 1, 2009. As a result of the adoption of this statement, the Company has expanded its disclosures regarding derivative instruments and hedging activities within
Note 10.

In
April 2008, the FASB issued FASB Staff Position ("FSP") No. 142-3, "Determination of the Useful Lives of Intangible Assets", which amends the factors that should be
considered in developing renewal or extension assumptions used to determine the useful life of an intangible asset. This interpretation is effective for financial statements issued for fiscal years
beginning after December 15, 2008 and interim periods within those years. The Company will adopt this interpretation as of the beginning of fiscal 2010 and is still assessing the potential
impact of adoption.

In
June 2008, the FASB issued FSP EITF 03-6-1, "Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities",
which addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in
computing earnings per share. This interpretation is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The
Company will adopt this interpretation as of the beginning of fiscal 2010 and is still assessing the potential impact of adoption.

In
November 2008, the EITF issued Issue No. 08-06, "Equity Method Investment Considerations", which clarifies the accounting for certain transactions involving equity
method investments. This interpretation is effective for financial statements issued for fiscal years beginning on or after

7

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SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Accounting Pronouncements (Continued)

December 15,
2008 and interim periods within those years. The Company will adopt this issue as of the beginning of fiscal 2010 and is still assessing the potential impact of adoption.

In
December 2008, the FASB issued FSP 132(R)-1, "Employers Disclosures about Postretirement Benefit Plan Assets", which provides additional guidance on an employers'
disclosures about plan assets of a defined benefit pension or other postretirement plan. This interpretation is effective for financial statements issued for fiscal years ending after
December 15, 2009. The Company will adopt this interpretation in fiscal 2010. The adoption of this interpretation will increase the disclosures in the financial statements related to the assets
of the Company's defined benefit pension plans.

In
April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, "Interim Financial Disclosures about Fair Value of Financial Instruments", which amends
FASB Statement No. 107, "Disclosures about Fair Value of Financial Instruments", to require disclosures about fair value of financial instruments for interim reporting periods of publicly
traded companies as well as in annual financial statements. The FSP also amends APB Opinion No. 28, "Interim Financial Reporting", to require those disclosures in summarized financial
information at interim reporting periods. This interpretation is effective for interim reporting periods ending after June 15, 2009 and the Company adopted the provisions of this statement
effective August 30, 2009. As a result of the adoption of this statement, the Company has expanded its disclosures regarding the fair value of financial instruments within Note 11.

In
May 2009, the FASB issued FAS 165, "Subsequent Events", which established principles and requirements for subsequent events. The statement details the period after the balance
sheet date during which the Company should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which the Company
should recognize events or transactions occurring after the balance sheet date in its financial statements and the required disclosures for such events. This statement is effective for interim or
annual reporting periods ending after June 15, 2009. The Company adopted the provisions of this statement effective August 30, 2009 and have evaluated subsequent events occurring after
that date under the guidance provided by this pronouncement.

In
June 2009, the FASB issued FAS 166, "Accounting for Transfers of Financial Assets an amendment of FASB Statement No. 140", which amends the derecognition guidance in
FASB Statement No. 140 and eliminates the exemption from consolidation for qualifying special-purpose entities. This statement is effective for financial asset transfers occurring after the
beginning of an entity's first fiscal year that
begins after November 15, 2009. This statement will be effective for the Company beginning in fiscal 2010. The Company is still assessing the potential impact of adoption.

In
June 2009, the FASB issued FAS 167, "Amendments to FASB Interpretation No. 46(R)", which amends the consolidation guidance applicable to variable interest entities. The
amendments will significantly affect the overall consolidation analysis under FASB Interpretation No. 46(R). This statement is effective as of the beginning of the first fiscal year that begins
after November 15, 2009. This statement will be effective for the Company beginning in fiscal 2010. The Company is still assessing the potential impact of adoption.

In
June 2009, the FASB issued FAS 168, "The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principlesa replacement of FASB
Statement No. 162", which replaced FAS 162 and established theFASB Accounting Standards Codification(the

8

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SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Accounting Pronouncements (Continued)

"Codification")
as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with
GAAP. Rules and interpretive releases of the SEC are also considered sources of authoritative GAAP for SEC registrants. This statement becomes effective for interim and annual periods ending on or
after September 15, 2009. The Company will adopt this statement beginning in the fourth quarter of fiscal 2009.

In
August 2009, the FASB issued Accounting Standards Update No. 2009-05, "Measuring Liabilities at Fair Value", which provides clarification that in circumstances
where a quoted market price in an active market for an identical liability is not available, a reporting entity must measure fair value of the liability using one of the following techniques:
1) the quoted price of the identical liability when traded as an asset; 2) quoted prices for similar liabilities or similar liabilities when traded as assets; or 3) another
valuation technique, such as a present value technique or the amount that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability that
is consistent with the provisions of FAS 157. This statement becomes effective for the first reporting period (including interim periods) beginning after issuance. The Company will adopt this
statement beginning in the fourth quarter of fiscal 2009.

Note 3: Change in Estimate

During the second quarter of fiscal 2008, the Company completed an analysis of its returns claims experience based on historical return trends for the Company's U.S. business, which is a
component of the Americas segment, using newly available information as a result of a new and improved product return process that allows it to better track and match claims received to the sales for
which those claims were initially recorded. This analysis was applied to both its warrantable and other product returns. The effect of this change in estimate for warranty claims was to reduce other
accrued liabilities and cost of sales by approximately $4.5 million. The change in estimate for other product returns reduced other accounts receivable balances by approximately
$3.7 million, with a corresponding increase in net sales. For both the three and nine month periods ended August 31, 2008, the change in estimate increased operating income by
$8.2 million and net income by $5.1 million. This change in estimate also increased net income per basic and diluted share by $0.06 and $0.05, respectively, for the three and nine months
ended August 31, 2008.

Note 4: Share-Based Compensation

The Company maintains the 1998 Stock Option Plan ("1998 Plan") and the 2004 Stock Option Plan for Key Employees of Sealy Corporation and its Subsidiaries ("2004 Plan") which are
collectively referred to as the "Option Plans". The Company accounts for all new stock options granted or outstanding
options modified after August 29, 2005 (the beginning of the fourth quarter of fiscal 2005) under the provisions of FAS No. 123 (revised 2004) "Share-Based Payment"
("FAS 123(R)"). Effective May 26, 2009, the Company adopted the Second Amended and Restated Equity Plan for Key Employees of Sealy Corporation and its Subsidiaries which, among other
things, increases the number of shares available for issuance under the 2004 Plan from 15,190,000 to 40,190,000.

9

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

Modification of Awards

During the third quarter of fiscal 2009, the Company undertook a modification to the terms of its outstanding share-based compensation
awards to give effect to the dilution caused by the issuance of the rights for the Convertible Notes. For outstanding stock option awards granted under the 1998 Plan, the number of awards was
increased by 32.7696% and the strike price of the awards was reduced by 24.6815%. For awards granted under the 2004 Plan, the number of awards outstanding was not adjusted, but the strike price of the
outstanding awards was reduced by 24.6815%. The increase to the number of outstanding awards has been treated as an additional grant of stock options under the 1998 Plan as disclosed below.

The
Company also modified the terms of its restricted share unit (RSU) awards by increasing the number of awards by 32.7696%. This resulted in an additional 112,856 awards being granted
in the third quarter of fiscal 2009. However, since the Company's restricted shares outstanding as of the modification date participated in the rights offering, there was no modification of these
awards.

The
number of units outstanding under the Sealy Corporation Directors' Deferred Compensation Plan was also increased by 32.7696% as part of this modification, resulting in an additional
62,953 awards being granted in the third quarter of fiscal 2009 at a grant date fair value of $2.00 per unit.

In
connection with the modification of its outstanding share-based compensation awards, the Company will recognize additional compensation expense of $2.1 million, which will be
recorded as a component of selling, general and administrative expenses in the Condensed Consolidated Statements of Operations. Of this amount, $1.6 million was recognized in the three and nine
months ended August 30, 2009 which primarily represents the additional compensation cost related to awards that were vested at the date of the modification. Unrecognized compensation cost
related to this modification as of August 30, 2009 is $0.5 million and will be recognized over the remaining vesting period of the awards.

Three Months
Ended
August 30, 2009Expected volatility


60%Expected dividend yield


0.00%Expected term (in years)


0.00-7.47Risk-free rate


0.52%-3.46%


Stock Option Awards

During the three months ended August 30, 2009, the Company granted 620,472 new options to purchase shares of common stock due to
the modification to outstanding options discussed above. During the nine months ended August 30, 2009, the Company granted options to purchase 58,487 shares of common stock, in addition to
those granted through the modification, to newly hired and promoted employees and recognized compensation expense related to these options of an insignificant amount during the nine months ended
August 30, 2009. During the three and nine months ended August 31, 2008, the Company granted new options to purchase 307,750 and 1,660,205 shares of common stock and recognized
compensation expense associated with these grants of approximately

10

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SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

$0.1 million
and $0.3 million during the three and nine months ended August 31, 2008. The options granted during the third quarter of fiscal 2008 had a weighted average
grant-date fair value of $3.09 per option.

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

Three Months
Ended
August 31, 2008Expected volatility


40%Expected dividend yield


0.00%Expected term (in years)


5.71-6.31Risk-free rate


3.48%


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

A
summary of option activity under the 1998 Plan for the nine months ended August 30, 2009, is presented below:

Shares Subject
to Options

Weighted Average
Exercise Price
Per ShareOutstanding November 30, 2008


1,935,478

$
1.50Granted


620,472


1.12Exercised


(57,284
)

0.37Forfeited


(18,104
)

2.68Outstanding August 30, 2009 (all fully vested and exercisable)


2,480,562

$
1.13Weighted average remaining contractual term


4.8 yearsAggregate intrinsic value of in-the-money options at August 30, 2009 (in thousands)

$
2,124


11

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SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

A
summary of option activity under the 2004 Plan for the nine months ended August 30, 2009, is presented below:

Shares Subject
to Options

Weighted Average
Exercise Price
Per ShareOutstanding November 30, 2008


9,948,520

$
6.96Granted


58,487

$
0.89Forfeited


(412,254
)
$
5.39Outstanding August 30, 2009


9,594,753

$
5.20Weighted average remaining contractual term


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

$
484Exercisable at August 30, 2009


5,513,758Weighted average remaining contractual term


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

$
88


As
of August 30, 2009, the Company had approximately $4.9 million of unrecognized compensation expense related to stock option awards, which is expected to be recognized
over a weighted average period of 4.4 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 August 30, 2009, it is the Company's expectation that
the performance targets for these stock options will not be met. As such, the related unrecognized compensation cost is being recognized over the remainder of the requisite service period for those
options that vest over the remaining service period. Further, the Company has not recognized compensation cost in the current period for certain options to purchase 674,532 shares of common stock that
do not vest unless the
performance targets are achieved. Total unrecognized compensation cost related to these options is $1.3 million.

During
the three and nine months ended August 31, 2008, the Company recognized expense of an insignificant amount and $0.2 million, respectively, resulting from the
accretion of an obligation to certain executives of the Company for their right to sell to the Company, upon their retirement, vested shares of the Company's common stock. These rights to sell the
vested shares have expired and the related liability was reclassified to common stock and options subject to redemption and additional paid-in capital in fiscal 2008. In the second quarter
of fiscal 2009, due to the expiration of the ability of share and option holders to redeem the outstanding shares or options following the death or disability of the share or option holder, the
amounts recorded as common stock and options subject to redemption were reclassified to additional paid-in capital. See Note 22.

12

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

Restricted Shares and Share Unit Awards

The Company has outstanding 291,971 restricted shares that are considered to be non-vested shares under the provisions of
FAS 123(R), and have the same rights as the Company's outstanding common shares except that they cannot be sold by the holder until the end of the vesting period. As of August 30, 2009,
the remaining unrecognized compensation cost related to restricted stock awards was $1.3 million which is expected to be recognized over the remaining vesting period of 1.9 years. As of
August 30, 2009, none of the outstanding restricted stock awards have vested.

During
the three and nine months ended August 30, 2009, the Company approved grants of 16,251,433 and 16,595,833 restricted share units (RSUs), respectively. The RSUs granted in
the third quarter of fiscal 2009 have a weighted average grant date fair value of $2.00 based on the closing price of the Company's common stock as of the grant date. The RSUs granted during the third
quarter of fiscal 2009 vest based on the passage of time and do not contain performance requirements. The RSU award amount accretes in the number of RSUs at an annual rate of 8% payable
semi-annually until the RSUs are vested or forfeited. The grants discussed above give effect to this accretion. The Company also has outstanding 344,400 RSUs which vest based on the
attainment of certain performance targets that are tied to the Company's earnings performance. If these performance targets are not met, then the RSUs will not vest. As of August 30, 2009, the
remaining unrecognized compensation cost related to these outstanding RSUs was $25.1 million which will be recognized based on the Company's forecasted attainment of the performance targets or
over time depending upon the vesting criteria of the award. As of August 30, 2009, it is the Company's expectation that the performance targets for RSUs with performance targets will be met.

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

A
summary of restricted share unit award activity for the nine months ended August 30, 2009, is presented below:

Unvested
Restricted
Share Units

Weighted Average
Grant Date
Fair ValueOutstanding November 30, 2008




$
0.00Granted


16,595,833


1.98Outstanding August 30, 2009


16,595,833

$
1.98Weighted average remaining vesting period


3.4 years


13

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

Share-based Compensation Expense

A summary of share-based compensation expense for each of the types of awards discussed above as recorded in the Condensed Consolidated
Statements of Operations is as follows (in thousands):

Three months ended

Nine months endedAugust 30,
2009

August 31,
2008

August 30,
2009

August 31,
2008Stock option awards

$
819

$
554

$
2,465

$
1,563Restricted shares


167


56


500


56Restricted share units


2,575





2,617


Directors' deferred stock compensation


10


94


205


54Adjustment to options and shares subject to redemption





(151
)




164Modifications of share-based awards


1,594





1,594


713Total share-based compensation

$
5,165

$
553

$
7,381

$
2,550


Note 5: Inventories

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

August 30,
2009

November 30,
2008Raw materials

$
29,313

$
27,335Work in process


19,350


29,140Finished goods


8,956


8,159$
57,619

$
64,634


Note 6: 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 other Sealy-branded products as well as a 20-year
warranty on the major components of itsTrueFormandMirrorFormvisco-elastic products and its SpringFreelatex
product, the last ten years of which are prorated on a straight-line basis. The Company also offers a 20-year limited warranty on its RightTouchproduct line which covers only certain parts of the
product and is prorated for part of the twenty years. The RightTouchline was discontinued in the third quarter of fiscal 2008. The Company's policy is to accrue the estimated cost of warranty coverage
at the
time the sale is recorded. The estimate involves an average lag time in days between the sale of a bed and the date of its return, applied to the current rate of the warranty returns.

