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



FORM 10-Q

ý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934For the quarterly period ended: February 27, 2011o

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


Commission file number 001-08738



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

Delaware(State or other jurisdiction of incorporation)

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

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




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

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

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

Large accelerated filer o

Accelerated filer ý

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

Smaller reporting company o


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

The number of shares of the registrant's common stock outstanding as of March 17, 2011 is approximately: 98,120,413.



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PART I. FINANCIAL INFORMATION

Item 1.    Financial Statements

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

Three Months EndedFebruary 27,
2011

February 28,
2010Net sales

$
305,529

$
311,888Cost of goods sold


187,025


179,006Gross profit


118,504


132,882Selling, general and administrative expenses


103,734


100,289Amortization expense


72


72Royalty income, net of royalty expense


(4,971
)

(4,122
)Income from operations


19,669


36,643Interest expense


21,708


21,733Other income, net


(105
)

(50
)(Loss) income before income taxes


(1,934
)

14,960Income tax (benefit) provision


(1,209
)

7,627Equity in earnings of unconsolidated affiliates


855


943Income from continuing operations


130


8,276(Loss) from discontinued operations


(1,032
)

(2,562
)Net (loss) income

$
(902
)
$
5,714(Loss) earnings per common shareBasicIncome from continuing operations per common share

$


$
0.09Loss from discontinued operations per common share


(0.01
)

(0.03
)(Loss) earnings per common shareBasic

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

$


$
0.04(Loss) from discontinued operations per common share


(0.01
)

(0.01
)(Loss) earnings per common shareDiluted

$
(0.01
)
$
0.03Weighted average number of common shares outstanding:Basic


97,816


94,524Diluted


107,828


283,576


See
accompanying notes to Condensed Consolidated Financial Statements.

1

---





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

February 27,
2011

November 28,
2010ASSETSCurrent assets:Cash and equivalents

$
102,390

$
109,255Accounts receivable (net of allowance for doubtful accounts, discounts and returns, 2011$26,538; 2010$25,812)


154,950


140,778Inventories


57,216


57,178Other current assets


22,890


19,543Deferred income tax assets


20,169


19,127Total current assets


357,615


345,881Property, plant and equipmentat cost


392,479


385,470Less accumulated depreciation


(223,865
)

(217,398
)168,614


168,072Goodwill


363,455


361,958Intangible assets, net


1,314


1,387Deferred income tax assets


5,205


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


52,896


53,319422,870


422,804Total assets

$
949,099

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

$
2,156

$
2,166Accounts payable


79,879


66,507Accrued incentives and advertising


26,418


34,510Accrued compensation


20,655


22,390Accrued interest


17,346


14,359Other accrued liabilities


33,237


37,198Total current liabilities


179,691


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


789,999


793,084Other liabilities


52,680


53,357Deferred income tax liabilities


843


825Stockholders' deficit:Common stock, $0.01 par value; Authorized 600,000 shares Issued and outstanding: 201197,949; 201097,688


981


979Additional paid-in capital


921,763


911,066Accumulated deficit


(1,007,591
)

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


10,733


7,005Total stockholders' deficit


(74,114
)

(87,639
)Total liabilities and stockholders' deficit

$
949,099

$
936,757


See
accompanying notes to Condensed Consolidated Financial Statements.

2

---





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

Common Stock





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

Additional
Paid-in
Capital

Accumulated
DeficitShares

Amount

TotalBalance at November 28, 2010





97,688

$
979

$
911,066

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

$
(87,639
)Net loss


(902
)










(902
)




(902
)Foreign currency translation adjustment


4,390














4,390


4,390Adjustment to defined benefit plan liability, net of tax of $68


62














62


62Change in fair value of cash flow hedges, net of tax of $(339)


(724
)













(724
)

(724
)Share-based compensation











2,879








2,879Exercise of stock options





261


2


578








580Excess tax benefit on share based awards











(323
)







(323
)Beneficial conversion feature on Convertible paid in kind Notes











7,563








7,563Balance at February 27, 2011

$
2,826


97,949

$
981

$
921,763

$
(1,007,591
)
$
10,733

$
(74,114
)


See
accompanying notes to Condensed Consolidated Financial Statements.

3

---





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

Three Months EndedFebruary 27,
2011

February 28,
2010Operating activities:Net (loss) income

$
(902
)
$
5,714Adjustments to reconcile net income to cash provided by operating activities:Depreciation and amortization


6,054


7,549Deferred income taxes


322


2,656Bad debt expense


1,146


312Amortization of deferred gain on sale-leaseback


(167
)

(163
)Paid in kind interest on convertible notes


4,586


3,365Amortization of discount on new senior secured notes


382


389Amortization of debt issuance costs and other


1,175


2,067Share-based compensation


2,879


4,117(Gain) loss on sale of assets


(231
)

171Dividends received from unconsolidated affiliates


1,011


Equity in earnings of unconsolidated affiliates


(855
)

(943
)Loss on disposition of subsidiary


206


Other, net


638


420Changes in operating assets and liabilities:Accounts receivable


(13,605
)

(23,217
)Inventories


161


(3,991
)Other current assets


(2,796
)

2,011Other assets


(839
)

71Accounts payable


12,547


8,577Accrued expenses


(13,294
)

(19,419
)Other liabilities


(615
)

1,565Net cash used in operating activities


(2,197
)

(8,749
)Investing activities:Purchase of property, plant and equipment


(5,927
)

(2,449
)Proceeds from sale of property, plant and equipment


224


57Net cash used in investing activities


(5,703
)

(2,392
)Financing activities:Proceeds from issuance of long-term obligations


787


516Repayments of long-term obligations


(1,118
)

(3,361
)Exercise of employee stock options, including related excess tax benefits


581


Debt issuance costs


(147
)

Other


(34
)

(16
)Net cash provided by (used in) financing activities


69


(2,861
)Effect of exchange rate changes on cash


966


(370
)Change in cash and equivalents


(6,865
)

(14,372
)Cash and equivalents:Beginning of period


109,255


131,427End of period

$
102,390

$
117,055


See accompanying notes to Condensed Consolidated Financial Statements.

4

---





SEALY CORPORATION        Notes to Condensed Consolidated Financial Statements        (unaudited)

Note 1: Basis of Presentation and Significant Accounting Policies

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

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

At
February 27, 2011, affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") controlled approximately 47.6% of the issued and outstanding common stock of
the Company.

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

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

Allowance for Doubtful Accounts

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

5

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Authoritative Accounting Guidance

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

In
July 2010, the FASB issued authoritative guidance that requires expanded disclosures about the credit quality of an entity's financing receivables and its allowance for credit losses
on a disaggregated basis. The Company has adopted the portion of this guidance that pertains to disclosures as of the end of the first quarter of fiscal 2011 and has provided the required disclosures
herein. The Company will adopt the portion of this guidance that pertains to the disclosure of the allowance activity that occurs during a reporting period in the second quarter of fiscal 2011.

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

Note 3: Share-Based Compensation

The Company maintains the 1998 Stock Option Plan ("1998 Plan") and the 2004 Stock Option Plan for Key Employees of Sealy Corporation and its Subsidiaries ("2004 Plan") which are
collectively referred to as the "Option Plans". The Company accounts for all new share-based awards granted and outstanding awards using the fair value based method under FASB authoritative guidance
surrounding share-based payments. Total share-based compensation recognized during the three months ended February 27, 2011 and February 28, 2010 was $2.9 million and
$4.1 million, respectively.

Stock Option Awards

During the three months ended February 27, 2011 and February 28, 2010, the Company granted no new options to purchase
shares of its common stock.

6

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

A
summary of option activity under the 1998 Plan for the three months ended February 27, 2011, is presented below:

Shares Subject to Options

Weighted Average
Exercise Price Per ShareOutstanding November 28, 2010


1,776,804

$
1.17Exercised


(231,791
)

2.28Forfeited


(22,000
)

2.12Outstanding February 27, 2011 (all fully vested and exercisable)


1,523,013

$
0.99Weighted average remaining contractual term


3.1 yearsAggregate intrinsic value of in-the-money options at February 27, 2011 (in thousands)

$
2,830


A
summary of option activity under the 2004 Plan for the three months ended February 27, 2011, is presented below:

Shares Subject to Options

Weighted Average
Exercise Price Per ShareOutstanding November 28, 2010


6,420,012

$
5.50Exercised


(30,031
)
$
1.67Forfeited


(527,213
)
$
5.67Outstanding February 27, 2011


5,862,768

$
5.50Weighted average remaining contractual term


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

$
1,806Exercisable at February 27, 2011


4,309,302Weighted average remaining contractual term


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

$
1,360


As
of February 27, 2011, the Company had approximately $1.1 million of unrecognized compensation expense related to stock option awards, which is expected to be recognized over a
weighted average period of 2.9 years.

