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



FORM 10-Q

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended: May 30, 2010o

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


Commission file number 001-08738



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

Delaware(State or other jurisdiction of incorporation)

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

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




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

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

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

Large accelerated filer o

Accelerated filer ý

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

Smaller reporting company o


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

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



---





PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

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

Three Months EndedMay 30,
2010

May 31,
2009Net sales

$
316,528

$
298,455Cost of goods sold


188,290


176,509Gross profit


128,238


121,946Selling, general and administrative expenses


107,182


95,581Amortization expense


115


778Restructuring expenses and asset impairment





1,335Royalty income, net of royalty expense


(3,785
)

(4,600
)Income from operations


24,726


28,852Interest expense


21,765


16,876Loss on rights for convertible notes





2,729Refinancing and extinguishment of debt and interest rate derivatives


3,759


17,422Other income, net


(50
)

(13
)Loss before income taxes


(748
)

(8,162
)Income tax provision


(550
)

(2,773
)Equity in earnings of unconsolidated affiliates


1,047


Net income (loss)

$
849

$
(5,389
)Earnings (loss) per common shareBasic

$
0.01

$
(0.06
)Earnings (loss) per common shareDiluted

$
0.01

$
(0.06
)Weighted average number of common shares outstanding:Basic


94,604


91,819Diluted


106,842


91,819


See
accompanying notes to Condensed Consolidated Financial Statements.

1

---





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

Six Months EndedMay 30,
2010

May 31,
2009Net sales

$
656,155

$
608,431Cost of goods sold


387,797


368,845Gross profit


268,358


239,586Selling, general and administrative expenses


216,138


192,277Amortization expense


454


1,593Restructuring expenses and asset impairment





1,448Royalty income, net of royalty expense


(7,808
)

(7,970
)Income from operations


59,574


52,238Interest expense


44,106


34,424Loss on rights for convertible notes





2,729Refinancing and extinguishment of debt and interest rate derivatives


3,759


17,422Gain on sale of subsidiary stock





(1,292
)Other income, net


(104
)

(46
)Income (loss) before income taxes


11,813


(999
)Income tax provision


7,240


46Equity in earnings of unconsolidated affiliates


1,990


Net income (loss)

$
6,563

$
(1,045
)Earnings (loss) per common shareBasic

$
0.07

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

$
0.05

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


94,563


91,813Diluted


286,092


91,813


See
accompanying notes to Condensed Consolidated Financial Statements.

2

---





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

May 30,
2010

November 29,
2009ASSETSCurrent assets:Cash and equivalents

$
79,557

$
131,427Accounts receivable, less allowances for bad debts, cash discounts and returns


164,769


156,850Inventories


67,276


56,810Other current assets


22,069


21,080Deferred income tax assets


14,669


20,222Total current assets


348,340


386,389Property, plant and equipmentat cost


432,869


446,989Less accumulated depreciation


(238,748
)

(239,508
)194,121


207,481Goodwill


360,893


360,583Intangible assets, net


1,528


1,937Deferred income tax assets


9,425


6,874Other assets, including debt issuance costs, net


51,094


52,206422,940


421,600Total assets

$
965,401

$
1,015,470LIABILITIES AND STOCKHOLDERS' DEFICITCurrent liabilities:Current portionlong-term obligations

$
10,400

$
13,693Accounts payable


88,371


88,971Accrued incentives and advertising


27,808


31,804Accrued compensation


22,801


43,105Accrued interest


14,659


15,230Other accrued liabilities


31,785


36,436Total current liabilities


195,824


229,239Long-term obligations, net of current portion


798,122


833,766Other liabilities


58,754


59,625Deferred income tax liabilities


871


832Stockholders' deficit:Common stock, $0.01 par value; Authorized shares: 2010 and 2009600,000 Issued and outstanding: 201094,654; 200994,417


950


947Additional paid-in capital


900,932


885,064Accumulated deficit


(986,387
)

(992,950
)Accumulated other comprehensive income, net


(3,665
)

(1,053
)Total shareholders' deficit


(88,170
)

(107,992
)Total liabilities and shareholders' deficit

$
965,401

$
1,015,470


See
accompanying notes to Condensed Consolidated Financial Statements.

3

---





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

Common Stock





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

Additional
Paid-in
Capital

Accumulated
DeficitShares

Amount

TotalBalance at November 29, 2009

$
32,143


94,417

$
947

$
885,064

$
(992,950
)
$
(1,053
)
$
(107,992
)Net income


6,563











6,563





6,563Foreign currency translation adjustment


(2,713
)













(2,713
)

(2,713
)Adjustment to defined benefit plan liability, net of tax of $127


367














367


367Change in fair value of cash flow hedges, net of tax of $177


(266
)













(266
)

(266
)Share-based compensation











9,215








9,215Exercise of stock options





237


3


142








145Excess tax deficiency on options exercised











(480
)







(480
)Beneficial conversion feature on Convertible paid-in-kind Notes











6,991








6,991Balance at May 30, 2010

$
3,951


94,654

$
950

$
900,932

$
(986,387
)
$
(3,665
)
$
(88,170
)


See
accompanying notes to Condensed Consolidated Financial Statements.

4

---





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

Six Months EndedMay 30,
2010

May 31,
2009Operating activities:Net income (loss)

$
6,563

$
(1,045
)Adjustments to reconcile net income to cash provided by operating activities:Depreciation and amortization


14,736


16,553Deferred income taxes


3,891


(5,786
)Impairment charges





1,326Amortization of deferred gain on sale-leaseback


(327
)

(324
)Paid in kind interest on convertible notes


6,980


Amortization of discount on new senior secured notes


1,030


Amortization of debt issuance costs and other


2,889


579Loss on rights for convertible notes





2,729Share-based compensation


9,215


2,229Loss on sale of assets


262


451Write-off of debt issuance costs related to debt extinguishments


2,709


2,113Loss on repurchase of senior notes


1,050


15,232Payment to terminate interest rate swaps





(15,232
)Gain on sale of subsidiary stock





(1,292
)Other, net


157


(661
)Changes in operating assets and liabilities:Accounts receivable


(12,007
)

(9,747
)Inventories


(13,123
)

6,125Other current assets


1,188


14,136Other assets


(282
)

1,262Accounts payable


3,311


1,303Accrued expenses


(33,472
)

(15,757
)Other liabilities


800


1,126Net cash (used in) provided by operating activities


(4,430
)

15,320Investing activities:Purchase of property, plant and equipment


(6,678
)

(4,592
)Proceeds from sale of property, plant and equipment


67


10,149Net proceeds from sale of subsidiary stock





1,237Investments in and loans to unconsolidated affiliate





(2,322
)Net cash (used in) provided by investing activities


(6,611
)

4,472Financing activities:Proceeds from issuance of long-term obligations


1,806


2,830Repayments of long-term obligations


(5,107
)

(8,995
)Repayment of senior term loans





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





335,916Proceeds from issuance of related party notes





177,132Repayment of senior secured notes, including premium of $1,050


(36,050
)

Borrowings under revolving credit facilities





140,616Repayments under revolving credit facilities





(205,016
)Exercise of employee stock options, including related excess tax benefits


145


(295
)Debt issuance costs


2


(20,553
)Other


(77
)

Net cash (used in) provided by financing activities


(39,281
)

44,454Effect of exchange rate changes on cash


(1,548
)

1,656Change in cash and equivalents


(51,870
)

65,902Cash and equivalents:Beginning of period


131,427


26,596End of period

$
79,557

$
92,498


See accompanying notes to Condensed Consolidated Financial Statements.

