Sealy 10Q 2012 Q3 Quarterly report

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q


ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: August 26, 2012
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from to

Commission file number 001-08738

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


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

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

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

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

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


Large accelerated filer o		Accelerated filer ý		Non-accelerated filer o (Do not check if a smaller reporting company)		Smaller reporting company o

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

The number of shares of the registrant's common stock outstanding as of September 20, 2012 is approximately: 104,082,411.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

SEALY CORPORATION

Condensed Consolidated Statements of Operations

(in thousands, except per share data)

(unaudited)

	Three Months Ended

	August 26, 2012			August 28, 2011
Net sales	$	365,434		$	334,067
Cost of goods sold		217,229			197,067

Gross profit		148,205			137,000
Selling, general and administrative expenses		120,632			104,127
Amortization expense		73			73
Royalty income, net of royalty expense		(5,105	)		(5,021	)

Income from operations		32,605			37,821
Interest expense		20,929			21,935
Refinancing and extinguishment of debt		416			28
Other income, net		(131	)		(130	)

Income before income taxes		11,391			15,988
Income tax provision		12,156			9,556
Equity in earnings of unconsolidated affiliates		875			1,057

Income from continuing operations		110			7,489
Loss from discontinued operations		(307	)		(891	)

Net (loss) income		(197	)		6,598
Net loss attributable to noncontrolling interests		91			—

Net (loss) income attributable to common shareholders	$	(106	)	$	6,598

Earnings (loss) per common share attributable to common shareholders—Basic
Income from continuing operations per common share	$	—		$	0.07
Loss from discontinued operations per common share		—			—

Earnings (loss) per common share attributable to common shareholders—Basic	$	—		$	0.07

Earnings (loss) per common share attributable to common shareholders—Diluted
Income from continuing operations per common share	$	—		$	0.04
Loss from discontinued operations per common share		—			—

Earnings (loss) per common share attributable to common shareholders—Diluted	$	—		$	0.04

Weighted average number of common shares outstanding:
Basic		103,534			100,334
Diluted		109,800			308,566

See accompanying notes to Condensed Consolidated Financial Statements.

SEALY CORPORATION

Condensed Consolidated Statements of Operations (Continued)

(in thousands, except per share data)

(unaudited)

	Nine Months Ended

	August 26, 2012			August 28, 2011
Net sales	$	989,755		$	960,892
Cost of goods sold		592,155			580,314

Gross profit		397,600			380,578
Selling, general and administrative expenses		327,254			315,308
Amortization expense		217			217
Royalty income, net of royalty expense		(14,425	)		(14,796	)

Income from operations		84,554			79,849
Interest expense		65,554			65,309
Refinancing and extinguishment of debt		3,341			1,264
Other income, net		(410	)		(337	)

Income before income taxes		16,069			13,613
Income tax provision		14,821			7,779
Equity in earnings of unconsolidated affiliates		3,283			2,535

Income from continuing operations		4,531			8,369
Loss from discontinued operations		(1,814	)		(3,050	)

Net income		2,717			5,319
Net loss attributable to noncontrolling interests		91			—

Net income attributable to common shareholders	$	2,808		$	5,319

Earnings per common share attributable to common shareholders—Basic
Income from continuing operations per common share	$	0.05		$	0.08
Loss from discontinued operations per common share		(0.02	)		(0.03	)

Earnings per common share attributable to common shareholders—Basic	$	0.03		$	0.05

Earnings per common share attributable to common shareholders—Diluted
Income from continuing operations per common share	$	0.04		$	0.08
Loss from discontinued operations per common share		(0.02	)		(0.01	)

Earnings per common share attributable to common shareholders—Diluted	$	0.02		$	0.07

Weighted average number of common shares outstanding:
Basic		101,849			98,725
Diluted		109,329			304,659

See accompanying notes to Condensed Consolidated Financial Statements.

SEALY CORPORATION

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)

(unaudited)

	August 26, 2012			November 27, 2011

ASSETS
Current assets:
Cash and equivalents	$	88,833		$	107,975
Accounts receivable (net of allowance for doubtful accounts, discounts and returns, 2012—$31,390; 2011—$30,104)		177,954			126,494
Inventories		70,819			57,002
Other current assets		21,345			29,275
Deferred income tax assets		21,770			21,349

Total current assets		380,721			342,095

Property, plant and equipment		418,124			406,115
Less accumulated depreciation		(253,445	)		(239,370	)

		164,679			166,745

Goodwill		363,305			361,026
Intangible assets, net		16,001			1,116
Deferred income tax assets		1,377			1,772
Other assets, including debt issuance costs, net		45,426			46,440

		426,109			410,354

Total assets	$	971,509		$	919,194

LIABILITIES AND STOCKHOLDERS' DEFICIT
Current liabilities:
Current portion—long-term obligations	$	2,324		$	1,584
Accounts payable		96,184			68,774
Accrued incentives and advertising		29,267			26,038
Accrued compensation		26,224			17,601
Accrued interest		15,369			14,074
Other accrued liabilities		32,516			28,426

Total current liabilities		201,884			156,497

Long-term obligations, net of current portion		758,204			790,297
Other liabilities		51,927			52,415
Deferred income tax liabilities		326			549
Redeemable noncontrolling interest		12,131			—
Stockholders' deficit:
Common stock, $0.01 par value; Authorized 600,000 shares Issued and outstanding: 2012—104,066; 2011—100,916		1,043			1,010
Additional paid-in capital		953,598			935,512
Treasury stock, at cost: 2012—102; 2011—0		(180	)		—
Accumulated deficit		(1,013,769	)		(1,016,577	)
Accumulated other comprehensive income (loss), net		6,345			(509	)

Total stockholders' deficit		(52,963	)		(80,564	)

Total liabilities and stockholders' deficit	$	971,509		$	919,194

See accompanying notes to Condensed Consolidated Financial Statements.

SEALY CORPORATION

Condensed Consolidated Statement of Stockholders' Deficit

(in thousands)

(unaudited)

				Common Stock													Accumulated Other Comprehensive Income (Loss)

	Comprehensive Income (Loss)			Common Stock				Additional Paid-in Capital			Treasury Stock			Accumulated Deficit
	Comprehensive Income (Loss)			Shares		Amount		Additional Paid-in Capital			Treasury Stock			Accumulated Deficit						Total
Balance at November 27, 2011					100,916	$	1,010	$	935,512		$	—		$	(1,016,577	)	$	(509	)	$	(80,564	)
Net income attributable to common shareholders		2,808													2,808						2,808
Foreign currency translation adjustment		7,623																7,623			7,623
Adjustment to defined benefit plan liability, net of tax of $243		335																335			335
Change in fair value of cash flow hedges, net of tax of $704		(1,104	)															(1,104	)		(1,104	)
Share-based compensation									6,566												6,566
Exercise of stock options					40		2		62												64
Vesting of restricted share units, net					3,110		31		(2,938	)											(2,907	)
Treasury shares repurchased									180			(180	)								—
Excess tax benefit on share based awards									(552	)											(552	)
Beneficial conversion features on Convertible Paid in Kind Notes									14,768												14,768

Balance at August 26, 2012	$	9,662			104,066	$	1,043	$	953,598		$	(180	)	$	(1,013,769	)	$	6,345		$	(52,963	)

See accompanying notes to Condensed Consolidated Financial Statements.

SEALY CORPORATION

Condensed Consolidated Statements of Cash Flows

(in thousands)

(unaudited)

	Nine Months Ended

	August 26, 2012			August 28, 2011
Operating activities:
Net income	$	2,717		$	5,319
Adjustments to reconcile net income to cash provided by (used in) operating activities:
Depreciation and amortization		18,753			18,001
Deferred income taxes		348			946
Amortization of deferred gain on sale-leaseback		(260	)		(515	)
Paid in kind interest on convertible notes		17,064			14,551
Amortization of discount on new senior secured notes		1,250			1,101
Amortization of debt issuance costs and other		3,139			3,511
Impairment charges		—			288
Share-based compensation		6,566			9,239
Loss (gain) on sale of assets		197			(30	)
Write-off of debt issuance costs related to debt extinguishments		1,862			643
Loss on repurchase of senior notes		1,050			300
Dividends received from unconsolidated affiliates		2,500			1,011
Equity in earnings of unconsolidated affiliates		(3,283	)		(2,535	)
Loss on disposition of subsidiary		—			206
Other, net		(2,252	)		(532	)
Changes in operating assets and liabilities:
Accounts receivable		(45,686	)		(29,787	)
Inventories		(20,201	)		(1,224	)
Other current assets		6,554			(2,750	)
Other assets		482			2,361
Accounts payable		25,321			9,255
Accrued expenses		15,101			(20,338	)
Other liabilities		180			(2,159	)

Net cash provided by operating activities		31,402			6,862

Investing activities:
Purchase of property, plant and equipment		(10,011	)		(17,692	)
Acquisition of Comfort Revolution, inclusive of cash acquired of $159		159			—
Proceeds from sale of property, plant and equipment		2,544			24

Net cash used in investing activities		(7,308	)		(17,668	)

Financing activities:
Proceeds from issuance of long-term obligations		1,269			2,568
Repayments of long-term obligations		(9,009	)		(3,882	)
Repayment of senior secured notes, including premium of $1,050		(36,050	)		(10,300	)
Repurchase of common stock associated with vesting of employee share-based awards		(2,905	)		(3,674	)
Exercise of employee stock options		62			621
Debt issuance costs		(1,120	)		(147	)
Other		—			(34	)

Net cash used in financing activities		(47,753	)		(14,848	)

Effect of exchange rate changes on cash		4,517			2,333

Change in cash and equivalents		(19,142	)		(23,321	)
Cash and equivalents:
Beginning of period		107,975			109,255

End of period	$	88,833		$	85,934

Noncash investing transaction:
Investment in Comfort Revolution	$	10,000		$	—
Inventory items transferred to property, plant and equipment	$	8,454		$	—

See accompanying notes to Condensed Consolidated Financial Statements.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements

(unaudited)

Note 1: Basis of Presentation and Significant Accounting Policies

The interim Condensed Consolidated Financial Statements are unaudited, and certain related information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted in accordance with Rule 10-01 of Regulation S-X. The accompanying interim Condensed Consolidated Financial Statements were prepared following the same policies and procedures used in the preparation of the annual financial statements and reflect all adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of Sealy Corporation and its subsidiaries (collectively, the "Company"). The results of operations for the interim periods are not necessarily indicative of the results for the fiscal year. Our third fiscal quarter sales are typically 5% to 15% higher than other fiscal quarters. These Condensed Consolidated Financial Statements should be read in conjunction with the annual consolidated financial statements for the year ended November 27, 2011 included within the Company's Annual Report on Form 10-K (File No. 001-08738).

At August 26, 2012, affiliates of Kohlberg Kravis Roberts & Co. L.P. ("KKR") controlled approximately 44.8% of the issued and outstanding common stock of the Company.

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

Principles of Consolidation

The Company evaluates, at inception, each investment to determine if it qualifies as a variable interest entity ("VIE") under the authoritative guidance for consolidations. A variable interest entity is an entity used for business purposes that either (a) does not have equity investors with voting rights or (b) has equity investors who are not required to provide sufficient financial resources for the entity to support is activities without additional subordinated financial support. Upon the occurrence of certain events outlined in the FASB's consolidation guidance, the Company reassesses its initial determination of whether the investment is a VIE.

The Company also evaluates whether it is the primary beneficiary of each VIE and consolidates the VIE if the Company has both (a) the power to direct the economically significant activities of the entity and (b) the obligation to absorb losses of, or the right to receive benefits from, the entity that could potentially be significant to the VIE. The Company considers the contractual agreement that define ownership structure, distribution of profits and losses, risks, responsibilities, indebtedness, voting rights and board representation of the respective parties in determining whether it qualifies as the primary beneficiary. The Company also considers all parties that have direct or implicit variable interests when determining whether it is the primary beneficiary. When the Company is determined to be the primary beneficiary, the VIE is consolidated. As required by the Financial Accounting Standard Board's (the "FASB") consolidation guidance, the assessment of whether the Company is the primary beneficiary of the VIE is continuously performed.

On June 13, 2012, the Company acquired a 45% ownership interest in Comfort Revolution International, LLC ("Comfort Revolution"), a joint venture with Comfort Revolution, LLC ("CR

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 1: Basis of Presentation and Significant Accounting Policies (Continued)

Member"). Upon review of the FASB authoritative guidance for consolidation, the Company determined that Comfort Revolution constitutes a VIE for which the Company is considered to be the primary beneficiary due, primarily, to the Company's disproportionate share of the economic risk associated with its equity contribution and debt financing. As of August 26, 2012, the Company had recorded net assets of $9.9 million within the accompanying Condensed Consolidated Balance Sheets related to Comfort Revolution. These assets are only able to be used to settle obligations of Comfort Revolution. Further, the creditors of Comfort Revolution do not have recourse to the assets of the Company. Since the Company is considered to be the primary beneficiary, the financial statements of Comfort Revolution are consolidated herein.

Due to the difference in Comfort Revolution's fiscal year, which ends on December 31, and the availability of financial statements from Comfort Revolution, the results of Comfort Revolution are presented on a two month lag. As such, for the three and nine month periods ended August 26, 2012, the results of Comfort Revolution are included from the acquisition date through June 30, 2012.

The Company also invests in a group of joint ventures which were formed to develop markets forSealy branded products in Asia, New Zealand and India. The Company has concluded that these entities do not qualify as VIEs and are accounted for as equity method investments since the Company is deemed to have significant influence but does not have effective control of the entities.

Promotional Displays

The Company invests in promotional displays in certain retail stores for certain products to demonstrate product features and specifications. These assets are owned by the Company and are considered to be productive assets which provide the benefits described above. The Company's investment in promotional displays is carried at cost less accumulated depreciation. Depreciation is provided by the straight line method for each display over a period of two years, which represents the estimated period of the benefit provided by these assets. Promotional displays of $9.8 million and related accumulated depreciation of $1.8 million as of August 26, 2012 were recognized as a component of property, plant and equipment and accumulated depreciation, respectively in the Condensed Consolidated Balance Sheets. Depreciation expense related to these displays for the three and nine months ended August 26, 2012 was $0.6 million and $1.0 million, respectively and is recorded as a component of selling, general and administrative expense in the Condensed Consolidated Statement of Operations.

The Company's significant accounting policies are described in Note 1 to the annual consolidated financial statements for the year ended November 27, 2011 within the Company's Annual Report on Form 10-K.

Note 2: Recently Issued Authoritative Accounting Guidance

In January 2010, the FASB issued authoritative guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The Company adopted the portion of this guidance that requires a gross reporting of purchases, sales, issuance and settlements of assets and liabilities measured using Level 3 fair value measurements in the first quarter of fiscal 2012. The

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Authoritative Accounting Guidance (Continued)

adoption of this guidance did not have a significant impact on the financial statements due to the immateriality of the Company's assets and liabilities measured using a Level 3 fair value measurement.

In December 2010, the FASB issued authoritative guidance that modifies the requirements of step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. The Company adopted this guidance in the first quarter of fiscal 2012. The adoption of this guidance did not have a significant impact on the financial statements of the Company due to the conclusion that it is more likely than not that the goodwill of reporting units with negative carrying values are not impaired.

In May 2011, the FASB issued authoritative guidance to improve the consistency of fair value measurement and disclosure requirements between US GAAP and International Financial Reporting Standards ("IFRS"). The provisions of this guidance change certain of the fair value principles related to the highest and best use premise, the consideration of blockage factors and other premiums and discounts, the measurement of financial instruments held in a portfolio and instruments classified within shareholders' equity. Further, the guidance provides additional disclosure requirements surrounding Level 3 fair value measurements, the uses of nonfinancial assets in certain circumstances and identification of the level in the fair value hierarchy used for assets and liabilities which are not recorded at fair value, but where fair value is disclosed. The Company adopted this guidance in the second quarter of fiscal 2012. The adoption of this guidance did not have a significant impact on the Company's financial statements.