The
Company has granted stock options to employees that have accelerated vesting provisions which take effect if certain performance levels are achieved by the Company. If the Company
does not meet these performance targets, then the vesting of the options occurs over the remainder of the requisite service period. As of February 27, 2011, the performance targets for these
stock options have not been met. As such, the related unrecognized compensation cost is being recognized over the remainder of the requisite service period for those options that vest over the
remaining service period. Further, the Company has not recognized compensation cost in the current period for certain options to purchase 667,532 shares of common stock that contain performance
targets for fiscal years through

7

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

2010
which will not vest, but have not yet been cancelled. No compensation cost will be recognized related to these options.

Restricted Shares and Share Unit Awards

The Company has outstanding 97,324 restricted shares that are considered to be non-vested shares, and have the same rights
as the Company's outstanding common shares, including dividend participation rights, except that they cannot be sold by the holder until the end of the vesting period. As of February 27, 2011,
the remaining unrecognized compensation cost related to restricted stock awards was $0.3 million which is expected to be recognized over the remaining vesting period of 0.4 years. None
of these awards vested during the three months ended February 27, 2011 or February 28, 2010.

During
the three months ended February 27, 2011, the Company approved grants of 115,100 time-based restricted stock units ("RSUs"). The weighted average grant date
fair value of these awards was $2.61 and is based on the closing price of the Company's common stock on the date of grant. There were no RSUs granted during the three months ended February 28,
2010. The Company has outstanding RSU awards of several types: 1) Time-based RSU awards
accrete in the number of RSUs at an annual rate of 8% payable semi-annually until the RSUs are vested or forfeited; 2) Time-based RSU awards that vest ratably over a
three year period; and 3) Performance-based RSUs which do not vest unless certain targets that are tied to the Company's earnings performance are met. A summary of the outstanding unvested RSU
awards by type as of February 27, 2011 follows:

Number of Awards

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


11,566,184

$
7,487Time-based vesting awards without accretion factor


926,100


1,256Performance-based awards outstanding


430,968


18Total


12,923,252

$
8,761Performance-based awards where targets are not expected to be met


114,800

$
88


8

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

A
summary of restricted share unit award activity for the three months ended February 27, 2011, is presented below:

Unvested Restricted
Share Units

Weighted Average
Grant Date Fair ValueOutstanding November 28, 2010


12,811,956

$
2.07Granted


115,100


2.61Forfeited


(3,804
)

2.00Outstanding February 27, 2011


12,923,252

$
2.08Weighted average remaining vesting period


1.5 years


Note 4: Inventories

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

February 27, 2011

November 28, 2010Raw materials

$
24,446

$
26,449Work in process


23,366


22,629Finished goods


9,404


8,100$
57,216

$
57,178


Note 5: Warranty Costs

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

The
change in the Company's accrued warranty obligations for each of the three months ended February 27, 2011 and February 28, 2010 was as follows (in thousands):

February 27, 2011

February 28, 2010Accrued warranty obligations at beginning of period

$
17,584

$
16,464Warranty claims


(3,561
)

(4,546
)Warranty provisions


3,434


4,404Accrued warranty obligations at end of period

$
17,457

$
16,322


9

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 5: Warranty Costs (Continued)

As
of February 27, 2011 and November 28, 2010, $10.4 million and $10.5 million is included as a component of other accrued liabilities and $7.0 million and
$7.1 million is included as a component of other noncurrent liabilities within the accompanying Condensed Consolidated Balance Sheet, respectively. In estimating its warranty obligations, the
Company considers the impact of recoverable
salvage value on warranty cost in determining its estimate of future warranty obligations. Warranty claims and provisions shown above do not include estimated salvage recoveries that reduced cost of
sales by $1.4 million and $1.5 million for the three months ended February 27, 2011 and the three months ended February 28, 2010, respectively.

Note 6: Goodwill and Other Intangible Assets

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

The
changes in the carrying amount of goodwill for the three months ended February 27, 2011 are as follows (in thousands):

Balance as of November 28, 2010

$
361,958Increase due to foreign currency translation


1,497Balance as of February 27, 2011

$
363,455


Total
other intangibles of $1.3 million (net of accumulated amortization of $3.3 million) as of February 27, 2011 consist primarily of licenses, which are amortized using a
straight-line method over periods ranging from 5 to 15 years. Costs to renew or extend the term of a recognized intangible asset are expensed as incurred. During the three months
ended February 27, 2011 and February 28, 2010, the Company recognized amortization expense associated with intangibles of $0.1 million. The Company expects to recognize amortization
expense relating to these intangibles of $0.2 million for the remainder of 2011, $0.3 million in 2012, $0.3 million in 2013, $0.3 million in 2014 and $0.2 million in
2015.

Note 7: Unconsolidated Affiliate Companies

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

10

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 7: Unconsolidated Affiliate Companies (Continued)

Summarized
statements of operations for these joint ventures for each of the three month periods ended February 27, 2011 and February 28, 2010 are as follows (in
thousands):

February 27, 2011

February 28, 2010Revenues

$
12,318

$
11,552Gross profit


7,795


6,512Income from operations


1,956


2,264Net income


1,709


1,886


Note 8: Long-Term Obligations

Long-term obligations as of February 27, 2011 and November 28, 2010 consisted of the following (in thousands):

February 27, 2011

November 28, 2010Asset-based revolving credit facility

$


$
Senior secured notes


304,699


304,318Convertible notes(1)


178,204


181,341Senior subordinated notes


268,945


268,945Financing obligations


39,612


39,896Other


695


750792,155


795,250Less current portion


(2,156
)

(2,166
)$
789,999

$
793,084


(1)Includes
paid in kind ("PIK") interest of $1.9 million from January 16, 2011 through February 27, 2011 for which the principal balance
of the Convertible Notes has not yet been increased.


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

ABL Revolver

The ABL Revolver provides for revolving credit financing of up to $100.0 million, subject to borrowing base availability, and
matures in May 2013. As of February 27, 2011, there were no amounts outstanding under the ABL Revolver. At February 27, 2011, the Company had approximately $61.9 million available under
the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $16.0 million.

11

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 8: Long-Term Obligations (Continued)

The ABL Revolver agreement requires the Company to maintain a fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two
consecutive calendar days is less than the greater of 1) 15% of the total commitment under the ABL Revolver and
2) $15.0 million. As of February 27, 2011, the Company was not in a minimum availability period under the ABL Revolver.

Senior Secured Notes

The Senior Notes mature in April 2016 and bear interest at 10.875% per annum payable semi-annually in arrears on
April 15 and October 15. The total proceeds received by the Company from the issuance of these notes was $335.9 million, resulting in an original issue discount ("OID") of
$14.1 million which will be accreted over the life of the agreement with the related expense recognized as a component of interest expense in the Condensed Consolidated Statement of Operations.
For each of the three months ended February 27, 2011 and February 28, 2010, the Company recognized additional interest expense of $0.4 million related to the accretion of the OID.

Convertible PIK Notes

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

During
the three months ended February 27, 2011, there were no conversions of Convertible Notes into common shares.

The
Company accounts for the PIK interest on the Convertible Notes in accordance with the applicable FASB authoritative guidance pertaining to convertible instruments and derivative
financial instruments indexed to, and potentially settled in, a company's own stock. This guidance requires an allocation of a portion of the issuance amount to an embedded beneficial conversion
feature based on the difference between the effective conversion price of the convertible debt and the fair value of the underlying common stock. Upon the
January 15th interest payment dates in both fiscal 2011 and 2010, the fair value of the underlying common stock was more than double the conversion price of the Convertible
Notes. Therefore, a beneficial conversion feature was recognized for the entire amount of the PIK interest payment of $7.6 million during the three months ended February 27, 2011. The
recognition of the beneficial conversion feature resulted in the recognition of a discount, which was reflected as a reduction of the balance of the Convertible Notes with an offsetting increase to
additional
paid-in capital. The recognized discount will be accreted through interest expense over the remaining term of the Convertible Notes.

The
indentures and agreements governing the ABL Revolver, Senior Notes, Convertible Notes and the 2014 Notes also impose certain restrictions including, but not limited to, the payment
of dividends or other equity distributions and the incurrence of debt or liens upon the assets of the Company or its

12

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 8: Long-Term Obligations (Continued)

subsidiaries.
For instance, the agreement governing Sealy Mattress Company's ABL Revolver contains restrictions on the ability of Sealy Corporation's subsidiaries to pay dividends or make other
distributions to Sealy Corporation subject to specified exceptions including the satisfaction of a minimum fixed charge coverage ratio and average daily availability levels. Likewise, under the
indentures governing Sealy Mattress Company's Senior Notes and 2014 Notes, Sealy Mattress Company is restricted from paying dividends or making other distributions to Sealy Corporation unless Sealy
Mattress Company is able to satisfy certain requirements or use an available exception from the limitation. As of February 27, 2011, Sealy Mattress Company is restricted in distributing the net
assets of its subsidiaries in the amount of $239.6 million to its parent due to the provisions in its long-term debt agreements. However, $30.3 million would be available for
distribution without restriction. At February 27, 2011, the Company was in compliance with the covenants contained within the related note indentures and agreements.