5

---





SEALY CORPORATION        Notes to Condensed Consolidated Financial Statements        (unaudited)

Note 1: Basis of Presentation

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

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

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

Note 2: Recently Issued Accounting Pronouncements

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

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

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

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

6

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Accounting Pronouncements (Continued)

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

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

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

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

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

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

Note 3: Restatement of Previous Periods

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

7

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Restatement of Previous Periods (Continued)

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

Condensed Consolidated Statements of Operation InformationThree Months Ended
May 31, 2009

Six Months Ended
May 31, 2009As Previously
Reported

Adjustments

Restated

As Previously
Reported

Adjustments

RestatedCost of goods sold

$
176,304

$
205

$
176,509

$
368,030

$
815

$
368,845Gross profit


122,151


(205
)

121,946


240,401


(815
)

239,586Income from operations


29,057


(205
)

28,852


53,053


(815
)

52,238Loss before income taxes


(7,957
)

(205
)

(8,162
)

(184
)

(815
)

(999
)Income tax provision


(2,719
)

(54
)

(2,773
)

308


(262
)

46Net loss


(5,238
)

(151
)

(5,389
)

(492
)

(553
)

(1,045
)Loss per common shareBasic


(0.06
)




(0.06
)

(0.01
)




(0.01
)Loss per common shareDiluted


(0.06
)




(0.06
)

(0.01
)




(0.01
)Basic shares


91,819





91,819


91,813





91,813Diluted shares


91,819





91,819


91,813





91,813




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

Adjustments

RestatedNet loss

$
(492
)
$
(553
)
$
(1,045
)Adjustments to reconcile net income to cash provided by operating activities:Depreciation and amortization


15,738


815


16,553Deferred income taxes


(5,524
)

(262
)

(5,786
)


8

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation

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

Stock Option Awards

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

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

Three Months
Ended
May 31, 2009Expected volatility


60
%Expected dividend yield


0.00
%Expected term (in years)


5.63Risk-free rate


1.92
%


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

9

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

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

Shares Subject to Options

Weighted Average
Exercise Price Per ShareOutstanding November 29, 2009


2,102,162

$
1.09Exercised


(208,507
)

0.51Outstanding May 30, 2010 (all fully vested and exercisable)


1,893,655

$
1.15Weighted average remaining contractual term


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

$
2,649


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

Shares Subject to Options

Weighted Average
Exercise Price Per ShareOutstanding November 29, 2009


9,568,777

$
5.20Exercised


(23,901
)
$
1.64Forfeited


(2,618,327
)
$
4.61Outstanding May 30, 2010


6,926,549

$
5.44Weighted average remaining contractual term


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

$
1,482Exercisable at May 30, 2010


3,460,186Weighted average remaining contractual term


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

$
257


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

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

10

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

Restricted Shares

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

Restricted Share Unit ("RSU") Awards

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

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

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

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

11

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Share-Based Compensation (Continued)

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

Unvested Restricted
Share Units

Weighted Average Grant
Date Fair ValueOutstanding November 29, 2009


16,954,906

$
2.02Granted


250,000


3.66Vested


(4,179
)

2.00Forfeited


(408,132
)

1.97Outstanding May 30, 2010


16,792,595

$
2.04Weighted average remaining vesting period


3.6 years


Note 5: Inventories

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

May 30, 2010

November 29, 2009Raw materials

$
32,367

$
29,700Work in process


25,335


19,158Finished goods


9,574


7,952$
67,276

$
56,810


Note 6: Warranty Costs

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

12

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 6: Warranty Costs (Continued)

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

May 30, 2010

May 31, 2009Accrued warranty obligations at beginning of period

$
16,464

$
16,487Warranty claims


(9,865
)

(9,348
)Warranty provisions


9,577


9,400Accrued warranty obligations at end of period

$
16,176

$
16,539


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

Note 7: Goodwill and Other Intangible Assets

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

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

Balance as of November 29, 2009

$
360,583Increase due to foreign currency translation


310Balance as of May 30, 2010

$
360,893


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

13

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 8: Debt Issuance Costs

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

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

Note 9: Long-Term Obligations

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

May 30, 2010

November 29, 2009Asset-based revolving credit facility

$


$
Senior secured notes


303,638


336,625Convertible notes(1)


180,409


180,109Senior subordinated notes


268,945


268,945Financing obligations


40,635


41,296Other


14,895


20,484808,522


847,459Less current portion


(10,400
)

(13,693
)$
798,122

$
833,766


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


14

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)




Debt Refinancing

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

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

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

ABL Revolver

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

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

Senior Secured Notes

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

15

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

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

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

Convertible PIK Notes

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

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

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

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

16

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

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

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

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

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

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

17

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

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

Note 10: Derivative Instruments and Hedging Strategies

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

Interest Rate Risk

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

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

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

18

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

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

Foreign Currency Exposure

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

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

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

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

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

19

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

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

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

Commodity Price Exposure

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

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

Embedded Derivatives

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

Rights to Purchase Convertible Notes

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

20

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

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

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

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

Asset Derivatives

Liability DerivativesMay 30, 2010

May 30, 2010Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
ValueDerivatives designated as hedging instrumentsForeign exchange contracts

Other current assets

$
568

Other current liabilities

$
Commodity fixed price swap contracts

Other current assets


30

Other current liabilities


(20
)Total derivatives designated as hedging instruments




598




(20
)Derivatives not designated as hedging instrumentsInterest rate contracts

Other noncurrent assets


496

Other noncurrent liabilities


Total derivatives not designated as hedging instruments




496




Total derivatives



$
1,094



$
(20
)




Asset Derivatives

Liability DerivativesNovember 29, 2009

November 29, 2009Balance Sheet
Location

Fair
Value

Balance Sheet
Location

Fair
ValueDerivatives designated as hedging instrumentsForeign exchange contracts

Other current assets

$
1,133

Other current liabilities

$
Total derivatives designated as hedging instruments




1,133




Derivatives not designated as hedging instrumentsInterest rate contracts

Other noncurrent assets


475

Other noncurrent liabilities


Total derivatives not designated as hedging instruments




475




Total derivatives



$
1,608



$



21

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)

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

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

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

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

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

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

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


(11
)
Selling, general and administrative expenses


32

Selling, general and administrative expenses


(16
)Foreign exchange contracts


(39
)
Cost of goods sold


(5
)
Cost of goods sold


Total

$
(50
)


$
27



$
(16
)




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

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

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

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

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

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


6

Selling, general and administrative expenses


32

Selling, general and administrative expenses


Foreign exchange contracts


(175
)
Cost of goods sold


52

Cost of goods sold


Total

$
(169
)


$
84



$





Three Months Ended May 31, 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)Interest rate contracts


(2,484
)
Interest income (expense)


(2,967
)
Interest income (expense)


Interest rate contracts




Refinancing expense




Refinancing expense


(15,232
)Foreign exchange contracts


192

Selling, general and administrative expenses


19

Selling, general and administrative expenses


Total

$
(2,292
)


$
(2,948
)


$
(15,232
)




Six Months Ended May 31, 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)Interest rate contracts


(3,864
)
Interest income (expense)


(5,266
)
Interest income (expense)


Interest rate contracts




Refinancing expense




Refinancing expense


(15,232
)Foreign exchange contracts


189

Selling, general and administrative expenses


108

Selling, general and administrative expenses


Total

$
(3,675
)


$
(5,158
)


$
(15,232
)


22

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Derivative Instruments and Hedging Strategies (Continued)



Three Months EndedMay 30, 2010

May 31, 2009Derivatives Not Designated as
Hedging Instruments

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

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

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

Interest income (expense)

$
(9
)
$
108Rights to purchase convertible notes

Loss on rights for convertible notes





(2,729
)Total



$
(9
)
$
(2,621
)




Six Months EndedMay 30, 2010

May 31, 2009Derivatives Not Designated as
Hedging Instruments

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

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

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

Interest income (expense)

$
21

$
319Rights to purchase convertible notes

Loss on rights for convertible notes





(2,729
)Total



$
21

$
(2,410
)


Note 11: Fair Value of Financial Instruments

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

Fair Value Measurements at May 30, 2010 UsingMay 30, 2010

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

Significant Other
Observable Inputs
(Level 2)

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

$
1,074

$


$
1,074

$



23

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 11: Fair Value of Financial Instruments (Continued)

Fair Value Measurements at November 29, 2009 UsingNovember 29, 2009

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

Significant Other
Observable Inputs
(Level 2)

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

$
1,608

$


$
1,608

$



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

Senior Secured Notes

$
387,170Convertible Notes


650,203Senior Subordinated Notes


266,928


Note 12: Debt Extinguishment and Refinancing Expense

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

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

Note 13: Other Income, Net

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

Note 14: Acquisitions and Dispositions

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

24

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 14: Acquisitions and Dispositions (Continued)

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

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

Note 15: Defined Benefit Pension Expense

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

Three Months Ended

Six Months EndedMay 30, 2010

May 31, 2009

May 30, 2010

May 31, 2009Service cost

$
244

$
184

$
488

$
551Interest cost


383


352


766


1,057Expected return on plan assets


(305
)

