**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

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**FORM 10-Q**

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

**Forthe quarterly period ended: May 27, 2007**

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

**Forthe Transition Period from                  to                  **

**Commissionfile number 001-08738**

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**SEALY CORPORATION**

(Exact name of registrantas specified in its charter)

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

 

**(336) 861-3500**

Registrant’s telephonenumber, including area code

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

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer. Seedefinition of “accelerated filer” and “large accelerated filer” in Rule 12b-2of the Exchange Act. (check one):

Large accelerated filer o          Acceleratedfiler o          Non-acceleratedfiler x

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

**The number of shares ofthe registrant’s common stock outstanding as of July 2, 2007 isapproximately: 91,481,769.**

 

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**PART I.FINANCIAL INFORMATION**

**Item 1.**                        *Financial Statements*

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

| ** **                                                       | ** ** | **Quarter Ended** | ** ** |
|------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                       | ** ** | **May 27,  2007** | ** ** | **May 28,  2006** | ** ** |
| Net sales                                                        |       | $                      | 401,828    |   | $ | 376,712 |   |
| Cost of goods  sold                                              |       | 229,310                |       | 208,136 |   |
| Gross profit                                                     |       | 172,518                |       | 168,576 |   |
| Selling, general and administrative expenses                     |       | 135,532                |       | 123,111 |   |
| Expenses  associated with intial public offering of common stock |       | —                 |       | 28,510 |   |
| Amortization of  intangibles                                     |       | 830                    |       | 133 |   |
| Royalty income,  net of royalty expense                          |       | (4,411                 | )          | (3,706 | ) |
| Income from operations                                           |       | 40,567                 |       | 20,528 |   |
| Interest expense                                                 |       | 15,229                 |       | 17,893 |   |
| Debt  extinguishment and refinancing expenses                    |       | —                 |       | 5,295 |   |
| Other income, net                                                |       | (134                   | )          | (379 | ) |
| Income (loss) before income tax expense (benefit)                |       | 25,472                 |       | (2,281 | ) |
| Income tax  expense (benefit)                                    |       | 9,339                  |       | (2,407 | ) |
| Net income                                                       |       | $                      | 16,133     |   | $ | 126 |   |
| Earnings per common share—Basic                             |       | $                      | 0.18       |   | $ | 0.00 |   |
| Earning per common share—Diluted                            |       | $                      | 0.17       |   | $ | 0.00 |   |
| Weighted average  number of common shares outstanding:           |       |                   |       |   |   |
| Basic                                                            |       | 91,467                 |       | 82,065 |   |
| Diluted                                                          |       | 96,146                 |       | 88,440 |   |

 

See accompanying notes to condensed consolidated financial statements.

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

| ** **                                                                                                  | ** ** | **Six Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                  | ** ** | **May 27,**               | ** ** | **May 28,** | ** ** |
| ** **                                                                                                  | ** ** | **2007**                       | ** ** | **2006** | ** ** |
| Net sales                                                                                                   |       | $                              | 814,395    |   | $ | 772,447 |   |
| Cost of goods  sold                                                                                         |       | 464,603                        |       | 427,174 |   |
| Gross profit                                                                                                |       | 349,792                        |       | 345,273 |   |
| Selling, general and administrative expenses                                                                |       | 262,445                        |       | 246,715 |   |
| Expenses  associated with intial public offering of common stock                                            |       | —                         |       | 28,510 |   |
| Amortization of  intangibles                                                                                |       | 1,613                          |       | 255 |   |
| Royalty income,  net of royalty expense                                                                     |       | (9,703                         | )          | (7,395 | ) |
| Income from operations                                                                                      |       | 95,437                         |       | 77,188 |   |
| Interest expense                                                                                            |       | 31,134                         |       | 36,629 |   |
| Debt  extinguishment and refinancing expenses                                                               |       | —                         |       | 5,295 |   |
| Other income, net                                                                                           |       | (214                           | )          | (566 | ) |
| Income before income tax expense                                                                            |       | 64,517                         |       | 35,830 |   |
| Income tax expense                                                                                          |       | 23,750                         |       | 12,445 |   |
| Income before cumulative effect of change in  accounting principle                                          |       | 40,767                         |       | 23,385 |   |
| Cumulative effect  of the adoption of FASB Interpretation No. 47, net of   related tax benefit of $191 |       | —                         |       | 287 |   |
| Net income                                                                                                  |       | $                              | 40,767     |   | $ | 23,098 |   |
| Earnings per  common share—Basic                                                                       |       |                           |       |   |   |
| Income before cumulative effect of change in  accounting principle                                          |       | $                              | 0.45       |   | $ | 0.30 |   |
| Cumulative effect of a change in accounting  principle                                                      |       | —                         |       | — |   |
| Earnings per common share—Basic                                                                        |       | $                              | 0.45       |   | $ | 0.30 |   |
| Earnings per common  share—Diluted                                                                     |       |                           |       |   |   |
| Income before cumulative effect of change in  accounting principle                                          |       | $                              | 0.42       |   | $ | 0.28 |   |
| Cumulative effect of a change in accounting  principle                                                      |       | —                         |       | — |   |
| Earning per common share—Diluted                                                                       |       | $                              | 0.42       |   | $ | 0.28 |   |
| Weighted average number  of common shares outstanding:                                                      |       |                           |       |   |   |
| Basic                                                                                                       |       | 91,409                         |       | 76,273 |   |
| Diluted                                                                                                     |       | 96,683                         |       | 82,458 |   |

 

See accompanying notes to condensed consolidated financial statements.

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

| ** **                                                                                                                                                                                                                                 | ** ** | **May 27,** | ** ** | **November 26,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                 | ** ** | **2007**         | ** ** | **2006**              | ** ** |
| **ASSETS**                                                                                                                                                                                                                                 |       |             |       |                  |       |   |   |
| Current assets:                                                                                                                                                                                                                            |       |             |       |                  |       |   |   |
| Cash and cash  equivalents                                                                                                                                                                                                                 |       | $                | 21,722     |                  |       | $ | 45,620 |   |   |
| Accounts receivable, net  of allowances for bad debts, cash discounts and returns                                                                                                                                                          |       | 207,999          |       |                  | 193,838    |   |   |
| Inventories                                                                                                                                                                                                                                |       | 71,210           |       |                  | 66,126     |   |   |
| Assets held for sale                                                                                                                                                                                                                       |       | —           |       |                  | 2,338      |   |   |
| Prepaid expenses and  other current assets                                                                                                                                                                                                 |       | 27,871           |       |                  | 24,710     |   |   |
| Deferred income taxes                                                                                                                                                                                                                      |       | 13,355           |       |                  | 12,627     |   |   |
|                                                                                                                                                                                                                                       |       | 342,157          |       |                  | 345,259    |   |   |
| Property, plant and  equipment—at cost                                                                                                                                                                                                |       | 425,158          |       |                  | 397,167    |   |   |
| Less accumulated  depreciation                                                                                                                                                                                                             |       | (191,078         | )          |                  | (178,957   | ) |   |
|                                                                                                                                                                                                                                       |       | 234,080          |       |                  | 218,210    |   |   |
| Other assets:                                                                                                                                                                                                                              |       |             |       |                  |       |   |   |
| Goodwill                                                                                                                                                                                                                                   |       | 390,534          |       |                  | 388,204    |   |   |
| Other intangibles, net  of accumulated amortization                                                                                                                                                                                        |       | 11,818           |       |                  | 13,026     |   |   |
| Debt issuance costs,  net, and other assets                                                                                                                                                                                                |       | 38,372           |       |                  | 38,033     |   |   |
|                                                                                                                                                                                                                                       |       | 440,724          |       |                  | 439,263    |   |   |
|                                                                                                                                                                                                                                       |       | $                | 1,016,961  |                  |       | $ | 1,002,732 |   |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                                                                                                             |       |             |       |                  |       |   |   |
| Current liabilities:                                                                                                                                                                                                                       |       |             |       |                  |       |   |   |
| Current portion—long-term  obligations                                                                                                                                                                                                |       | $                | 26,830     |                  |       | $ | 18,282 |   |   |
| Accounts payable                                                                                                                                                                                                                           |       | 126,672          |       |                  | 118,885    |   |   |
| Accrued incentives and  advertising                                                                                                                                                                                                        |       | 37,153           |       |                  | 40,578     |   |   |
| Accrued compensation                                                                                                                                                                                                                       |       | 31,362           |       |                  | 35,484     |   |   |
| Accrued interest                                                                                                                                                                                                                           |       | 19,450           |       |                  | 17,286     |   |   |
| Other accrued expenses                                                                                                                                                                                                                     |       | 51,227           |       |                  | 57,669     |   |   |
|                                                                                                                                                                                                                                       |       | 292,694          |       |                  | 288,184    |   |   |
| Long-term obligations,  net of current portion                                                                                                                                                                                             |       | 797,570          |       |                  | 814,236    |   |   |
| Other noncurrent  liabilities                                                                                                                                                                                                              |       | 43,646           |       |                  | 42,688     |   |   |
| Deferred income taxes                                                                                                                                                                                                                      |       | 10,960           |       |                  | 10,199     |   |   |
| Common stock and options  subject to redemption                                                                                                                                                                                            |       | 16,671           |       |                  | 20,263     |   |   |
| Stockholders’ deficit:                                                                                                                                                                                                                |       |             |       |                  |       |   |   |
| Common stock, $0.01 par  value; Authorized shares: 2007 and 2006—200,000 Issued and outstanding:  2007—91,373; 2006—90,983 (including shares classified above as subject  to redemption: 2007—399; 2006—424) |       | 908              |       |                  | 904        |   |   |
| Additional paid-in  capital                                                                                                                                                                                                                |       | 662,694          |       |                  | 664,609    |   |   |
| Accumulated deficit                                                                                                                                                                                                                        |       | (819,101         | )          |                  | (846,144   | ) |   |
| Accumulated other  comprehensive income                                                                                                                                                                                                    |       | 10,919           |       |                  | 7,793      |   |   |
|                                                                                                                                                                                                                                       |       | (144,580         | )          |                  | (172,838   | ) |   |
|                                                                                                                                                                                                                                       |       | $                | 1,016,961  |                  |       | $ | 1,002,732 |   |   |

 

See accompanying notes to condensed consolidated financial statements.

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

| ** **                                                                                      | ** ** | ** **        | ** ** | ** **            | ** ** | ** **  | ** ** | ** **      | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** ** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-----------------|------------|------------|------------|
| ** **                                                                                      | ** ** | ** **        | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional**  | ** ** | ** **        | ** ** | **Other**       | ** ** | ** ** | ** ** |
| ** **                                                                                      | ** ** | **Comprehensive** | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | ** **      | ** ** |
| ** **                                                                                      | ** ** | **Income**        | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**     | ** ** | **Deficit**       | ** ** | **Income**      | ** ** | **Total**  | ** ** |
| Balance at November 26, 2006                                                               |       |              | $          | —                |       |        |       | 90,983          |       |              |       | $               | 904        |       |       |   | $ | 664,609 |   |   |   | $ | (846,144 | ) |   |   | $ | 7,793 |   |   | $ | (172,838 | ) |
| Net income                                                                                      |       |              | 40,767     |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   | 40,767 |   |   |   |   |   |   | 40,767 |   |
| Foreign currency translation adjustment                                                         |       |              | 3,740      |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   | 3,740 |   |   | 3,740 |   |
| Excess of additional pension liability over unrecognized  prior service cost, net of tax of $55 |       |              | (82        | )                     |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   | (82 | ) |   | (82 | ) |
| Change in fair value of cash flow hedge, net of tax  of $295                                    |       |              | (532       | )                     |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   | (532 | ) |   | (532 | ) |
| Stock-based compensation:                                                                       |       |              |       |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Compensation associated with stock option grants                                                |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 1,058      |   |   |   |   |   |   |   |   |   |   | 1,058 |   |
| Directors’ deferred stock  compensation                                                    |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 213        |   |   |   |   |   |   |   |   |   |   | 213 |   |
| Cash dividend                                                                                   |       |              |       |                  |       |        |       |            |       |              |       |            |       |       |       |   |   |   | (13,724 | ) |   |   |   |   |   | (13,724 | ) |
| Repurchase of common stock                                                                      |       |              |       |                  |       |        | (317       | )               |       |              | (3         | )               |       |       | (5,373     | ) |   |   |   |   |   |   |   |   |   | (5,376 | ) |
| Exercise of stock options                                                                       |       |              |       |                  |       |        | 707        |            |       |              | 7          |            |       |       | (7,333     | ) |   |   |   |   |   |   |   |   |   | (7,326 | ) |
| Excess tax benefit on options exercised                                                         |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 5,879      |   |   |   |   |   |   |   |   |   |   | 5,879 |   |
| Adjustment of temporary equity subject to redemption                                       |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 3,591      |   |   |   |   |   |   |   |   |   |   | 3,591 |   |
| Other                                                                                           |       |              |       |                  |       |        |       |            |       |              |       |            |       |       | 50         |   |   |   |   |   |   |   |   |   |   | 50 |   |
| Balance at  May 27, 2007                                                                   |       |              | $          | 43,893                |       |        |       | 91,373          |       |              |       | $               | 908        |       |       |   | $ | 662,694 |   |   |   | $ | (819,101 | ) |   |   | $ | 10,919 |   |   | $ | (144,580 | ) |

 

See accompanying notes to condensed consolidated financial statements.

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

| ** **                                                                                                                   | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                   | ** ** | **May 27,  2007**         | ** ** | **May 28,  2006** | ** ** |
| Cash flows from operating activities:                                                                                        |       |                           |       |   |   |
| Net income                                                                                                                   |       | $                              | 40,767     |   | $ | 23,098 |   |
| Adjustments to reconcile net income to net cash  provided by (used in) operating activities:                                 |       |                           |       |   |   |
| Depreciation and  amortization                                                                                               |       | 15,183                         |       | 10,994 |   |
| Deferred income taxes                                                                                                        |       | 220                            |       | 975 |   |
| Non-cash interest expense:                                                                                                   |       |                           |       |   |   |
| Senior  Subordinated PIK Notes                                                                                               |       | —                         |       | 3,348 |   |
| Amortization of  debt issuance costs and other                                                                               |       | 1,471                          |       | 756 |   |
| Stock-based compensation                                                                                                     |       | 1,774                          |       | 2,074 |   |
| Excess tax benefits from  share-based payment arrangements                                                                   |       | (5,879                         | )          | (1,760 | ) |
| (Gain) loss on sale of  assets                                                                                               |       | (2,404                         | )          | 564 |   |
| Write-off of debt  issuance costs related to debt extinguishments                                                            |       | —                         |       | 1,725 |   |
| Cumulative effect of  accounting change                                                                                      |       | —                         |       | 287 |   |
| Other, net                                                                                                                   |       | (940                           | )          | (177 | ) |
| Changes in operating assets and liabilities:                                                                                 |       |                           |       |   |   |
| Accounts receivable                                                                                                          |       | (11,199                        | )          | (8,682 | ) |
| Inventories                                                                                                                  |       | (4,221                         | )          | (7,686 | ) |
| Prepaid expenses and  other current assets                                                                                   |       | (3,979                         | )          | (6,644 | ) |
| Accounts payable                                                                                                             |       | 6,233                          |       | (12,114 | ) |
| Accrued expenses                                                                                                             |       | (14,356                        | )          | (27,380 | ) |
| Other liabilities                                                                                                            |       | (208                           | )          | 778 |   |
| Net cash provided by  (used in) operating activities                                                                         |       | 22,462                         |       | (19,844 | ) |
| Cash flows from investing activities:                                                                                        |       |                           |       |   |   |
| Purchase of property,  plant and equipment                                                                                   |       | (22,404                        | )          | (16,047 | ) |
| Proceeds from sale of  property, plant and equipment                                                                         |       | 4,938                          |       | 464 |   |
| Net cash used in  investing activities                                                                                       |       | (17,466                        | )          | (15,583 | ) |
| Cash flows from financing activities:                                                                                        |       |                           |       |   |   |
| Proceeds from initial  public offering of common stock, net of underwriting discount and other  direct costs of $24,489 |       | —                         |       | 295,511 |   |
| Cash dividends                                                                                                               |       | (13,724                        | )          | (125,000 | ) |
| Repayments of long-term  obligations, including premims paid of $2,703 in 2006                                               |       | (10,000                        | )          | (139,317 | ) |
| Borrowings under  revolving credit facilities                                                                                |       | 20,207                         |       | 108,718 |   |
| Repayments under  revolving credit facilities                                                                                |       | (25,517                        | )          | (121,576 | ) |
| Repurchase of common  stock                                                                                                  |       | (5,376                         | )          | — |   |
| Exercise of employee  stock options, including related excess tax benefits                                                   |       | 5,900                          |       | 1,814 |   |
| Other                                                                                                                        |       | 19                             |       | 2,594 |   |
| Net cash (used in)  provided by financing activities                                                                         |       | (28,491                        | )          | 22,744 |   |
| Effect of exchange  rate changes on cash                                                                                     |       | (403                           | )          | 336 |   |
| Change in cash and  cash equivalents                                                                                         |       | (23,898                        | )          | (12,347 | ) |
| Cash and cash equivalents:                                                                                                   |       |                           |       |   |   |
| Beginning of period                                                                                                          |       | 45,620                         |       | 36,554 |   |
| End of period                                                                                                                |       | $                              | 21,722     |   | $ | 24,207 |   |

 

See accompanying notes to condensed consolidated financial statements.