Note 9: Derivative Instruments and Hedging Strategies

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

Interest Rate Risk

Prior to the disposition of the European operations, the Company was exposed to interest rate risk associated with fluctuations in the
interest rates on its variable interest rate debt. However, the Company now has predominantly fixed rate debt outstanding. In order to manage the risk of variable interest rates prior to this event,
the Company had entered into several interest rate swap agreements that converted the debt's variable interest rate to a fixed interest rate. The swap agreements pertaining to the Company's European
debt were considered to be economic hedges which were not designated as hedging instruments. The gains and losses on both designated and undesignated swap agreements offset losses and gains on the
transactions being hedged. The fair values of the interest rate agreements were estimated as described in Note 10, taking into consideration current interest rates and the current
creditworthiness of the counterparties or the Company, as applicable.

As
of February 27, 2011 and November 28, 2010, the Company did not have any outstanding interest rate swap agreements.

Foreign Currency Exposure

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

13

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Derivative Instruments and Hedging Strategies (Continued)

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

At
February 27, 2011, the Company had 51 forward foreign currency contracts and 2 foreign currency option contracts to sell a total of 36.9 million Canadian dollars and receive
U.S. dollars at specified exchange rates with expiration dates ranging from March 2011 through February 2012. These hedges were entered into to protect against the fluctuation in the Canadian
subsidiary's U.S. dollar
denominated purchases of raw materials. Further, the Company had outstanding five foreign currency forward contracts to purchase a total of 1.0 million Swiss francs for U.S. dollars at
specified exchange rates with expiration dates ranging from March 2011 through June 2011. These hedges were entered into to protect against the fluctuations in the scheduled payments to be made for
certain equipment denominated in Swiss francs. The Company has formally designated these contracts as cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in the
forecasted purchases of these raw materials related to changes in the foreign currency exchange rates.

The
Company also enters into foreign currency contracts that are not designated as hedges for accounting purposes. The changes in fair value of these foreign currency hedges are included
as a part of selling, general and administrative expenses in the Condensed Consolidated Statements of Operations. At February 27, 2011 and November 28, 2010, the Company did not have any
outstanding foreign currency contracts that were not designated as hedges for accounting purposes.

At
February 27, 2011, the maximum length of time over which the Company is hedging its exposure to the reduction in value of forecasted foreign currency cash flows through foreign
currency forward agreements is through February 2012. Over the next 12 months, the Company expects to reclassify $1.3 million of deferred losses from accumulated other comprehensive
income to selling, general and administrative expense as related forecasted foreign currency payments are made.

For
the three months ended February 27, 2011 and February 28, 2010, recognized foreign currency transaction gains were $0.3 million and $1.2 million,
respectively. These gains are recognized in cost of goods sold or selling, general and administrative expenses at the time they occur.

Commodity Price Exposure

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

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

14

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Derivative Instruments and Hedging Strategies (Continued)

to
be highly effective in offsetting fluctuations in the forecasted purchases of diesel fuel related to changes in the underlying diesel fuel prices. No such contracts were outstanding at
February 27, 2011.

Embedded Derivatives

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

The
Company concluded that the floor on the foreign exchange rate related to the payments to be made associated with the lease of its former Brazilian manufacturing facility and the
related purchase option qualifies as an embedded derivative instrument that should be bifurcated from the lease agreement and recorded at fair value at the end of each reporting period. As of
February 27, 2011 and November 28, 2010, the fair value of this derivative was $0.1 million and $0.4 million, respectively and is recorded as a component of debt issuance
costs, net, and other assets in the Consolidated Balance Sheet. The initial fair value of the embedded derivative was recorded as deferred lease income and is being amortized over the term of the
lease.

At
February 27, 2011 and November 28, 2010, the fair value carrying amount of the Company's derivative instruments was recorded as follows (in thousands):

Asset Derivatives

Liability DerivativesFebruary 27, 2011

February 27, 2011Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair ValueDerivatives designated as hedging instrumentsForeign exchange contracts

Other current assets

$
50

Other current liabilities

$
(1,310
)Total derivatives designated as hedging instruments




50




(1,310
)Derivatives not designated as hedging instrumentsEmbedded foreign currency derivative

Other noncurrent assets


166

Other noncurrent liabilities


Total derivatives not designated as hedging instruments




166




Total derivatives



$
216



$
(1,310
)


15

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Derivative Instruments and Hedging Strategies (Continued)



Asset Derivatives

Liability DerivativesNovember 28, 2010

November 28, 2010Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair ValueDerivatives designated as hedging instrumentsForeign exchange contracts

Other current assets

$
85

Other current liabilities

$
(163
)Commodity fixed price swap contracts

Other current assets


44

Other current liabilities


Total derivatives designated as hedging instruments




129




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

Other noncurrent assets


380

Other noncurrent liabilities


Total derivatives



$
509



$
(163
)


The effect of derivative instruments on the Condensed Consolidated Statement of Operations for the three months ended February 27, 2011 and
February 28, 2010, was as follows (in thousands):

Three Months Ended February 27, 2011Derivatives in Designated
Cash Flow Hedging
Relationships

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

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

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

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

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




Selling, general and administrative expenses


63

Selling, general and administrative expenses


Foreign exchange contracts


(746
)
Cost of goods sold


(106
)
Cost of goods sold


Total

$
(746
)


$
(43
)


$





Three Months Ended February 28, 2010Derivatives in Designated
Cash Flow Hedging
Relationships

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

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

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

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

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


17

Selling, general and administrative expenses




Selling, general and administrative expenses


16Foreign exchange contracts


(136
)
Selling, general and administrative expenses


57

Selling, general and administrative expenses


Total

$
(119
)


$
57



$
16




Three Months EndedFebruary 27, 2011

February 28, 2010Derivatives Not Designated as
Hedging Instruments

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

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

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

(Loss) from discontinued operations

$


$
30Total



$


$
230


16

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Fair Value of Financial Instruments

For assets and liabilities measured at fair value on a recurring basis during the period, the Company uses an income approach to value the assets and liabilities for outstanding interest
rate swaps, foreign currency derivative contracts and diesel fixed price swap contracts discussed above. See Note 9. These contracts are valued using an income approach, which consists of a
discounted cash flow model that takes into account the present value of future cash flows under the terms of the contracts by using current market information available as of the reporting date such
as prevailing interest rates and foreign currency spot and forward rates. We mitigate derivative credit risk by transacting with highly rated counterparties. There were no non-financial
assets or liabilities requiring initial measurement or subsequent remeasurement during the first quarter of fiscal 2011 or 2010. The following table provides a summary of the fair values of assets and
liabilities (in thousands):

Fair Value Measurements at February 27, 2011 UsingFebruary 27, 2011

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

Significant Other
Observable Inputs
(Level 2)

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

$
50

$


$
50

$
Foreign exchange and commodity derivative liabilities


(1,310
)




(1,310
)

Embedded foreign currency derivative in lease agreement


166








166Total

$
(1,094
)
$


$
(1,260
)
$
166




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

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

Significant Other
Observable Inputs
(Level 2)

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

$
129

$


$
129

$
Foreign exchange and commodity derivative liabilities


(163
)




(163
)

Embedded foreign currency derivative in lease agreement


380








380Total

$
346

$


$
(34
)
$
380


17

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Fair Value of Financial Instruments (Continued)

Due
to the short maturity of cash and equivalents, accounts receivable, accounts payable and accrued expenses, their carrying values approximate fair value. The carrying amounts of long
term debt, based on quoted market prices, at February 27, 2011 were as follows (in thousands):

Senior Secured Notes

$
359,100Convertible Notes


587,154Senior Subordinated Notes


275,669


Note 11: Other Income, Net

Other income, net, includes interest income for the three months ended February 27, 2011 and February 28, 2010 of an insignificant amount.

Note 12: Discontinued Operations

In the fourth quarter of fiscal 2010, management divested the assets of its European manufacturing operations in France and Italy and ceased manufacturing operations in Brazil. These
businesses have
been accounted for as discontinued operations. During the three months ended February 27, 2011, the Company continued the liquidation of certain of its assets related to its Brazil operations.
The charges related to these activities were recorded as a component of discontinued operations. The remaining current assets and liabilities of the Brazilian operations reflected within the
Consolidated Balance Sheet at February 27, 2011 and November 28, 2010 were immaterial. The Company also recognized additional expenses related to the disposition of its European
manufacturing operations which were primarily related to services rendered in connection with the disposition.