(235
)

(611
)

(705
)Amortization of unrecognized losses


37


91


74


274Amortization of unrecognized prior service cost


143


63


287


188Net periodic pension cost*

$
502

$
455

$
1,004

$
1,365Cash contributions

$
636

$
0

$
636

$
1,447


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


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

Note 16: Income Taxes

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

25

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 16: Income Taxes (Continued)

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

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

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

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

Note 17: Comprehensive Income

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

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

May 30, 2010

November 29, 2009Unrealized gain on cash flow hedges, net of tax

$
197

$
463Unrealized actuarial loss and prior service credit for pension liability, net of tax


(7,567
)

(7,936
)Accumulated foreign currency translation adjustment


3,705


6,420$
(3,665
)
$
(1,053
)


26

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 18: Commitments and Contingencies

Contingencies

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

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

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

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



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

27

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 18: Commitments and Contingencies (Continued)

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

Note 19: Related Party Transactions

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

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

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

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

28

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 19: Related Party Transactions (Continued)

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

Note 20: Segment Information

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

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

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

Three Months Ended

Six Months EndedMay 30, 2010

May 31, 2009

May 30, 2010

May 31, 2009Americas:United States

$
229,131

$
222,478

$
475,505

$
457,233Canada


42,091


32,743


86,818


63,782Other International


20,133


19,098


42,026


38,989Total Americas


291,355


274,319


604,349


560,004Europe


25,173


24,136


51,806


48,427Total

$
316,528

$
298,455

$
656,155

$
608,431Total International

$
87,397

$
75,977

$
180,650

$
151,198


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

29

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Segment Information (Continued)

Three Months Ended

Six Months EndedMay 30, 2010

May 31, 2009

May 30, 2010

May 31, 2009(in thousands)

(in thousands)Net sales to external customers:Americas

$
291,355

$
274,319

$
604,349

$
560,003Europe


25,173


24,136


51,806


48,427316,528


298,455


656,155


608,430Capital expenditures:Americas


4,068


2,129


6,160


4,337Europe


161


52


518


1904,229


2,181


6,678


4,527EBITDA:Americas


30,174


20,607


74,430


54,560Europe


(921
)

(3,502
)

(1,784
)

(4,515
)Inter-segment eliminations





(67
)




(68
)29,253


17,038


72,646


49,977Reconciliation of EBITDA to net income:EBITDA from segments


29,253


17,038


72,646


49,977Interest


21,767


16,876


44,107


34,424Income taxes


(550
)

(2,773
)

7,240


46Depreciation and amortization


7,187


8,323


14,736


16,552Net Income

$
849

$
(5,388
)
$
6,563

$
(1,045
)




May 30, 2010

November 29, 2009(in thousands)Total assets:Americas

$
913,616

$
949,051Europe


53,338


67,972Intersegment eliminations


(1,553
)

(1,553
)$
965,401

$
1,015,470


Note 21: Earnings per Share

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

30

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 21: Earnings per Share (Continued)

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

Three Months Ended

Six Months EndedMay 30, 2010

May 31, 2009

May 30, 2010

May 31, 2009(in thousands)

(in thousands)Numerator:Net income (loss), as reported

$
849

$
(5,389
)
$
6,563

$
(1,045
)Net income (loss) attributable to participating securities


(3
)

17


(20
)

3Interest on convertible notes








7,610


Net income available to common shareholders

$
846

$
(5,372
)
$
14,153

$
(1,042
)Denominator:Denominator for basic earnings per shareweighted average shares


94,604


91,819


94,563


91,813Effect of dilutive securities:Convertible debt








180,000


Stock options


1,233





1,217


Restricted shares











Restricted share units


10,660





9,977


Other


345





335


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


106,842


91,819


286,092


91,813


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

Note 22: Restructuring Activities

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

31

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 22: Restructuring Activities (Continued)

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

Three Months Ended

Six Months EndedMay 30, 2010

May 31, 2009

May 30, 2010

May 31, 2009(in thousands)

(in thousands)Americas Segment

$


$
1,335

$


$
1,448Europe Segment











$


$
1,335

$


$
1,448


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

2009 Restructuring ActivitiesLiabilities
November 30, 2008

Charges to
Expense

Cash
Payments

Non-cash
Utilized

Liabilities
May 31, 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


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

Note 23: Guarantor/Non-Guarantor Financial Information

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

32

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

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

The
following supplemental Condensed Consolidating Financial Statements present:



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

33

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION        Supplemental Condensed Consolidating Balance Sheets        May 30, 2010        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
769

$


$
24,234

$
18,369

$
36,185

$


$
79,557Accounts receivable, net








22


96,765


67,982





164,769Inventories








1,670


44,475


21,491


(360
)

67,276Other current assets and deferred income taxes


391





780


30,429


5,138





36,738Total current assets


1,160





26,706


190,038


130,796


(360
)

348,340Property, plant and equipment, at cost








9,415


332,945


90,509





432,869Less accumulated depreciation








(5,066
)

(183,882
)

(49,800
)




(238,748
)





4,349


149,063


40,709





194,121Other assets:Goodwill








24,741


301,942


34,210





360,893Intangible assets, net











1,522


6





1,528Net investment in subsidiaries


(165,380
)

251,721


368,016


196,116


(1
)

(650,472
)

Due from (to) affiliates


256,603


(417,101
)

558,251


(116,928
)

(100,486
)

(180,339
)

Debt issuance costs, net and other assets








24,886


19,480


16,153





60,51991,223


(165,380
)

975,894


402,132


(50,118
)

(830,811
)

422,940Total assets

$
92,383

$
(165,380
)
$
1,006,949

$
741,233

$
121,387

$
(831,171
)
$
965,401Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$


$
1,741

$
8,659

$


$
10,400Accounts payable








303


50,139


37,929





88,371Accrued customer incentives and advertising











20,789


7,019





27,808Accrued compensation








356


15,309


7,136





22,801Accrued interest








1,228


13,273


158





14,659Other accrued liabilities








287


25,756


5,742





31,785Total current liabilities








2,174


127,007


66,643





195,824Long-term obligations


180,409





752,992


39,366


5,764


(180,409
)

798,122Other liabilities











47,765


10,989





58,754Deferred income tax liabilities


144





62


21


644





871Stockholders' equity (deficit)


(88,170
)

(165,380
)

251,721


527,074


37,347


(650,762
)

(88,170
)Total liabilities and stockholders' equity (deficit)

$
92,383

$
(165,380
)
$
1,006,949

$
741,233

$
121,387

$
(831,171
)
$
965,401


34

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION        Supplemental Condensed Consolidating Balance Sheets        November 29, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
357

$


$
29,234

$
67,950

$
33,886

$


$
131,427Accounts receivable, net








6


82,339


74,505





156,850Inventories








1,663


37,023


18,478


(354
)

56,810Other current assets and deferred income taxes


394





1,169


31,405


8,334





41,302Total current assets


751





32,072


218,717


135,203


(354
)

386,389Property, plant and equipment, at cost








9,337


335,302


102,350





446,989Less accumulated depreciation








(4,802
)

(180,116
)

(54,590
)




(239,508
)





4,535


155,186


47,760





207,481Other assets:Goodwill








24,741


301,942


33,900





360,583Intangible assets, net


271








1,666








1,937Net investment in subsidiaries


(170,794
)

245,511


389,844


75,527





(540,088
)

Due from (to) affiliates


243,154


(416,305
)

553,243


(102,010
)

(98,073
)

(180,009
)

Debt issuance costs, net and other assets








29,226


17,902


11,952





59,08072,631


(170,794
)

997,054


295,027


(52,221
)

(720,097
)

421,600Total assets

$
73,382

$
(170,794
)
$
1,033,661

$
668,930

$
130,742

$
(720,451
)
$
1,015,470Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$


$
2,159

$
11,534

$


$
13,693Accounts payable








275


45,413


43,283





88,971Accrued customer incentives and advertising











24,175


7,629





31,804Accrued compensation








391


32,706


10,008





43,105Accrued interest


6





1,343


13,658


223





15,230Other accrued liabilities


1,116





401


28,046


6,873





36,436Total current liabilities


1,122





2,410


146,157


79,550





229,239Long-term obligations


180,108





785,678


40,220


7,868


(180,108
)