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**SEALY CORPORATIONNotes to Condensed Consolidated Financial Statements(unaudited)**

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

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

On April 6, 2004, the Company completed a mergerwith affiliates of Kohlberg Kravis Roberts & Co. L.P. (“KKR”) wherebyKKR acquired 92% of the Company’s capital stock. Certain of the Company’sprevious stockholders, including affiliates of Bain Capital, LLC and others,retained an 8% interest in the Company’s stock. The merger was accounted for asa recapitalization. Subsequent to the recapitalization, the Company contributedall of its interest in Sealy Mattress Company, of which it was the soleshareholder, to a newly formed subsidiary holding company, Sealy MattressCorporation, which also replaced the Company as the parent-guarantor ofthe 8.25% Senior Subordinated Notes due 2014 (the “Notes”) issued by SealyMattress Company. Effective May 25, 2006, Sealy Corporation was named aguarantor of the Notes. At May 27, 2007, KKR controlled approximately 51%of the issued and outstanding common stock of the Company.

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

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

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

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

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

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

In February 2007, theFASB issued FAS 159, “The Fair Value Option for Financial Assets and FinancialLiabilities—including an amendment to FASB Statement No. 115” whichpermits entities to choose to measure many financial instruments and certainother items at fair value that are not currently required to be measured atfair value. The statement is effective for fiscal years beginning after November 15,2007. The Company will adopt this statement as of the beginning of fiscal 2008and does not expect it to have a material impact on the Company’s financialposition or results of operations.

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

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

Duringthe three and six months ended May 27, 2007, the Company granted newoptions to purchase 17,821 and 450,282 shares, respectively, of common stock,and recognized compensation expense associated with these grants ofapproximately $0.3 million and $0.5 million during the three and sixmonths ended May 27, 2007, respectively. During the three months ended May 28,2006, the Company granted new options to purchase 1,781,160 shares of commonstock and recognized compensation expense associated with these grants ofapproximately $0.6 million. No new stock options were granted, nor wereoutstanding 

7

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options modified during the first quarter of fiscal2006. The options granted during the second quarter of fiscal 2007 had aweighted average grant-date fair value of $5.06 per option. The Company valuedthese stock option grants using the trinomial lattice valuation model with thefollowing assumptions:

| Expected  volatility      |   | 30           | %      |
|---------------------------|--------|--------------|--------|
| Expected dividend  yield  |   | 1.76 - 2.03  | %      |
| Expected term (in  years) |   | 6.71 - 7.88  |   |
| Risk-free rate            |   | 4.54% - 4.72 | %      |

 

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

As of May 27, 2007, the Company had approximately$7.2 million of unrecognized compensation expense which is expected to be recognizedover a weighted average period of 5.7 years.

During the three and six months ended May 27,2007 and May 28, 2006, the Company recognized total non-cash compensationexpense associated with stock options of $0.7 million and $1.1 million,respectively, for fiscal 2007 and $1.0 million and $1.0 million, respectively,for fiscal 2006.

During the three and sixmonths ended May 27, 2007 and May 28, 2006, the Company recognizedexpense of $0.4 million and $0.5 million, respectively, for fiscal2007 and $0.6 million and $0.9 million, respectively, for fiscal 2006,resulting from the accretion of an obligation to certain executives of theCompany for their right to sell to the Company, upon their retirement, vestedshares of the Company’s common stock.

**Note 4: *Inventories***

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

| ** **      | ** ** | **May 27,** | ** ** | **November 26,** | ** ** |
|-----------------|------------|------------------|------------|-----------------------|------------|
| ** **      | ** ** | **2007**         | ** ** | **2006**              | ** ** |
| Raw materials   |       | $                | 37,463     |                  |       | $ | 35,041 |   |   |
| Work in process |       | 21,431           |       |                  | 19,594     |   |   |
| Finished goods  |       | 12,316           |       |                  | 11,491     |   |   |
|            |       | $                | 71,210     |                  |       | $ | 66,126 |   |   |

 

8

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**Note 5: *Warranty Costs***

TheCompany’s warranty policy provides a 10-year non-prorated warrantyservice period on all currently manufactured *SealyPosturepedic, Stearns & Foster* and *Bassett*bedding products and certain other Sealy-branded products, a 20-yearwarranty on its *TrueForm *product line and a20-year limited warranty on its *RightTouch*productline that covers only certain parts of the product and is prorated for part ofthe twenty years. In fiscal 2007, the Company amended its warranty policy onSealy-branded promotional bedding to three years for the new line introduced inJanuary 2007 and shipped in the second quarter of fiscal 2007. The Company’spolicy is to accrue the estimated cost of warranty coverage at the time thesale is recorded. The change in the Company’s accrued warranty obligations foreach of the six months ended May 27, 2007 and May 28, 2006 and theyear ended November 26, 2006 was as follows (in thousands):

| ** **                                           | ** ** | **May 27,** | ** ** | **November 26,** | ** ** | **May 28,** | ** ** |
|------------------------------------------------------|------------|------------------|------------|-----------------------|------------|------------------|------------|
| ** **                                           | ** ** | **2007**         | ** ** | **2006**              | ** ** | **2006**         | ** ** |
| Accrued warranty  obligations at beginning of period |       | $                | 15,349     |                  |       | $                | 14,321     |   |   | $ | 14,321 |   |
| Warranty claims                                      |       | (7,778           | )          |                  | (15,832    | )                |       | (8,426 | ) |
| Warranty  provisions                                 |       | 6,415            |       |                  | 16,860     |             |       | 8,543 |   |
| Accrued warranty  obligations at end of period       |       | $                | 13,986     |                  |       | $                | 15,349     |   |   | $ | 14,438 |   |

 

Warranty claims for theyear ended November 26, 2006 include approximately $10.5 million forclaims associated with products sold prior to November 27, 2005 that werestill under warranty. In estimating its warranty obligations, the Companyconsiders the impact of recoverable salvage value on warranty cost indetermining its estimate of future warranty obligations. Warranty claims andprovisions shown above do not include estimated salvage recoveries that reducedcost of sales by $3.3 million, $5.5 million and $2.8 million for thethree months ended May 27, 2007, the year ended November 26, 2006 andthe three months ended May 28, 2006, respectively.

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

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

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

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

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

The Company performs an annual assessment of itsgoodwill for impairment as of the beginning of the fiscal fourth quarter. TheCompany also assesses its goodwill and other intangible assets for impairment 

9

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when events or circumstancesindicate that their carrying value may not be recoverable from future cashflows.

Thechanges in the carrying amount of goodwill for the six months ended May 27,2007 are as follows:

| ** **                                    | ** ** | **Americas**            | ** ** | **Europe** | ** ** | **Total** | ** ** |
|-----------------------------------------------|------------|-------------------------|------------|------------|------------|-----------|------------|
| ** **                                    | ** ** | **(in thousands)** | ** ** |
| Balance as of  November 26, 2006         |       | $                       | 362,675    |       | $          | 25,529    |       | $ | 388,204 |   |
| Increase due to  foreign currency translation |       | 1,648                   |       | 682        |       | 2,330     |       |
| Balance as of  May 27, 2007              |       | $                       | 364,323    |       | $          | 26,211    |       | $ | 390,534 |   |

 

Total other intangibles of$11.8 million (net of accumulated amortization of $9.3 million) as of May 27,2007 consist primarily of licenses, which are amortized on the straight-linemethod over periods ranging from 5 to 15 years, and unamortized pensionprior service costs of $1.9 million.

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

Long-termobligations as of May 27, 2007 and November 26, 2006 consisted of thefollowing:

| ** **                        | ** **         | **May 27,  2007**  | ** **          | **November 26,  2006** | ** ** |
|-----------------------------------|--------------------|-------------------------|---------------------|-----------------------------|------------|
| ** **                        | ** **         | **(in thousands)** | ** **          |
| Senior revolving  credit facility |               | $                       | 8,801               |                        |       | $ | 14,090 |   |   |
| Senior secured  term loans        |               | 405,000                 |                |                        | 415,000    |   |   |
| Senior subordinated  notes        |               | 342,000                 |                |                        | 342,000    |   |   |
| Financing  obligations            |               | 42,131                  |                |                        | 37,535     |   |   |
| Other                             |               | 26,468                  |                |                        | 23,893     |   |   |
|                              |               | 824,400                 |                |                        | 832,518    |   |   |
| Less current  portion             |     | (26,830                 | )    |                        | (18,282    | ) |    |
|                              |               | $                       | 797,570             |                        |       | $ | 814,236 |   |   |

 

The total borrowing capacity under the seniorrevolving credit facility is $125 million, of which up to $25 millionmay be borrowed in Canada. At May 27, 2007, amounts outstanding under thesenior revolving credit facility were $8.8 million under the Canadian portionof the facility. At May 27, 2007, the Company had approximately$84.7 million available under the revolving credit facility after takinginto account letters of credit issued totaling $31.5 million.

Annually, the Company may be required to makeprincipal prepayments depending on certain financial ratios, as defined in itssenior secured credit agreement. At May 27, 2007, the Company is unable todetermine the amount of such required payment, if any, that would be duefollowing the first quarter of fiscal 2008 with respect to excess cash flow forthe 2007 fiscal year.

At May 27, 2007 theCompany was in compliance with the covenants contained within its senior creditagreements and indenture governing the senior subordinated notes. The seniorcredit agreements and the senior subordinated notes restrict the Company’sability to pay dividends.

**Note 10:*Hedging Strategy***

Use of hedging contracts allows the Company to reduceits overall exposure to interest rate changes, since gains and losses on thesecontracts will offset losses and gains on the transactions being hedged. TheCompany formally documents all hedged transactions and hedging instruments, andassesses, both at inception of the contract and on an ongoing basis, whetherthe hedging instruments are effective in 

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offsetting changes in cashflows of the hedged transaction. The fair values of the interest rateagreements are estimated by obtaining quotes from brokers and are the estimatedamounts that the Company would receive or pay to terminate the agreements atthe reporting date, taking into consideration current interest rates and thecurrent creditworthiness of the counterparties.

In June 2004,the Company entered into a swap agreement that has the effect of converting$200 million of the floating-rate debt under the Company’s senior creditfacilities to a fixed-rate basis, declining to $150 million from December 2005through November 2007. The Company has formally designated this swapagreement as a cash flow hedge and expects the hedge to be highly effective inoffsetting fluctuations in the designated interest payments resulting fromchanges in the benchmark interest rate. Effective August 25, 2006, theCompany de-designated $13 million of the interest rate swap for hedgeaccounting due to an amendment of the senior secured term loan agreement. As aresult of the dedesignation, $0.2 million previously recorded inaccumulated other comprehensive income was recorded as a reduction of interestexpense. The effective portion of changes in the market value of$137 million of the swap is recorded in other comprehensive income andwill be amortized into interest expense over the remaining life of the interestrate swap agreement. For the three and six months ended May 27, 2007 and May 28,2006, $0.6 million and $1.2 million, respectively, for fiscal 2007 and $0.4million and $0.7 million, respectively, for fiscal 2006 were recorded asreductions of interest expense. At May 27, 2007 and November 26,2006, the fair value carrying amount of the instrument was recorded as follows:

| ** **                   | ** ** | **May 27,  2007**  | ** ** | **November 26,  2006** | ** ** |
|------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                   | ** ** | **(in thousands)** | ** ** |
| Accrued interest  receivable |       | $                       | 592        |                        |       | $ | 607 |   |   |
| Other current  assets        |       | 1,254                   |       |                        | 2,160      |   |   |
| Total net asset              |       | $                       | 1,846      |                        |       | $ | 2,767 |   |   |

 

At May 27, 2007 and November 26, 2006,accumulated other comprehensive income associated with the interest rate swapwas $0.7 million and $1.2 million, respectively, net of income taxeffects.

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

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

To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, the Company enters into foreign currencyforward and option contracts. The Company does not designate its foreigncurrency forward and option contracts as hedges for accounting purposes,therefore all changes in fair value are charged to earnings. At May 27,2007, the 

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Companyhad forward contracts to sell a total of 27 million Canadian dollars withexpiration dates ranging from May 31, 2007 through November 30, 2007.At May 27, 2007 and November 26, 2006, the fair value of the Company’snet receivable under the forward contracts was a liability of $1.5 million andan asset of $0.1 million, respectively. For the three and six months endedMay 27, 2007, recognized foreign currency transaction losses were $1.5 millionand $1.3 million, respectively, compared with gains of $0.2 million and$0.2 million for the three and six months ended May 28, 2006,respectively.

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

Other income, net,includes interest income for the three and six months ended May 27, 2007and May 28, 2006 of $0.1 million and $0.2 million, respectively, forfiscal 2007 and $0.4 million and $0.6 million, respectively, for fiscal 2006.