During
fiscal 2008, the Company completed an analysis of its warranty claims experience. The analysis was based on historical return trends using newly available information as a result
of a new and improved product return process that allows the Company to better track and match claims received to the sales for which those claims were initially recorded. As a result of the analysis

14

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 6: Warranty Costs (Continued)

performed,
the Company changed its estimate of accrued warranty obligations. This resulted in a reduction of accrued warranty obligations and cost of sales of approximately $4.5 million. The
change in the Company's accrued warranty obligations for each of the nine months ended August 30, 2009 and August 31, 2008 was as follows (in thousands):

August 30,
2009

August 31,
2008Accrued warranty obligations at beginning of period

$
16,487

$
15,964Warranty claims


(13,379
)

(14,611
)Warranty provisions


13,354


18,147Change in estimate





(4,484
)Accrued warranty obligations at end of period

$
16,462

$
15,016


As
of August 30, 2009 and November 30, 2008, $10.5 million and $9.9 million is included as a component of other accrued liabilities and $5.9 million
and $6.6 million is included as a component of other noncurrent liabilities within the accompanying 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 $4.4 million and $4.2 million for the nine months ended August 30, 2009 and the nine months ended August 30,
2008, respectively.

Note 7: Goodwill and Other Intangible Assets

The Company performs an annual assessment of its goodwill for impairment as of the beginning of the fiscal fourth quarter. The Company also assesses its goodwill and other intangible
assets for impairment when events or circumstances indicate that their carrying value may not be recoverable from future cash flows. During the fourth quarter of fiscal 2008, the Company recognized an
impairment charge on the goodwill of its Europe reporting unit that was based upon an estimate of the fair value of the property and equipment and certain intangible assets, including customer
relationships. During the first quarter of fiscal 2009, the Company completed its measurement of the impairment loss for the Europe reporting unit and concluded that the entire balance of the goodwill
of this reporting unit was determined to be impaired. Thus, the $24.7 million impairment charge recognized in the fourth quarter of fiscal 2008 as an estimate required no adjustment in the
first quarter of fiscal 2009.

The
changes in the carrying amount of goodwill which relates entirely to the Americas segment for the nine months ended August 30, 2009 are as follows (in thousands):

TotalBalance as of November 30, 2008

$
357,149Increase due to foreign currency translation


3,668Balance as of August 30, 2009

$
360,817


Total
other intangibles of $2.8 million (net of accumulated amortization of $17.3 million) as of August 30, 2009 consist primarily of licenses, which are amortized
using a straight-line method over

15

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 7: Goodwill and Other Intangible Assets (Continued)

periods
ranging from 5 to 15 years. During the three and nine months ended August 30, 2009 and August 31, 2008, the Company recognized amortization expense associated with
intangibles of $0.8 million and $2.4 million, respectively for fiscal 2009 and $1.0 million and $2.8 million, respectively for fiscal 2008. The Company expects to recognize
amortization expense relating to these intangibles of $0.8 million for the remainder of 2009, $0.5 million in 2010, $0.3 million in 2011, $0.3 million in 2012,
$0.3 million in 2013 and $0.7 million thereafter.

Note 8: Debt Issuance Costs

The Company capitalizes costs associated with the issuance of debt and amortizes them as additional interest expense over the lives of the debt on a straight-line basis which
approximates the effective interest method. In connection with the refinancing of the Company's senior secured credit facilities in May 2009, the Company recorded fees in the amount of
$27.4 million which were deferred and will be amortized over the life of the new agreements. As of August 30, 2009, an insignificant amount of these fees had not yet been paid and were
recorded as a component of other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. Since the old senior secured term loans are considered terminated, under the provisions
of FAS 140, "Accounting for Transfers and Servicing of Financial Assets and Extinguishment of Liabilities", the remaining unamortized debt issuance costs of $2.1 million were expensed
and recognized as a component of debt extinguishment and refinancing expenses in the Condensed Consolidated Statements of Operations. The remaining unamortized debt issuance costs associated with the
old senior revolving credit facility will continue to be amortized over the life of the Company's new asset-based revolving credit facility in accordance with the provisions of
EITF 98-14, "Debtor's Accounting for Changes in Line-of-Credit or Revolving-Debt Arrangements".

Note 9: Long-Term Obligations

Long-term obligations as of August 30, 2009 and November 30, 2008 consisted of the following:

August 30,
2009

November 30,
2008(in thousands)Asset-based revolving credit facility

$


$
Old senior revolving credit facility





64,400New senior secured notes


336,267


Convertible notes, including paid in kind interest


178,780


Old senior secured term loans





377,181Senior subordinated notes


273,945


273,945Financing obligations


41,595


42,348Other


18,840


25,531849,427


783,405Less current portion


(11,591
)

(21,243
)$
837,836

$
762,162


16

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

Debt Refinancing

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

The
Convertible Notes were issued pursuant to a rights offering issued to all existing shareholders of the Company's common stock which expired on July 2, 2009. The Company issued
the related $177.1 million of Convertible Notes on July 10, 2009. Approximately $93.8 million of the Convertible Notes were issued through a forward purchase agreement with a
related party, Sealy Holding LLC (the "Purchaser") an affiliate of KKR. The forward purchase agreement required the exercise of the rights assigned to the Purchaser as well as an
oversubscription for those rights that were not exercised by other common shareholders.

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

ABL Revolver

The ABL Revolver provides for revolving credit financing of up to $100.0 million, subject to borrowing base availability, and
matures in May 2013. 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. Borrowings under the ABL
Revolver bear interest at the Company's choice of either 1) a base rate (determined by reference to the higher of i) the prime rate; ii) the federal funds effective rate plus
one-half of one percent; or iii) the three month LIBOR rate for U.S. dollar deposits) plus 1% plus an applicable margin of 3.00% or 2) a three month LIBOR rate for U.S.
dollar deposits plus an applicable margin of 4.00%. The ABL Revolver also requires the Company to pay a commitment fee for the unused portion. As of August 30, 2009, there were no amounts
outstanding under the ABL Revolver. At August 30, 2009, the Company had approximately $70.9 million available
under the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $16.0 million.

The
obligations under the Company's ABL Revolver are guaranteed by the Company and all of its current and future domestic subsidiaries, and are also secured by substantially all of the
assets of the Company and its current and future domestic subsidiaries through a first-priority security interest in the accounts receivable, inventory, cash, related general intangibles and
instruments and proceeds of the foregoing, and a second-priority security interest in substantially all of the material real property,

17

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

equipment,
Intellectual Property, equity interests and equipment and all other assets of the Company and its current and future domestic subsidiaries that secure the Senior Notes on a first-priority
basis.

The
ABL Revolver imposes 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. The agreement also 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 August 30, 2009, the Company is
not in a minimum availability period under the ABL Revolver.

In
accordance with EITF 95-22, "Balance Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include both a Subjective Acceleration
Clause and a Lock-Box Arrangement", the Company will classify our ABL Revolver, which has a maturity date of more than one year from the balance sheet date, as a current liability since it
includes both a lockbox arrangement and a subjective acceleration clause.

Senior Secured Notes

On May 29, 2009, the Company issued $350.0 million aggregate principal amount of Senior Notes maturing April 2016 bearing
interest at 10.875% per annum payable semi-annually in arrears on April 15 and October 15. The total proceeds received by the Company from the issuance of these notes was
$335.9 million, resulting in an original issue discount ("OID") of $14.1 million which will be accreted over the life of the agreement with the related expense recognized as a component
of interest expense in the Condensed Consolidated Statement of Operations. For the three and nine months ended August 30, 2009, the Company recognized additional interest expense of
$0.4 million related to the accretion of the OID. The Senior Notes rank equally in right of payment with all of the Company's existing and future senior indebtedness, including amounts
outstanding under the ABL Revolver and the Convertible Notes and senior in right of payment to any
existing and future subordinated indebtedness, including the existing 8.25% Senior Subordinated Notes due 2014 ("2014 Notes"). The obligations under the Senior Notes are guaranteed by the Company and
all of its current and future domestic subsidiaries, and are also secured by substantially all of the assets of the Company and the assets of its current and future domestic subsidiaries through a
first-priority security interest in substantially all of the Company's material real property and equipment and all other assets of its current and future domestic subsidiaries that secure the Senior
Notes on a first-priority basis, and a second-priority security interest in the accounts receivable, inventory, cash, related general intangibles and instruments and proceeds of the foregoing.

The
Senior Notes are governed by an indenture which calls for the Company to offer to repurchase the notes at a price equal to 101% of the outstanding principal amount in the event of a
change in control as defined in the indenture. After April 15, 2012, the Senior Notes are subject to redemption by the Company at 30 to 60 days' notice at the redemption prices
(expressed as percentages of principal amount) set forth below, plus accrued and unpaid interest thereon, to the

18

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

applicable
redemption date, if redeemed during the twelve month period beginning on April 15 of each of the years indicated below:

Year

Percentage of
Principal Amount2012


108.156
%2013


105.438
%2014


102.719
%2015 and thereafter


100.000
%


Further,
during any twelve month period commencing on the date of issuance, the Company will be entitled to redeem up to 10% of the aggregate principal amount of the Senior Notes at a
redemption price equal to 103.000% plus accrued and unpaid interest. Prior to April 15, 2011, the Company may redeem up to 40% of the aggregate principal amount of the Senior Notes at a
redemption price equal to 110.875% of the aggregate principal amount plus accrued and unpaid interest thereon with the net proceeds of an equity offering.

Convertible PIK Notes and Related Rights

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

The
issuance of the rights to purchase the Convertible Notes was considered a non-monetary distribution of $188.8 million in the second quarter of fiscal 2009.
Further,
the rights are considered to be representative of the substantial premium at which the related Convertible Notes were issued which is presumed to represent additional paid-in capital. The
distribution was recorded at its fair value based on the initial trading value of the rights on the active market on which they trade. See Note 11. The rights are considered to constitute
written options which are accounted for as derivative instruments under the provisions of FAS 133 and must be adjusted, prior to exercise or expiration, to fair value through earnings. See
Note 10.

On
May 15, 2009, the Company entered into a forward purchase agreement (the "Forward Contract") with the Purchaser in connection with the distribution of the subscription rights
discussed above. The Forward Contract required the Purchaser to purchase up to $177.1 million aggregate principal amount of Convertible Notes which represents the maximum number of Convertible
Notes that the Purchaser may be obligated to purchase. The Forward Contract was settled upon the expiration of the rights offering. Upon settlement, the Company delivered to the Purchaser the
Convertible Notes that were not subscribed for by the Company's shareholders (other than the Purchaser) and cash in an amount equal to the purchase price of the Convertible Notes that were subscribed
to by the Company's shareholders (other than the Purchaser) along with accrued interest. In consideration of the Forward Contract, the Purchaser posted cash of $177.1 million on May 29,
2009 which bore interest during the rights offering period at the rate of LIBOR plus 3.00%. On July 10,

19

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

2009,
the forward contract was settled resulting in a repayment to the Purchaser of $84.0 million which represented $83.3 million related to rights exercised by shareholders other than
the Purchaser and an interest payment of $0.7 million. Under the terms of the Forward Contract, the Company paid the Purchaser a forward contract payment of $1.0 million which was
recorded as a component of debt issuance costs, net, and other assets in the Condensed Consolidated Balance Sheet as of August 30, 2009 and is being amortized as a component of interest expense
within the Condensed Consolidated Statements of Operations.

Due
to the agreement by the Purchaser to exercise all of the rights distributed to it under the terms of the Forward Contract, the associated rights have been considered to be exercised
at issuance and the fair value of these rights were immediately recorded as a component of additional paid-in capital. The rights issued to the Company's other shareholders remained
outstanding through the rights period and were adjusted to their fair value (See Note 11) until the issuance of the Convertible Notes on July 10, 2009, at which time they were then
recorded as a component of additional paid-in capital within the Condensed Consolidated Balance Sheets.

The
$177.1 million of 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 nine months ended August 30, 2009, $0.2 million of Convertible Notes were converted into shares resulting in the issuance of 171,325 shares at the
conversion price of $1.00 per share.

The
Convertible Notes rank equally in right of payment with all of the Company's existing and future senior indebtedness, including amounts outstanding under the ABL Revolver and the
Senior Notes, and senior in right of payment to any existing and future subordinated indebtedness, including the existing 2014 Notes. The Convertible Notes are also secured by a third-priority lien on
all of the collateral securing the ABL Revolver and the Senior Notes which liens will be effectively junior to the senior priority liens securing the Senior Notes and the ABL Revolver.

The
Company will account for the PIK interest on the Convertible Notes in accordance with the provisions of EITF No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features or Contingently Adjustable Conversion Ratios", EITF 00-27, "Application of Issue No. 98-5 to Certain Convertible Instruments", and
EITF 00-19, "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock". This may require 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.
The resulting discount will be shown as a reduction of the balance of the Convertible Notes which will be accreted to the par value through interest expense over the term of the Convertible Notes.

20

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

The
indentures and agreements governing our 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. At August 30, 2009, 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 interest rate and foreign currency changes. All of the Company's designated hedging instruments are
considered to be cash flow hedges.

Interest Rate Risk

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

On
June 15, 2007, the Company entered into an interest rate swap agreement effective December 3, 2007 fixing the floating portion of the interest rate at 5.495% on
$242 million of the outstanding balance under the old senior secured term loan through November 2008, declining to $240 million from December 2008 through November 2009, and further
declining to $180 million from December 2009 through November 2010. The Company formally designated this swap agreement as a cash flow hedge as it was expected to be highly effective in
offsetting fluctuations in the designated interest payments resulting from changes in the benchmark interest rate. The Company selected the Eurodollar rate on the hedged portion of the old senior
secured term loan during the term of the swap.

