**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

**x**                              QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe quarterly period ended: August 26, 2007**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACTOF 1934

**Forthe Transition Period from                 to                 **

**Commissionfile number 001-08738**

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**SEALY CORPORATION**

(Exact name of registrantas specified in its charter)

| **Delaware**                                                |   | **36-3284147**                        |
|-------------------------------------------------------------|--------|---------------------------------------|
| (State or other  jurisdiction of incorporation)             |   | (I.R.S. Employer  Identification No.) |
| **Sealy Drive One Office Parkway  Trinity, North Carolina** |   | **27370**                             |
| (Address of  principal executive offices)                   |   | (Zip Code)                            |

 

**(336) 861-3500**

Registrant’s telephonenumber, including area code

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Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding12 months (or for such shorter period that the registrant was required tofile such reports) and (2) has been subject to such filing requirementsfor the past 90 days. Yes  x  No  o

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler” and “large accelerated filer” in Rule 12b-2 of the ExchangeAct. (check one):
| Large accelerated filer  o | Accelerated  filer  o | Non-accelerated  filer  x |
|--------------------------------------|---------------------------------|-------------------------------------|

 

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

**The number of shares ofthe registrant’s common stock outstanding as of September 28, 2007 isapproximately: 90,935,598.**

 

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**PART I.FINANCIAL INFORMATION**

**Item 1.**                        *Financial Statements*

**SEALY CORPORATIONCondensed Consolidated Statements of Operations(in thousands, except per share data)(unaudited)**

| ** **                                             | ** ** | **Quarter Ended**    | ** ** |
|--------------------------------------------------------|------------|---------------------------|------------|
| ** **                                             | ** ** | **August 26,  2007** | ** ** | **August 27,  2006** | ** ** |
| Net sales                                              |       | $                         | 446,380    |   | $ | 415,124 |   |
| Cost of goods  sold                                    |       | 266,492                   |       | 229,941 |   |
| Gross profit                                           |       | 179,888                   |       | 185,183 |   |
| Selling, general and administrative expenses           |       | 140,097                   |       | 127,207 |   |
| Amortization of  intangibles                           |       | 871                       |       | 144 |   |
| Royalty income,  net of royalty expense                |       | (3,771                    | )          | (3,830 | ) |
| Income from operations                                 |       | 42,691                    |       | 61,662 |   |
| Interest expense                                       |       | 15,936                    |       | 15,981 |   |
| Debt  extinguishment and refinancing expenses          |       | 249                       |       | 4,567 |   |
| Other income, net                                      |       | (70                       | )          | (75 | ) |
| Income before income tax expense                       |       | 26,576                    |       | 41,189 |   |
| Income tax  expense                                    |       | 5,105                     |       | 11,821 |   |
| Net income                                             |       | $                         | 21,471     |   | $ | 29,368 |   |
| Earnings per common share—Basic                   |       | $                         | 0.23       |   | $ | 0.32 |   |
| Earning per common share—Diluted                  |       | $                         | 0.22       |   | $ | 0.30 |   |
| Weighted average  number of common shares outstanding: |       |                      |       |   |   |
| Basic                                                  |       | 91,465                    |       | 90,959 |   |
| Diluted                                                |       | 96,376                    |       | 96,650 |   |

 

See accompanying notes to condensed consolidated financial statements.

1

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**SEALY CORPORATIONCondensed Consolidated Statements of Operations (Continued)(in thousands, except per share data)(unaudited)**

| ** **                                                                                                 | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                 | ** ** | **August 26,**             | ** ** | **August 27,** | ** ** |
| ** **                                                                                                 | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| Net sales                                                                                                  |       | $                               | 1,260,775  |   | $ | 1,187,571 |   |
| Cost of goods  sold                                                                                        |       | 731,095                         |       | 657,115 |   |
| Gross profit                                                                                               |       | 529,680                         |       | 530,456 |   |
| Selling, general and administrative expenses                                                               |       | 402,542                         |       | 373,922 |   |
| Expenses  associated with intial public offering of common stock                                           |       | —                          |       | 28,510 |   |
| Amortization of  intangibles                                                                               |       | 2,484                           |       | 399 |   |
| Royalty income,  net of royalty expense                                                                    |       | (13,474                         | )          | (11,225 | ) |
| Income from operations                                                                                     |       | 138,128                         |       | 138,850 |   |
| Interest expense                                                                                           |       | 47,070                          |       | 52,610 |   |
| Debt  extinguishment and refinancing expenses                                                              |       | 249                             |       | 9,862 |   |
| Other income, net                                                                                          |       | (284                            | )          | (641 | ) |
| Income before income tax expense                                                                           |       | 91,093                          |       | 77,019 |   |
| Income tax  expense                                                                                        |       | 28,855                          |       | 24,266 |   |
| Income before cumulative effect of change in  accounting principle                                         |       | 62,238                          |       | 52,753 |   |
| Cumulative effect  of the adoption of FASB Interpretation No. 47, net of related tax  benefit of $191 |       | —                          |       | 287 |   |
| Net income                                                                                                 |       | $                               | 62,238     |   | $ | 52,466 |   |
| Earnings per  common share—Basic                                                                      |       |                            |       |   |   |
| Income before cumulative effect of change in  accounting principle                                         |       | $                               | 0.68       |   | $ | 0.65 |   |
| Cumulative effect of a change in accounting  principle                                                     |       | —                          |       | — |   |
| Earnings per common share—Basic                                                                       |       | $                               | 0.68       |   | $ | 0.65 |   |
| Earnings per common  share—Diluted                                                                    |       |                            |       |   |   |
| Income before cumulative effect of change in  accounting principle                                         |       | $                               | 0.64       |   | $ | 0.60 |   |
| Cumulative effect of a change in accounting  principle                                                     |       | —                          |       | — |   |
| Earning per common share—Diluted                                                                      |       | $                               | 0.64       |   | $ | 0.60 |   |
| Weighted average number  of common shares outstanding:                                                     |       |                            |       |   |   |
| Basic                                                                                                      |       | 91,427                          |       | 81,169 |   |
| Diluted                                                                                                    |       | 96,586                          |       | 87,185 |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATIONCondensed Consolidated Balance Sheets(in thousands, except per share amounts)(unaudited)**

| ** **                                                                                                                                                                                                                            | ** ** | **August 26,**       | ** ** | **November 26,** | ** **                |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|-----------------------|---------------------------|
| ** **                                                                                                                                                                                                                            | ** ** | **2007**                  | ** ** | **2006**              | ** **                |
| **ASSETS**                                                                                                                                                                                                                            |       |                      |       |                  |                      |   |   |
| Current assets:                                                                                                                                                                                                                       |       |                      |       |                  |                      |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                            |       | $   14,648 |       |                  | $   45,620 |   |   |
| Accounts receivable,  net of allowances for bad debts, cash discounts and returns                                                                                                                                                     |       | 229,370                   |       |                  | 193,838                   |   |   |
| Inventories                                                                                                                                                                                                                           |       | 65,277                    |       |                  | 66,126                    |   |   |
| Assets held for  sale                                                                                                                                                                                                                 |       | —                    |       |                  | 2,338                     |   |   |
| Prepaid expenses  and other current assets                                                                                                                                                                                            |       | 20,799                    |       |                  | 24,710                    |   |   |
| Deferred income  taxes                                                                                                                                                                                                                |       | 13,434                    |       |                  | 12,627                    |   |   |
|                                                                                                                                                                                                                                  |       | 343,528                   |       |                  | 345,259                   |   |   |
| Property, plant and  equipment—at cost                                                                                                                                                                                           |       | 434,331                   |       |                  | 397,167                   |   |   |
| Less accumulated  depreciation                                                                                                                                                                                                        |       | (195,096                  | )          |                  | (178,957                  | ) |   |
|                                                                                                                                                                                                                                  |       | 239,235                   |       |                  | 218,210                   |   |   |
| Other assets:                                                                                                                                                                                                                         |       |                      |       |                  |                      |   |   |
| Goodwill                                                                                                                                                                                                                              |       | 391,786                   |       |                  | 388,204                   |   |   |
| Other intangibles,  net of accumulated amortization                                                                                                                                                                                   |       | 11,125                    |       |                  | 13,026                    |   |   |
| Debt issuance  costs, net, and other assets                                                                                                                                                                                           |       | 37,281                    |       |                  | 38,033                    |   |   |
|                                                                                                                                                                                                                                  |       | 440,192                   |       |                  | 439,263                   |   |   |
|                                                                                                                                                                                                                                  |       | $ 1,022,955          |       |                  | $ 1,002,732          |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                                                                                        |       |                      |       |                  |                      |   |   |
| Current liabilities:                                                                                                                                                                                                                  |       |                      |       |                  |                      |   |   |
| Current portion—long-term  obligations                                                                                                                                                                                           |       | $   30,152 |       |                  | $   18,282 |   |   |
| Accounts payable                                                                                                                                                                                                                      |       | 139,065                   |       |                  | 118,885                   |   |   |
| Accrued incentives  and advertising                                                                                                                                                                                                   |       | 44,944                    |       |                  | 40,578                    |   |   |
| Accrued  compensation                                                                                                                                                                                                                 |       | 32,419                    |       |                  | 35,484                    |   |   |
| Accrued interest                                                                                                                                                                                                                      |       | 11,770                    |       |                  | 17,286                    |   |   |
| Other accrued  expenses                                                                                                                                                                                                               |       | 45,230                    |       |                  | 57,669                    |   |   |
|                                                                                                                                                                                                                                  |       | 303,580                   |       |                  | 288,184                   |   |   |
| Long-term obligations,  net of current portion                                                                                                                                                                                        |       | 776,110                   |       |                  | 814,236                   |   |   |
| Other noncurrent  liabilities                                                                                                                                                                                                         |       | 45,019                    |       |                  | 42,688                    |   |   |
| Deferred income taxes                                                                                                                                                                                                                 |       | 10,399                    |       |                  | 10,199                    |   |   |
| Common stock and options  subject to redemption                                                                                                                                                                                       |       | 16,244                    |       |                  | 20,263                    |   |   |
| Stockholders’ deficit:                                                                                                                                                                                                           |       |                      |       |                  |                      |   |   |
| Common stock,  $0.01 par value; Authorized shares: 2007 and 2006—200,000 Issued and  outstanding: 2007—91,394; 2006—90,983 (including shares classified above as  subject to redemption: 2007—392; 2006—424) |       | 908                       |       |                  | 904                       |   |   |
| Additional paid-in  capital                                                                                                                                                                                                           |       | 662,862                   |       |                  | 664,609                   |   |   |
| Accumulated  deficit                                                                                                                                                                                                                  |       | (804,484                  | )          |                  | (846,144                  | ) |   |
| Accumulated other  comprehensive income                                                                                                                                                                                               |       | 12,317                    |       |                  | 7,793                     |   |   |
|                                                                                                                                                                                                                                  |       | (128,397                  | )          |                  | (172,838                  | ) |   |
|                                                                                                                                                                                                                                  |       | $ 1,022,955          |       |                  | $ 1,002,732          |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATIONCondensed Consolidated Statement of Stockholders’ Deficit(in thousands)(unaudited)**

| ** **                                                                                            | ** ** | ** **        | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                            | ** ** | ** **        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                                            | ** ** | **Comprehensive** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                                            | ** ** | **Income**        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Income**      | ** ** | **Total**  | ** ** |
| Balance at  November 26, 2006                                                                    |       |              | $          | —                |       |        |       | 90,983          |       |              |       | $               | 904        |       |       |   | $ | 664,609 |   |   |   | $ | (846,144 | ) |   |   | $ | 7,793 |   |   | $ | (172,838 | ) |
| Net income                                                                                            |       |              | 62,238     |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   | 62,238 |   |   |   |   |   |   | 62,238 |   |
| Foreign currency  translation adjustment                                                              |       |              | 5,460      |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   | 5,460 |   |   | 5,460 |   |
| Excess of  additional pension liability over unrecognized prior service cost, net  of tax of $55 |       |              | (82        | )                     |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   | (82 | ) |   | (82 | ) |
| Change in fair value  of cash flow hedge, net of tax of $503                                          |       |              | (854       | )                     |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   | (854 | ) |   | (854 | ) |
| Stock-based compensation:                                                                             |       |              |       |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Compensation  associated with stock option grants                                                |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 1,587      |   |   |   |   |   |   |   |   |   |   | 1,587 |   |
| Directors’  deferred stock compensation                                                          |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 260        |   |   |   |   |   |   |   |   |   |   | 260 |   |
| Cash dividend                                                                                         |       |              |       |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   | (20,578 | ) |   |   |   |   |   | (20,578 | ) |
| Repurchase of  common stock                                                                           |       |              |       |                  |       |        | (429       | )               |       |              | (4         | )               |       |       | (7,096     | ) |   |   |   |   |   |   |   |   |   | (7,100 | ) |
| Exercise of stock  options                                                                            |       |              |       |                  |       |        | 840        |            |       |              | 8          |            |       |       | (7,010     | ) |   |   |   |   |   |   |   |   |   | (7,002 | ) |
| Excess tax benefit  on options  exercised                                                             |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 6,443      |   |   |   |   |   |   |   |   |   |   | 6,443 |   |
| Adjustment of  temporary equity subject to redemption                                                 |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 4,019      |   |   |   |   |   |   |   |   |   |   | 4,019 |   |
| Other                                                                                                 |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 50         |   |   |   |   |   |   |   |   |   |   | 50 |   |
| Balance at  August 26, 2007                                                                      |       |              | $          | 66,762                |       |        |       | 91,394          |       |              |       | $               | 908        |       |       |   | $ | 662,862 |   |   |   | $ | (804,484 | ) |   |   | $ | 12,317 |   |   | $ | (128,397 | ) |

 

See accompanying notes to condensed consolidated financial statements.

4

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**SEALY CORPORATIONCondensed Consolidated Statements of Cash Flows(in thousands)(unaudited)**

| ** **                                                                                                                   | ** ** | **Nine Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                                                   | ** ** | **August 26,**             | ** ** | **August 27,** | ** ** |
| ** **                                                                                                                   | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| Cash flows from operating activities:                                                                                        |       |                            |       |   |   |
| Net income                                                                                                                   |       | $                               | 62,238     |   | $ | 52,466 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities:                                 |       |                            |       |   |   |
| Depreciation and  amortization                                                                                               |       | 23,064                          |       | 16,625 |   |
| Deferred income taxes                                                                                                        |       | (332                            | )          | 1,700 |   |
| Non-cash interest expense:                                                                                                   |       |                            |       |   |   |
| Senior Subordinated PIK  Notes                                                                                               |       | —                          |       | 3,348 |   |
| Amortization of debt  issuance costs and other                                                                               |       | 2,171                           |       | 1,237 |   |
| Stock-based compensation                                                                                                     |       | 2,411                           |       | 3,040 |   |
| Excess tax benefits from  share-based payment arrangements                                                                   |       | (6,443                          | )          | (2,884 | ) |
| (Gain) loss on sale of  assets                                                                                               |       | (2,318                          | )          | 402 |   |
| Write-off of debt  issuance costs related to debt extinguishments                                                            |       | 709                             |       | 6,302 |   |
| Cumulative effect of  accounting change                                                                                      |       | —                          |       | 287 |   |
| Other, net                                                                                                                   |       | (1,003                          | )          | (5,011 | ) |
| Changes in operating assets and liabilities:                                                                                 |       |                            |       |   |   |
| Accounts receivable                                                                                                          |       | (31,275                         | )          | (33,346 | ) |
| Inventories                                                                                                                  |       | 1,814                           |       | (6,324 | ) |
| Prepaid expenses and  other current assets                                                                                   |       | 4,012                           |       | (4,587 | ) |
| Accounts payable                                                                                                             |       | 17,858                          |       | (4,589 | ) |
| Accrued expenses                                                                                                             |       | (19,655                         | )          | (32,295 | ) |
| Other liabilities                                                                                                            |       | 199                             |       | 511 |   |
| Net cash provided by  (used in) operating activities                                                                         |       | 53,450                          |       | (3,118 | ) |
| Cash flows from investing activities:                                                                                        |       |                            |       |   |   |
| Purchase of property,  plant and equipment                                                                                   |       | (33,526                         | )          | (20,674 | ) |
| Proceeds from sale of  property, plant and equipment                                                                         |       | 4,998                           |       | 494 |   |
| Net cash used in  investing activities                                                                                       |       | (28,528                         | )          | (20,180 | ) |
| Cash flows from financing activities:                                                                                        |       |                            |       |   |   |
| Proceeds from initial  public offering of common stock, net of underwriting discount and other  direct costs of $24,489 |       | —                          |       | 295,511 |   |
| Cash dividends                                                                                                               |       | (20,578                         | )          | (131,824 | ) |
| Repayments of long-term  obligations, including discounts taken of $460 in 2007 and premiums paid of  $2,703 in 2006         |       | (37,540                         | )          | (586,614 | ) |
| Borrowings under new  credit facility                                                                                        |       | —                          |       | 440,000 |   |
| Borrowings under  revolving credit facilities                                                                                |       | 116,596                         |       | 137,191 |   |
| Repayments under  revolving credit facilities                                                                                |       | (110,821                        | )          | (150,106 | ) |
| Repurchase of common  stock                                                                                                  |       | (7,100                          | )          | — |   |
| Exercise of employee  stock options, including related excess tax benefits                                                   |       | 6,898                           |       | 3,012 |   |
| Debt issuance costs                                                                                                          |       | —                          |       | (657 | ) |
| Other                                                                                                                        |       | (2,695                          | )          | 1,312 |   |
| Net cash (used in)  provided by financing activities                                                                         |       | (55,240                         | )          | 7,825 |   |
| Effect of exchange rate  changes on cash                                                                                     |       | (654                            | )          | 1,125 |   |
| Change in cash and cash  equivalents                                                                                         |       | (30,972                         | )          | (14,348 | ) |
| Cash and cash equivalents:                                                                                                   |       |                            |       |   |   |
| Beginning of period                                                                                                          |       | 45,620                          |       | 36,554 |   |
| End of period                                                                                                                |       | $                               | 14,648     |   | $ | 22,206 |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATION Notes to Condensed Consolidated Financial Statements (unaudited)**

**Note 1: *Basis of Presentation***

The interim condensed consolidated financialstatements are unaudited, and certain related information and footnotedisclosures normally included in financial statements prepared in accordancewith accounting principles generally accepted in the United States of Americahave been omitted in accordance with Rule 10-01 ofRegulation S-X. The accompanying interim condensed consolidated financialstatements were prepared following the same policies and procedures used in thepreparation of the annual financial statements and reflect all adjustments(consisting of normal recurring adjustments) necessary to present fairly thefinancial position of Sealy Corporation and its subsidiaries (the “Company”).The results of operations for the interim periods are not necessarilyindicative of the results for the fiscal year. These condensed consolidatedfinancial statements should be read in conjunction with the annual consolidatedfinancial statements for the year ended November 26, 2006 included withinthe Company’s Annual Report on Form 10-K (File No. 001-08738).