In June 2011, the FASB issued authoritative guidance surrounding the presentation of comprehensive income, with an objective of increasing the prominence of items reported in other comprehensive income ("OCI"). This guidance provides entities with the option to present the total of comprehensive income, the components of net income and the components of OCI in either a single continuous statement of comprehensive income or in two separate but consecutive statements. In addition, entities must present on the face of the financial statement, items reclassified from OCI to net income in the section of the financial statement where the components of net income and OCI are presented, regardless of the option selected to present comprehensive income. The guidance is applicable retrospectively and is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2011. Early adoption is permitted. The Company will adopt this guidance in the first quarter of fiscal 2013, and is currently evaluating its options for the presentation of comprehensive income upon adoption.

In September 2011, the FASB issued authoritative guidance that permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The Company plans to adopt this guidance in the fourth quarter of fiscal 2012 in connection with its annual testing of goodwill for impairment.

In September 2011, the FASB issued authoritative guidance that increases the Company's disclosures surrounding the multiemployer pension plans in which it participates by providing users with additional information to 1) assess the potential future cash flow implications relating to the Company's participation in these plans and 2) indicate the financial health of all of the significant plans in which the Company participates. The Company will adopt this guidance in the fourth quarter of fiscal 2012.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 2: Recently Issued Authoritative Accounting Guidance (Continued)

The adoption of this guidance will increase the Company's disclosures surrounding its participation in multiemployer pension plans.

Note 3: Share-Based Compensation

The Company maintains the 1998 Stock Option Plan ("1998 Plan") and the 2004 Stock Option Plan for Key Employees of Sealy Corporation and its Subsidiaries ("2004 Plan") which are collectively referred to as the "Option Plans". The Company accounts for all new share-based awards granted and outstanding using the fair value based method under FASB authoritative guidance surrounding share-based payments. Total share-based compensation recognized during the three and nine months ended August 26, 2012 and August 28, 2011 was $1.8 million and $6.6 million, respectively, for fiscal 2012 and $3.5 million and $9.2 million, respectively, for fiscal 2011.

Stock Option Awards

During the three and nine months ended August 26, 2012 and August 28, 2011, the Company granted no new options to purchase shares of its common stock.

A summary of outstanding options under the 1998 Plan as of August 26, 2012, is presented below:

	Shares Subject to Options			Weighted Average Exercise Price Per Share

Outstanding November 27, 2011		1,508,275		$	0.99
Exercised		(12,002	)		1.40
Forfeited		(10,999	)		2.57

Outstanding August 26, 2012 (all fully vested and exercisable)		1,485,274		$	0.97
Weighted average remaining contractual term		1.6 years
Aggregate intrinsic value of in-the-money options at August 26, 2012 (in thousands)	$	1,094

A summary of outstanding options under the 2004 Plan as of August 26, 2012, is presented below:

	Shares Subject to Options			Weighted Average Exercise Price Per Share

Outstanding November 27, 2011		5,394,364		$	5.43
Exercised		(28,000	)	$	1.64
Forfeited		(90,872	)	$	5.45

Outstanding August 26, 2012		5,275,492		$	5.45
Weighted average remaining contractual term		2.8 years
Aggregate intrinsic value of in-the-money options (in thousands)	$	48
Exercisable at August 26, 2012		4,648,431
Weighted average remaining contractual term		2.9 years
Aggregate intrinsic value of in-the-money options (in thousands)	$	48

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 3: Share-Based Compensation (Continued)

As of August 26, 2012, the Company had approximately $0.3 million of unrecognized compensation expense related to stock option awards, which is expected to be recognized over a weighted average period of 1.4 years.

The Company has granted stock options to employees that have accelerated vesting provisions which take effect if certain performance levels are achieved by the Company. If the Company does not meet these performance targets, then the vesting of the options occurs over the remainder of the requisite service period. As of August 26, 2012, the performance targets for certain of these stock options have not been met. As such, the related unrecognized compensation cost is being recognized over the remainder of the requisite service period.

Restricted Share Unit Awards

During the three and nine months ended August 26, 2012 and August 28, 2011, the Company approved the following grants of time-based restricted stock units ("RSUs"):

	Three months				Nine months

	August 26, 2012		August 28, 2011		August 26, 2012		August 28, 2011
Number of awards granted		76,000		50,000		587,456		2,120,156
Weighted average grant date fair value	$	1.83	$	2.31	$	1.85	$	2.64

The awards granted in fiscal 2012 and 2011 vest ratably over a requisite service period and do not contain an accretion factor. The fair value of the Company's RSU awards is based on the closing price of the Company's common stock as of the grant date. The Company has outstanding RSU awards of two types: 1) Time-based RSU awards that accrete in the number of RSUs at an annual rate of 8% payable semi-annually until the RSUs are vested or forfeited; and 2) Time-based RSU awards that vest ratably over a requisite service period. Certain of the Company's outstanding RSUs contain dividend participation rights and are considered participating securities for the purposes of calculating the Company's earnings per share. The unrecognized compensation expense for the outstanding unvested RSU awards as of August 26, 2012 is $3,569 (in thousands).

A summary of restricted share unit award activity for the nine months ended August 26, 2012, is presented below:

			Weighted Average Grant Date Fair Value

Outstanding November 27, 2011	10,728,028		$	2.16
Granted	587,456			1.85
Vested	(4,820,324	)		2.03
Forfeited	(482,320	)		1.48

Outstanding August 26, 2012	6,012,840		$	2.26
Expected to vest August 26, 2012	5,703,172			2.27
Weighted average remaining vesting period	4.5 years

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 4: Inventories

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

	August 26, 2012		November 27, 2011

Raw materials	$	29,566	$	25,635
Work in process		24,866		26,056
Finished goods		16,387		5,311

	$	70,819	$	57,002

Note 5: Warranty Costs

The Company's warranty policy provides a 10-year non-prorated warranty service period on all currently manufacturedSealy Posturepedic, andBassett bedding products and certain otherSealy branded products. In addition, the Company is beginning a 20 year, limited warranty (10 year non-prorated and 10 year additional warranty on certain components of its 2012Optimum by Sealy Posturepedic andStearns & Foster products. Also, the Company has a 20-year warranty on the major components of itsTrueForm andMirrorForm visco-elastic products and itsSpringFree latex product, the last ten years of which are prorated on a straight-line basis. Though discontinued in 2008, the Company also offered a 20-year limited warranty on itsRightTouch product line which covered only certain parts of the product and will be prorated for part of the twenty years. The Company's policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded. The estimate involves an average lag time in days between the sale of a bed and the date of its return, applied to the current rate of the warranty returns.

The change in the Company's accrued warranty obligations for each of the nine months ended August 26, 2012 and August 28, 2011 was as follows (in thousands):

	August 26, 2012			August 28, 2011

Accrued warranty obligations at beginning of period	$	13,606		$	17,584
Warranty claims		(12,980	)		(11,823	)
Warranty provisions		15,888			11,238

Accrued warranty obligations at end of period	$	16,514		$	16,999

As of August 26, 2012 and November 27, 2011, $9.3 million and $7.5 million are included as a component of other accrued liabilities and $7.2 million and $6.1 million are included as a component of other noncurrent liabilities within the accompanying Condensed Consolidated Balance Sheet, respectively. In estimating its warranty obligations, the Company considers the impact of recoverable salvage value on warranty cost in determining its estimate of future warranty obligations. Warranty claims and provisions shown above do not include estimated salvage recoveries that reduced cost of sales by $3.9 million and $3.8 million for the nine months ended August 26, 2012 and the nine months ended August 28, 2011, respectively.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 6: Goodwill and Other Intangible Assets

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

The changes in the carrying amount of goodwill for the nine months ended August 26, 2012 are as follows (in thousands):


Balance as of November 27, 2011	$	361,026
Additions due to acquisition of Comfort Revolution		357
Increase due to foreign currency translation		1,922

Balance as of August 26, 2012	$	363,305

The Company's intangible assets consist of the following (in thousands):

	August 26, 2012							November 27, 2011

	Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization			Net Carrying Amount		Weighted Average Useful Life
Licenses	$	4,617	$	(3,716	)	$	901	$	4,617	$	(3,501	)	$	1,116		15.0
Trademarks		3,100		—			3,100		—		—			—		11.5
Intellectual property		3,300		—			3,300		—		—			—		9.5
Customer relationships		8,700		—			8,700		—		—			—		10.5

Total intangible assets	$	19,717	$	(3,716	)	$	16,001	$	4,617	$	(3,501	)	$	1,116		11.5

Intangible assets with determinable lives are amortized using a straight-line method. Costs to renew or extend the term of a recognized intangible asset are expensed as incurred. During each of the three and nine months ended August 26, 2012 and August 28, 2011, the Company recognized amortization expense associated with intangibles of $0.1 million and $0.2 million, for both fiscal 2011 and fiscal 2010. The Company expects to recognize amortization expense relating to these intangibles of $0.7 million for the remainder of 2012, $1.7 million in 2013, $1.7 million in 2014, $1.7 million in 2015, $1.4 million in 2016 and $8.6 million thereafter.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 7: Debt Issuance Costs

Senior Note Redemptions

During the nine months ended August 26, 2012 and August 28, 2011, the Company redeemed portions of the principal amount of its outstanding senior secured notes due April 2016 (the "Senior Notes") at a redemption price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date. The Company did not redeem any of its outstanding Senior Notes during the three months ended August 26, 2012 and August 28, 2011.

	Nine Months Ended

	August 26, 2012		August 28, 2011
Principal amount redeemed	$	35,000	$	10,000

Premium paid to redeem the notes	$	1,050	$	300
Write-off of related debt issuance costs and original issue discount		1,862		643

	$	2,912	$	943

ABL Revolver Amendment

On May 9, 2012, the Company amended and restated its existing senior secured asset-based revolving credit facility to extend the stated maturity of this facility until May 2017 and amend certain other provisions. In connection with this amendment, the Company recorded fees of $1.0 million which were deferred and will be amortized over the life of the amended agreement. As of August 26, 2012, $0.3 million of these fees had not yet been paid and were recorded as a component of other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. In addition, the remaining unamortized debt issuance costs associated with the existing senior revolving credit facility will continue to be amortized over the life of the agreement, as amended, in accordance with the authoritative accounting guidance surrounding debtor's accounting for changes in line-of-credit or revolving-debt arrangements.

Note 8: Unconsolidated Affiliate Companies

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

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 8: Unconsolidated Affiliate Companies (Continued)

Summarized statements of operations for these joint ventures for each of the three and nine month periods ended are as follows (in thousands):

	Three months				Nine months

	August 26, 2012		August 28, 2011		August 26, 2012		August 28, 2011
Revenues	$	17,186	$	13,627	$	49,066	$	39,048
Gross profit		10,855		8,476		31,286		24,098
Income from operations		2,148		2,374		8,356		6,038
Net income		1,696		2,114		6,513		5,069

Note 9: Long-Term Obligations

Long-term obligations as of August 26, 2012 and November 27, 2011 consisted of the following (in thousands):

	August 26, 2012			November 27, 2011

Asset-based revolving credit facility	$	—		$	—
Senior notes		263,291			296,119
Convertible notes(1)		187,083			185,268
Senior subordinated notes		268,945			268,945
Financing obligations		40,288			41,225
Other		921			324

		760,528			791,881
Less current portion		(2,324	)		(1,584	)

	$	758,204		$	790,297

(1): Includes paid in kind ("PIK") interest of $2.0 million from July 16, 2012 through August 26, 2012 for which the principal balance of the Convertible Notes has not yet been increased. This balance also includes the impact of unamortized beneficial conversion features recognized upon prior interest payment dates.

The Company's outstanding debt as of August 26, 2012 primarily consists of the following: 1) a senior secured asset-based revolving credit facility (the "Amended ABL Revolver") which is discussed further below; 2) $270.0 million in aggregate principal amount of Senior Notes; 3) $221.1 million in aggregate principal amount of senior secured convertible PIK notes due June 2016 which are convertible into shares of the Company's common stock (the "Convertible Notes") and 4) $268.9 million aggregate principal amount of senior subordinated notes due June 2014, which bear interest at 8.25% per annum payable semi annually (the "2014 Notes").

Debt Refinancing

On May 9, 2012, the Company amended its existing senior secured asset-based revolving credit facility to extend the stated maturity of this facility until May 2017 and amend certain other provisions. In addition to the extension of the maturity date, the amendment to the facility provides for an

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

increase in the available accordion feature on the facility which, if exercised and additional commitments are obtained, can increase the total principal amount to $150.0 million. Further, the amendment provides an adjustment to the interest margins which both reduced the margin rates and provides a feature through which they adjust based on the availability under the facility. In connection with this amendment, the Company incurred charges of $1.0 million which have been recorded as a component of deferred debt issuance costs and will be amortized over the remaining maturity of the agreement as a component of interest expense (See Note 7).

Amended and Restated ABL Revolver

The Company's Amended ABL Revolver provides for revolving credit financing of up to $100.0 million (or, if the accordion feature described above is exercised and additional commitments are obtained, $150.0 million), subject to borrowing base availability, and matures in May 2017. The borrowing base consists of the following: 1) 85% of the net amount of eligible accounts receivable and 2) the lesser of (i) 85% of the net orderly liquidation value of eligible inventory or (ii) 75% of the net amount of eligible inventory. These amounts are reduced by reserves deemed necessary by the security agents for the facility. Borrowings under the Amended ABL Revolver bear interest at the Company's choice of either a base rate (determined by reference to the highest of three rates as defined in the Amended ABL Revolver agreement) or a LIBOR rate for U.S. dollar deposits plus an applicable margin between 0.75% and 1.25% for base rate loans and 1.75% and 2.25% for LIBOR loans based on current availability. The Amended ABL Revolver also requires the Company to pay a commitment fee for the unused portion. As of August 26, 2012, there were no amounts outstanding under the Amended ABL Revolver. At August 26, 2012, the Company had approximately $77.7 million available under the Amended ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $16.9 million.

The obligations under the Company's Amended ABL Revolver are guaranteed by Sealy Mattress Corporation and all of its current and future domestic subsidiaries, and are also secured by substantially all of the assets of the Company and the assets of its current and future domestic subsidiaries through a first-priority security interest in the accounts receivable, inventory, cash, related general intangibles and instruments and proceeds of the foregoing, and a second-priority security interest in substantially all of the Company's material real property and equipment and all other assets of its current and future domestic subsidiaries that secure the Senior Notes on a first-priority basis.

The Amended ABL Revolver agreement requires the Company to maintain a fixed charge coverage ratio in excess of 1.0 to 1.0 in periods of minimum availability under the facility where the availability for two consecutive calendar days is less than the greater of 1) 12.5% of the borrowing base under the Amended ABL Revolver and 2) $10.0 million. As of August 26, 2012, the Company was not in a minimum availability period under the Amended ABL Revolver.

In accordance with FASB authoritative guidance, the Company will classify borrowings under its Amended ABL Revolver, which has a maturity date of more than one year from the balance sheet date, as a current liability since it includes both a lockbox arrangement and a subjective acceleration clause.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

Senior Notes

The Senior Notes mature in April 2016 and bear interest at 10.875% per annum payable semi-annually in arrears on April 15 and October 15. The total proceeds received by the Company from the issuance of these notes was $335.9 million, resulting in an original issue discount ("OID") of $14.1 million which will be accreted over the life of the agreement with the related expense recognized as a component of interest expense in the Condensed Consolidated Statement of Operations. For each of the three and nine months ended August 26, 2012 and August 28, 2011, the Company recognized additional interest expense related to the accretion of the OID of $0.4 million and $1.3 million, respectively, for fiscal 2012 and $0.4 and $1.1 million, respectively, for fiscal 2011.