On
December 1, 2008, the Company entered into two interest rate swap agreements effective December 4, 2008. The first of these swaps fixed the floating portion of the
interest rate at 1.952% on $20.0 million of the outstanding balance under the old senior credit facility through November 4, 2009. The second of these swaps fixed the floating portion of
the interest rate at 1.991% on $107.0 million of the outstanding balance under the old senior credit facility through February 4, 2010. The Company formally designated these swap
agreements as cash flow hedges as they were expected to be highly effective in offsetting fluctuations in the designated interest payments resulting from changes in the benchmark interest rate. The
Company selected the Eurodollar rate on the hedged portion of the old senior credit facility during the term of these swaps.

21

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

In
connection with the Refinancing (Note 9), the Company paid $15.2 million to terminate the above interest rate swaps. As the future variable interest rate payments are no
longer probable of being made, the amounts which had previously been recorded in accumulated other comprehensive income were charged to refinancing expense for the nine months ended August 30,
2009 in accordance with the provisions of FAS 133.

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

As
of August 30, 2009, the total notional amount of the Company's interest rate swap agreements was $12.4 million which relates to agreements that have not been designated
as hedging instruments. The maximum length of time over which the Company is hedging its exposure to the variability of future cash flows related to forecasted interest payments through interest rate
swap agreements is through May 2019.

Foreign Currency Exposure

The Company is exposed to foreign currency risk related to purchases of materials and royalty payments made in a foreign currency. To
manage the risk associated with fluctuations in foreign currencies, the Company enters into foreign currency forward contracts. As with
its interest rate swap instruments, the Company designates certain of these forward contract hedges as hedging instruments and enters into some forward contracts that are considered to be economic
hedges which are not designated as hedging instruments. Whether designated or undesignated, these forward 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 Company, as applicable. Details of the specific instruments used by the Company to hedge its exposure to foreign currency fluctuations follow:

At
August 30, 2009, the Company had two forward foreign currency contracts outstanding to purchase a total of 0.9 million Euros with expiration dates ranging from
September 30, 2009 through December 31, 2009. These hedges were entered into to protect against the fluctuation in the Euro denominated royalty payments related to a third party license
held by the Company. The Company has formally designated these contracts as cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in these royalty payments related
to changes in the foreign currency exchange rates.

At
August 30, 2009, the Company had three forward foreign currency contracts and three foreign currency option contracts to sell a total of 10.2 million Canadian dollars
and receive US dollars at specified exchange rates with expiration dates ranging from September 15, 2009 through November 15, 2009. These hedges were entered into to protect against the
fluctuation in the Canadian subsidiary's US dollar denominated purchases of raw materials. The Company has formally designated these contracts

22

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

as
cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in the forecasted purchases of these raw materials related to changes in the foreign currency exchange
rates.

The
Company also enters into forward 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 selling, general and administrative expenses in the Condensed Consolidated Statements of Operations. At August 30, 2009 and November 30, 2008, the Company did not
have any outstanding foreign currency contracts that were not designated as hedges for accounting purposes.

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 December 31, 2009. Over the next 12 months, the Company expects to reclassify $0.3 million of deferred gains from accumulated other comprehensive income to selling,
general and administrative expense as related forecasted foreign currency payments are made.

For
the three and nine months ended August 30, 2009, recognized foreign currency transaction losses were $(2.4 million) and $(3.2 million), respectively, compared
with (losses) gains of $(0.1 million) and $0.6 million for the three and nine months ended August 31, 2008.

Embedded Derivatives

The Company evaluates its outstanding debt arrangements in accordance with FAS 133, 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 derivative was determined to be immaterial.

Rights to Purchase Convertible Notes

During the second quarter of fiscal 2009, the Company issued rights to holders of its common stock at close of business on
May 26, 2009. As described in Note 9, these rights entitled holders to purchase the Company's Convertible Notes issued in connection with the Refinancing and expired on July 2,
2009. These rights were considered to be written options and therefore were treated as derivatives under the provisions of FAS 133 which requires that they be adjusted, after issuance, to fair
value through earnings. Based on the terms of the forward purchase agreement with the Purchaser, the rights related to the Purchaser's approximate 50.6% ownership, as of the date of issuance, are
considered to be exercised as of the date of the issuance of the right. The fair value of the rights attributable to the Purchaser, which was $95.6 million at May 27, 2009, was recorded
as additional paid-in capital upon issuance. The rights issued to other shareholders remained outstanding through the issuance of the Convertible Notes on July 10, 2009, and were
adjusted to their market value through that date. The Company recognized losses on these rights of $1.8 million and $4.5 million for the three and nine months ended August 30,
2009, respectively. At the expiration of the rights, the fair value of the rights issued to other shareholders of $97.8 million was recorded as additional paid-in capital.

23

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

At
August 30, 2009 and November 30, 2008, the fair value carrying amount of the Company's derivative instruments was recorded as follows (in thousands):

Asset Derivatives

Liability DerivativesAugust 30, 2009

August 30, 2009Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
ValueDerivatives designated as hedging instruments under FAS 133Foreign exchange contracts

Other current assets

$
252

Other current liabilities

$
Total derivatives designated as hedging instruments under FAS 133




252




Derivatives not designated as hedging instruments under FAS 133Interest rate contracts

Other noncurrent assets


723

Other noncurrent liabilities


Total derivatives not designated as hedging instruments under FAS 133




723




Total derivatives



$
975



$





Asset Derivatives

Liability DerivativesNovember 30, 2008

November 30, 2008Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
ValueDerivatives designated as hedging instruments under FAS 133Interest rate contracts

Accrued interest receivable

$


Accrued interest payable

$
1,624Interest rate contracts

Other current assets




Other current liabilities


6,285Interest rate contracts

Other noncurrent assets




Other noncurrent liabilities


8,055Total derivatives designated as hedging instruments under FAS 133









15,964Derivatives not designated as hedging instruments under FAS 133Interest rate contracts

Other noncurrent assets


388

Other noncurrent liabilities


Foreign exchange contracts

Other noncurrent assets




Other noncurrent liabilities


21Total derivatives not designated as hedging instruments under FAS 133




388




21Total derivatives



$
388



$
15,985


24

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

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

Three Months Ended August 30, 2009Derivatives in FAS 133 Cash Flow Hedging Relationships

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

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

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

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

Amount of
Gain/(Loss)
Recognized in
Income on Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)Foreign exchange contracts


70

Selling, general and administrative expenses


56

Selling, general and administrative expenses


Total

$
70



$
56



$





Nine Months Ended August 30, 2009Derivatives in FAS 133 Cash Flow Hedging Relationships

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

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

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

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

Amount of
Gain/(Loss)
Recognized in
Income on Derivative
(Ineffective Portion
and Amount
Excluded from
Effectiveness Testing)Interest rate contracts


(3,864
)
Interest income (expense)


(5,266
)
Interest income (expense)


Interest rate contracts




Refinancing expense




Refinancing expense


(15,232
)Foreign exchange contracts


259

Selling, general and administrative expenses


164

Selling, general and administrative expenses


Total

$
(3,605
)


$
(5,102
)


$
(15,232
)




Three Months Ended August 30, 2009Derivatives Not Designated as Hedging
Instruments under Statement 133

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

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

Interest income (expense)

$
227Rights to purchase convertible notes

Loss on rights for convertible notes


(1,820
)Total



$
(1,593
)




Nine Months Ended August 30, 2009Derivatives Not Designated as Hedging
Instruments under Statement 133

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

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

Interest income (expense)

$
335Rights to purchase convertible notes

Loss on rights for convertible notes


(4,549
)Total



$
(4,214
)


25

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

At August 30, 2009 there were no outstanding interest rate swaps qualifying for hedge accounting treatment due to the termination of these swaps and the repayment of the related
variable-rate debt in connection with the Refinancing (Note 9). At November 30, 2008, accumulated other comprehensive income associated with interest rate swaps qualifying
for hedge
accounting treatment was $(8.9 million), net of income tax effects. At August 30, 2009 and November 30, 2008, accumulated other comprehensive income associated with foreign
currency forwards qualifying for hedge accounting treatment was $0.1 million, net of income tax effects.

Note 11: Fair Value of Financial Instruments

For assets and liabilities measured at fair value on a recurring basis during the period under the provisions of FAS 157, the Company uses an income approach to value the assets
and liabilities for outstanding interest rate swap and foreign currency forward derivative contracts discussed in Note 10 above. 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 using current market information as of the reporting date such
as prevailing interest rates and foreign currency spot and forward rates. We mitigate derivative credit risk by transacting with highly rated counterparties. We have evaluated the credit and
non-performance risks associated with our derivative counterparties or the Company, as applicable, and have recorded a credit valuation adjustment of an insignificant amount at
August 30, 2009. The fair value of the Company's rights for convertible notes during the period they were outstanding was determined based on the closing price reported on the active market on
which the related rights trade. As noted in Note 2 above, the Company adopted the provisions of FAS 157 with respect to its non-financial assets and liabilities during the
first quarter of fiscal 2009. However, there were no non-financial assets or liabilities requiring initial measurement or subsequent remeasurement during the first three quarters of fiscal
2009. The following table provides a summary of the fair values of assets and liabilities as determined under FAS 157 (in thousands):

Fair Value Measurements at August 30, 2009 UsingAugust 30, 2009

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

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)Interest rate and foreign exchange derivatives

$
975

$


$
975

$





Fair Value Measurements at November 30, 2008 UsingNovember 30, 2008

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

Significant Other
Observable Inputs
(Level 2)

Significant
Unobservable
Inputs
(Level 3)Interest rate and foreign exchange derivatives

$
(15,597
)
$


$
(15,597
)
$



26

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 11: Fair Value of Financial Instruments (Continued)

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 August 30, 2009 were as follows (in thousands):

Senior Notes

$
374,938Convertible Notes


502,372Senior Subordinated Notes


241,414


Note 12: Debt Extinguishment and Refinancing Expense

Debt extinguishment and refinancing expenses for the nine months ended August 30, 2009 includes non-cash charges of $2.1 million relating to the
write-off of debt issuance costs associated with the old senior term loans as well as $15.2 million of cash charges associated with the termination of the interest rate swap
agreements that were associated with the old senior credit facility. See Note 9.

Note 13: Other Income, Net

Other income, net, includes interest income for the three and nine months ended August 30, 2009 and August 31, 2008 of an insignificant amount and $0.1 million, for
fiscal 2009 and $0.1 million and $0.3 million, respectively, for fiscal 2008.

Note 14: Conditional Asset Retirement Obligations

Under the provisions of FASB Interpretation No. 47, "Accounting for Conditional Asset Retirement Obligations" ("FIN 47"), the Company recorded additional property, plant
and equipment and other noncurrent liabilities of $0.1 million and $0.3 million in the nine months ended August 30, 2009 and August 31, 2008, respectively. These amounts
resulted from obligations of new facility leases that require the Company to return the property to the same or similar condition at the end of the lease as existed when the Company began using the
facility. Also during the third quarter of fiscal 2008, the Company reversed the unused portion of the asset retirement obligation related to a leased facility that was exited. This resulted in the
recognition of a reduction of $0.1 million in selling, general and administrative expenses for the three and nine months ended August 31, 2008.

Note 15: Acquisitions and Dispositions

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

27

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 15: Acquisitions and Dispositions (Continued)

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

Note 16: Defined Benefit Pension Expense

The components of net periodic pension cost recognized for the Company's defined benefit pension plans in the U.S., Canada and France for the three and nine months ended
August 30, 2009 and August 31, 2008 are as follows:

Three Months Ended

Nine Months EndedAugust 30, 2009

August 31, 2008

August 30, 2009

August 31, 2008(in thousands)

(in thousands)Service cost

$
191

$
272

$
574

$
816Interest cost


359


339


1,076


1,018Expected return on plan assets


(237
)

(335
)

(712
)

(1,004
)Curtailment loss





213





213Amortization of unrecognized gains and losses


91


39


274


118Amortization of unrecognized transition asset





(22
)




(66
)Amortization of unrecognized prior service cost


64


69


192


208Net periodic pension cost*

$
468

$
575

$
1,404

$
1,303Cash contributions

$
285

$
501

$
570

$
1,447


---

The
Company expects to make additional cash contributions to the plans of approximately $0.3 million during the remainder of fiscal 2009.

Note 17: 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,
non-deductible mark to market adjustments for derivatives associated with the Convertible Notes subscription rights, certain foreign tax

28

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 17: Income Taxes (Continued)

rate
differentials and state and local income taxes. The effective tax rate for the three and nine months ended August 30, 2009 was approximately 20.7% and 23.0%, respectively, compared to
approximately 39.1% and 38.0%, respectively, for the three and nine months ended August 31, 2008. The effective rate for the three and nine months ended August 30, 2009 was lower than
the rate for the three and nine months ended August 31, 2008 primarily due to the reversal of $10.2 million of the liability for uncertain tax positions and related interest (net) and
penalties due to the expiration of statutes of limitations, offset by lower pre-tax income in fiscal 2009.

The
Company adopted Financial Accounting Standards Board (FASB) Interpretation (FIN) No. 48, "Accounting for Uncertainty in Income Taxes", effective December 3, 2007. As a
result of the implementation, the Company recognized a $10.5 million net increase to the liability for uncertain tax positions including interest and penalties of $0.7 million and
$2.5 million, respectively. These increases were accounted for as a cumulative effect adjustment and recognized as an increase in the beginning accumulated deficit in the consolidated balance
sheet. Including the cumulative effect adjustment, the Company had approximately $25.9 million of total unrecognized tax benefits as of December 3, 2007.

The
Condensed Consolidated Balance Sheet as of August 30, 2009 includes accrued interest of $3.4 million and penalties of $3.6 million due to unrecognized tax
benefits. As of November 30, 2008, the Company had recorded accrued interest of $5.3 million and penalties of $3.4 million due to unrecognized tax benefits. Additional interest
and penalities, recorded as a component of income tax expense during the three and nine months ended August 30, 2009 and August 31, 2008, were as follows:

Three Months Ended

Nine Months EndedAugust 30, 2009

August 31, 2008

August 30, 2009

August 31, 2008(in thousands)

(in thousands)Additional interest, net


(2,657
)

579


(1,705
)

1,709Additional penalties


226


59


226


374


The
Company expects the liability for uncertain tax positions to decrease by approximately $2.6 million within the succeeding twelve months due to expiration of income tax
statutes of limitations. Federal years open to examination are fiscal year 2006 and forward. State and international jurisdictions remain open to examination for fiscal year 2000 and forward.