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

February 27, 2011

February 28, 2010Net sales

$


$
27,739Loss before income taxes


(418
)

(2,399
)Income tax provision (benefit)





163Loss from operations of discontinued operations


(418
)

(2,562
)Loss on disposition of business, net of tax of $164


(614
)

Loss from discontinued operations

$
(1,032
)
$
(2,562
)


In
connection with the sale of the Company's European manufacturing operations, the Company made certain guarantees with respect to the existence of liabilities and deficiencies related
to assets as of the closing date that were not reflected in the European business' financial statements as of the closing date. Further, certain guarantees were made with respect to losses or damages
incurred by the purchaser related to any misrepresentations or warranties made by the Company, outstanding disputes or judicial proceedings. Such guarantees are limited to an aggregate amount of
3.5 million Euro under the terms of the contract. As of February 27, 2011, the Company knows of no outstanding contingencies that would be covered by this guarantee.

18

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 13: Defined Benefit Pension Expense

The components of net periodic pension cost recognized for the Company's defined benefit pension plans in the U.S. and Canada for the three months ended February 27, 2011 and
February 28, 2010 are as follows (in thousands):

Three Months EndedFebruary 27, 2011

February 28, 2010Service cost

$
199

$
179Interest cost


360


337Expected return on plan assets


(367
)

(305
)Amortization of unrecognized losses


35


37Amortization of unrecognized prior service cost


144


129Net periodic pension cost*

$
371

$
377Cash contributions

$
220

$
0Weighted average expected return on plan assets


7.85
%

7.85
%


*Net
periodic pension cost recognized for the three months ended February 27, 2011 is based upon preliminary estimates pending the final actuarial
determination of such costs for fiscal 2010. Similarly, net periodic pension cost for the three months ended February 28, 2010 is based upon preliminary estimates.


The
Company expects to make additional cash contributions to the defined benefit pension plans of approximately $1.5 million during the remainder of fiscal 2011.

Note 14: Income Taxes

The Company's effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of non-deductible paid in kind interest, certain
foreign tax rate differentials and state and local income taxes. The effective tax rate for the three months ended February 27, 2011 was approximately 62.5%, compared to approximately 51.0%,
for the three months ended February 28, 2010. The effective rate for the three months ended February 27, 2011 was higher than the rate for the three months ended February 28,
2010, primarily due to the decrease in income before income taxes.

The
Condensed Consolidated Balance Sheet as of February 27, 2011 includes accrued interest of $3.8 million and penalties of $2.2 million due to unrecognized tax
benefits. As of November 28, 2010, the Company had recorded accrued interest of $3.7 million and penalties of $2.2 million due to unrecognized tax benefits.

The
Company expects the liability for uncertain tax positions to decrease by approximately $1.3 million within the succeeding twelve months due to expiration of income tax
statutes of limitations. Federal years open to examination are fiscal year 2006 and forward. State and international jurisdictions remain open to examination for fiscal year 2004 and forward.

19

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 14: Income Taxes (Continued)

Significant
judgment is required in evaluating the Company's federal, state and foreign tax positions and in the determination of its tax provision. Despite the Company's belief that its
liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of any particular tax matter. The Company may adjust these
liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, or resolution of issues in the courts. These adjustments are recognized as a component of income tax
expense entirely in the period in which they are identified. The Company is currently undergoing examinations of certain of its corporate income tax returns by tax authorities. Issues related to
certain of these reserves have been presented to the Company and the Company believes that such audits will not result in a material assessment or payment of taxes related to these positions during
the one year period following February 27, 2011. The Company also cannot predict when or if any other future tax payments related to these tax positions may occur.

Note 15: Comprehensive Income

Comprehensive income for the three months ended February 27, 2011 and February 28, 2010 was $2.8 million and $4.6 million, respectively. The decrease in
comprehensive income for the three months ended February 27, 2011 compared to the three months ended February 28, 2010, was driven primarily by a decrease in net income offset by an
increase in gains from foreign exchange translation.

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

February 27, 2011

November 28, 2010Unrealized gain (loss) on cash flow hedges, net of tax of $(505) and $(64), respectively

$
(793
)
$
(69
)Unrealized actuarial loss and prior service credit for pension liability, net of tax of $4,660 and $4,717, respectively


(7,325
)

(7,387
)Accumulated foreign currency translation adjustment


18,851


14,461$
10,733

$
7,005


Note 16: Commitments and Contingencies

Commitments

The Company has employment agreements with certain of its executive officers and key employees which, among other things, provide
severance benefits to those employees. For the three months ended February 27, 2011, severance costs of $0.2 were recorded as a component of operating income within the accompanying Condensed
Consolidated Statements of Operations. For the three months ended February 28, 2010, severance costs of $1.3 million, were recorded as a component of operating income within the
accompanying Condensed Consolidated Statements of Operations. Severance benefits of $0.4 million and $0.5 million have been accrued as of February 27, 2011 and November 28,
2010, respectively. The entire liability has been recorded as a component of accrued compensation within the

20

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 16: Commitments and Contingencies (Continued)

accompanying
Condensed Consolidated Balance Sheets as of February 27, 2011 and November 28, 2010, respectively.

Contingencies

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

The
Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. The
Company and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, the Company and its
subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the
property in 1997. The Company and its subsidiary retained primary responsibility for the required remediation. The Company has completed essentially all soil remediation with the approval of the New
Jersey Department of Environmental Protection and continues to operate a groundwater remediation system on the site. During 2005, with the approval of the New Jersey Department of Environmental
Protection, the Company removed and disposed of sediment in Oakeys Brook adjoining the site. The Company continues to monitor ground water at the site. The Company has recorded a reserve as a
component of other accrued liabilities and other noncurrent liabilities in the accompanying Condensed Consolidated Balance Sheets as of February 27, 2011 for $2.0 million ($2.1 million prior to
discounting at 4.75%) associated with this remediation project.

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

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

During
fiscal 2010, the Company was assessed $8.0 million by the Brazilian government for the failure to provide certain income tax filings. Due to the accumulated net operating
losses in this jurisdiction, the Company's exposure is expected to be limited. At February 27, 2011, the Company has

21

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 16: Commitments and Contingencies (Continued)

recorded
a reserve of $1.1 million related to the expected requirement to pay certain sales tax, fees and penalties associated with this assessment as a component of accrued expenses.

Note 17: Related Party Transactions

During the three months ended February 27, 2011, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC (a consulting company that
works exclusively with KKR's portfolio companies) of $0.4 million. As of February 27, 2011, $0.3 million of this amount was accrued as a component of other accrued liabilities and
accounts payable in the accompanying Condensed Consolidated Balance Sheets. We also participate in a lease arrangement with a KKR affiliate for our Clarion facility for a six month initial term with
two six month renewal options available. We have received lease income on this property of an insignificant amount during the first quarter of fiscal 2011.

During
the three months ended February 28, 2010, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC of $0.5 million. As
discussed above, we also participate in a lease arrangement with a KKR affiliate for our Clarion facility. We received lease income on this property of an insignificant amount during the first quarter
of fiscal 2010.

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

During
the first quarter of fiscal 2011 and 2010, the Company's joint ventures made a distribution to the Company of $1.0 million. These amounts have been reflected as a reduction
of the investment in these joint ventures in the accompanying Condensed Consolidated Balance Sheets as of February 27, 2011 and November 28, 2010.

Note 18: Geographical Information

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

Three Months EndedFebruary 27, 2011

February 28, 2010United States

$
238,743

$
246,374Canada


43,506


44,727Other International


23,280


20,787Total

$
305,529

$
311,888Total International

$
66,786

$
65,514


Long
lived assets (principally property, plant and equipment) outside the United States were $34.1 million and $34.4 million as of February 27, 2011 and
November 28, 2010, respectively.

22

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 19: Earnings per Share

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

Three Months EndedFebruary 27, 2011

February 28, 2010(in thousands)Numerator:Net income from continuing operations, as reported

$
130

$
8,276Net income attributable to participating securities





(25
)Interest on convertible notes





3,365Net income from continuing operations available to common shareholders

$
130

$
11,616Denominator:Denominator for basic earnings per shareweighted average shares


97,816


94,524Effect of dilutive securities:Convertible debt





178,204Stock options


886


1,316Restricted share units


8,720


9,206Other


406


326Denominator for diluted earnings per shareadjusted weighted average shares and assumed conversions


107,828


283,576


Options
and share units (in thousands) not included in the computation of diluted earnings per share because their impact is antidilutive for the three months ended February 27,
2011 are 4,404. Additionally, for the three months ended February 27, 2011, the outstanding Convertible Notes were excluded from the computation of diluted earnings per share since their
inclusion would be antidilutive. The Convertible Notes not included in the computation of diluted earnings per share for the three months ended February 27, 2011 convert into a weighted average
192,661 shares (in thousands). Options and share units (in thousands) not included in the calculation of diluted earnings per share because their impact is antidilutive for the three months ended
February 28, 2010 are 7,808.

