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                                 UNITED STATES
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                   FORM 10-K
 
                 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
                    OF THE SECURITIES EXCHANGE ACT OF 1934
 
  FOR THE FISCAL YEAR                                        COMMISSION FILE
         ENDED                                                   NUMBER
   NOVEMBER 29, 1998                                             1-8738
 
                               SEALY CORPORATION
            (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
 
        DELAWARE                                               36-3284147
    (STATE OR OTHER                                         (I.R.S. EMPLOYER
    JURISDICTION OF                                        IDENTIFICATION NO.)
    INCORPORATION OR
     ORGANIZATION)
 
    520 PIKE STREET                                               98101
  SEATTLE, WASHINGTON                                          (ZIP CODE)
 (ADDRESS OF PRINCIPAL
  EXECUTIVE OFFICES)*
 
              REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE
                                (206) 625-1233
 
       SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
 
       SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
 
  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 and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [_]
 
  The aggregate market value of the voting stock held by nonaffiliates of the
registrant as of February 15, 1999: not applicable.
 
  Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
 
  The number of shares of the registrant's common stock outstanding as of
February 15, 1999: 31,409,665.2711.
 
          DOCUMENTS OR PARTS THEREOF INCORPORATED BY REFERENCE: NONE
 
                               ----------------
 
* All Corporate and administrative services are provided by Sealy, Inc., One
Office Parkway, Trinity, NC 27370
 
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<PAGE>
 
                                    PART I
 
ITEM 1. BUSINESS
 
 General
 
  Sealy Corporation (the "Company" or the "Parent"), through its subsidiaries,
is the largest bedding manufacturer in North America and manufactures,
distributes and sells a broad line of conventional bedding products including
mattresses and foundations. The Company's conventional bedding products
include the SEALY(R), SEALY POSTUREPEDIC(R), SEALY POSTUREPEDIC CROWN
JEWEL(R), SEALY CORRECT COMFORT(R), and the STEARNS & FOSTER(R) brands and
account for approximately 99% of the Company's total net sales for the year
ended November 29, 1998. In January, 1997, the Company completed the sale of
its Samuel Lawrence subsidiary and no longer manufactures or markets wood
furniture. The Company has a components parts manufacturing subsidiary which
produces substantially all of the Company's mattress innerspring requirements
and approximately 50% of the Company's boxspring component parts requirements.
Another subsidiary, Sealy, Inc., provides corporate and administrative
services for the Company.
 
 History of the Company
 
  The Company was founded in 1907 under the name Ohio Mattress Company. In
1924, the Company was granted its first license to produce Sealy-brand
products. Starting in 1956, the Company began acquiring Sealy-brand licenses
in other geographic areas, and by 1987, had acquired all of the capital stock
of its licensor, then named Sealy, Incorporated (which prior to that time was
independent of the Company), along with all but one of the remaining Sealy
conventional bedding domestic licensees. The Company expanded its bedding
manufacturing operations in 1983 by acquiring Stearns & Foster, a producer of
premium mattresses, boxsprings and convertible sleep sofas. In 1985, the
Company acquired Woodstuff Manufacturing, Inc., a manufacturer of waterbed
furniture, which with a later decline of waterbed sales was converted to
manufacturing solely conventional wood bedroom furniture and doing business as
Samuel Lawrence Furniture Company. In January, 1997, the Company completed the
sale of its Samuel Lawrence subsidiary and no longer manufactures or markets
wood furniture.
 
  In 1989, the Company's common stock was acquired through a leveraged buyout
(the "LBO") which was financed in part by First Boston Securities Corporation
("FBSC"), an affiliate of The First Boston Corporation ("First Boston"). In
April 1990, the Company exchanged certain outstanding debt issued to FBSC for
new debt at lower interest rates plus additional common stock (the
"Exchange"). In December 1990, FBSC transferred its equity and debt interest
in the Company to its affiliate MB L.P. I ("MBLP"). In November 1991, the
Company successfully completed a recapitalization in which the Company's
capital structure was significantly improved, the face amount of its
indebtedness and interest thereon was reduced by approximately $417 million,
the Company's interest expense obligations were substantially reduced and the
principal repayment schedule on a portion of its existing bank term loan
facility was extended. As a result of this recapitalization, MBLP's equity
interest in the Company increased to approximately 94%, consisting of shares
of Class A Common Stock, $0.01 par value (the "Shares").
 