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

29

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 17: Income Taxes (Continued)

August 30,
2009. The Company also cannot predict when or if any other future tax payments related to these tax positions may occur.

Note 18: Comprehensive Income

Comprehensive income for the three and nine months ended August 30, 2009 and August 31, 2008 was $12.2 million and $29.1 million, respectively, for fiscal
2009 and $3.6 million and $35.4 million, respectively, for fiscal 2008. The increase in comprehensive income for the three months ended August 30, 2009 compared to the three
months ended August 31, 2008, has been driven by the change in the foreign currency translation adjustment and an increase in net income. The decrease in comprehensive income for the nine
months August 30, 2009 as compared to the nine months ended August 31, 2008 has been primarily driven by the decrease in net income as compared to the prior period which has been
partially offset by the change in the fair value and termination of the previously existing interest rate swaps and the increase in the foreign currency translation adjustment.

Note 19: Commitments and Contingencies

Contingencies

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

The
Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. The
Company and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, the Company and its
subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the
property in 1997. The Company and its subsidiary retained primary responsibility for the required remediation. The Company has completed essentially all soil remediation with the New Jersey Department
of Environmental Protection approval and operates a groundwater remediation system on the site. During 2005, with the approval of the New Jersey Department of Environmental Protection, the Company
removed and disposed of sediment in Oakeys Brook adjoining the site. The Company continues to monitor ground water at the site. The Company has recorded a reserve as a component of other accrued
liabilities and other noncurrent liabilities in the accompanying Condensed Consolidated Balance Sheets as of August 30, 2009 for $2.3 million ($3.6 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

30

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 19: Commitments and Contingencies (Continued)

recorded
a liability of approximately $0.2 million associated with the additional work and ongoing monitoring. The Company believes the contamination is attributable to the manufacturing
operations of previous unaffiliated occupants of the facility.

While
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.

On
June 15, 2009, Sealy was served with a lawsuit filed by Tempur-Pedic, LLC North America in the Western District of Virginia. In the lawsuit, Tempur-Pedic alleges that
Sealy and sixteen other defendants are infringing a patent issued to Tempur-Pedic in March of 2009, requesting injunctive relief and unspecified damages against all of the defendants. Sealy is
currently reviewing the lawsuit and intends to pursue a vigorous defense in the matter. As the suit was filed in June 2009, no trial date has been set and the parties are now pursuing discovery.
Accordingly, at this time, Sealy cannot predict the potential outcome of this litigation.



On December 1, 2008, the Company completed a sale-leaseback transaction of its South Gate, California facility,
including the land, building and improvements affixed to the properties. The facility is being leased back over a seven year term and is classified as an operating lease. The net proceeds from the
sale were $8.4 million and were reinvested in the business. The sale of this facility resulted in a gain of approximately $4.9 million. This gain has been deferred and is being amortized
over the lease term. During the three and nine months ended August 30, 2009, the Company has recognized $0.2 million and $0.5 million of this gain, respectively. The remaining
deferred gain was $4.4 million at August 30, 2009. Amounts recorded as a component of other accrued liabilities and other noncurrent liabilities within the accompanying Condensed
Consolidated Balance Sheets as of August 30, 2009 are $0.6 million and $3.7 million, respectively. The future minimum payments associated with this lease for the next five years,
from the date of the sale, are as follows (in thousands):

Fiscal Year2009

$
6302010


8612011


8832012


9052013


927Thereafter


1,925$
6,131


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
nine

31

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 19: Commitments and Contingencies (Continued)

months
ended August 30, 2009, severance costs of $0.1 million and $1.3 million, respectively, were recorded as a component of operating income within the accompanying Condensed
Consolidated Statements of Operations. For the three and nine months ended August 31, 2008, severance costs of an insignificant amount and $4.2 million, respectively, were recorded as a
component of operating income within the accompanying Condensed Consolidated Statements of Operations. The charges recognized for the nine months ended August 31, 2008 are inclusive of the
$0.7 million of compensation cost that was recognized in connection with a modification of the terms of certain stock options in connection with the resignation of certain employees. Severance
benefits of $1.7 million and $3.2 million have been accrued as of August 30, 2009 and November 30, 2008, respectively. Of this amount, $1.7 million and
$2.2 million is included as a component of accrued liabilities and none and $1.0 million is included as a component of other noncurrent liabilities within the accompanying Condensed
Consolidated Balance Sheet as of August 30, 2009 and November 30, 2008, respectively.

Note 20: Related Party Transactions

During the three and nine months ended August 30, 2009, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC (a consulting company
that works exclusively with KKR's portfolio companies) of $0.7 million and $2.3 million, respectively. As of August 30, 2009, $1.3 million of this amount was accrued as a
component of other accrued liabilities and accounts
payable in the accompanying Condensed Consolidated Balance Sheets. The Company was also billed $0.3 million for executive search costs incurred by KKR on the Company's behalf for the three and
nine months ended August 30, 2009. During the third quarter of fiscal 2009, we entered into a lease arrangement with a KKR affiliate for our Clarion facility for a six month initial term with
two six month renewal options available. We have received lease income on this property of an insignificant amount during the third quarter of fiscal 2009.

During
the nine months ended August 30, 2008, the Company was billed for premiums of $0.2 million and for excess directors and officers liability insurance and excess
liability insurance to KKR. During the three and nine months ended August 31, 2008, the Company incurred costs of $0.1 million for consulting services provided by Capstone
Consulting LLC. Additionally during the three and nine months ended August 31, 2008, the Company was billed for $0.5 million of CEO search costs performed by KKR. As of
August 31, 2008, the $0.1 million of consulting services and $0.5 million of CEO search costs were accrued as a component of other accrued expenses in the accompanying Condensed
Consolidated Balance Sheets.

In
connection with the Refinancing (Note 9), the Company entered into an agreement with Sealy Holding, LLC, a company which is owned by KKR, whereby the Purchaser provided
$177.1 million in cash to support its obligation to exercise its rights as well as an oversubscription for those rights that were not exercised by other common shareholders. Until the
conclusion of the rights offering period, the $177.1 million bore interest at a rate of LIBOR plus 3.0%. At the expiration of the rights offering period, the Company repaid the Purchaser
$83.3 million which represented the proceeds obtained from the subscription to the Convertible Notes by other shareholders. Convertible Notes were issued to the Purchaser in an aggregate amount
of $93.8 million. Interest paid to the Purchaser on the $177.1 million related party loan outstanding during the rights period was $0.7 million. As consideration for the

32

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Related Party Transactions (Continued)

forward
purchase, the Company paid the Purchaser $1.0 million which has been deferred as debt issuance costs which will be amortized as a component of interest expense.

KKR
Financial LLC, an affiliate of KKR, also participated in the Senior Notes that were issued in connection with the Refinancing. As part of the offering, KKR
Financial LLC purchased $53.0 million principal amount of the outstanding Senior Notes. Interest expense of $1.5 million has been recorded related to KKR Financial LLC's
portion of the outstanding Senior Notes and remains accrued at August 30, 2009.

Note 21: Segment Information

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

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

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

Three Months Ended

Nine Months EndedAugust 30, 2009

August 31, 2008

August 30, 2009

August 31, 2008Americas:United States

$
256,755

$
296,105

$
713,988

$
836,073Canada


45,201


49,438


108,982


138,697Other International


19,763


27,688


58,752


81,830Total Americas


321,719


373,231


881,722


1,056,600Europe


27,854


31,732


76,282


115,667Total

$
349,573

$
404,963

$
958,004

$
1,172,267Total International

$
92,818

$
108,858

$
244,016

$
336,194


There
were no sales from Europe to the Americas for the three and nine months ended August 30, 2009. Sales from Europe to the Americas for the three and nine months ended
August 30, 2008 were $0.0 million and $3.6 million, respectively. Long lived assets (principally property, plant and

33

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 21: Segment Information (Continued)

equipment)
outside the United States were $67.7 million and $60.8 million as of August 30, 2009 and November 30, 2008, respectively.

Three Months Ended

Nine Months EndedAugust 30, 2009

August 31, 2008

August 30, 2009

August 31, 2008(in thousands)

(in thousands)Net sales to external customers:Americas

$
321,719

$
373,231

$
881,722

$
1,056,600Europe


27,854


31,732


76,282


115,667349,573


404,963


958,004


1,172,267Capital expenditures:Americas


4,055


7,142


8,392


19,720Europe


87


94


277


1,3824,142


7,236


8,669


21,102EBITDA:Americas


45,210


44,893


99,771


134,110Europe


230


(3,775
)

(4,285
)

(352
)Inter-segment eliminations





(137
)

(68
)

25445,440


40,981


95,418


134,012Reconciliation of EBITDA to net income:EBITDA from segments*


45,440


40,981


95,418


134,012Interest


22,127


14,379


56,551


45,124Income taxes


3,155


7,017


3,463


24,013Depreciation and amortization


8,102


8,643


23,840


25,763Net Income

$
12,056

$
10,942

$
11,564

$
39,112


---

August 30, 2009

November 30, 2008(in thousands)Total assets:Americas

$
961,141

$
852,644Europe


72,095


69,784Intersegment eliminations


(1,553
)

(1,554
)$
1,031,683

$
920,874


34

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 22: Common Stock and Options Subject to Redemption

In connection with its adoption of FAS 123(R), the Company reclassified as temporary equity amounts previously included in additional paid-in capital that were
associated with outstanding shares and options which, under the terms of management shareholder agreements, were potentially redeemable for a 180 day period following the death or disability of
the share or option holder. During the second quarter of fiscal 2009, the right of the share or option holder to redeem the shares or options expired. As a result, the remaining balance of temporary
equity of $8.6 million was reclassified to additional paid-in capital.

Note 23: Earnings per Share

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

Three Months Ended

Nine Months EndedAugust 30, 2009

August 31, 2008

August 30, 2009

August 31, 2008(in thousands)

(in thousands)Numerator:Net income, as reported

$
12,056

$
10,942

$
11,564

$
39,113Interest on convertible notes


1,820





1,820


Net income available to common shareholders

$
13,876

$
10,942

$
13,384

$
39,113Denominator:Denominator for basic earnings per shareweighted average shares


91,884


91,269


91,836


91,044Effect of dilutive securities:Convertible debt


177,088





60,549


Stock options


1,745


2,014


1,016


2,772Restricted shares





148





154Restricted share units


8,172








Other


267


107


201


96Denominator for diluted earnings per shareadjusted weighted average shares and assumed conversions


279,156


93,538


153,602


94,066


On
May 26, 2009, in order to have sufficient authorized but unissued shares of common stock for issuance with any conversion of the Convertible Notes, the Company amended its
Certificate of Incorporation to increase the number of voting Class A shares of common stock authorized for issuance by 400,000,000 to a total of 600,000,000 shares. The number of authorized
shares of preferred stock, par value $0.01 per share, remained unchanged at 50,000,000.

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 nine months ended
August 30, 2009 and

35

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 23: Earnings per Share (Continued)

August 31,
2008 are 8,617 and 25,188, respectively for fiscal 2009 and 3,278 and 2,970, respectively for fiscal 2008.

Note 24: Restructuring Activities

For the three and nine months ended August 30, 2009 and August 31, 2008, the Company recognized restructuring charges related to initiatives, including facility closures
and organizational changes. The pretax restructuring charges recognized by the Company during the three and nine months ended August 30, 2009 and August 31, 2008 were as follows:

Three Months Ended

Nine Months EndedAugust 30, 2009

August 31, 2008

August 30, 2009

August 31, 2008(in thousands)

(in thousands)Americas Segment

$


$
2,217

$
1,448

$
2,676Europe Segment





231





231$


$
2,448

$
1,448

$
2,907


The
following table summarizes the restructuring activity for the nine months ended August 30, 2009 and the related restructuring liabilities balance:

2009 Restructuring ActivitiesLiabilities
November 30, 2008

Charges to
Expense

Cash
Payments

Non-cash
Utilized

Liabilities
August 30, 2009(in thousands)Severance and employee benefits

$
393

$
114

$
(315
)
$


$
192Asset impairment charges





1,334





(1,334
)

Total

$
393

$
1,448

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


For
the nine months ended August 30, 2009, the Company incurred restructuring charges of $0.1 million representing costs incurred to relocate machinery and equipment
associated with the closure of its Clarion, Pennsylvania manufacturing facility which occurred in October 2008. Additionally, in the second quarter of fiscal 2009, management made the decision to
cease manufacturing of certain foundation components and begin purchasing all of these components from third party suppliers. As a result, the Company incurred certain costs which were insignificant
related to one-time terminations of employees. Additionally, the Company recognized an impairment charge of approximately $1.3 million for the related equipment used in this
manufacturing process that was not sold. This plan was completed in the second quarter of fiscal 2009 and we do not expect to incur additional costs related to this restructuring activity.

36

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 24: Restructuring Activities (Continued)

The
following table summarizes the restructuring activity for the nine months ended August 31, 2008 and the related restructuring liabilities balance:

2008 Restructuring ActivitiesLiabilities
December 2, 2007

Charges to
Expense

Cash
Payments

Non-cash
Utilized

Liabilities
August 31, 2008(in thousands)Severance and employee benefits

$


$
2,034

$
(389
)
$


$
1,645Asset impairment charges





873





(873
)

Total

$


$
2,907

$
(389
)
$
(873
)
$
1,645


In
the first quarter of fiscal 2008, the Company incurred charges for employee severance and related benefit charges related to the decision to cut back the manufacturing operations in
Brazil and move to a business model under which more product would be supplied by production from other Sealy manufacturing facilities.

In
the third quarter of fiscal 2008, management elected to close its administrative offices near Milan, Italy and relocate these activities to its manufacturing facility in Silvano,
Italy. This closure resulted in the elimination of approximately 10 employees who elected not to relocate in the fourth quarter of fiscal 2008. The Company recorded a pre-tax restructuring
charge related to this action of $0.2 million during the quarter ended August 31, 2008, which was entirely related to employee severance and benefits.