833,766Other liabilities











48,456


11,169





59,625Deferred income tax liabilities


144





62


21


605





832Common stock and options subject to redemption




















Stockholders' equity (deficit)


(107,992
)

(170,794
)

245,511


434,076


31,550


(540,343
)

(107,992
)Total liabilities and stockholders' equity (deficit)

$
73,382

$
(170,794
)
$
1,033,661

$
668,930

$
130,742

$
(720,451
)
$
1,015,470


35

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

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

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
18,676

$
218,859

$
85,907

$
(6,914
)
$
316,528Cost and expenses:Cost of goods sold








11,310


130,484


53,494


(6,998
)

188,290Selling, general and administrative


369





1,770


80,108


24,935





107,182Amortization expense











72


43





115Restructuring expenses and asset impairment




















Royalty (income) expense, net











(3,807
)

22





(3,785
)Income from operations


(369
)




5,596


12,002


7,413


84


24,726Interest expense





79


20,332


571


783





21,765Loss on rights for convertible notes




















Gain on sale of subsidiary stock




















Refinancing and extinguishment of debt and interest rate derivatives








3,759











3,759Other (income) expense, net














(50
)




(50
)Loss (income) from equity investees


(2,454
)

(3,343
)

23,918








(18,121
)

Loss (income) from non- guarantor equity investees











(3,879
)




3,879


Capital charge and intercompany interest allocation








(18,627
)

17,959


668





Income (loss) before income taxes


2,085


3,264


(23,786
)

(2,649
)

6,012


14,326


(748
)Income tax provision (benefit)


1,236


810


(27,129
)

21,254


3,180


99


(550
)Equity in earnings of unconsolidated affiliates














1,047





1,047Net income (loss)

$
849

$
2,454

$
3,343

$
(23,903
)
$
3,879

$
14,227

$
849


36

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Three Months Ended May 31, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
19,327

$
210,797

$
74,789

$
(6,458
)
$
298,455Cost and expenses:

















Cost of goods sold








11,751


121,595


49,673


(6,510
)

176,509Selling, general and administrative


(197
)




1,819


71,506


22,453





95,581Goodwill impairment loss




















Amortization of intangibles


723








72


(17
)




778Restructuring and related costs











1,335








1,335Royalty (income) expense, net


(999
)







(4,600
)

999





(4,600
)Income from operations


473





5,757


20,889


1,681


52


28,852Interest expense


27


72


15,951


623


203





16,876Loss on rights for convertible notes


2,729

















2,729Gain on sale of subsidiary stock




















Refinancing and extinguishment of debt and interest rate derivatives








17,422











17,422Other (income) expense, net














(13
)




(13
)Loss (income) from equity investees


4,786


4,812


(1,109
)







(8,489
)

Loss (income) from non- guarantor equity investees











309





(309
)

Capital charge and intercompany interest allocation








(14,544
)

14,039


505





Income (loss) before income taxes


(7,069
)

(4,884
)

(11,963
)

5,918


986


8,850


(8,162
)Income tax expense (benefit)


(1,680
)

(98
)

(7,151
)

4,838


1,362


(44
)

(2,773
)Net income (loss)

$
(5,389
)
$
(4,786
)
$
(4,812
)
$
1,080

$
(376
)
$
8,894

$
(5,389
)


37

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

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

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
40,259

$
452,279

$
177,531

$
(13,914
)
$
656,155Cost and expenses:Cost of goods sold








24,237


267,826


109,642


(13,908
)

387,797Selling, general and administrative


379





3,729


161,209


50,821





216,138Amortization expense


266








144


44





454Restructuring expenses and asset impairment




















Royalty (income) expense, net


(368
)







(7,928
)

488





(7,808
)Income from operations


(277
)




12,293


31,028


16,536


(6
)

59,574Interest expense


1


159


41,048


1,235


1,663





44,106Refinancing and extinguishment of debt and interest rate derivatives








3,759











3,759Other (income) expense, net














(104
)




(104
)Loss (income) from equity investees


(8,148
)

(9,054
)

19,250








(2,048
)

Loss (income) from non- guarantor equity investees











(8,302
)




8,302


Capital charge and intercompany interest allocation








(37,483
)

34,579


2,904





Income (loss) before income taxes


7,870


8,895


(14,281
)

3,516


12,073


(6,260
)

11,813Income tax provision (benefit)


1,307


747


(23,335
)

22,732


5,761


28


7,240Equity in earnings of unconsolidated affiliates














1,990





1,990Net income (loss)

$
6,563

$
8,148

$
9,054

$
(19,216
)
$
8,302

$
(6,288
)
$
6,563


38

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Operations        Six Months Ended May 31, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
40,220

$
433,466

$
148,334

$
(13,589
)
$
608,431Cost and expenses:

















Cost of goods sold








24,124


257,675


100,624


(13,578
)

368,845Selling, general and administrative


(3
)




3,752


146,684


41,844





192,277Goodwill impairment loss




















Amortization of intangibles


1,450








144


(1
)




1,593Restructuring and related costs











1,448








1,448Royalty (income) expense, net


(2,003
)







(8,001
)

2,034





(7,970
)Income from operations


556





12,344


35,516


3,833


(11
)

52,238Interest expense


63


160


31,853


1,242


1,106





34,424Loss on rights for convertible notes


2,729

















2,729Gain on sale of subsidiary stock














(1,292
)




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








17,422











17,422Other (income) expense, net














(46
)




(46
)Loss (income) from equity investees


478


437


(1,569
)







654


Loss (income) from non- guarantor equity investees











(303
)




303


Capital charge and intercompany interest allocation








(29,014
)

27,919


1,095





Income (loss) before income taxes


(2,714
)

(597
)

(6,348
)

6,658


2,970


(968
)

(999
)Income tax expense (benefit)


(1,669
)

(119
)

(5,911
)

5,069


2,735


(59
)

46Net income (loss)

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

$
235

$
(909
)
$
(1,045
)


39

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

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

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by operating activities

$


$


$
43,214

$
(52,628
)
$
4,984

$


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








(116
)

(5,121
)

(1,441
)




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








26





41





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


267





(11,999
)

9,609


2,123





Net cash provided by (used in) investing activities


267





(12,089
)

4,488


723





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


145

















145Proceeds from issuance of long term obligations














1,806





1,806Repayments of long-term obligations











(1,441
)

(3,666
)




(5,107
)Repayment of senior secured notes








(36,050
)










(36,050
)Debt issuance costs








2











2Other








(77
)










(77
)Net cash used in financing activities


145





(36,125
)

(1,441
)

(1,860
)




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














(1,548
)




(1,548
)Change in cash and equivalents


412





(5,000
)

(49,581
)

2,299





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


357





29,234


67,950


33,886





131,427End of period

$
769

$


$
24,234

$
18,369

$
36,185

$


$
79,557


40

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION        Supplemental Condensed Consolidating Statements of Cash Flows        Six Months Ended May 31, 2009        (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by operating activities

$


$


$
887

$
19,742

$
(5,309
)
$


$
15,320Investing activities:Purchase of property, plant and equipment








(12
)

(3,946
)

(634
)




(4,592
)Proceeds from the sale of property, plant, and equipment








46


10,153


(50
)




10,149Net 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


(265
)




(15,739
)

10,665


5,339





Net cash provided by (used in) investing activities


(265
)




(15,705
)

16,872


3,570





4,472Financing activities:Equity received upon exercise of stock including related excess tax benefits


(295
)
















(295
)Proceeds from issuance of long term obligations














2,830





2,830Repayments of long-term obligations











(3,041
)

(5,954
)




(8,995
)Repayment of old senior term loans








(377,181
)










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








335,916











335,916Proceeds from issuance of related party debt








177,132











177,132Borrowings under new asset-based revolver




















Borrowings under old revolving credit facilities








130,300





10,316





140,616Repayments on old revolving credit facilities








(194,700
)




(10,316
)




(205,016
)Debt issuance costs








(20,553
)










(20,553
)Other




















Net cash used in financing activities


(295
)




50,914


(3,041
)

(3,124
)




44,454Effect of exchange rate changes on cash














1,656





1,656Change in cash and equivalents


(560
)




36,096


33,573


(3,207
)




65,902Cash and equivalents:Beginning of period


589





1


2,423


23,583





26,596End of period

$
29

$


$
36,097

$
35,996

$
20,376

$


$
92,498


41

---





SEALY CORPORATION

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

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

BUSINESS OVERVIEW

Our mattress and foundation products include 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 continued to put pressure on U.S. mattress sales, though we have begun to
see some stabilization in the retail environment recently. Some of the international markets where we operate are experiencing similar challenges as well. We expect this challenging business
environment to potentially continue through 2010. Furthermore, changes in foreign exchange rates contributed favorably to international results and these trends are expected to continue.