On April 6, 2004, the Company completed a mergerwith affiliates of Kohlberg Kravis Roberts & Co. L.P. (“KKR”) wherebyKKR acquired 92% of the Company’s capital stock. Certain of the Company’sprevious stockholders, including affiliates of Bain Capital, LLC and others,retained an 8% interest in the Company’s stock. The merger was accounted for asa recapitalization. Subsequent to the recapitalization, the Company contributedall of its interest in Sealy Mattress Company, of which it was the soleshareholder, to a newly formed subsidiary holding company, Sealy MattressCorporation, which also replaced the Company as the parent-guarantor ofthe 8.25% Senior Subordinated Notes due 2014 (the “2014 Notes”) issued by SealyMattress Company. Effective May 25, 2006, Sealy Corporation was named aguarantor of the 2014 Notes. At August 26, 2007, KKR controlledapproximately 51% of the issued and outstanding common stock of the Company.

The preparation offinancial statements in conformity with generally accepted accountingprinciples in the United States of America requires management to makeestimates and assumptions that affect the amount of assets and liabilities anddisclosures on contingent assets and liabilities at period end and the reportedamounts of revenue and expenses during the reporting period. Actual results maydiffer from these estimates.

**Note 2: *Recently Issued Accounting Pronouncements***

In May 2005, the Financial Accounting StandardsBoard (“FASB”) issued FAS 154, “Accounting Changes and Error Corrections—areplacement of APB Opinion No. 20 and FASB Statement No. 3.” Thisstatement provides guidance on the accounting for and reporting of accountingchanges and error corrections. It establishes, unless impracticable,retrospective application as the required method for reporting a change inaccounting principle in the absence of explicit transition guidance specific toany newly adopted pronouncement. This statement also addresses the reporting ofthe correction of an error in previously issued financial statements, whichrequires similar retrospective adjustment. Changes in accounting estimatescontinue to be reported in the period of the change and any future periodsaffected. This statement became effective for accounting changes and errorcorrections made in fiscal years beginning after December 15, 2005. TheCompany adopted this statement as of the beginning of fiscal 2007. It did nothave a material impact on the Company’s consolidated financial position orresults of operations.

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In June 2006, the FASB issued Interpretation No. 48,“Accounting for Uncertainty in Income Taxes—an interpretation of FASB StatementNo. 109” (“FIN 48”). This interpretation clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with FAS 109, “Accounting for Income Taxes.” This interpretationprescribes a recognition threshold and measurement attribute for the financialstatement recognition and measurement of a tax position taken or expected to betaken in a tax return. This interpretation also provides guidance onderecognition, classification, interest and penalties, accounting in interimperiods, disclosure, and transition. The interpretation is effective for fiscalyears beginning after December 15, 2006. The Company will adopt thisinterpretation as of the beginning of fiscal 2008 and is still assessing thepotential impact of adoption.

In September 2006, the FASB issued FAS 157, “FairValue Measurements,” which defines fair value, establishes a framework formeasuring fair value in generally accepted accounting principles (“GAAP”) andexpands disclosure about fair value measurements. The statement is effectivefor fiscal years beginning after November 15, 2007. The Company will adoptthis statement as of the beginning of fiscal 2008 and is still assessing thepotential impact of adoption.

In September 2006, the FASB also issued FAS 158, “Employers’Accounting for Defined Benefit Pension and Other Postretirement Plans, anamendment of FASB Statements No. 87, 88, 106, and 132(R).” Thisstatement requires an employer to recognize the overfunded or underfundedstatus of a defined benefit postretirement plan as an asset or liability in itsstatement of financial position and to recognize changes in that funded statusin the year in which the changes occur through comprehensive income of abusiness entity. This statement also requires an employer to measure the fundedstatus of a plan as of the date of its year end statement of financialposition, with limited exceptions. The Company will be required to initiallyrecognize the funded status of a defined benefit postretirement plan and toprovide the required disclosures as of the end of the fiscal year ending after December 15,2006, which for the Company will be the end of fiscal 2007. The requirement tomeasure plan assets and benefit obligations as of the date of the employer’sfiscal year end statement of financial position is effective for fiscal yearsending after December 15, 2008, or fiscal 2009 for the Company. TheCompany is still assessing the potential impact of adoption.

In February 2007, the FASB issued FAS 159, “TheFair Value Option for Financial Assets and Financial Liabilities—including anamendment to FASB Statement No. 115,” which permits entities to choose tomeasure many financial instruments and certain other items at fair value thatare not currently required to be measured at fair value. The statement iseffective for fiscal years beginning after November 15, 2007. The Companywill adopt this statement as of the beginning of fiscal 2008 and does notexpect it to have a material impact on the Company’s financial position orresults of operations.

In June 2007, theEmerging Issues Task Force (“EITF”) issued EITF 07-3, “Accounting forNonrefundable Advance Payments for Goods or Services to Be Used in FutureResearch and Development Activities,” which provides guidance on the accountingfor certain nonrefundable advance payments for goods or services that will beused or rendered for future research and development activities. This issue iseffective prospectively for fiscal years beginning after December 15,2007, or fiscal 2009 for the Company. The Company is still assessing thepotential impact of adoption.

**Note 3: *Share-Based Compensation***

The Company accounts for all new stock options grantedor outstanding options modified after August 29, 2005 (the beginning ofthe fourth quarter of fiscal 2005) under the provisions of FAS No. 123(revised 2004) “Share-Based Payment” (“FAS 123(R)”). The Company hascontinued to account for any portion of awards outstanding at August 29,2005 using the provisions of Accounting Principles Board Opinion No. 25 “Accountingfor Stock Issued to Employees,” as previously permitted under FAS No. 123,“Accounting for Stock-Based Compensation”.

7

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Duringthe three and nine months ended August 26, 2007, the Company granted newoptions to purchase 28,332 and 478,614 shares, respectively, of common stock,and recognized compensation expense associated with these grants ofapproximately $0.1 million and $0.6 million during the three and nine monthsended August 26, 2007, respectively. During the three and nine monthsended August 27, 2006, the Company granted new options to purchase 239,823and 2,020,983 shares of common stock, respectively, and recognized compensationexpense associated with these grants of approximately $0.6 million and $1.2million, respectively. The options granted during the third quarter of fiscal2007 had a weighted average grant-date fair value of $5.37 per option and theweighted average grant-date fair value for all option grants during fiscal 2007was $5.19 per option. The Company valued these stock option grants using thetrinomial lattice valuation model with the following assumptions:

| Expected  volatility      |   | 30           | %      |
|---------------------------|--------|--------------|--------|
| Expected dividend  yield  |   | 1.76 - 2.03  | %      |
| Expected term (in  years) |   | 6.71 - 7.88  |   |
| Risk-free rate            |   | 4.54% - 4.85 | %      |

                                                

Due to the lack of sufficient historical tradinginformation with respect to its own shares, the Company estimates expectedvolatility based on a portfolio of selected stocks of companies believed tohave market and economic characteristics similar to its own. The expecteddividend yield is based on the Company’s current quarterly dividend of $0.075per share relative to the fair value of the underlying stock at grant date. Therisk-free rate is based on the U.S. Treasury yield curve in effect at the timeof grant. The expected term is based on an analysis of the early exercisebehavior of employees.

As of August 26, 2007, the Company hadapproximately $6.5 million of unrecognized compensation expense which isexpected to be recognized over a weighted average period of 5.5 years.

During the three and nine months ended August 26,2007 and August 27, 2006, the Company recognized total non-cashcompensation expense associated with stock options of $0.5 million and $1.6million, respectively, for fiscal 2007 and $0.6 million and $1.6 million,respectively, for fiscal 2006.

During the three and ninemonths ended August 26, 2007 and August 27, 2006, the Companyrecognized expense of $0.1 million and $0.6 million, respectively, forfiscal 2007 and $0.3 million and $1.2 million, respectively, for fiscal 2006,resulting from the accretion of an obligation to certain executives of theCompany for their right to sell to the Company, upon their retirement, vestedshares of the Company’s common stock.

**Note 4: *Inventories***

Themajor components of inventories were as follows (in thousands):

| ** **      | ** ** | **August 26,** | ** ** | **November 26,** | ** ** |
|-----------------|------------|---------------------|------------|-----------------------|------------|
| ** **      | ** ** | **2007**            | ** ** | **2006**              | ** ** |
| Raw materials   |       |                | $          | 34,426                |       |   |   | $ | 35,041 |   |   |
| Work in process |       |                | 17,727     |                  |       |   | 19,594 |   |   |
| Finished goods  |       |                | 13,124     |                  |       |   | 11,491 |   |   |
|            |       |                | $          | 65,277                |       |   |   | $ | 66,126 |   |   |

 

**Note 5: *Warranty Costs***

TheCompany’s warranty policy provides a 10-year non-prorated warrantyservice period on all currently manufactured *SealyPosturepedic, Stearns & Foster* and *Bassett*bedding products and certain other Sealy-branded products as well as a 20-yearwarranty on its *TrueForm *product line and a 20-yearlimited warranty on its *RightTouch*productline which cover only certain parts of the products and are prorated for 

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part of the twenty years. In fiscal 2007, the Companyamended its warranty policy on Sealy-branded promotional bedding to three yearsfor the new line introduced in January 2007 and shipped in the secondquarter of fiscal 2007. The Company’s policy is to accrue the estimated cost ofwarranty coverage at the time the sale is recorded. The change in the Company’saccrued warranty obligations for each of the nine months ended August 26,2007 and August 27, 2006 and the year ended November 26, 2006 was asfollows (in thousands):

| ** **                                           | ** ** | **August 26,** | ** ** | **November 26,** | ** ** | **August 27,** | ** ** |
|------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|---------------------|------------|
| ** **                                           | ** ** | **2007**            | ** ** | **2006**              | ** ** | **2006**            | ** ** |
| Accrued warranty  obligations at beginning of period |       | $                   | 15,349     |                  |       | $                   | 14,321     |   |   | $ | 14,321 |   |
| Warranty claims                                      |       | (12,240             | )          |                  | (15,832    | )                   |       | (12,236 | ) |
| Warranty  provisions                                 |       | 12,237              |       |                  | 16,860     |                |       | 12,580 |   |
| Accrued warranty  obligations at end of period       |       | $                   | 15,346     |                  |       | $                   | 15,349     |   |   | $ | 14,665 |   |

 

Warranty claims for theyear ended November 26, 2006 include approximately $10.5 million forclaims associated with products sold prior to November 27, 2005 that werestill under warranty. In estimating its warranty obligations, the Companyconsiders the impact of recoverable salvage value on warranty cost indetermining its estimate of future warranty obligations. Warranty claims andprovisions shown above do not include estimated salvage recoveries that reducedcost of sales by $4.5 million, $5.5 million and $4.0 million for thenine months ended August 26, 2007, the year ended November 26, 2006and the nine months ended August 27, 2006, respectively.

**Note 6: *Assets Held for Sale***

The Company had assetsheld for sale totaling $2.3 million at November 26, 2006. Theseassets were sold in March 2007. A pretax gain on sale of the facility ofapproximately $2.6 million was recorded in the second quarter of fiscal 2007 asa reduction of selling, general and administrative expenses in the CondensedConsolidated Statements of Operations.

**Note**7: *Assets Constructed on Behalf of the Company*

The Company has engagedthird parties to construct production facilities to be leased by the Company.Emerging Issues Task Force Issue No. 97-10, “The Effect of LesseeInvolvement in Asset Construction” (“EITF 97-10”), is applied to entitiesinvolved with certain structural elements of the construction of an asset thatwill be leased when construction of the asset is completed. EITF 97-10requires the Company to be considered the owner, for accounting purposes, ofthese production facilities. Accordingly, in the first quarter of fiscal 2007,the Company recorded an additional $5.2 million in property, plant andequipment with an offsetting financing obligation in the Condensed ConsolidatedBalance Sheets for a facility that was placed in service in February 2007.During the lease terms, the Company recognizes building depreciation andinterest expense for the obligations.

**Note 8: *Goodwill and Other Intangible Assets***

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

9

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Thechanges in the carrying amount of goodwill for the nine months ended August 26,2007 are as follows:

| ** **                                    | ** ** | **Americas**            | ** ** | **Europe** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------|------------|-----------|------------|
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| Balance as of  November 26, 2006              |       | $                       | 362,675    |       | $          | 25,529    |       | $ | 388,204 |   |
| Increase due to  foreign currency translation |       | 2,471                   |       | 1,111      |       | 3,582     |       |
| Balance as of  August 26, 2007                |       | $                       | 365,146    |       | $          | 26,640    |       | $ | 391,786 |   |

 

Total other intangibles of$11.1 million (net of accumulated amortization of $10.2 million) as of August 26,2007 consist primarily of licenses, which are amortized on the straight-linemethod over periods ranging from 5 to 15 years, and unamortized pensionprior service costs of $1.9 million.

**Note 9: *Long-Term Obligations***

Long-termobligations as of August 26, 2007 and November 26, 2006 consisted ofthe following:

| ** **                        | ** ** | **August 26,**     | ** ** | **November 26,** | ** ** |
|-----------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                        | ** ** | **2007**                | ** ** | **2006**              | ** ** |
| ** **                        | ** ** | **(in thousands)** | ** ** |
| Senior revolving  credit facility |       | $                       | 20,000     |                  |       | $ | 14,090 |   |   |
| Senior secured  term loans        |       | 405,000                 |       |                  | 415,000    |   |   |
| Senior  subordinated notes        |       | 314,000                 |       |                  | 342,000    |   |   |
| Financing  obligations            |       | 41,885                  |       |                  | 37,535     |   |   |
| Other                             |       | 25,377                  |       |                  | 23,893     |   |   |
|                              |       | 806,262                 |       |                  | 832,518    |   |   |
| Less current  portion             |       | (30,152                 | )          |                  | (18,282    | ) |   |
|                              |       | $                       | 776,110    |                  |       | $ | 814,236 |   |   |

 

The total borrowingcapacity under the senior revolving credit facility is $125 million, ofwhich up to $25 million may be borrowed in Canada. At August 26,2007, amounts outstanding under the senior revolving credit facility included$20 million under the U.S. portion of the facility. No amounts were outstandingunder the Canadian portion at August 26, 2007. At August 26, 2007,the Company had approximately $78 million available under the revolvingcredit facility after taking into account letters of credit issued totaling$27 million.

During the third quarterof fiscal 2007, the Company repurchased and retired $28 million aggregateprincipal amount of the 2014 Notes on the open market at prices ranging from98.0% to 98.5% of par, plus accrued interest. In connection with thesetransactions, the Company recorded a gain on the retirement of $0.5 millionoff-set by non-cash charges of $0.7 million resulting from the write-off ofdebt issuance costs associated with the retired debt. This net expense of $0.2million was recorded in the debt extinguishment and refinancing expenses lineon the Condensed Consolidated Statements of Operations.

Annually, the Company maybe required to make principal prepayments depending on certain financialratios, as defined in its senior secured credit agreement. At August 26,2007, the Company is unable to estimate the amount of such required payment, ifany, that would be due following the first quarter of fiscal 2008 with respectto excess cash flow for the 2007 fiscal year.

At August 26, 2007,the Company was in compliance with the covenants contained within its seniorcredit agreements and indenture governing the senior subordinated notes. Thesenior credit agreements and the senior subordinated notes restrict theCompany’s ability to pay dividends.

 

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**Note 10: *Hedging Strategy***

Use of hedging contractsallows the Company to reduce its overall exposure to interest rate changes,since gains and losses on these contracts will offset losses and gains on thetransactions being hedged. The Company formally documents all hedgedtransactions and hedging instruments, and assesses, both at inception of thecontract and on an ongoing basis, whether the hedging instruments are effectivein offsetting changes in cash flows of the hedged transaction. The fair values ofthe interest rate agreements are estimated by obtaining quotes from brokers andare the estimated amounts that the Company would receive or pay to terminatethe agreements at the reporting date, taking into consideration currentinterest rates and the current creditworthiness of the counterparties.

In June 2004,the Company entered into a swap agreement that has the effect of converting$200 million of the floating-rate debt under the Company’s senior creditfacilities to a fixed-rate basis, declining to $150 million from December 2005through November 2007. The Company has formally designated this swapagreement as a cash flow hedge and expects the hedge to be highly effective inoffsetting fluctuations in the designated interest payments resulting from changesin the benchmark interest rate. Effective August 25, 2006, the Companyde-designated $13 million of the interest rate swap for hedge accountingdue to an amendment of the senior secured term loan agreement. As a result ofthe amendment, $0.2 million previously recorded in accumulated othercomprehensive income was recorded as a reduction of interest expense. Theeffective portion of changes in the market value of $137 million of theswap is recorded in other comprehensive income and will be amortized intointerest expense over the remaining life of the interest rate swap agreement.For the three and nine months ended August 26, 2007 and August 27,2006, $0.6 million and $1.8 million, respectively, for fiscal 2007 and $0.5million and $1.1 million, respectively, for fiscal 2006 were recorded asreductions of interest expense. At August 26, 2007 and November 26,2006, the fair value carrying amount of the instrument was recorded as follows:

| ** **                   | ** ** | **August 26,  2007** | ** ** | **November 26,  2006** | ** ** |
|------------------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **(in thousands)**   | ** ** |
| Accrued interest  receivable |       |                      | $          | 593                         |       |   |   | $ | 607 |   |   |
| Other current assets         |       |                      | 674        |                        |       |   | 2,160 |   |   |
| Total net asset              |       |                      | $          | 1,267                       |       |   |   | $ | 2,767 |   |   |

 

At August 26, 2007 and November 26, 2006,accumulated other comprehensive income associated with the interest rate swapwas $0.4 million and $1.2 million, respectively, net of income taxeffects.

The Company had also entered into two interest rateswap agreements associated with debt that no longer exists. Although therelated debt was repaid, the swaps remained in effect until their expiration inDecember 2006. Because the first swap converted a portion of floating ratedebt to a fixed rate and the subsequent swap effectively reestablished afloating rate on the same debt, the effect of the two instruments on both cashflows and earnings was largely off-setting. Changes in the fair market value ofthese swaps were recorded in interest expense. At November 26, 2006, thefair value carrying amount of these instruments was a current liability of $0.1million.

On June 15, 2007 theCompany entered into an interest rate swap agreement effective December 3,2007 fixing the floating portion of the interest rate at 5.495% on $242 millionof the outstanding balance under the senior secured term loan through November 2008,declining to $240 million from December 2008 through November 2009, andfurther declining to $180 million from December 2009 through November 2010.The Company has formally designated this swap agreement as a cash flow hedgeand expects the hedge to be highly effective in offsetting fluctuations in thedesignated interest payments resulting from charges in the benchmark interestrate. The Company will select the Eurodollar rate on the hedged portion of thesenior secured term loan during the term of the swap.

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To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, the Company enters into foreign currencyforward contracts. The Company does not designate its foreign currency forwardcontracts as hedges for accounting purposes, therefore all changes in fairvalue are charged to earnings. At August 26, 2007, the Company had forwardcontracts to sell a total of 14 million Canadian dollars with expirationdates ranging from August 30, 2007 through November 30, 2007. At August 26,2007 and November 26, 2006, the fair value of the Company’s forwardcontracts was a liability of $1.1 million and an asset of $0.1 million,respectively. For the three and nine months ended August 26, 2007,recognized foreign currency transaction gains (losses) were $0.3 millionand $(1.0) million, respectively, compared with gains of $0.4 million and$0.6 million for the three and nine months ended August 27, 2006,respectively.

**Note 11: *Other Income, Net***

Other income, net,includes interest income for the three and nine months ended August 26,2007 and August 27, 2006 of $0.1 million and $0.3 million, respectively,for fiscal 2007 and $0.1 million and $0.6 million, respectively, for fiscal2006.