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

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

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

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

Thecomponents of net periodic pension cost recognized for the Company’s definedbenefit pension plan for the three and six months ended May 27, 2007 andMay 28, 2006 are as follows:

| ** **                                       | ** ** | **Three months ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                       | ** ** | **May 27,  2007**           | ** ** | **May 28,  2006**         | ** ** | **May 27,  2007** | ** ** | **May 28,  2006** | ** ** |
| ** **                                       | ** ** | **(in thousands)**          | ** ** | **(in thousands)**        | ** ** |
| Service cost                                     |       |                             | $          | 177                            |       |   |   | $ | 145 |   |   |   | $ | 324 |   |   |   | $ | 295 |   |   |
| Interest cost                                    |       |                             | 245        |                           |       |   | 195 |   |   |   | 452 |   |   |   | 414 |   |   |
| Expected return  on plan assets                  |       |                             | (268       | )                              |       |   | (216 | ) |   |   | (486 | ) |   |   | (437 | ) |   |
| Amortization of  unrecognized gains and losses   |       |                             | 38         |                           |       |   | (7 | ) |   |   | 68 |   |   |   | 60 |   |   |
| Amortization of  unrecognized transition asset   |       |                             | (22        | )                              |       |   | (22 | ) |   |   | (44 | ) |   |   | (44 | ) |   |
| Amortization of  unrecognized prior service cost |       |                             | 56         |                           |       |   | 48 |   |   |   | 106 |   |   |   | 99 |   |   |
| Net periodic  pension cost*                      |       |                             | $          | 226                            |       |   |   | $ | 143 |   |   |   | $ | 420 |   |   |   | $ | 387 |   |   |
| Cash contributions                               |       |                             | $          | 444                            |       |   |   | $ | 425 |   |   |   | $ | 589 |   |   |   | $ | 699 |   |   |

----

*                    Net periodicpension cost recognized for the three and six months ended May 27, 2007 isbased upon preliminary estimates pending the final actuarial determination ofsuch costs for fiscal 2007. Similarly, net periodic pension cost for the threeand six months ended May 28, 2006 is based upon preliminary estimates.

The Company expects tomake additional cash contributions to the plan of approximately $1.1 millionduring the remainder of fiscal 2007.

**Note 14: *Income Taxes***

The Company’s effective income tax rates differ fromthe Federal statutory rate principally because of the effect of certain foreigntax rate differentials and state and local income taxes. The effective tax ratefor the three and six months ended May 27, 2007 was approximately 36.7 %and 36.8%, respectively, compared to 105.5% and 34.7%, respectively, for thethree and six months ended May 28, 2006.

Significant judgment isrequired in evaluating the Company’s federal, state and foreign tax positionsand in the determination of its tax provision. Despite the Company’s beliefthat its tax return positions are fully supportable, reserves have beenestablished where the Company believes that certain tax positions are likely tobe challenged and the Company may not fully prevail in overcoming thesechallenges. The Company may adjust these reserves as relevant circumstancesevolve, such as guidance from the relevant tax authority, or resolution ofissues in the courts. In addition the Company is still assessing the potentialimpact of FIN 48 (Note 2). The Company’s tax expense includes the impactof reserve positions and changes to reserves that it considers appropriate, aswell as related interest and penalties. While the Company is currentlyundergoing examinations of certain of its corporate income tax returns by taxauthorities, no issues related to these reserves have been presented to theCompany and the Company believes that such audits will not result in anassessment or payment of taxes related to these positions during the one yearfollowing May 27, 2007. The Company also cannot predict when or if anyother future tax payments related to these tax positions may occur.

**Note 15: *Comprehensive Income***

Comprehensive income forthe three and six months ended May 27, 2007 was $20.2 million and $43.9 million,respectively, and for the three and six months ended May 28, 2006 was$3.6 million and $27.7 million, respectively.

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**Note 16: *Contingencies***

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

The Company is currently conducting an environmentalcleanup at a formerly owned facility in South Brunswick, New Jerseypursuant to the New Jersey Industrial Site Recovery Act. The Company and one ofits subsidiaries are parties to an Administrative Consent Order issued by theNew Jersey Department of Environmental Protection. Pursuant to that order, theCompany and its subsidiary agreed to conduct soil and groundwater remediationat the property. The Company does not believe that its manufacturing processeswere the source of contamination. The Company sold the property in 1997. TheCompany and its subsidiary retained primary responsibility for the requiredremediation. The Company has completed essentially all soil remediation withNew Jersey Department of Environmental Protection approval, and has concluded apilot test of the groundwater remediation system. During 2005, with theapproval of the New Jersey Department of Environmental Protection, the Companyremoved and disposed of sediment in Oakeys Brook adjoining the site. TheCompany continues to monitor ground water at the site. The Company has recordeda reserve for $2.3 million ($2.9 million prior to discounting at4.75%) associated with this remediation project. Also in connection with thissite, the Company received a written complaint from the New Jersey Departmentof Environmental Protection alleging natural resources damages in anunspecified amount. Because the natural resources damages claim is in an earlystage and the Company’s liability, if any, cannot be reasonably estimated atthis time, no amounts have been accrued related to this matter.

The Company is also remediating soil and groundwatercontamination at an inactive facility located in Oakville, Connecticut.Although the Company is conducting the remediation voluntarily, it obtainedConnecticut Department of Environmental Protection approval of the remediationplan. The Company has completed essentially all soil remediation under theremediation plan and is currently monitoring groundwater at the site. TheCompany has identified cadmium in the ground water at the site and intends toaddress that during fiscal 2007. The Company has recorded a reserve ofapproximately $1.1 million associated with the additional work and ongoingmonitoring. The Company believes the contamination is attributable to themanufacturing operations of previous unaffiliated occupants of the facility.

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

While the Company cannot predict the ultimate timingor costs of the South Brunswick, Oakville, and South Gate environmental matters,based on facts currently known, the Company believes that the accruals recordedare adequate and does not believe the resolution of these matters will have amaterial adverse effect on the financial position or future operations of theCompany; however, in the event of an adverse decision by the agencies involved,or an unfavorable result in the New Jersey natural resources damages matter,these matters could have a material adverse effect.

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

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

The Company used $11.0million of IPO proceeds received in the second quarter of fiscal 2006 to payKKR a termination fee to end the Management Services Agreement between theCompany and KKR. As a result these fees are no longer being paid starting in April 2006.During the three and six months ended May 28, 2006, the Company paid managementfees of $0.3 million and $0.8 million, respectively, to KKR.

**Note 18: *Segment Information***

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

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

Salesoutside the United States for the three and six months ended May 27, 2007and May 28, 2006 were $98.7 million and $194.5 million, respectively, forfiscal 2007 and $85.2 million and $166.4 million, respectively, for fiscal2006. Sales from Europe to the Americas for the three and six months ended May 27,2007 and May 28, 2006 were $4.2 million and $6.6 million, respectively,for fiscal 2007 and $1.6 million and $6.1 million, respectively, forfiscal 2006. Long lived assets (principally property, plant and equipment)outside the United States were $58.8 million and $57.6 million as of May 27,2007 and November 26, 2006, respectively.

| ** **                                         | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                         | ** ** | **May 27, 2007**       | ** ** | **May 28, 2006**     | ** ** | **May 27, 2007** | ** ** | **May 28, 2006** | ** ** |
| ** **                                         | ** ** | **(in thousands)**          | ** ** | **(in thousands)**        | ** ** |
| Net sales to  external customers:                  |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Americas                                           |       |                             | $          | 367,334                        |       |   |   | $ | 348,372 |   |   |   | $ | 747,896 |   |   |   | $ | 720,039 |   |   |
| Europe                                             |       |                             | 34,494     |                           |       |   | 28,340 |   |   |   | 66,499 |   |   |   | 52,408 |   |   |
|                                               |       |                             | 401,828    |                           |       |   | 376,712 |   |   |   | 814,395 |   |   |   | 772,447 |   |   |
| Capital  expenditures:                             |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Americas                                           |       |                             | 9,234      |                           |       |   | 9,133 |   |   |   | 21,004 |   |   |   | 12,717 |   |   |
| Europe                                             |       |                             | 257        |                           |       |   | 1,337 |   |   |   | 1,400 |   |   |   | 3,330 |   |   |
|                                               |       |                             | 9,491      |                           |       |   | 10,470 |   |   |   | 22,404 |   |   |   | 16,047 |   |   |
| EBITDA:                                            |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Americas                                           |       |                             | 46,936     |                           |       |   | 19,630 |   |   |   | 108,976 |   |   |   | 82,164 |   |   |
| Europe                                             |       |                             | 1,538      |                           |       |   | 1,772 |   |   |   | 2,255 |   |   |   | 3,230 |   |   |
| Inter-segment eliminations                         |       |                             | 88         |                           |       |   | (496 | ) |   |   | (397 | ) |   |   | (1,941 | ) |   |
|                                               |       |                             | 48,562     |                           |       |   | 20,906 |   |   |   | 110,834 |   |   |   | 83,453 |   |   |
| Reconciliation  of EBITDA to net income:           |       |                             |       |                           |       |   |   |   |   |   |   |   |   |   |   |   |   |
| EBITDA from segments                               |       |                             | 48,562     |                           |       |   | 20,906 |   |   |   | 110,834 |   |   |   | 83,453 |   |   |
| Interest                                           |       |                             | 15,229     |                           |       |   | 17,893 |   |   |   | 31,134 |   |   |   | 36,629 |   |   |
| Income taxes                                       |       |                             | 9,339      |                           |       |   | (2,407 | ) |   |   | 23,750 |   |   |   | 12,445 |   |   |
| Depreciation and amortization                      |       |                             | 7,861      |                           |       |   | 5,294 |   |   |   | 15,183 |   |   |   | 10,994 |   |   |
| Cumulative effect of change in acconting principle |       |                             | —     |                           |       |   | — |   |   |   | — |   |   |   | 287 |   |   |
| Net Income                                         |       |                             | $          | 16,133                         |       |   |   | $ | 126 |   |   |   | $ | 40,767 |   |   |   | $ | 23,098 |   |   |

 

15

----

 

| ** **                | ** ** | **May 27,  2007**  | ** ** | **November 26,  2006** | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------------|------------|
| ** **                | ** ** | **(in thousands)** | ** ** |
| Total assets:             |       |                    |       |                        |       |   |   |
| Americas                  |       | $                       | 904,551    |                        |       | $ | 894,628 |   |   |
| Europe                    |       | 113,254                 |       |                        | 109,345    |   |   |
| Intersegment eliminations |       | (844                    | )          |                        | (1,241     | ) |   |
|                      |       | $                       | 1,016,961  |                        |       | $ | 1,002,732 |   |   |

 

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

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

16

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The Company has correctedcertain errors in the presentation of net investment in subsidiaries, due from(to) affiliates, stockholders’ deficit, income from equity investees, capitalcharge and intercompany interest allocation, income taxes, and net income lineitems for Sealy Mattress Corporation, the Combined Guarantor Subsidiaries andthe Combined Non-Guarantor Subsidiaries from amounts previously reported. Thenature of the errors related principally to eliminations of intercompany transactionswithin certain of the consolidating columns in the Supplemental CondensedConsolidating Balance Sheet as well as the Supplemental Condensed ConsolidatingStatements of Operations and Cash Flows. Specifically, an intercompany dividendfrom the Combined Non-Guarantor Subsidiaries to the Combined GuarantorSubsidiaries in fiscal 2005 was improperly eliminated, an amount allocated fromSealy Mattress Corporation to the Combined Guarantor Subsidiaries in fiscal2005 was not properly reflected on the Supplemental Condensed ConsolidatingBalance Sheet, and an allocation of capital charges from Sealy Mattress Companyto the Combined Guarantor Subsidiaries in fiscal 2006 was incorrect, all as theresult of clerical errors. These corrections are limited to intercompany,investment and subsidiary equity consolidating amounts within this Note 19, anddo not affect the Condensed Consolidated Financial Statements of the Company.The Company has also shown separately the net investment in subsidiaries andthe due from (to) affiliates on the Condensed Consolidating Balance Sheets. Thefollowing schedules present the specific line item amounts that have changed asa result of the separation of the intercompany line items and corrections (inthousands):

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

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

 

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

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

 

17

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

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

 

The followingsupplemental condensed consolidating financial statements present:

1.                Condensedconsolidating balance sheets as of May 27, 2007 and November 26, 2006and condensed consolidating statements of operations for the three and sixmonths ended May 27, 2007 and May 28, 2006, and condensedconsolidating statements of cash flows for the six months ended May 27,2007 and May 28, 2006.

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

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

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

18

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**SEALY CORPORATIONSupplemental Condensed Consolidating Balance SheetsMay 27, 2007(in thousands)**

| ** **                                                             | ** ** | ** **      | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                             | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                             | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                             | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                             | ** ** |            | ** ** | ** **      |       |         | ** ** | ** **       |       |             | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Current assets:                                                        |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cash and cash equivalents                                              |       |            | $          | 10              |       |         |       | $                | —     |             |       |             | $          | 1                |       |   |   | $ | 12,136 |   |   |   | $ | 9,575 |   |   |   | $ | — |   |   |   | $ | 21,722 |   |   |
| Accounts receivable, net                                               |       |            | 30         |            |       |         | —     |             |       |             | 598        |             |       |             | 122,966    |   |   |   | 84,405 |   |   |   | — |   |   |   | 207,999 |   |   |
| Inventories                                                            |       |            | —     |            |       |         | —     |             |       |             | 1,494      |             |       |             | 45,532     |   |   |   | 25,269 |   |   |   | (1,085 | ) |   |   | 71,210 |   |   |
| Assets held for sale                                                   |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | — |   |   |
| Prepaid expenses, deferred income taxes and  other current assets |       |            | 1,017      |            |       |         | —     |             |       |             | 1,290      |             |       |             | 35,733     |   |   |   | 3,186 |   |   |   | — |   |   |   | 41,226 |   |   |
|                                                                   |       |            | 1,057      |            |       |         | —     |             |       |             | 3,383      |             |       |             | 216,367    |   |   |   | 122,435 |   |   |   | (1,085 | ) |   |   | 342,157 |   |   |
| Property, plant  and equipment, at cost                                |       |            | —     |            |       |         | —     |             |       |             | 8,599      |             |       |             | 329,402    |   |   |   | 87,157 |   |   |   | — |   |   |   | 425,158 |   |   |
| Less accumulated depreciation                                          |       |            | —     |            |       |         | —     |             |       |             | (3,682     | )                |       |             | (155,259   | ) |   |   | (32,137 | ) |   |   | — |   |   |   | (191,078 | ) |   |
|                                                                   |       |            | —     |            |       |         | —     |             |       |             | 4,917      |             |       |             | 174,143    |   |   |   | 55,020 |   |   |   | — |   |   |   | 234,080 |   |   |
| Other assets:                                                          |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Goodwill                                                               |       |            | —     |            |       |         | —     |             |       |             | 24,741     |             |       |             | 304,773    |   |   |   | 61,020 |   |   |   | — |   |   |   | 390,534 |   |   |
| Other intangibles, net                                                 |       |            | 7,547      |            |       |         | —     |             |       |             | —     |             |       |             | 4,267      |   |   |   | 4 |   |   |   | — |   |   |   | 11,818 |   |   |
| Net investment in subsidiaries                                         |       |            | (185,897   | )               |       |         | 229,992    |             |       |             | 367,265    |             |       |             | 27,990     |   |   |   | — |   |   |   | (439,350 | ) |   |   | — |   |   |
| Due from (to) affiliates                                               |       |            | 59,615     |            |       |         | (415,889   | )                |       |             | 566,251    |             |       |             | (119,345   | ) |   |   | (90,804 | ) |   |   | 172 |   |   |   | — |   |   |
| Debt issuance costs, net and other  assets                             |       |            | —     |            |       |         | —     |             |       |             | 13,866     |             |       |             | 21,894     |   |   |   | 2,612 |   |   |   | — |   |   |   | 38,372 |   |   |
|                                                                   |       |            | (118,735   | )               |       |         | (185,897   | )                |       |             | 972,123    |             |       |             | 239,579    |   |   |   | (27,168 | ) |   |   | (439,178 | ) |   |   | 440,724 |   |   |
| Total assets                                                           |       |            | $          | (117,678        | )          |         |       | $                | (185,897   | )                |       |             | $          | 980,423          |       |   |   | $ | 630,089 |   |   |   | $ | 150,287 |   |   |   | $ | (440,263 | ) |   |   | $ | 1,016,961 |   |   |
| **Liabilities and Stockholders’ Deficit**                         | ** ** |            | ** ** | ** **      |       |         | ** ** | ** **       |       |             | ** ** | ** **       |       |             | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Current liabilities:                                                   |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Current portion—long-term  obligations                            |       |            | $          | —          |       |         |       | $                | —     |             |       |             | $          | 9,107            |       |   |   | $ | 2,925 |   |   |   | $ | 14,798 |   |   |   | $ | — |   |   |   | $ | 26,830 |   |   |
| Accounts payable                                                       |       |            | —     |            |       |         | —     |             |       |             | 278        |             |       |             | 74,108     |   |   |   | 52,286 |   |   |   | — |   |   |   | 126,672 |   |   |
| Accrued customer incentives and advertising                            |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | 32,331     |   |   |   | 4,822 |   |   |   | — |   |   |   | 37,153 |   |   |
| Accrued compensation                                                   |       |            | —     |            |       |         | —     |             |       |             | 422        |             |       |             | 21,649     |   |   |   | 9,291 |   |   |   | — |   |   |   | 31,362 |   |   |
| Accrued interest                                                       |       |            | 60         |            |       |         | —     |             |       |             | 1,212      |             |       |             | 17,968     |   |   |   | 210 |   |   |   | — |   |   |   | 19,450 |   |   |
| Other accrued expenses                                                 |       |            | 2,897      |            |       |         | —     |             |       |             | 394        |             |       |             | 41,803     |   |   |   | 6,133 |   |   |   | — |   |   |   | 51,227 |   |   |
|                                                                   |       |            | 2,957      |            |       |         | —     |             |       |             | 11,413     |             |       |             | 190,784    |   |   |   | 87,540 |   |   |   | — |   |   |   | 292,694 |   |   |
| Long-term obligations                                                  |       |            | —     |            |       |         | —     |             |       |             | 737,893    |             |       |             | 41,740     |   |   |   | 17,937 |   |   |   | — |   |   |   | 797,570 |   |   |
| Other noncurrent liabilities                                           |       |            | 7,107      |            |       |         | —     |             |       |             | —     |             |       |             | 26,207     |   |   |   | 10,332 |   |   |   | — |   |   |   | 43,646 |   |   |
| Deferred income taxes                                                  |       |            | 167        |            |       |         | —     |             |       |             | 1,125      |             |       |             | 3,910      |   |   |   | 5,758 |   |   |   | — |   |   |   | 10,960 |   |   |
| Common stock and options subject to redemption                         |       |            | 16,671     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | 16,671 |   |   |
| Stockholders’ deficit                                             |       |            | (144,580   | )               |       |         | (185,897   | )                |       |             | 229,992    |             |       |             | 367,448    |   |   |   | 28,720 |   |   |   | (440,263 | ) |   |   | (144,580 | ) |   |
| Total liabilities  and stockholders’  deficit                     |       |            | $          | (117,678        | )          |         |       | $                | (185,897   | )                |       |             | $          | 980,423          |       |   |   | $ | 630,089 |   |   |   | $ | 150,287 |   |   |   | $ | (440,263 | ) |   |   | $ | 1,016,961 |   |   |