As discussed in Note 7, during the nine months ended August 26, 2012 and August 28, 2011, the Company redeemed a portion of the principal amount of its outstanding Senior Notes at a redemption price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date.

Convertible PIK Notes

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

During the three and nine months ended August 26, 2012, there were no conversions of Convertible Notes into common shares.

The Company accounts for the PIK interest on the Convertible Notes in accordance with the applicable FASB authoritative guidance pertaining to convertible instruments and derivative financial instruments indexed to, and potentially settled in, a company's own stock. This guidance requires an allocation of a portion of the issuance amount to an embedded beneficial conversion feature based on the difference between the effective conversion price of the convertible debt of $1.00 and the fair value of the underlying common stock. Upon the January 15, 2012 interest payment date, the fair value of the underlying common stock was $1.87. Therefore, a beneficial conversion feature was recognized for 87% of the total PIK interest payment. Upon the July 15, 2012 interest payment date, the fair value of the underlying common stock was $1.90. Therefore, a beneficial conversion feature was recognized for 90% of the total PIK interest payment. Upon the January 15, 2011 and July 15, 2011 interest payment date, the fair value of the underlying common stock was more than double the conversion price of the Convertible Notes. Therefore, a beneficial conversion feature was recognized for the entire amount of

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 9: Long-Term Obligations (Continued)

the PIK interest payment. Details of the amounts recognized as beneficial conversion features for the three months ended August 26, 2012 and August 28, 2011 are as follows:

	Three Months Ended				Nine Months Ended

	August 26, 2012		August 28, 2011		August 26, 2012		August 28, 2011
	(in thousands)				(in thousands)
January 15	$	—	$	—	$	7,114	$	7,563
July 15		7,654		7,864		7,654		7,864

	$	7,654	$	7,864	$	14,768	$	15,427

The outstanding balance of the Convertible Notes at August 26, 2012 was $187.1 million which includes accrued but unpaid interest as well as the total of the unamortized beneficial conversion features of $35.7 million which are recognized as a discount to the outstanding principal amount. The recognized discounts for the beneficial conversion features will be accreted through interest expense over the remaining term of the Convertible Notes.

The indentures and agreements governing the Amended ABL Revolver, Senior Notes, Convertible Notes and the 2014 Notes also impose certain restrictions including, but not limited to, the payment of dividends or other equity distributions and the incurrence of debt or liens upon the assets of the Company or its subsidiaries. For instance, the agreement governing the Amended ABL Revolver contains restrictions on the ability of Sealy Corporation's subsidiaries to pay dividends or make other distributions to Sealy Corporation subject to specified exceptions including the satisfaction of a minimum fixed charge coverage ratio and average daily availability levels. Likewise, under the indentures governing the Senior Notes and 2014 Notes, Sealy Mattress Company is restricted from paying dividends or making other distributions to Sealy Corporation unless Sealy Mattress Company is able to satisfy certain requirements or use an available exception from the limitation. Although we meet the minimum fixed charge coverage ratio requirements contained in our Amended ABL Revolver agreement, the Company does not meet the minimum fixed charge coverage ratio levels under the note indentures as of August 26, 2012, therefore the Company is limited in its ability to incur new indebtedness and pay dividends and distributions, other than pursuant to specified exceptions in these agreements. As of August 26, 2012, Sealy Mattress Company is restricted in distributing the net assets of its subsidiaries in the amount of $230.4 million to its parent due to the provisions in its long-term debt agreements. However, $30.0 million would be available for distribution without restriction to the parent and to the common shareholders of Sealy Corporation. At August 26, 2012, the Company was in compliance with the covenants contained within the related note indentures and agreements.

Note 10: Acquisition

On June 13, 2012, the Company obtained a 45% ownership interest in a newly formed company, Comfort Revolution, an investment with the CR Member for a contribution of $10.0 million. Upon formation, the CR Member contributed the assets and liabilities of its existing business. Comfort Revolution develops specialty foam and gel bedding products which are believed to complement the Company's product offerings and had net revenues of approximately $8.9 million for the fiscal year ended December 31, 2011.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Acquisition (Continued)

The Company's $10.0 million equity contribution to Comfort Revolution was used, in part, to retire and terminate an existing $8.1 million of debt and pay $0.4 million in legal and advisory fees. These amounts were paid to members of the acquired enterprise or their affiliates.

In connection with the acquisition, the Company entered into a revolving credit facility arrangement with Comfort Revolution under which it is obligated to provide funding up to $20.0 million for the operations of this entity. This credit facility bears interest at a rate of 12.0% per annum and matures in June 2014. Further, Comfort Revolution will be obligated to pay royalties to the Company for its sales ofSealy andStearns & Foster branded product under the terms of a licensing arrangement.

The consolidated statements of operations include the results of Comfort Revolution since the date of acquisition. The assets acquired and liabilities assumed through this acquisition have been recorded at preliminary estimates of fair value based on information currently available and on current assumptions as to the future operations of Comfort Revolution. The Company will recognize additional assets or liabilities if new information is obtained during the measurement period about facts and circumstances that existed as of the acquisition date that, if known, would have resulted in the recognition of those assets and liabilities as of that date. The measurement period will not exceed one year from the acquisition date. These preliminary estimates are subject to change upon the completion of the acquisition accounting.

The following is a summary of the preliminary fair values of the assets acquired and liabilities assumed based on the acquisition (amounts in thousands):


Assets acquired:
Current assets, including cash and equivalents of $10,159	$	16,010
Property, plant and equipment		481
Goodwill		357
Intangible assets		15,100
Other assets		35

Total assets acquired		31,983

Liabilities assumed:
Current liabilities		1,659
Other long-term liabilities		8,102

Total liabilities assumed		9,761

Noncontrolling interest		(12,222	)

Net assets acquired	$	10,000

The identifiable intangible assets acquired consist of trademarks, customer relationships and intellectual property of $3.1 million, $8.7 million and $3.3 million, respectively, with such amounts based on a preliminary assessment of the fair value. The fair value of the noncontrolling interest was determined using a market approach based on the Company's acquisition of its 45% ownership stake in Comfort Revolution as well as the enterprise values of comparable companies in the industry.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 10: Acquisition (Continued)

Between the acquisition date and June 30, 2012, Comfort Revolution recognized revenues and a net loss of $1.1 million and $0.2 million, respectively. During the three and nine months ended August 26, 2012, we incurred acquisition related costs for Comfort Revolution of $0.2 million which have been recorded as a component of selling, general and administrative expense in the accompanying Condensed Consolidated Statements of Operations.

Note 11: Derivative Instruments and Hedging Strategies

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

Foreign Currency Exposure

The Company is exposed to foreign currency risk related to purchases of materials and certain equipment made in a foreign currency. To manage the risk associated with fluctuations in foreign currencies, the Company enters into foreign currency forward and option contracts. As with its interest rate swap instruments, the Company designates certain of these contracts as hedging instruments and enters into some contracts that are considered to be economic hedges which are not designated as hedging instruments. Whether designated or undesignated, these contracts protect against the reduction in value of forecasted foreign currency cash flows resulting from payments in a foreign currency. The fair values of foreign currency agreements are estimated as described in Note 11, taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable. Details of the specific instruments used by the Company to hedge its exposure to foreign currency fluctuations are as follows:

At August 26, 2012, the Company had outstanding 49 forward foreign currency contracts to sell a total of 31.5 million Canadian dollars and receive U.S. dollars at specified exchange rates with expiration dates ranging from September 2012 through August 2013. These hedges were entered into to protect against the fluctuation in the Canadian subsidiary's U.S. dollar denominated purchases of raw materials. The Company has formally designated these contracts as cash flow hedges, and they are expected to be highly effective in offsetting fluctuations in the forecasted purchases of these raw materials related to changes in the foreign currency exchange rates.

The Company also enters into foreign currency contracts that are not designated as hedges for accounting purposes. The changes in fair value of these foreign currency hedges are included as a part of cost of goods sold in the Condensed Consolidated Statements of Operations. At August 26, 2012 and November 27, 2011, the Company did not have any outstanding foreign currency contracts that were not designated as hedges for accounting purposes.

At August 26, 2012, the maximum length of time over which the Company is hedging its exposure to the reduction in value of forecasted foreign currency cash flows through foreign currency forward agreements is through August 2013. Over the next 12 months, the Company expects to reclassify $0.5 million of deferred losses from accumulated other comprehensive income to cost of goods sold as related forecasted foreign currency payments are made.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 11: Derivative Instruments and Hedging Strategies (Continued)

For the three and nine months ended August 26, 2012, the Company recognized foreign currency transaction losses of $0.2 million and $0.1 million, respectively, compared with gains of $0.1 million and $1.3 million for the three and nine months ended August 28, 2011, respectively. These amounts are recognized in cost of goods sold, selling, general and administrative expenses, or royalty income, net at the time they occur.

Commodity Price Exposure

The Company is exposed to risk associated with fluctuations in the prices of diesel fuel used in the transportation of its finished product to its customers. To manage this risk, the Company enters into fixed price swap agreements. These agreements were entered into to protect against the fluctuations in the prices of diesel fuel purchased by certain of the Company's U.S. manufacturing facilities. The fair values of the fixed price swap agreements are estimated as described in Note 12, taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable. Details of the specific instruments used by the Company to hedge its exposure to foreign currency fluctuations are as follows:

At August 26, 2012, the Company had outstanding fourteen fixed price swap contracts to purchase 2.1 million gallons of diesel fuel at specified prices from August 2012 through May 2013. Since these contracts were not formally designated as cash flow hedges, the $0.2 million change in fair value is recorded as a component of selling, general and administrative expense in the Condensed Consolidated Statements of Operations.

Embedded Derivatives

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

The Company concluded that the floor on the foreign exchange rate related to the payments to be made associated with the lease of its former Brazilian manufacturing facility and the related purchase option qualifies as an embedded derivative instrument that should be bifurcated from the lease agreement and recorded at fair value at the end of each reporting period. As of August 26, 2012 and November 27, 2011, the fair value of this derivative was an insignificant amount and is recorded as a component of debt issuance costs, net, and other assets in the Consolidated Balance Sheet. The initial fair value of the embedded derivative was recorded as deferred lease income and is being amortized over the term of the lease.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 11: Derivative Instruments and Hedging Strategies (Continued)

At August 26, 2012 and November 27, 2011, the fair value carrying amount of the Company's derivative instruments was recorded as follows (in thousands):

	Asset Derivatives			Liability Derivatives

	August 26, 2012			August 26, 2012
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Foreign exchange contracts	Other current assets	$	—	Other current liabilities	$	(474	)

Total derivatives designated as hedging instruments			—			(474	)

Derivatives not designated as hedging instruments
Commodity fixed price swap contracts	Other current assets		132	Other current liabilities		—

Total derivatives not designated as hedging instruments			132			—

Total derivatives		$	132		$	(474	)

	Asset Derivatives			Liability Derivatives

	November 27, 2011			November 27, 2011
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Derivatives designated as hedging instruments
Foreign exchange contracts	Other current assets	$	1,368	Other current liabilities	$	(34	)

Total derivatives designated as hedging instruments			1,368			(34	)

Total derivatives		$	1,368		$	(34	)

The effect of derivative instruments on the Consolidated Statement of Operations for the three and nine months ended August 26, 2012 and August 28, 2011 was not significant.

Note 12: Fair Value of Financial Instruments

For assets and liabilities measured at fair value on a recurring basis during the period, the Company uses an income approach to value the assets and liabilities for outstanding foreign currency derivative contracts discussed above in Note 11. These contracts are valued using an income approach, which consists of a discounted cash flow model that takes into account the present value of future cash flows under the terms of the contracts by using current market information available as of the reporting date such as prevailing interest rates and foreign currency spot and forward rates. We mitigate derivative credit risk by transacting with highly rated counterparties. There were no non-financial assets or liabilities requiring initial measurement or subsequent remeasurement during the first nine months

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 12: Fair Value of Financial Instruments (Continued)

of fiscal 2012 or 2011. The following table provides a summary of the fair values of assets and liabilities (in thousands):

				Fair Value Measurements at August 26, 2012 Using

	August 26, 2012			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Foreign exchange and commodity derivative assets	$	132		$	—	$	132		$	—
Foreign exchange and commodity derivative liabilities		(474	)		—		(474	)		—

Total	$	(342	)	$	—	$	(342	)	$	—

				Fair Value Measurements at November 27, 2011 Using

	November 27, 2011			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Foreign exchange and commodity derivative assets	$	1,379		$	—	$	1,379		$	—
Foreign exchange and commodity derivative liabilities		(34	)		—		(34	)		—
Embedded foreign currency derivative in lease agreement		56			—		—			56

Total	$	1,401		$	—	$	1,345		$	56

Due to the short maturity of cash and equivalents, accounts receivable, accounts payable and accrued expenses, their carrying values approximate fair value. The fair value of long term debt which is valued using Level 1 inputs based on quoted market prices, at August 26, 2012 was as follows (in thousands):


Senior Secured Notes	$	293,625
Convertible Notes		398,370
Senior Subordinated Notes		268,273

Note 13: Discontinued Operations

In the fourth quarter of fiscal 2010, management divested the assets of its European manufacturing operations in France and Italy and ceased manufacturing operations in Brazil. These businesses have been accounted for as discontinued operations. During the three and nine months ended August 26, 2012, the Company continued the liquidation of certain of its assets related to its Brazil operations. The charges related to these activities were recorded as a component of discontinued operations. The remaining current assets and liabilities of the Brazilian operations reflected within the Consolidated

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 13: Discontinued Operations (Continued)

Balance Sheet at August 26, 2012 and November 27, 2011 were immaterial. The Company also recognized additional expenses related to the settlement of certain outstanding contingencies related to the sale of the European business unit which resulted in the recognition of an additional $0.9 million of expense relating to the disposition of its European manufacturing operations.

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

	Three months ended						Nine months ended

	August 26, 2012			August 28, 2011			August 26, 2012			August 28, 2011
Net sales	$	—		$	—		$	—		$	—
Loss before income taxes		(173	)		(466	)		(665	)		(1,630	)
Income tax provision (benefit)		—			—			—			—

Loss from operations of discontinued operations		(173	)		(466	)		(665	)		(1,630	)
Loss on disposition of business, net of tax of $0 and $164		(134	)		(425	)		(1,149	)		(1,420	)

Loss from discontinued operations	$	(307	)	$	(891	)	$	(1,814	)	$	(3,050	)

In connection with the sale of the Company's European manufacturing operations, the Company made certain guarantees with respect to the existence of liabilities and deficiencies related to assets as of the closing date that were not reflected in the European business' financial statements as of the closing date. Further, certain guarantees were made with respect to losses or damages incurred by the purchaser related to any misrepresentations or warranties made by the Company, outstanding disputes or judicial proceedings. Such guarantees are limited to an aggregate amount of €1.8 million under the terms of the contract. During the three and nine months ended August 26, 2012, the Company settled certain outstanding claims related to these guarantees for €1.8 million.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 14: Defined Benefit Pension Expense

The components of net periodic pension cost recognized for the Company's defined benefit pension plans in the U.S. and Canada for the three and nine months ended August 26, 2012 and August 28, 2011 are as follows (in thousands):

	Three Months Ended						Nine Months Ended

	August 26, 2012			August 28, 2011			August 26, 2012			August 28, 2011
Service cost	$	240		$	199		$	721		$	597
Interest cost		382			360			1,146			1,079
Expected return on plan assets		(388	)		(367	)		(1,165	)		(1,100	)
Amortization of unrecognized losses		202			35			606			106
Amortization of unrecognized prior service cost		38			144			113			432

Net periodic pension cost*	$	474		$	371		$	1,421		$	1,114

Cash contributions	$	426		$	538		$	426		$	758

Weighted average expected return on plan assets		7.50	%		7.85	%		7.50	%		7.85	%

*: Net periodic pension cost recognized for the three and nine months ended August 26, 2012 is based upon preliminary estimates pending the final actuarial determination of such costs for fiscal 2012. Similarly, net periodic pension cost for the three and nine months ended August 28, 2011 is based upon preliminary estimates.