In
the third quarter of fiscal 2008, management also made the decision to close its manufacturing facility in Clarion, Pennsylvania. This closure resulted in the elimination of
approximately 114 positions. The Company recorded a pre-tax restructuring and impairment charge related to this action of $2.2 million during the quarter ended August 31,
2008, of which $1.3 million was related to employee severance and benefits and other exit costs, and $0.9 million which was non-cash in nature, related to fixed asset
impairment charges.

The
accrued balances related to these restructuring activities were recorded as a component of other accrued expenses in the accompanying Condensed Consolidated Balance Sheet.

Note 25: Guarantor/Non-Guarantor Financial Information

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

37

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 25: Guarantor/Non-Guarantor Financial Information (Continued)

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

The
following supplemental Condensed Consolidating Financial Statements present:



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.

38

---





SEALY CORPORATION        Supplemental Condensed Consolidating Balance Sheets        August 30, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
57

$


$
29,121

$
52,140

$
18,522

$


$
99,840Accounts receivable, net








11


113,813


75,622





189,446Inventories








2,037


36,153


19,882


(453
)

57,619Other current assets and deferred income taxes


1,357





393


31,228


9,472





42,450Total current assets


1,414





31,562


233,334


123,498


(453
)

389,355Property, plant and equipment, at cost








9,294


333,694


97,015





440,003Less accumulated depreciation








(4,661
)

(174,328
)

(41,667
)




(220,656
)





4,633


159,366


55,348





219,347Other assets:Goodwill








24,741


301,942


34,134





360,817Intangible assets, net


1,036








1,738








2,774Net investment in subsidiaries


(175,849
)

239,810


378,333


50,180


(1
)

(492,473
)

Due from (to) affiliates


239,955


(415,659
)

560,339


(109,844
)

(96,259
)

(178,532
)

Debt issuance costs, net and other assets








30,683


17,259


11,448





59,39065,142


(175,849
)

994,096


261,275


(50,678
)

(671,005
)

422,981Total assets

$
66,556

$
(175,849
)
$
1,030,291

$
653,975

$
128,168

$
(671,458
)
$
1,031,683Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$


$
2,726

$
8,865

$


$
11,591Accounts payable








485


61,748


43,681





105,914Accrued customer incentives and advertising











24,747


6,863





31,610Accrued compensation








339


26,143


7,248





33,730Accrued interest


12





1,279


13,305


247





14,843Other accrued liabilities


2,123





308


35,811


6,936





45,178Total current liabilities


2,135





2,411


164,480


73,840





242,866Long-term obligations


178,780





788,992


40,782


8,062


(178,780
)

837,836Written option liability for convertible notes




















Other liabilities











48,099


11,486





59,585Deferred income tax liabilities


783





(922
)

386


6,291





6,538Common stock and options subject to redemption




















Stockholders' equity (deficit)


(115,142
)

(175,849
)

239,810


400,228


28,489


(492,678
)

(115,142
)Total liabilities and stockholders' equity (deficit)

$
66,556

$
(175,849
)
$
1,030,291

$
653,975

$
128,168

$
(671,458
)
$
1,031,683


39

---





SEALY CORPORATION        Supplemental Condensed Consolidating Balance Sheets        November 30, 2008        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
589

$


$
1

$
2,423

$
23,583

$


$
26,596Accounts receivable, net








7


80,528


76,048





156,583Inventories








1,695


44,454


18,945


(460
)

64,634Other current assets and deferred income tax assets


1,368





2,645


38,406


5,325





47,7441,957





4,348


165,811


123,901


(460
)

295,557Property, plant and equipment, at cost








9,676


352,888


86,744





449,308Less accumulated depreciation








(4,613
)

(180,256
)

(33,691
)




(218,560
)





5,063


172,632


53,053





230,748Other assets:Goodwill








24,741


301,942


30,466





357,149Intangible assets, net


2,989








1,956








4,945Net investment in subsidiaries


(199,388
)

216,613


367,163


29,866





(414,254
)

Due from (to) affiliates


43,933


(416,001
)

534,520


(72,344
)

(90,206
)

98


Debt issuance costs, net and other assets








8,640


17,088


6,747





32,475(152,466
)

(199,388
)

935,064


278,508


(52,993
)

(414,156
)

394,569Total assets

$
(150,509
)
$
(199,388
)
$
944,475

$
616,951

$
123,961

$
(414,616
)
$
920,874Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$
3,750

$
2,737

$
14,756

$


$
21,243Accounts payable








341


52,337


44,406





97,084Accrued incentives and advertising











24,013


10,529





34,542Accrued compensation








392


16,082


8,323





24,797Accrued interest


27





1,127


14,919


359





16,432Other accrued liabilities


3,702





6,408


27,560


6,693





44,3633,729





12,018


137,648


85,066





238,461Long-term obligations








711,776


42,034


8,352





762,162Other liabilities


947





8,055


51,280


10,975





71,257Deferred income tax liabilities


783





(3,987
)

3,443


4,723





4,962Common stock and options subject to redemption


8,856

















8,856Stockholders' equity (deficit)


(164,824
)

(199,388
)

216,613


382,546


14,845


(414,616
)

(164,824
)Total liabilities and stockholders' equity (deficit)

$
(150,509
)
$
(199,388
)
$
944,475

$
616,951

$
123,961

$
(414,616
)
$
920,874


40

---





SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Three Months Ended August 30, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
22,373

$
242,758

$
91,307

$
(6,865
)
$
349,573Cost and expenses:Cost of goods sold








12,651


139,179


58,561


(6,883
)

203,508Selling, general and administrative


(9
)




2,038


86,554


21,673





110,256Amortization expense


770








73


(1
)




842Restructuring expenses and asset impairment




















Royalty (income) expense, net


(1,063
)







(4,216
)

1,063





(4,216
)Income from operations


302





7,684


21,168


10,011


18


39,183Interest expense


19


72


20,300


627


1,109





22,127Loss on rights for convertible notes


1,820

















1,820Gain on sale of subsidiary stock




















Refinancing and extinguishment of debt and interest rate derivatives








39











39Other (income) expense, net














(14
)




(14
)Loss (income) from equity investees


(5,927
)

(5,544
)

(495
)







11,966


Loss (income) from non- guarantor equity investees











(5,568
)




5,568


Capital charge and intercompany interest allocation








(18,508
)

17,858


650





Income (loss) before income taxes


4,390


5,472


6,348


8,251


8,266


(17,516
)

15,211Income tax provision (benefit)


(7,666
)

(455
)

804


7,866


2,698


(92
)

3,155Net income (loss)

$
12,056

$
5,927

$
5,544

$
385

$
5,568

$
(17,424
)
$
12,056


41

---





SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Three Months Ended August 31, 2008        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
19,415

$
285,425

$
107,266

$
(7,143
)
$
404,963Cost and expenses:Cost of goods sold








11,424


166,106


70,647


(7,334
)

240,843Selling, general and administrative expenses


106





1,912


102,474


28,400





132,892Amortization expense


844








72


65





981Restructuring expenses and asset impairment











2,217


231





2,448Royalty (income) expense, net


(1,168
)







(4,419
)

1,165





(4,422
)Income from operations


218





6,079


18,975


6,758


191


32,221Interest expense


62


99


12,649


607


962





14,379Other (income) expense, net











1


(118
)




(117
)Loss (income) from equity investees


(10,838
)

(10,902
)

(7,814
)







29,554


Loss (income) from non- guarantor equity investees











(2,339
)




2,339


Capital charge and intercompany interest allocation








(11,792
)

11,002


790





Income (loss) before income taxes


10,994


10,803


13,036


9,704


5,124


(31,702
)

17,959Income tax expense (benefit)


52


(35
)

2,134


1,916


2,922


28


7,017Net income (loss)

$
10,942

$
10,838

$
10,902

$
7,788

$
2,202

$
(31,730
)
$
10,942


42

---





SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Nine Months Ended August 30, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
62,593

$
676,224

$
239,641

$
(20,454
)
$
958,004Cost and expenses:Cost of goods sold








36,775


396,854


158,370


(20,461
)

571,538Selling, general and administrative


(12
)




5,790


233,238


63,517





302,533Amortization expense


2,220








217


(2
)




2,435Restructuring expenses and asset impairment











1,448








1,448Royalty (income) expense, net


(3,066
)







(12,217
)

3,097





(12,186
)Income from operations


858





20,028


56,684


14,659


7


92,236Interest expense


82


232


52,153


1,869


2,215





56,551Loss on rights for convertible notes


4,549

















4,549Gain on sale of subsidiary stock














(1,292
)




(1,292
)Refinancing and extinguishment of debt and interest rate derivatives








17,461











17,461Other (income) expense, net














(60
)




(60
)Loss (income) from equity investees


(6,002
)

(5,660
)

(2,617
)







14,279


Loss (income) from non- guarantor equity investees











(6,424
)




6,424


Capital charge and intercompany interest allocation








(47,522
)

45,777


1,745





Income (loss) before income taxes


2,229


5,428


553


15,462


12,051


(20,696
)

15,027Income tax provision (benefit)


(9,335
)

(574
)

(5,107
)

12,935


5,695


(151
)

3,463Net income (loss)

$
11,564

$
6,002

$
5,660

$
2,527

$
6,356

$
(20,545
)
$
11,564


43

---





SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Nine Months Ended August 31, 2008        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
55,879

$
804,025

$
334,875

$
(22,512
)
$
1,172,267Cost and expenses:Cost of goods sold








33,060


479,335


217,004


(22,820
)

706,579Selling, general and administrative expenses


73





5,503


274,159


85,801





365,536Amortization expense


2,491








217


142





2,850Restructuring expenses and asset impairment











2,217


690





2,907Royalty (income) expense, net


(3,382
)







(13,555
)

3,379





(13,558
)Income from operations


818





17,316


61,652


27,859


308


107,953Interest expense


211


369


39,963


1,662


2,919





45,124Other (income) expense, net











1


(298
)




(297
)Loss (income) from equity investees


(38,823
)

(38,999
)

(32,059
)







109,881


Loss (income) from non- guarantor equity investees











(18,568
)




18,568


Capital charge and intercompany interest allocation








(37,193
)

33,740


3,453





Income (loss) before income taxes


39,430


38,630


46,605


44,817


21,785


(128,141
)

63,126Income tax expense (benefit)


317


(193
)

7,606


12,784


3,471


28


24,013Net income (loss)

$
39,113

$
38,823

$
38,999

$
32,033

$
18,314

$
(128,169
)
$
39,113


44

---





SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Cash Flows        Nine Months Ended August 30, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by operating activities

$


$


$
11,069

$
28,929

$
215

$


$
40,213Investing activities:Purchase of property, plant and equipment








(57
)

(7,677
)

(935
)




(8,669
)Proceeds from the sale of property, plant, and equipment








47


10,272


66





10,385Net proceeds from sale of subsidiary














1,237





1,237Investments in and loans to unconsolidated affiliate














(2,322
)




(2,322
)Net activity in investment in and advances from (to) subsidiaries and affiliates


(202
)




(25,985
)

22,349


3,838





Net cash provided by (used in) investing activities


(202
)




(25,995
)

24,944


1,884





631Financing activities:Equity received upon exercise of stock including related excess tax benefits


(330
)
















(330
)Proceeds from issuance of long term obligations














3,343





3,343Repayments of long-term obligations











(4,156
)

(11,512
)




(15,668
)Repayment of old senior term loans








(377,181
)










(377,181
)Proceeds from issuance of new senior secured notes








335,916











335,916Proceeds from issuance of related party debt








177,132











177,132Repayment of related party notes








(83,284
)










(83,284
)Proceeds from issuance of convertible notes, net








83,284











83,284Borrowings under new asset-based revolver




















Borrowings under old revolving credit facilities








130,300





10,604





140,904Repayments on old revolving credit facilities








(194,700
)




(10,604
)




(205,304
)Debt issuance costs




















Other








(27,421
)










(27,421
)Net cash used in financing activities


(330
)




44,046


(4,156
)

(8,169
)




31,391Effect of exchange rate changes on cash














1,009





1,009Change in cash and equivalents


(532
)




29,120


49,717


(5,061
)




73,244Cash and equivalents:Beginning of period


589





1


2,423


23,583





26,596End of period

$
57

$


$
29,121

$
52,140

$
18,522

$


$
99,840


45

---





SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Cash Flows        Nine Months Ended August 31, 2008        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by operating activities

$


$


$
8,956

$
25,573

$
30,249

$


$
64,778Cash flows from investing activities:Purchase of property, plant and equipment








(136
)

(16,685
)

(4,281
)




(21,102
)Proceeds from the sale of property, plant, and equipment








53


(38
)

19





34Net activity in investment in and advances from (to) subsidiaries and affiliates


6,399





5,739


(6,307
)

(5,831
)




Net cash provided by (used in) investing activities


6,399





5,656


(23,030
)

(10,093
)




(21,068
)Cash flows from financing activities:Dividend


(6,811
)
















(6,811
)Equity received upon exercise of stock including related excess tax benefits


824

















824Repurchase of common stock




















Proceeds from issuance of long term obligations














8,114





8,114Repayments of long-term obligations








(11,212
)

(4,283
)

(8,326
)




(23,821
)Borrowings under revolving credit facilities








260,700





16,958





277,658Repayments on revolving credit facilities








(264,100
)




(16,985
)




(281,085
)Other




















Net cash used in financing activities


(5,987
)




(14,612
)

(4,283
)

(239
)




(25,121
)Effect of exchange rate changes on cash














(2,497
)




(2,497
)Change in cash and cash equivalents


412








(1,740
)

17,420





16,092Cash and cash equivalents:Beginning of period


4





1


4,012


10,590





14,607End of period

$
416

$


$
1

$
2,272

$
28,010

$


$
30,699


46

---





SEALY CORPORATION

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

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

BUSINESS OVERVIEW

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

The
current economic and weak retail environments have affected the level of spending by end consumers and have caused a decrease in U.S. mattress sales across the industry and we are
experiencing a slowdown in our international markets as well. We expect this challenging business environment to continue through 2009. Furthermore, changes in foreign exchange rates contributed
favorably to international results in fiscal 2008 and these trends have begun to reverse.