**Note 12: *Conditional Asset Retirement Obligations***

The Company adopted FASBInterpretation No. 47, “Accounting**forConditional Asset Retirement Obligations” (“FIN 47”) as of the beginning offiscal 2006 and has recorded an adjustment as of November 28, 2005, thefirst day of fiscal 2006, of approximately $0.3 million, net of income taxbenefit of $0.2 million, to recognize the cumulative effect of theaccounting change. During fiscal 2006, the Company recorded $0.4 millionin property, plant and equipment and a liability of $0.9 million in othernoncurrent liabilities. In the first quarter of fiscal 2007, the Companyrecorded an additional $0.1 million in property, plant and equipment and othernoncurrent liabilities. These amounts resulted from obligations in certain ofthe Company’s facility leases that require the Company to return thoseproperties to the same or similar condition at the end of the lease as existedwhen the Company began using those facilities. Although the lease terminationdates range from 2008 to 2022, the Company may be able to renegotiate suchleases to extend the terms.

In addition to the aboveobligations, the Company also owns certain factories that contain asbestos.Current regulations require that the Company remove and dispose of asbestos ifthe factory undergoes major renovations or is demolished. Although the Companyis not required to remove the asbestos unless renovation or demolition occurs,it is required to monitor and ensure that it remains stable and is required tonotify any potential buyer of its existence. In the fourth quarter of fiscal2006, the Company recognized an asset retirement obligation of $0.1 million toremove asbestos at a facility that was renovated in the second quarter offiscal 2007. The Company has not recognized asset retirement obligations in itsfinancial statements for asbestos at other facilities because managementbelieves that there is an indeterminate settlement date for the retirementobligation as the range of time over which the Company may be required toremove and dispose of the asbestos is unknown or cannot be estimated. TheCompany currently has no plans to demolish a factory or to undertake a majorrenovation that would require removal of the asbestos at any of these otherfacilities. Management will continue to monitor this issue and will record anasset retirement obligation when sufficient information becomes available toestimate the obligation.

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**Note 13: *Defined Benefit Pension Expense***

Thecomponents of net periodic pension cost recognized for the Company’s definedbenefit pension plan for the three and nine months ended August 26, 2007and August 27, 2006 are as follows:

| ** **                                       | ** ** | **Three months ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                       | ** ** | **August 26, 2007**    | ** ** | **August 27, 2006**   | ** ** | **August 26, 2007** | ** ** | **August 27, 2006** | ** ** |
| ** **                                       | ** ** | **(in thousands)**          | ** ** | **(in thousands)**         | ** ** |
| Service cost                                     |       |                             | $          | 177                             |       |   |   | $ | 147 |   |   |   | $ | 501 |   |   |   | $ | 442 |   |   |
| Interest cost                                    |       |                             | 245        |                            |       |   | 207 |   |   |   | 697 |   |   |   | 621 |   |   |
| Expected return  on plan assets                  |       |                             | (268       | )                               |       |   | (218 | ) |   |   | (754 | ) |   |   | (655 | ) |   |
| Amortization of  unrecognized gains and losses   |       |                             | 38         |                            |       |   | 30 |   |   |   | 106 |   |   |   | 90 |   |   |
| Amortization of  unrecognized transition asset   |       |                             | (22        | )                               |       |   | (22 | ) |   |   | (66 | ) |   |   | (66 | ) |   |
| Amortization of  unrecognized prior service cost |       |                             | 56         |                            |       |   | 50 |   |   |   | 162 |   |   |   | 149 |   |   |
| Net periodic  pension cost*                      |       |                             | $          | 226                             |       |   |   | $ | 194 |   |   |   | $ | 646 |   |   |   | $ | 581 |   |   |
| Cash contributions                               |       |                             | $          | 698                             |       |   |   | $ | 425 |   |   |   | $ | 1,287 |   |   |   | $ | 1,125 |   |   |

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*                    Net periodicpension cost recognized for the three and nine months ended August 26,2007 is based upon preliminary estimates pending the final actuarialdetermination of such costs for fiscal 2007. Similarly, net periodic pensioncost for the three and nine months ended August 27, 2006 is based uponpreliminary estimates.

The Company expects tomake additional cash contributions to the plan of approximately $0.4 millionduring the remainder of fiscal 2007.

**Note 14: *Income Taxes***

The Company’s effective income tax rates differ fromthe Federal statutory rate principally because of the effect of certain foreigntax rate differentials and state and local income taxes. The effective tax ratefor the three and nine months ended August 26, 2007 was approximately19.2% and 31.7%, respectively, compared to 28.7% and 31.5%, respectively, forthe three and nine months ended August 27, 2006. The effective rate forthe three months ended August 26, 2007 was lower than the rate for thethree months ended August 27, 2006 primarily as a result of a $7.0 millionreduction in tax reserves due to the elimination of federal and state taxexposures from statutes of limitations expiring.

Significant judgment isrequired in evaluating the Company’s federal, state and foreign tax positionsand in the determination of its tax provision. Despite the Company’s beliefthat its tax return positions are fully supportable, reserves have beenestablished where the Company believes that certain tax positions are likely tobe challenged and the Company may not fully prevail in overcoming thesechallenges. The Company may adjust these reserves as relevant circumstancesevolve, such as guidance from the relevant tax authority, or resolution ofissues in the courts. In addition the Company is still assessing the potentialimpact of FIN 48 (Note 2). The Company’s tax expense includes the impactof reserve positions and changes to reserves that it considers appropriate, aswell as related interest and penalties. While the Company is currentlyundergoing examinations of certain of its corporate income tax returns by taxauthorities, no issues related to these reserves have been presented to theCompany and the Company believes that such audits will not result in anassessment or payment of taxes related to these positions during the one yearperiod following August 26, 2007. The Company also cannot predict when orif any other future tax payments related to these tax positions may occur.

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**Note 15: *Comprehensive Income***

Comprehensive income forthe three and nine months ended August 26, 2007 was $22.9 million and$66.8 million, respectively, and for the three and nine months ended August 27,2006 was $27.7 million and $56.4 million, respectively.

**Note 16: *Contingencies***

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

The Company is currently conducting an environmentalcleanup at a formerly owned facility in South Brunswick, New Jerseypursuant to the New Jersey Industrial Site Recovery Act. The Company and one ofits subsidiaries are parties to an Administrative Consent Order issued by theNew Jersey Department of Environmental Protection. Pursuant to that order, theCompany and its subsidiary agreed to conduct soil and groundwater remediationat the property. The Company does not believe that its manufacturing processeswere the source of contamination. The Company sold the property in 1997. TheCompany and its subsidiary retained primary responsibility for the requiredremediation. The Company has completed essentially all soil remediation withNew Jersey Department of Environmental Protection approval and operates agroundwater remediation system on the site. During 2005, with the approval ofthe New Jersey Department of Environmental Protection, the Company removed anddisposed of sediment in Oakeys Brook adjoining the site. The Company continuesto monitor ground water at the site. The Company has recorded a reserve for$2.1 million ($2.8 million prior to discounting at 4.75%) associatedwith this remediation project. Also in connection with this site, the Companyreceived a written complaint from the New Jersey Department of EnvironmentalProtection alleging natural resources damages in an unspecified amount. Becausethe natural resources damages claim is in an early stage and the Company’sliability, if any, cannot be reasonably estimated at this time, no amounts havebeen accrued related to this matter.

The Company is also remediating soil and groundwatercontamination at an inactive facility located in Oakville, Connecticut.Although the Company is conducting the remediation voluntarily, it obtainedConnecticut Department of Environmental Protection approval of the remediationplan. The Company has completed essentially all soil remediation under theremediation plan and is currently monitoring groundwater at the site. TheCompany identified cadmium in the soil and ground water at the site and removedthe cadmium contaminated soil and rock from the site during the third quarterof fiscal 2007. The Company has recorded a reserve of approximately$0.2 million associated with the additional work and ongoing monitoring.The Company believes the contamination is attributable to the manufacturingoperations of previous unaffiliated occupants of the facility.

The Company removed three underground storage tankspreviously used for diesel, gasoline, and waste oil from its South Gate,California facility in March 1994 and remediated the soil in the area.Since August 1998, the Company has been working with the CaliforniaRegional Water Quality Control Board, Los Angeles Region to monitor groundwater at the site.

While the Company cannot predict the ultimate timingor costs of the South Brunswick, Oakville, and South Gate environmentalmatters, based on facts currently known, the Company believes that the accrualsrecorded are adequate and does not believe the resolution of these matters willhave a material adverse effect on the financial position or future operationsof the Company; however, in the event of an adverse decision by the agenciesinvolved, or an unfavorable result in the New Jersey natural resources damagesmatter, these matters could have a material adverse effect.

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On October 12, 2006,the Canadian government passed legislation providing for tariff refunds oncertain purchases of wood made by the Company from 2002 through 2005. Duringthe second quarter of fiscal 2007, certain factors on which the refund wascontingent were resolved; thus, the Company recorded $2.5 million as refunds inthe second quarter of fiscal 2007 as a reduction of costs of goods sold on theCondensed Consolidated Statements of Operations.

**Note 17: *Related Party Transactions***

The Company used $11.0 million of initial publicoffering (“IPO”) proceeds received in the second quarter of fiscal 2006 to pay KKRa termination fee to end the Management Services Agreement between the Companyand KKR. As a result these fees are no longer being paid starting in April 2006.During the nine months ended August 27, 2006, the Company paid managementfees of $0.8 million to KKR.

**Note18: *Segment Information***

The Company has determined that it has two reportablesegments: the Americas and Europe. These segments have been identified andaggregated based on the Company’s organizational structure which is organizedaround geographic areas.

Both reportable segments manufacture and marketconventional and specialty bedding. The Americas segment’s operations areconcentrated in the United States, Canada, Mexico, Argentina, Brazil and PuertoRico. Europe’s operations are concentrated in western Europe. The accountingpolicies of the segments are the same as those described in Note 1. The Companyevaluates performance based on profit or loss from operations before interestexpense, income taxes, depreciation and amortization (“EBITDA”). The Companyaccounts for inter-segment sales and transfers as if the sales or transferswere to third parties, that is, at current market prices.

Sales outside the United States for the three and ninemonths ended August 26, 2007 and August 27, 2006 were $111.3 millionand $305.8 million, respectively, for fiscal 2007 and $96.7 million and $263.1million, respectively, for fiscal 2006. Sales from Europe to the Americas forthe three and nine months ended August 26, 2007 and August 27, 2006were $1.1 million and $7.6 million, respectively, for fiscal 2007 and$0.8 million and $6.9 million, respectively, for fiscal 2006. Long livedassets (principally property, plant and equipment) outside the United Stateswere $62.6 million and $57.6 million as of August 26, 2007 and November 26,2006, respectively.

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| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                         | ** ** | **August 26,  2007**        | ** ** | **August 27,  2006**       | ** ** | **August 26,  2007** | ** ** | **August 27,  2006** | ** ** |
| ** **                                         | ** ** | **(in thousands)**          | ** ** | **(in thousands)**         | ** ** |
| Net sales to external  customers:                  |       |                             |       |                            |       |   |   |   |   |   |   |
| Americas                                           |       | $                                | 410,548    |                            |       | $ | 383,767 |   |   | $ | 1,158,444 |   | $ | 1,103,806 |   |
| Europe                                             |       | 35,832                           |       |                            | 31,357     |   |   | 102,331 |   | 83,765 |   |
|                                               |       | 446,380                          |       |                            | 415,124    |   |   | 1,260,775 |   | 1,187,571 |   |
| Capital  expenditures:                             |       |                             |       |                            |       |   |   |   |   |   |   |
| Americas                                           |       | 8,067                            |       |                            | 3,274      |   |   | 29,071 |   | 15,991 |   |
| Europe                                             |       | 3,055                            |       |                            | 1,353      |   |   | 4,455 |   | 4,683 |   |
|                                               |       | 11,122                           |       |                            | 4,627      |   |   | 33,526 |   | 20,674 |   |
| EBITDA:                                            |       |                             |       |                            |       |   |   |   |   |   |   |
| Americas                                           |       | 51,222                           |       |                            | 61,029     |   |   | 160,198 |   | 143,193 |   |
| Europe                                             |       | (495                             | )          |                            | 899        |   |   | 1,760 |   | 4,129 |   |
| Inter-segment eliminations                         |       | (334                             | )          |                            | 873        |   |   | (731 | ) | (1,068 | ) |
|                                               |       | 50,393                           |       |                            | 62,801     |   |   | 161,227 |   | 146,254 |   |
| Reconciliation of  EBITDA to net income:           |       |                             |       |                            |       |   |   |   |   |   |   |
| EBITDA from segments                               |       | 50,393                           |       |                            | 62,801     |   |   | 161,227 |   | 146,254 |   |
| Interest                                           |       | 15,936                           |       |                            | 15,981     |   |   | 47,070 |   | 52,610 |   |
| Income taxes                                       |       | 5,105                            |       |                            | 11,821     |   |   | 28,855 |   | 24,266 |   |
| Depreciation and amortization                      |       | 7,881                            |       |                            | 5,631      |   |   | 23,064 |   | 16,625 |   |
| Cumulative effect of change in acconting principle |       | —                           |       |                            | —     |   |   | — |   | 287 |   |
| Net Income                                         |       | $                                | 21,471     |                            |       | $ | 29,368 |   |   | $ | 62,238 |   | $ | 52,466 |   |

 

| ** **                | ** ** | **August 26,  2007** | ** ** | **November 26,  2006** | ** ** | ** ** | ** ** | ** ** | ** ** |
|---------------------------|------------|---------------------------|------------|-----------------------------|------------|------------|------------|------------|------------|
| ** **                | ** ** | **(in thousands)**   | ** ** | ** **                  | ** ** |
| Total assets:             |       |                      |       |                        |       |       |       |       |       |   |   |
| Americas                  |       | $                         | 908,194    |                        |       | $          | 894,628    |       |       |   |   |   |   |
| Europe                    |       | 115,271                   |       |                        | 109,345    |       |       |       |       |   |   |
| Intersegment eliminations |       | (510                      | )          |                        | (1,241     | )          |       |       |       |   |   |
|                      |       | $                         | 1,022,955  |                        |       | $          | 1,002,732  |       |       |   |   |   |   |

 

**Note 19: *Guarantor/Non-Guarantor Financial Information***

Sealy Corporation, Sealy Mattress Corporation (a 100%owned subsidiary of Sealy Corporation) and each of the subsidiaries of SealyMattress Company (the “Issuer”) that guarantee the 2014 Notes (the “GuarantorSubsidiaries”) have fully and unconditionally guaranteed, on a joint andseveral basis, the obligation to pay principal and interest with respect to the2014 Notes of the Issuer. Substantially all of the Issuer’s operating incomeand cash flow is generated by its subsidiaries. As a result, funds necessary tomeet the Issuer’s debt service obligations are provided in part bydistributions or advances from its subsidiaries. Under certain circumstances,contractual and legal restrictions, as well as the financial condition andoperating requirements of the Issuer’s subsidiaries, could limit the Issuer’sability to obtain cash from its subsidiaries for the purpose of meeting its debtservice obligations, including the payment of principal and interest on the2014 Notes. Although holders of the 2014 Notes will be direct creditors of theIssuer’s principal direct subsidiaries by virtue of the guarantees, the Issuerhas subsidiaries (“Non-Guarantor Subsidiaries”) that are not included among theGuarantor Subsidiaries, and such subsidiaries will not be obligated withrespect to the 2014 Notes. As a result, the claims of creditors of the 

16

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Non-GuarantorSubsidiaries will effectively have priority with respect to the assets andearnings of such companies over the claims of creditors of the Issuer,including the holders of the 2014 Notes.

The Company has correctedcertain errors in the presentation of net investment in subsidiaries, due from (to)affiliates, stockholders’ deficit, income from equity investees, capital chargeand intercompany interest allocation, income taxes, and net income line itemsfor Sealy Mattress Corporation, the Combined Guarantor Subsidiaries and theCombined Non-Guarantor Subsidiaries from amounts previously reported. Thenature of the errors related principally to eliminations of intercompanytransactions within certain of the consolidating columns in the SupplementalCondensed Consolidating Balance Sheet as well as the Supplemental CondensedConsolidating Statements of Operations and Cash Flows. Specifically, anintercompany dividend from the Combined Non-Guarantor Subsidiaries to theCombined Guarantor Subsidiaries in fiscal 2005 was improperly eliminated, anamount allocated from Sealy Mattress Corporation to the Combined GuarantorSubsidiaries in fiscal 2005 was not properly reflected on the SupplementalCondensed Consolidating Balance Sheet, and an allocation of capital chargesfrom Sealy Mattress Company to the Combined Guarantor Subsidiaries in fiscal2006 was incorrect, all as the result of clerical errors. These corrections arelimited to intercompany, investment and subsidiary equity consolidating amountswithin this Note 19, and do not affect the Condensed Consolidated FinancialStatements of the Company. The Company has also shown separately the netinvestment in subsidiaries and the due from (to) affiliates on the CondensedConsolidating Balance Sheets. The following schedules present the specific lineitem amounts that have changed as a result of the separation of theintercompany line items and corrections (in thousands):

**SupplementalCondensed Consolidating Balance Sheets as of November 26, 2006**

| ** **                           | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Combined**      | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------------|------------|------------------|------------|
| ** **                           | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                           | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| As Originally Reported:              |       |            |       |            |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net investment in subsidiaries       |       |            | (229,646   | )               |       |         | 194,817    |             |       |              | 340,427    |             |       |             | 14,068     |   |   |   | — |   |   |   | (319,666 | ) |   |   | — |   |   |
| Due from (to) affiliates             |       |            | 77,632     |            |       |         | (424,463   | )                |       |              | 567,356    |             |       |             | (176,693   | ) |   |   | (43,982 | ) |   |   | 150 |   |   |   | — |   |   |
| Stockholders’ deficit           |       |            | (172,838   | )               |       |         | (229,646   | )                |       |              | 194,817    |             |       |             | 290,734    |   |   |   | 65,032 |   |   |   | (320,937 | ) |   |   | (172,838 | ) |   |
| As Corrected:                        |       |            |       |            |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net investment in subsidiaries       |       |            | (229,646   | )               |       |         | 186,057    |             |       |              | 329,602    |             |       |             | 14,068     |   |   |   | — |   |   |   | (300,081 | ) |   |   | — |   |   |
| Due from (to) affiliates             |       |            | 77,632     |            |       |         | (415,703   | )                |       |              | 569,421    |             |       |             | (137,551   | ) |   |   | (93,949 | ) |   |   | 150 |   |   |   | — |   |   |
| Stockholders’  (deficit) equity |       |            | (172,838   | )               |       |         | (229,646   | )                |       |              | 186,057    |             |       |             | 329,876    |   |   |   | 15,065 |   |   |   | (301,352 | ) |   |   | (172,838 | ) |   |

 