 

19

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**SEALY CORPORATIONSupplemental Condensed Consolidating Balance SheetsNovember 26, 2006 (as corrected) (in thousands)**

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

 

20

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of OperationsThree Months Ended May 27, 2007(in thousands)**

| ** **                                          | ** ** | ** **      | ** ** | ** **              | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Combined**      | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|-------------------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------------|------------|------------------|------------|
| ** **                                          | ** ** | **Sealy**       | ** ** | **Sealy Mattress** | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                          | ** ** | **Corporation** | ** ** | **Corporation**         | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net sales                                           |       |            | $          | —                  |       |         |       | $                | —     |              |       |             | $          | 19,687           |       |   |   | $ | 291,962 |   |   |   | $ | 100,687 |   |   |   | $ | (10,508 | ) |   |   | $ | 401,828 |   |   |
| Cost and expenses:                                  |       |            |       |                    |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |            | —     |                    |       |         | —     |             |       |              | 11,299     |             |       |             | 163,988    |   |   |   | 64,367 |   |   |   | (10,344 | ) |   |   | 229,310 |   |   |
| Selling, general and administrative                 |       |            | 57         |                    |       |         | —     |             |       |              | 1,875      |             |       |             | 107,084    |   |   |   | 26,516 |   |   |   | — |   |   |   | 135,532 |   |   |
| Amortization of intangibles                         |       |            | 728        |                    |       |         | —     |             |       |              | —     |             |       |             | 71         |   |   |   | 31 |   |   |   | — |   |   |   | 830 |   |   |
| Royalty (income) expense, net                       |       |            | (838       | )                       |       |         | —     |             |       |              | —     |             |       |             | (4,410     | ) |   |   | 837 |   |   |   | — |   |   |   | (4,411 | ) |   |
| Income from  operations                             |       |            | 53         |                    |       |         | —     |             |       |              | 6,513      |             |       |             | 25,229     |   |   |   | 8,936 |   |   |   | (164 | ) |   |   | 40,567 |   |   |
| Interest expense                                    |       |            | 91         |                    |       |         | 153        |             |       |              | 14,252     |             |       |             | 158        |   |   |   | 575 |   |   |   | — |   |   |   | 15,229 |   |   |
| Other income, net                                   |       |            | —     |                    |       |         | —     |             |       |              | —     |             |       |             | (45        | ) |   |   | (89 | ) |   |   | — |   |   |   | (134 | ) |   |
| Loss (income) from equity investees                 |       |            | (16,155    | )                       |       |         | (16,252    | )                |       |              | (12,725    | )                |       |             | —     |   |   |   | — |   |   |   | 45,132 |   |   |   | — |   |   |
| Loss (income) from non-guarantor equity investees   |       |            | —     |                    |       |         | —     |             |       |              | —     |             |       |             | (4,618     | ) |   |   | — |   |   |   | 4,618 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |            | —     |                    |       |         | —     |             |       |              | (13,301    | )                |       |             | 12,353     |   |   |   | 948 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes                   |       |            | 16,117     |                    |       |         | 16,099     |             |       |              | 18,287     |             |       |             | 17,381     |   |   |   | 7,502 |   |   |   | (49,914 | ) |   |   | 25,472 |   |   |
| Income tax expense (benefit)                        |       |            | (16        | )                       |       |         | (56        | )                |       |              | 2,035      |             |       |             | 4,608      |   |   |   | 2,796 |   |   |   | (28 | ) |   |   | 9,339 |   |   |
| Net income (loss)                                   |       |            | $          | 16,133                  |       |         |       | $                | 16,155     |              |       |             | $          | 16,252           |       |   |   | $ | 12,773 |   |   |   | $ | 4,706 |   |   |   | $ | (49,886 | ) |   |   | $ | 16,133 |   |   |

 

21

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of OperationsThree Months Ended May 28, 2006(in thousands)**

| ** **                                          | ** ** | ** **      | ** ** | ** **              | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Combined**      | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------|------------|-----------------|------------|-------------------------|------------|--------------|------------|------------------|------------|-------------------|------------|------------------|------------|------------------|------------|
| ** **                                          | ** ** | **Sealy**       | ** ** | **Sealy Mattress** | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Non-Guarantor** | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                          | ** ** | **Corporation** | ** ** | **Corporation**         | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**  | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net sales                                           |       |            | $          | —                  |       |         |       | $                | —     |              |       |             | $          | 16,393           |       |   |   | $ | 284,793 |   |   |   | $ | 88,974 |   |   |   | $ | (13,448 | ) |   |   | $ | 376,712 |   |   |
| Costs and expenses:                                 |       |            |       |                    |       |         |       |             |       |              |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                  |       |            | —     |                    |       |         | —     |             |       |              | 9,636      |             |       |             | 154,874    |   |   |   | 54,300 |   |   |   | (10,674 | ) |   |   | 208,136 |   |   |
| Selling, general and administrative                 |       |            | (3         | )                       |       |         | —     |             |       |              | 1,542      |             |       |             | 98,678     |   |   |   | 22,894 |   |   |   | — |   |   |   | 123,111 |   |   |
| Expenses asscoiated with IPO                        |       |            | —     |                    |       |         | —     |             |       |              | —     |             |       |             | 27,958     |   |   |   | 552 |   |   |   | — |   |   |   | 28,510 |   |   |
| Amortization of intangibles                         |       |            | —     |                    |       |         | —     |             |       |              | —     |             |       |             | 72         |   |   |   | 61 |   |   |   | — |   |   |   | 133 |   |   |
| Royalty (income) expense, net                       |       |            | —     |                    |       |         | —     |             |       |              | —     |             |       |             | (4,256     | ) |   |   | 550 |   |   |   | — |   |   |   | (3,706 | ) |   |
| Income from  operations                             |       |            | 3          |                    |       |         | —     |             |       |              | 5,215      |             |       |             | 7,467      |   |   |   | 10,617 |   |   |   | (2,774 | ) |   |   | 20,528 |   |   |
| Interest expense                                    |       |            | 1,240      |                    |       |         | 131        |             |       |              | 16,252     |             |       |             | (121       | ) |   |   | 391 |   |   |   | — |   |   |   | 17,893 |   |   |
| Other (income) expense, net                         |       |            | 1,160      |                    |       |         | —     |             |       |              | 4,135      |             |       |             | (256       | ) |   |   | (123 | ) |   |   | — |   |   |   | 4,916 |   |   |
| Loss (income) from equity investees                 |       |            | (1,401     | )                       |       |         | (1,473     | )                |       |              | (1,477     | )                |       |             | —     |   |   |   | — |   |   |   | 4,351 |   |   |   | — |   |   |
| Loss (income) from nonguarantor equity investees    |       |            | —     |                    |       |         | —     |             |       |              | —     |             |       |             | (5,376     | ) |   |   | — |   |   |   | 5,376 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |            | —     |                    |       |         | —     |             |       |              | (15,403    | )                |       |             | 14,460     |   |   |   | 943 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes                   |       |            | (996       | )                       |       |         | 1,342      |             |       |              | 1,708      |             |       |             | (1,240     | ) |   |   | 9,406 |   |   |   | (12,501 | ) |   |   | (2,281 | ) |   |
| Income tax expense (benefit)                        |       |            | (1,122     | )                       |       |         | (59        | )                |       |              | 235        |             |       |             | (3,113     | ) |   |   | 1,945 |   |   |   | (293 | ) |   |   | (2,407 | ) |   |
| Net income (loss)                                   |       |            | $          | 126                     |       |         |       | $                | 1,401      |              |       |             | $          | 1,473            |       |   |   | $ | 1,873 |   |   |   | $ | 7,461 |   |   |   | $ | (12,208 | ) |   |   | $ | 126 |   |   |

 

22

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of OperationsSix Months Ended May 27, 2007(in thousands)**

| ** **                                             | ** ** | ** **      | ** ** | ** **              | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|--------------------------------------------------------|------------|-----------------|------------|-------------------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                             | ** ** | ** **      | ** ** | ** **              | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                             | ** ** | **Sealy**       | ** ** | **Sealy Mattress** | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                             | ** ** | **Corporation** | ** ** | **Corporation**         | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net sales                                              |       |            | $          | —                  |       |         |       | $                | —     |             |       |             | $          | 39,157           |       |   |   | $ | 598,481 |   |   |   | $ | 196,386 |   |   |   | $ | (19,629 | ) |   |   | $ | 814,395 |   |   |
| Cost and expenses:                                     |       |            |       |                    |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                     |       |            | —     |                    |       |         | —     |             |       |             | 22,772     |             |       |             | 336,889    |   |   |   | 124,906 |   |   |   | (19,964 | ) |   |   | 464,603 |   |   |
| Selling, general and administrative                    |       |            | 121        |                    |       |         | —     |             |       |             | 3,792      |             |       |             | 207,935    |   |   |   | 50,597 |   |   |   | — |   |   |   | 262,445 |   |   |
| Amortization of  intangibles                           |       |            | 1,438      |                    |       |         | —     |             |       |             | —     |             |       |             | 144        |   |   |   | 31 |   |   |   | — |   |   |   | 1,613 |   |   |
| Royalty (income) expense, net                          |       |            | (1,962     | )                       |       |         | —     |             |       |             | —     |             |       |             | (9,319     | ) |   |   | 1,578 |   |   |   | — |   |   |   | (9,703 | ) |   |
| Income from operations                                 |       |            | 403        |                    |       |         | —     |             |       |             | 12,593     |             |       |             | 62,832     |   |   |   | 19,274 |   |   |   | 335 |   |   |   | 95,437 |   |   |
| Interest expense                                       |       |            | 186        |                    |       |         | 296        |             |       |             | 28,747     |             |       |             | 307        |   |   |   | 1,598 |   |   |   | — |   |   |   | 31,134 |   |   |
| Other income, net                                      |       |            | (8         | )                       |       |         | —     |             |       |             | —     |             |       |             | (46        | ) |   |   | (160 | ) |   |   | — |   |   |   | (214 | ) |   |
| Loss (income) from equity investees                    |       |            | (40,625    | )                       |       |         | (40,811    | )                |       |             | (34,057    | )                |       |             | —     |   |   |   | — |   |   |   | 115,493 |   |   |   | — |   |   |
| Loss (income) from non-guarantor equity investees |       |            | —     |                    |       |         | —     |             |       |             | —     |             |       |             | (10,314    | ) |   |   | — |   |   |   | 10,314 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation    |       |            | —     |                    |       |         | —     |             |       |             | (26,880    | )                |       |             | 24,800     |   |   |   | 2,080 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes                      |       |            | 40,850     |                    |       |         | 40,515     |             |       |             | 44,783     |             |       |             | 48,085     |   |   |   | 15,756 |   |   |   | (125,472 | ) |   |   | 64,517 |   |   |
| Income tax expense (benefit)                           |       |            | 83         |                    |       |         | (110       | )                |       |             | 3,972      |             |       |             | 13,989     |   |   |   | 5,839 |   |   |   | (23 | ) |   |   | 23,750 |   |   |
| Net income (loss)                                      |       |            | $          | 40,767                  |       |         |       | $                | 40,625     |             |       |             | $          | 40,811           |       |   |   | $ | 34,096 |   |   |   | $ | 9,917 |   |   |   | $ | (125,449 | ) |   |   | $ | 40,767 |   |   |

 