  On February 12, 1993, Zell/Chilmark Fund, L.P., a Delaware limited
partnership ("Zell/Chilmark"), led an investor group which purchased MBLP's
94% equity interest in the Company (the "Acquired Shares") for a cash purchase
price of $250 million (the "Acquisition").
 
  On May 7, 1993, the Company completed a refinancing plan which consisted of
(i) the sale of $200.0 million of 9 1/2% Senior Subordinated Notes Due 2003
(the "Parent Notes") pursuant to a public offering, (ii) the application of
$194.5 million of net proceeds therefrom to redeem all of the then outstanding
12.4% Senior Subordinated Notes of the Company Due 2001 (approximately $139.6
million), and to reduce amounts outstanding under the Company's then existing
credit agreement and (iii) the execution of a new secured credit agreement
(the "1993 Credit Agreement") by and among the Company, certain banks and
other financial
 
                                       1
<PAGE>
 
institutions and Banque Paribas, Citicorp USA, Inc., Bank of America (formerly
Continental Bank N.A.) and General Electric Capital Corporation, as managing
agents.
 
  On May 27, 1994, the Company entered into a restated secured credit
agreement (the "1994 Credit Agreement") with a majority of its then current
group of senior lenders (the "Senior Lenders"), which modified the terms of
the 1993 Credit Agreement by reducing the amounts available under its existing
term loan facilities thereunder from an aggregate of $250 million to a single
facility of $150 million (the "Term Loan Facility") and by increasing the
amount available under its existing revolving credit facility thereunder from
$75 million to $125 million (the "Revolving Credit Facility").
 
  Pursuant to a Solicitation of Consents dated as of January 24, 1997, as
subsequently amended (the "Consent Solicitation"), the Company solicited
consents from the record holders (the "Registered Holders") of its Parent
Notes to certain amendments, consents and waivers under the Indenture (the
"Indenture"), dated as of May 7, 1993, between the Company and Mellon Bank,
F.S.B., as successor trustee (the "Trustee"), under which the Parent Notes
were issued. Following receipt of the requisite consents of the Registered
Holders, on February 21, 1997, the Company and the Trustee executed a
Supplemental Indenture incorporating the amendments to the Indenture. The
Supplemental Indenture provided for (i) an increase in the interest rate on
the Parent Notes to 10 1/4%, (ii) provision to allow for the payment of a
special dividend of up to One Hundred Million Dollars ($100,000,000) (the
"Dividend") to qualifying equity security holders of the Company, (iii) an
increase in the redemption premiums paid to Registered Holders in the event
the Parent Notes are repurchased by the Company, and (iv) the corresponding
waiver of Section 4.05 of the Indenture, such that the Dividend will not
constitute a "Restricted Payment" (as defined in the Indenture). The Company
paid an aggregate of Four Million Dollars ($4,000,000) on a pro rata basis to
those Registered Holders that had timely consented.
 
  Concurrent with the distribution of the Consent Solicitation documentation,
the Company entered into negotiations for a new senior secured financing
facility. On February 25, 1997, the Company entered into the $275,000,000
Second Restated Secured Credit Agreement (the "1997 Credit Agreement") with a
majority of its then current group of senior lenders. The proceeds of the 1997
Credit Agreement were used (a) to refinance approximately $48.7 million of
indebtedness under the Company's 1994 Credit Agreement, (b) to pay a
$99.8 million Dividend, and (c) for general corporate purposes, including,
without limitation, for working capital.
 