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**SupplementalCondensed Consolidating Statements of Operations for the year ended November 26,2006**

| ** **                                               | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|------------------|------------|------------------|------------|
| As Originally   Reported:                                |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss (income) from equity investees                      |       |                   | (78,417    | )                                |       |                         | (78,756    | )                                     |       |                                      | (80,805    | )                |       |             | —     |   |   |   | — |   |   |   | 237,978 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | (47,028    | )                |       |             | 40,765     |   |   |   | 6,263 |   |   |   | — |   |   |   | — |   |   |
| Income tax expense (benefit)                             |       |                   | (2,364     | )                                |       |                         | (194       | )                                     |       |                                      | (1,381     | )                |       |             | 29,428     |   |   |   | 12,236 |   |   |   | (149 | ) |   |   | 37,576 |   |   |
| Net income (loss)                                        |       |                   | 73,967     |                             |       |                         | 78,417     |                                  |       |                                      | 78,756     |             |       |             | 81,026     |   |   |   | 21,922 |   |   |   | (260,121 | ) |   |   | 73,967 |   |   |
| As Corrected:                                            |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Loss (income) from equity investees                      |       |                   | (78,417    | )                                |       |                         | (78,756    | )                                     |       |                                      | (78,737    | )                |       |             | —     |   |   |   | — |   |   |   | 235,910 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | (50,535    | )                |       |             | 44,272     |   |   |   | 6,263 |   |   |   | — |   |   |   | — |   |   |
| Income tax expense (benefit)                             |       |                   | (2,364     | )                                |       |                         | (194       | )                                     |       |                                      | 58         |             |       |             | 27,989     |   |   |   | 12,236 |   |   |   | (149 | ) |   |   | 37,576 |   |   |
| Net income (loss)                                        |       |                   | 73,967     |                             |       |                         | 78,417     |                                  |       |                                      | 78,756     |             |       |             | 78,958     |   |   |   | 21,922 |   |   |   | (258,053 | ) |   |   | 73,967 |   |   |

 

**SupplementalCondensed Consolidating Statements of Cash Flows for the year ended November 26,2006**

| ** **                                                                        | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|------------------|------------|------------------|------------|
| As  Originally   Reported:                                                        |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by operating  activities                                        |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | 4,816      |             |       |             | 33,054     |   |   |   | 20,355 |   |   |   | — |   |   |   | 58,225 |   |   |
| Net activity in investment in and advances to (from) subsidiaries  and affiliates |       |                   | (69,211    | )                                |       |                         | —     |                                  |       |                                      | 79,265     |             |       |             | 5,224      |   |   |   | (15,278 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing  activities                         |       |                   | (69,211    | )                                |       |                         | —     |                                  |       |                                      | 78,804     |             |       |             | (17,746    | ) |   |   | (22,184 | ) |   |   | — |   |   |   | (30,337 | ) |   |
| As  Corrected:                                                                    |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net cash provided by operating  activities                                        |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | 6,882      |             |       |             | 30,879     |   |   |   | 20,464 |   |   |   | — |   |   |   | 58,225 |   |   |
| Net activity in investment in and advances to (from) subsidiaries  and affiliates |       |                   | (69,211    | )                                |       |                         | —     |                                  |       |                                      | 77,199     |             |       |             | 7,399      |   |   |   | (15,387 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) investing activities                         |       |                   | (69,211    | )                                |       |                         | —     |                                  |       |                                      | 76,738     |             |       |             | (15,571    | ) |   |   | (22,293 | ) |   |   | — |   |   |   | (30,337 | ) |   |

 

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The followingsupplemental condensed consolidating financial statements present:

1.                Condensedconsolidating balance sheets as of August 26, 2007 and November 26,2006, condensed consolidating statements of operations for the three and ninemonths ended August 26, 2007 and August 27, 2006, and condensedconsolidating statements of cash flows for the nine months ended August 26,2007 and August 27, 2006.

2.                Sealy Corporation,who became a guarantor of the 2014 Notes effective May 25, 2006 (as “GuarantorParent”), Sealy Mattress Corporation (a guarantor), the Issuer, combinedGuarantor Subsidiaries and combined Non- Guarantor Subsidiaries withtheir investments in subsidiaries accounted for using the equity method (seeNote 1).

3.                Eliminationentries necessary to consolidate the Guarantor Parent and all of itssubsidiaries.

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

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**SEALY CORPORATIONSupplemental Condensed Consolidating Balance SheetsAugust 26, 2007(in thousands)**

| ** **                                                        | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                        |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current assets:                                                   |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                         |       |                   | $          | 100                              |       |                         |       | $                                     | —     |                                        |       |             | $          | 1                |       |   |   | $ | 7,197 |   |   |   | $ | 7,350 |   |   |   | $ | — |   |   |   | $ | 14,648 |   |   |
| Accounts receivable, net                                          |       |                   | 30         |                             |       |                         | —     |                                  |       |                                        | 607        |             |       |             | 140,240    |   |   |   | 88,493 |   |   |   | — |   |   |   | 229,370 |   |   |
| Inventories                                                       |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 1,332      |             |       |             | 41,937     |   |   |   | 22,784 |   |   |   | (776 | ) |   |   | 65,277 |   |   |
| Assets held for sale                                              |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Prepaid expenses, deferred income taxes and other current  assets |       |                   | 1,017      |                             |       |                         | —     |                                  |       |                                        | 923        |             |       |             | 29,751     |   |   |   | 2,542 |   |   |   | — |   |   |   | 34,233 |   |   |
|                                                              |       |                   | 1,147      |                             |       |                         | —     |                                  |       |                                        | 2,863      |             |       |             | 219,125    |   |   |   | 121,169 |   |   |   | (776 | ) |   |   | 343,528 |   |   |
| Property, plant and equipment, at cost                            |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 8,758      |             |       |             | 333,851    |   |   |   | 91,722 |   |   |   | — |   |   |   | 434,331 |   |   |
| Less accumulated depreciation                                     |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | (3,587     | )                |       |             | (158,565   | ) |   |   | (32,944 | ) |   |   | — |   |   |   | (195,096 | ) |   |
|                                                              |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 5,171      |             |       |             | 175,286    |   |   |   | 58,778 |   |   |   | — |   |   |   | 239,235 |   |   |
| Other assets:                                                     |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                          |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 24,741     |             |       |             | 304,773    |   |   |   | 62,272 |   |   |   | — |   |   |   | 391,786 |   |   |
| Other intangibles, net                                            |       |                   | 6,928      |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | 4,195      |   |   |   | 2 |   |   |   | — |   |   |   | 11,125 |   |   |
| Net investment in subsidiaries                                    |       |                   | (162,949   | )                                |       |                         | 253,033    |                                  |       |                                        | 387,743    |             |       |             | 34,572     |   |   |   | — |   |   |   | (512,399 | ) |   |   | — |   |   |
| Due from (to) affiliates                                          |       |                   | 52,390     |                             |       |                         | (415,982   | )                                     |       |                                        | 561,859    |             |       |             | (106,466   | ) |   |   | (91,986 | ) |   |   | 185 |   |   |   | — |   |   |
| Debt issuance costs, net and other assets                         |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 12,494     |             |       |             | 22,035     |   |   |   | 2,752 |   |   |   | — |   |   |   | 37,281 |   |   |
|                                                              |       |                   | (103,631   | )                                |       |                         | (162,949   | )                                     |       |                                        | 986,837    |             |       |             | 259,109    |   |   |   | (26,960 | ) |   |   | (512,214 | ) |   |   | 440,192 |   |   |
| Total assets                                                      |       |                   | $          | (102,484                         | )          |                         |       | $                                     | (162,949   | )                                           |       |             | $          | 994,871          |       |   |   | $ | 653,520 |   |   |   | $ | 152,987 |   |   |   | $ | (512,990 | ) |   |   | $ | 1,022,955 |   |   |
| **Liabilities  and Stockholders’ Deficit**                   |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current liabilities:                                              |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current portion—long-term obligations                        |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                        |       |             | $          | 12,857           |       |   |   | $ | 3,302 |   |   |   | $ | 13,993 |   |   |   | $ | — |   |   |   | $ | 30,152 |   |   |
| Accounts payable                                                  |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 253        |             |       |             | 82,059     |   |   |   | 56,753 |   |   |   | — |   |   |   | 139,065 |   |   |
| Accrued customer incentives and advertising                       |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | 38,021     |   |   |   | 6,923 |   |   |   | — |   |   |   | 44,944 |   |   |
| Accrued compensation                                              |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 440        |             |       |             | 22,704     |   |   |   | 9,275 |   |   |   | — |   |   |   | 32,419 |   |   |
| Accrued interest                                                  |       |                   | 57         |                             |       |                         | —     |                                  |       |                                        | 723        |             |       |             | 10,763     |   |   |   | 227 |   |   |   | — |   |   |   | 11,770 |   |   |
| Other accrued expenses                                            |       |                   | 2,659      |                             |       |                         | —     |                                  |       |                                        | 297        |             |       |             | 36,136     |   |   |   | 6,138 |   |   |   | — |   |   |   | 45,230 |   |   |
|                                                              |       |                   | 2,716      |                             |       |                         | —     |                                  |       |                                        | 14,570     |             |       |             | 192,985    |   |   |   | 93,309 |   |   |   | — |   |   |   | 303,580 |   |   |
| Long-term obligations                                             |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 726,143    |             |       |             | 41,596     |   |   |   | 8,371 |   |   |   | — |   |   |   | 776,110 |   |   |
| Other noncurrent liabilities                                      |       |                   | 6,786      |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | 27,655     |   |   |   | 10,578 |   |   |   | — |   |   |   | 45,019 |   |   |
| Deferred income taxes                                             |       |                   | 167        |                             |       |                         | —     |                                  |       |                                        | 1,125      |             |       |             | 3,265      |   |   |   | 5,842 |   |   |   | — |   |   |   | 10,399 |   |   |
| Common stock and options subject to redemption                    |       |                   | 16,244     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | 16,244 |   |   |
| Stockholders’ equity (deficit)                               |       |                   | (128,397   | )                                |       |                         | (162,949   | )                                     |       |                                        | 253,033    |             |       |             | 388,019    |   |   |   | 34,887 |   |   |   | (512,990 | ) |   |   | (128,397 | ) |   |
| Total liabilities  and stockholders’ equity (deficit)        |       |                   | $          | (102,484                         | )          |                         |       | $                                     | (162,949   | )                                           |       |             | $          | 994,871          |       |   |   | $ | 653,520 |   |   |   | $ | 152,987 |   |   |   | $ | (512,990 | ) |   |   | $ | 1,022,955 |   |   |

 

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**SEALY CORPORATION Supplemental Condensed Consolidating Balance Sheets (Continued) November 26, 2006 (as corrected)  (in thousands)**

| ** **                                                             | ** ** | ** **      | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                             | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                             | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                             | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                             |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current assets:                                                        |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |       |            | $          | 934             |       |         |       | $                | —     |             |       |             | $          | 1                |       |   |   | $ | 36,182 |   |   |   | $ | 8,503 |   |   |   | $ | — |   |   |   | $ | 45,620 |   |   |
| Accounts receivable, net                                               |       |            | 7          |            |       |         | —     |             |       |             | 620        |             |       |             | 105,812    |   |   |   | 87,399 |   |   |   | — |   |   |   | 193,838 |   |   |
| Inventories                                                            |       |            | —     |            |       |         | —     |             |       |             | 1,218      |             |       |             | 45,977     |   |   |   | 20,352 |   |   |   | (1,421 | ) |   |   | 66,126 |   |   |
| Assets held for sale                                                   |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | 2,338      |   |   |   | — |   |   |   | — |   |   |   | 2,338 |   |   |
| Prepaid expenses, deferred income taxes and  other current assets |       |            | 1,001      |            |       |         | —     |             |       |             | 1,913      |             |       |             | 31,628     |   |   |   | 2,795 |   |   |   | — |   |   |   | 37,337 |   |   |
|                                                                   |       |            | 1,942      |            |       |         | —     |             |       |             | 3,752      |             |       |             | 221,937    |   |   |   | 119,049 |   |   |   | (1,421 | ) |   |   | 345,259 |   |   |
| Property, plant and equipment, at cost                            |       |            | —     |            |       |         | —     |             |       |             | 7,995      |             |       |             | 306,934    |   |   |   | 82,238 |   |   |   | — |   |   |   | 397,167 |   |   |
| Less accumulated depreciation                                          |       |            | —     |            |       |         | —     |             |       |             | (4,436     | )                |       |             | (146,452   | ) |   |   | (28,069 | ) |   |   | — |   |   |   | (178,957 | ) |   |
|                                                                   |       |            | —     |            |       |         | —     |             |       |             | 3,559      |             |       |             | 160,482    |   |   |   | 54,169 |   |   |   | — |   |   |   | 218,210 |   |   |
| Other assets:                                                          |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                               |       |            | —     |            |       |         | —     |             |       |             | 24,741     |             |       |             | 304,773    |   |   |   | 58,690 |   |   |   | — |   |   |   | 388,204 |   |   |
| Other intangibles, net                                                 |       |            | 8,773      |            |       |         | —     |             |       |             | —     |             |       |             | 4,246      |   |   |   | 7 |   |   |   | — |   |   |   | 13,026 |   |   |
| Net investment in   subsidiaries                                       |       |            | (229,646   | )               |       |         | 186,057    |             |       |             | 329,602    |             |       |             | 14,068     |   |   |   | — |   |   |   | (300,081 | ) |   |   | — |   |   |
| Due from (to) affiliates                                               |       |            | 77,632     |            |       |         | (415,703   | )                |       |             | 569,421    |             |       |             | (137,551   | ) |   |   | (93,949 | ) |   |   | 150 |   |   |   | — |   |   |
| Debt issuance costs, net and other  assets                             |       |            | —     |            |       |         | —     |             |       |             | 15,230     |             |       |             | 20,566     |   |   |   | 2,237 |   |   |   | — |   |   |   | 38,033 |   |   |
|                                                                   |       |            | (143,241   | )               |       |         | (229,646   | )                |       |             | 938,994    |             |       |             | 206,102    |   |   |   | (33,015 | ) |   |   | (299,931 | ) |   |   | 439,263 |   |   |
| Total assets                                                           |       |            | $          | (141,299        | )          |         |       | $                | (229,646   | )                |       |             | $          | 946,305          |       |   |   | $ | 588,521 |   |   |   | $ | 140,203 |   |   |   | $ | (301,352 | ) |   |   | $ | 1,002,732 |   |   |
| **Liabilities and Stockholders’ Equity (Deficit)**                |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current liabilities:                                                   |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current portion—long-term  obligations                            |       |            | $          | —          |       |         |       | $                | —     |             |       |             | $          | 3,750            |       |   |   | $ | 2,256 |   |   |   | $ | 12,276 |   |   |   | $ | — |   |   |   | $ | 18,282 |   |   |
| Accounts payable                                                       |       |            | —     |            |       |         | —     |             |       |             | 326        |             |       |             | 72,106     |   |   |   | 46,453 |   |   |   | — |   |   |   | 118,885 |   |   |
| Accrued customer incentives and advertising                            |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | 31,735     |   |   |   | 8,843 |   |   |   | — |   |   |   | 40,578 |   |   |
| Accrued compensation                                                   |       |            | —     |            |       |         | —     |             |       |             | 513        |             |       |             | 25,167     |   |   |   | 9,804 |   |   |   | — |   |   |   | 35,484 |   |   |
| Accrued interest                                                       |       |            | 66         |            |       |         | —     |             |       |             | 922        |             |       |             | 16,099     |   |   |   | 199 |   |   |   | — |   |   |   | 17,286 |   |   |
| Other accrued expenses                                                 |       |            | 2,730      |            |       |         | —     |             |       |             | 362        |             |       |             | 45,673     |   |   |   | 8,904 |   |   |   | — |   |   |   | 57,669 |   |   |
|                                                                   |       |            | 2,796      |            |       |         | —     |             |       |             | 5,873      |             |       |             | 193,036    |   |   |   | 86,479 |   |   |   | — |   |   |   | 288,184 |   |   |
| Long-term obligations                                                  |       |            | —     |            |       |         | —     |             |       |             | 753,250    |             |       |             | 37,449     |   |   |   | 23,537 |   |   |   | — |   |   |   | 814,236 |   |   |
| Other noncurrent liabilities                                           |       |            | 8,313      |            |       |         | —     |             |       |             | —     |             |       |             | 24,964     |   |   |   | 9,411 |   |   |   | — |   |   |   | 42,688 |   |   |
| Deferred income taxes                                                  |       |            | 167        |            |       |         | —     |             |       |             | 1,125      |             |       |             | 3,196      |   |   |   | 5,711 |   |   |   | — |   |   |   | 10,199 |   |   |
| Common stock and options subject to redemption                    |       |            | 20,263     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | 20,263 |   |   |
| Stockholders’ equity (deficit)                                    |       |            | (172,838   | )               |       |         | (229,646   | )                |       |             | 186,057    |             |       |             | 329,876    |   |   |   | 15,065 |   |   |   | (301,352 | ) |   |   | (172,838 | ) |   |
| Total liabilities  and stockholders’  equity (deficit)       |       |            | $          | (141,299        | )          |         |       | $                | (229,646   | )                |       |             | $          | 946,305          |       |   |   | $ | 588,521 |   |   |   | $ | 140,203 |   |   |   | $ | (301,352 | ) |   |   | $ | 1,002,732 |   |   |

 

21

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of OperationsThree Months Ended August 26, 2007(in thousands)**

| ** **                                          | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                           |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                        |       |             | $          | 20,928           |       |   |   | $ | 323,370 |   |   |   | $ | 109,594 |   |   |   | $ | (7,512 | ) |   |   | $ | 446,380 |   |   |
| Cost and expenses:                                  |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 12,382     |             |       |             | 191,884    |   |   |   | 70,048 |   |   |   | (7,822 | ) |   |   | 266,492 |   |   |
| Selling, general and administrative                 |       |                   | 73         |                             |       |                         | —     |                                  |       |                                        | 1,985      |             |       |             | 109,490    |   |   |   | 28,549 |   |   |   | — |   |   |   | 140,097 |   |   |
| Amortization of  intangibles                        |       |                   | 740        |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | 72         |   |   |   | 59 |   |   |   | — |   |   |   | 871 |   |   |
| Royalty (income) expense, net                       |       |                   | (851       | )                                |       |                         | —     |                                  |       |                                        | —     |             |       |             | (3,771     | ) |   |   | 851 |   |   |   | — |   |   |   | (3,771 | ) |   |
| Income from operations                              |       |                   | 38         |                             |       |                         | —     |                                  |       |                                        | 6,561      |             |       |             | 25,695     |   |   |   | 10,087 |   |   |   | 310 |   |   |   | 42,691 |   |   |
| Interest expense                                    |       |                   | 86         |                             |       |                         | 171        |                                  |       |                                        | 14,284     |             |       |             | 511        |   |   |   | 884 |   |   |   | — |   |   |   | 15,936 |   |   |
| Other (income) expense, net                         |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 249        |             |       |             | —     |   |   |   | (70 | ) |   |   | — |   |   |   | 179 |   |   |
| Loss (income) from equity investees                 |       |                   | (21,507    | )                                |       |                         | (21,600    | )                                     |       |                                        | (18,715    | )                |       |             | —     |   |   |   | — |   |   |   | 61,822 |   |   |   | — |   |   |
| Loss (income) from non- guarantor equity investees  |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | (4,738     | ) |   |   | — |   |   |   | 4,738 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | (13,358    | )                |       |             | 12,337     |   |   |   | 1,021 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes                   |       |                   | 21,459     |                             |       |                         | 21,429     |                                  |       |                                        | 24,101     |             |       |             | 17,585     |   |   |   | 8,252 |   |   |   | (66,250 | ) |   |   | 26,576 |   |   |
| Income tax expense  (benefit)                       |       |                   | (12        | )                                |       |                         | (78        | )                                     |       |                                        | 2,501      |             |       |             | (1,142     | ) |   |   | 3,848 |   |   |   | (12 | ) |   |   | 5,105 |   |   |
| Net income (loss)                                   |       |                   | $          | 21,471                           |       |                         |       | $                                     | 21,507     |                                        |       |             | $          | 21,600           |       |   |   | $ | 18,727 |   |   |   | $ | 4,404 |   |   |   | $ | (66,238 | ) |   |   | $ | 21,471 |   |   |