We
have continued our focus on new product development to bring new and innovative products to the market. In February 2009, we introduced our redesigned Stearns & Fosterproduct line which
features our Variable Response Technology foam to provide a softer, more indulgent sleep surface. Earlier, in
January 2008, we introduced our newSealy Posturepedicinnerspring line which is designed to eliminate tossing and turning caused by pressure points. We
have also invested capital in the business to increase our capability to design products including the opening of our Center of Excellence pressure-mapping laboratory in 2008.

Our
industry continues to recover from volatility in the price of petroleum-based and steel products, which affects the cost of our polyurethane foam, polyester, polyethylene foam and
steel innerspring component parts. Domestic supplies of these raw materials are being limited by supplier consolidation, the exporting of these raw materials outside of the U.S. and other forces
beyond our control. During fiscal 2008, the cost of these components saw significant increases above their recent historical averages. These costs, particularly those related to steel and polyurethane
and latex foams, decreased during the third quarter of fiscal 2009 and we expect these prices to stabilize during the fourth quarter of fiscal 2009 due to reduced volatility in related commodity
prices. The manufacturers of products such as petro-chemicals and wire rod, which are the feed stocks purchased by our suppliers of foam and drawn wire, may reduce supplies in an effort to maintain
higher prices. These actions would delay or eliminate price reductions from our suppliers.

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

47

---



RESULTS OF OPERATIONS



The following table sets forth our summarized results of operations for the three months ended August 30, 2009 and
August 31, 2008, expressed in thousands of dollars, as well as a percentage of each period's net sales:

For the three months ended:August 30, 2009

August 31, 2008(in thousands)

(percentage
of net sales)

(in thousands)

(percentage
of net sales)Net sales

$
349,573


100.0
%
$
404,963


100.0
%Cost of goods sold


203,508


58.2


240,843


59.5Gross profit


146,065


41.8


164,120


40.5Selling, general and administrative expenses


110,256


31.5


132,892


32.8Amortization expense


842


0.2


981


0.2Restructuring expenses and asset impairment








2,448


0.6Royalty income, net of royalty expense


(4,216
)

(1.2
)

(4,422
)

(1.1
)Income from operations


39,183


11.2


32,221


8.0Interest expense


22,127


6.3


14,379


3.6Loss on rights for convertible notes


1,820


0.5





Refinancing and extinguishment of debt and interest rate derivatives


39








Other income, net


(14
)




(117
)

Income before income taxes


15,211


4.4


17,959


4.4Income tax provision


3,155


0.9


7,017


1.7Net income

$
12,056


3.4
%
$
10,942


2.7
%Effective tax rate


20.7
%




39.1
%


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

Three Months Ended:August 30,
2009

August 31,
2008Americas:United States


73.4
%

73.1
%Canada


12.9


12.2Other


5.7


6.9Total Americas


92.0


92.2Europe


8.0


7.8Total


100.0
%

100.0
%


48

---



The
following table shows our net sales and margin profitability for our Americas and Europe segments as well as the major geographic regions within our Americas segment:

For the three months endedAugust 30, 2009

August 31, 2008(in thousands)

(percentage
of net sales)

(in thousands)

(percentage
of net sales)Total Americas (US Dollars):Net sales

$
321,719


100.0
%
$
373,231


100.0
%Cost of goods sold


183,105


56.9


214,593


57.5Gross profit


138,614


43.1


158,638


42.5United States (US Dollars):Net sales


256,755


100.0


296,105


100.0Cost of goods sold


143,943


56.1


169,223


57.1Gross profit


112,812


43.9


126,882


42.9Total International (US Dollars):Net sales


92,818


100.0


108,858


100.0Cost of goods sold


59,565


64.2


71,620


65.8Gross profit


33,253


35.8


37,238


34.2Canada:US Dollars:Net sales


45,201


100.0


49,438


100.0Cost of goods sold


27,263


60.3


28,705


58.1Gross profit


17,938


39.7


20,733


41.9Canadian Dollars:Net sales


49,996


100.0


50,525


100.0Cost of goods sold


30,164


60.3


29,343


58.1Gross profit


19,832


39.7


21,182


41.9Other Americas (US Dollars):Net sales


19,763


100.0


27,688


100.0Cost of goods sold


11,899


60.2


16,665


60.2Gross profit


7,864


39.8


11,023


39.8Europe:US Dollars:Net sales


27,854


100.0


31,732


100.0Cost of goods sold


20,403


73.2


26,250


82.7Gross profit


7,451


26.8


5,482


17.3Euros:Net sales


19,672


100.0


20,407


100.0Cost of goods sold


14,405


73.2


16,891


82.8Gross profit


5,267


26.8
%

3,516


17.2
%


49

---







Net Sales.Our consolidated net sales for the quarter ended August 30, 2009, were $349.6 million, a decrease of
$55.4 million,
or 13.7%, from the quarter ended August 31, 2008. Total Americas net sales were $321.7 million for the third quarter of fiscal 2009, a decrease of 13.8% from the third quarter of fiscal
2008. This decrease was primarily related to decreased sales in the U.S. coupled with decreases in the Canada and Other Americas businesses. Total U.S. net sales were $256.8 million for the
third quarter of fiscal 2009, a decrease of 13.3% from the third quarter of fiscal 2008. The U.S. net sales decrease of $39.4 million was attributable to a 12.9% decrease in wholesale unit
volume, which excludes third party sales from our component plants, partially offset by a 0.1% increase in wholesale average unit selling price. The decrease in unit volume is primarily attributable
to continued weak retail demand as described above under "Business Overview". International net sales decreased $16.0 million or 14.7%, from the third quarter of fiscal 2008 to
$92.8 million. Excluding the effects of currency fluctuation, net sales declined 4.3% from the third quarter of fiscal 2008. This decline was primarily due to declines in finished goods sales
in Europe and, to a lesser extent, the weak retail environment in the Other Americas. In Canada, local currency sales decreases of 1.0% translated into decreases of 8.6% in U.S. dollars due to a lower
average value of the Canadian dollar versus the U.S. dollar. Local currency sales performance in Canada was driven by a 1.8% decrease in average unit selling price, which was partially offset by a
0.8% increase in unit volume. The decreased average unit selling price was driven by the increased volume of lower priced products as well as increased promotional activities. The increase in unit
volume is primarily attributable to relatively more promotional activity compared to the third quarter of fiscal 2008 when our business was disrupted by the relocation of our Toronto facility.
Elsewhere in the Americas, we have experienced sales decreases in our Mexico and South American markets. In our Europe segment, local currency sales decreases of 3.6% translated into decreases of
12.2% in U.S. dollars due to the decline in value of the Euro versus the U.S. dollar. The
decline in local currency sales was driven by a 16.1% decrease in finished goods sales which we believe is reflective of the overall economic slowdown in Europe, which was offset by increases in OEM
sales.

Gross Profit.Our consolidated gross profit for the quarter was $146.1 million, a decrease of $18.1 million from the
comparable prior
year period. As a percentage of net sales, gross profit increased 1.3 percentage points to 41.8% due to an increase in gross profit margins in both of our segments. Total Americas gross profit
for the quarter was $138.6 million, a decrease of $20.0 million from the comparable prior year period. As a percentage of net sales, gross profit for the Americas increased
0.6 percentage points to 43.1%. This increase as a percentage of sales was primarily due to an increase in gross profit margins in our U.S. operations partially offset by decreased gross profit
margins in Canada. U.S. gross profit decreased $14.1 million to $112.8 million, which, as a percent of sales, represents an increase of 1.0 percentage points to 43.9% of net
sales. The increase in percentage of net sales was driven primarily by lower material costs as the related commodity prices remained below prior year levels through the third quarter. Conversely,
margins were negatively impacted by less absorption of fixed costs as a result of lower volume. In local currency, the gross profit margin in Canada was 39.7% as a percentage of net sales which
represents a decrease of 2.2 percentage points. This decrease was driven by the impact of higher material costs per unit and the lower average unit selling price discussed above. In our Europe
segment, the local currency gross profit margin increase of 9.6 percentage points was primarily due to decreased prices of raw materials due to deflation in the prices of the underlying
commodities.

Selling, General, Administrative.Our consolidated selling, general and administrative expense decreased $22.6 million to
$110.3 million. As a percent of net sales this expense was 31.5% and 32.8% for the quarters ended August 30, 2009 and August 31, 2008, respectively, a decrease of
1.3 percentage points. The decrease as a percent of sales is primarily due to our efforts to improve efficiencies and our cost structure to compensate for the current retail environment. The
decrease in absolute dollars is primarily due to a $14.9 million reduction in volume driven variable expenses including a $7.6 million

50

---



reduction
in cooperative advertising and promotional costs, a $4.8 million reduction in delivery costs due primarily to a decrease in unit volume shipped and a decrease in bad debt expense of
$2.5 million. Fixed operating costs, exclusive of compensation expense, decreased $17.0 million from the prior year period primarily due to a $10.1 million reduction in national
advertising expenses as well as reductions in other discretionary expenditures such as travel and entertainment. Improvements of $2.5 million on foreign exchange related transactions also
contributed positively to the third quarter of fiscal 2009. Compensation expense increased by $9.3 million compared to the third quarter of fiscal 2008. This increase is primarily due to
increases of $5.8 million for incentive-based payments and our expected defined contribution plan payments based on operating results through the third quarter of fiscal 2009 coupled with
non-cash compensation expense recognized for new grants and the modification of share-based awards of $4.1 million the effects of which were partially offset by lower compensation
expense due to reduced headcount.

Restructuring expenses and asset impairment.We recognized no pretax restructuring costs during the quarter ended August 30, 2009
as compared
with costs of $2.4 million recognized during the comparable prior year period.

In
the third quarter of fiscal 2008, management made the decision to close its manufacturing facility in Clarion, Pennsylvania. We recorded a pre-tax restructuring and
impairment charge related to this action of $2.2 million during the quarter ended August 31, 2008, of which $1.3 million was related to employee severance and benefits and other
exit costs, and $0.9 million which was non-cash in nature, related to fixed asset impairment charges. This plan was completed in the first quarter of fiscal 2009 and we do not
expect to incur additional costs related to this restructuring activity.

In
the third quarter of fiscal 2008, management also elected to close its administrative offices near Milan, Italy and relocate these activities to its manufacturing facility in Silvano,
Italy. We recorded a pre-tax restructuring charge related to this action of $0.2 million during the quarter ended August 31, 2008, which was entirely related to employee
severance and benefits. This plan was completed in the fourth quarter of fiscal 2008.

Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, of $4.2 million for the three
months ended
August 30, 2009 remained relatively flat as compared with the prior year period.

Interest Expense.Our consolidated interest expense for the third quarter of fiscal 2009 increased $7.7 million as compared with
the prior
year period to $22.1 million which included $4.2 million of non-cash interest expense. Our net weighted average borrowing cost was 10.4% and 7.2% for the three months ended
August 30, 2009 and August 31, 2008, respectively. Our borrowing cost was unfavorably impacted by the Refinancing which resulted in increased interest rates and outstanding debt
balances.

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, non-deductible mark to market adjustments for derivatives associated with the Convertible Notes subscription rights, certain foreign tax
rate differentials and state and local income taxes. Our effective tax rate for the three months ended August 30, 2009 was 20.7% compared to 39.1% for the three months ended August 31,
2008. The effective rate for the fiscal 2009 period was lower
than the fiscal 2008 period primarily due to the reversal of $10.2 million of the liability for uncertain tax positions and related interest (net) and penalties due to the expiration of
statutes of limitations, offset by lower pre-tax income in fiscal 2009.

51

---





The following table sets forth our summarized results of operations for the nine months ended August 30, 2009 and
August 31, 2008, expressed in thousands of dollars, as well as a percentage of each period's net sales:

For the nine months ended:August 30, 2009

August 31, 2008(in thousands)

(percentage
of net sales)

(in thousands)

(percentage
of net sales)Net sales

$
958,004


100.0
%
$
1,172,267


100.0
%Cost of goods sold


571,538


59.7


706,579


60.3Gross profit


386,466


40.3


465,688


39.7Selling, general and administrative expenses


302,533


31.6


365,536


31.2Amortization expense


2,435


0.3


2,850


0.2Restructuring expenses and asset impairment


1,448


0.2


2,907


0.2Royalty income, net of royalty expense


(12,186
)

(1.3
)

(13,558
)

(1.2
)Income from operations


92,236


9.6


107,953


9.2Interest expense


56,551


5.9


45,124


3.8Loss on rights for convertible notes


4,549


0.5





Refinancing and extinguishment of debt and interest rate derivatives


17,461


1.8





Gain on sale of subsidiary stock


(1,292
)

(0.1
)




Other income, net


(60
)




(297
)

Income before income taxes


15,027


1.6


63,126


5.5Income tax provision


3,463


0.4


24,013


2.0Net income

$
11,564


1.2
%
$
39,113


3.5
%Effective tax rate


23.0
%




38.0
%


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

Nine Months
Ended:2009

2008Americas:United States


74.5
%

71.3
%Canada


11.4


11.8Other


6.1


7.0Total Americas


92.0


90.1Europe


8.0


9.9Total


100.0
%

100.0
%


52

---



The
following table shows our net sales and margin profitability for our Americas and Europe segments as well as the major geographic regions within our Americas segment:

For the nine months ended:August 30, 2009

August 31, 2008(in thousands)

(percentage
of net sales)

(in thousands)