23

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of OperationsSix Months Ended May 28, 2006(in thousands)**

| ** **                                               | ** ** | ** **      | ** ** | ** **              | ** ** | ** **              | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------|------------|-----------------|------------|-------------------------|------------|-------------------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                               | ** ** | ** **      | ** ** | ** **              | ** ** | ** **              | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                               | ** ** | **Sealy**       | ** ** | **Sealy Mattress** | ** ** | **Sealy Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                               | ** ** | **Corporation** | ** ** | **Corporation**         | ** ** | **Company**             | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net sales                                                |       |            | $          | —                  |       |                    |       | $                | —     |             |       |             | $          | 32,100           |       |   |   | $ | 589,450 |   |   |   | $ | 167,420 |   |   |   | $ | (16,523 | ) |   |   | $ | 772,447 |   |   |
| Costs and  expenses:                                     |       |            |       |                    |       |                    |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Cost of goods sold                                       |       |            | —     |                    |       |                    | —     |             |       |             | 19,046     |             |       |             | 319,796    |   |   |   | 102,081 |   |   |   | (13,749 | ) |   |   | 427,174 |   |   |
| Selling, general and administrative                      |       |            | (3         | )                       |       |                    | —     |             |       |             | 3,092      |             |       |             | 199,235    |   |   |   | 44,391 |   |   |   | — |   |   |   | 246,715 |   |   |
| Expenses asscoiated with IPO                        |       |            | —     |                    |       |                    | —     |             |       |             | —     |             |       |             | 27,958     |   |   |   | 552 |   |   |   | — |   |   |   | 28,510 |   |   |
| Amortization of intangibles                              |       |            | —     |                    |       |                    | —     |             |       |             | —     |             |       |             | 144        |   |   |   | 111 |   |   |   | — |   |   |   | 255 |   |   |
| Royalty (income) expense, net                            |       |            | —     |                    |       |                    | —     |             |       |             | —     |             |       |             | (8,472     | ) |   |   | 1,077 |   |   |   | — |   |   |   | (7,395 | ) |   |
| Income from operations                                   |       |            | 3          |                    |       |                    | —     |             |       |             | 9,962      |             |       |             | 50,789     |   |   |   | 19,208 |   |   |   | (2,774 | ) |   |   | 77,188 |   |   |
| Interest expense                                         |       |            | 3,360      |                    |       |                    | 251        |             |       |             | 32,328     |             |       |             | (203       | ) |   |   | 893 |   |   |   | — |   |   |   | 36,629 |   |   |
| Other (income) expense, net                              |       |            | 1,160      |                    |       |                    | —     |             |       |             | 4,135      |             |       |             | (275       | ) |   |   | (291 | ) |   |   | — |   |   |   | 4,729 |   |   |
| Loss (income) from equity investees                      |       |            | (25,699    | )                       |       |                    | (25,844    | )                |       |             | (23,464    | )                |       |             | —     |   |   |   | — |   |   |   | 75,007 |   |   |   | — |   |   |
| Loss (income) from nonguarantor equity investees         |       |            | —     |                    |       |                    | —     |             |       |             | —     |             |       |             | (9,639     | ) |   |   | — |   |   |   | 9,639 |   |   |   | — |   |   |
| Capital charge and intercompany interest allocation |       |            | —     |                    |       |                    | —     |             |       |             | (30,635    | )                |       |             | 28,677     |   |   |   | 1,958 |   |   |   | — |   |   |   | — |   |   |
| Income (loss) before income taxes and cumulative  effect |       |            | 21,182     |                    |       |                    | 25,593     |             |       |             | 27,598     |             |       |             | 32,229     |   |   |   | 16,648 |   |   |   | (87,420 | ) |   |   | 35,830 |   |   |
| Income tax expense (benefit)                             |       |            | (1,916     | )                       |       |                    | (106       | )                |       |             | 1,754      |             |       |             | 8,082      |   |   |   | 4,924 |   |   |   | (293 | ) |   |   | 12,445 |   |   |
| Income (loss) before cumulative effect                   |       |            | 23,098     |                    |       |                    | 25,699     |             |       |             | 25,844     |             |       |             | 24,147     |   |   |   | 11,724 |   |   |   | (87,127 | ) |   |   | 23,385 |   |   |
| Cumulative effect of change in accounting principle      |       |            | —     |                    |       |                    | —     |             |       |             | —     |             |       |             | 287        |   |   |   | — |   |   |   | — |   |   |   | 287 |   |   |
| Net income (loss)                                        |       |            | $          | 23,098                  |       |                    |       | $                | 25,699     |             |       |             | $          | 25,844           |       |   |   | $ | 23,860 |   |   |   | $ | 11,724 |   |   |   | $ | (87,127 | ) |   |   | $ | 23,098 |   |   |

 

24

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Cash FlowsSix Months Ended May 27, 2007(in thousands)**

| ** **                                                                        | ** ** | ** **      | ** ** | ** **      | ** ** | ** **   | ** ** | ** **       | ** ** | **Combined**     | ** ** | ** **       | ** ** | ** **       | ** ** |
|-----------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                        | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Non-**         | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                        | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**    | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                        | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net cash provided by operating activities                                         |       |            | $          | —          |       |         |       | $                | —     |             |       |             | $          | 8,407            |       |   |   | $ | 2,547 |   |   |   | $ | 11,508 |   |   |   | $ | — |   |   |   | $ | 22,462 |   |   |
| Cash flows from  investing activities:                                            |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment                                         |       |            | —     |            |       |         | —     |             |       |             | (1,627     | )                |       |             | (19,017    | ) |   |   | (1,760 | ) |   |   | — |   |   |   | (22,404 | ) |   |
| Proceeds from the sale of property, plant, and equipment                          |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | 4,913      |   |   |   | 25 |   |   |   | — |   |   |   | 4,938 |   |   |
| Net activity in investment in and advances from (to) subsidiaries  and affiliates |       |            | 12,226     |            |       |         | —     |             |       |             | 3,220      |             |       |             | (10,864    | ) |   |   | (4,582 | ) |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                               |       |            | 12,226     |            |       |         | —     |             |       |             | 1,593      |             |       |             | (24,968    | ) |   |   | (6,317 | ) |   |   | — |   |   |   | (17,466 | ) |   |
| Cash flows from financing  activities:                                            |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Dividend                                                                          |       |            | (13,724    | )               |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (13,724 | ) |   |
| Equity received upon exercise of stock including  related excess tax benefits     |       |            | 5,900      |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | 5,900 |   |   |
| Repurchase of common stock                                                        |       |            | (5,376     | )               |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (5,376 | ) |   |
| Repayments of long-term   obligations                                             |       |            | —     |            |       |         | —     |             |       |             | (10,000    | )                |       |             | —     |   |   |   | — |   |   |   | — |   |   |   | (10,000 | ) |   |
| Borrowings under revolving credit facilities                                      |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | 20,207 |   |   |   | — |   |   |   | 20,207 |   |   |
| Repayments on revolving credit facilities                                         |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | (25,517 | ) |   |   | — |   |   |   | (25,517 | ) |   |
| Other                                                                             |       |            | 50         |            |       |         | —     |             |       |             | —     |             |       |             | (1,625     | ) |   |   | 1,594 |   |   |   | — |   |   |   | 19 |   |   |
| Net cash used in financing activities                                             |       |            | (13,150    | )               |       |         | —     |             |       |             | (10,000    | )                |       |             | (1,625     | ) |   |   | (3,716 | ) |   |   | — |   |   |   | (28,491 | ) |   |
| Effect of exchange rate changes on   cash                                         |       |            | —     |            |       |         | —     |             |       |             | —     |             |       |             | —     |   |   |   | (403 | ) |   |   | — |   |   |   | (403 | ) |   |
| Change in cash and cash equivalents                                               |       |            | (924       | )               |       |         | —     |             |       |             | —     |             |       |             | (24,046    | ) |   |   | 1,072 |   |   |   | — |   |   |   | (23,898 | ) |   |
| Cash and cash  equivalents:                                                       |       |            |       |            |       |         |       |             |       |             |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                                               |       |            | 934        |            |       |         | —     |             |       |             | 1          |             |       |             | 36,182     |   |   |   | 8,503 |   |   |   | — |   |   |   | 45,620 |   |   |
| End of period                                                                     |       |            | $          | 10              |       |         |       | $                | —     |             |       |             | $          | 1                |       |   |   | $ | 12,136 |   |   |   | $ | 9,575 |   |   |   | $ | — |   |   |   | $ | 21,722 |   |   |

 

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**SEALY CORPORATIONSupplemental Condensed Consolidating Statements of Cash FlowsSix Months Ended May 28, 2006(in thousands)**

| ** **                                                                             | ** ** | ** **      | ** ** | **Sealy**       | ** ** | **Sealy**    | ** ** | **Combined**     | ** ** | **Combined  Non-** | ** ** | ** **       | ** ** | ** **       | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------|------------|-----------------|------------|--------------|------------|------------------|------------|--------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                             | ** ** | **Sealy**       | ** ** | **Mattress**    | ** ** | **Mattress** | ** ** | **Guarantor**    | ** ** | **Guarantor**      | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                                             | ** ** | **Corporation** | ** ** | **Corporation** | ** ** | **Company**  | ** ** | **Subsidiaries** | ** ** | **Subsidiaries**   | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| Net cash provided by (used in) operating activities                                    |       |            | $          | —          |       |         |       | $                | —     |               |       | $                | 5,110      |             |       | $ | (32,089 | ) |   |   | $ | 7,135 |   |   |   | $ | — |   |   |   | $ | (19,844 | ) |   |
| Cash flows from investing  activities:                                                 |       |            |       |            |       |         |       |             |       |               |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Purchase of property, plant and equipment                                              |       |            | —     |            |       |         | —     |             |       | (166               | )          |             | (11,438    | )                |       |   | (4,443 | ) |   |   | — |   |   |   | (16,047 | ) |   |
| Proceeds from the sale of property, plant, and equipment                               |       |            | —     |            |       |         | —     |             |       | —             |       |             | 439        |             |       |   | 25 |   |   |   | — |   |   |   | 464 |   |   |
| Net activity in investment in and advances to (from) subsidiaries and  affiliates |       |            | (82,875    | )               |       |         | —     |             |       | 45,260             |       |             | 31,369     |             |       |   | 6,246 |   |   |   | — |   |   |   | — |   |   |
| Net cash provided by (used in) investing activities                                    |       |            | (82,875    | )               |       |         | —     |             |       | 45,094             |       |             | 20,370     |             |       |   | 1,828 |   |   |   | — |   |   |   | (15,583 | ) |   |
| Cash flows from financing  activities:                                                 |       |            |       |            |       |         |       |             |       |               |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Proceeds from issuance of common stock                                                 |       |            | 295,511    |            |       |         | —     |             |       | —             |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | 295,511 |   |   |
| Dividend                                                                               |       |            | (125,000   | )               |       |         | —     |             |       | —             |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | (125,000 | ) |   |
| Repyament of existing long- term debt                                                  |       |            | (89,114    | )               |       |         | —     |             |       | (50,203            | )          |             | —     |             |       |   | — |   |   |   | — |   |   |   | (139,317 | ) |   |
| Equity received upon exercise of stock including  related excess tax benefits     |       |            | 1,814      |            |       |         | —     |             |       | —             |       |             | —     |             |       |   | — |   |   |   | — |   |   |   | 1,814 |   |   |
| Borrowings under revolving credit facilities                                           |       |            | —     |            |       |         | —     |             |       | 104,700            |       |             | —     |             |       |   | 4,018 |   |   |   | — |   |   |   | 108,718 |   |   |
| Repayments under revolving credit facilities                                           |       |            | —     |            |       |         | —     |             |       | (104,700           | )          |             | —     |             |       |   | (16,876 | ) |   |   | — |   |   |   | (121,576 | ) |   |
| Other                                                                                  |       |            | —     |            |       |         | —     |             |       | —             |       |             | 979        |             |       |   | 1,615 |   |   |   | — |   |   |   | 2,594 |   |   |
| Net cash provided by (used in) financing activities                                    |       |            | 83,211     |            |       |         | —     |             |       | (50,203            | )          |             | 979        |             |       |   | (11,243 | ) |   |   | 0 |   |   |   | 22,744 |   |   |
| Effect of exchange rate changes on cash                                                |       |            | —     |            |       |         | —     |             |       | —             |       |             | —     |             |       |   | 336 |   |   |   | — |   |   |   | 336 |   |   |
| Change in cash and cash equivalents                                                    |       |            | 336        |            |       |         | —     |             |       | 1                  |       |             | (10,740    | )                |       |   | (1,944 | ) |   |   | — |   |   |   | (12,347 | ) |   |
| Cash and cash  equivalents:                                                            |       |            |       |            |       |         |       |             |       |               |       |             |       |             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Beginning of period                                                                    |       |            | —     |            |       |         | —     |             |       | 1                  |       |             | 25,387     |             |       |   | 11,166 |   |   |   | — |   |   |   | 36,554 |   |   |
| End of period                                                                          |       |            | $          | 336             |       |         |       | $                | —     |               |       | $                | 2          |             |       | $ | 14,647 |   |   |   | $ | 9,222 |   |   |   | $ | — |   |   |   | $ | 24,207 |   |   |

 

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**SEALY CORPORATION**

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

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

**BUSINESS OVERVIEW**

Our conventional bedding products include the *Sealy, Sealy Posturepedic, Stearns & Foster,*and*Bassett* brands and accounted forapproximately 92% of our total net sales for the year ended November 26,2006. In addition to our innerspring bedding, we also produce a variety ofvisco-elastic (memory foam) and latex foam bedding products.

In the first quarter of fiscal 2007, we introduced anew line of *Stearns & Foster* brandedmattresses and boxsprings that incorporates the features we determined were themost desired by the consumer during our intensive market and consumer research.In the second quarter of fiscal 2007, we introduced a new line of *Posturepedic* Reserve branded mattressesand boxsprings. We expect that these launches will be completed in the third quarterof fiscal 2007. In addition, we introduced new *Sealy-*brandedproducts that are compliant with the new Federal flame retardant standardswhich became effective July 1, 2007. As with earlier major productlaunches, we expect our sales and profitability growth to be limited during theperiod in which our customers complete the transition to the new product lines.

Our industry continues tobe challenged by the volatility in the price of petroleum and steel products,which affects the cost of our polyurethane foam, polyester and rayon fibers,polyethylene foam and steel innerspring component parts. During fiscal 2006 andinto the first half of fiscal 2007, the cost of these components has continuedto remain elevated above their recent historical averages, and we expect thesecosts to continue at or above current levels over the remainder of fiscal 2007.