 

22

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Operations (Continued)Three Months Ended August 27, 2006(in thousands)**

| ** **                                          | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|---------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                           |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                        |       |             | $          | 16,989           |       |   |   | $ | 310,037 |   |   |   | $ | 94,891 |   |   |   | $ | (6,793 | ) |   |   | $ | 415,124 |   |   |
| Costs and expenses:                                 |       |                   |       |                             |       |                         |       |                                  |       |                                        |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | 9,823      |             |       |             | 168,374    |   |   |   | 58,962 |   |   |   | (7,218 | ) |   |   | 229,941 |   |   |
| Selling, general and administrative                 |       |                   | 133        |                             |       |                         | —     |                                  |       |                                        | 1,714      |             |       |             | 101,354    |   |   |   | 24,006 |   |   |   | — |   |   |   | 127,207 |   |   |
| Amortization of  intangibles                        |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | 73         |   |   |   | 71 |   |   |   | — |   |   |   | 144 |   |   |
| Royalty (income) expense, net                       |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | (4,400     | ) |   |   | 570 |   |   |   | — |   |   |   | (3,830 | ) |   |
| Income from operations                              |       |                   | (133       | )                                |       |                         | —     |                                  |       |                                        | 5,452      |             |       |             | 44,636     |   |   |   | 11,282 |   |   |   | 425 |   |   |   | 61,662 |   |   |
| Interest expense                                    |       |                   | —     |                             |       |                         | 138        |                                  |       |                                        | 15,342     |             |       |             | (122       | ) |   |   | 623 |   |   |   | — |   |   |   | 15,981 |   |   |
| Other income (expense), net                         |       |                   | (17        | )                                |       |                         | —     |                                  |       |                                        | 4,566      |             |       |             | 10         |   |   |   | (67 | ) |   |   | — |   |   |   | 4,492 |   |   |
| Income from equity investees                        |       |                   | (29,498    | )                                |       |                         | (29,582    | )                                     |       |                                        | (29,563    | )                |       |             | —     |   |   |   | — |   |   |   | 88,643 |   |   |   | — |   |   |
| Income from nonguarantor equity investees           |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | —     |             |       |             | (6,984     | ) |   |   | — |   |   |   | 6,984 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |                   | —     |                             |       |                         | —     |                                  |       |                                        | (14,392    | )                |       |             | 13,484     |   |   |   | 908 |   |   |   | — |   |   |   | — |   |   |
| Income before income taxes                          |       |                   | 29,382     |                             |       |                         | 29,444     |                                  |       |                                        | 29,499     |             |       |             | 38,248     |   |   |   | 9,818 |   |   |   | (95,202 | ) |   |   | 41,189 |   |   |
| Income tax expense  (benefit)                       |       |                   | 14         |                             |       |                         | (54        | )                                     |       |                                        | (83        | )                |       |             | 8,782      |   |   |   | 3,077 |   |   |   | 85 |   |   |   | 11,821 |   |   |
| Net income                                          |       |                   | $          | 29,368                           |       |                         |       | $                                     | 29,498     |                                        |       |             | $          | 29,582           |       |   |   | $ | 29,466 |   |   |   | $ | 6,741 |   |   |   | $ | (95,287 | ) |   |   | $ | 29,368 |   |   |

 

23

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Operations (Continued)Nine Months Ended August 26, 2007(in thousands)**

| ** **                                           | ** ** | **Sealy  Corporation** | ** **                                  | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** **                                  | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-  Guarantor  Subsidiaries** | ** **    | **Eliminations** | ** ** | **Consolidated** | ** **     |
|------------------------------------------------------|------------|------------------------|---------------------------------------------|----------------------------------|------------|------------------------------|---------------------------------------------|---------------------------------------|------------|---------------------------------------------|---------------|------------------|------------|------------------|----------------|
| Net sales                                            |       |                   | $      — |                             |       |                         | $      — |                                  |       |                                        | $ 60,085 |             |       |             | $ 921,851 |   |   |   | $ 305,980 |   |   |   | $ (27,141 | ) |   |   | $ 1,260,775 |   |   |
| Cost and expenses:                                   |       |                   |                                        |                             |       |                         |                                        |                                  |       |                                        |          |             |       |             |           |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                   |       |                   | —                                      |                             |       |                         | —                                      |                                  |       |                                        | 35,154        |             |       |             | 528,773        |   |   |   | 194,954 |   |   |   | (27,786 | ) |   |   | 731,095 |   |   |
| Selling, general  and administrative                 |       |                   | 194                                         |                             |       |                         | —                                      |                                  |       |                                        | 5,777         |             |       |             | 317,425        |   |   |   | 79,146 |   |   |   | — |   |   |   | 402,542 |   |   |
| Amortization of  intangibles                         |       |                   | 2,178                                       |                             |       |                         | —                                      |                                  |       |                                        | —        |             |       |             | 216            |   |   |   | 90 |   |   |   | — |   |   |   | 2,484 |   |   |
| Royalty (income)  expense, net                       |       |                   | (2,813                                      | )                                |       |                         | —                                      |                                  |       |                                        | —        |             |       |             | (13,090        | ) |   |   | 2,429 |   |   |   | — |   |   |   | (13,474 | ) |   |
| Income from operations                               |       |                   | 441                                         |                             |       |                         | —                                      |                                  |       |                                        | 19,154        |             |       |             | 88,527         |   |   |   | 29,361 |   |   |   | 645 |   |   |   | 138,128 |   |   |
| Interest expense                                     |       |                   | 272                                         |                             |       |                         | 467                                         |                                  |       |                                        | 43,031        |             |       |             | 818            |   |   |   | 2,482 |   |   |   | — |   |   |   | 47,070 |   |   |
| Other (income)  expense, net                         |       |                   | (8                                          | )                                |       |                         | —                                      |                                  |       |                                        | 249           |             |       |             | (46            | ) |   |   | (230 | ) |   |   | — |   |   |   | (35 | ) |   |
| Loss (income) from  equity investees                 |       |                   | (62,132                                     | )                                |       |                         | (62,411                                     | )                                     |       |                                        | (52,772       | )                |       |             | —         |   |   |   | — |   |   |   | 177,315 |   |   |   | — |   |   |
| Loss (income) from  non- guarantor equity investees  |       |                   | —                                      |                             |       |                         | —                                      |                                  |       |                                        | —        |             |       |             | (15,052        | ) |   |   | — |   |   |   | 15,052 |   |   |   | — |   |   |
| Capital charge and  intercompany interest allocation |       |                   | —                                      |                             |       |                         | —                                      |                                  |       |                                        | (40,238       | )                |       |             | 37,137         |   |   |   | 3,101 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before  income taxes                   |       |                   | 62,309                                      |                             |       |                         | 61,944                                      |                                  |       |                                        | 68,884        |             |       |             | 65,670         |   |   |   | 24,008 |   |   |   | (191,722 | ) |   |   | 91,093 |   |   |
| Income tax expense   (benefit)                       |       |                   | 71                                          |                             |       |                         | (188                                        | )                                     |       |                                        | 6,473         |             |       |             | 12,847         |   |   |   | 9,687 |   |   |   | (35 | ) |   |   | 28,855 |   |   |
| Net income (loss)                                    |       |                   | $ 62,238                               |                             |       |                         | $ 62,132                               |                                  |       |                                        | $ 62,411 |             |       |             | $ 52,823  |   |   |   | $ 14,321 |   |   |   | $ (191,687 | ) |   |   | $  62,238 |   |   |

 

24

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Operations (Continued)Nine Months Ended August 27, 2006(in thousands)**

| ** **                                             | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|------------------|------------|------------------|------------|
| Net sales                                              |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                      |       |             | $          | 49,089           |       |   |   | $ | 899,487 |   |   |   | $ | 262,311 |   |   |   | $ | (23,316 | ) |   |   | $ | 1,187,571 |   |   |
| Costs and expenses:                                    |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods  sold                                    |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | 28,869     |             |       |             | 488,170    |   |   |   | 161,043 |   |   |   | (20,967 | ) |   |   | 657,115 |   |   |
| Selling, general  and administrative                   |       |                   | 130        |                             |       |                         | —     |                                  |       |                                      | 4,806      |             |       |             | 300,589    |   |   |   | 68,397 |   |   |   | — |   |   |   | 373,922 |   |   |
| Expenses  Associated with IPO                     |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | —     |             |       |             | 27,958     |   |   |   | 552 |   |   |   | — |   |   |   | 28,510 |   |   |
| Amortization of  intangibles                           |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | —     |             |       |             | 217        |   |   |   | 182 |   |   |   | — |   |   |   | 399 |   |   |
| Royalty (income)  expense, net                         |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | —     |             |       |             | (12,872    | ) |   |   | 1,647 |   |   |   | — |   |   |   | (11,225 | ) |   |
| Income from  operations                                |       |                   | (130       | )                                |       |                         | —     |                                  |       |                                      | 15,414     |             |       |             | 95,425     |   |   |   | 30,490 |   |   |   | (2,349 | ) |   |   | 138,850 |   |   |
| Interest expense                                       |       |                   | 3,360      |                             |       |                         | 389        |                                  |       |                                      | 47,670     |             |       |             | (325       | ) |   |   | 1,516 |   |   |   | — |   |   |   | 52,610 |   |   |
| Other (income)  expense, net                           |       |                   | 1,143      |                             |       |                         | —     |                                  |       |                                      | 8,701      |             |       |             | (265       | ) |   |   | (358 | ) |   |   | — |   |   |   | 9,221 |   |   |
| Income from equity  investees                          |       |                   | (55,197    | )                                |       |                         | (55,426    | )                                     |       |                                      | (53,027    | )                |       |             | —     |   |   |   | — |   |   |   | 163,650 |   |   |   | — |   |   |
| Income from  nonguarantor  equity investees            |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | —     |             |       |             | (16,623    | ) |   |   | — |   |   |   | 16,623 |   |   |   | — |   |   |
| Capital charge and  intercompany interest allocation   |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | (45,027    | )                |       |             | 42,161     |   |   |   | 2,866 |   |   |   | — |   |   |   | — |   |   |
| Income before  income taxes                       |       |                   | 50,564     |                             |       |                         | 55,037     |                                  |       |                                      | 57,097     |             |       |             | 70,477     |   |   |   | 26,466 |   |   |   | (182,622 | ) |   |   | 77,019 |   |   |
| Income tax expense  (benefit)                          |       |                   | (1,902     | )                                |       |                         | (160       | )                                     |       |                                      | 1,671      |             |       |             | 16,864     |   |   |   | 8,001 |   |   |   | (208 | ) |   |   | 24,266 |   |   |
| Income before  cumulative effect                  |       |                   | 52,466     |                             |       |                         | 55,197     |                                  |       |                                      | 55,426     |             |       |             | 53,613     |   |   |   | 18,465 |   |   |   | (182,414 | ) |   |   | 52,753 |   |   |
| Cumulative effect of  change in  accounting  principle |       |                   | —     |                             |       |                         | —     |                                  |       |                                      | —     |             |       |             | 287        |   |   |   | — |   |   |   | — |   |   |   | 287 |   |   |
| Net income                                             |       |                   | $          | 52,466                           |       |                         |       | $                                     | 55,197     |                                      |       |             | $          | 55,426           |       |   |   | $ | 53,326 |   |   |   | $ | 18,465 |   |   |   | $ | (182,414 | ) |   |   | $ | 52,466 |   |   |

 

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Cash FlowsNine Months Ended August 26, 2007(in thousands)**

| ** **                                                                         | ** ** | ** **              | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                         | ** ** | ** **              | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                         | ** ** | **Sealy**               | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                         | ** ** | **Corporation**         | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| ** **                                                                         | ** ** | **(in thousands)** | ** ** |
| Net cash provided by operating activities                                          |       |                    | $          | —          |       |         |       | $                | —     |             |       |             | $          | 11,976           |       |   |   | $ | 17,737 |   |   |   | $ | 23,737 |   |   |   | $ | — |   |   |   | $ | 53,450 |   |   |
| Cash flows from investing  activities:                                             |       |                    |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment                                          |       |                    | —     |            |       |         | —     |             |       |             | (2,033     | )                |       |             | (25,721    | ) |   |   | (5,772 | ) |   |   | — |   |   |   | (33,526 | ) |   |
| Proceeds from the  sale of property, plant, and  equipment                         |       |                    | —     |            |       |         | —     |             |       |             | —     |             |       |             | 4,932      |   |   |   | 66 |   |   |   | — |   |   |   | 4,998 |   |   |
| Net activity in  investment in and advances from (to) subsidiaries and affiliates  |       |                    | 19,896     |            |       |         | —     |             |       |             | 7,612      |             |       |             | (23,366    | ) |   |   | (4,142 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) investing activities                          |       |                    | 19,896     |            |       |         | —     |             |       |             | 5,579      |             |       |             | (44,155    | ) |   |   | (9,848 | ) |   |   | — |   |   |   | (28,528 | ) |   |
| Cash flows from financing  activities:                                             |       |                    |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Dividend                                                                           |       |                    | (20,578    | )               |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (20,578 | ) |   |
| Equity received  upon exercise of stock including related excess tax benefits |       |                    | 6,898      |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | 6,898 |   |   |
| Repurchase of common  stock                                                        |       |                    | (7,100     | )               |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (7,100 | ) |   |
| Repayments of  long-term obligations                                               |       |                    | —     |            |       |         | —     |             |       |             | (37,540    | )                |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (37,540 | ) |   |
| Borrowings under  revolving credit facilities                                      |       |                    | —     |            |       |         | —     |             |       |             | 94,500     |             |       |             | —     |   |   |   | 22,096 |   |   |   | — |   |   |   | 116,596 |   |   |
| Repayments on  revolving credit facilities                                         |       |                    | —     |            |       |         | —     |             |       |             | (74,500    | )                |       |             | —     |   |   |   | (36,321 | ) |   |   | — |   |   |   | (110,821 | ) |   |
| Other                                                                              |       |                    | 50         |            |       |         | —     |             |       |             | (15        | )                |       |             | (2,567     | ) |   |   | (163 | ) |   |   | — |   |   |   | (2,695 | ) |   |
| Net cash used in  financing activities                                             |       |                    | (20,730    | )               |       |         | —     |             |       |             | (17,555    | )                |       |             | (2,567     | ) |   |   | (14,388 | ) |   |   | — |   |   |   | (55,240 | ) |   |
| Effect of exchange  rate changes on cash                                      |       |                    | —     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | (654 | ) |   |   | — |   |   |   | (654 | ) |   |
| Change in cash and  cash equivalents                                               |       |                    | (834       | )               |       |         | —     |             |       |             | —     |             |       |             | (28,985    | ) |   |   | (1,153 | ) |   |   | — |   |   |   | (30,972 | ) |   |
| Cash and cash  equivalents:                                                        |       |                    |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of  period                                                               |       |                    | 934        |            |       |         | —     |             |       |             | 1          |             |       |             | 36,182     |   |   |   | 8,503 |   |   |   | — |   |   |   | 45,620 |   |   |
| End of period                                                                      |       |                    | $          | 100             |       |         |       | $                | —     |             |       |             | $          | 1                |       |   |   | $ | 7,197 |   |   |   | $ | 7,350 |   |   |   | $ | — |   |   |   | $ | 14,648 |   |   |

 

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Cash Flows (Continued)Nine Months Ended August 27, 2006(in thousands)**

| ** **                                                                             | ** ** | **Sealy  Corporation** | ** ** | **Sealy  Mattress  Corporation** | ** ** | **Sealy  Mattress  Company** | ** ** | **Combined  Guarantor  Subsidiaries** | ** ** | **Combined  Non-Guarantor  Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------------|------------|------------------------------|------------|---------------------------------------|------------|-------------------------------------------|------------|------------------|------------|------------------|------------|
| Net cash provided  by (used in) operating activities                              |       |                   | $          | —                           |       |                         |       | $                                     | —     |                                      |       | $                | 9,146      |             |       | $ | (22,473 | ) |   |   | $ | 10,209 |   |   |   | $ | — |   |   |   | $ | (3,118 | ) |   |
| Cash flows from investing activities:                                                  |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of  property, plant and equipment, net                                        |       |                   | —     |                             |       |                         | —     |                                  |       | (400                                      | )          |             | (15,564    | )                |       |   | (4,710 | ) |   |   | — |   |   |   | (20,674 | ) |   |
| Proceeds from the  sale of property, plant, and equipment                    |       |                   | —     |                             |       |                         | —     |                                  |       | —                                    |       |             | 460        |             |       |   | 34 |   |   |   | — |   |   |   | 494 |   |   |
| Net activity in  investment in and advances to (from) subsidiaries and affiliates |       |                   | (73,129    | )                                |       |                         | —     |                                  |       | 49,411                                    |       |             | 26,072     |             |       |   | (2,354 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided  by (used in) investing activities                                   |       |                   | (73,129    | )                                |       |                         | —     |                                  |       | 49,011                                    |       |             | 10,968     |             |       |   | (7,030 | ) |   |   | — |   |   |   | (20,180 | ) |   |
| Cash flows from  financing activities:                                            |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from  issuance of common stock                                           |       |                   | 295,511    |                             |       |                         | —     |                                  |       | —                                    |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | 295,511 |   |   |
| Dividend                                                                               |       |                   | (131,824   | )                                |       |                         | —     |                                  |       | —                                    |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | (131,824 | ) |   |
| Proceeds from  issuance of long-term debt                                         |       |                   | —     |                             |       |                         | —     |                                  |       | 440,000                                   |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | 440,000 |   |   |
| Repayment of  existing long-term debt                                                  |       |                   | (89,114    | )                                |       |                         | —     |                                  |       | (497,500                                  | )          |             | —     |             |       |   | — |   |   |   | — |   |   |   | (586,614 | ) |   |
| Equity received  upon exercise of stock including related excess tax benefits     |       |                   | 3,012      |                             |       |                         | —     |                                  |       | —                                    |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | 3,012 |   |   |
| Borrowings under  revolving credit facilities                                          |       |                   | —     |                             |       |                         | —     |                                  |       | 120,600                                   |       |             | —     |             |       |   | 16,591 |   |   |   | — |   |   |   | 137,191 |   |   |
| Repayments on  revolving credit facilities                                        |       |                   | —     |                             |       |                         | —     |                                  |       | (120,600                                  | )          |             | —     |             |       |   | (29,506 | ) |   |   | — |   |   |   | (150,106 | ) |   |
| Debt issuance  costs                                                                   |       |                   | —     |                             |       |                         | —     |                                  |       | (657                                      | )          |             | —     |             |       |   | — |   |   |   | — |   |   |   | (657 | ) |   |
| Other borrowings                                                                       |       |                   | —     |                             |       |                         | —     |                                  |       | —                                    |       |             | (2,802     | )                |       |   | 4,114 |   |   |   | — |   |   |   | 1,312 |   |   |
| Net cash provided  by (used in) financing activities                                   |       |                   | 77,585     |                             |       |                         | —     |                                  |       | (58,157                                   | )          |             | (2,802     | )                |       |   | (8,801 | ) |   |   | — |   |   |   | 7,825 |   |   |
| Effect of exchange  rate changes on cash                                               |       |                   | —     |                             |       |                         | —     |                                  |       | —                                    |       |             | —     |             |       |   | 1,125 |   |   |   | — |   |   |   | 1,125 |   |   |
| Change in cash and  cash equivalents                                                   |       |                   | 4,456      |                             |       |                         | —     |                                  |       | —                                    |       |             | (14,307    | )                |       |   | (4,497 | ) |   |   | — |   |   |   | (14,348 | ) |   |
| Cash and cash equivalents:                                                             |       |                   |       |                             |       |                         |       |                                  |       |                                      |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of  period                                                                   |       |                   | —     |                             |       |                         | —     |                                  |       | 1                                         |       |             | 25,387     |             |       |   | 11,166 |   |   |   | — |   |   |   | 36,554 |   |   |
| End of period                                                                          |       |                   | $          | 4,456                            |       |                         |       | $                                     | —     |                                      |       | $                | 1          |             |       | $ | 11,080 |   |   |   | $ | 6,669 |   |   |   | $ | — |   |   |   | $ | 22,206 |   |   |

 

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**SEALY CORPORATION**

**Item 2.**                        *Management’s Discussion and Analysis of Financial Condition and Resultsof Operations*

*The following management’s discussion and analysis isprovided as a supplement to, and should be read in conjunction with, ourCondensed Consolidated Financial Statements and accompanying notes included inthis Quarterly Report on Form 10-Q as well as our management’sdiscussion 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 conventional bedding products include the *Sealy, Sealy Posturepedic, Stearns & Foster,*and*Bassett* brands and accounted forapproximately 92% of our total net sales for the year ended November 26,2006. In addition to our innerspring bedding, we also produce a variety ofvisco-elastic (memory foam) and latex foam bedding products.