  In December 1997, Sealy Mattress Company (the "Issuer"), a wholly owned
subsidiary of Parent, issued $125 million principal amount of 9 7/8% Senior
Subordinated Notes due 2007 (the "Senior Subordinated Notes") and $128 million
principal amount of 10 7/8% Senior Subordinated Discount Notes due 2007 (the
"Senior Subordinated Discount Notes" and, together with the Senior
Subordinated Notes, the "Notes"). The Issuer issued the Notes in a private
placement (the "Offerings") pursuant to separate Indentures, each dated as of
December 18, 1997 (the "Indentures"). The Notes are guaranteed fully and
unconditionally, and jointly and severally on a senior subordinated basis (the
"Note Guarantees"), by Parent and certain of the Issuer's current and all of
the Issuer's future U.S. Subsidiaries ("the Subsidiary Guarantors" and
together with the Parent, the "Guarantors"). The Notes are not guaranteed by
certain of the Issuer's U.S. Subsidiaries or by any of its current or future
foreign subsidiaries.
 
  Pursuant to an agreement entered into in connection with the private
placement of the Notes, the Company filed a registration statement (the
"Exchange Offer Registration Statement") relating to $125 million and $128
million principal amount of the 9 7/8% and 10 7/8% Senior Subordinated Notes
and Senior Subordinated Discount Notes, respectively, due 2007 (the "Exchange
Notes") issued in an exchange offer for the original Notes. The Exchange Notes
have terms substantially identical in all material respects to the Notes and
will be guaranteed by the Guarantors on the same basis as the Notes. The
Company registered the Exchange Notes using Form S-4 which went effective June
23, 1998.
 
  On December 18, 1997, concurrent with the consummation of the Offerings, the
Company consummated (i) a merger and recapitalization whereby, among other
things, funds managed by Bain Capital, Inc., together with other equity
investors, including members of management (the "Management Investors" and
collectively
 
                                       2
<PAGE>
 
with the other investors, the "Investors"), acquired an approximate 90%
economic equity stake and an approximate 85.3% voting stake in Parent, (ii) a
tender offer to purchase for cash all of the Parent Notes and the related
Consent Solicitation to modify certain terms of the Indenture and (iii) a
refinancing whereby the Issuer issued the Notes, entered into and borrowed
under the Senior Credit Agreements as defined herein and repaid Parent
indebtedness outstanding under the 1997 Credit Agreement. Approximately 99% of
the Parent Notes were purchased as a result of the tender offer and the Parent
called and repurchased in May 1998 the remaining outstanding Parent Notes. As
a result of the above transaction, the warrants to purchase Class B Common
Stock of the Company, upon exercise, were now only entitled to receive the
same cash consideration paid to holders of the Company's Class B Common Stock.
In addition, all of the Company's Series A Warrants were redeemed at a
redemption price per Warrant of $0.9411 and Series B Warrants were redeemed at
a redemption price per Warrant of $0.3777. This redemption for all warrants
was completed by February 3, 1998.
 
 Conventional Bedding
 
  Industry and Competition. According to industry sales data compiled by the
International Sleep Products Association ("ISPA"), a bedding industry trade
group, approximately 800 manufacturers of mattresses and foundations make up
the domestic conventional bedding industry, generating wholesale revenues
estimated at $3.6 billion during calendar year 1998. The market for
conventional bedding represents more than 85% of the entire bedding market in
North America. According to ISPA, approximately 75% of conventional bedding is
sold to furniture stores and specialty sleep shops. Most of the remaining
conventional bedding is sold to department stores, national mass
merchandisers, membership clubs and contract customers such as motels, hotels
and hospitals. Management estimates that approximately two-thirds of
conventional bedding is sold for replacement purposes and that the average
time between consumer purchases of conventional mattresses is approximately
10 to 12 years. Factors such as disposable income and sales of homes also have
some effect on bedding purchases.
 
  Management believes that sales by companies with recognized national brands
account for more than half of total conventional bedding sales. The Company
supplies such nationally recognized brands as Sealy, Sealy Posturepedic, Sealy
Posturepedic Crown Jewel, and Stearns & Foster. Sealy branded products are
considered by management to be the most well-recognized in the domestic
conventional bedding industry. Competition in conventional bedding is
generally based on quality, brand name recognition, service and price. The
Company's largest competitors include Simmons Company, Serta, Inc. and Spring
Air Company. Management believes the Company derives a competitive advantage
over its conventional bedding competitors as a result of strong consumer
recognition of Sealy branded products.
 