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

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

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

RESULTS OF OPERATIONS

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

42

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



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

For the three months ended:May 30, 2010

May 31, 2009(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)Net sales

$
316,528


100.0
%
$
298,455


100.0
%Cost of goods sold


188,290


59.5


176,509


59.1Gross profit


128,238


40.5


121,946


40.9Selling, general and administrative expenses


107,182


33.9


95,581


32.0Amortization expense


115





778


0.3Restructuring expenses and asset impairment








1,335


0.4Royalty income, net of royalty expense


(3,785
)

(1.2
)

(4,600
)

(1.5
)Income from operations


24,726


7.8


28,852


9.7Interest expense


21,765


6.9


16,876


5.7Loss on rights for convertible notes








2,729


0.9Refinancing and extinguishment of debt and interest rate derivatives


3,759


1.2


17,422


5.8Other income, net


(50
)




(13
)

Loss before income taxes


(748
)

(0.3
)

(8,162
)

(2.7
)Income tax provision


(550
)

(0.2
)

(2,773
)

(0.9
)Equity in earnings of unconsolidated affiliates


1,047


0.3





Net income (loss)

$
849


(0.2
)%
$
(5,389
)

(0.9
)%Effective tax rate


73.5
%




34.0
%


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

Three Months
Ended:May 30,
2010

May 31,
2009Americas:United States


72.4
%

74.5
%Canada


13.3


11.0Other


6.3


6.4Total Americas


92.0


91.9Europe


8.0


8.1Total


100.0
%

100.0
%


43

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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 EndedMay 30, 2010

May 31, 2009(in thousands)

(percentage of
net sales)

(in thousands)

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

$
291,355


100.0
%
$
274,319


100.0
%Cost of goods sold


169,533


58.2


158,609


57.8Gross profit


121,822


41.8


115,710


42.2United States (US Dollars):Net sales


229,131


100.0


222,478


100.0Cost of goods sold


133,843


58.4


126,038


56.7Gross profit


95,288


41.6


96,440


43.3Total International (US Dollars):Net sales


87,397


100.0


75,977


100.0Cost of goods sold


54,447


62.3


50,471


66.4Gross profit


32,950


37.7


25,506


33.6Canada:US Dollars:Net sales


42,091


100.0


32,743


100.0Cost of goods sold


23,684


56.3


21,184


64.7Gross profit


18,407


43.7


11,559


35.3Canadian Dollars:Net sales


43,132


100.0


39,217


100.0Cost of goods sold


24,272


56.3


25,367


64.7Gross profit


18,860


43.7


13,850


35.3Other Americas (US Dollars):Net sales


20,133


100.0


19,098


100.0Cost of goods sold


12,006


59.6


11,387


59.6Gross profit


8,127


40.4


7,711


40.4Europe:US Dollars:Net sales


25,173


100.0


24,136


100.0Cost of goods sold


18,757


74.5


17,900


74.2Gross profit


6,416


25.5


6,236


25.8Euros:Net sales


18,958


100.0


18,122


100.0Cost of goods sold


14,126


74.5


13,414


74.0Gross profit


4,832


25.5
%

4,708


26.0
%


44

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Net Sales.Our consolidated net sales for the quarter ended May 30, 2010, were $316.5 million, an increase of
$18.1 million, or
6.1%, from the quarter ended May 31, 2009. Total Americas net sales were $291.4 million for the second quarter of fiscal 2010, an increase of 6.2% from the second quarter of fiscal 2009.
This increase was primarily due to increases in the Canada, U.S. and Other Americas businesses. Total U.S. net sales were $229.1 million for the second quarter of fiscal 2010, an increase of
3.0% from the second quarter of fiscal 2009. The U.S. net sales increase of $6.7 million was attributable to a 2.2% increase in wholesale unit volume, which excludes third party sales from our
component plants, coupled with a 0.7% increase in wholesale average unit selling price. The increase in unit volume is primarily attributable to the successful launch of our new Stearns & Fosterline and a more stable retail environment. The increase in wholesale average unit selling price has been driven by growth in
sales of product priced greater than $1,000, but has been partially offset by increased spending for customer incentive programs. International net sales increased $11.4 million or 15.0%, from
the second quarter of fiscal 2009 to $87.4 million primarily driven by favorable changes in foreign exchange rates. Excluding the effects of currency fluctuation, international net sales
increased 5.9% from the second quarter of fiscal 2009. In Canada, local currency sales increases of 10.0% translated into increases of 28.5% in U.S. dollars due to an increase in the average value of
the Canadian dollar versus the U.S. dollar. Local currency sales performance in Canada was driven by a 17.8% increase in unit volume, which was partially offset by a 6.6% decrease in average unit
selling price. The increase in unit volume was driven by strategic promotional activity and the success of our newStearns & Fosterline. The
lower average unit selling price was driven primarily by strategic merchandising and promotional activity. In our Europe segment, local currency sales increases of 4.6% translated into increases of
4.3% in U.S. dollars due to the decrease in the average value of the Euro versus the U.S. dollar. The increase in local currency sales resulted from a 10.6% increase in sales of latex cores. Finished
goods sales in local currency remained flat to the prior year.

Gross Profit.Our consolidated gross profit for the quarter was $128.2 million, an increase of $6.3 million from the
comparable prior
year period. As a percentage of net sales, gross profit decreased 0.4 percentage points to 40.5% due to a decrease in gross profit margins in both of our segments. Total Americas gross profit
for the quarter was $121.8 million, an increase of $6.1 million from the comparable prior year period. As a percentage of net sales, gross profit for the Americas decreased
0.4 percentage points to 41.8%. The decrease in percentage of net sales was primarily driven by decreases in the U.S. business. U.S. gross profit decreased $1.2 million to
$95.3 million, which, as a percentage of net sales, represents a decrease of 1.7 percentage points to 41.6% of net sales. The decrease in percentage of net sales was driven primarily by
changes in product mix and investments made to introduce new products. Partially offsetting these decreases were improvements in operations efficiencies as well as higher absorption of fixed costs as
a result of higher unit volumes. Material costs in the U.S. during the quarter were relatively consistent with those of the second quarter of fiscal 2009. In local currency, the gross profit margin in
Canada was 43.7% which is consistent with historical levels and was achieved through a reduction in material costs per unit, improved operating efficiencies and higher absorption of fixed costs on a
17.8% increase in unit volume. These increases have been partially offset by the lower average unit selling price discussed above. In our Europe segment, the local currency gross profit margin
decreased 0.5 percentage points due to conversion costs increases.

Selling, General, Administrative.Our consolidated selling, general and administrative expense increased $11.6 million to
$107.2 million. As a percentage of net sales, this expense was 33.9% and 32.0% for the quarters ended May 30, 2010 and May 31, 2009, respectively, an increase of
1.9 percentage points. The increase as a percentage of net sales was primarily driven by an increase in non-cash compensation costs. The increase in absolute dollars is primarily
due to a $5.1 million increase in volume driven variable expenses including a $5.4 million increase in cooperative advertising and promotional costs, and a $1.4 million increase
in delivery costs due primarily to an increase in fuel

45

---



costs
and unit volume shipped. The increase in these costs have been partially offset by a $1.7 million decrease in bad debt expense. Fixed operating costs, exclusive of non-cash
compensation expense, increased $1.7 million from the prior year period primarily due to increases in expected defined contribution plan payments and cash compensation costs.
Non-cash compensation expense increased by $3.9 million compared to the second quarter of fiscal 2009 due primarily to the recognition of expense related to the restricted share
unit grants that occurred in the third quarter of fiscal 2009.

Restructuring expenses and asset impairment.We recognized pretax restructuring costs of $1.3 million during the quarter ended
May 31,
2009. No such costs were recognized during the quarter ended May 30, 2010.

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.

Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, of $3.8 million for the three
months ended
May 30, 2010 decreased $0.8 million from the prior year period due to decreased royalties received from domestic licensees.