The Company expects to make additional cash contributions to the defined benefit pension plans of approximately $1.3 million during the remainder of fiscal 2012.

Note 15: Income Taxes

The Company's effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of non-deductible interest on the Company's Convertible Notes, certain foreign tax rate differentials and state and local income taxes. The effective tax rate for the three and nine months ended August 26, 2012 was approximately 106.7% and 92.2%, respectively, compared to approximately 59.8% and 57.1%, respectively, for the three and nine months ended August 28, 2011. The effective rate for the three months ended August 26, 2012 was higher than the rate for the three months ended August 28, 2011, primarily due to the impact of the permanent tax differences, the most significant of which relates to the non-deductible interest on the Company's Convertible Notes.

The Condensed Consolidated Balance Sheet as of August 26, 2012 includes accrued interest of $3.7 million and penalties of $1.7 million due to unrecognized tax benefits. As of November 27, 2011, the Company had recorded accrued interest of $3.7 million and penalties of $1.9 million due to unrecognized tax benefits.

The Company expects the liability for uncertain tax positions to decrease by approximately $1.5 million within the succeeding twelve months due to expiration of income tax statutes of limitations. Federal years open to examination are fiscal year 2004 and forward. State and international jurisdictions remain open to examination for fiscal year 2000 and forward.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 15: Income Taxes (Continued)

Significant judgment is required in evaluating the Company's federal, state and foreign tax positions and in the determination of its tax provision. Despite the Company's belief that its liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of any particular tax matter. The Company may adjust these liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, or resolution of issues in the courts. These adjustments are recognized as a component of income tax expense entirely in the period in which they are identified. The Company is currently undergoing examinations of certain of its corporate income tax returns by tax authorities. Issues related to certain of these reserves have been presented to the Company and the Company believes that such audits will not result in a material assessment or payment of taxes related to these positions during the one year period following August 26, 2012. The Company also cannot predict when or if any other future tax payments related to these tax positions may occur.

Note 16: Redeemable Noncontrolling Interest

The Company is party to a put and call arrangement with respect to the common securities that represent the 55% noncontrolling interest from the acquisition of Comfort Revolution. The call arrangement may be exercised by the Company upon the fifth anniversary of the acquisition date. Likewise, the put arrangement may be exercised by the CR Member upon the sixth anniversary of the acquisition date. The redemption value of both the put and the call arrangement is equal to 7.5 times earnings before interest, taxes, depreciation and amortization ("EBITDA"), as defined in the related LLC agreement, of Comfort Revolution for the preceding 12 months, adjusted for net debt outstanding and multiplied by the 55% ownership interest held by the CR Member. Due to the existing put and call arrangements, the noncontrolling interest is considered to be redeemable in accordance with the related authoritative accounting guidance and is recorded on the balance sheet as a redeemable noncontrolling interest outside of permanent equity. The redeemable noncontrolling interest is recognized at the higher of 1) the accumulated earnings associated with the noncontrolling interest or 2) the redemption value as of the balance sheet date. At August 26, 2012, the redeemable noncontrolling interest was recorded based on the fair value upon acquisition and the accumulated losses of Comfort Revolution since the acquisition date. The redemption amount as of August 26, 2012 is an insignificant amount.

A reconciliation of redeemable noncontrolling interests for the three and nine months ended August 26, 2012 is as follows (in thousands):


Balance, beginning of period	$	—
Acquisition of redeemable noncontrolling interest		12,222
Net loss attributable to noncontrolling interest		(91	)

Balance, end of period	$	12,131

Note 17: Comprehensive Income

Comprehensive income for the three and nine months ended August 26, 2012 was $5.5 million and $9.7 million, respectively and for the three and nine months ended August 28, 2011 was $5.5 million and $9.0 million, respectively. The increase in comprehensive income for the three months ended

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 17: Comprehensive Income (Continued)

August 26, 2012 compared to the three months ended August 28, 2011, was driven primarily by the Company's stronger earnings performance coupled with higher gains related to the translation effects of foreign currencies in the third quarter of fiscal 2012. The increase in comprehensive income for the nine months ended August 26, 2012 compared to the nine months ended August 28, 2011 was driven by the Company's stronger earnings performance offset by lower gains related to the translation effects of foreign currencies in the first three quarters of fiscal 2012.

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

	August 26, 2012			November 27, 2011

Unrealized gain (loss) on cash flow hedges, net of tax of $(184) and $519, respectively	$	(289	)	$	815
Unrealized actuarial loss and prior service credit for pension liability, net of tax of $6,370 and $6,623, respectively		(10,103	)		(10,438	)
Accumulated foreign currency translation adjustment		16,737			9,114

	$	6,345		$	(509	)

Note 18: Contingencies

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

Product Warranty Claims

During the third quarter of fiscal 2012, the Company identified a manufacturing defect with respect to certain of its foundation units that were sold to certain customers during the 2008 through 2011 fiscal years. The Company plans to repair or replace these defective foundation units and is expected to incur costs of $1.1 million related to the replacement products, and charges for transportation and labor. This expense was recorded as a component of cost of goods sold in the accompanying Condensed Consolidated Statement of Operations.

Multi-employer Pension Liabilities

The Company is currently involved in negotiations with representatives of its labor unions for employees of its Portland, Oregon facility with respect to a potential move of this facility to Lacey, Washington. Though a decision has not been reached regarding this move pending the results of these negotiations, if the Company relocates its operations, it is expected to incur charges of $1.8 million related to underfunded multiemployer pension plans. The payment of this liability is expected to occur over the next three years. As this liability is not considered probable as of August 26, 2012, an accrual for this liability has not been made.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 18: Contingencies (Continued)

Legal Proceedings

On July 19, 2012, a purported shareholder of the Company filed a shareholder derivative complaint in the Court of Chancery of the State of Delaware against the members of the Company's Board of Directors (the "Board"), styledPlourde, v. Rogers et al., Civ. Action No. 7709-VCP. The complaint alleges that since at least April 2009 the Board has breached its fiduciary duties and mismanaged the Company by paying certain fees to the Company's largest shareholder for services provided to the Company. The complaint further alleges that the Company has made false and misleading statements about the services provided by its largest shareholder and the payments the Company has made for such services. The Company understands that the Board expects to move to dismiss the complaint.

Environmental

The Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey Industrial Site Recovery Act. The Company and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, the Company and its subsidiary agreed to conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the property in 1997. The Company and its subsidiary retained primary responsibility for the required remediation. The Company, with the approval of the New Jersey Department of Environmental Protection, has undertaken soil remediation on the site. During 2005, with the approval of the New Jersey Department of Environmental Protection, the Company removed and disposed of sediment in Oakeys Brook adjoining the site. The Company continues to monitor ground water at the site and also operates a groundwater remediation system on the site. During the remainder of 2012, the Company plans to remove additional contaminated soil from the site. The Company has recorded a reserve as a component of other accrued liabilities and other noncurrent liabilities in the accompanying Condensed Consolidated Balance Sheets as of August 26, 2012 for $1.5 million ($2.3 million prior to discounting at 4.75%) associated with this remediation project.

The Company has also undertaken a remediation of soil and groundwater contamination at an inactive facility located in Oakville, Connecticut. Although the Company is conducting the remediation voluntarily, it obtained Connecticut Department of Environmental Protection approval of the remediation plan. The Company believes that it has essentially completed its remediation of the site. Accordingly, the Company has submitted a closure report to the Connecticut Department of Environmental Protection for the lower portion of the site and is preparing a closure report for the upper portion of the site. The Company has recorded a liability of approximately $0.1 million associated with the completion of these closure reports and the closure of the Company's remediation efforts at the site. The Company believes the contamination is attributable to the manufacturing operations of previous, unrelated, unaffiliated occupants of the facility.

The Company cannot predict the ultimate timing or costs of the South Brunswick and Oakville environmental matters. Based on facts currently known, the Company believes that the accruals recorded are adequate and does not believe the resolution of these matters will have a material effect on the financial position or future operations of the Company. However, in the event of an adverse

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 18: Contingencies (Continued)

decision by the agencies involved, or an unfavorable result in the New Jersey natural resources damages matter, these matters could have a material effect.

In 1998, the Company sold an inactive facility located in Putnam, Connecticut. Recently, the Company received a letter from the attorney for the current owner of that property claiming that Sealy may have some responsibility for an environmental condition on the property. The Company has requested additional information on this matter and is awaiting receipt of that information.

During fiscal 2010, the Company was assessed $8.0 million by the Brazilian government for the failure to provide certain income tax filings. Due to the accumulated net operating losses in this jurisdiction, the Company's exposure is expected to be limited. At August 26, 2012, the Company has recorded a reserve of $1.0 million associated with this assessment related to the expected requirement to pay certain sales tax, fees and penalties. This amount is recorded as a component of accrued expenses in the accompanying Condensed Consolidated Balance Sheets.

Note 19: Related Party Transactions

During the three and nine months ended August 26, 2012 and August 28, 2011, the Company incurred costs for consulting services rendered by KKR and Capstone Consulting LLC (a consulting company that works exclusively with KKR's portfolio companies) of an insignificant amount and $0.7 million, respectively for fiscal 2012 and $0.4 million and $1.2 million, respectively for fiscal 2011. As of August 26, 2012 and November 27, 2011, $0.1 million and $0.2 million, respectively, of the costs incurred for these services were accrued as a component of other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. The Company also participates in a lease arrangement with a KKR affiliate for our Clarion facility for a six month initial term with two six month renewal options available. The Company has received lease income on this property of an insignificant amount during the three months ended August 26, 2012 and August 28, 2011. Capstone Consulting LLC also provided general consulting services as well as specific services related to the Company's acquisition of Comfort Revolution during the three and nine months ended August 26, 2012 for which the Company did not pay fees.

Sealy Holding LLC, an affiliate of KKR, holds an aggregate amount of $118.7 million of the Company's Convertible Notes. In connection with the PIK interest payment on the Convertible Notes on January 15, 2012 and July 15, 2012, the par value of the notes held by KKR was increased by $4.4 million and $4.6 million, respectively.

During the three and nine months ended August 26, 2012, the Company's Asian joint ventures made a distribution to the Company of $1.5 million and $2.5 million, respectively. During the three and nine months ended August 28, 2011, the Company's Asian joint ventures made a distribution of $1.0 million. These amounts have been reflected as a reduction of the investment in these joint ventures in the accompanying Condensed Consolidated Balance Sheets as of August 26, 2012 and November 27, 2011.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 20: Revenue by Product and Geographical Information

Domestic Revenue by Product

The Company produces sleep sets across a range of technologies, including innerspring, latex foam and visco-elastic "memory foam". The U.S. mattress industry groups these products in categories based on innerspring and specialty technologies. The products for international locations are aggregated as they are substantially similar and the international markets do not have similar product categorization. In the domestic market the Company's net revenue by product type for the three and nine months ended August 26, 2012 and August 28, 2011 was as follows (in thousands):

	Three months ended				Nine months ended

	August 26, 2012		August 28, 2011		August 26, 2012		August 28, 2011
Net sales—Domestic innerspring bedding	$	241,610	$	232,328	$	672,914	$	672,558
Net sales—Domestic specialty bedding		37,724		20,498		75,331		62,507

Total bedding sales		279,334		252,826		748,245		735,065
Other revenue(1)		6,866		4,467		18,507		14,415

Net sales	$	286,200	$	257,293	$	766,752	$	749,480

(1): Other revenue includes external sales of Comfort Revolution and the Company's components and U.S. latex businesses.

Geographical Information

Net sales by geographic area are as follows (in thousands):

	Three Months Ended				Nine Months Ended

	August 26, 2012		August 28, 2011		August 26, 2012		August 28, 2011
United States	$	286,200	$	257,293	$	766,752	$	749,480
Canada		50,729		52,433		143,572		140,518
Other International		28,505		24,341		79,431		70,894

Total	$	365,434	$	334,067	$	989,755	$	960,892

Total International	$	79,234	$	76,774	$	223,003	$	211,412

Long lived assets (principally property, plant and equipment) outside the United States were $37.0 million and $35.4 million as of August 26, 2012 and November 27, 2011, respectively.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 21: Earnings per Share

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

	Three Months Ended						Nine Months Ended

	August 26, 2012			August 28, 2011			August 26, 2012			August 28, 2011
	(in thousands)						(in thousands)
Numerator:
Net income from continuing operations, as reported	$	201		$	7,489		$	4,622		$	8,369
Net income attributable to participating securities		(1	)		(4	)		(12	)		(7	)
Interest on convertible notes		—			5,239			—			14,551

Net income from continuing operations available to common shareholders	$	200		$	12,724		$	4,610		$	22,913

Denominator:
Denominator for basic earnings per share—weighted average shares		103,534			100,334			101,849			98,725
Effect of dilutive securities:
Convertible debt		—			200,455			—			196,576
Stock options		679			747			693			811
Restricted share units		4,977			6,561			6,213			8,117
Other		610			469			574			430

Denominator for diluted earnings per share—adjusted weighted average shares and assumed conversions		109,800			308,566			109,329			304,659

For the three and nine months ended August 26, 2012, 4,109 options and share units (in thousands) were not included in the computation of diluted earnings per share because their impact is antidilutive. Additionally, for the three and nine months ended August 26, 2012, a weighted average 216,620 and 212,521 shares (in thousands), respectively of the outstanding Convertible Notes were excluded from the computation of diluted earnings per share since their inclusion would be antidilutive. For the three and nine months ended August 28, 2011, 4,142 and 3,985 options and share units (in thousands), respectively, were not included in the computation of diluted earnings per share because their impact is antidilutive.

Note 22: Subsequent Event

On September 26, 2012, the Company entered into a Merger Agreement with Tempur-Pedic International, Inc. pursuant to which a wholly-owned subsidiary of Tempur-Pedic International, Inc. will merge with and into the Company, resulting in the Company becoming a subsidiary of Tempur-Pedic International, Inc. (the "Merger"). In connection with the Merger, each issued and outstanding share of the Company's common stock immediately prior to the Merger will be converted into the right to receive $2.20 per share in cash (the "Merger Consideration"). As part of the transaction it is anticipated that the Company's outstanding Senior and Subordinated Notes will also be redeemed in accordance with the provisions of the related note indentures.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

Note 22: Subsequent Event (Continued)

Completion of the Merger is subject to several conditions, including (i) the adoption of the Merger Agreement by the affirmative vote or written consent of the holders of at least a majority of the outstanding shares of the Company's common stock; (ii) the expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976; (iii) the absence of a material adverse effect on the Company; and (iv) other customary closing conditions.

The Merger Agreement may be terminated under certain customary circumstances, including by Tempur-Pedic International, Inc. if their Board of Directors withdraws or changes its recommendation in support of the Offer, or by the Company if the Company's Board of Directors decides to accept a Superior Proposal (as defined in the Merger Agreement). In the case of such termination, Tempur-Pedic International, Inc. would be entitled to a break-up fee of $25.0 million.

In the event that the Merger is not consummated because the HSR approval is not obtained, Tempur-Pedic International, Inc. is required to pay the Company a reverse break-up fee of $90.0 million or $40.0 million, depending on the circumstances of such termination.