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***RESULTS OF OPERATIONS***

***Tabular Information—Current FiscalQuarter***

Thefollowing table sets forth our summarized results of operations for the threemonths ended May 27, 2007 and May 28, 2006, expressed in thousands ofdollars as well as a percentage of each period’s net sales:

| ** **                                    | ** ** | **For the three months ended:** | ** ** |
|-----------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                    | ** ** | **May 27, 2007**                          | ** ** | **May 28, 2006** | ** ** |
| ** **                                    | ** ** | **(in thousands)**                             | ** ** | **(percentage   of net sales)** | ** ** | **(in thousands)** | ** ** | **(percentage   of net sales)** | ** ** |
| Net sales                                     |       |                                                | $          | 401,828 |   |   |   | 100.0 | % |   |   | $ | 376,712 |   |   |   | 100.0 | % |   |
| Cost of goods  sold                           |       |                                                | 229,310    |   |   |   | 57.1 |   |   |   | 208,136 |   |   |   | 55.3 |   |   |
| Gross profit                                  |       |                                                | 172,518    |   |   |   | 42.9 |   |   |   | 168,576 |   |   |   | 44.7 |   |   |
| Selling, general  and administrative expenses |       |                                                | 135,532    |   |   |   | 33.7 |   |   |   | 123,111 |   |   |   | 32.7 |   |   |
| Expenses  associated with IPO                 |       |                                                | —     |   |   |   | — |   |   |   | 28,510 |   |   |   | 7.6 |   |   |
| Amortization of  intangibles                  |       |                                                | 830        |   |   |   | 0.2 |   |   |   | 133 |   |   |   | — |   |   |
| Royalty income,  net of royalty expense       |       |                                                | (4,411     | ) |   |   | (1.1 | ) |   |   | (3,706 | ) |   |   | (1.0 | ) |   |
| Income from operations                        |       |                                                | 40,567     |   |   |   | 10.1 |   |   |   | 20,528 |   |   |   | 5.4 |   |   |
| Interest expense                              |       |                                                | 15,229     |   |   |   | 3.8 |   |   |   | 17,893 |   |   |   | 4.7 |   |   |
| Debt  extinguishment and refinancing          |       |                                                | —     |   |   |   | — |   |   |   | 5,295 |   |   |   | 1.4 |   |   |
| Other income, net                             |       |                                                | (134       | ) |   |   | — |   |   |   | (379 | ) |   |   | (0.1 | ) |   |
| Income (loss) before income taxes             |       |                                                | 25,472     |   |   |   | 6.3 |   |   |   | (2,281 | ) |   |   | (0.6 | ) |   |
| Income tax  expense (benefit)                 |       |                                                | 9,339      |   |   |   | 2.3 |   |   |   | (2,407 | ) |   |   | (0.6 | ) |   |
| Net income                                    |       |                                                | $          | 16,133 |   |   |   | 4.0 | % |   |   | $ | 126 |   |   |   | 0.0 | % |   |
| Effective tax rate                            |       |                                                | 36.7       | % |   |   |   |   |   |   | 105.5 | % |   |   |   |   |   |

 

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

| ** **         | ** ** | **Three Months Ended:** | ** ** |
|--------------------|------------|-----------------------------------|------------|
| ** **         | ** ** | **May 27,**                  | ** ** | **May 28,** | ** ** |
| ** **         | ** ** | **2007**                          | ** ** | **2006** | ** ** |
| **US  Domestic**   |       |                              | 75.4       | % |   |   | 77.4 | % |   |
| **International:** |       |                              |       |   |   |   |   |   |   |
| Canada             |       |                              | 10.1       |   |   |   | 10.0 |   |   |
| Europe             |       |                              | 8.6        |   |   |   | 7.5 |   |   |
| Other              |       |                              | 5.9        |   |   |   | 5.1 |   |   |
| **Total**          | ** ** | ** **                        | **100.0**  | **%** | ** ** | ** ** | **100.0** | **%** | ** ** |

 

28

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Thefollowing table shows our net sales and margin profitability for the majorgeographic regions of our operations, including local currency results for thesignificant international operations:

| ** **                             | ** ** | **For the Three Months Ended** | ** ** |
|----------------------------------------|------------|----------------------------------------------------|------------|
| ** **                             | ** ** | **May 27,**                                   | ** ** | **May 28,** | ** ** |
| ** **                             | ** ** | **2007**                                           | ** ** | **2006** | ** ** |
| ** **                             | ** ** | ** **                                         | ** ** | **(percentage** | ** ** | ** ** | ** ** | **(percentage** | ** ** |
| ** **                             | ** ** | **(in thousands)**                            | ** ** | **of net sales)** | ** ** | **(in thousands)** | ** ** | **of net sales)** | ** ** |
| **Total Domestic (US Dollars):**       | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                              |       |                                               | $          | 303,172 | ** ** |   |   | 100.0 | % |   |   | $ | 291,487 | ** ** |   |   | 100.0 | % |   |
| Cost of goods sold                     |       |                                               | 167,666    | ** ** |   |   | 55.3 |   |   |   | 156,334 | ** ** |   |   | 53.6 |   |   |
| Gross profit                           |       |                                               | 135,506    | ** ** |   |   | 44.7 |   |   |   | 135,153 | ** ** |   |   | 46.4 |   |   |
| **Total  International (US Dollars):** | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                              |       |                                               | 98,656     | ** ** |   |   | 100.0 |   |   |   | 85,225 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                     |       |                                               | 61,644     | ** ** |   |   | 62.5 |   |   |   | 51,802 | ** ** |   |   | 60.8 |   |   |
| Gross profit                           |       |                                               | 37,012     | ** ** |   |   | 37.5 |   |   |   | 33,423 | ** ** |   |   | 39.2 |   |   |
| **Canada:**                            | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US  Dollars:**                       | ** ** |                                               | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                              |       |                                               | 40,552     | ** ** |   |   | 100.0 |   |   |   | 37,765 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                     |       |                                               | 23,432     | ** ** |   |   | 57.8 |   |   |   | 20,850 | ** ** |   |   | 55.2 |   |   |
| Gross profit                           |       |                                               | 17,120     | ** ** |   |   | 42.2 |   |   |   | 16,915 | ** ** |   |   | 44.8 |   |   |
| **Canadian  Dollars:**                 |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                              |       |                                               | 45,824     | ** ** |   |   | 100.0 |   |   |   | 43,127 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                     |       |                                               | 26,485     | ** ** |   |   | 57.8 |   |   |   | 23,829 | ** ** |   |   | 55.3 |   |   |
| Gross profit                           |       |                                               | 19,339     | ** ** |   |   | 42.2 |   |   |   | 19,298 | ** ** |   |   | 44.7 |   |   |
| **Europe:**                            |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| **US  Dollars:**                       |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                              |       |                                               | 34,494     | ** ** |   |   | 100.0 |   |   |   | 28,340 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                     |       |                                               | 24,764     | ** ** |   |   | 71.8 |   |   |   | 19,720 | ** ** |   |   | 69.6 |   |   |
| Gross profit                           |       |                                               | 9,730      | ** ** |   |   | 28.2 |   |   |   | 8,620 | ** ** |   |   | 30.4 |   |   |
| **Euros:**                             |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                              |       |                                               | 25,758     | ** ** |   |   | 100.0 |   |   |   | 23,180 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                     |       |                                               | 18,488     | ** ** |   |   | 71.8 |   |   |   | 16,100 | ** ** |   |   | 69.5 |   |   |
| Gross profit                           |       |                                               | 7,270      | ** ** |   |   | 28.2 |   |   |   | 7,080 | ** ** |   |   | 30.5 |   |   |
| **Other  International (US Dollars):** |       |                                               |       | ** ** |   |   |   |   |   |   |   | ** ** |   |   |   |   |   |
| Net sales                              |       |                                               | 23,610     | ** ** |   |   | 100.0 |   |   |   | 19,120 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                     |       |                                               | 13,448     | ** ** |   |   | 57.0 |   |   |   | 11,232 | ** ** |   |   | 58.7 |   |   |
| Gross profit                           |       |                                               | $          | 10,162 | ** ** |   |   | 43.0 | % |   |   | $ | 7,888 | ** ** |   |   | 41.3 | % |   |

 

***Quarter Ended May 27, 2007compared with Quarter Ended May 28, 2006***

*NetSales.**  *Ournet sales for the quarter ended May 27,2007, were $401.8 million, an increase of $25.1 million, or 6.7% fromthe quarter ended May 28, 2006.Total domestic net sales were $303.2 million for the second quarter of fiscal2007, an increase of 4.0% over the second quarter of fiscal 2006. The domesticnet sales increase of $11.7 million was attributable to a 7.9% increase involume partially offset by a 3.6% decrease in average unit selling price. Theincrease in volume is primarily attributable to the strong performance of ourpromotional products such as our 125th Anniversary beds as well as our specialtybedding products, which grew approximately 69% over the comparable prior yearperiod, and early sales of the new *Stearns & Foster*line. The decrease in average unit selling price is primarily due to strategicpricing actions taken in the fiscal first quarter of 2007 on selected productssuch as the *Stearns & Foster*and 

29

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*TrueForm *linesand higher volumes of lower priced mattress sales. Total international salesincreased $13.4 million, or 15.8%. Excluding the effect of currencyfluctuations, international sales increased 11.3%. This represents a 47.3%increase in unit volume, partially offset by a decrease in average unit sellingprice. In Canada, local currency sales gains of 6.3% translated into gains of7.4%  in US dollars. Local currency gainsin Canada were driven by an 11.7% increase in volume, which were partiallyoffset by a 4.9% decline in average unit selling price. The changes in volumeand average unit selling price were a result of selective pricing actions andincreased promotional product sales. In our European market, local currencysales gains of 11.1% translated into gains of 21.7% in US dollars. Local currencygains in Europe were driven by an 83.1% increase in volume, partially offset bya 39.3% decrease in average unit selling price. Increased sales of OEM latexbed cores, which have lower prices, drove the unit growth and the decrease inaverage unit selling price. Local currency finished goods sales in Europeincreased 2.5%.   Elsewhere, weexperienced sales gains in our Mexico, Argentina and Brazil markets.

*GrossProfit.**  *Ourgross profit for the quarter was $172.5 million, an increase of $3.9 millionover the comparable prior year period. As a percentage of net sales, grossprofit decreased 1.8 percentage points to 42.9%. This was due to a decrease ingross profit margins in both the domestic and international operations. Domesticgross profit increased $0.4 million to $135.5 million, which, as a percentageof sales, represented a decrease of 1.7 percentage points to 44.7% of netsales. This decrease is driven by the above mentioned pricing actions, theaddition of flame retardant materials to most of our products, an increase insales of lower margin promotional products, as well as startup costs of $1.3million associated with the new latex facility in Mountain Top, PA. Partiallyoffsetting this decrease were continued improvements in our manufacturingefficiencies, $2.5 million of refunds on lumber tariffs received from Canadiansuppliers (see note 16, Contingencies, in Part I), as well as loweremployee health insurance costs arising from our transition to a new, thirdparty administrator. On a per unit basis, material costs increased 3.4%relative to the second quarter of fiscal 2006 primarily due to additional coststo make our products compliant with the 2007 federal flame retardancyregulations, partially offset by product mix as well as improved laborproductivity and  yield on raw materials.International gross profit margin decreased from 39.2% to 37.5% of net sales,primarily as a result of lower gross profit margins in Canada and in Europe. Thegross profit margin decrease in Canada resulted from increased sales of lowermargin promotional products and pricing actions taken that reduced average unitselling prices. In Europe, the gross profit margin decrease resulted from anincreased mix of lower margin sales of latex bed cores to other manufacturers.

*Selling,General, Administrative.**  *Our selling, general, and administrative expenseincreased $12.4 million to $135.5 million. This increase is due primarily toincreases in volume variable expenses, which included a $5.2 million increasein cooperative advertising costs to support the revenue increases and a $2.9million increase in delivery costs due to higher unit volume. Other costincreases included a $3.4 million increase in promotional expenses in the U.S.associated with the 2007 roll out of our new *Stearns &Foster* and *Posturepedic*Reserve product lines, a $2.8 million increase in spending on nationaladvertising and $1.7 million of costs associated with an organizationalrealignment. This increase is partially offset by a $2.6 million gain on saleof the Orlando facility as well as $1.0 million decrease in other sales andadministration costs. As a percent of net sales this expense was 33.7% and32.7% for the quarters ended May 27, 2007 and May 28, 2006,respectively, an increase of 1.0 percentage point.

*ExpensesAssociated With IPO.*   During the three monthsended May 28, 2006, we incurred $28.5 million of expenses directly relatedto our initial public offering which included approximately $17.5 million oftransaction-related bonuses paid to management employees, and $11.0 million paidto KKR for the termination of the Management Services Agreement.

*Royaltyincome, net of royalty expense.*   Our royaltyincome, net of royalty expenses, for the three months ended May 27,2007 was $4.4 million, an increase of $0.7 million compared with the threemonths ended May 28, 2006, primarily due to a $0.4 million increase ininternational royalty revenue.

30

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*InterestExpense.**  *Our interest expense for the second quarterof fiscal 2007 decreased $2.7 million from the prior year period to$15.2 million, primarily due to lower debt levels resulting from the retirementof the $89.1 million of senior subordinated Pay-In-Kind Notes (“PIK Notes”) and$47.5 million of the 8.25% Senior Subordinated Notes due June 2014 (“2014Notes”) in the second quarter of fiscal 2006 using proceeds from the initialpublic offering (“IPO”) as well as $45 million in voluntary prepayments of oursenior term debt since May 28, 2006. Our net weighted average borrowingcost was 7.4% and 7.9% for the three months ended May 27, 2007 and May 28,2006, respectively. The decrease in our borrowing cost was due to lowerinterest rates on the unhedged variable rate component of our floating ratedebt as well as lower interest rates on the fixed component of our seniorsecured term debt as a result of the August 2006 amendment of our seniorcredit agreement.

*DebtExtinguishment and Refinancing Expenses.**  *During the three months ended May 28,2006 we incurred $5.3 million of debt extinguishment costs consisting of $3.7million of cash expenses and $1.7 million of non-cash charges related to theextinguishment of debt retired using proceeds from the IPO. We did not incurcomparable costs during the three months ended May 27, 2007.

*Income Tax.**  *Our effective income tax ratesdiffer from the Federal statutory rate principally because of the effect ofcertain foreign tax rate differentials and state and local income taxes. Oureffective tax rate for the three months ended May 27, 2007 was 36.7%compared to 105.5% for the three months ended May 28, 2006. The effectiverate for the fiscal 2007 period was lower than the fiscal 2006 period due torecognition of a benefit of approximately $1.5 million resulting from areduction in our income tax reserve as a result of resolutions with taxauthorities.

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

Thefollowing table sets forth our summarized results of operations for the sixmonths ended May 27, 2007 and May 28, 2006, expressed in thousands ofdollars as well as a percentage of each period’s net sales:

| ** **                                                         | ** ** | **For the six months ended:** | ** ** |
|--------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                         | ** ** | **May 27, 2007**                        | ** ** | **May 28, 2006** | ** ** |
| ** **                                                         | ** ** | ** **                                        | ** ** | **(percentage** | ** ** | ** ** | ** ** | **(percentage** | ** ** |
| ** **                                                         | ** ** | **(in thousands)**                           | ** ** | **of net sales)** | ** ** | **(in thousands)** | ** ** | **of net sales)** | ** ** |
| Net sales                                                          |       |                                              | $          | 814,395 |   |   |   | 100.0 | % |   |   | $ | 772,447 |   |   |   | 100.0 | % |   |
| Cost of goods sold                                                 |       |                                              | 464,603    |   |   |   | 57.0 |   |   |   | 427,174 |   |   |   | 55.3 |   |   |
| Gross profit                                                       |       |                                              | 349,792    |   |   |   | 43.0 |   |   |   | 345,273 |   |   |   | 44.7 |   |   |
| Selling, general and administrative expenses                       |       |                                              | 262,445    |   |   |   | 32.2 |   |   |   | 246,715 |   |   |   | 31.9 |   |   |
| Expenses associated with IPO                                       |       |                                              | —     |   |   |   | — |   |   |   | 28,510 |   |   |   | 3.7 |   |   |
| Amortization of intangibles                                        |       |                                              | 1,613      |   |   |   | 0.2 |   |   |   | 255 |   |   |   | — |   |   |
| Royalty income, net of royalty expense                             |       |                                              | (9,703     | ) |   |   | (1.2 | ) |   |   | (7,395 | ) |   |   | (0.9 | ) |   |
| Income from operations                                             |       |                                              | 95,437     |   |   |   | 11.8 |   |   |   | 77,188 |   |   |   | 10.0 |   |   |
| Interest expense                                                   |       |                                              | 31,134     |   |   |   | 3.8 |   |   |   | 36,629 |   |   |   | 4.7 |   |   |
| Debt extinguishment and refinancing                                |       |                                              | —     |   |   |   | — |   |   |   | 5,295 |   |   |   | 0.7 |   |   |
| Other income, net                                                  |       |                                              | (214       | ) |   |   | — |   |   |   | (566 | ) |   |   | (0.1 | ) |   |
| Income before income taxes and cumulative effect                   |       |                                              | 64,517     |   |   |   | 8.0 |   |   |   | 35,830 |   |   |   | 4.6 |   |   |
| Income taxes                                                       |       |                                              | 23,750     |   |   |   | 2.9 |   |   |   | 12,445 |   |   |   | 1.6 |   |   |
| Income before cumulative effect of change in  accounting principle |       |                                              | 40,767     |   |   |   | 5.1 |   |   |   | 23,385 |   |   |   | 3.0 |   |   |
| Cumulative effect of change in accounting principle                |       |                                              | —     |   |   |   | — |   |   |   | 287 |   |   |   | — |   |   |
| Net income                                                         |       |                                              | $          | 40,767 |   |   |   | 5.1 | % |   |   | $ | 23,098 |   |   |   | 3.0 | % |   |
| Effective tax rate                                                 |       |                                              | 36.8       | % |   |   |   |   |   |   | 34.7 | % |   |   |   |   |   |