Note 20: Guarantor/Non-Guarantor Financial Information

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

23

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

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

The
following supplemental Condensed Consolidating Financial Statements present:



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

24

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION    Supplemental Condensed Consolidating Balance Sheets    February 27, 2011    (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
1,655

$


$
9,234

$
42,221

$
49,280

$


$
102,390Accounts receivable, net








24


97,669


57,257





154,950Inventories








1,890


47,167


8,362


(203
)

57,216Other current assets and deferred income taxes


400





775


36,881


5,003





43,059Total current assets


2,055





11,923


223,938


119,902


(203
)

357,615Property, plant and equipment, at cost








9,502


345,857


37,120





392,479Less accumulated depreciation








(5,472
)

(197,972
)

(20,421
)




(223,865
)





4,030


147,885


16,699





168,614Other assets:Goodwill








24,741


301,942


36,772





363,455Intangible assets, net











1,305


9





1,314Net investment in subsidiaries


(177,012
)

239,554


383,404


128,881





(574,827
)

Due from (to) affiliates


279,046


(416,566
)

550,209


(131,087
)

(102,820
)

(178,782
)

Debt issuance costs, net and other assets








20,953


20,563


16,585





58,101102,034


(177,012
)

979,307


321,604


(49,454
)

(753,609
)

422,870Total assets

$
104,089

$
(177,012
)
$
995,260

$
693,427

$
87,147

$
(753,812
)
$
949,099Liabilities and Stockholders' (Deficit) EquityCurrent liabilities:Current portionlong-term obligations

$


$


$


$
1,668

$
488

$


$
2,156Accounts payable








610


59,017


20,252





79,879Accrued customer incentives and advertising











19,657


6,761





26,418Accrued compensation








362


17,484


2,809





20,655Accrued interest








1,537


15,809








17,346Other accrued liabilities


(1
)




1,660


25,759


5,819





33,237Total current liabilities


(1
)




4,169


139,394


36,129





179,691Long-term obligations


178,204





751,848


38,151





(178,204
)

789,999Other liabilities











46,307


6,373





52,680Deferred income tax liabilities








(311
)

523


631





843Stockholders' equity (deficit)


(74,114
)

(177,012
)

239,554


469,052


44,014


(575,608
)

(74,114
)Total liabilities and stockholders' equity (deficit)

$
104,089

$
(177,012
)
$
995,260

$
693,427

$
87,147

$
(753,812
)
$
949,099


25

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

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

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-Guarantor
Subsidiaries

Eliminations

ConsolidatedAssetsCurrent assets:Cash and equivalents

$
1,010

$


$
9,234

$
59,108

$
39,903

$


$
109,255Accounts receivable, net


7





23


80,202


60,546





140,778Inventories








1,605


47,230


8,684


(341
)

57,178Other current assets and deferred income taxes


410





448


32,541


5,271





38,670Total current assets


1,427





11,310


219,081


114,404


(341
)

345,881Property, plant and equipment, at cost








9,452


340,077


35,941





385,470Less accumulated depreciation








(5,326
)

(192,881
)

(19,191
)




(217,398
)





4,126


147,196


16,750





168,072Other assets:Goodwill








24,741


301,942


35,275





361,958Intangible assets, net











1,377


10





1,387Net investment in subsidiaries


(179,840
)

236,674


383,319


114,072





(554,225
)

Due from (to) affiliates


272,114


(416,514
)

547,919


(124,622
)

(97,023
)

(181,874
)

Debt issuance costs, net and other assets








22,142


20,522


16,795





59,45992,274


(179,840
)

978,121


313,291


(44,943
)

(736,099
)

422,804Total assets

$
93,701

$
(179,840
)
$
993,557

$
679,568

$
86,211

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

$


$


$


$
1,724

$
442

$


$
2,166Accounts payable








446


44,406


21,655





66,507Accrued customer incentives and advertising











24,446


10,064





34,510Accrued compensation








383


17,840


4,167





22,390Accrued interest








1,239


13,120








14,359Other accrued liabilities


(1
)




530


28,198


8,471





37,198Total current liabilities


(1
)




2,598


129,734


44,799





177,130Long-term obligations


181,341





754,603


38,481





(181,341
)

793,084Other liabilities











46,746


6,611





53,357Deferred income tax liabilities








(318
)

530


613





825Stockholders' equity (deficit)


(87,639
)

(179,840
)

236,674


464,077


34,188


(555,099
)

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

$
93,701

$
(179,840
)
$
993,557

$
679,568

$
86,211

$
(736,440
)
$
936,757


26

---





SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION    Supplemental Condensed Consolidating Statements of Operations    Three Months Ended February 27, 2011    (in thousands)

Sealy
Corporation

Sealy Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
21,158

$
224,625

$
65,029

$
(5,283
)
$
305,529Cost and expenses:Cost of goods sold








12,130


142,655


37,661


(5,421
)

187,025Selling, general and administrative








1,954


83,757


18,023





103,734Amortization expense











72








72Royalty (income) expense, net











(4,971
)







(4,971
)Income from operations








7,074


3,112


9,345


138


19,669Interest expense





77


20,645


572


414





21,708Other (income) expense, net














(105
)




(105
)Loss (income) from equity investees


902


850


4,370








(6,122
)

Loss (income) from non- guarantor equity investees











(5,611
)




5,611


Capital charge and intercompany interest allocation








(18,770
)

17,974


796





Income (loss) before income taxes


(902
)

(927
)

829


(9,823
)

8,240


649


(1,934
)Income tax provision (benefit)





(25
)

1,679


(5,541
)

2,633


45


(1,209
)Equity in earnings of unconsolidated affiliates














855





855Income (loss) from continuing operations


(902
)

(902
)

(850
)

(4,282
)

6,462


604


130Loss from discontinued operations











(181
)

(851
)




(1,032
)Net income (loss)

$
(902
)
$
(902
)
$
(850
)
$
(4,463
)
$
5,611

$
604

$
(902
)


27

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION    Supplemental Condensed Consolidating Statements of Operations    Three Months Ended February 28, 2010    (in thousands)

Sealy
Corporation

Sealy Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet sales

$


$


$
21,583

$
233,420

$
63,885

$
(7,000
)
$
311,888Cost and expenses:Cost of goods sold








12,927


137,342


35,647


(6,910
)

179,006Selling, general and administrative


19





1,959


81,101


17,210





100,289Amortization of intangibles


(1
)







72


1





72Royalty (income) expense, net


(1
)







(4,121
)







(4,122
)Income from operations


(17
)




6,697


19,026


11,027


(90
)

36,643Interest expense


1


80


20,716


664


272





21,733Other (income) expense, net














(50
)




(50
)Loss (income) from equity investees


(5,693
)

(5,710
)

(4,667
)







16,070


Loss (income) from non- guarantor equity investees











(4,422
)




4,422


Capital charge and intercompany interest allocation








(18,856
)

16,620


2,236





Income (loss) before income taxes


5,675


5,630


9,504


6,164


8,569


(20,582
)

14,960Income tax expense (benefit)


71


(63
)

3,794


1,478


2,418


(71
)

7,627Equity in earnings of unconsolidated affiliates














943





943Income (loss) from continuing operations


5,604


5,693


5,710


4,686


7,094


(20,511
)

8,276Loss from discontinued operations


110











(2,672
)




(2,562
)Net income (loss)

$
5,714

$
5,693

$
5,710

$
4,686

$
4,422

$
(20,511
)
$
5,714


28

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION    Supplemental Condensed Consolidating Statements of Cash Flows    Three Months Ended February 27, 2011    (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by (used in) operating activities

$


$


$
10,070

$
(14,803
)
$
2,536

$


$
(2,197
)Investing activities:Purchase of property, plant and equipment








(36
)

(5,633
)

(258
)




(5,927
)Proceeds from the sale of property, plant, and equipment











203


21





224Net activity in investment in and advances from (to) subsidiaries and affiliates


64





(9,853
)

3,729


6,060





Net cash provided by (used in) investing activities


64





(9,889
)

(1,701
)

5,823





(5,703
)Financing activities:Equity received upon exercise of stock including related excess tax benefits


581

















581Proceeds from issuance of long-term obligations














787





787Repayments of long-term obligations











(383
)

(735
)




(1,118
)Debt issuance costs








(147
)










(147
)Other








(34
)










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


581





(181
)

(383
)

52





69Effect of exchange rate changes on cash














966





966Change in cash and equivalents


645








(16,887
)

9,377





(6,865
)Cash and equivalents:Beginning of period


1,010





9,234


59,108


39,903





109,255End of period

$
1,655

$


$
9,234

$
42,221

$
49,280

$


$
102,390


29

---



SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION    Supplemental Condensed Consolidating Statements of Cash Flows    Three Months Ended February 28, 2010    (in thousands)