The indenture governing the Company's outstanding Convertible Notes contain provisions pursuant to which (i) a holder of Convertible Notes will be entitled following completion of the Merger to convert the Convertible Notes into the Merger Consideration at a more favorable "make whole" conversion rate for a 35 trading day period and (ii) the Company will be required to make an offer to holders of Convertible Notes following completion of the Merger to purchase the Convertible Notes at a price equal to 100% of the outstanding principal amount thereof. The indentures governing the Company's outstanding Senior and Subordinated Notes contain a provision which requires the Company to make an offer to holders of such notes following completion of the Merger to purchase such notes at a price equal to 101% of the outstanding principal amount thereof.

Upon completion of the Merger, all of the Company's outstanding stock options, restricted share units and equity share units, whether vested or unvested, will become fully vested and exercisable and converted into a right to receive a cash payment based upon the Merger Consideration and value of such awards.

Note 23: Guarantor/Non-Guarantor Financial Information

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

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

has subsidiaries ("Non-Guarantor Subsidiaries") that are not included among the Guarantor Subsidiaries, and such subsidiaries will not be obligated with respect to the Guaranteed Notes. As a result, the claims of creditors of the Non-Guarantor Subsidiaries will effectively have priority with respect to the assets and earnings of such companies over the claims of creditors of the Issuer, including the holders of the Guaranteed Notes.

The following supplemental Condensed Consolidating Financial Statements present:

1.: Condensed Consolidating Balance Sheets as of August 26, 2012 and November 27, 2011, Condensed Consolidating Statements of Operations for the three months ended August 26, 2012 and August 28, 2011, and Condensed Consolidating Statements of Cash Flows for the three months ended August 26, 2012 and August 28, 2011.
2.: Sealy Corporation, who became a guarantor of the 2014 Notes effective May 25, 2006 and who is guarantor of the Senior Notes and a co-issuer of the Convertible Notes (as "Guarantor Parent"), Sealy Mattress Corporation (a guarantor), the Issuer, combined Guarantor Subsidiaries and combined Non-Guarantor Subsidiaries with their investments in subsidiaries accounted for using the equity method (see Note 1).
3.: Elimination entries necessary to consolidate the Guarantor Parent and all of its subsidiaries.

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Balance Sheets

August 26, 2012

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation			Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations			Consolidated

Assets
Current assets:
Cash and equivalents	$	155		$	—		$	237		$	16,230		$	72,211		$	—		$	88,833
Accounts receivable, net		—			—			—			113,377			64,577			—			177,954
Inventories		—			—			1,419			57,191			12,324			(115	)		70,819
Other current assets and deferred income taxes		1,380			—			666			36,456			4,613			—			43,115

Total current assets		1,535			—			2,322			223,254			153,725			(115	)		380,721
Property, plant and equipment, at cost		—			—			10,391			369,577			38,156			—			418,124
Less accumulated depreciation		—			—			(6,122	)		(225,007	)		(22,316	)		—			(253,445	)

		—			—			4,269			144,570			15,840			—			164,679
Other assets:
Goodwill		—			—			24,741			301,942			36,622			—			363,305
Intangible assets, net		—			—			—			872			15,129			—			16,001
Net investment in subsidiaries		(186,459	)		230,358			362,500			316,933			—			(723,332	)		—
Due from (to) affiliates		319,044			(416,817	)		545,815			(168,532	)		(91,915	)		(187,595	)		—
Debt issuance costs, net and other assets		—			—			13,784			21,587			21,432			(10,000	)		46,803

		132,585			(186,459	)		946,840			472,802			(18,732	)		(920,927	)		426,109

Total assets	$	134,120		$	(186,459	)	$	953,431		$	840,626		$	150,833		$	(921,042	)	$	971,509

Liabilities and Stockholders' (Deficit) Equity
Current liabilities:
Current portion—long-term obligations	$	—		$	—		$	—		$	1,413		$	911		$	—		$	2,324
Accounts payable		—			—			210			69,124			26,850			—			96,184
Accrued customer incentives and advertising		—			—			—			21,851			7,416			—			29,267
Accrued compensation		—			—			377			21,759			4,088			—			26,224
Accrued interest		—			—			1,365			14,004			—			—			15,369
Other accrued liabilities		—			—			1,662			25,783			5,071			—			32,516

Total current liabilities		—			—			3,614			153,934			44,336			—			201,884
Long-term obligations		187,083			—			719,320			38,884			—			(187,083	)		758,204
Other liabilities		—			—			—			45,266			6,661			—			51,927
Deferred income tax liabilities		—			—			139			(139	)		326			—			326
Redeemable noncontrolling interest		—			—			—			—			12,131			—			12,131
Stockholders' equity (deficit)		(52,963	)		(186,459	)		230,358			602,681			87,379			(733,959	)		(52,963	)

Total liabilities and stockholders' equity (deficit)	$	134,120		$	(186,459	)	$	953,431		$	840,626		$	150,833		$	(921,042	)	$	971,509

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Balance Sheets

November 27, 2011

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation			Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations			Consolidated

Assets
Current assets:
Cash and equivalents	$	1,655		$	—		$	9,123		$	50,170		$	47,027		$	—		$	107,975
Accounts receivable, net		—			—			—			69,345			57,149			—			126,494
Inventories		—			—			1,476			47,391			8,293			(158	)		57,002
Other current assets and deferred income taxes		9,153			—			1,154			34,427			5,890			—			50,624

Total current assets		10,808			—			11,753			201,333			118,359			(158	)		342,095
Property, plant and equipment, at cost		—			—			10,174			359,908			36,033			—			406,115
Less accumulated depreciation		—			—			(5,902	)		(213,043	)		(20,425	)		—			(239,370	)

		—			—			4,272			146,865			15,608			—			166,745
Other assets:
Goodwill		—			—			24,741			301,942			34,343			—			361,026
Intangible assets, net		—			—			—			1,088			28			—			1,116
Net investment in subsidiaries		(196,903	)		219,918			368,983			161,796			(1	)		(553,793	)		—
Due from (to) affiliates		290,797			(416,821	)		546,305			(143,182	)		(91,275	)		(185,824	)		—
Debt issuance costs, net and other assets		—			—			16,649			12,654			18,909			—			48,212

		93,894			(196,903	)		956,678			334,298			(37,996	)		(739,617	)		410,354

Total assets	$	104,702		$	(196,903	)	$	972,703		$	682,496		$	95,971		$	(739,775	)	$	919,194

Liabilities and Stockholders' (Deficit) Equity
Current liabilities:
Current portion—long-term obligations	$	—		$	—		$	—		$	1,286		$	298		$	—		$	1,584
Accounts payable		—			—			186			45,985			22,603			—			68,774
Accrued customer incentives and advertising		—			—			—			18,014			8,024			—			26,038
Accrued compensation		—			—			392			14,416			2,793			—			17,601
Accrued interest		—			—			1,271			12,803			—			—			14,074
Other accrued liabilities		(2	)		—			465			21,997			5,966			—			28,426

Total current liabilities		(2	)		—			2,314			114,501			39,684			—			156,497
Long-term obligations		185,268			—			750,332			39,965			—			(185,268	)		790,297
Other liabilities		—			—			—			46,086			6,329			—			52,415
Deferred income tax liabilities		—			—			139			72			338			—			549
Stockholders' equity (deficit)		(80,564	)		(196,903	)		219,918			481,872			49,620			(554,507	)		(80,564	)

Total liabilities and stockholders' equity (deficit)	$	104,702		$	(196,903	)	$	972,703		$	682,496		$	95,971		$	(739,775	)	$	919,194

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Three Months Ended August 26, 2012

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation			Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations			Consolidated

Net sales	$	—		$	—		$	24,849		$	260,700		$	78,493		$	1,392		$	365,434
Cost and expenses:
Cost of goods sold		—			—			13,163			155,963			46,738			1,365			217,229
Selling, general and administrative		—			—			2,118			97,385			21,129			—			120,632
Amortization expense		—			—			—			73			—			—			73
Royalty (income) expense, net		—			—			—			(5,105	)		—			—			(5,105	)

Income from operations		—			—			9,568			12,384			10,626			27			32,605
Interest expense		—			79			19,917			600			333			—			20,929
Refinancing and extinguishment of debt		—			—			416			—			—			—			416
Other (income) expense, net		—			—			40			(1	)		(170	)		—			(131	)
Loss (income) from equity investees		(189	)		(266	)		8,343			—			—			(7,888	)		—
Loss (income) from non- guarantor equity investees		—			—			—			(7,404	)		—			7,404			—
Capital charge and intercompany interest allocation		—			—			(18,163	)		17,437			726			—			—

Income (loss) before income taxes		189			187			(985	)		1,752			9,737			511			11,391
Income tax provision (benefit)		297			(2	)		(1,251	)		10,163			2,992			(43	)		12,156
Equity in earnings of unconsolidated affiliates		—			—			—			—			875			—			875

Income (loss) from continuing operations		(108	)		189			266			(8,411	)		7,620			554			110
Loss from discontinued operations		—			—			—			—			(307	)		—			(307	)
Net income (loss)		(108	)		189			266			(8,411	)		7,313			554			(197	)

Net loss attributable to noncontrolling interests		—			—			—			—			91			—			91

Net income (loss) attributable to common shareholders	$	(108	)	$	189		$	266		$	(8,411	)	$	7,404		$	554		$	(106	)

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Three Months Ended August 28, 2011

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation			Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations			Consolidated

Net sales	$	—		$	—		$	20,729		$	243,403		$	75,231		$	(5,296	)	$	334,067
Cost and expenses:
Cost of goods sold		—			—			11,319			147,516			43,510			(5,278	)		197,067
Selling, general and administrative		—			—			1,943			81,847			20,337			—			104,127
Amortization expense		—			—			—			73			—			—			73
Royalty (income) expense, net		—			—			—			(5,021	)		—			—			(5,021	)

Income from operations		—			—			7,467			18,988			11,384			(18	)		37,821
Interest expense		—			76			20,979			493			387			—			21,935
Refinancing and extinguishment of debt		—			—			28			—			—			—			28
Other (income) expense, net		—			—			—			(7	)		(123	)		—			(130	)
Loss (income) from equity investees		(6,598	)		(6,758	)		4,480			—			—			8,876			—
Loss (income) from non- guarantor equity investees		—			—			—			(7,988	)		—			7,988			—
Capital charge and intercompany interest allocation		—			—			(19,248	)		18,641			607			—			—

Income (loss) before income taxes		6,598			6,682			1,228			7,849			10,513			(16,882	)		15,988
Income tax provision (benefit)		—			84			(5,530	)		12,400			2,691			(89	)		9,556
Equity in earnings of unconsolidated affiliates		—			—			—			—			1,057			—			1,057

Income (loss) from continuing operations		6,598			6,598			6,758			(4,551	)		8,879			(16,793	)		7,489
Loss from discontinued operations		—			—			—			—			(891	)		—			(891	)

Net income (loss)	$	6,598		$	6,598		$	6,758		$	(4,551	)	$	7,988		$	(16,793	)	$	6,598

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Nine Months Ended August 26, 2012

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation			Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations			Consolidated

Net sales	$	—		$	—		$	68,095		$	712,322		$	219,278		$	(9,940	)	$	989,755
Cost and expenses:
Cost of goods sold		—			—			36,909			435,361			129,868			(9,983	)		592,155
Selling, general and administrative		—			—			6,169			259,777			61,308			—			327,254
Amortization expense		—			—			—			217			—			—			217
Royalty (income) expense, net		—			—			—			(14,425	)		—			—			(14,425	)

Income from operations		—			—			25,017			31,392			28,102			43			84,554
Interest expense		—			234			62,399			1,868			1,053			—			65,554
Refinancing and extinguishment of debt		—			—			3,341			—			—			—			3,341
Other (income) expense, net		—			—			40			(5	)		(445	)		—			(410	)
Loss (income) from equity investees		(3,467	)		(3,694	)		14,344			—			—			(7,183	)		—
Loss (income) from non- guarantor equity investees		—			—			—			(19,903	)		—			19,903			—
Capital charge and intercompany interest allocation		—			—			(56,747	)		54,873			1,874			—			—

Income (loss) before income taxes		3,467			3,460			1,640			(5,441	)		25,620			(12,677	)		16,069
Income tax provision (benefit)		661			(7	)		(2,054	)		8,987			7,277			(43	)		14,821
Equity in earnings of unconsolidated affiliates		—			—			—			—			3,283			—			3,283

Income (loss) from continuing operations		2,806			3,467			3,694			(14,428	)		21,626			(12,634	)		4,531
Loss from discontinued operations		—			—			—			—			(1,814	)		—			(1,814	)
Net income (loss)		2,806			3,467			3,694			(14,428	)		19,812			(12,634	)		2,717

Net loss attributable to noncontrolling interests		—			—			—			—			91			—			91

Net income (loss) attributable to common shareholders	$	2,806		$	3,467		$	3,694		$	(14,428	)	$	19,903		$	(12,634	)	$	2,808

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Operations

Nine Months Ended August 28, 2011

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation			Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations			Consolidated

Net sales	$	—		$	—		$	64,850		$	704,880		$	206,785		$	(15,623	)	$	960,892
Cost and expenses:
Cost of goods sold		—			—			36,327			439,723			120,068			(15,804	)		580,314
Selling, general and administrative		—			—			6,059			252,262			56,987			—			315,308
Amortization expense		—			—			—			217			—			—			217
Royalty (income) expense, net		—			—			—			(14,796	)		—			—			(14,796	)

Income from operations		—			—			22,464			27,474			29,730			181			79,849
Interest expense		—			230			62,411			1,595			1,073			—			65,309
Refinancing and extinguishment of debt		—			—			1,264			—			—			—			1,264
Other (income) expense, net		—			—			—			(7	)		(330	)		—			(337	)
Loss (income) from equity investees		(5,319	)		(5,586	)		12,595			—			—			(1,690	)		—
Loss (income) from non- guarantor equity investees		—			—			—			(18,720	)		—			18,720			—
Capital charge and intercompany interest allocation		—			—			(56,876	)		53,800			3,076			—			—

Income (loss) before income taxes		5,319			5,356			3,070			(9,194	)		25,911			(16,849	)		13,613
Income tax provision (benefit)		—			37			(2,516	)		3,255			7,032			(29	)		7,779
Equity in earnings of unconsolidated affiliates		—			—			—			—			2,535			—			2,535

Income (loss) from continuing operations		5,319			5,319			5,586			(12,449	)		21,414			(16,820	)		8,369
Loss from discontinued operations		—			—			—			(356	)		(2,694	)		—			(3,050	)

Net income (loss)	$	5,319		$	5,319		$	5,586		$	(12,805	)	$	18,720		$	(16,820	)	$	5,319

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Cash Flows

Nine Months Ended August 26, 2012

(in thousands)

	Sealy Corporation			Sealy Mattress Corporation		Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non- Guarantor Subsidiaries			Eliminations		Consolidated

Net cash provided by (used in) operating activities	$	—		$	—	$	42,908		$	(29,258	)	$	17,752		$	—	$	31,402

Investing activities:
Purchase of property, plant and equipment		—			—		(436	)		(8,266	)		(1,309	)		—		(10,011	)
Proceeds from the sale of property, plant, and equipment		—			—		90			2,220			234			—		2,544
Acquisition of Comfort Revolution		—			—		—			—			159			—		159
Net activity in investment in and advances from (to) subsidiaries and affiliates		(1,562	)		—		(14,278	)		5,223			10,617			—		—