 

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

| ** **         | ** ** | **Six Months Ended:** | ** ** |
|--------------------|------------|---------------------------------|------------|
| ** **         | ** ** | **May 27,**                | ** ** | **May 28,** | ** ** |
| ** **         | ** ** | **2007**                        | ** ** | **2006** | ** ** |
| **US  Domestic**   |       |                            | 76.1       | % |   |   | 78.4 | % |   |
| **International:** |       |                            |       |   |   |   |   |   |   |
| Canada             |       |                            | 9.9        |   |   |   | 9.6 |   |   |
| Europe             |       |                            | 8.2        |   |   |   | 6.8 |   |   |
| Other              |       |                            | 5.8        |   |   |   | 5.2 |   |   |
| **Total**          | ** ** | ** **                      | **100.0**  | **%** | ** ** | ** ** | **100.0** | **%** | ** ** |

 

Thefollowing table shows our net sales and margin profitability for the majorgeographic regions of our operations, including local currency results for thesignificant international operations:

| ** **                            | ** ** | **For the six months ended:** | ** ** |
|---------------------------------------|------------|---------------------------------------------------|------------|
| ** **                            | ** ** | **May 27, 2007**                        | ** ** | **May 28, 2006** | ** ** |
| ** **                            | ** ** | **(in thousands)**                           | ** ** | **(percentage  of net sales)** | ** ** | **(in thousands)** | ** ** | **(percentage  of net sales)** | ** ** |
| **Total Domestic (US Dollars):**      | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | $          | 619,879 | ** ** |   |   | 100.0 | % |   |   | $ | 606,041 | ** ** |   |   | 100.0 | % |   |
| Cost of goods sold                    |       |                                              | 343,682    | ** ** |   |   | 55.4 |   |   |   | 325,742 | ** ** |   |   | 53.7 |   |   |
| Gross profit                          |       |                                              | 276,197    | ** ** |   |   | 44.6 |   |   |   | 280,299 | ** ** |   |   | 46.3 |   |   |
| **Total International (US Dollars):** | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | 194,516    | ** ** |   |   | 100.0 |   |   |   | 166,406 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                    |       |                                              | 120,921    | ** ** |   |   | 62.2 |   |   |   | 101,432 | ** ** |   |   | 61.0 |   |   |
| Gross profit                          |       |                                              | 73,595     | ** ** |   |   | 37.8 |   |   |   | 64,974 | ** ** |   |   | 39.0 |   |   |
| **Canada:**                           | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US Dollars:**                       | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | 80,998     | ** ** |   |   | 100.0 |   |   |   | 74,061 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                    |       |                                              | 46,473     | ** ** |   |   | 57.4 |   |   |   | 41,055 | ** ** |   |   | 55.4 |   |   |
| Gross profit                          |       |                                              | 34,525     | ** ** |   |   | 42.6 |   |   |   | 33,006 | ** ** |   |   | 44.6 |   |   |
| **Canadian Dollars:**                 | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | 92,704     | ** ** |   |   | 100.0 |   |   |   | 85,177 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                    |       |                                              | 53,175     | ** ** |   |   | 57.4 |   |   |   | 47,237 | ** ** |   |   | 55.5 |   |   |
| Gross profit                          |       |                                              | 39,529     | ** ** |   |   | 42.6 |   |   |   | 37,940 | ** ** |   |   | 44.5 |   |   |
| **Europe:**                           | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| **US Dollars:**                       | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | 66,499     | ** ** |   |   | 100.0 |   |   |   | 52,408 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                    |       |                                              | 48,294     | ** ** |   |   | 72.6 |   |   |   | 36,538 | ** ** |   |   | 69.7 |   |   |
| Gross profit                          |       |                                              | 18,205     | ** ** |   |   | 27.4 |   |   |   | 15,870 | ** ** |   |   | 30.3 |   |   |
| **Euros:**                            | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | 50,235     | ** ** |   |   | 100.0 |   |   |   | 43,328 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                    |       |                                              | 36,484     | ** ** |   |   | 72.6 |   |   |   | 30,151 | ** ** |   |   | 69.6 |   |   |
| Gross profit                          |       |                                              | 13,751     | ** ** |   |   | 27.4 |   |   |   | 13,177 | ** ** |   |   | 30.4 |   |   |
| **Other International (US Dollars):** | ** ** |                                              | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |   | ** ** | ** ** |   |
| Net sales                             |       |                                              | 47,019     | ** ** |   |   | 100.0 |   |   |   | 39,937 | ** ** |   |   | 100.0 |   |   |
| Cost of goods sold                    |       |                                              | 26,154     | ** ** |   |   | 55.6 |   |   |   | 23,839 | ** ** |   |   | 59.7 |   |   |
| Gross profit                          |       |                                              | $          | 20,865 | ** ** |   |   | 44.4 | % |   |   | $ | 16,098 | ** ** |   |   | 40.3 | % |   |

 

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***Six Months Ended May 27, 2007 compared with SixMonths Ended May 28, 2006***

*NetSales.**  *Ournet sales for the six months ended May 27,2007, were $814.4 million, an increase of $41.9 million, or 5.4% fromthe six months ended May 28, 2006.Total domestic net sales were $619.9 million for the first half of fiscal2007 compared to $606.0 million for the first half of fiscal 2006. The domesticnet sales increase of $13.8 million was attributable to a 6.1% increase involume partially offset by an 3.6% decrease in average unit selling price. Theincrease in volume is primarily attributable to the strong performance of ourpromotional products such as our 125th Anniversary beds as well as our specialtybedding products. The decrease in average unit selling price is primarily dueto the higher volume of lower priced mattress sales. In addition strategicpricing actions were taken on selected products such as the *Stearns & Foster*and *TrueForm *lines.Total international sales increased $28.1 million, or 16.9%. Excluding theeffect of currency fluctuations, international sales increased 13.5%. Theincrease represents a 40.4% increase in unit volume, partially offset by adecrease in average unit selling price. In Canada, local currency sales gainsof 8.8% translated into gains of 9.4% in US dollars. Local currency gains inthe Canada were driven by an 18.3% increase in volume, which were partiallyoffset by a 8.0% decline in average unit selling price. The changes in volumeand average unit selling price were a result of selective pricing actions andincreased promotional product sales. In our European market, local currencygains of 15.9% translated into gains of 26.9% in US dollars. Local currencygains in Europe were driven by a 68.7% increase in volume, partiallyoffset by 31.3% decrease in average unit selling price. The decrease in averageunit selling price is attributed to increased sales of latex bed cores to othermanufacturers. Local currency finished goods sales in Europe increased 10.0%. Elsewhere,we experienced sales gains in our Mexico, Argentina and Brazil markets.

*GrossProfit.**  *Ourgross profit for the six months ended May 27, 2007 was $349.8 million, anincrease of $4.5 million over the comparable prior year period. As a percentageof net sales, gross profit decreased 1.7 percentage points to 43.0%. This wasdue primarily to a decrease in our domestic gross profit margin. Domestic grossprofit decreased $4.1 million to $276.2 million, which, as a percentage ofsales, represented a decrease of 1.7 percentage points to 44.6%. This decreaseis driven by the addition of flame retardant materials to most of our products,strategic pricing actions, an increase in sales of lower margin promotionalproducts, as well as $1.9 million of startup costs associated with the newlatex facility in Mountain Top, PA. Partially offsetting this decrease werecontinued improvements in our manufacturing efficiencies, lower employee healthinsurance costs arising from our transition to a new, third partyadministrator, as well as $2.5 million of refunds on lumber tariffs receivedfrom Canadian suppliers (see Note 16, Contingencies, in Part I), On a perunit basis, material costs increased 3.1% relative to the first half of fiscal2006 primarily due to additional costs to make our products compliant with the2007 federal flame retardancy regulations, partially offset by product mix aswell as improved yield on raw materials. International gross margin decreasedfrom 39.0% to 37.8% as a result of lower margins in Canada and Europe. Thegross profit margin decrease in Canada resulted from increased sales of lowermargin promotional products and pricing action taken that reduced average unitselling prices. In Europe, the gross profit margin decrease resulted from anincreased mix of lower margin sales of latex bed cores to other manufacturers.

*Selling,General, Administrative.**  *Our selling, general, and administrative expenseincreased $15.7 million to $262.4 million. This increase is due primarilyto volume variable expenses, which included a $7.3 million increase incooperative advertising costs to support the revenue increases and a $5.0million increase in delivery costs due to higher unit volume. Other costincreases included a $0.9 million increase in promotional expenses in the U.S.associated with the 2007 roll out of our new *Stearns &Foster* product lines, a $3.0 million increase in the spending onnational advertising, $1.9 million of costs associated with an organizationalrealignment and a $0.2 million increase in other sales and administrationcosts. This increase is partially offset by a gain on the sale of our Orlandofacility of $2.6 million. As a percent of net 

33

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sales this expense was32.2% and 31.9% for the six months ended May 27, 2007 and May 28,2006, respectively.

*ExpensesAssociated With IPO.*   During the six months endedMay 28, 2006, we incurred $28.5 million of expenses directly related tothe IPO which included approximately $17.5 million of transaction-relatedbonuses paid to management employees, and $11.0 million paid to KKR for thetermination of the Management Services Agreement.

*Royaltyincome, net of royalty expense.*   Our royaltyincome, net of royalty expenses, for the six months ended May 27, 2007 was$9.7 million, an increase of $2.3 million compared with the six months ended May 28,2006, primarily due to an increase in international royalty revenue.

*InterestExpense.**  *Our interest expense for the first half offiscal 2007 decreased $5.5 million from the prior year period to $31.1million, primarily due to lower debt levels resulting from the retirement ofthe $89.1 million of PIK Notes and $47.5 million of the 2014 Notes in thesecond quarter of fiscal 2006 using proceeds from the IPO as well as $45 millionin voluntary prepayments of our senior term debt since May 28, 2006. Ournet weighted average borrowing cost was 7.5% and 7.9% for the six months ended May 27,2007 and May 28, 2006, respecitively. The decrease in our borrowing costwas due to lower interest rates on the unhedged variable rate component of ourfloating rate debt as well as lower interest rates on the fixed component ofour senior secured term debt as a result of the August 2006 amendment ofour senior credit agreement. 

*DebtExtinguishment and Refinancing Expenses.*   Duringthe six months ended May 28, 2006 we incurred $5.3 million of debtextinguishment costs consisting of $3.7 million of cash expenses and $1.7 millionof non-cash charges related to the extinguishment of debt retired usingproceeds from the IPO. We did not incur comparable costs during the six monthsended May 27, 2007.

*Income Tax.*   Oureffective income tax rates differ from the Federal statutory rate principallybecause of the effect of certain foreign tax rate differentials and state andlocal income taxes. Our effective tax rate for the six months ended May 27,2007 was 36.8% compared to 34.7% for the six months ended May 28, 2006. Theeffective rate for the fiscal 2006 period was lower than the fiscal 2007 perioddue to recognition of a benefit of approximately $1.5 million resulting from areduction in our income tax reserve as a result of resolutions with taxauthorities.

**LIQUIDITY ANDCAPITAL RESOURCES**

***Principal Sources of Funds***

Our principal sources offunds are cash flows from operations and borrowings under our senior securedrevolving credit facility. Our principal use of funds consists of operatingexpenditures, payments of principal and interest on our senior creditagreements, capital expenditures, interest payments on our outstanding seniorsubordinated notes, and dividend payments to shareholders. Capital expenditurestotaled $22.4 million for the six months ended May 27, 2007. We expecttotal 2007 capital expenditures to be approximately $40 million. We believethat annual capital expenditure limitations in our current debt agreements willnot prevent us from meeting our ongoing capital needs. Our introductions of newproducts typically require us to make initial cash investments in inventory,promotional supplies and employee training which may not be immediatelyrecovered through new product sales. However, we believe that we havesufficient liquidity to absorb such expenditures related to new products andthat these expenses will not have a significant adverse impact on our operatingcash flow. At May 27, 2007, we had approximately $84.7 millionavailable under our revolving credit facility after taking into account lettersof credit issued totaling $31.5 million. Our net weighted averageborrowing cost was 7.5% and 7.9% for the six months ended May 27, 2007 andMay 28, 2006, respectively. The decrease in our borrowing cost was due tolower interest rates on the unhedged variable rate component of our floatingrate debt as well as lower interest 

34

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rates onthe fixed component of our senior secured term debt as a result of the August 2006amendment of our senior credit agreement as discussed below in greater detail. Asa result of the IPO completed April 12, 2006, approximately $90 million ofthe net proceeds were used to retire the PIK Notes including accrued interestand prepayment penalties thereon, and approximately $52 million was used torepurchase and retire $47.5 million of the aggregate principal amountoutstanding under our 2014 Notes along with accrued interest and market premiumsthereon. 

***Debt***

We have incurred debt, including senior creditfacilities consisting of a $125 million senior secured revolving creditfacility maturing in 2010 and senior secured term loan facilities maturing in August 2011 andAugust 2012 with an outstanding balance of $405 million at May 27,2007. We also have an outstanding principal balance of $342 million at May 27,2007 on the 2014 Notes.

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

Future principal debt payments are expected to be paidout of cash flows from operations and borrowings on our revolving creditfacility. As of June 28, 2007, we had $11.5 million outstanding under ourrevolving credit facility.

Borrowings under our new senior secured creditfacilities bear interest at our choice of the Eurodollar rate or adjusted baserate (‘‘ABR’’), in each case, plus an applicable margin, subject to adjustmentbased on a pricing grid. Annually, we may be required to make principalprepayments equal to 25% of excess cash flow for the preceding fiscal year, asdefined in our senior secured credit agreement, if our leverage ratio is lessthan 4.00 to 1.00 reducing to 0% if our leverage ratio is less than 3.25 to1.00. At May 27, 2007, we are unable to determine the amount of suchrequired payment, if any, that would be due following the first quarter offiscal 2008 with respect to excess cash flow for the 2007 fiscal year.

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

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

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The outstanding 2014 Notes consist of$342 million aggregate principal amount maturing June 15, 2014,bearing interest at 8.25% per annum payable semiannually in arrears on June 15and December 15, commencing on December 15, 2004. On September 29,2004, we completed an exchange offer whereby all of the 2014 Notes wereexchanged for publicly traded, registered securities with identical terms(other than certain terms relating to registration rights and certain interestrate provisions otherwise applicable to the original senior subordinated notes).During the second quarter of fiscal 2006, we used a portion of the proceedsfrom the IPO to retire approximately $47.5 million aggregate principal amountof the 2014 Notes.

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

At May 27, 2007, we were in compliance with thecovenants contained within our senior credit agreements and indenture governingthe 2014 Notes.

As part of our ongoing evaluation of our capitalstructure, we continually assess opportunities to reduce our debt, whichopportunities may from time to time include voluntary prepayments of our seniorsecured term debt, or redemption or repurchase of a portion of our seniorsubordinated notes to the extent permitted by our debt covenants. In addition,our Board authorized a common stock repurchase program under which we mayrepurchase up to $100 million of our Company’s stock. As of May 27, 2007,we had repurchased $5.4 million under this program.