  Products. The Company manufactures a variety of Sealy and Stearns & Foster
brand conventional bedding in various sizes ranging in retail price from under
$200 to approximately $4,000 per queen size set. Sealy Posturepedic brand
mattress is the largest selling mattress brand in North America. Approximately
96% of the Sealy brand and the Stearns & Foster brand conventional bedding
products sold in North America are produced by the Company, with the remainder
being produced by Sealy Mattress Company of New Jersey, Inc. ("Sealy New
Jersey"), a licensee. The Stearns & Foster product line consists of top
quality, premium mattresses sold under the Stearns & Foster brand name.
 
  Customers. The Company serves over 7,000 retail outlets (approximately 3,200
customers), which include furniture stores, national mass merchandisers,
specialty sleep shops, department stores, contract customers and other stores.
The top five conventional bedding customers accounted for approximately 29% of
the Company's net sales for the year ended November 29, 1998 and no single
customer accounted for over 10% of the Company's net sales.
 
  Sales and Marketing. The Company's sales depend primarily on its ability to
provide quality products with recognized brand names at competitive prices.
Additionally, the Company works to build brand loyalty with its ultimate
consumers, principally through targeted national advertising and cooperative
advertising with its dealers,
 
                                       3
<PAGE>
 
along with superior "point-of-sale" materials designed to emphasize the
various features and benefits of the Company's products which differentiate
them from other brands.
 
  The Company's sales force structure is generally based on regions of the
country and districts within those regions, and also includes a sales staff
for specific national accounts. The Company believes that it has one of the
most comprehensive training and development programs for its sales force,
including its University of Sleep curriculum, which provides ongoing training
sessions with programs focusing on advertising, merchandising and sales
education, including techniques to help analyze a dealer's business and
profitability.
 
  The Company's sales force emphasizes follow-up service to retail stores and
provides retailers with promotional and merchandising assistance as well as
extensive specialized professional training and instructional materials.
Training for retail sales personnel focuses on several programs, designed to
assist retailers in maximizing the effectiveness of their own sales personnel,
store operations, and advertising and promotional programs, thereby creating
loyalty to, and enhanced sales of, the Company's products.
 
  Suppliers. The Company purchases fabric, polyfiber, wire and foam from a
variety of vendors. The Company purchases approximately 50% of its Sealy
foundation parts from a single third-party source, which has patents on
various interlocking wire configurations (the "Wire Patents"), and
manufactures the remainder of these parts as a licensee under the Wire
Patents. The Company purchases substantially all of its Stearns & Foster
foundation parts from the same single third-party source. In order to reduce
the risks of dependence on external supply sources and to enhance
profitability, the Company has expanded its own internal components parts
manufacturing capacity. See "Components Division." As is the case with all of
the Company's product lines, the Company does not consider itself dependent
upon any single outside vendor as a source of supply to its conventional
bedding business and believes that sufficient alternative sources of supply
for the same, similar or alternative components are available.
 
  Manufacturing and Facilities. The Company manufactures most conventional
bedding to order and has adopted "just-in-time" inventory techniques in its
manufacturing process to more efficiently serve its dealers' needs and to
minimize their inventory carrying costs. Most bedding orders are scheduled,
produced and shipped within 5 days of receipt. This rapid delivery capability
allows the Company to minimize its inventory of finished products and better
satisfy customer demand for prompt shipments.
 