Sealy
Corporation

Sealy
Mattress
Corporation

Sealy
Mattress
Company

Combined
Guarantor
Subsidiaries

Combined
Non-
Guarantor
Subsidiaries

Eliminations

ConsolidatedNet cash provided by (used in) operating activities

$


$


$
6,813

$
(15,086
)
$
(476
)
$


$
(8,749
)Investing activities:Purchase of property, plant and equipment








(40
)

(1,765
)

(644
)




(2,449
)Proceeds from the sale of property, plant, and equipment














57





57Net activity in investment in and advances from (to) subsidiaries and affiliates








(6,757
)

5,558


1,199





Net cash provided by (used in) investing activities








(6,797
)

3,793


612





(2,392
)Financing activities:Proceeds from issuance of long term obligations














516





516Repayments of long-term obligations











(904
)

(2,457
)




(3,361
)Other








(16
)










(16
)Net cash used in financing activities








(16
)

(904
)

(1,941
)




(2,861
)Effect of exchange rate changes on cash














(370
)




(370
)Change in cash and equivalents











(12,197
)

(2,175
)




(14,372
)Cash and equivalents:Beginning of period


357





29,234


67,950


33,886





131,427End of period

$
357

$


$
29,234

$
55,753

$
31,711

$


$
117,055


30

---





SEALY CORPORATION

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

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

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

BUSINESS OVERVIEW

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

During
2010, we saw the weak economic and retail environments begin to turn around and saw an increase in mattress sales across the industry in the fourth quarter of 2010. This trend has
continued through the first few months of 2011.

In
2011, we launched our Next GenerationPosturepedicline which is the single largest product line in our portfolio. This line of
products incorporates the knowledge gained from our consumer research and product reviews with key retail partners as well as new benefits and technologies developed specifically for the line. In
conjunction with the release of our Next GenerationPosturepedicline, we also introduced a new national advertising campaign which is being
communicated across a variety of mediums including television, print, digital outlets and the retail environment.

Our
industry has experienced significant volatility in the price of petroleum-based and steel products, which affects the cost of our polyurethane foam, polyester, polyethylene foam and
steel innerspring component parts. Domestic supplies of these raw materials are being limited by supplier consolidation, the exporting of these raw materials outside of the U.S. and other forces
beyond our control. During fiscal 2010, the cost of these components became more stable, but began increasing in the latter part of the year. The cost of raw materials through the first quarter of
fiscal 2011 has remained relatively consistent with the levels experienced at the end of fiscal 2010, but we are now seeing trends that may create inflation in the prices of these raw materials. The
manufacturers of products such as petro-chemicals and wire rod, which are the feed stocks purchased by our suppliers of foam and drawn wire, have enacted cost increases that have had an effect on our
purchases.

31

---



RESULTS OF OPERATIONS



The following table sets forth our summarized results of operations for the three months ended February 27, 2011 and
February 28, 2010, expressed in thousands of dollars, as well as a percentage of each period's net sales:

For the three months ended:February 27, 2011

February 28, 2010(in thousands)

(percentage of
net sales)

(in thousands)

(percentage of
net sales)Net sales

$
305,529


100.0
%
$
311,888


100.0
%Cost of goods sold


187,025


61.2


179,006


57.4Gross profit


118,504


38.8


132,882


42.6Selling, general and administrative expenses


103,734


34.0


100,289


32.2Amortization expense


72





72


Royalty income, net of royalty expense


(4,971
)

(1.6
)

(4,122
)

(1.3
)Income from operations


19,669


6.4


36,643


11.7Interest expense


21,708


7.1


21,733


7.0Other income, net


(105
)




(50
)

(Loss) income before income taxes


(1,934
)

(0.7
)

14,960


4.7Income tax (benefit) provision


(1,209
)

(0.4
)

7,627


2.4Equity in earnings of unconsolidated affiliates


855


0.3


943


0.3Income (loss) from continuing operations


130





8,276


2.7Loss from discontinued operations


(1,032
)

(0.3
)

(2,562
)

(0.8
)Net (loss) income

$
(902
)

(0.3
)%
$
5,714


1.9
%Effective tax rate


62.5
%




51.0
%


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

Three Months Ended:February 27,
2011

February 28,
2010United States


78.1
%

79.0
%Canada


14.2


14.3Other


7.7


6.7Total


100.0
%

100.0
%


32

---



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

For the three months endedFebruary 27,
2011

February 28,
2010(in thousands)

(percentage of
net sales)

(in thousands)

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


238,743


100.0


246,374


100.0Cost of goods sold


148,175


62.1


142,260


57.7Gross profit


90,568


37.9


104,114


42.3Total International (U.S. Dollars):Net sales


66,786


100.0


65,514


100.0Cost of goods sold


38,850


58.2


36,746


56.1Gross profit


27,936


41.8


28,768


43.9Canada:US Dollars:Net sales


43,506


100.0


44,727


100.0Cost of goods sold


25,302


58.2


24,780


55.4Gross profit


18,204


41.8


19,947


44.6Canadian Dollars:Net sales


43,505


100.0


47,187


100.0Cost of goods sold


25,292


58.1


26,143


55.4Gross profit


18,213


41.9


21,044


44.6Other International (U.S. Dollars):Net sales


23,280


100.0


20,787


100.0Cost of goods sold


13,548


58.2


11,966


57.6Gross profit


9,732


41.8


8,821


42.4




Net Sales.Our consolidated net sales for the quarter ended February 27, 2011, were $305.5 million, a decrease of
$6.4 million,
or 2.0%, from the quarter ended February 28, 2010. This decrease was due to decreases in the Canada and U.S. businesses. Total U.S. net sales were $238.7 million for the first quarter of
fiscal 2011, a decrease of 3.1% from the first quarter of fiscal 2010. The U.S. net sales decrease of $7.6 million was attributable to a 1.3% decrease in wholesale unit volume, which excludes
third party sales from our component plants, coupled with a 1.9% decrease in wholesale average unit selling price. The decreases in unit volume and average unit selling price are attributable to
slower sales and heavier discounting onPosturepedicproducts at the end of their life cycle in advance of the introduction of the Next Generation Posturepedicline. In addition, the growth of ourSealybranded products has contributed to the lower
average unit selling price as these value priced products made up an increased portion of total sales. International net sales increased $1.3 million or 1.9%, from the first quarter of fiscal
2010 to $66.8 million. This increase was primarily due to increased sales in the Argentina and Mexico markets but was partially offset by decreases in sales in our Canadian market. In Canada,
local currency sales decreases of 7.8% translated into decreases of 2.7% in U.S. dollars due to an increase in the average value of the Canadian dollar versus the U.S. dollar. Local currency sales
performance in Canada was driven by a 5.0% decrease in unit

33

---



volume,
coupled with a 2.9% decrease in average unit selling price. The decrease in unit volume was driven by slower retail sales traffic as compared with stronger market conditions in the first
quarter of fiscal 2010. The lower average unit selling price was driven by the overall decrease in sales of premium products which more than offset the impact of stronger sales of products at lower
price points.

Gross Profit.Our consolidated gross profit for the quarter was $118.5 million, a decrease of $14.4 million from the
comparable prior
year period. As a percentage of net sales, gross profit decreased 3.8 percentage points to 38.8%. While margin decreases were experienced in both the U.S. and Canadian markets, the decrease in
percentage of net sales was primarily due to a decrease in gross profit margin in our U.S. operations. U.S. gross profit decreased $13.5 million to $90.6 million, which, as a percentage
of net sales, represents a decrease of 4.4 percentage points to 37.9% of net sales. The decrease in percentage of net sales was driven primarily by the launch of the Next Generation Posturepedicline, which began shipping in the first quarter. The launch included costs related to the floor samples and start up efforts of the new
line, and unfavorable pricing due to increased discounting of the oldPosturepedicline at the end of its life cycle. These combined actions negatively
impacted U.S. gross profit margin by approximately 2.0 percentage points. Higher material costs related to increased commodity prices and other inflation contributed 1.6 percentage points of the
decrease in U.S. gross profit margin. Additionally, the increased sales ofSealybranded product discussed above contributed to the lower margins in the
current quarter as these value priced products carry a lower gross margin. In local currency, the gross profit margin in Canada was 41.8% as a percentage of net sales which represents a decrease of
2.8 percentage points. This decrease was primarily driven by the impact of the lower average unit selling price discussed above coupled with higher material costs.

Selling, General, Administrative.Our consolidated selling, general and administrative expense increased $3.4 million to
$103.7 million. As a percentage of net sales, this expense was 34.0% and 32.2% for the quarters ended February 27, 2011 and February 28, 2010, respectively, an increase of
1.8 percentage points. The increase as a percentage of net sales was primarily driven by an increase in fixed operating costs. Fixed operating costs, exclusive of non-cash
compensation expense, increased $6.0 million from the prior year period. This increase is primarily due to an increase of $2.2 million related to our new advertising campaign and
$2.5 million in costs incurred to support the launch of the Next GenerationPosturepedicline. Volume driven variable expenses remained
relatively flat with the prior year period with a $1.1 million decrease in cooperative advertising and promotional costs being offset by a $0.8 million increase in delivery costs due to
higher fuel costs. Non-cash compensation expense decreased by $1.2 million compared to the first quarter of fiscal 2010 due primarily to the recognition of expense related to the
vesting of restricted share unit grants.