Our ability to make scheduled payments of principal,or to pay the interest or liquidated damages, if any, on or to refinance ourindebtedness, or to fund planned capital expenditures will depend on our futureperformance, which, to a certain extent, is subject to general economic,financial, competitive, legislative, regulatory and other factors that are beyondour control. Based upon the current level of operations, we believe that cashflow from operations and available cash, together with available borrowingsunder the senior credit agreement, will be adequate to meet the futureliquidity needs during the one year following May 27, 2007. We will berequired to make scheduled principal payments of $26.8 million during the nexttwelve months, with $9.1 million for our senior secured term loans, $2.0million for our financing obligations and capital leases and the remainder fordebt owed by our international subsidiaries. However, as we continuallyevaluate our ability to make additional prepayments as permitted under oursenior credit agreements, it is possible that we will make additional voluntaryprepayments on our senior debt during that time.

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

***Dividend***

On July 10, 2007, ourBoard of Directors declared a cash dividend in the amount of $0.075 per shareof common stock payable on August 1, 2007 to stockholders of record as of July 23,2007. This will result in a dividend distribution of approximately $6.9 millionto be paid during the third quarter of fiscal 2007.

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***Cash Flow Analysis***

Thefollowing table summarizes our changes in cash:

| ** **                              | ** ** | **Six Months Ended:** | ** ** |
|-----------------------------------------|------------|---------------------------------|------------|
| ** **                              | ** ** | **May 27,  2007**          | ** ** | **May 28,  2006** | ** ** |
| ** **                              | ** ** | **(in thousands)**         | ** ** |
| Statement of Cash Flow  Data:           |       |                            |       |   |   |
| Cash flows  provided by (used in):      |       |                            |       |   |   |
| Operating activities                    |       | $                               | 22,462     |   | $ | (19,844 | ) |
| Investing activities                    |       | (17,466                         | )          | (15,583 | ) |
| Financing activities                    |       | (28,491                         | )          | 22,744 |   |
| Effect of exchange rate changes on cash |       | (403                            | )          | 336 |   |
| Change in cash and cash equivalents     |       | (23,898                         | )          | (12,347 | ) |
| Cash and cash  equivalents:             |       |                            |       |   |   |
| Beginning of period                     |       | 45,620                          |       | 36,554 |   |
| End of period                           |       | $                               | 21,722     |   | $ | 24,207 |   |

 

***Six Months Ended May 27, 2007 Compared With SixMonths Ended May 28, 2006***

*CashFlows from Operating Activities.**  *Ourcash flow from operations increased $42.3 million to $22.5 millionnet cash provided for the six months ended May 27, 2007, compared to a$19.8 million net use of cash for the six months ended May 28, 2006.Contributing to this increase were approximately $30.8 million of cashexpenses and interest payments associated with the IPO in fiscal 2006, $4.4million lower cash payments for interest in the first half of fiscal 2007 as comparedto the first half of fiscal 2006 due to lower average debt balances, with theremaining increase primarily the result of changes in working capital andtiming of various vendor payments.

*CashFlows from Investing Activities.**  *Ourcash flows used in investing activities increased approximately$1.9 million to $17.5 million net use of cash for the six monthsended May 27, 2007, compared to a $15.6 million net use of cash for sixmonths ended May 28, 2006 due to $6.4 million higher capital expendituresfor the first six months of fiscal 2007 as compared with the prior year period.The increased capital expenditures were primarily due to the construction ofour new facility in Mountain Top, PA. These expenditures werepartially offset by $4.5 million higher gains on sales of assets, including$2.6 million related to the sale of our Orlando facility.

*Cash Flows from FinancingActivities.**  *Our cashflow used in financing activities for the six months ended May 27, 2007increased $51.2 million to a $28.5 million net use of cash from a netsource of $22.7 million for the six months ended May 28, 2006. Thisdecrease is primarily due to $13.7 million of cash dividends paid in thefirst half of fiscal 2007 and $5.4 million used to repurchase our common stockduring the first half of fiscal 2007 partially offset by an increase of $4.1 millionrelated to the exercise of employee stock options in the first half of fiscal2007 as compared with the prior year period. In addition, the prior periodincluded $31.2 million of proceeds from our initial public offering that stillwere available at May 28, 2006 to cover operating cash costs related to thetransaction.

***Income Taxes***

Significant judgment isrequired in evaluating our federal, state and foreign tax positions and in thedetermination of our tax provision. Despite our belief that our tax returnpositions are fully supportable, we have established reserves where we believethat certain tax positions are likely to be challenged and we may not fullyprevail in overcoming these challenges. We may adjust these reserves asrelevant circumstances evolve, such as guidance from the relevant taxauthority, our tax advisors, or resolution of 

37

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issuesin the courts. In addition, the FASBrecently issued Interpretation No. 48 “Accounting for Uncertainty inIncome Taxes—an Interpretation of FASB Statement No. 109” (“FIN 48”), asdescribed in Note 2 to the Condensed Consolidated Financial Statements, Part I,Item 1, included herein. We are still assessing the potential impact ofadopting this interpretation. Our tax expense includes the impact ofreserve positions and changes to reserves that we consider appropriate, as wellas related interest. While the Company is currently undergoing examinations ofits corporate income tax returns by tax authorities, no issues related to thesereserved positions have been presented to the Company. The Company believesthat such audits will not result in assessment and payment of taxes related tothese positions during one year following May 27, 2007. We also cannotpredict when or if any other future tax payments related to these tax positionsmay occur.

***Debt Covenants***

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

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

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

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Thefollowing table sets forth a reconciliation of net income to EBITDA and EBITDAto Adjusted EBITDA for the three and six months ended May 27, 2007:

| ** **                                 | ** ** | **Three Months  Ended:** | ** ** | **Six Months  Ended:** | ** ** |
|--------------------------------------------|------------|-------------------------------|------------|-----------------------------|------------|
| ** **                                 | ** ** | **May 27,  2007**        | ** ** | **May 27,  2007**      | ** ** |
| ** **                                 | ** ** | **(in thousands)**       | ** ** | **(in thousands)**     | ** ** |
| Net income                                 |       |                          | $          | 16,133                      |       |   |   | $ | 40,767 |   |   |
| Interest expense                           |       |                          | 15,229     |                        |       |   | 31,134 |   |   |
| Income taxes                               |       |                          | 9,339      |                        |       |   | 23,750 |   |   |
| Depreciation and amortization              |       |                          | 7,861      |                        |       |   | 15,183 |   |   |
| EBITDA                                     |       |                          | 48,562     |                        |       |   | 110,834 |   |   |
| Unusual and nonrecurring  (income) losses: |       |                          |       |                        |       |   |   |   |   |
| Refund of  Canadian lumber tariff          |       |                          | (2,518     | )                           |       |   | (2,518 | ) |   |
| North American  realignment                |       |                          | 1,734      |                        |       |   | 1,911 |   |   |
| Gain on sale of  Orlando facility          |       |                          | (2,557     | )                           |       |   | (2,557 | ) |   |
| Non-cash  compensation                     |       |                          | 1,127      |                        |       |   | 1,766 |   |   |
| Mountain Top, PA  start-up costs           |       |                          | 1,417      |                        |       |   | 2,147 |   |   |
| Other (various)(a)                         |       |                          | 1,001      |                        |       |   | 1,181 |   |   |
| Adjusted EBITDA                            |       |                          | $          | 48,766                      |       |   |   | $ | 112,764 |   |   |

----

(a)           Consists of variousimmaterial adjustments

Thefollowing table reconciles EBITDA to cash flow from operations:

| ** **                                                     | ** ** | **Six Months  Ended:** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                     | ** ** | **27-May-07**               | ** ** |
| ** **                                                     | ** ** | **(in thousands)**     | ** ** |
| EBITDA                                                         |       |                        | $          | 110,834 |   |   |
| Adjustments to  EBITDA to arrive at cash flow from operations: |       |                        |       |   |   |
| Interest expense                                               |       |                        | (31,134    | ) |   |
| Income taxes                                                   |       |                        | (23,750    | ) |   |
| Non-cash credits to net income                                 |       |                        | (5,758     | ) |   |
| Changes in operating assets & liabilities             |       |                        | (27,730    | ) |   |
| Cash flow from  operations                                     |       |                        | $          | 22,462 |   |   |

 

***Forward Looking Statements***

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

·       thelevel of competition in the bedding industry;

·       legaland regulatory requirements;

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·       thesuccess of new products;

·       ourrelationships with our major suppliers;

·       fluctuationsin costs of raw materials;

·       ourrelationship with significant customers and licensees;

·       ourlabor relations;

·       departureof key personnel;

·       encroachmentson our intellectual property;

·       productliability claims;

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

·       ourlevel of indebtedness;

·       interestrate risks;

·       futureacquisitions;

·       anincrease in return rates; and

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

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

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

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

***Foreign Currency Exposures***

Our earnings are affected by fluctuations in the valueof our subsidiaries’ functional currency as compared to the currencies of ourforeign denominated purchases. Foreign currency forward, swap and optioncontracts are used to hedge against the earnings effects of such fluctuations.The result of a uniform 10% change in the value of the U.S. dollar relative tocurrencies of countries in which we manufacture or sell our products would havean approximately $0.9 million dollar impact on our financial position for thesix months ended May 27, 2007. This calculation assumes that each exchangerate would change in the same direction relative to the U.S. dollar.

To protect against thereduction in value of forecasted foreign currency cash flows resulting frompurchases in a foreign currency, we have instituted a forecasted cash flowhedging program. We hedge portions of our purchases denominated in foreigncurrencies with forward and option contracts. At May 27, 2007, we hadforward contracts to sell a total of 27 million Canadian dollars withexpiration dates ranging from May 31, 2007 through November 30, 2007.At May 27, 2007, the fair value of our net liability under the forwardcontracts was $1.5 million. We do not designate our foreign currency hedges foraccounting purposes, therefore all changes in fair value are charged toearnings.

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***Interest Rate Risk***

On June 3, 2004, we entered into an interest rateswap agreement effective July 6, 2004 effectively fixing the floatingportion of the interest rate at 3.725% on $200 million of our outstandingbalance under the senior secured term loan through November 2005,declining to $150 million through November 2007. The fair value of thisswap instrument was an asset of $1.8 million at May 27, 2007 and $2.8million at November 26, 2006.

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

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

Based on the unhedgedportion of our variable rate debt outstanding at May 27, 2007, a 12.5basis point increase or decrease in variable interest rates would have anapproximately $0.4 million dollar impact on our annual interest expense.

***Commodity Price Risks***

The cost of our steelinnerspring, polyurethane foam, polyester and rayon fibers and polyethylenecomponent parts are impacted by volatility in the price of steel and petroleum.We believe the cost of the components could remain slightly elevated abovetheir recent historical averages throughout fiscal 2007. Through May 27,2007, we have been able to partially offset these cost pressures through priceincreases announced May of 2004 and November of 2005 and through costreduction efforts. We do not engage in commodity hedging programs.

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

Under the supervision and with the participation ofour management, including our principal executive officer and principalaccounting officer, we conducted an evaluation of the effectiveness of thedesign and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and15d-15(e) under the Securities Exchange Act of 1934, as amended, asof the end of the period covered by this report (the “Evaluation Date”). Basedon this evaluation, our principal executive officer and principal accountingofficer concluded as of the Evaluation Date that our disclosure controls andprocedures were effective such that the information relating to the Company,including our consolidated subsidiaries, required to be disclosed in ourSecurities and Exchange Commission (“SEC”) reports (i) is recorded,processed, summarized and reported within the time periods specified in SEC rules andforms, and (ii) is accumulated and communicated to the Company’smanagement, including our principal executive and principal accounting officer,as appropriate to allow timely decisions regarding required disclosure.

There were no changes in our internal control overfinancial reporting identified in connection with the foregoing evaluation thatoccurred during the second quarter of fiscal 2007 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

We are preparing for our first management report oninternal control over financial reporting, as required by Section 404 ofthe Sarbanes-Oxley Act of 2002, for our fiscal year ending December 2,2007, on which our auditors will be required to deliver an attestation reporton management’s assessment of, and operating effectiveness of, internalcontrols over financial reporting. As a result, we expect to continue enhancingour internal controls over financial reporting throughout fiscal 2007.

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**PART II. OTHERINFORMATION**

**Item 1.**                        *Legal Proceedings*

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

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

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

| **Period**                              | ** ** | ** ** | ** ** | **Total number of  shares purchased(1)** | ** ** | **Average price paid  per share(1)** | ** ** | **Total number of shares  purchased as part of**

**publically announced  program(2)** | ** ** | **Approximate dollar**

**value of shares that may  yet be purchased under  program** | ** ** |
|-----------------------------------------|------------|------------|------------|---------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|------------|
| February 26  - March 25, 2007 |       |       | 85,873     |                                                    |       |                                                | $          | 17.04                                                                                                                     |       |                                                                                                                          |       | 84,900 |   |   |   | $ | 98,545,952 |   |   |
| March 26 - April 22,  2007    |       |       | 344,163    |                                                    |       |                                                | 17.23      |                                                                                                                      |       |                                                                                                                          | 148,700    |   |   |   | 96,033,206 |   |   |
| April 23 - May 27,  2007      |       |       | 82,600     |                                                    |       |                                                | 17.06      |                                                                                                                      |       |                                                                                                                          | 82,600     |   |   |   | 94,623,832 |   |   |
| Total                                   |       |       | 512,636    |                                                    |       |                                                | $          | 17.17                                                                                                                     |       |                                                                                                                          |       | 316,200 |   |   |   | $ | 94,623,832 |   |   |

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(1)          These amounts includecommon stock surrendered or withheld to cover the exercise price and/or taxwithholding obligations in stock option exercises, as permitted under the Company’s1998 and 2004 Stock Option Plans. For the quarter ended May 27, 2007, thefollowing shares of Sealy Corporation common stock were surrended byparticipants in the Plans and included in the total number of shares purchased:February 26 - March 25, 2007 - 973 shares at an average price pershare of $9.22; March 26 - April 22, 2007 - 195,463 sharesat an average price per share of $17.48; and April 23 - May 27,2007 - no shares were purchased from participants in the Plans.

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

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

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

None

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

(a)   The annualmeeting of the shareholders of the Company was held on April 25, 2007.

(b)   Election ofthe directors is set forth in (c) below.

(c)   Theshareholders elected all of the Company’s nominees for directors and ratifiedthe appointment of Deloitte & Touche LLP as the Company’s independentregistered public accounting firm for the fiscal year ending December 2,2007.

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(1)   Election of Directors

| ** **          | ** ** | **Shares For** | ** ** | **Shares Withheld** | ** ** |
|---------------------|------------|---------------------|------------|--------------------------|------------|
| Brian F. Carroll    |       | 70,075,356          |       |                     | 6,350,450  |   |   |
| James W. Johnston   |       | 75,225,842          |       |                     | 1,199,964  |   |   |
| David J.  McIlquham |       | 70,081,170          |       |                     | 6,344,636  |   |   |
| Gary E. Morin       |       | 76,212,523          |       |                     | 212,283    |   |   |
| Dean Nelson         |       | 70,151,193          |       |                     | 6,274,613  |   |   |
| Paul J. Norris      |       | 71,196,150          |       |                     | 5,229,656  |   |   |
| Richard W.  Roedell |       | 75,733,204          |       |                     | 692,602    |   |   |
| Scott M. Stuart     |       | 70,099,583          |       |                     | 6,326,223  |   |   |

 

(2)   Ratification of Appointment of IndependentRegistered Public Accounting Firm

| For       |   | 76,371,849 |   |
|-----------|--------|------------|--------|
| Against   |   | 49,634     |   |
| Abstained |   | 4,322      |   |

 

**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.                       |

 

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**SIGNATURES**

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

|  | SEALY CORPORATION |
|--|-------------------|

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

 

Date: July 10, 2007

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