Net cash provided by (used in) investing activities		(1,562	)		—		(14,624	)		(823	)		9,701			—		(7,308	)
Financing activities:
Equity received upon exercise of stock including related excess tax benefits		62			—		—			—			—			—		62
Repurchase of common stock		—			—		—			(2,905	)		—			—		(2,905	)
Proceeds from issuance of long term obligations		—			—		—			—			1,269			—		1,269
Repayments of long-term obligations		—			—		—			(954	)		(8,055	)		—		(9,009	)
Repayment of senior secured notes		—			—		(36,050	)		—			—			—		(36,050	)
Debt issuance costs		—			—		(1,120	)		—			—			—		(1,120	)
Other		—			—		—			—			—			—		—

Net cash provided by (used in) financing activities		62			—		(37,170	)		(3,859	)		(6,786	)		—		(47,753	)

Effect of exchange rate changes on cash		—			—		—			—			4,517			—		4,517

Change in cash and equivalents		(1,500	)		—		(8,886	)		(33,940	)		25,184			—		(19,142	)
Cash and equivalents:
Beginning of period		1,655			—		9,123			50,170			47,027			—		107,975

End of period	$	155		$	—	$	237		$	16,230		$	72,211		$	—	$	88,833

SEALY CORPORATION

Notes to Condensed Consolidated Financial Statements (Continued)

(unaudited)

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

SEALY CORPORATION

Supplemental Condensed Consolidating Statements of Cash Flows

Nine Months Ended August 28, 2011

(in thousands)

	Sealy Corporation		Sealy Mattress Corporation		Sealy Mattress Company			Combined Guarantor Subsidiaries			Combined Non-Guarantor Subsidiaries			Eliminations		Consolidated

Net cash provided by (used in) operating activities	$	—	$	—	$	39,015		$	(39,104	)	$	6,951		$	—	$	6,862

Investing activities:
Purchase of property, plant and equipment		—		—		(160	)		(16,612	)		(920	)		—		(17,692	)
Proceeds from the sale of property, plant, and equipment		—		—		—			2			22			—		24
Net activity in investment in and advances from (to) subsidiaries and affiliates		24		—		(28,374	)		26,372			1,978			—		—

Net cash provided by (used in) investing activities		24		—		(28,534	)		9,762			1,080			—		(17,668	)
Financing activities:
Equity received upon exercise of stock including related excess tax benefits		621		—		—			—			—			—		621
Repurchase of common stock		—		—		—			(3,674	)		—			—		(3,674	)
Proceeds from issuance of long term obligations		—		—		—			—			2,568			—		2,568
Repayments of long-term obligations		—		—		—			(1,214	)		(2,668	)		—		(3,882	)
Repayment of senior secured notes		—		—		(10,300	)		—			—			—		(10,300	)
Debt issuance costs		—		—		(147	)		—			—			—		(147	)
Other		—		—		(34	)		—			—			—		(34	)

Net cash provided by (used in) financing activities		621		—		(10,481	)		(4,888	)		(100	)		—		(14,848	)

Effect of exchange rate changes on cash		—		—		—			—			2,333			—		2,333

Change in cash and equivalents		645		—		—			(34,230	)		10,264			—		(23,321	)
Cash and equivalents:
Beginning of period		1,010		—		9,234			59,108			39,903			—		109,255

End of period	$	1,655	$	—	$	9,234		$	24,878		$	50,167		$	—	$	85,934

SEALY CORPORATION

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

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

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

BUSINESS OVERVIEW

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

The bedding market continued to see revenue, unit and average unit selling price growth in the third quarter of fiscal 2012. There is also strength in the market with respect to queen size set retail price points above $1,000. As such, we have focused our recent product introductions on these areas to take advantage of this increased market activity. Specifically, we continued shipping new products in the third quarter of fiscal 2012 including ourOptimum by Sealy Posturepedic line which targets the luxury price points of the specialty bedding market and includesOpticool gel memory foam which is designed to provide a cooler feel than more traditional memory foam mattresses. Additionally, we completed the rollout of our 2012 Sealy Brand collection which targets the value price points of the bedding market as this sector of the market continues to be more resilient.

We are exposed to inflationary pressures which can significantly impact the results of our operations. We particularly experience volatility related to the prices of steel, and petroleum-based polyurethane foam. We have experienced recent decreases in the prices of steel as manufacturers are reducing inventories. This trend is expected to reverse in the beginning of fiscal 2013 as demand for steel products increases. The primary components of polyurethane foam, TDI and Polyol, continue to experience price increases due to the strength of demand in the market as well as supply constraints due to the shift from oil to natural gas production as the price of oil rises.

THIRD QUARTER 2012 HIGHLIGHTS

Revenues for the third quarter of fiscal 2012 were $365.4 million, with income from operations of $32.6 million and net income from continuing operations of $0.1 million. These results were impacted by the following key items:

•: Our U.S. operations experienced a net sales increase of 11.2% while gross profit margins declined 0.3 percentage points as a percentage of net sales. These results were driven by increased sales of ourOptimum by Sealy Posturepedic product line, premium-priced Next GenerationStearns & Foster product line and Sealy Brand collection, and premium-priced Next GenerationStearns & Foster product line and were partially offset by lower sales of ourPosturepedic product line. In continuing with the trend of higher price point products, we introduced theOptimum pillow top product to the market during the third quarter of fiscal 2012.
•: Our International operations experienced net sales increases of approximately 3.2%, coupled with gross profit margin decreases of 1.3 percentage points as a percentage of net sales. The

increase in sales was primarily due to increased sales in Mexico and Argentina, partially offset by lower sales in Canada in US dollars. We also experienced gross margin erosion in the Canadian market which was partially offset by gross margin improvement in Argentina and Mexico.

•: Selling, general, and administrative expenses increased $16.5 million to $120.6 million for the third quarter of fiscal 2012. As a percentage of net sales, these expenses increased to 33.0% of net sales in the third quarter of fiscal 2012 compared to 31.2% of net sales for the third quarter of fiscal 2011. Approximately $6.4 million of this increase was due to increased national advertising messaging surrounding the Independence and Labor Day holidays in the U.S. market.
•: As part of theOptimum rollout during the third quarter of fiscal 2012, we further utilized company owned promotional displays in retail stores to demonstrate Optimum's product features and specifications. These displays are capitalized and amortized over the expected product life. During the first nine months of fiscal 2012, $8.5 million of promotional displays were transferred to various retailers.
•: During the third quarter of fiscal 2012, we obtained a 45% ownership interest in a newly formed company, Comfort Revolution International, LLC ("Comfort Revolution"), a joint venture with Comfort Revolution, LLC, for a contribution of $10.0 million. Upon formation, Comfort Revolution, LLC contributed the assets and liabilities of its existing business. Comfort Revolution develops specialty foam and gel bedding products which are believed to complement our existing product offerings. Due to the difference in Comfort Revolution's fiscal year, which ends on December 31, and the availability of financial statements from Comfort Revolution, the results of Comfort Revolution are presented on a two month lag. Between June 13, 2012, the acquisition date, and June 30, 2012, the Company recognized revenues and a net loss for Comfort Revolution of $1.1 million and $0.2 million, respectively.

RESULTS OF OPERATIONS

Tabular Information—Current Fiscal Quarter

The following table sets forth our summarized results of operations for the three months ended August 26, 2012 and August 28, 2011, expressed in thousands of dollars, as well as a percentage of each period's net sales:

	For the three months ended:

	August 26, 2012						August 28, 2011
	(in thousands)			(percentage of net sales)			(in thousands)			(percentage of net sales)
Net sales	$	365,434			100.0	%	$	334,067			100.0	%
Cost of goods sold		217,229			59.4			197,067			59.0

Gross profit		148,205			40.6			137,000			41.0
Selling, general and administrative expenses		120,632			33.0			104,127			31.2
Amortization expense		73			—			73			—
Royalty income, net of royalty expense		(5,105	)		(1.4	)		(5,021	)		(1.5	)

Income from operations		32,605			9.0			37,821			11.3
Interest expense		20,929			5.7			21,935			6.6
Refinancing and extinguishment of debt		416			0.1			28			—
Other income, net		(131	)		—			(130	)		—

Income before income taxes		11,391			3.2			15,988			4.7
Income tax provision		12,156			3.3			9,556			2.9
Equity in earnings of unconsolidated affiliates		875			0.2			1,057			0.3

Income (loss) from continuing operations		110			—			7,489			2.2
Loss from discontinued operations		(307	)		(0.1	)		(891	)		(0.3	)

Net (loss) income		(197	)		(0.1	)		6,598			1.9
Net loss attributable to noncontrolling interests		91			—			—			—

Net (loss) income attributable to common shareholders	$	(106	)		(0.1	)%	$	6,598			1.9	%

Effective tax rate		106.7	%					59.8	%

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

	Three Months Ended:

	August 26, 2012			August 28, 2011
United States		78.3	%		77.0	%
Canada		13.9			15.7
Other		7.8			7.3

Total		100.0	%		100.0	%

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

	For the three months ended

	August 26, 2012				August 28, 2011
	(in thousands)		(percentage of net sales)		(in thousands)		(percentage of net sales)
United States (U.S. Dollars):
Net sales		286,200		100.0		257,293		100.0
Cost of goods sold		170,173		59.5		152,429		59.2

Gross profit		116,027		40.5		104,864		40.8
Total International (U.S. Dollars):
Net sales		79,234		100.0		76,774		100.0
Cost of goods sold		47,056		59.4		44,638		58.1

Gross profit		32,178		40.6		32,136		41.9
Canada:
U.S. Dollars:
Net sales		50,729		100.0		52,433		100.0
Cost of goods sold		30,311		59.8		30,100		57.4

Gross profit		20,418		40.2		22,333		42.6
Canadian Dollars:
Net sales		51,507		100.0		50,898		100.0
Cost of goods sold		30,760		59.7		29,217		57.4

Gross profit		20,747		40.3		21,681		42.6
Other International (U.S. Dollars):
Net sales		28,505		100.0		24,341		100.0
Cost of goods sold		16,745		58.7		14,538		59.7

Gross profit		11,760		41.3		9,803		40.3

Quarter Ended August 26, 2012 compared with Quarter Ended August 28, 2011

Net Sales. Our consolidated net sales for the quarter ended August 26, 2012, were $365.4 million, an increase of $31.4 million, or 9.4%, from the quarter ended August 28, 2011. This increase was driven by increased sales volumes in both our domestic and international markets.

Domestic—Total U.S. net sales were $286.2 million for the third quarter of fiscal 2012, an increase of 11.2% from the third quarter of fiscal 2011. The U.S. net sales increase, excluding the effects of third party sales from our component plants and the Comfort Revolution joint venture, was attributable to a 7.6% increase in wholesale average unit selling price and a 2.7% increase in wholesale unit volume. The increase in our average unit selling price was driven primarily by increases in all major innerspring lines and improved product mix related to the newly introduced Next GenerationStearns & Foster product line. The increase in unit volume is attributable to increased sales volume for ourOptimum by Sealy Posturepedic,Stearns & Foster and,Sealy branded, product lines partially offset by lower sales volumes for ourPosturepedic beds.

Our Next GenerationStearns & Foster product line continues to perform strongly and drove growth in our innerspring sales which experienced a 4.0% increase from the third quarter of fiscal 2011. The success of our recently introducedOptimum by Sealy Posturepedic product line drove an 84.0% increase in the sales of our specialty products for the third quarter of fiscal 2012.

International—International net sales increased $2.5 million, or 3.2%, from the third quarter of fiscal 2011 to $79.2 million. This increase was primarily due to increased sales in Mexico and Argentina partially offset by lower sales in Canada. In Canada, local currency sales increases of 1.2% translated into decreases of 3.2% in U.S. dollars due to a decline in value of the Canadian dollar. Local currency sales performance in Canada was driven by a 3.8% increase in average unit selling price, offset by a 2.5% decrease in unit volume. The increase in average unit selling price was attributable to a shift in the mix of product sold to higher priced product due to strategic promotional events featuring products at these price points. The decline in unit volume resulted from our strategic decision to focus on higher priced product that typically experiences lower unit volume.

Gross Profit. Our consolidated gross profit for the quarter was $148.2 million, an increase of $11.2 million from the comparable prior year period. As a percentage of net sales, gross profit decreased 0.4 percentage points to 40.6%. The decrease in percentage of net sales was primarily due to decreases in gross profit margin in our Canadian and U.S. operations, partially offset by increases in gross profit margin in our Argentina and Mexico operations. U.S. gross profit margin decreased 0.3 percentage points to 40.5% of net sales. An increase in customer incentives and certain warranty expenses reduced the U.S. gross profit percentage by 2.3 percentage points. These were partially offset by improvements in operating efficiencies as well as a shift in the mix of our product sales to higher priced products in the third quarter of fiscal 2012. In local currency, the gross profit margin in Canada was 40.3% as a percentage of net sales, which represents a decrease of 2.3 percentage points. This decrease was primarily driven by the impact of higher raw material costs.

Selling, General, and Administrative. Selling, general, and administrative expenses increased $16.5 million to $120.6 million for the third quarter of fiscal 2012 compared to $104.1 million for the third quarter of fiscal 2011. As a percentage of net sales, selling, general, and administrative expenses were 33.0% for the third quarter of fiscal 2012 compared with 31.2% for the third quarter of fiscal 2011. The primary changes in selling, general and administrative expenses between the third quarter of fiscal 2012 and 2011 were as follows:

	(Increase) / Decrease

Outbound delivery	$	(0.2	)
Cooperative advertising/promotional costs		1.1
Bad debt		(0.2	)

Volume driven variable expenses		0.7
Operational fixed expenses		(5.6	)
Product launch costs		(1.3	)
National advertising		(6.6	)
Incentive compensation and defined contribution expense		(5.5	)

Fixed operating expenses		(19.0	)
Non-cash compensation		1.7
Other		0.1

Total selling, general and administrative expense change	$	(16.5	)

During the third quarter of fiscal 2012, the Company increased its level of spending for national advertising in connection with the promotion of its newOptimum by Sealy Posturepedic line of products in connection with the Independence and Labor Day holidays in the U.S., which drove increases in the related expense. The increase in operational fixed expenses is due to higher compensation and product development costs. Additionally, incentive compensation and defined contribution expense increased based on the change in our projected achievement of the associated incentive targets relative to the

prior year. The increases have been partially offset by decreases in non-cash compensation and promotional costs in fiscal 2012.

Royalty income, net of royalty expense. Our consolidated royalty income, net of royalty expenses, was $5.1 million for the three months ended August 26, 2012, which is relatively consistent with the royalty income for the three months ended August 28, 2011.

Interest Expense. Our consolidated interest expense for the third quarter of fiscal 2012 remained relatively consistent with the comparable prior year period. Our net weighted average borrowing cost was 11.0% and 11.2% for the three months ended August 26, 2012 and August 28, 2011, respectively. Our net weighted average borrowing cost was favorably impacted by the redemptions of our outstanding Senior Notes in the first and second quarters of fiscal 2012.

We recognize non-cash interest related to the PIK interest on our outstanding Convertible Notes and the accretion or amortization of original issue discount and deferred debt issuance costs. The table below provides a breakout of cash and non-cash interest for the three month periods ended August 26, 2012 and August 28, 2011:

	Three Months Ended:

	August 26, 2012		August 28, 2011
Cash interest expense	$	14,061	$	15,161
Non-cash interest expense		6,868		6,774

	$	20,929	$	21,935

Income Tax. Our effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of non-deductible paid in kind interest, certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for the three months ended August 26, 2012 was 106.7% compared to 59.8% for the three months ended August 28, 2011. The effective rate for the third quarter of fiscal 2012 period was higher than the tax rate for the third quarter of fiscal 2011 primarily due to the impact of the permanent tax differences. The most significant permanent tax difference relates to the non-deductible interest on the Company's Convertible Notes.

Equity in Earnings of Unconsolidated Affiliates. Earnings related to our joint ventures remained relatively consistent with that of the third quarter of fiscal 2011.