Royalty income, net of royalty expense.Our consolidated royalty income, net of royalty expenses, of $5.0 million for the three
months ended
February 27, 2011 increased $0.8 million from the prior year period due to increased royalties recognized related to international licenses including the new Europe and Brazil license
arrangements.

Interest Expense.Our consolidated interest expense for the first quarter of fiscal 2011 remained consistent with the prior year period.
Our net
weighted average borrowing cost was 10.9% and 10.5% for the three months ended February 27, 2011 and February 28, 2010, respectively. Our borrowing cost was unfavorably impacted by the
relatively flat interest expense due to offsetting decreases and increases in cash and non-cash interest expense compared to a lower average debt balance in the fiscal 2011 period as
compared with the fiscal 2010 period due to the $35.0 million repayment of Senior Notes which occurred in the second quarter of fiscal 2010.

34

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We recognize non-cash interest related to the PIK interest on our outstanding Convertible Notes and the accretion or amortization of original issue discount and deferred debt
issuance costs. The table below provides a breakout of cash and non-cash interest for the three month periods ending February 27, 2011 and February 28, 2010:

Three Months Ended:February 27, 2011

February 28, 2010Cash interest expense

$
15,565

$
16,451Non-cash interest expense


6,143


5,282$
21,708

$
21,733


Equity in Earnings of Unconsolidated Affiliates.Earnings related to our joint ventures have remained relatively consistent with the
first quarter of
fiscal 2010.

Income Tax.Our effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of
non-deductible paid in kind interest, certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for the three months ended February 27, 2011
was 62.5% compared to 51.0% for the three months ended February 28, 2010. The effective rate for the fiscal 2011 period was higher than the fiscal 2010 period primarily due to lower income
before income taxes.

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

LIQUIDITY AND CAPITAL RESOURCES



Our principal sources of funds are cash flows from operations and borrowings under our asset-based revolving credit facility (the "ABL
Revolver"). Our principal use of funds consists of operating expenditures, payments of interest on our senior debt, capital expenditures, and interest payments on our outstanding senior subordinated
notes. Capital expenditures totaled $5.9 million for the three months ended February 27, 2011. We expect total 2011 capital expenditures to be approximately $24.0 to
$26.0 million. We believe that annual capital expenditure limitations in our current debt agreements will not prevent us from meeting our ongoing capital needs. Our introductions of new
products typically require us to make initial cash investments in inventory, promotional supplies and employee training which may not be immediately recovered through new product sales. However, we
believe that we have sufficient liquidity to absorb such expenditures related to new products and that these expenses will not have a significant adverse impact on our operating cash flow. At
February 27, 2011, the Company had approximately $61.9 million available under the ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of
$16.0 million, and certain reserves related to our outstanding derivative contracts. The calculated borrowing base under the ABL Revolver is determined based on our domestic accounts receivable
and inventory balances. Our net weighted average borrowing cost was 10.9% and 10.5% for the three months ended February 27, 2011 and February 28, 2010, respectively. As of
March 17, 2011, we had no borrowings outstanding under the ABL Revolver.

35

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Our outstanding debt primarily consists of the following: 1) the ABL Revolver which provides commitments of up to
$100.0 million maturing in May 2013, which bears interest at our choice of either a base rate (determined by reference to the higher of several rates as defined by the ABL Revolver agreement)
or a LIBOR rate for U.S. dollar deposits plus an applicable margin of 4.00%; 2) $350.0 million in original aggregate principal amount of senior secured notes due
April 2016 (the "Senior Notes"), which bear interest at 10.875% per annum payable semi-annually; 3) $177.1 million in initial aggregate principal amount of senior secured
convertible paid in kind ("PIK") notes due July 2016 which are convertible into shares of the Company's common stock (the "Convertible Notes") and bear interest at 8.00% per annum payable
semi-annually in the form of additional Convertible Notes; and 4) senior subordinated notes which consist of an original $314 million aggregate principal amount maturing
June 15, 2014, bearing interest at 8.25% per annum payable semi annually (the "2014 Notes").

At
February 27, 2011, there were no amounts outstanding under the ABL Revolver. The Senior Notes have an outstanding balance of $304.7 million at February 27, 2011
which gives effect to an unamortized original issue discount of $10.3 million. As of February 27, 2011, the Convertible Notes have an outstanding balance of $178.2 million. We
also have an outstanding principal balance of $268.9 million at February 27, 2011 on the 2014 Notes.

Future
interest payments are expected to be paid out of cash flows from operations and borrowings on our ABL Revolver. The ABL Revolver provides for revolving credit financing, subject
to borrowing base availability. The borrowing base consists of the following: 1) 85% of the net amount of eligible accounts receivable and 2) the lesser of (i) 85% of the net
orderly liquidation value of eligible inventory or (ii) 65% of the net amount of eligible inventory. These amounts are reduced by reserves deemed necessary by the lenders. At
February 27, 2011, there were no amounts outstanding under the ABL Revolver.

At
February 27, 2011, the Company was in compliance with the covenants contained within its ABL Revolver agreement and the indentures governing the Senior Notes, the Convertible
Notes and the 2014 Notes. These agreements also restrict our ability to pay dividends and repurchase common stock.

As
part of our ongoing evaluation of our capital structure, we continually assess opportunities to reduce our debt, which may from time to time include the redemption or repurchase of
part or all of our Senior Notes, the 2014 Notes or the Convertible Notes to the extent permitted by our debt covenants. In addition, our Board authorized a common stock repurchase program under which
we may repurchase up to $100 million of our common stock. As of February 27, 2011, we have repurchased shares for $16.3 million under this program, none of which was repurchased
during the first quarter of fiscal 2011. From February 27, 2011 through March 17, 2011, we did not repurchase any additional shares under this program.

Our
ability to make scheduled payments of principal, or to pay the interest or liquidated damages, if any, on or to refinance our indebtedness, or to fund planned capital expenditures
will depend on our future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We
will be required to make scheduled principal payments of $2.2 million during the next twelve months, with $1.7 million for our financing obligations and capital leases and the remainder
for debt owed by our international subsidiaries. However, as we continually evaluate our ability to make additional prepayments as permitted under our ABL Revolver agreement and the indentures
governing the Senior Notes, the
Convertible Notes and the 2014 Notes, it is possible that we will redeem or repurchase additional portions of our senior debt, subordinated debt or the Convertible Notes during that time.

36

---





Our ABL Revolver agreement and the indentures governing the Senior Notes, the 2014 Notes and the Convertible Notes contain restrictions
on our ability to pay dividends, including a requirement in the ABL Revolver agreement that we meet a minimum fixed charge coverage ratio and restrictions as to the amount available for payment.
Although we meet the minimum fixed charge coverage ratio requirement as of February 27, 2011, we do not currently expect a dividend will be declared in the second quarter of fiscal 2011.



The following table summarizes our changes in cash:

Three Months Ended:February 27,
2011

February 28,
2010(in thousands)Statement of Cash Flow Data:Cash flows provided by (used in):Operating activities

$
(2,197
)
$
(8,749
)Investing activities


(5,703
)

(2,392
)Financing activities


69


(2,861
)Effect of exchange rate changes on cash


966


(370
)Change in cash and cash equivalents


(6,865
)

(14,372
)Cash and cash equivalents:Beginning of period


109,255


131,427End of period

$
102,390

$
117,055




Cash Flows from Operating Activities.Our cash flow from operations increased $6.5 million to a use of cash of $2.2 million
for the
three months ended February 27, 2011 from a use of cash of $8.7 million for the three months ended February 28, 2010. Cash flows from operations for the three months ended
February 27, 2011 compared to the same prior year period reflect a lower use of working capital coupled with lower net income. The primary changes in working capital requirements driving this
change include decreases in accounts receivable driven by lower sales volume in the first quarter of fiscal 2011 and the increases in accounts payable balances to support the launch of the Next
GenerationPosturepedicline.

Cash Flows from Investing Activities.Our cash flows used in investing activities for the three months ended February 27, 2011
were
$5.7 million as compared to net cash used in investing activities of $2.4 million for the three months ended February 28, 2010. This difference of $3.3 million is primarily
due to higher capital expenditures in support of the launch of our Next GenerationPosturepedicline.