Interest Expense.Our consolidated interest expense for the second quarter of fiscal 2010 increased $4.9 million as compared with
the prior
year period to $21.8 million which included $5.7 million of non-cash interest expense, of which $4.1 million relates to non-cash interest on our
Convertible Notes and the remainder of which relates to the accretion or amortization of original issue discount and deferred debt issuance costs. Our net weighted average borrowing cost was 10.7% and
8.5% for the three months ended May 30, 2010 and May 31, 2009, respectively. Our borrowing cost was unfavorably impacted by the refinancing of our senior secured credit facilities in May
2009 (the "Refinancing") which resulted in increased interest rates and outstanding debt balances.

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

Debt
extinguishment and refinancing expenses for the quarter ended May 31, 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.

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 May 31, 2010 was 73.5% compared to 34.0% for the three months ended March 1, 2009. The effective rate for the fiscal 2010 period
was higher than the fiscal 2009 period primarily due to the effect of non-deductible paid in kind interest which resulted from the Refinancing in the second quarter of fiscal 2009.

46

---



Equity in Earnings of Unconsolidated Affiliates.Earnings related to our joint ventures for the second quarter of fiscal 2010 have
increased from the
prior year period due to increased demand seen in the Asian markets.



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

For the six months ended:May 30, 2010

May 31, 2009(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)Net sales

$
656,155


100.0
%
$
608,431


100.0
%Cost of goods sold


387,797


59.1


368,845


60.6Gross profit


268,358


40.9


239,586


39.4Selling, general and administrative expenses


216,138


32.9


192,277


31.6Amortization expense


454


0.1


1,593


0.3Restructuring expenses and asset impairment








1,448


0.2Royalty income, net of royalty expense


(7,808
)

(1.2
)

(7,970
)

(1.3
)Income from operations


59,574


9.1


52,238


8.6Interest expense


44,106


6.7


34,424


5.7Loss on rights for convertible notes








2,729


0.4Refinancing and extinguishment of debt and interest rate derivatives


3,759


0.6


17,422


2.9Gain on sale of subsidiary stock








(1,292
)

(0.2
)Other income, net


(104
)




(46
)

Income (loss) before income taxes


11,813


1.8


(999
)

(0.2
)Income tax provision


7,240


1.1


46


Equity in earnings of unconsolidated affiliates


1,990


0.3





Net income (loss)

$
6,563


1.0
%
$
(1,045
)

(0.2
)%Effective tax rate


61.3
%




(4.6
)%


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

Six Months Ended:2010

2009Americas:United States


72.5
%

75.1
%Canada


13.2


10.5Other


6.4


6.4Total Americas


92.1


92.0Europe


7.9


8.0Total


100.0
%

100.0
%


47

---



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 six months ended:May 30, 2010

May 31, 2009(in thousands)

(percentage of
net sales)

(in thousands)

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

$
604,349


100.0
%
$
560,004


100.0
%Cost of goods sold


349,249


57.8


331,822


59.3Gross profit


255,100


42.2


228,182


40.7United States (US Dollars):Net sales


475,505


100.0


457,233


100.0Cost of goods sold


276,104


58.1


266,340


58.3Gross profit


199,401


41.9


190,893


41.7Total International (US Dollars):Net sales


180,650


100.0


151,198


100.0Cost of goods sold


111,693


61.8


102,505


67.8Gross profit


68,957


38.2


48,693


32.2Canada:US Dollars:Net sales


86,818


100.0


63,782


100.0Cost of goods sold


48,464


55.8


41,733


65.4Gross profit


38,354


44.2


22,049


34.6Canadian Dollars:Net sales


90,319


100.0


77,607


100.0Cost of goods sold


50,416


55.8


50,795


65.5Gross profit


39,903


44.2


26,812


34.5Other Americas (US Dollars):Net sales


42,026


100.0


38,989


100.0Cost of goods sold


24,681


58.7


23,749


60.9Gross profit


17,345


41.3


15,240


39.1Europe:US Dollars:Net sales


51,806


100.0


48,427


100.0Cost of goods sold


38,548


74.4


37,023


76.5Gross profit


13,258


25.6


11,404


23.5Euros:Net sales


37,646


100.0


36,455


100.0Cost of goods sold


28,010


74.4


27,786


76.2Gross profit


9,636


25.6
%

8,669


23.8
%


48

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Net Sales.Our consolidated net sales for the six months ended May 30, 2010, were $656.2 million, an increase of
$47.7 million,
or 7.8%, from the six months ended May 31, 2009. Total Americas net sales were $604.3 million for the first half of fiscal 2010, an increase of 7.9% from the first half of fiscal 2009.
This increase was due to increases in the Canada, U.S. and Other Americas businesses. Total U.S. net sales were $475.5 million for the first half of fiscal 2010, an increase of 4.0% from the
first half of fiscal 2009. The U.S. net sales increase of $18.3 million was attributable to a 2.3% increase in wholesale unit volume, which excludes third party sales from our component plants,
coupled with a 1.4% increase in wholesale average unit selling price. The increase in unit volume is primarily attributable to the successful launch of our newStearns &
Fosterline and a more stable retail environment. International net sales increased $29.5 million or 19.5%, from the first half of fiscal 2009 to $180.7 million.
This increase has been driven primarily by the favorable changes in foreign currency exchange rates. Excluding the effects of currency fluctuation, international net sales increased 8.9% from the
first half of fiscal 2009. In Canada, local currency sales increases of 16.4% translated into increases of 36.1% in U.S. dollars due to an increase in the average value of the Canadian dollar versus
the U.S. dollar. Local currency sales performance in Canada was driven by a 25.0% increase in unit volume, which was partially offset by a 6.9% decrease in average unit selling price. The increase in
unit volume was driven by strategic promotional activity and the success of our newStearns & Fosterline. The lower average unit selling
price was driven primarily by strategic merchandising and promotional activity. Elsewhere in the Americas, we experienced sales increases in our Mexico markets and relatively flat sales in our South
American markets. In our Europe segment, local currency sales increases of 3.3% translated into increases of 7.0% in U.S. dollars due to the increase in the average value of the Euro versus the U.S.
dollar. The increase in local currency sales resulted from a 7.5% increase in sales of latex cores. Finished goods sales in local currency remained flat as compared to the prior year.

Gross Profit.Our consolidated gross profit for the six months ended May 30, 2010 was $268.4 million, an increase of
$28.8 million from the comparable prior year period. As a percentage of net sales, gross profit increased 1.5 percentage points to 40.9% due to an increase in gross profit margins in
both of our segments. Total Americas gross profit for the six months ended May 30, 2010 was $255.1 million, an increase of $26.9 million from the comparable prior year period. As
a percentage of net sales, gross profit for the Americas increased 1.5 percentage points to 42.2%. The increase in percentage of net sales was primarily due to an increase in gross profit
margins in our U.S. and Canadian operations. U.S. gross profit as a percentage of net sales, increased 0.2 percentage points to 41.9% of net sales. The increase in percentage of net sales was
driven primarily by lower material costs due to commodity price decreases from the prior year and improved operational efficiencies. These increases have been partially offset by changes in product
mix and investments made to introduce new products. In local currency, the gross profit margin in Canada was 44.2%. This performance was driven by a reduction in material costs per unit, operational
efficiencies and higher absorption of fixed costs on a 25.0% increase in unit volume. These increases have been partially offset by the lower average unit selling price discussed above. In our Europe
segment, the local currency gross profit margin increased 1.8 percentage points due to conversion costs reductions.

Selling, General, Administrative.Our consolidated selling, general and administrative expense increased $23.9 million to
$216.1 million. As a percentage of net sales this expense was 32.9% and 31.6% for the six months ended May 30, 2010 and May 31, 2009, respectively, an increase of
1.3 percentage points. The increase as a percentage of net sales was primarily driven by an increase in non-cash compensation costs. The increase in absolute dollars is primarily
due to a $11.4 million increase in volume driven variable expenses including an $14.2 million increase in cooperative advertising and promotional costs, and a $2.1 million
increase in delivery costs due primarily to an increase in unit volume shipped. The increase in these costs have been partially offset by a $4.9 million decrease in bad debt expense. Fixed
operating costs, exclusive of non-cash compensation expense,

49

---



increased
$4.6 million from the prior year period primarily due to increases in expected defined contribution plan payments, cash compensation costs and professional services.
Non-cash compensation expense increased by $7.0 million compared to the first half of fiscal 2009 due primarily to the recognition of expense related to the restricted share unit
grants that occurred in the third quarter of fiscal 2009.