  The Company operates 25 bedding manufacturing facilities and three component
manufacturing facilities in 19 states, three Canadian provinces, Puerto Rico
and Mexico. Management believes that through the utilization of extra shifts,
it will be able to continue to meet growing demand for its products without a
significant investment in facilities. See Item 2, "Properties," herein. The
Company also operates a Research and Development center in High Point, North
Carolina with a staff which tests new materials and machinery, trains
personnel, compares the quality of the Company's products with those of its
competitors and develops new processes. The Company has developed and patented
a computerized model of an adult person, known as Dataman, which is used in
testing the support level of its mattresses. In addition, the Company has
developed very advanced and proprietary methods (Digital Image Analysis) of
dynamically measured spinal morphology on any human subject in any sleep
position. This sophisticated technology is expected to enhance Sealy's
Posturepedic brand leadership and market position.
 
 Components Division
 
  The Company operates a Components Division with headquarters in Rensselaer,
Indiana. The Components Division sells its component parts at current market
prices exclusively to the Company's bedding plants and licensees. The
Components Division currently provides substantially all of the Company's
mattress innerspring unit requirements. The Components Division also supplies
approximately 50% of the Company's Sealy foundation parts requirements under a
license of the Wire Patents. In March 1997, the Company divested the assets of
its mattress insulator pad manufacturing operation in South Brunswick, New
Jersey. The Components
 
                                       4
<PAGE>
 
Division operates three owned manufacturing sites located in Rensselaer,
Indiana; Delano, Pennsylvania, and Colorado Springs, Colorado. See Item 2,
"Properties," herein.
 
  Over the last eight years, the Company has made substantial commitments to
ensure that the coil-making equipment at its component plants remains state-
of-the-art. Since 1989, the Company has installed 30 automated coil-producing
machines. This equipment has resulted in higher capacity at lower per-unit
costs and has increased self-production capacity for the Company's innerspring
requirements over that time period from approximately 60% to substantially
all.
 
  In addition to reducing the risks associated with relying on single sources
of supply for certain essential raw materials, the Company believes the
vertical integration resulting from its component manufacturing capability
provides it with a significant competitive advantage. The Company believes
that it is the only conventional bedding manufacturer in the United States
with substantial innerspring and form wire component-making capacity.
 
 Wood Furniture
 
  The Company manufactured and marketed conventional bedroom furniture through
its Samuel Lawrence subsidiary under the Samuel Lawrence label. In 1996,
Samuel Lawrence had approximately 500 customers as one of many manufacturers
of wood bedroom furniture. In January, 1997, the Company completed the sale of
its Samuel Lawrence subsidiary and no longer manufactures wood bedroom
furniture.
 
 Licensing
 
  At November 29, 1998, there are 16 separate license arrangements in effect
with domestic independent and foreign independent licensees. Sealy New Jersey
(a bedding manufacturer), Sealy Furniture of Maryland (a sleep sofa
manufacturer), Kolcraft Enterprises, Inc. (a crib mattress manufacturer),
Pacific Coast Feather Company (a pillow, comforter and mattress pad
manufacturer), and Dorel Industries (a futon manufacturer) are the only
domestic manufacturers that are licensed to use the Sealy trademark, subject
to the terms of license agreements. Under license agreements between Sealy New
Jersey and the Company, Sealy New Jersey has the perpetual right to use
certain of the Company's trademarks in the manufacture and sale of Sealy brand
and Stearns & Foster brand products in the United States. Sealy entered into a
long-term license agreement with Klaussner Corporation Services ("Klaussner")
on December 19, 1996 under which Klaussner will manufacture and market sofas,
sleep sofas, chairs, recliners and other upholstered furniture products in
North America, primarily under the Sealy FurnitureTM logo. During the fiscal
year ended November 29, 1998, Sealy entered into licensing arrangements with
Pacific Coast Feather Company for the manufacture and sale of pillows,
comforters and mattress pads under the Sealy brand name and Dorel Industries
for the manufacture and sale of futons under the Sealy Furniture brand name
each with a commencement date of April 1, 1998.
 
  The Company's licensing division generates royalties by licensing Sealy
brand technology and trademarks to manufacturers located throughout the world.
The Company also provides its licensees with product specifications, quality
control inspections, research and development, statistical services and
marketing programs. In the fiscal year ended November 29, 1998, the licensing
division as a whole generated royalties of approximately $7.2 million, which
were accounted for as a reduction of selling, general and administrative
expenses in the Consolidated Financial Statements included herein.
 