Cash Flows from Financing Activities.Our cash flow provided by financing activities for the three months ended February 27, 2011
was
$0.1 million compared with cash used in financing activities of $2.9 million for the three months ended February 28, 2010. This change has been primarily driven by lower
repayments of long-term obligations outstanding for our international subsidiaries due to the discontinuance of operations in Europe and Brazil.

37

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Significant judgment is required in evaluating our federal, state and foreign tax positions and in the determination of our tax
provision. Despite our belief that our liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of any particular tax
matters. We may adjust these liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, our tax advisors, or resolution of issues in the courts. These adjustments
are recognized as a component of income tax expense entirely in the period in which they are identified. The Company is currently undergoing examinations of its corporate income tax returns by tax
authorities. Issues related to certain of these reserved positions have been presented to the Company. The Company believes that such audits will not result in a material assessment and payment of
taxes related to these positions during the one year period following February 27, 2011. We also cannot predict when or if any other future tax payments related to these tax positions may
occur.



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

Our
ABL Revolver requires us to maintain a minimum fixed charge coverage ratio in excess of 1.1 to 1.0 in periods of minimum availability where the availability for two consecutive
calendar days is less than the greater of 1) 15% of the total commitment under the ABL Revolver and 2) $15.0 million. As of February 27, 2011, we were not in a period of
minimum availability and did not have any outstanding borrowings under the ABL Revolver. Non-compliance with the minimum fixed charge coverage ratio in a period of minimum availability
could result in the requirement to immediately repay all amounts outstanding under the ABL Revolver. The fixed charge coverage ratio is defined by the ABL Revolver agreement as the ratio of Adjusted
EBITDA less unfinanced capital expenditures and net cash taxes paid to fixed charges which include cash payments for interest, capital lease obligations, scheduled principal payments on debt and other
restricted payments.



The covenants contained in our senior debt agreements also restrict our ability to enter into certain transactions (the most
significant of which are summarized below). Our ABL Revolver requires us to meet a minimum fixed charge coverage ratio of 1.25 to 1.00 in order to make certain restricted payments including dividend
distributions to holders of our common stock, dividends or distributions to the parent company (Sealy Corporation), and debt repayments, subject to certain exceptions. The fixed charge coverage ratio
is defined by the ABL Revolver agreement as the ratio of Adjusted EBITDA less unfinanced capital expenditures and net cash paid to fixed charges which include cash payments for interest, capital lease
obligations, scheduled principal payments on debt and restricted payments. At February 27, 2011, adjustments to Adjusted EBITDA for cash taxes paid and unfinanced capital expenditures were
$41.2 million. Fixed charges as calculated under the terms of the ABL Revolver agreement were $66.9 million. This results in a fixed charge coverage ratio of 1.75 to 1.00 at
February 27, 2011 under the terms of the ABL Revolver agreement.

The
indentures governing our Senior Notes, Convertible Notes and 2014 Notes also require us to meet a fixed charge coverage ratio of 2.0 to 1.0 in order to incur additional indebtedness
and make certain restricted payments, including dividends or equity distributions, subject to certain exceptions. The fixed charge coverage ratio is defined by the indentures related to these notes as
the ratio of Adjusted EBITDA to fixed charges which include interest expense, and cash dividend payments on certain preferred stock. At February 27, 2011, fixed charges as calculated under the
terms of the

38

---



indentures
governing our Senior Notes, Convertible Notes and 2014 Notes were $81.4 million, resulting in a fixed charge coverage ratio of 1.94 to 1.00.

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

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

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

The
following table sets forth a reconciliation of net income to EBITDA and EBITDA to Adjusted EBITDA for the three months ended February 27, 2011 and February 28, 2010:

Three Months Ended:February 27, 2011

February 28, 2010(in thousands)Net (loss) income

$
(902
)
$
5,714Interest expense


21,708


21,733Income taxes


(1,209
)

7,627Depreciation and amortization


6,054


7,866EBITDA


25,651


42,940Adjustments for debt covenants:Non-cash compensation


2,880


4,107KKR consulting fees


366


496Severance charges


232


1,115Discontinued operations


1,032


2,562Other (various)(a)


(157
)

(1,283
)Adjusted EBITDA

$
30,004

$
49,937


(a)Consists
of various immaterial adjustments




There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7,
"Management's Discussion and Analysis of Financial Condition and

39

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Results
of Operations", included in our Annual Report on Form 10-K for the fiscal year ended November 28, 2010.



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



All
forward-looking statements attributable to us or persons acting on our behalf apply only as of the date of this Quarterly Report on Form 10-Q and are expressly
qualified in their entirety by the cautionary statements included in this Quarterly Report on Form 10-Q. Except as may be required by law, we undertake no obligation to publicly
update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events. For a more detailed
discussion of these factors see the information under the caption "Risk Factors" herein, in "Item 1A. Risk Factors" in the Company's most recent Annual Report on Form 10-K
and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the Company's most recent Annual Report on Form 10-K.

40

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Item 3.    Quantitative and Qualitative Disclosures About Market Risk

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



Our earnings are affected by fluctuations in the value of our subsidiaries' functional currency as compared to the currencies of our
foreign denominated purchases. The result of a uniform 10% change in the value of the U.S. dollar relative to currencies of countries in which we manufacture or sell our products would have an
approximate $0.7 million impact on our financial position for the three months ended February 27, 2011. This calculation assumes that each exchange rate would change in the same
direction relative to the U.S. dollar.

To
protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, we have instituted a forecasted cash flow hedging
program. We hedge portions of our purchases denominated in foreign currencies and royalty payments to third parties with forward and option contracts. At February 27, 2011, we had outstanding
forward and option foreign currency contracts to sell a total of 36.9 million Canadian dollars for U.S. dollars. The expiration dates for the Canadian dollar contracts range from March 2011 to
February 2012. At February 27, 2011, the fair value of these contracts was a liability of $1.3 million. The changes in fair value of the foreign currency hedges are included in net
income, except for those contracts that have been designated as hedges for accounting purposes. For contracts designated as hedges for accounting purposes, the changes in fair value related to the
effective portion of the hedge are recognized as a component of accumulated other comprehensive income.



A 10% increase or decrease in market interest rates that affect our interest rate derivative instruments would not have a material
impact on our earnings during the next fiscal year. Based on the amount of variable-rate debt outstanding at February 27, 2011, a 12.5 basis point increase or decrease in variable
interest rates would have an insignificant dollar impact on our annual interest expense.



We experienced more stability in the prices of polyurethane foam, polyester, polyethylene foam and steel innerspring component parts in
fiscal 2010, but saw the prices increase in the latter part of the year. In addition, we are now seeing trends that may create inflation in the prices of these products. We expect volatility in the
prices of these commodities through fiscal 2011. We have entered into commodity-based physical contracts to buy natural gas at agreed-upon fixed prices. These contracts were entered into
in the normal course of business. From time to time we hedge a portion of our expected diesel fuel consumption through the use of fixed price swap contracts. These contracts reduce the Company's
exposure to the volatility in diesel fuel prices. At February 27, 2011 we had no diesel fuel contracts outstanding. At November 28, 2010, there were outstanding contracts to purchase
0.2 million gallons of diesel fuel. The fair value of the contracts outstanding at November 28, 2010 was an asset of an insignificant amount.

41

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Item 4.    Controls and Procedures

Under the supervision and with the participation of our management, including our principal executive officer and principal financial
officer, we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended, as of the end of the period covered by this report (the "Evaluation Date"). Based on this evaluation, our principal
executive officer and principal financial officer concluded as of the Evaluation Date that our disclosure controls and procedures were effective such that the information relating to the Company,
including our consolidated subsidiaries, required to be disclosed in our Securities and Exchange Commission ("SEC") reports (i) is recorded, processed, summarized and reported within the time
periods specified in SEC rules and forms, and (ii) is accumulated and communicated to the Company's management, including our principal executive and principal financial officers, as
appropriate to allow timely decisions regarding required disclosure.

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

42

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PART II. OTHER INFORMATION

Item 1.    Legal Proceedings

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

Item 1A.    Risk Factors.

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

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

There were no repurchases of the Company's common stock during the first quarter of fiscal 2011 as part of a publicly announced program
or otherwise. Our common stock repurchase program, which authorizes us to repurchase up to $100 million of our Company's common stock, was initially approved by our Board of Directors on
February 19, 2007. As of February 27, 2011, the approximate dollar value of shares that may yet be purchased under the program was $83.7 million.

Subsequent
to February 27, 2011, through March 17, 2011, no shares of Sealy Corporation common stock were surrendered by participants in the Company's 1998 and 2004 Stock
Option Plans to cover the exercise price and/or tax withholding obligations in stock option exercises.

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

Item 3.    Defaults Upon Senior Securities

None

Item 4.    (Removed and Reserved)

Item 5.    Other Information

None

Item 6.    Exhibits

31.1

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

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

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


Filed
herewith.


43

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SIGNATURES

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



Signature

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

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

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


Date:
March 29, 2011

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