Restructuring expenses and asset impairment.We recognized pretax restructuring costs of $1.4 million during the six months ended
May 31, 2009. No such costs were incurred during the six months ended May 30, 2010.

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.

Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, of $7.8 million for the six
months ended
May 30, 2010 has remained relatively flat as compared to the six months ended May 31, 2009.

Interest Expense.Our consolidated interest expense for the first half of fiscal 2010 as compared with the prior year period increased
$9.7 million to $44.1 million. Interest expense for the first half of fiscal 2010 includes $10.9 million of non-cash interest expense, of which $7.6 million
relates to non-cash interest on our Convertible Notes and the remainder of which relates to the accretion or amortization of original issue discount and deferred debt issuance costs. Our
net weighted average borrowing cost was 10.6% and 8.7% for the six months ended May 30, 2010 and May 31, 2009, respectively. Our borrowing cost was unfavorably impacted by the
Refinancing which resulted in increased interest rates and outstanding debt balances.

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

Debt
extinguishment and refinancing expenses for the quarter ended May 31, 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.

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 six months ended May 30, 2010 was 61.3% compared
to (4.6)% for the six months ended May 31, 2009. The effective rate for the fiscal 2010 period was higher than the fiscal 2009 period primarily due to the effect of non-deductible
paid in kind interest which resulted from the Refinancing in the second quarter of fiscal 2009.

Equity in Earnings of Unconsolidated Affiliates.Earnings related to our joint ventures for the first half of fiscal 2010 have
increased over the
prior year period due to increased demand seen in the Asian markets.

50

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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 $6.7 million for the six months ended May 30, 2010. We expect total 2010 capital expenditures to be approximately $20.0 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 May 30, 2010, the Company had
approximately $57.7 million available under the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $15.7 million, and certain
reserves related to our outstanding derivative contracts. 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 10.6% and 8.7% for the six months ended May 30, 2010 and May 31, 2009, respectively. As of June 22, 2010, we had no borrowings outstanding under the ABL
Revolver.

On
May 13, 2009, the Company announced its Refinancing, 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 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
May 30, 2010, there were no amounts outstanding under the ABL Revolver. The Senior Notes have an outstanding balance of $303.6 million at May 30, 2010 which gives
effect to an unamortized original issue discount of $11.4 million. As of May 30, 2010, the Convertible Notes have an outstanding balance of $180.4 million. We also have an
outstanding principal balance of $268.9 million at May 30, 2010 on the 8.25% Senior Subordinated Notes due 2014 (the "2014 Notes").

On
March 16, 2010, the Company redeemed 10%, or $35.0 million, of the principal amount of its outstanding Senior Notes at a redemption price of 103% of the principal amount
of the notes, plus accrued and unpaid interest to the redemption date. In connection with the repurchase, the Company

51

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recognized
charges of $1.1 million related to the premium paid to repurchase the notes and $2.7 million related to write-off of related debt issuance costs and original issue
discount.

Future
interest payments are expected to be paid out of cash flows from operations and borrowings on our ABL Revolver. The ABL Revolver provides for revolving credit financing, subject
to borrowing base availability. The borrowing base consists of the following: 1) 85% of the net amount of eligible accounts receivable and 2) the lesser of (i) 85% of the net
orderly liquidation value of eligible inventory or (ii) 65% of the net amount of eligible inventory. These amounts are reduced by reserves deemed necessary by the lenders. At May 30,
2010, there were no amounts outstanding under the ABL Revolver.

Prior
to the Refinancing, we had 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.

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, respectively. 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.

At
May 30, 2010, 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 May 30, 2010, we have
repurchased shares for $16.3 million under this program, none of which was repurchased during fiscal 2010. From May 30, 2010 through June 22, 2010, we did not repurchase any
additional shares under this program.

Our
ability to make scheduled payments of principal, or to pay the interest or liquidated damages, if any, on or to refinance our indebtedness, or to fund planned capital expenditures
will depend on our future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We
will be required to make scheduled principal payments of $10.4 million during the next twelve months, with $1.4 million for our financing obligations and capital leases and the remainder
for debt owed by our international subsidiaries. However, as we continually evaluate our ability to make additional prepayments as permitted under our ABL Revolver agreement and the indentures
governing the Senior Notes, the Convertible Notes and the 2014 Notes, it is possible that we will redeem or repurchase additional portions of our senior or subordinated debt during that time.

52

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Our ABL Revolver agreement and the indentures governing the Senior Notes, the 2014 Notes and the Convertible Notes contain restrictions
on our ability to pay dividends, including a requirement in the ABL Revolver agreement that we meet a minimum fixed charge coverage ratio and restrictions as to the amount available for payment.
Although we meet the minimum fixed charge coverage ratio requirement as of May 30, 2010, we do not currently expect a dividend will be declared in the third quarter of fiscal 2010.



The following table summarizes our changes in cash:

Six Months Ended:May 30,
2010

May 31,
2009(in thousands)Statement of Cash Flow Data:Cash flows provided by (used in):Operating activities

$
(4,430
)
$
15,320Investing activities


(6,611
)

4,472Financing activities


(39,281
)

44,454Effect of exchange rate changes on cash


(1,548
)

1,656Change in cash and cash equivalents


(51,870
)

65,902Cash and cash equivalents:Beginning of period


131,427


26,596End of period

$
79,557

$
92,498




Cash Flows from Operating Activities.Our cash flow from operations decreased $19.7 million to a use of cash of $4.4 million
for the
six months ended May 30, 2010 from a source of cash of $15.3 million for the six months ended May 31, 2009. Net income and cash flows from operations for the six months ended
May 31, 2010 compared to the same prior year period reflect a greater use of working capital. The uses include increases in inventories to support higher sales in the quarter and the payment of
incentive compensation that was accrued at the end of fiscal 2009. Cash flows from operations for the six months ended May 31, 2009 included a benefit of $8.0 million for the receipt of
income tax refunds.

Cash Flows from Investing Activities.Our cash flows used in investing activities for the six months ended May 30, 2010 were
$6.6 million as compared to net cash provided by investing activities of $4.5 million for the six months ended May 31, 2009. This difference of $11.1 million is primarily
due to the receipt of $8.4 million of proceeds in the six months ended May 31, 2009 from the sale-leaseback of the Company's South Gate, California facility as well as higher
capital spending in fiscal 2010.

Cash Flows from Financing Activities.Our cash flow used in financing activities for the six months ended May 30, 2010 was
$39.3 million compared with cash provided by financing activities of $44.5 million for the six months ended May 31, 2009. The use of cash during the six months ended
May 30, 2010 has been primarily driven by the repayment of $35.0 million of our Senior Notes. Cash provided by financing activities for the six months ended May 31, 2009 was
impacted significantly by the Refinancing which provided $50.9 million of cash after considering the effects of the payments of costs to issue our new debt.

53

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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 Company. The Company believes that such audits will not result in a material assessment and payment of
taxes related to these positions during the one year period following May 30, 2010. We also cannot predict when or if any other future tax payments related to these tax positions may occur.



Our long-term obligations contain various financial tests and covenants, but do not require that we meet quarterly
financial ratio targets in order to maintain compliance with the terms of the obligations unless we are in a minimum availability period under the terms of our ABL Revolver.

Our
ABL Revolver requires us to maintain a minimum fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two
consecutive calendar days is less than the greater of 1) 15% of the total commitment under the ABL Revolver and 2) $15.0 million. As of May 30, 2010, we are not in a period
of minimum availability and do not have any outstanding borrowings under the ABL Revolver. Non-compliance with the minimum fixed charge coverage ratio in a period of minimum availability
could result in the requirement to immediately repay all amounts outstanding under the ABL Revolver. The fixed charge coverage ratio is defined by the ABL Revolver agreement as the ratio of Adjusted
EBITDA less unfinanced capital expenditures and net cash taxes paid to fixed charges which include cash payments for interest, capital lease obligations, scheduled principal payments on debt and other
restricted payments.