In the first quarter of fiscal 2007, we introduced anew line of *Stearns & Foster* brandedmattresses and box springs that incorporates the features we determined werethe most desired by the consumer during our intensive market and consumerresearch. We also introduced a new line of *Posturepedic*Reserve branded mattresses and box springs. These launches were essentiallycompleted in the third quarter of fiscal 2007. In addition, we introducednew *Sealy-*branded products that arecompliant with the new Federal flame retardant standards, 16 CFR Part 1633passed by the U.S. Consumer Product Safety Commission, which became effective July 1,2007. As with earlier major product launches, we expect our sales andprofitability growth to be limited during the period in which our customerscomplete the transition to the new product lines.

Our industry continues to be challenged by thevolatility in the price of petroleum and steel products, which affects the costof our polyurethane foam, polyester, polyethylene foam and steel innerspringand box spring components. Due to production capacity constraints, we have alsoseen an increase in price for rayon fibers. During fiscal 2006 and into thethird quarter of fiscal 2007, the cost of these components has continued toremain elevated above their recent historical averages, and we expect these coststo continue at or above current levels over the remainder of fiscal 2007.

We have two reportablesegments: the Americas and Europe. These segments have been identified andaggregated based on our organizational structure which is organized aroundgeographic areas. Both reportable segments manufacture and market conventionaland specialty bedding. The Americas segment’s operations are concentrated inthe United States, Canada, Mexico, Argentina, Brazil and Puerto Rico. Europe’soperations are concentrated in western Europe.

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***RESULTS OF OPERATIONS***

***Tabular Information—Current Fiscal Quarter***

Thefollowing table sets forth our summarized results of operations for the threemonths ended August 26, 2007 and August 27, 2006, expressed inthousands of dollars, as well as a percentage of each period’s net sales:

| ** **                                    | ** ** | **For the three months ended:** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **August 26, 2007**                       | ** ** | **August 27, 2006** | ** ** |
| ** **                                    | ** ** | ** **                                          | ** ** | **(percentage** | ** ** | ** ** | ** ** | **(percentage** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                             | ** ** | **of net sales)** | ** ** | **(in thousands)** | ** ** | **of net sales)** | ** ** |
| Net sales                                     |       |                                                | $          | 446,380 |   |   |   | 100.0 | % |   |   | $ | 415,124 |   |   |   | 100.0 | % |   |
| Cost of goods  sold                           |       |                                                | 266,492    |   |   |   | 59.7 |   |   |   | 229,941 |   |   |   | 55.4 |   |   |
| Gross profit                                  |       |                                                | 179,888    |   |   |   | 40.3 |   |   |   | 185,183 |   |   |   | 44.6 |   |   |
| Selling, general  and administrative expenses |       |                                                | 140,097    |   |   |   | 31.4 |   |   |   | 127,207 |   |   |   | 30.6 |   |   |
| Amortization of  intangibles                  |       |                                                | 871        |   |   |   | 0.2 |   |   |   | 144 |   |   |   | — |   |   |
| Royalty income,  net of royalty expense       |       |                                                | (3,771     | ) |   |   | (0.8 | ) |   |   | (3,830 | ) |   |   | (0.9 | ) |   |
| Income from operations                        |       |                                                | 42,691     |   |   |   | 9.5 |   |   |   | 61,662 |   |   |   | 14.9 |   |   |
| Interest expense                              |       |                                                | 15,936     |   |   |   | 3.5 |   |   |   | 15,981 |   |   |   | 3.9 |   |   |
| Debt  extinguishment and refinancing          |       |                                                | 249        |   |   |   | 0.1 |   |   |   | 4,567 |   |   |   | 1.1 |   |   |
| Other income, net                             |       |                                                | (70        | ) |   |   | — |   |   |   | (75 | ) |   |   | — |   |   |
| Income before income taxes                    |       |                                                | 26,576     |   |   |   | 5.9 |   |   |   | 41,189 |   |   |   | 9.9 |   |   |
| Income tax  expense                           |       |                                                | 5,105      |   |   |   | 1.1 |   |   |   | 11,821 |   |   |   | 2.8 |   |   |
| Net income                                    |       |                                                | $          | 21,471 |   |   |   | 4.8 | % |   |   | $ | 29,368 |   |   |   | 7.1 | % |   |
| Effective tax rate                            |       |                                                | 19.2       | % |   |   |   |   |   |   | 28.7 | % |   |   |   |   |   |

 

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

| ** **          | ** ** | **Three Months Ended:** | ** ** |
|---------------------|------------|-----------------------------------|------------|
| ** **          | ** ** | **August 26,**               | ** ** | **August 27,** | ** ** |
| ** **          | ** ** | **2007**                          | ** ** | **2006** | ** ** |
| **Americas:**       |       |                              |       |   |   |   |   |   |   |
| United States       |       |                              | 75.1       | % |   |   | 76.7 | % |   |
| Canada              |       |                              | 11.4       |   |   |   | 10.3 |   |   |
| Other               |       |                              | 5.5        |   |   |   | 5.4 |   |   |
| **Total  Americas** | ** ** | ** **                        | **92.0**   | ** ** | ** ** | ** ** | **92.4** | ** ** | ** ** |
| **Europe**          | ** ** | ** **                        | 8.0        | ** ** | ** ** | ** ** | 7.6 | ** ** | ** ** |
| **Total**           | ** ** | ** **                        | **100.0**  | **%** | ** ** | ** ** | **100.0** | **%** | ** ** |

 

29

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Thefollowing table shows our net sales and margin profitability for our Americasand Europe segments as well as the major geographic regions within our Americassegment:

| ** **                        | ** ** | **For the Three Months Ended** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **August 26, 2007**                      | ** ** | **August 27, 2006** | ** ** |
| ** **                        | ** ** | ** **                                         | ** ** | **(percentage** | ** ** | ** ** | ** ** | **(percentage** | ** ** |
| ** **                        | ** ** | **(in thousands)**                            | ** ** | **of net sales)** | ** ** | **(in thousands)** | ** ** | **of net sales)** | ** ** |
| **Total Americas (US Dollars):**  | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                         |       |                                               | $          | 410,548 |   |   |   | 100.0 | % |   |   | $ | 383,767 |   |   |   | 100.0 | % |   |
| Cost of goods sold                |       |                                               | 239,653    |   |   |   | 58.4 |   |   |   | 208,337 |   |   |   | 54.3 |   |   |
| Gross profit                      |       |                                               | 170,895    |   |   |   | 41.6 |   |   |   | 175,430 |   |   |   | 45.7 |   |   |
| **United  States (US Dollars):**  | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                         |       |                                               | 335,084    |   |   |   | 100.0 |   |   |   | 318,394 |   |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 196,173    |   |   |   | 58.5 |   |   |   | 170,328 |   |   |   | 53.5 |   |   |
| Gross profit                      |       |                                               | 138,911    |   |   |   | 41.5 |   |   |   | 148,066 |   |   |   | 46.5 |   |   |
| **Canada:**                       | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US  Dollars:**                  | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                         |       |                                               | 51,031     |   |   |   | 100.0 |   |   |   | 42,927 |   |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 29,136     |   |   |   | 57.1 |   |   |   | 23,820 |   |   |   | 55.5 |   |   |
| Gross profit                      |       |                                               | 21,895     |   |   |   | 42.9 |   |   |   | 19,107 |   |   |   | 44.5 |   |   |
| **Canadian  Dollars:**            |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                         |       |                                               | 54,121     |   |   |   | 100.0 |   |   |   | 48,210 |   |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 30,896     |   |   |   | 57.1 |   |   |   | 26,750 |   |   |   | 55.5 |   |   |
| Gross profit                      |       |                                               | 23,225     |   |   |   | 42.9 |   |   |   | 21,460 |   |   |   | 44.5 |   |   |
| **Other  Americas (US Dollars):** |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                         |       |                                               | 24,433     |   |   |   | 100.0 |   |   |   | 22,446 |   |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 14,344     |   |   |   | 58.7 |   |   |   | 14,189 |   |   |   | 63.2 |   |   |
| Gross profit                      |       |                                               | 10,089     |   |   |   | 41.3 |   |   |   | 8,257 |   |   |   | 36.8 |   |   |
| **Europe:**                       |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **US  Dollars:**                  |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                         |       |                                               | 35,832     |   |   |   | 100.0 |   |   |   | 31,357 |   |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 26,839     |   |   |   | 74.9 |   |   |   | 21,604 |   |   |   | 68.9 |   |   |
| Gross profit                      |       |                                               | 8,993      |   |   |   | 25.1 |   |   |   | 9,753 |   |   |   | 31.1 |   |   |
| **Euros:**                        |       |                                               |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net sales                         |       |                                               | 26,323     |   |   |   | 100.0 |   |   |   | 24,798 |   |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 19,712     |   |   |   | 74.9 |   |   |   | 17,082 |   |   |   | 68.9 |   |   |
| Gross profit                      |       |                                               | $          | 6,611 |   |   |   | 25.1 | % |   |   | $ | 7,716 |   |   |   | 31.1 | % |   |

 

***Quarter Ended August 26, 2007 compared withQuarter Ended August 27, 2006***

*NetSales.**  *Ourconsolidated net sales for the quarter ended August 26, 2007, were $446.4 million, an increase of $31.3million, or 7.5% from the quarter ended August 27, 2006. Total Americas net sales were $410.5 million for thethird quarter of fiscal 2007, an increase of 7.0% over the third quarter offiscal 2006. This increase was primarily related to our U.S. and Canadianoperations within the Americas segment. Total U.S. net sales were $335.1million for the third quarter of fiscal 2007, an increase of 5.2% over thethird quarter of fiscal 2006. In response to the softness of the U.S. beddingindustry, our focus has been on driving unit volume. The U.S. net salesincrease of $16.7 million was attributable to a 10.3% increase in unit volumepartially offset by a 4.6% decrease in average unit selling price. The increasein unit volume is primarily attributable to the strong sales of our *Posturepedic*Reserve beds, which we began shipping in our 

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second fiscal quarter of 2007,as well as the continued success of our specialty bedding products, which grewapproximately 73% over the comparable prior year period. The decrease inaverage unit selling price is primarily due to increased sales of our Reservebeds, decreased sales of higher priced luxury *Posturepedic*beds and strategic pricing actions taken in the fiscal first quarterof 2007 on selected products such as the *TrueForm *line,partially offset by a favorable mix of higher-end specialty and *Stearns & Foster* sales. In Canada, local currencysales gains of 12.3% translated into gains of 18.9% in U.S. dollars. Localcurrency gains in Canada were driven by a 15.9% increase in unit volume, whichwas partially offset by a 3.1% decline in average unit selling price. The changesin volume and average unit selling price were a result of selective pricingactions. Elsewhere in the Americas, we experienced sales gains in our Mexicoand Argentina markets. In our European segment, local currency sales gains of6.2% translated into gains of 14.3% in U.S. dollars. Local currency gains inEurope were driven by a 63.2% increase in unit volume, partially offset by a35% decrease in average unit selling price. Increased sales of OEM latex bedcores, which have lower prices, drove the unit growth and the decrease inaverage unit selling price. Local currency finished goods sales in Europeincreased 8.5%.

*GrossProfit.**  *Ourconsolidated gross profit for the quarter was $179.9 million, a decrease of$5.3 million from the comparable prior year period. As a percentage of netsales, gross profit decreased 4.3 percentage points to 40.3%. This was due to adecrease in gross profit margins in both of our segments. Total Americas grossprofit for the quarter was $170.9 million, a decrease of $4.5 million from thecomparable prior year period. As a percentage of net sales, gross profit forthe Americas decreased 4.1 percentage points to 41.6%. This decrease wasprimarily due to a decrease in gross profit margins in our U.S. and Canadianoperations. U.S. gross profit decreased $9.2 million to $138.9 million, which,as a percentage of sales, represents a decrease of 5.0 percentage points to41.5% of net sales. This decrease was primarily driven by the addition of $9.5million of flame retardant materials to the remainder of our products as wellas the above mentioned shift in sales mix and pricing actions. Partiallyoffsetting this decrease were continued improvements in our manufacturingefficiencies. On a per unit basis, material costs increased 7.9% relative tothe third quarter of fiscal 2006 primarily due to additional costs to make ourproducts compliant with the 2007 federal flame retardancy regulations as wellas steps taken to provide greater value through the Reserve and *Stearns & Foster* beds, partially offset by improvedyields on raw materials. The gross profit margin in Canada decreased 1.6percentage points to 42.9% of net sales due to the selective pricing actionsmentioned above that reduced average unit selling prices. In our Europeansegment, the gross profit margin decrease resulted from a shift in sales oflatex bed cores to other manufacturers to lower margin accounts.

*Selling,General, Administrative.**  *Our consolidated selling, general, and administrativeexpense increased $12.9 million to $140.1 million. This increase was due to $7.5million of increases in volume variable expenses, which included a $5.0 millionincrease in cooperative advertising costs and a $1.7 million increase indelivery costs due to higher unit volume. Other cost increases included a $3.6million increase in promotional expenses in the U.S. operations associated withnew product roll outs in the quarter and other promotional expenses, $1.4million of costs associated with an organizational realignment in the U.S., a$1.3 million increase in spending on national advertising, and $1.0 million ofhigher selling costs to support the international sales growth, particularly inEurope. These increases were partially offset by $1.9 million of costreductions. As a percent of net sales this expense was 31.4% and 30.6% for thequarters ended August 26, 2007 and August 27, 2006, respectively, anincrease of 0.8 percentage points.

*Royaltyincome, net of royalty expense.*   Our consolidatedroyalty income, net of royalty expenses, for the three months ended August 26,2007 remained flat as compared with the prior year period at $3.8 million.

*InterestExpense.**  *Ourconsolidated interest expense for the third quarter of fiscal 2007 remainedflat as compared with the prior year period at $16.0 million. Our net weightedaverage borrowing cost was 7.8% for the three months ended August 26, 2007and August 27, 2006. Our borrowing cost was favorably 

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impacted by the retirementof $28.0 million of our 2014 Notes late in the quarter and by lower rates onthe fixed component of our senior secured term debt as a result of the August 2006amendment of our senior credit agreement. This was offset by higher interestrates on the unhedged variable rate component of our floating rate debt.

*DebtExtinguishment and Refinancing Expenses.**  *During the three months ended August 26, 2007, we incurred$0.2 million of debt extinguishment costs consisting of $0.7 million ofnon-cash charges offset by a $0.5 million gain relating to the retirement of$28 million of our 2014 Notes. During the three months ended August 27,2006 we incurred $4.6 million of debt extinguishment costs consisting of $0.5million of cash expenses and $4.1 million of non-cash charges related to therefinancing of our senior secured term loans.

*Income Tax.**  *Our effective income tax ratesdiffer from the Federal statutory rate principally because of the effect ofcertain foreign tax rate differentials and state and local income taxes. Oureffective tax rate for the three months ended August 26, 2007 was 19.2%compared to 28.7% for the three months ended August 27, 2006. Theeffective rate for the fiscal 2007 period was lower than the fiscal 2006 periodprimarily as the result of a $7.0 million reduction in tax reserves due to theelimination of federal and state tax exposures from statutes of limitationsexpiring.