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

Tabular Information—Year to Date

The following table sets forth our summarized results of operations for the nine months ended August 26, 2012 and August 28, 2011, expressed in thousands of dollars, as well as a percentage of each period's net sales:

	For the nine months ended:

	August 26, 2012						August 28, 2011
	(in thousands)			(percentage of net sales)			(in thousands)			(percentage of net sales)
Net sales	$	989,755			100.0	%	$	960,892			100.0	%
Cost of goods sold		592,155			59.8			580,314			60.4

Gross profit		397,600			40.2			380,578			39.6
Selling, general and administrative expenses		327,254			33.1			315,308			32.8
Amortization expense		217			—			217			—
Royalty income, net of royalty expense		(14,425	)		(1.5	)		(14,796	)		(1.5	)

Income from operations		84,554			8.6			79,849			8.3
Interest expense		65,554			6.6			65,309			6.8
Refinancing and extinguishment of debt		3,341			0.3			1,264			0.1
Other income, net		(410	)		—			(337	)		—

Income before income taxes		16,069			1.7			13,613			1.4
Income tax provision		14,821			1.5			7,779			0.8
Equity in earnings of unconsolidated affiliates		3,283			0.3			2,535			0.3

Income (loss) from continuing operations		4,531			0.5			8,369			0.9
Loss from discontinued operations		(1,814	)		(0.2	)		(3,050	)		(0.3	)

Net income		2,717			0.3			5,319			0.6
Net loss attributable to noncontrolling interests		91			—			—			—

Net income attributable to common shareholders	$	2,808			0.3	%	$	5,319			0.6	%

Effective tax rate		92.2	%					57.1	%

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

	Nine Months Ended:

	2012			2011
United States		77.5	%		78.0	%
Canada		14.5			14.6
Other		8.0			7.4

Total		100.0	%		100.0	%

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

	For the nine months ended:

	August 26, 2012				August 28, 2011
	(in thousands)		(percentage of net sales)		(in thousands)		(percentage of net sales)
United States (U.S. Dollars):
Net sales		766,752		100.0		749,480		100.0
Cost of goods sold		459,684		60.0		456,945		61.0

Gross profit		307,068		40.0		292,535		39.0
Total International (U.S. Dollars):
Net sales		223,003		100.0		211,412		100.0
Cost of goods sold		132,471		59.4		123,369		58.4

Gross profit		90,532		40.6		88,043		41.6
Canada:
US Dollars:
Net sales		143,572		100.0		140,518		100.0
Cost of goods sold		85,401		59.5		81,877		58.3

Gross profit		58,171		40.5		58,641		41.7
Canadian Dollars:
Net sales		145,328		100.0		137,668		100.0
Cost of goods sold		86,439		59.5		80,206		58.3

Gross profit		58,889		40.5		57,462		41.7
Other International (U.S. Dollars):
Net sales		79,431		100.0		70,894		100.0
Cost of goods sold		47,070		59.3		41,492		58.5

Gross profit		32,361		40.7		29,402		41.5

Nine months Ended August 26, 2012 compared with Nine months Ended August 28, 2011

Net Sales. Our consolidated net sales for the nine months ended August 26, 2012, were $989.8 million, an increase of $28.9 million, or 3.0%, from the nine months ended August 28, 2011. This increase was driven by increased unit sales in both our domestic and international markets.

Domestic—Total U.S. net sales were $766.8 million for the first three quarters of fiscal 2012, an increase of 2.3% from the first three quarters of fiscal 2011. The U.S. net sales increase, excluding the effects of third party sales from our component plants and Comfort Revolution, was attributable to a 5.6% increase in wholesale average unit selling price partially offset by a 3.9% decrease in wholesale unit volume. The increase in our average unit selling price was primarily driven by the increase in sales of our newly introduced Next GenerationStearns & Foster product line and byOptimum by Sealy product line which sell at higher price points in the market. The decrease in unit volume is attributable to lower sales volumes for ourPosturepedic andSealy branded product.

Our innerspring sales for the first nine months of fiscal 2012 increased by 0.1% compared to the first nine months of fiscal 2011. This relative stability has been caused by the offsetting strength ofStearns & Foster and weakness ofPosturepedic innerspring products. The success of our recently introducedOptimum by Sealy Posturepedic product line drove a 20.5% increase in the sales of our specialty product for the first nine months of fiscal 2012.

International—International net sales increased $11.6 million, or 5.5%, from the first three quarters of fiscal 2011 to $223.0 million. This increase was due to increased sales in all of our international markets including particular strength in Mexico and Argentina. In Canada, local currency sales increases of 5.6% translated into increases of 2.2% in U.S. dollars due to a decline in value of the Canadian dollar. Local currency sales performance in Canada was driven by a 4.5% increase in unit volume, coupled with a 1.0% increase in average unit selling price. The increase in unit volume was attributable to strategic promotional events focused on product at the lower price points in the first half of the year, while the increase in average unit selling price was driven by a shift to product at higher price points in the third quarter of fiscal 2012.

Gross Profit. Our consolidated gross profit for the nine months ended August 26, 2012 was $397.6 million, an increase of $17.0 million from the comparable prior year period. As a percentage of net sales, gross profit increased 0.6 percentage points to 40.2%. The increase in percentage of net sales was primarily due to an increase in gross profit margin in our U.S. operations. U.S. gross profit margin increased 1.0 percentage points to 40.0% of net sales. The increase in the U.S. gross profit percentage was due primarily to improved pricing and a shift in the mix of our product sales to higher priced Next GenerationStearns & Foster andOptimum by Sealy Posturepedic products, which resulted in an improvement in our gross profit percentage by approximately 1.4 percentage points. Additionally, operational efficiencies due to higher sales volumes and improvements in the manufacturing processes resulted in a 0.7 percentage point increase in U.S. gross profit margin. These improvements were partially offset by the impact of an additional expense recognized related to expected product returns related, primarily, due to an identified warranty issue with certain foundation units which caused a 0.8 percentage point decrease in gross profit margins. The gross profit margin in Canada was 40.5% as a percentage of net sales, which represents a decrease of 1.2 percentage points. This decrease was primarily driven by the impact of higher raw material costs.

Selling, General, and Administrative. Selling, general, and administrative expenses increased $11.9 million to $327.3 million for the first three quarters of fiscal 2012 compared to $315.3 million for the first three quarters of fiscal 2011. As a percentage of net sales, selling, general, and administrative expenses were 33.1% for the first three quarters of fiscal 2012 compared with 32.8% for the first three quarters of fiscal 2011. The primary changes in selling, general, and administrative expenses between the first three quarters of fiscal 2012 and 2011 were as follows:

	(Increase) / Decrease

Outbound delivery	$	(0.6	)
Cooperative advertising/promotional costs		6.3
Bad debt		1.3

Volume driven variable expenses		7.0
Operational fixed expenses		(6.7	)
Product launch costs		0.9
National advertising		(8.0	)
Incentive compensation and defined contribution expense		(7.7	)

Fixed operating expenses		(21.5	)
Non-cash compensation		2.7
Other		(0.1	)

Total selling, general and administrative expense change	$	(11.9	)

During the nine months ended August 26, 2012, the Company increased its level of spending for national advertising in connection with the promotion of its newOptimum by Sealy Posturepedic line of

products in connection with the Memorial, Independence and Labor Day holidays in the U.S., which drove increases in the related expense. Incentive compensation and defined contribution expense increased based on the change in our projected achievement of the associated incentive targets relative to the prior year. Additionally, the Company has experienced increases in operational fixed expenses due to higher compensation costs. Decreases in our product launch, cooperative advertising and promotional costs are primarily the result of a decrease in the level of spending and promotional programs offered on the products introduced in fiscal 2012 as compared to fiscal 2011.

Royalty income, net of royalty expense. Our consolidated royalty income, net of royalty expenses, was $14.4 million for the nine months ended August 26, 2012, a decrease of $0.4 million compared to the prior year period which has been driven primarily by reductions in income from domestic licensees partially offset by stronger performance by international licensees.

Interest Expense. Our consolidated interest expense for the first three quarters of fiscal 2012 remained relatively consistent with the prior year period. Our net weighted average borrowing cost was 11.3% and 11.0% for the nine months ended August 26, 2012 and August 28, 2011, respectively. Our net weighted average borrowing cost was unfavorably impacted by increases in non-cash interest expense which was driven by the accretion of the beneficial conversion features in our Convertible Notes. Our cash interest expense for the first nine months of fiscal 2012 decreased due to the redemptions of our outstanding Senior Notes in the first and second quarters of fiscal 2012

We recognize non-cash interest related to the PIK interest on our outstanding Convertible Notes and the accretion or amortization of original issue discount and deferred debt issuance costs. The table below provides a breakout of cash and non-cash interest for the six month periods ended August 26, 2012 and August 28, 2011:

	Nine Months Ended:

	August 26, 2012		August 28, 2011
Cash interest expense	$	44,102	$	46,145
Non-cash interest expense		21,452		19,164

	$	65,554	$	65,309

Income Tax. Our effective income tax rates regularly differ from the Federal statutory rate principally because of the effect of non-deductible paid in kind interest, certain foreign tax rate differentials and state and local income taxes. Our effective tax rate for the nine months ended August 26, 2012 was 92.2% compared to 57.1% for the nine months ended August 28, 2011. The effective rate for the first nine months of fiscal 2012 period was higher than the effective rate for the first nine months of fiscal 2011 period primarily due to the impact of the permanent tax differences, the most significant of which relates to the non-deductible interest on the Company's Convertible Notes.

Equity in Earnings of Unconsolidated Affiliates. Earnings related to our joint ventures have increased by $0.8 million from the first three quarters of fiscal 2011 primarily due to increased profitability in the New Zealand and China markets.

charges related to the settlement of certain outstanding contingencies related to the sale of the European business unit which resulted in the recognition of an additional $0.9 million of expense.

LIQUIDITY AND CAPITAL RESOURCES

Principal Sources of Funds

Our principal source of funds is cash flows from operations. However, we also have the ability to borrow under our asset-based revolving credit facility (the "Amended ABL Revolver"). Our principal use of funds consists of operating expenditures, payments of interest on our senior debt, capital expenditures, and interest payments on our outstanding senior subordinated notes. Capital expenditures totaled $10.0 million for the nine months ended August 26, 2012. We expect total 2012 capital expenditures to be approximately $16.0 to $17.0 million. We believe that annual capital expenditure limitations in our current debt agreements will not prevent us from meeting our ongoing capital needs. Our introductions of new products typically require us to make initial cash investments in inventory, machinery and equipment, promotional supplies and employee training which may not be immediately recovered through new product sales. However, we believe that we have sufficient liquidity to absorb such expenditures related to new products and that these expenses will not have a significant adverse impact on our operating cash flow. At August 26, 2012, the Company had approximately $77.7 million available under the Amended ABL Revolver which represents the calculated borrowing base reduced by outstanding letters of credit of $16.7 million, and certain reserves related to our outstanding derivative contracts. The calculated borrowing base under the Amended ABL Revolver is determined based on our U.S. accounts receivable and inventory balances. Our net weighted average borrowing cost was 11.3% and 11.0% for the nine months ended August 26, 2012 and August 28, 2011, respectively.

As of September 20, 2012, we had no borrowings outstanding under the Amended ABL Revolver. Due to the lower available interest rates on this facility, we plan to periodically borrow on this facility in future periods. Further, as discussed in Note 10 to the Condensed Consolidated Financial Statements, we entered into a revolving credit agreement with Comfort Revolution through which we are obligated to provide financing of up to $20.0 million. This obligation may also impact our borrowings on our Amended ABL Revolver in future periods.

Approximately $71.3 million of our outstanding cash balance at August 26, 2012 was held in foreign jurisdictions. While we are not prohibited from repatriating these funds to the U.S., the cost of doing so may be significant depending upon the prevailing tax rates. However, since we have the intent and ability to reinvest these earnings, we have not provided for income taxes against the earnings of these subsidiaries

Debt

On May 9, 2012, the Company amended its existing senior secured asset-based revolving credit facility to extend the terms of this facility until May 2017 and amend certain other provisions. In addition to the extension of the maturity date, the amendment to the facility provides for an increase in the available accordion feature on the facility which, if exercised, can increase the total principal amount to $150.0 million. Further, the amendment provides an adjustment to the interest margins which both reduced the margin rates and provides a feature through which they adjust based on the availability under the facility. In connection with this amendment, we incurred charges of $1.0 million which have been recorded as a component of deferred debt issuance costs and will be amortized over the remaining maturity of the agreement as a component of interest expense.

During the nine months ended August 26, 2012, we redeemed $35.0 million of our outstanding Senior Notes (defined below) at a redemption price of 103% of the principal amount of the notes, plus accrued and unpaid interest to the redemption date. We incurred expenses of $2.9 million for the nine

months ended August 26, 2012 in connection with these redemptions related to the payment of premiums and write off of unamortized original issue discount and debt issuance costs. The Company did not redeem any of its outstanding Senior Notes during the three months ended August 26, 2012 and August 28, 2011.

Our outstanding debt primarily consists of the following: 1) the Amended ABL Revolver that currently provides commitments of up to $100.0 million maturing in May 2017, which bears interest at our choice of either a base rate (determined by reference to the highest of three rates as defined by the Amended ABL Revolver agreement) or a LIBOR rate for U.S. dollar deposits plus an applicable margin between 0.75% and 1.75% for base rate loans and 1.75% and 2.25% for LIBOR loans; 2) $350.0 million in original aggregate principal amount of senior secured notes due April 2016 (the "Senior Notes"), which bear interest at 10.875% per annum payable semi-annually; 3) $177.1 million in initial aggregate principal amount of senior secured convertible PIK notes due July 2016 which are convertible into shares of the Company's common stock (the "Convertible Notes") and bear interest at 8.00% per annum payable semi-annually in the form of additional Convertible Notes; and 4) an original $314 million aggregate principal amount of senior subordinated notes due June 15, 2014 (the "2014 Notes"), which bear interest at 8.25% per annum payable semi-annually.

At August 26, 2012 there were no amounts outstanding under the Amended ABL Revolver. The Company did not borrow any amounts under the Amended ABL Revolver during the third quarter of fiscal 2012. The outstanding principal and carrying amounts at August 26, 2012 related to our outstanding notes are as follows:



Senior notes due 2016(1)	270,000	263,291
Convertible notes due 2016(2)	221,125	187,083
Senior subordinated notes due 2014	268,945	268,945

(1): The carrying value of the Senior Notes gives effect to an unamortized original issue discount of $6.7 million.
(2): The carrying value of the Convertible Notes includes accrued PIK interest and the effects of the accounting for the beneficial conversion features that were recognized upon each of the January 15 and July 15 interest payment dates since their issuance. See Note 9 of our Consolidated Financial Statements included in this Quarterly Report on Form 10-Q for further details.

Future interest payments are expected to be paid out of cash flows from operations and borrowings on our Amended ABL Revolver. The Amended ABL Revolver provides for revolving credit financing, subject to borrowing base availability. The borrowing base consists of the following: 1) 85% of the net amount of eligible accounts receivable and 2) the lesser of (i) 85% of the net orderly liquidation value of eligible inventory or (ii) 75% of the net amount of eligible inventory. These amounts are reduced by reserves deemed necessary by the security agents for the facility.

At August 26, 2012, the Company was in compliance with the covenants contained within its Amended ABL Revolver agreement and the indentures governing the Senior Notes, the Convertible Notes and the 2014 Notes. These agreements also restrict our ability to pay dividends and repurchase common stock.