The covenants contained in our senior debt agreements also restrict our ability to enter into certain transactions (the significant of
which are summarized below). Our ABL Revolver requires us to meet a minimum fixed charge coverage ratio of 1.25 to 1.00 in order to make certain restricted payments including dividend distributions to
holders of our common stock, dividends or distributions to the parent company (Sealy Corporation), and debt repayments, subject to certain exceptions. The fixed charge coverage ratio is defined by the
ABL Revolver agreement as the ratio of Adjusted EBITDA less unfinanced capital expenditures and net cash paid to fixed charges which include cash payments for interest, capital lease obligations,
scheduled principal payments on debt and restricted payments. At May 30, 2010, adjustments to Adjusted EBITDA for cash taxes paid and unfinanced capital expenditures were $37.1 million.
Fixed charges as calculated under the terms of the ABL Revolver agreement were $72.6 million. This results in a fixed charge coverage ratio of 1.95 to 1.00 at May 30, 2010 under the
terms of the ABL Revolver agreement.

The
indentures governing our Senior Notes, Convertible Notes and Senior Subordinated Notes also require us to meet a fixed charge coverage ratio of 2.0 to 1.0 in order to incur
additional indebtedness and make certain restricted payments, including dividends or equity distributions, subject to certain exceptions. The fixed charge coverage ratio is defined by the indentures
related to these notes as the ratio of Adjusted EBITDA to fixed charges which include interest expense, and cash dividend payments on certain preferred stock. At May 30, 2010, fixed charges as
calculated under the

54

---



terms
of the indentures governing our Senior Notes, Convertible Notes and Senior Subordinated Notes were $82.5 million, resulting in a fixed charge coverage ratio of 2.17 to 1.00.

Non-compliance
with the minimum fixed charge ratio contained in the ABL Revolver agreement and the indentures governing the Senior Notes, Convertible Notes and 2014 Notes
would prohibit Sealy Mattress Company and its subsidiaries from being able to incur additional indebtedness other than pursuant to specified exceptions.

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

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

The
following table sets forth a reconciliation of net income to Adjusted EBITDA for the three and six months ended May 30, 2010 and May 31, 2009:

Three Months Ended:

Six Months Ended:May 30, 2010

May 31, 2009

May 30, 2010

May 31, 2009(in thousands)

(in thousands)Net income

$
849

$
(5,389
)
$
6,563

$
(1,045
)Interest expense


21,765


16,876


44,106


34,424Income taxes


(550
)

(2,773
)

7,240


46Depreciation and amortization


7,187


8,324


14,736


16,553EBITDA


29,251


17,038


72,645


49,978Adjustments for debt covenants:Refinancing charges


3,759


17,422


3,759


17,442Non-cash compensation


5,098


1,212


9,214


2,223Impairment charges





1,334





1,334KKR consulting fees


524


890


1,020


1,610Severance charges


137


669


1,252


1,942Loss on rights for Convertible Notes





2,729





2,729Gain on sale of subsidiary











(1,292
)Other (various)(a)


88


319


255


1,148Adjusted EBITDA

$
38,857

$
41,613

$
88,145

$
77,114


(a)Consists
of various immaterial adjustments


55

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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 29,
2009.



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



All
forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Quarterly Report on Form 10-Q and are expressly
qualified in their entirety by the cautionary statements included in this Quarterly Report on Form 10-Q. Except as may be required by law, we undertake no obligation to publicly
update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events. For a more detailed
discussion of these factors, see the information under the

56

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caption
"Risk Factors" herein and in the Company's most recent Annual Report on Form 10-K filed with the Securities and Exchange Commission and "Management's Discussion and Analysis
of Financial Condition and Results of Operations" herein and in the Company's most recent Annual Report on Form 10-K.

Item 3.    Quantitative and Qualitative Disclosures About Market Risk

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



Our earnings are affected by fluctuations in the value of our subsidiaries' functional currency as compared to the currencies of our
foreign denominated purchases. The result of a uniform 10% change in the value of the U.S. dollar relative to currencies of countries in which we manufacture or sell our products would have an
approximate $0.4 million and $0.7 million dollar impact on our financial position for the three and six months ended May 30, 2010, respectively. This calculation assumes that each
exchange rate would change in the same direction relative to the U.S. dollar.

To
protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, we have instituted a forecasted cash flow hedging
program. We hedge portions of our purchases denominated in foreign currencies and royalty payments to third parties with forward and option contracts. At May 30, 2010, we had outstanding
forward and option foreign currency contracts to sell a total of 24.8 million Canadian dollars for US dollars. The expiration dates for the Canadian dollar contracts range from June 2010 to
February 2011. At May 30, 2010, the fair value of these contracts was an asset of $0.6 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.



At May 30, 2010, 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 October 2013. The fair value of these swaps was an asset totaling $0.5 million and $0.4 million as of
May 30, 2010 and November 29, 2009, 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 May 30, 2010, a 12.5 basis point increase or decrease in variable interest rates would have an insignificant dollar impact
on our annual interest expense.



Polyurethane foam, polypropylene, polyethylene foam and High Carbon Steel Wire prices are moving upwards but we expect stability in the
prices of these commodities starting in the third quarter of fiscal 2010. 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. During the first quarter of fiscal 2010, we entered into a program through which we hedge a portion of our expected diesel fuel
consumption through the use of fixed price swap contracts. These contracts reduce

57

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the
Company's exposure to the volatility in diesel fuel prices. At May 30, 2010 we had contracts outstanding for 1.0 million gallons of diesel fuel to be consumed from May 31,
2010 through November 30, 2010. The fair value of these fixed price swap diesel contracts was an asset of an insignificant amount as of May 30, 2010. There were no such contracts
outstanding at November 29, 2009.

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 second quarter of fiscal 2010 that
have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

58

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PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

See Note 18 to the Condensed Consolidated Financial Statements, Part I, Item 1 included herein.

Item 1A.    Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed below and in
Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended November 29, 2009, which could materially affect our business, financial
condition or future results. The risks described herein and in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not
currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

The recently enacted legislation on healthcare reform and proposed amendments thereto could impact the healthcare benefits required to be provided by the Company and cause
our compensation costs to increase, potentially reducing our net income and adversely affecting our cash flows.

The recently enacted healthcare legislation and proposed amendments thereto contain provisions which could materially impact the future
healthcare costs of the Company. While the legislation's ultimate impact is not yet known, it is possible that these changes could significantly increase our compensation costs which would reduce our
net income and adversely affect our cash flows.

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

There were no repurchases of the Company's common stock during the second quarter of fiscal 2010 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 May 30, 2010, the approximate dollar value of shares that may yet be purchased under the program was $83.7 million.

Subsequent
to May 30, 2010, through June 22, 2010, 1,471,593 shares of Sealy Corporation common stock were surrendered by participants in the Company's 1998 and 2004 Stock
Option Plans to cover the individuals' minimum tax withholding obligations related to the vesting of certain restricted stock unit awards that were granted on June 12, 2010. For further details
of these awards and related stock ownership guidelines for the Company's senior management, refer to the Company's definitive Proxy Statement filed on April 14, 2010 and Exhibit 10.41 to
the Company's Annual Report on Form 10-K filed on January 25, 2010.

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.    (Removed and Reserved)

Item 5.    Other Information

None

59

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Item 6.    Exhibits

*10.19

Third Amended and Restated Credit Agreement, dated as of August 25, 2006, among Sealy Mattress Company, as Borrower, Sealy Canada Ltd./Ltee as Canadian Borrower, the Guarantors named therein, 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, J.P. Morgan Securities Inc., as Joint Lead Arranger and Joint
Bookrunner, Citigroup Global Markets, Inc. as Joint Lead Arranger and Joint Bookrunner, Citibank N.A., as Syndication Agent, General Electric Capital Corporation, as Co-Documentation Agent, Wachovia Bank, National Assocation, as Co-Documentation
Agent and LaSalle Bank National Association as Co-Documentation Agent.10.43

Amended and Restated Sealy Corporation Bonus Plan dated April 14, 2010 (incorporated herein by reference to Sealy Corporation's report on Form 8-K (File No. 1-8738) filed on April 20,
2010).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.


*Agreement
previously filed by the registrant at the time of execution. Refiling is being made herewith in order to include related schedules and/or exhibits
relating thereto.Filed
herewith.


60

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SIGNATURES

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



Signature

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

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

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


Date:
June 29, 2010

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