***Tabular Information—Year to Date***

Thefollowing table sets forth our summarized results of operations for the ninemonths ended August 26, 2007 and August 27, 2006, expressed in thousandsof dollars as well as a percentage of each period’s net sales:

| ** **                                                              | ** ** | **For the nine months ended:** | ** ** |
|-------------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| ** **                                                              | ** ** | **August 26, 2007**                      | ** ** | **August 27, 2006** | ** ** |
| ** **                                                              | ** ** | ** **                                         | ** ** | **(percentage** | ** ** | ** ** | ** ** | **(percentage** | ** ** |
| ** **                                                              | ** ** | **(in thousands)**                            | ** ** | **of net sales)** | ** ** | **(in thousands)** | ** ** | **of net sales)** | ** ** |
| Net sales                                                               |       |                                               | $          | 1,260,775 |   |   |   | 100.0 | % |   |   | $ | 1,187,571 |   |   |   | 100.0 | % |   |
| Cost of goods  sold                                                     |       |                                               | 731,095    |   |   |   | 58.0 |   |   |   | 657,115 |   |   |   | 55.3 |   |   |
| Gross profit                                                            |       |                                               | 529,680    |   |   |   | 42.0 |   |   |   | 530,456 |   |   |   | 44.7 |   |   |
| Selling, general  and administrative expenses                           |       |                                               | 402,542    |   |   |   | 31.9 |   |   |   | 373,922 |   |   |   | 31.5 |   |   |
| Expenses associated  with IPO                                           |       |                                               | —     |   |   |   | — |   |   |   | 28,510 |   |   |   | 2.4 |   |   |
| Amortization of  intangibles                                            |       |                                               | 2,484      |   |   |   | 0.2 |   |   |   | 399 |   |   |   | — |   |   |
| Royalty income,  net of royalty expense                                 |       |                                               | (13,474    | ) |   |   | (1.1 | ) |   |   | (11,225 | ) |   |   | (0.9 | ) |   |
| Income from operations                                                  |       |                                               | 138,128    |   |   |   | 11.0 |   |   |   | 138,850 |   |   |   | 11.7 |   |   |
| Interest expense                                                        |       |                                               | 47,070     |   |   |   | 3.7 |   |   |   | 52,610 |   |   |   | 4.5 |   |   |
| Debt  extinguishment and refinancing                                    |       |                                               | 249        |   |   |   | — |   |   |   | 9,862 |   |   |   | 0.8 |   |   |
| Other income, net                                                       |       |                                               | (284       | ) |   |   | — |   |   |   | (641 | ) |   |   | (0.1 | ) |   |
| Income before income taxes and cumulative effect                        |       |                                               | 91,093     |   |   |   | 7.3 |   |   |   | 77,019 |   |   |   | 6.5 |   |   |
| Income taxes                                                            |       |                                               | 28,855     |   |   |   | 2.3 |   |   |   | 24,266 |   |   |   | 2.1 |   |   |
| Income before cumulative effect of change in accounting  principle |       |                                               | 62,238     |   |   |   | 5.0 |   |   |   | 52,753 |   |   |   | 4.4 |   |   |
| Cumulative effect  of change in accounting principle                    |       |                                               | —     |   |   |   | — |   |   |   | 287 |   |   |   | — |   |   |
| Net income                                                              |       |                                               | $          | 62,238 |   |   |   | 5.0 | % |   |   | $  | 52,466 |   |   |   | 4.4 | % |   |
| Effective tax rate                                                      |       |                                               | 31.7       | % |   |   |   |   |   |   | 31.5 | % |   |   |   |   |   |

 

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

| ** **         | ** ** | **Nine Months Ended:** | ** ** |
|--------------------|------------|----------------------------------|------------|
| ** **         | ** ** | **August 26,**              | ** ** | **August 27,** | ** ** |
| ** **         | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| **Americas:**      |       |                             |       |   |   |   |   |   |   |
| United States      |       |                             | 75.7       | % |   |   | 77.8 | % |   |
| Canada             |       |                             | 10.5       |   |   |   | 9.9 |   |   |
| Other              |       |                             | 5.7        |   |   |   | 5.2 |   |   |
| **Total Americas** | ** ** | ** **                       | **91.9**   | ** ** | ** ** | ** ** | **92.9** | ** ** | ** ** |
| **Europe**         | ** ** | ** **                       | 8.1        | ** ** | ** ** | ** ** | 7.1 | ** ** | ** ** |
| **Total**          | ** ** | ** **                       | **100.0**  | **%** | ** ** | ** ** | **100.0** | **%** | ** ** |

 

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

| ** **                        | ** ** | **For the nine months ended:** | ** ** |
|-----------------------------------|------------|----------------------------------------------------|------------|
| ** **                        | ** ** | **August 26,**                                | ** ** | **August 27,** | ** ** |
| ** **                        | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                        | ** ** | ** **                                         | ** ** | **(percentage** | ** ** | ** ** | ** ** | **(percentage** | ** ** |
| ** **                        | ** ** | **(in thousands)**                            | ** ** | **of net sales)** | ** ** | **(in thousands)** | ** ** | **of net sales)** | ** ** |
| **Total  Americas (US Dollars):** | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                         |       |                                               | $          | 1,158,444 | ** ** |   |   | 100.0 | % |   |   | $ | 1,103,806 | ** ** |   |   | 100.0 | % |   |
| Cost of goods sold                |       |                                               | 655,929    | ** ** |   |   | 56.6 |   |   |   | 598,972 | ** ** |   |   | 54.3 |   |   |
| Gross profit                      |       |                                               | 502,515    | ** ** |   |   | 43.4 |   |   |   | 504,834 | ** ** |   |   | 45.7 |   |   |
| **United States (US Dollars):**   | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                         |       |                                               | 954,963    | ** ** |   |   | 100.0 |   |   |   | 924,434 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 539,855    | ** ** |   |   | 56.5 |   |   |   | 496,069 | ** ** |   |   | 53.7 |   |   |
| Gross profit                      |       |                                               | 415,108    | ** ** |   |   | 43.5 |   |   |   | 428,365 | ** ** |   |   | 46.3 |   |   |
| **Canada:**                       | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US Dollars:**                   | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                         |       |                                               | 132,028    | ** ** |   |   | 100.0 |   |   |   | 116,988 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 75,610     | ** ** |   |   | 57.3 |   |   |   | 64,875 | ** ** |   |   | 55.5 |   |   |
| Gross profit                      |       |                                               | 56,418     | ** ** |   |   | 42.7 |   |   |   | 52,113 | ** ** |   |   | 44.5 |   |   |
| **Canadian Dollars:**             |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                         |       |                                               | 146,824    | ** ** |   |   | 100.0 |   |   |   | 133,387 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 84,070     | ** ** |   |   | 57.3 |   |   |   | 73,988 | ** ** |   |   | 55.5 |   |   |
| Gross profit                      |       |                                               | 62,754     | ** ** |   |   | 42.7 |   |   |   | 59,399 | ** ** |   |   | 44.5 |   |   |
| **Other Americas (US Dollars):**  |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                         |       |                                               | 71,453     | ** ** |   |   | 100.0 |   |   |   | 62,384 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 40,464     | ** ** |   |   | 56.6 |   |   |   | 38,028 | ** ** |   |   | 61.0 |   |   |
| Gross profit                      |       |                                               | 30,989     | ** ** |   |   | 43.4 |   |   |   | 24,356 | ** ** |   |   | 39.0 |   |   |
| **Europe:**                       |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| **US Dollars:**                   |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                         |       |                                               | 102,331    | ** ** |   |   | 100.0 |   |   |   | 83,765 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 75,166     | ** ** |   |   | 73.5 |   |   |   | 58,142 | ** ** |   |   | 69.4 |   |   |
| Gross profit                      |       |                                               | 27,165     | ** ** |   |   | 26.5 |   |   |   | 25,623 | ** ** |   |   | 30.6 |   |   |
| **Euros:**                        |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                         |       |                                               | 76,558     | ** ** |   |   | 100.0 |   |   |   | 68,125 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                |       |                                               | 56,221     | ** ** |   |   | 73.4 |   |   |   | 47,503 | ** ** |   |   | 69.7 |   |   |
| Gross profit                      |       |                                               | $          | 20,337 | ** ** |   |   | 26.6 | % |   |   | $ | 20,622 | ** ** |   |   | 30.3 | % |   |

 

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***Nine Months Ended August 26, 2007 compared withNine Months Ended August 27, 2006***

*NetSales.**  *Ourconsolidated net sales for the nine months ended August 26, 2007, were $1,260.8 million, an increase of$73.2 million, or 6.2% from the nine months ended August 27, 2006. Total Americas net sales were$1,158.4 million for the first nine months of fiscal 2007 compared to $1,103.8million for the first nine months of fiscal 2006. This increase was primarilyrelated to our U.S. and Canadian operations within the Americas segment. TotalU.S. net sales were $955.0 million for the first nine months of fiscal2007 compared to $924.4 million for the first nine months of fiscal 2006. Inresponse to the softness of the U.S. bedding industry, our focus has been ondriving unit volume. The U.S. net sales increase of $30.5 million wasattributable to a 7.6% increase in unit volume partially offset by a 4.0%decrease in average unit selling price. The increase in unit volume isprimarily attributable to the strong performance of our *Sealy*brandpromotional product sales, which were up 23% from the prior year period, aswell as our specialty bedding product sales, which increased 70% over thecomparable prior year period. The decrease in average unit selling price isprimarily due to the higher volume of lower priced mattresses, such as ourpromotional products. In addition, strategic pricing actions were taken onselected products such as the *Stearns & Foster*and*TrueForm *lines to drive unitvolume. In Canada, local currency sales gains of 10.1% translated into gains of12.9% in US dollars. Local currency gains in Canada were driven by a 17.4%increase in unit volume, which were partially offset by a 6.2% decline inaverage unit selling price. The changes in volume and average unit sellingprice were a result of selective pricing actions and increased promotionalproduct sales. Elsewhere in the Americas, we experienced sales gains in ourMexico and Argentina markets. In our European segment, local currency gains of12.4% translated into gains of 22.2% in US dollars. Local currency gains inEurope were driven by a 66.7% increase in unit volume, partially offset by32.6% decrease in average unit selling price. The decrease in average unitselling price is attributable to increased sales of latex bed cores to othermanufacturers. Local currency finished goods sales in Europe increased 9.5%.

*GrossProfit.**  *Ourconsolidated gross profit for the nine months ended August 26, 2007 was$529.7 million, a decrease of $0.8 million from the comparable prior yearperiod. As a percentage of net sales, gross profit decreased 2.7 percentagepoints to 42.0%. This was due primarily to a decrease in our U.S. and Canadagross profit margins within our Americas segment. Total Americas gross profitdecreased $2.3 million to $502.5 million, which, as a percentage of sales,represented a decrease of 2.3 percentage points to 43.4%. U.S. gross profitdecreased $13.3 million to $415.1 million, which, as a percentage of sales,represented a decrease of 2.8 percentage points to 43.5%. This decrease was drivenby the addition of $19.1 million of flame retardant materials to most of ourproducts, the change in product mix and the strategic pricing actions mentionedabove, and $2.6 million of startup costs associated with the new latex facilityin Mountain Top, PA. Partially offsetting this decrease were continuedimprovements in our manufacturing efficiencies, lower employee health insurancecosts arising from our transition to a new, third party administrator, as wellas $2.5 million of refunds on lumber tariffs received from Canadian suppliers(see Note 16, Contingencies, in Part I). On a per unit basis, materialcosts increased 4.8% relative to the first nine months of fiscal 2006 primarilydue to additional costs to make our products compliant with the 2007 federalflame retardancy regulations, partially offset by improved yield on rawmaterials. Gross profit margin in our Canadian operations decreased 1.8percentage points to 42.7% resulting from pricing actions taken that reducedaverage unit selling prices and increased sales of lower margin promotionalproducts. In our European segment, the gross profit margin decrease resultedfrom an increased mix of lower margin sales of latex bed cores to othermanufacturers.

*Selling,General, Administrative.**  *Our consolidated selling, general, and administrativeexpense increased $28.6 million to $402.5 million. This increase was dueto $23.0 million of volume variable expenses, which included a $12.4 millionincrease in cooperative advertising costs and a $6.7 million increase indelivery costs due primarily to higher unit volume. Other cost increasesincluded a $4.5 million increase in promotional expenses in the U.S. operationsassociated with the 2007 roll out of our new 

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*Posturepedic*Reserveproducts and *Stearns & Foster* productline and other promotional expenses, a $4.3 million increase in spending onnational advertising, and $3.3 million of costs associated with anorganizational realignment in the U.S.. This increase was partially offset by a$3.9 million reduction in compensation and other sales and administration costsin addition to a gain on the sale of our Orlando facility of $2.6 million. As apercent of net sales this expense was 31.9% and 31.5% for the nine months endedAugust 26, 2007 and August 27, 2006, respectively.

*ExpensesAssociated With IPO.*   During the second quarterof fiscal 2006, we incurred $28.5 million of expenses directly related to theIPO, which included approximately $17.5 million of transaction-related bonusespaid to management employees and $11.0 million paid to KKR for the terminationof the Management Services Agreement.

*Royaltyincome, net of royalty expense.*   Our consolidatedroyalty income, net of royalty expenses, for the nine months ended August 26,2007 was $13.5 million, an increase of $2.2 million compared with the ninemonths ended August 27, 2006, primarily due to an increase ininternational royalty revenue.

*InterestExpense.**  *Our consolidated interest expense for thefirst nine months of fiscal 2007 decreased $5.5 million from the prioryear period to $47.1 million, primarily due to lower debt levels resulting fromthe retirement of the $89.1 million of PIK Notes and $47.5 million of the 2014Notes in the second quarter of fiscal 2006 using proceeds from the IPO, anadditional retirement of $28 million of the 2014 Notes late in the thirdquarter of fiscal 2007, as well as $35 million in voluntary prepayments of oursenior term debt since August 27, 2006. Our net weighted average borrowingcost was 7.6% and 7.7% for the nine months ended August 26, 2007 and August 27,2006, respectively. The decrease in our borrowing cost was due to lowerinterest rates on the unhedged variable rate component of our floating ratedebt as well as lower interest rates on the fixed component of our seniorsecured term debt as a result of the August 2006 amendment of our seniorcredit agreement.

*DebtExtinguishment and Refinancing Expenses.*   During the nine months ended August 26,2007, we incurred $0.2 million of debt extinguishment costs consisting of $0.7million of non-cash charges offset by a $0.5 million gain relating to theretirement of $28 million of our 2014 Notes. During the nine months ended August 27,2006 we incurred $9.9 million of debt extinguishment costs consisting of $3.6million of cash expenses and $1.7 million of non-cash charges related tothe extinguishment of debt retired using proceeds from the IPO as well as $0.5million of cash expenses and $4.1 million of non-cash charges related to therefinancing of our senior term debt in August 2006.

*Income Tax.*   Oureffective income tax rates differ from the Federal statutory rate principallybecause of the effect of certain foreign tax rate differentials and state andlocal income taxes. Our effective tax rate for the nine months ended August 26,2007 was 31.7% compared to 31.5% for the nine months ended August 27,2006.

**LIQUIDITY ANDCAPITAL RESOURCES**

***Principal Sources of Funds***

Our principal sources offunds are cash flows from operations and borrowings under our senior securedrevolving credit facility. Our principal use of funds consists of operatingexpenditures, payments of principal and interest on our senior creditagreements, capital expenditures, interest payments on our outstanding seniorsubordinated notes, and dividend payments to shareholders. Capital expenditurestotaled $33.5 million for the nine months ended August 26, 2007. We expecttotal 2007 capital expenditures to be approximately $40 million. We believethat annual capital expenditure limitations in our current debt agreements willnot prevent us from meeting our ongoing capital needs. Our introductions of newproducts typically require us to make initial cash investments in inventory,promotional supplies and employee training which may not be immediatelyrecovered through new product sales. However, we 

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believethat we have sufficient liquidity to absorb such expenditures related to newproducts and that these expenses will not have a significant adverse impact onour operating cash flow. At August 26, 2007, we had approximately$78.0 million available under our revolving credit facility after takinginto account letters of credit issued totaling $27.0 million. Our netweighted average borrowing cost was 7.6% and 7.7% for the nine months ended August 26,2007 and August 27, 2006, respectively. The decrease in our borrowing costwas due to lower interest rates on the unhedged variable rate component of ourfloating rate debt as well as lower interest rates on the fixed component ofour senior secured term debt as a result of the August 2006 amendment ofour senior credit agreement as discussed below in greater detail. As a resultof the IPO completed April 12, 2006, approximately $90 million of the netproceeds were used to retire the PIK Notes including accrued interest andprepayment penalties thereon, and approximately $52 million was used torepurchase and retire $47.5 million of the aggregate principal amountoutstanding under our 2014 Notes along with accrued interest and marketpremiums thereon. In addition, we retired $28 million of our 2014 Notes duringthe third quarter of fiscal 2007.

***Debt***

We have incurred debt, including senior creditfacilities consisting of a $125 million senior secured revolving creditfacility maturing in 2010 and senior secured term loan facilities maturing in August 2011and August 2012 with outstanding balances of $425 million at August 26,2007 for the senior facilities. We also have an outstanding principal balanceof $314 million at August 26, 2007 on the 2014 Notes.

On August 25, 2006, we amended our senior securedcredit agreement to provide for two senior secured term loans, one for $300million maturing August 25, 2011 and one for $140 million maturing August 25,2012. This amendment reduced the applicable interest rate margins charged onthe senior secured term loans, provided certain financial leverage ratio testsare met, by 50 basis points on the $300 million loan and 25 basis pointson the $140 million loan. In addition, this amendment provides us with greaterflexibility for Sealy Mattress Company to make dividend payments to us, or torepay certain subordinated debt, provided certain leverage ratio tests andother conditions are met. The terms and conditions of our $125 million seniorrevolving credit facility were unchanged by the amendment. Since August 25,2006 we have repaid $32.9 million of the original $140 million outstanding onour term loan maturing August 25, 2012 and $2.1 million of the original$300 million outstanding on our term loan maturing August 25, 2011.

Future principal debt payments are expected to be paidout of cash flows from operations and borrowings on our revolving creditfacility. As of September 27, 2007, we had $15 million outstanding underour revolving credit facility.

Borrowings under our new senior secured creditfacilities bear interest at our choice of the Eurodollar rate or adjusted baserate (“ABR”), in each case, plus an applicable margin, subject to adjustmentbased on a pricing grid. Annually, we may be required to make principalprepayments equal to 25% of excess cash flow for the preceding fiscal year, asdefined in our senior secured credit agreement, if our leverage ratio is lessthan 4.00 to 1.00 reducing to 0% if our leverage ratio is less than 3.25 to1.00. At August 26, 2007, we are unable to determine the amount of suchrequired payment, if any, that would be due following the first quarter offiscal 2008 with respect to excess cash flow for the 2007 fiscal year.

On June 3, 2004, we entered into an interest rateswap agreement effective July 6, 2004 effectively fixing the floatingportion of the interest rate at 3.725% on $200 million of the outstandingbalance under the senior secured term loan through November 2005,declining to $150 million from December 2005 through November 2007.Concurrent with the refinancing of our senior secured term loan, wede-designated $13 million of this swap as a hedging instrument and recorded areduction of interest expense of $0.2 million related to this de-designation.To retain the designation of this swap as a hedging 

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instrument, we must selectthe Eurodollar rate on the hedged portion of the senior secured term loanduring the term of the swap.

On June 15, 2007 we entered into an interest rateswap agreement effective December 3, 2007 fixing the floating portion ofthe interest rate at 5.495% on $242 million of the outstanding balance underthe senior secured term loan through November 2008, declining to $240million from December 2008 through November 2009, and furtherdeclining to $180 million from December 2009 through November 2010.To retain the designation of this swap as a hedging instrument, we will selectthe Eurodollar rate on the hedged portion of the senior secured term loanduring the term of the swap.

The outstanding 2014 Notes consist of$314 million aggregate principal amount maturing June 15, 2014,bearing interest at 8.25% per annum payable semiannually in arrears on June 15and December 15, commencing on December 15, 2004. On September 29,2004, we completed an exchange offer whereby all of the 2014 Notes wereexchanged for publicly traded, registered securities with identical terms(other than certain terms relating to registration rights and certain interestrate provisions otherwise applicable to the original senior subordinatednotes). During the third quarter of fiscal 2007, we retired $28 millionaggregate principal amount of the 2014 Notes. During the second quarter offiscal 2006, we used a portion of the proceeds from the IPO to retireapproximately $47.5 million aggregate principal amount of the 2014 Notes.

On July 16, 2004, we issued $75.0 millionaggregate principal amount of PIK Notes to certain institutional investors intransactions exempt from registration under the Securities Act of 1933. The PIKNotes accrue interest in-kind at 10% per year, compounded semi-annually, andmature on July 15, 2015. On April 21, 2006, we used approximately$90 million of the proceeds from the IPO to redeem the outstandingprincipal amount of the PIK Notes and pay accrued interest thereon through thedate of the redemption, along with a related redemption premium.

At August 26, 2007, we were in compliance withthe covenants contained within our senior credit agreements and indenturegoverning the 2014 Notes.