As part of our ongoing evaluation of our capital structure, we continually assess opportunities to reduce our debt, which may from time to time include the redemption or repurchase of additional portions or all of our Senior Notes, the 2014 Notes or the Convertible Notes to the extent permitted by our debt covenants. In addition, our Board authorized a common stock repurchase program under which we may repurchase up to $100 million of our common stock. As of August 26, 2012, we have

repurchased shares for $16.3 million under this program, none of which was repurchased during the third quarter of fiscal 2012. From August 28, 2011 through September 20, 2012, we did not repurchase any additional shares under this program.

Our Convertible Notes contain a provision through which we are able to terminate the conversion rights on or after July 15, 2012 if (i) the closing sale price of our common stock equals or exceeds 250% of the conversion price then in effect for at least 20 days prior and (ii) our ratio of Net Debt to Adjusted EBITDA is less than 3.4 to 1.0. As of August 26, 2012, neither of these conditions was met and we do not expect to be able to exercise this provision of the Convertible Notes agreement in the fourth quarter of fiscal 2012. In the event that these provisions are able to be exercised in future periods, we would recognize the remaining unamortized discount related to the beneficial conversion features as a component of interest expense within our Condensed Consolidated Statement of Operations. As of August 26, 2012, the remaining unamortized discount related to the beneficial conversion features was $35.7 million.

Our ability to make scheduled payments of principal, or to pay the interest or liquidated damages, if any, on or to refinance our indebtedness, or to fund planned capital expenditures will depend on our future performance, which to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. We will be required to make scheduled principal payments of $2.3 million during the next twelve months, with $1.4 million for our financing obligations and capital leases and the remainder for debt owed by our international subsidiaries. However, as we continually evaluate our ability to make additional prepayments as permitted under our Amended ABL Revolver agreement and the indentures governing the Senior Notes, the Convertible Notes and the 2014 Notes, it is possible that we will redeem or repurchase additional portions of our Senior Notes, 2014 Notes or the Convertible Notes during that time.

Dividend

Our Amended ABL Revolver agreement and the indentures governing the Senior Notes, the 2014 Notes and the Convertible Notes contain restrictions on our ability to pay dividends, including a requirement in the Amended ABL Revolver agreement that we meet a minimum fixed charge coverage ratio and restrictions as to the amount available for payment. Although we meet the minimum fixed charge coverage ratio requirement in our Amended ABL Revolver agreement as of August 26, 2012, our ability to pay a dividend to our common shareholders is currently limited to $30.0 million under our note indentures and we do not currently expect a dividend will be declared in the fourth quarter of fiscal 2012.

Cash Flow Analysis

The following table summarizes our changes in cash:

	Nine Months Ended:

	August 26, 2012			August 28, 2011
	(in thousands)
Statement of Cash Flow Data:
Cash flows provided by (used in):
Operating activities	$	31,402		$	6,862
Investing activities		(7,308	)		(17,668	)
Financing activities		(47,753	)		(14,848	)
Effect of exchange rate changes on cash		4,517			2,333

Change in cash and cash equivalents		(19,142	)		(23,321	)
Cash and cash equivalents:
Beginning of period		107,975			109,255

End of period	$	88,833		$	85,934

Nine months Ended August 26, 2012 Compared With Nine months Ended August 28, 2011

Cash Flows from Operating Activities. Our cash flow from operations increased $24.5 million to a source of cash of $31.4 million for the nine months ended August 26, 2012 from a source of cash of $6.9 million for the nine months ended August 28, 2011. The increase in cash flows from operations for the nine months ended August 26, 2012 compared to the same prior year period was primarily driven by decreased uses of working capital during the first three quarters of fiscal 2012.

Cash Flows from Investing Activities. Our cash flows used in investing activities for the nine months ended August 26, 2012 were $7.3 million as compared to net cash used in investing activities of $17.7 million for the nine months ended August 28, 2011. This difference of $10.4 million is primarily due to lower capital expenditures in the first three quarters of fiscal 2012 coupled with approximately $1.7 million of proceeds received from the sale of our existing Phoenix, Arizona facility as we are relocating to a leased facility in that area.

Cash Flows from Financing Activities. Our cash flow used in financing activities for the nine months ended August 26, 2012 was $47.8 million compared with cash used in financing activities of $14.8 million for the nine months ended August 28, 2011. This change was primarily driven by $35.0 million of Senior Note redemptions in the first three quarters of fiscal 2012 compared with $10.0 million of Senior Note redemptions in the first three quarters of fiscal 2011. Our increased use of cash for financing activities was also the result of our repayment of Comfort Revolution's $7.4 million of outstanding debt upon acquisition.

Income Taxes

A valuation allowance is established against deferred tax assets when, in the judgment of management, it is more likely than not that such deferred tax assets will not become available. Because the judgment about the level of future taxable income is dependent to a great extent on matters that may, at least in part, be beyond our control, it is at least reasonably possible that management's judgment about the need for a valuation allowance for deferred taxes could change in the near term.

Significant judgment is required in evaluating our federal, state and foreign tax positions and in the determination of our tax provision. Despite our belief that our liability for unrecognized tax benefits is adequate, it is often difficult to predict the final outcome or the timing of the resolution of

any particular tax matters. We may adjust these liabilities as relevant circumstances evolve, such as guidance from the relevant tax authority, our tax advisors, or resolution of issues in the courts. These adjustments are recognized as a component of income tax expense entirely in the period in which they are identified. The Company is currently undergoing examinations of its corporate income tax returns by tax authorities. Issues related to certain of these reserved positions have been presented to the Company. The Company believes that such audits will not result in a material assessment and payment of taxes related to these positions during the one year period following August 26, 2012. We also cannot predict when or if any other future tax payments related to these tax positions may occur.

Events of Default

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

Our Amended ABL Revolver requires us to maintain a minimum fixed charge coverage ratio in excess of 1.0 to 1.0 in periods of minimum availability where the availability for two consecutive calendar days is less than the greater of 1) 12.5% of the borrowing base under the Amended ABL Revolver and 2) $10.0 million. As of August 26, 2012, we were not in a period of minimum availability and did not have any outstanding borrowings under the Amended ABL Revolver. Non-compliance with the minimum fixed charge coverage ratio in a period of minimum availability could result in the requirement to immediately repay all amounts outstanding under the Amended ABL Revolver. The fixed charge coverage ratio is defined by the Amended ABL Revolver agreement as the ratio of Adjusted EBITDA less unfinanced capital expenditures and net cash taxes paid to fixed charges which include cash payments for interest, capital lease obligations, scheduled principal payments on debt and other restricted payments.

Restrictions on Certain Transactions

The covenants contained in our senior debt agreements also restrict our ability to enter into certain transactions (the most significant of which are summarized below). Our Amended ABL Revolver requires us to meet either (i) an excess availability test of $20.0 million, or (ii) (a) an excess availability of at least the greater of (x) 17.5% of the lesser of total commitments and the borrowing base and (y) $15.0 million and (b) a minimum fixed charge coverage test of 1.10 to 1.00 in order to make certain restricted payments including dividend distributions to holders of our common stock, dividends or distributions to the parent company (Sealy Corporation), and debt repayments, subject to certain exceptions. The fixed charge coverage ratio is defined by the Amended ABL Revolver agreement as the ratio of Adjusted EBITDA less unfinanced capital expenditures and net cash taxes paid to fixed charges which include cash payments for interest, capital lease obligations, scheduled principal payments on debt and restricted payments. At August 26, 2012, Adjusted EBITDA less cash taxes paid and unfinanced capital expenditures was $97.0 million. Fixed charges as calculated under the terms of the Amended ABL Revolver agreement were $58.4 million. This results in a fixed charge coverage ratio of 1.66 to 1.00 at August 26, 2012 under the terms of the Amended ABL Revolver agreement.

The indentures governing our Senior Notes, Convertible Notes and 2014 Notes also require us to meet a fixed charge coverage ratio of 2.0 to 1.0 in order to incur additional indebtedness and make certain restricted payments, including dividends or equity distributions, subject to certain exceptions. The fixed charge coverage ratio is defined by the indentures related to these notes as the ratio of Adjusted EBITDA to fixed charges which include interest expense, and cash dividend payments on certain preferred stock. At August 26, 2012, fixed charges as calculated under the terms of the indentures governing our Senior Notes, Convertible Notes and 2014 Notes were $80.9 million, resulting in a fixed charge coverage ratio of 1.59 to 1.00.

Although we meet the minimum fixed charge coverage ratio requirements contained in our Amended ABL Revolver agreement, we do not meet the minimum fixed charge coverage ratio contained in the indentures governing the Senior Notes, Convertible Notes and 2014 Notes as of August 26, 2012. As such, Sealy Mattress Company and its subsidiaries are limited in their ability to incur additional new indebtedness and make certain restricted payments, including dividends or equity distributions other than pursuant to specified exceptions. We do not believe that these restrictions will impact our liquidity or our ability to meet our ongoing capital needs.

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

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

The following table sets forth a reconciliation of net income to Adjusted EBITDA for the three and nine months ended August 26, 2012 and August 28, 2011:

	Three Months Ended:						Nine Months Ended:

	August 26, 2012			August 28, 2011			August 26, 2012		August 28, 2011
	(in thousands)						(in thousands)
Net (loss) income	$	(197	)	$	6,598		$	2,717	$	5,319
Interest expense		20,929			21,935			65,554		65,309
Income taxes		12,156			9,556			14,821		7,779
Depreciation and amortization		6,554			5,739			18,753		18,001

		39,442			43,828			101,845		96,408
Adjustments for debt covenants:
Refinancing charges		416			28			3,341		1,264
Non-cash compensation		1,799			3,466			6,566		9,239
KKR consulting fees		40			323			324		981
Discontinued operations		307			891			1,814		3,050
Other (various)(a)		577			(149	)		1,073		246

Adjusted EBITDA	$	42,581		$	48,387		$	114,963	$	111,188

(a): Consists of various immaterial adjustments

Critical Accounting Estimates

There have been no material changes to our critical accounting policies and estimates from the information provided in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations", included in our Annual Report on Form 10-K for the fiscal year ended November 27, 2011.

Forward-Looking Statements

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

•: the consummation of our announced transaction with Tempur-Pedic International, Inc.;
•: a decrease in our business relationship with significant customers;
•: the level of competition in the bedding industry;
•: legal and regulatory requirements, including environmental and health and safety requirements and tax regulations;
•: the success of new products;
•: our relationships with our major suppliers, including any delay or interruption in supply;
•: fluctuations in costs of raw materials, particularly petroleum-based and steel products;
•: a change or deterioration in our labor relations;
•: departure of key personnel;
•: encroachments on our trademarks, patents or other intellectual property;
•: product liability claims;
•: the timing, cost and success of opening new manufacturing facilities;
•: our level of indebtedness and restrictions under our debt agreements;
•: reductions in consumer and business spending;
•: reduced access to credit;
•: the increasing market share of non-innerspring bedding products;
•: the under-funding of our pension plans;
•: our international operations and licensing arrangements;
•: the seasonality of our business;
•: interest rate risks;
•: access to financial credit by our customers, vendors or us;
•: future acquisitions;

•: an increase in return rates; and
•: other risks and factors identified from time to time in the Company's reports filed with the Securities and Exchange Commission, or the SEC.

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

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

Foreign Currency Exposures

Our earnings are affected by fluctuations in the value of our subsidiaries' functional currency as compared to the currencies of our foreign denominated purchases. The result of a uniform 10% change in the value of the U.S. dollar relative to currencies of countries in which we manufacture or sell our products would have an approximate $0.7 million and $1.8 million impact on our financial position for the three and nine months ended August 26, 2012, respectively. This calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar.

To protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, we have instituted a forecasted cash flow hedging program. We hedge portions of our purchases denominated in foreign currencies and royalty payments to third parties with forward and option contracts. At August 26, 2012, we had outstanding forward foreign currency contracts to sell a total of 31.5 million Canadian dollars for U.S. dollars. The expiration dates for the Canadian dollar contracts range from September 2012 to August 2013. At August 26, 2012, the fair value of these contracts was a net asset of $0.5 million. The changes in fair value of the foreign currency hedges are included in net income, except for those contracts that have been designated as hedges for accounting purposes. For contracts designated as hedges for accounting purposes, the changes in fair value related to the effective portion of the hedge are recognized as a component of accumulated other comprehensive income.

Interest Rate Risk

Based on the amount of variable-rate debt outstanding at August 26, 2012, a 12.5 basis point increase or decrease in variable interest rates would have an insignificant dollar impact on our annual interest expense.

Commodity Price Risks

reducing inventories. This trend is expected to reverse in the beginning of fiscal 2013 as demand for steel products increases. The primary components of polyurethane foam, TDI and Polyol, continue to experience price increases due to the strength of demand for these products in the market as well as supply constraints due to the shift from oil to natural gas production as the price of oil rises. From time to time we also hedge a portion of our expected diesel fuel consumption through the use of fixed price swap contracts. These contracts reduce the Company's exposure to the volatility in diesel fuel prices.

Item 4. Controls and Procedures

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

There were no changes in our internal control over financial reporting identified in connection with the foregoing evaluation that occurred during the third quarter of fiscal 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. Legal Proceedings

The information required with respect to this Item can be found in Note 18 to the Condensed Consolidated Financial Statements, Part I, Item 1 included herein.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended November 27, 2011 and Quarterly Report on Form 10-Q for the quarterly period ended May 27, 2012, which could materially affect our business, financial condition or future results. The risks described herein and in our Annual Report on Form 10-K and Quarterly Report on Form 10-Q are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

The table below shows information regarding our repurchases of the Company's common stock during the third quarter of fiscal 2012:

Period		Average price paid per share			Approximate dollar value of shares that may yet be purchased under program

May 28 - June 24, 2012	1,538,843	$	1.69	—	$	83,746,985
June 25 - July 22, 2012	63,785		1.82	—		83,746,985
July 23 - August 26, 2012	—		—	—		83,746,985

Total	1,602,628			—

(1): The entire amounts presented above are comprised of common stock surrendered or withheld to cover the minimum tax withholding obligations related to the vesting of restricted stock units as permitted under the 2004 Stock Option Plan. For further details of these awards and related stock ownership guidelines for the Company's senior management, refer to the Company's definitive Proxy Statement filed on March 9, 2012 and Exhibit 10.35 to the Company's Annual Report on Form 10-K filed on January 18, 2012.
(2): Our common stock repurchase program, which authorizes us to repurchase up to $100 million of our Company's common stock, was initially approved by our Board of Directors on February 19, 2007.

Subsequent to August 26, 2012 through September 20, 2012, 7,817 shares of Sealy Corporation common stock were surrendered by participants in the Company's 2004 Stock Option Plan to cover the individuals' minimum tax withholding obligations related to the vesting of certain restricted stock units.

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

Item 3. Defaults Upon Senior Securities

None

Item 4. Mine Safety Disclosures.

None

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.
	†101.1		The following financial information from Sealy Corporation's Quarterly Report on Form 10-Q for the quarter ended August 26, 2012, formatted in XBRL (Extensible Business Reporting Language): (i) the Condensed Consolidated Statements of Operations for the three and nine months ended August 26, 2012 and August 28, 2011, (ii) the Condensed Consolidated Balance Sheets as of August 26, 2012 and November 27, 2011, (iii) the Condensed Consolidated Statement of Stockholders' Deficit for the nine months ended August 26, 2012, (iv) the Condensed Consolidated Statements of Cash Flows for the nine months ended August 26, 2012 and August 28, 2011 and (v) the Notes to the Condensed Consolidated Financial Statements, tagged as blocks of text.

†: Filed herewith.

SIGNATURES

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

SEALY CORPORATION

Signature		Title


/s/ LAWRENCE J. ROGERS Lawrence J. Rogers		President and Chief Executive Officer (Principal Executive Officer)
/s/ JEFFREY C. ACKERMAN Jeffrey C. Ackerman		Executive Vice President and Chief Financial Officer (Principal Financial Officer)