(percentage
of net sales)Total Americas (US Dollars):Net sales

$
881,722


100.0
%
$
1,056,600


100.0
%Cost of goods sold


514,927


58.4


617,750


58.5Gross profit


366,795


41.6


438,850


41.5United States (US Dollars):Net sales


713,988


100.0


836,073


100.0Cost of goods sold


410,283


57.5


490,127


58.6Gross profit


303,705


42.5


345,946


41.4Total International (US Dollars):Net sales


244,016


100.0


336,194


100.0Cost of goods sold


161,255


66.1


216,452


64.4Gross profit


82,761


33.9


119,742


35.6Canada:US Dollars:Net sales


108,982


100.0


138,697


100.0Cost of goods sold


68,996


63.3


79,161


57.1Gross profit


39,986


36.7


59,536


42.9Canadian Dollars:Net sales


127,604


100.0


139,949


100.0Cost of goods sold


80,959


63.4


79,882


57.1Gross profit


46,645


36.6


60,067


42.9Other Americas (US Dollars):Net sales


58,752


100.0


81,830


100.0Cost of goods sold


35,648


60.7


48,462


59.2Gross profit


23,104


39.3


33,368


40.8Europe:US Dollars:Net sales


76,282


100.0


115,667


100.0Cost of goods sold


56,611


74.2


88,829


76.8Gross profit


19,671


25.8


26,838


23.2Euros:Net sales


56,127


100.0


75,643


100.0Cost of goods sold


41,644


74.2


58,049


76.7Gross profit


14,483


25.8
%

17,594


23.3
%


53

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Net Sales.Our consolidated net sales for the nine months ended August 30, 2009, were $958.0 million, a decrease of
$214.3 million, or 18.3%, from the nine months ended August 31, 2008. Total Americas net sales were $881.7 million for the first three quarters of fiscal 2009, a decrease of 16.6%
from the first three quarters of fiscal 2008. This decrease was primarily related to our U.S. and Canadian operations within the Americas segment. Total U.S. net sales were $714.0 million for
the first three quarters of fiscal 2009, a decrease of 14.6% from the first three quarters of fiscal 2008. The U.S. net sales decrease of $122.1 million was attributable to a 14.2% decrease in
wholesale unit volume, which excludes third party sales from our component plants, and a 0.2% decrease in wholesale average unit selling price. The decrease in unit volume is primarily attributable to
continued weak retail demand as described above under "Business Overview". Of the 0.2% decrease in wholesale average unit selling price, 0.4% was attributable to the $3.7 million favorable
impact received from the change in the estimated reserve for non-warranty product returns in fiscal 2008. These factors were partially offset by the favorable impact of the July 2008 price
increase, increased delivery revenue and fewer discounted floor samples in the second quarter of fiscal 2009 as theStearns & Fosterproduct
launch was not distributed as widely as thePosturepedicproduct launched in the second quarter of fiscal 2008. International net sales decreased
$92.2 million, or 27.4%, from the first three quarters of fiscal 2008 to $244.0 million. Excluding the effects of currency fluctuation, net sales declined 15.4% from the first three
quarters of fiscal 2008. This decline was primarily due to declines in sales in Europe and, to a lesser extent, the weak retail environment in Canada and the Other Americas. In Canada, local currency
sales decreases of 8.8% translated into decreases of 21.4% in U.S. dollars due to a lower average value of the Canadian dollar versus the U.S. dollar. Local currency sales performance in Canada was
driven by a 9.1% decrease in unit volume, which was partially offset by a 0.3% increase in average unit selling price. The decrease in unit volume is primarily attributable to weak Canadian retail
demand. Elsewhere in the Americas, we have experienced sales decreases in our Mexico and South American markets. In
our Europe segment, local currency sales decreases of 25.8% translated into decreases of 34.1% in U.S. dollars due to a decline in the value of the Euro versus the U.S. dollar. Decreased sales of OEM
latex bed cores, which have lower prices, drove most of the decline. Additionally, local currency finished goods sales in Europe also decreased by 11.7% and we believe such a decrease is due to the
overall economic slowdown in Europe.

Gross Profit.Our consolidated gross profit for the nine months ended August 30, 2009 was $386.5 million, a decrease of
$79.2 million from the comparable prior year period. As a percentage of net sales, gross profit increased 0.6 percentage points to 40.3% due to an increase in gross profit margins in the
U.S. offset by decreases in our international operations. Total Americas gross profit for the nine months was $366.8 million, a decrease of $72.1 million from the comparable prior year
period. As a percentage of net sales, gross profit for the Americas remained relatively flat at 41.6% as the increases seen in the U.S. were offset by the decreases in Canada and the Other Americas
businesses. U.S. gross profit decreased $42.2 million to $303.7 million. However, as a percent of sales, this represents an increase of 1.1 percentage points to 42.5% of net
sales. The increase as a percentage of net sales was driven by the continued favorable impact of operations efficiencies and the price increases taken in July 2008. Partially offsetting these
improvements was a benefit of $8.2 million from the change in accounting estimate related to our returns allowances in the prior year period which resulted in a reduction of cost of sales of
approximately $4.5 million and an increase to sales of approximately $3.7 million. Also, a decrease in absorption of fixed costs as a result of lower volume and the unfavorable impact of
inflation including significant increases on steel and foam in the first part of fiscal 2009 negatively impacted gross profit margin. The local currency gross profit margin in Canada was 36.6% as a
percentage of net sales which represents a decrease of 6.3 percentage points. This decrease was driven by the impact of currency fluctuations and inflation on raw materials. In our Europe
segment, the local currency gross profit margin increase of 2.5 percentage points was due to

54

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the
shift in product sales mix toward more finished goods sales coupled with decreased prices of raw materials due to the deflation in the prices of the underlying commodities.

Selling, General, Administrative.Our consolidated selling, general and administrative expense decreased $63.0 million to
$302.5 million. As a percent of net sales this expense was 31.6% and 31.2% for the nine months ended August 30, 2009 and August 31, 2008, respectively, an increase of
0.4 percentage points. The increase as a percent of sales is primarily due to lower sales volumes. The decrease in absolute dollars is primarily due to a $35.4 million reduction in
volume driven variable expenses including an $18.2 million decrease in cooperative advertising and promotional costs, a $15.5 million decrease in delivery costs due primarily to a
decrease in unit volume shipped and a $1.7 million decrease in bad debt expense. Fixed operating costs, exclusive of compensation expense, decreased $33.9 million from the prior year
period primarily due to reductions in national advertising expenses and discretionary expenditures such as travel and entertainment. Compensation expense increased $6.3 million compared to the
nine months ended August 31, 2008. This increase is primarily due to increases of $8.1 million for incentive-based payments and our expected defined contribution plan payments based on
operating results through the third quarter of fiscal 2009 coupled with the recognition of non-cash
compensation expense recognized for new grants and the modification of share-based awards of $4.1 million, the effects of which were partially offset by lower compensation expense due to
reduced headcount. In addition, severance and foreign exchange transaction related costs improved $2.8 million and $2.7 million, respectively from the first three quarters of fiscal
2008.

Restructuring expenses and asset impairment.We recognized pretax restructuring costs of $1.4 million during the nine months ended
August 30, 2009 as compared with costs of $2.9 million recognized during the comparable prior year period.

In
the second quarter of fiscal 2009, management made the decision to cease manufacturing of certain foundation components and begin purchasing all of these components from third-party
suppliers. As a result, we incurred certain insignificant costs related to one-time terminations of employees. Additionally, we recognized an impairment charge of approximately
$1.3 million for the related equipment used in this manufacturing process that was not sold. This plan was completed in the second quarter of fiscal 2009 and we do not expect to incur
additional costs related to this restructuring activity.

In
the first quarter of fiscal 2008, management made the decision to cut back the manufacturing operations in Brazil and move to a business model under which more product would be
supplied by production from other Sealy manufacturing facilities. As a result, we incurred charges of $0.5 million during that period related to employee severance and related benefits. The
plan was completed in the fourth quarter of fiscal 2008.

In
the third quarter of fiscal 2008, management also made the decision to close its manufacturing facility in Clarion, Pennsylvania. We recorded a pre-tax restructuring and
impairment charge related to this action of $2.2 million during the quarter ended August 31, 2008, of which $1.3 million was related to employee severance and benefits and other
exit costs, and $0.9 million which was non-cash in nature, related to fixed asset impairment charges. During the nine months ended August 30, 2009, we incurred additional
charges related to this action of $0.1 million primarily related to relocation costs. This plan was completed in the first quarter of fiscal 2009 and we do not expect to incur additional costs
related to this restructuring activity.

In
the third quarter of fiscal 2008, management elected to close its administrative offices near Milan, Italy and relocate these activities to its manufacturing facility in Silvano,
Italy. We recorded a pre-tax restructuring charge related to this action of $0.2 million during the quarter ended August 31, 2008, which was entirely related to employee
severance and benefits. This plan was completed in the fourth quarter of fiscal 2008.

55

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Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, for the nine months ended
August 30, 2009
decreased by $1.4 million as compared with the prior year period to $12.2 million primarily due to a decrease in domestic license sales along with unfavorable fluctuations in
international currency rates.

Interest Expense.Our consolidated interest expense for the nine months ended August 30, 2009 increased $11.4 million as
compared with
the prior year period to $56.6 million which includes $5.4 million of non-cash interest expense. Our net weighted average borrowing cost was 9.3% and 7.5% for the nine months
ended August 30, 2009 and August 31, 2008, respectively. Our borrowing cost was unfavorably impacted by the Refinancing which resulted in increased interest rates and outstanding debt
balances. Additionally, the amendment of our old senior credit facility in the fourth quarter of fiscal 2008 unfavorably impacted the interest rates that were applicable prior to the Refinancing.

Refinancing and extinguishment of debt and interest rate derivativesDebt extinguishment and refinancing expenses for the nine months
ended
August 30, 2009 includes non-cash charges of $2.1 million relating to the write-off of debt issuance costs related to our old senior term loans. Additionally, we
incurred $15.2 million of charges associated with termination payments on our interest rate swap agreements that were associated with the old senior credit facility.

Gain on sale of subsidiary stock.On December 1, 2008, the Company sold 50% of its ownership interest in its 100% owned subsidiary
Sealy Korea
Company to the Company's Australian licensee and these operations became part of the joint venture that we participate in with the Australian licensee. As a result of the sale of this 50% interest,
the Company recognized a gain of $1.3 million in the nine months ended August 30, 2009.

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, non-deductible mark to market adjustments for derivatives associated with the
Convertible Notes subscription rights, certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for the nine months ended August 30, 2009 was 23.0%
compared to 38.0% for the nine months ended August 31, 2008. The effective rate for the fiscal 2009 period was lower than the fiscal 2008 period primarily due to the reversal of
$10.2 million of the liability for uncertain tax positions and related interest (net) and penalties due to the expiration of statutes of limitations, offset by lower pre-tax income
in fiscal 2009.

LIQUIDITY AND CAPITAL RESOURCES



Our principal sources of funds are cash flows from operations and borrowings 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 $8.7 million for the nine months ended August 30, 2009. We expect total 2009 capital expenditures to be approximately $13.0 to $15.0 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, 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 August 30, 2009, the Company had
approximately $70.9 million available under the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $16.0 million. The calculated
borrowing base under the ABL Revolver is determined based on our domestic accounts receivable and inventory balances. Our net weighted average borrowing cost was 9.3% and 7.5% for the nine months
ended

56

---



August 30,
2009 and August 31, 2008, respectively. As of September 23, 2009, we had no borrowings outstanding under the ABL Revolver.

On
May 13, 2009, the Company announced a comprehensive plan to refinance its existing senior secured credit facilities (the "Old Senior Credit Facility") and replace them with
indebtedness that has longer-dated maturities and eliminates quarterly financial ratio based maintenance covenants (the "Refinancing"). The Refinancing converted much of the existing senior debt from
debt bearing interest
at variable rates to debt bearing interest at fixed rates. Due to increases in the interest rates associated with our senior debt, the amount of debt outstanding and increases in the amortization of
debt issuance costs, our interest expense in future periods is expected to increase significantly. However, we do not expect cash interest payments to change significantly due to the payment in kind
interest associated with the Convertible Notes (as discussed below).



In connection with the Refinancing, we have: 1) entered into a new asset-based revolving credit facility (the "ABL Revolver")
which provides commitments of up to $100.0 million maturing in May 2013, which bears interest at our choice of either a base rate (determined by reference to the higher of several rates as
defined by the ABL Revolver agreement) or a LIBOR rate for U.S. dollar deposits plus an applicable margin of 4.00%; 2) issued $350.0 million in aggregate principal amount of senior
secured notes due April 2016 (the "Senior Notes"), which bear interest at 10.875% per annum payable semi-annually; and 3) issued $177.1 million in aggregate principal amount
of senior secured convertible paid in kind ("PIK") notes due July 2016 which are convertible into shares of the Company's common stock (the "Convertible Notes") and bear interest at 8.00% per annum
payable semi-annually in the form of additional Convertible Notes.

At
August 30, 2009, there were no amounts outstanding under the ABL Revolver. The Senior Notes have an outstanding balance of $336.3 million at August 30, 2009 which
gives effect to an unamortized original issue discount of $13.7 million. As of August 30, 2009, the Convertible Notes have an outstanding principal balance of $178.8 million. We
also have an outstanding principal balance of $273.9 million at August 30, 2009 on the 8.25% Senior Subordinated Notes due 2014 (the "2014 Notes").

Future
interest payments are expected to be paid out of cash flows from operations and borrowings on our ABL Revolver. The ABL Revolver provides for revolving credit financing, subject
to borrowing base availability. The borrowing base consists of the following: 1) 85% of the net amount of eligible accounts receivable and 2) the lesser of (i) 85% of the net
orderly liquidation value of eligible inventory or (ii) 65% of the net amount of eligible inventory. These amounts are reduced by reserves deemed necessary by the lenders. At August 30,
2009, there were no amounts outstanding under the ABL Revolver.

Prior
to the Refinancing, we had outstanding three interest rate swap agreements related to term debt under our Old Senior Credit Facility. These interest rate swaps consisted of:
1) an agreement fixing the floating portion of the interest rate at 5.495% on $242 million of the outstanding balance through November 2008, declining to $240 million from
December 2008 through November 2009, and further declining to $180 million from December 2009 through November 2010; 2) an agreement fixing the floating portion of the interest rate at
1.952% on $20.0 million of the outstanding balance through November 4, 2009; and 3) an agreement fixing the floating portion of the interest rate at 1.991% on
$107.0 million of the outstanding balance through February 4, 2010. In connection with the Refinancing,
we paid $15.2 million to terminate these interest rate swap agreements. As the future variable interest rate payments are no longer probable of being made, the amounts which had previously been
recorded in accumulated other comprehensive income were charged to refinancing expense for the nine months ended August 30, 2009, in accordance with the provisions of FAS 133.

57

---



We
are also party to three interest rate swaps for 2.3 million Euros, 2.9 million Euros and 3.5 million Euros which fix the floating interest rates on the debt of
our Europe segment at 4.92%, 4.85% and 4.50%, respectively. The notional amounts of these contracts amortize over the life of the agreement and the agreements expire in May 2019, January 2013 and
October 2013. We have not formally documented these interest rate swaps as hedges. Therefore, changes in the fair value of these interest rate swaps are recorded as a component of interest expense.