As part of our ongoing evaluation of our capital structure,we continually assess opportunities to reduce our debt, which opportunities mayfrom time to time include voluntary prepayments of our senior secured termdebt, or redemption or repurchase of a portion of our senior subordinated notesto the extent permitted by our debt covenants. In addition, our Boardauthorized a common stock repurchase program under which we may repurchase upto $100 million of our Company’s stock. As of August 26, 2007, we hadrepurchased $7.1 million under this program, $1.7 million of which wasrepurchased during the third quarter of fiscal 2007. From August 27through October 3, 2007, we repurchased an additional 529,000 shares for$7.7 million 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 ourindebtedness, or to fund planned capital expenditures will depend on our futureperformance, which, to a certain extent, is subject to general economic,financial, competitive, legislative, regulatory and other factors that arebeyond our control. Based upon the current level of operations, we believe thatcash flow from operations and available cash, together with availableborrowings under the senior credit agreement, will be adequate to meet thefuture liquidity needs during the one year following August 26, 2007. Wewill be required to make scheduled principal payments of $30.2 million duringthe next twelve months, with $12.9 million for our senior secured term loans,$2.3 million for our financing obligations and capital leases and the remainderfor debt owed by our international subsidiaries. However, as we continuallyevaluate our ability to make additional prepayments as permitted under oursenior credit agreements, it is possible that we will make additional voluntaryprepayments on our senior debt during that time.

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While we believe that wewill have the necessary liquidity through our operating cash flow and revolvingcredit facility for the next several years to fund our debt servicerequirements, capital expenditures and other operational cash requirements, wemay not be able to generate sufficient cash flow from operations, realizeanticipated revenue growth and operating improvements or obtain futureborrowings under the senior credit agreements in an amount sufficient to enableus to do so. In addition, the expiration of the revolving credit facility in2010, followed by the maturities of the senior and subordinated debt in thefollowing years, will likely require us to refinance such debt as it matures.We may not be able to affect any future refinancing of our debt on commerciallyreasonable terms or at all.

***Dividend***

On October 3, 2007,our Board of Directors declared a cash dividend in the amount of $0.075 pershare of common stock payable on November 1, 2007 to stockholders of record asof October 22, 2007. This will result in a dividend distribution ofapproximately $6.8 million to be paid during the fourth quarter of fiscal 2007.

***Cash Flow Analysis***

Thefollowing table summarizes our changes in cash:

| ** **                              | ** ** | **Nine Months Ended:** | ** ** |
|-----------------------------------------|------------|----------------------------------|------------|
| ** **                              | ** ** | **August 26,**              | ** ** | **August 27,** | ** ** |
| ** **                              | ** ** | **2007**                         | ** ** | **2006** | ** ** |
| ** **                              | ** ** | **(in thousands)**          | ** ** |
| Statement of Cash Flow  Data:           |       |                             |       |   |   |
| Cash flows  provided by (used in):      |       |                             |       |   |   |
| Operating activities                    |       | $                                | 53,450     |   | $ | (3,118 | ) |
| Investing activities                    |       | (28,528                          | )          | (20,180 | ) |
| Financing activities                    |       | (55,240                          | )          | 7,825 |   |
| Effect of exchange rate changes on cash |       | (654                             | )          | 1,125 |   |
| Change in cash and cash equivalents     |       | (30,972                          | )          | (14,348 | ) |
| Cash and cash  equivalents:             |       |                             |       |   |   |
| Beginning of period                     |       | 45,620                           |       | 36,554 |   |
| End of period                           |       | $                                | 14,648     |   | $ | 22,206 |   |

 

***Nine Months Ended August 26, 2007 Compared WithNine Months Ended August 27, 2006***

*CashFlows from Operating Activities.**  *Ourcash flow from operations increased $56.6 million to $53.5 million netcash provided for the nine months ended August 26, 2007, compared to a$3.1 million net use of cash for the nine months ended August 27, 2006. Contributingto this increase were approximately $30.8 million of prior year cash expensesand interest payments associated with the initial public offering and relateddebt extinguishments in fiscal 2006. The remaining increase is primarily theresult of changes in working capital and timing of various vendor payments.

*CashFlows from Investing Activities.**  *Ourcash flows used in investing activities increased approximately$8.3 million to $28.5 million net use of cash for the nine monthsended August 26, 2007, compared to a $20.2 million net use of cash for thenine months ended August 27, 2006 due to $12.9 million higher capitalexpenditures for the first nine months of fiscal 2007 as compared with theprior year period. The increased capital expenditures were primarily due to theconstruction of our new facility in Mountain Top, PA. These expenditureswere partially offset by $4.5 million higher proceeds on sales of assets,including $4.8 million received from the sale of our Orlando facility.

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*Cash Flows from FinancingActivities.**  *Our cashflow used in financing activities for the nine months ended August 26,2007 increased $63.1 million to a $55.2 million net use of cash from a netsource of $7.8 million for the nine months ended August 27, 2006.This increased use of cash is primarily due to $20.6 million of cashdividends paid in the first nine months of fiscal 2007, $37.5 million of debtrepayments and $7.1 million used to repurchase our common stock during thefirst nine months of fiscal 2007, partially offset by an increase of$3.9 million related to the exercise of employee stock options in thefirst nine months of fiscal 2007 as compared with the prior year period. Inaddition, the prior year period included $295.5 million of proceeds from ourinitial public offering offset by $131.8 million of cash dividends and $139.3million of debt retirements.

***Income Taxes***

Significant judgment isrequired in evaluating our federal, state and foreign tax positions and in thedetermination of our tax provision. Despite our belief that our tax returnpositions are fully supportable, we have established reserves where we believethat certain tax positions are likely to be challenged and we may not fullyprevail in overcoming these challenges. We may adjust these reserves asrelevant circumstances evolve, such as guidance from the relevant taxauthority, our tax advisors, or resolution of issues in the courts. In addition, the FASB recently issuedInterpretation No. 48 “Accounting for Uncertainty in Income Taxes—anInterpretation of FASB Statement No. 109” (“FIN 48”), as described in Note2 to the Condensed Consolidated Financial Statements, Part I, Item 1,included herein. We are still assessing the potential impact of adopting thisinterpretation. Our tax expense includes the impact of reserve positionsand changes to reserves that we consider appropriate, as well as relatedinterest. While the Company is currently undergoing examinations of itscorporate income tax returns by tax authorities, no issues related to thesereserved positions have been presented to the Company. The Company believesthat such audits will not result in assessment and payment of taxes related tothese positions during the one year period following August 26, 2007. Wealso cannot predict when or if any other future tax payments related to thesetax positions may occur.

***Debt Covenants***

Our long-term obligations contain various financialtests and covenants. Our senior secured credit facilities require us to meet aminimum interest coverage ratio and a maximum leverage ratio. The indenturegoverning our senior subordinated notes also requires us to meet a fixed chargecoverage ratio in order to incur additional indebtedness, subject to certainexceptions. We are currently in compliance with all debt covenants. Thespecific covenants and related definitions can be found in the applicable debtagreements, each of which we have previously filed with the Securities andExchange Commission.

The covenants contained in our senior secured creditfacilities are based on what we refer to herein as “Adjusted EBITDA”. In thesenior secured credit facilities, EBITDA is defined as net income plusinterest, taxes, depreciation and amortization and Adjusted EBITDA is definedas EBITDA further adjusted to exclude unusual items and other adjustmentspermitted in calculating covenant compliance as discussed above. AdjustedEBITDA is presented herein as it is a material component of these covenants.Non-compliance with such covenants could result in the requirement toimmediately repay all amounts outstanding under such facilities. While thedetermination of “unusual items” is subject to interpretation and requiresjudgment, we believe the adjustments listed below are in accordance with thecovenants.

EBITDA and Adjusted EBITDA are not recognized termsunder generally accepted accounting principles (“GAAP”) and do not purport tobe alternatives to net income as a measure of operating performance or to cashflows from operating activities as a measure of liquidity. Additionally, theyare not intended to be measures of free cash flow for management’sdiscretionary use, as they do not consider certain cash requirements such asinterest payments, tax payments and debt service requirements. Because 

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not all companies useidentical calculations, these presentations may not be comparable to othersimilarly titled measures of other companies.

Thefollowing table sets forth a reconciliation of net income to EBITDA and EBITDAto Adjusted EBITDA for the three and nine months ended August 26, 2007:

| ** **                        | ** ** | **Three Months Ended:** | ** ** | **Nine Months Ended:** | ** ** |
|-----------------------------------|------------|-----------------------------------|------------|----------------------------------|------------|
| ** **                        | ** ** | **August 26, 2007**     | ** ** | **August 26, 2007**    | ** ** |
| ** **                        | ** ** | **(in thousands)**           | ** ** | **(in thousands)**          | ** ** |
| Net income                        |       |                              | $          | 21,471                           |       |   |   | $ | 62,238 |   |   |
| Interest expense                  |       |                              | 15,936     |                             |       |   | 47,070 |   |   |
| Income taxes                      |       |                              | 5,105      |                             |       |   | 28,855 |   |   |
| Depreciation and amortization     |       |                              | 7,881      |                             |       |   | 23,064 |   |   |
| EBITDA                            |       |                              | 50,393     |                             |       |   | 161,227 |   |   |
| Unusual and nonrecurring  losses: |       |                              |       |                             |       |   |   |   |   |
| North American realignment        |       |                              | 1,362      |                             |       |   | 3,274 |   |   |
| Other (various)(a)                |       |                              | 1,783      |                             |       |   | 1,799 |   |   |
| Adjusted EBITDA                   |       |                              | $          | 53,538                           |       |   |   | $ | 166,300 |   |   |

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(a)           Consists of variousimmaterial adjustments

Thefollowing table reconciles EBITDA to cash flow from operations:

| ** **                                                     | ** ** | **Nine Months Ended:** | ** ** |
|----------------------------------------------------------------|------------|----------------------------------|------------|
| ** **                                                     | ** ** | **August 26, 2007**    | ** ** |
| ** **                                                     | ** ** | **(in thousands)**          | ** ** |
| EBITDA                                                         |       |                             | $          | 161,227 |   |   |
| Adjustments to EBITDA to  arrive at cash flow from operations: |       |                             |       |   |   |
| Interest expense                                               |       |                             | (47,070    | ) |   |
| Income taxes                                                   |       |                             | (28,855    | ) |   |
| Non-cash charges against (credits to) net income               |       |                             | (4,805     | ) |   |
| Changes in operating assets & liabilities             |       |                             | (27,047    | ) |   |
| Cash flow from  operations                                     |       |                             | $          | 53,450 |   |   |

 

***Forward Looking Statements***

*“Safe Harbor” StatementUnder the Private Securities Litigation Reform Act of 1995.*   When used inthis Quarterly Report on Form 10-Q, the words “believes,” “anticipates,”“expects,” “intends,” “projects” and similar expressions are used to identifyforward-looking statements within the meaning of the Private SecuritiesLitigation Reform Act of 1995. Such forward-looking statements relate to futurefinancial and operational results. Any forward-looking statements contained inthis report represent our management’s current expectations, based on presentinformation and current assumptions, and are thus prospective and subject torisks and uncertainties which could cause actual results to differ materiallyfrom those expressed in such forward-looking statements. Actual results coulddiffer materially from those anticipated or projected due to a number offactors. These factors include, but are not limited to:

·       thelevel of competition in the bedding industry;

·       legaland regulatory requirements;

·       thesuccess of new products;

·       ourrelationships with our major suppliers;

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·       fluctuationsin costs of raw materials;

·       ourrelationship with significant customers and licensees;

·       ourlabor relations;

·       departureof key personnel;

·       encroachmentson our intellectual property;

·       productliability claims;

·       thetiming, cost and success of opening new manufacturing facilities;

·       ourlevel of indebtedness;

·       interestrate risks;

·       futureacquisitions;

·       anincrease in return rates; and

·       otherrisks and factors identified from time to time in the Company’s reports filedwith the Securities and Exchange Commission.

All forward-lookingstatements attributable to us or persons acting on our behalf apply only as ofthe date of this Quarterly Report on Form 10-Q and are expresslyqualified in their entirety by the cautionary statements included in thisQuarterly Report on Form 10-Q. Except as may be required by law, weundertake no obligation to publicly update or revise forward-looking statementswhich may be made to reflect events or circumstances after the date made or toreflect the occurrence of unanticipated events.

**Item 3.**                        *Quantitative and Qualitative Disclosures About Market Risk*

*The information appearing below relating to our marketrisk sensitive instruments by major category should be read in conjunction withthe related disclosure contained in the management’s discussion and analysissection of our Annual Report on Form 10-K (File No. 001-08738).*

***Foreign Currency Exposures***

Our earnings are affectedby fluctuations in the value of our subsidiaries’ functional currency ascompared to the currencies of our foreign denominated purchases. Foreigncurrency forward contracts are used to hedge against the earnings effects ofsuch fluctuations. The result of a uniform 10% change in the value of the U.S.dollar relative to currencies of countries in which we manufacture or sell ourproducts would have an approximately $1.3 million dollar impact on ourfinancial position for the nine months ended August 26, 2007. Thiscalculation assumes that each exchange rate would change in the same directionrelative to the U.S. dollar.

To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, we have instituted a forecasted cash flowhedging program. We hedge portions of our purchases denominated in foreigncurrencies with forward contracts. At August 26, 2007, we had forwardcontracts to sell a total of 14 million Canadian dollars with expirationdates ranging from August 30, 2007 through November 30, 2007. At August 26,2007, the fair value of our net liability under the forward contracts was $1.1million. We do not designate our foreign currency hedges for accountingpurposes, therefore all changes in fair value are charged to earnings.

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***Interest Rate Risk***

On June 3, 2004, we entered into an interest rateswap agreement effective July 6, 2004 effectively fixing the floatingportion of the interest rate at 3.725% on $200 million of our outstandingbalance under the senior secured term loan through November 2005,declining to $150 million through November 2007. The fair value of thisswap instrument was an asset of $1.3 million at August 26, 2007 and $2.8million at November 26, 2006.

On June 15, 2007 the Company entered into aninterest rate swap agreement effective December 3, 2007 fixing thefloating portion of the interest rate at 5.495% on $242 million of theoutstanding balance under the senior secured term loan through November 2008,declining to $240 million from December 2008 through November 2009,and further declining to $180 million from December 2009 through November 2010.

A 10% increase or decrease in market interest ratesthat affect our interest rate derivative instrument would not have a materialimpact on our earnings during the next fiscal year.

Based on the unhedgedportion of our variable rate debt outstanding at August 26, 2007, a 12.5basis point increase or decrease in variable interest rates would have anapproximately $0.4 million dollar impact on our annual interest expense.

***Commodity Price Risks***

The costs of our steel innerspring,polyurethane foam, polyester and polyethylene component parts are impacted byvolatility in the price of steel and petroleum. Due to tightness in supply, wehave also seen an increase in the price of rayon fibers. We believe the cost ofthe components could remain slightly elevated above their recent historicalaverages throughout fiscal 2007. We do not engage in commodity hedgingprograms.

**Item 4.**                        *Internal Control and Procedures*

Under the supervision and with the participation ofour management, including our principal executive officer and principalaccounting officer, we conducted an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended, asof the end of the period covered by this report (the “Evaluation Date”). Basedon this evaluation, our principal executive officer and principal accountingofficer concluded as of the Evaluation Date that our disclosure controls andprocedures were effective such that the information relating to the Company,including our consolidated subsidiaries, required to be disclosed in ourSecurities and Exchange Commission (“SEC”) reports (i) is recorded,processed, summarized and reported within the time periods specified in SEC rules andforms, and (ii) is accumulated and communicated to the Company’smanagement, 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 overfinancial reporting identified in connection with the foregoing evaluation thatoccurred during the third quarter of fiscal 2007 that have materially affected,or are reasonably likely to materially affect, our internal control overfinancial reporting.

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**PART II. OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

See Note 16 to theCondensed Consolidated Financial Statements, Part I, Item 1 includedherein.

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

Thetable below shows our repurchases of the Company’s common stock during thethird quarter of fiscal 2007.

| **Period**                           | ** ** | ** ** | ** ** | **Total number  of shares  purchased** (1) | ** ** | **Average price  paid per  share(1)** | ** ** | **Total number of shares  purchased during quarter  as part of publically  announced program(2)** | ** ** | **Approximate dollar  value of shares that  may yet be purchased  under program** | ** ** |
|--------------------------------------|------------|------------|------------|-----------------------------------------------------------|------------|-------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|
| May 28 -  June 24, 2007    |       |       | 18,112     |                                                      |       |                                            | $          | 16.47                                                                                                                                          |       |                                                                                                                      |       | — |   |   |   | $ | 94,623,832 |   |   |
| June 25 -  July 22, 2007   |       |       | —     |                                                      |       |                                            | —     |                                                                                                                                           |       |                                                                                                                      | —     |   |   |   | 94,623,832 |   |   |
| July 23 -  August 26, 2007 |       |       | 113,100    |                                                      |       |                                            | 15.25      |                                                                                                                                           |       |                                                                                                                      | 113,100    |   |   |   | 92,899,229 |   |   |
| Total                                |       |       | 131,212    |                                                      |       |                                            |       |                                                                                                                                           |       |                                                                                                                      | 113,100    |   |   |   |   |   |   |

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(1)          These amounts includecommon stock surrendered or withheld to cover the exercise price and/or taxwithholding obligations in stock option exercises, as permitted under theCompany’s 1998 and 2004 Stock Option Plans. For the quarter ended August 26,2007, the following shares of Sealy Corporation common stock were surrenderedby participants in the Plans and included in the total number of sharespurchased: May 28 – June 24, 2007—18,112 shares at an average priceper share of $16.47; no shares were purchased from participants in the Plansduring the periods June 25 – July 22, 2007 and July 23 – August 26,2007.

(2)          Our common stockrepurchase program, which authorizes us to repurchase up to $100 million of ourCompany’s common stock, was initially approved by our Board of Directors on February 19,2007.

Our ability to paydividends is restricted by our debt agreements. See “Management’s Discussionand Analysis of Financial Condition and Results of Operations.”

**Item 3.**                        *Defaults Upon Senior Securities*

None

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

None

**Item 5.**                        *Other Information*

None

**Item 6.**                        *Exhibits*
| 10.1 |   | Amendment No. 1 to the 2004 Stock Option Plan  for Key Employees of Sealy Corporation and its Subsidiaires, adopted  July 25, 2007. |
|------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------|
| 31.1 |   | Chief Executive Officer Certification of the  Quarterly Financial Statements.                                                                 |
| 31.2 |   | Chief Financial Officer Certification of the  Quarterly Financial Statements.                                                                 |
| 32   |   | Certification pursuant to 18 U.S.C.  Section 1350.                                                                                       |

 

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, Sealy Corporationhas duly caused this report to be signed on its behalf by the undersignedthereunto duly authorized.
|  |   | SEALY CORPORATION |
|--|--------|-------------------|

 
|                          | **Signature** | ** **                                            | ** ** | ** ** | **Title** | ** ** |
|--------------------------|---------------|-------------------------------------------------------|------------|------------|-----------|------------|
| /s/ DAVID J.  MCILQUHAM  |          | Chairman and  Chief Executive Officer                 |
| **David J. McIlquham**   |          | (Principal Executive  Officer)                        |
| /s/ JEFFREY C.  ACKERMAN |          | Executive Vice  President and Chief Financial Officer |
| **Jeffrey  C. Ackerman** |          | (Principal Accounting Officer)                        |

 

Date: October 4, 2007

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