The
outstanding 8.25% Senior Subordinated Notes due 2014 (the "2014 Notes") consist of an original $314 million aggregate principal amount maturing June 15, 2014, bearing
interest at 8.25% per annum payable semiannually in arrears on June 15 and December 15, commencing on December 15, 2004. At August 30, 2009, the outstanding balance of the
2014 Notes was $273.9 million.

At
August 30, 2009, 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 opportunities may from time to time include the redemption or
repurchase of a portion of our Senior Notes, the 2014 Notes or the Convertible Notes to the extent permitted by our debt covenants. 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 August 30, 2009, we have repurchased shares for $16.3 million under this program, none of which was
repurchased during fiscal 2009. From August 31 through September 23, 2009, 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 $11.6 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 portions of our
senior or subordinated debt during that time.



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. We currently do not meet this requirement.

58

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The following table summarizes our changes in cash:

Nine Months Ended:August 30,
2009

August 31,
2008(in thousands)Statement of Cash Flow Data:Cash flows provided by (used in):Operating activities

$
40,213

$
64,778Investing activities


631


(21,068
)Financing activities


31,391


(25,121
)Effect of exchange rate changes on cash


1,009


(2,497
)Change in cash and cash equivalents


73,244


16,092Cash and cash equivalents:Beginning of period


26,596


14,607End of period

$
99,840

$
30,699




Cash Flows from Operating Activities.Our cash flow from operations decreased $24.6 million to $40.2 million in net cash
provided for
the nine months ended August 30, 2009, compared to $64.8 million in net cash provided for the nine months ended August 31, 2008. This decrease is primarily the result of a
decrease in net income. Net income and cash flows from operations for the nine months ended August 30, 2009 includes $15.2 million of payment to terminate our interest rate swaps. The
decrease in cash used for working capital of $3.3 million includes a benefit for the receipt of $8.0 million of income tax refunds during the nine months ended August 30, 2009.

Cash Flows from Investing Activities.Our cash flows provided by investing activities for the nine months ended August 30, 2009
was
$0.6 million as compared to net cash used in investing activities of $21.1 million for the nine months ended August 31, 2008. This change is due to $8.4 million of proceeds
from the sale-leaseback of the Company's South Gate, California facility coupled with $12.4 million of lower capital expenditures for the first nine months of fiscal 2009 as
compared to the same fiscal period in the prior year.

Cash Flows from Financing Activities.Our cash flow provided by financing activities for the nine months ended August 30, 2009 was
$31.4 million compared with cash used in financing activities of $25.1 million for the nine months ended August 31, 2008. This change has been primarily driven by the Refinancing
which provided $44.0 million of cash after considering the effects of the payments of costs to issue our new debt.



Significant judgment is required in evaluating our federal, state and foreign tax positions and in the determination of our tax
provision. Despite our belief that our liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of any particular tax
matters. We may adjust these liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, our tax advisors, or resolution of issues in the courts. These adjustments
are recognized as a component of income tax expense entirely in the period in which they are identified. 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

59

---



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 August 30, 2009. 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. Our ABL Revolver requires us to meet a minimum
fixed charge coverage ratio in order to incur additional indebtedness and make dividend distributions to holders of our common stock, subject to certain exceptions. Additionally, the ABL Revolver
requires us to maintain a fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two consecutive calendar days is less than the greater of
1) 15% of the total commitment under the ABL Revolver and 2) $15.0 million. As of August 30, 2009, we are in compliance with the maintenance covenant and are not in a
minimum availability period under the ABL Revolver. The indentures governing our Senior Notes, Convertible Notes and Senior Subordinated Notes also require us to meet a fixed charge coverage ratio in
order to incur additional indebtedness, subject to certain exceptions.

The
covenants contained in our senior debt agreements are based on what we refer to herein as "Adjusted EBITDA". In the senior debt agreements, EBITDA is defined as net income plus
interest, taxes, depreciation and amortization and Adjusted EBITDA is defined as EBITDA further adjusted to exclude unusual items and other adjustments permitted in calculating covenant compliance as
discussed above. Adjusted EBITDA is presented herein as it is a material component of these covenants. Non-compliance with such covenants could result in the requirement to immediately
repay all amounts outstanding under such facilities. While the determination of "unusual items" is subject to interpretation and requires judgment, we believe the adjustments listed below are in
accordance with the covenants.

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

60

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The
following table sets forth a reconciliation of net income to EBITDA and EBITDA to Adjusted EBITDA for the three and nine months ended August 30, 2009:

Three Months Ended:
August 30, 2009

Nine Months Ended:
August 30, 2009(in thousands)

(in thousands)Net income

$
12,056

$
11,564Interest expense


22,127


56,551Income taxes


3,155


3,463Depreciation and amortization


8,102


23,840EBITDA


45,440


95,418Adjustments for debt covenants:Refinancing charges


40


17,461Non-cash compensation


5,164


7,387KKR consulting fees


655


2,196Severance charges


229


2,171Loss on written option derivative


1,820


4,549Other(a)


319


1,599Adjusted EBITDA

$
53,667

$
130,781






The
following table reconciles EBITDA to cash flow from operations:

Nine Months Ended:
August 30, 2009(in thousands)EBITDA

$
95,418Adjustments to EBITDA to arrive at cash flow from operations:Interest expense


(56,551
)Income taxes


(3,463
)Non-cash charges against (credits to) net income


9,310Changes in operating assets & liabilities


(4,501
)Cash flow from operations

$
40,213




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 30,
2008.



"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

61

---



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.



On December 1, 2008, we completed a sale-leaseback transaction of our South Gate, California facility, including the
land, building and improvements affixed to the properties. As described in Note 9 to the Condensed Consolidated Financial Statements, on May 29, 2009, we completed a refinancing of our
existing senior secured credit facilities and replaced them with indebtedness that has longer-dated maturities and eliminates quarterly maintenance-based covenants. Additionally, through the
Refinancing, we terminated our outstanding interest rate swaps related to the existing senior secured credit facilities. Therefore, we no longer have future obligations related to these contracts.

There
have been no other material changes in our contractual obligations and commercial commitments other than in the ordinary course of business since the end of fiscal 2008. Refer to
our Annual Report on Form 10-K for additional information regarding our contractual obligations and commercial commitments.

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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. Foreign currency forward contracts are used to hedge against the earnings effects of such fluctuations. The result of a uniform 10% change in the value of the U.S.
dollar relative to currencies of countries in which we manufacture or sell our products would have an approximate $0.5 million dollar impact on our financial position for the nine months ended
August 30, 2009. This calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar.

To
protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, we have instituted a forecasted cash flow hedging
program. We hedge portions of our purchases denominated in foreign currencies and royalty payments to third parties with forward contracts. At August 30, 2009, we had two forward foreign
currency contracts outstanding to purchase a total of 0.9 million Euros with expiration dates ranging from September 30, 2009 through December 31, 2009. Additionally, at
August 30, 2009, we had outstanding forward and option foreign currency contracts to sell a total of 10.2 million Canadian dollars for US dollars. The expiration dates for the Canadian
dollar contracts range from September 15, 2009 to November 15, 2009. At August 30, 2009, the fair value of these contracts was an asset of $0.3 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.



Prior to the Refinancing, we had outstanding three interest rate swap agreements related to term debt under our Old Senior Credit
Facility. These interest rate swaps consisted of: 1) an agreement fixing the floating portion of the interest rate at 5.495% on $242 million of the outstanding balance under the term
loan under our Old Senior Credit Facility through November 2008, declining to $240 million from December 2008 through November 2009, and further declining to $180 million from December
2009 through November 2010; 2) an agreement fixing the floating portion of the interest rate at 1.952% on $20.0 million of the outstanding balance through November 4, 2009; and
3) an agreement fixing the floating portion of the interest rate at 1.991% on $107.0 million of the outstanding balance through February 4, 2010. In connection with the
Refinancing, we paid $15.2 million to terminate these interest rate swap agreements. As the future variable interest rate payments are no longer probable of being made, the amounts which had
previously been recorded in accumulated other comprehensive income were charged to refinancing expense for the nine months ended August 30, 2009, in accordance with the provisions of
FAS 133.

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

Additionally,
the Company has entered into three interest rate swaps for 2.3 million Euro, 2.9 million Euro and 3.5 million Euro which fix the floating interest
rates on the Company's debt of its Europe segment at 4.92%, 4.85% and 4.50%, respectively. The notional amounts of these contracts amortize over the life of the agreement and the agreements expire in
May 2019, January 2013 and

63

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October
2013. The fair values of these swaps was an asset totaling $0.7 million and $0.4 million as of August 30, 2009 and November 30, 2008, respectively.

A
10% increase or decrease in market interest rates that affect our interest rate derivative instruments would not have a material impact on our earnings during the next fiscal year.
Based on the amount of variable-rate debt outstanding at August 30, 2009, a 12.5 basis point increase or decrease in variable interest rates would have an insignificant dollar
impact on our annual interest expense.



We achieved decreases in the cost of polyurethane foam, polyester, polyethylene foam and steel innerspring component parts in the first
through third quarters of fiscal 2009 but expect small increases will occur in the fourth quarter of fiscal 2009 due to reductions in various related feed stocks. We have entered into commodity-based
physical contracts to buy natural gas at agreed-upon fixed prices. These contracts were entered into in the normal course of business. We do not engage in commodity hedging programs.

Item 4.    Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal accounting
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 by this report (the "Evaluation Date"). Based on this
evaluation, our principal executive officer and principal accounting 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
accounting 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 third quarter of fiscal 2009 that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

See Note 19 to the Condensed Consolidated Financial Statements, Part I, Item 1 included herein.

Item 1A.    Risk Factors

The risk factors appearing below should be read in conjunction with the related disclosure contained in the section entitled "Item 1A. Risk Factors" contained in our
Annual Report on Form 10-K for the fiscal year ended November 30, 2008 (File No. 001-08738).

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

After the completion of the Refinancing, we continue to have substantial indebtedness. As of August 30, 2009, we had a total of
$849.4 million of debt outstanding, including $336.3 million Senior Notes, $178.8 million Convertible Notes and $273.9 million Senior Subordinated Notes. We also have
approximately $70.9 million of undrawn availability under the ABL Revolver, after taking into account $16.0 million of outstanding letters of credit and borrowing base limitations.

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



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

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

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

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

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

The terms of the ABL Revolver credit agreement and the indentures governing our Senior Notes, Convertible Notes and 2014 Notes will
restrict the Company and its subsidiaries from incurring substantial additional indebtedness in the future, but will not completely prohibit us from doing so. At August 30, 2009, we have
$70.9 million of undrawn availability under the ABL Revolver, after taking into account $16.0 million of letters of credit and borrowing base limitations. These restrictions are subject
to a number of important qualifications and exceptions and the indebtedness incurred in compliance with these restrictions could be substantial. If new debt is added to our existing debt levels, the
related risks that we now face, including those described above, could intensify.

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

There were no repurchases of the Company's common stock during the third quarter of fiscal 2009 as part of a publicly announced program
or otherwise. 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. As of August 30, 2009, the approximate dollar value of shares that may yet be purchased under the program was $83.7 million.

Subsequent
to August 30, 2009, through September 23, 2009, 36,616 shares of Sealy Corporation common stock were surrendered by participants in the Company's 1998 and 2004
Stock Option Plans to cover the exercise price and/or tax withholding obligations in stock option exercises.

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

None

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

None

Item 5.    Other Information

None

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Item 6.    Exhibits

| |        |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | ------ |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | *4.1   |  | Credit Agreement, dated May 13, 2009, among Sealy Mattress Company, as Borrower, Sealy Mattress Corporation, as Holdings and a Guarantor, Sealy Corporation, as Parent, the Several Lenders from time to time parties
thereto, JPMorgan Chase Bank, N.A., as Administrative Agent and Collateral Agent, J.P. Morgan Securities Inc., as Joint Lead Arranger and Joint Bookrunner, GE Capital Markets, Inc., as Joint Lead Arranger and Joint Bookrunner, General
Electric Capital Corporation, as Co-Collateral Agent, Citigroup Global Markets Inc. as Joint Lead Arranger and Joint Bookrunner, and Mizuho Corporate Bank, Ltd., as Syndication Agent (incorporated herein by reference to Exhibit 10.1 to
Sealy Mattress Company's filing on Form 8-K (File No. 333-117081) filed May 19, 2009).
| | *4.2   |  | Indenture, dated as of May 29, 2009, by and among Sealy Mattress Company, the Guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as Trustee and Notes Collateral Agent, with respect to
the 10.875% Senior Subordinated Notes due 2016 (incorporated herein by reference to Exhibit 4.1 to Sealy Mattress Company's filing on Form 8-K (File No. 333-117081) filed June 2, 2009).                                                                                                                                                                                                                                                                                                                                                                                       
| | *4.3   |  | Indenture, dated as of July 10, 2009, by and among Sealy Mattress Company, the Guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as Trustee, with respect to Guaranteed Debt Securities
(incorporated herein by reference to Exhibit 4.1 to Sealy Mattress Company's filing on Form 8-K (File No. 333-117081) filed July 16, 2009).                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | *4.4   |  | Supplemental Indenture, dated as of July 10, 2009, by and among Sealy Mattress Company, Sealy Corporation, the Guarantors named therein and The Bank of New York Mellon Trust Company, N.A., as Trustee and
Collateral Agent, with respect to 8% Senior Secured Third Lien Convertible Notes due 2016 (incorporated herein by reference to Exhibit 4.2 to Sealy Mattress Company's filing on Form 8-K (File No. 333-117081) filed July 16,
2009).                                                                                                                                                                                                                                                                                                                                                  
| | *10.1 |  | Employment Agreement dated August 1, 2009, by and between Sealy Corporation and Michael Q. Murray.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
| | *10.2 |  | Employment Agreement dated August 31, 2009, by and between Sealy Corporation and Jodi Allen.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | *10.3 |  | Form of Time Restricted Stock Unit Award Agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
| | 31.1  |  | Chief Executive Officer Certification of the Quarterly Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | 31.2  |  | Chief Financial Officer Certification of the Quarterly Financial Statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | 32    |  | Certification pursuant to 18 U.S.C. Section 1350.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, Sealy Corporation 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 Accounting Officer)


Date:
September 29, 2009

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