 Warranties
 
  Sealy and Stearns & Foster bedding offer limited warranties on their
manufactured products. The periods for "no-charge" warranty service varies
among products. Prior to fiscal year 1995, such warranties ranged from one
year on promotional bedding to 20 years on certain Posturepedic and Stearns &
Foster bedding. All currently manufactured Sealy Posturepedic models, Stearns
& Foster bedding and some other Sealy-brand products offer a 10-year non-
prorated warranty service period. Historically, the Company's warranty costs
have been immaterial for each of its product lines.
 
                                       5
<PAGE>
 
 Trademarks and Licenses
 
  The Company owns, among others, the Sealy and Stearns & Foster trademarks
and tradenames and also owns the Posturepedic, Posturepedic Crown Jewel,
Correct Comfort, Comfort Series, Dataman and University of Sleep trademarks,
service marks and certain related logos and design marks.
 
 Employees
 
  As of November 29, 1998, the Company had 5,193 full-time employees.
Approximately 68% of the Company's employees at its 28 North American plants
are represented by various labor unions with separate collective bargaining
agreements. Due to the large number of collective bargaining agreements, the
Company is periodically in negotiations with certain of the unions
representing its employees. The Company considers its overall relations with
its work force to be satisfactory.
 
 Seasonality/Other
 
  The Company's business is somewhat seasonal, with lower sales usually
experienced during the first quarter of each fiscal year and higher bedding
sales usually experienced in the last three quarters of each fiscal year. See
Note 14 to the Consolidated Financial Statements of the Company included in
Part II, Item 8 herein.
 
  Most of the Company's sales are by short term purchase orders. Since the
level of production of products is generally promptly adjusted to meet
customer order demand, the Company has a negligible backlog of orders. Most
finished goods inventories of bedding products are physically stored at
manufacturing locations until shipped (usually within days of manufacture).
 
  The Company has three manufacturing facilities in Canada and one in Mexico
which comprise all of the Company's foreign-owned manufacturing operations at
November 29, 1998. The Company's licensee for Mexico agreed to terminate its
license permitting Sealy to enter the market directly, and commence production
in May 1996. The Company began marketing its Sealy brand in South Korea
through local distributors during 1995 upon expiration of its Korean license
agreement. In addition the Company has license agreements in Thailand, Japan,
the United Kingdom, Australia, New Zealand, South Africa, Israel and Jamaica.
Additional international test markets are currently operating in Spain and
Brazil. The Company does not derive a material portion of its sales or
revenues from its foreign-owned operations or from customers in any other
foreign country.
 
ITEM 2. PROPERTIES
 
  The offices of the Company are located at 520 Pike Street, Seattle,
Washington 98101. Corporate, licensing and marketing services are provided to
the Company by Sealy, Inc. (a wholly-owned subsidiary of the Company), an Ohio
Corporation. The principal address of Sealy, Inc. is One Office Parkway,
Trinity, North Carolina 27370.
 
  The Company administers component operations at its Rensselaer, Indiana
facility. The Company leases an information technology facility in Cleveland,
Ohio. The Company's leased facilities are occupied under leases which expire
from 1999 to 2008, including renewal options.
 
                                       6
<PAGE>
 
  The following table sets forth certain information regarding manufacturing
facilities operated by the Company at February 15, 1999:
 
<TABLE>
<CAPTION>
                                          APPROXIMATE
   LOCATION                              SQUARE FOOTAGE TITLE
   --------                              -------------- -----
   <S>              <C>                  <C>            <C>
   UNITED STATES
    Arizona         Phoenix                   76,000     Owned(a)
    California      Richmond                 238,000     Owned(a)
                    South Gate               185,000     Owned(a)
    Colorado        Colorado Springs          70,000     Owned(a)
                    Denver                    92,900     Owned(a)
    Florida         Orlando                   97,600     Owned(a)
    Georgia         Atlanta                  292,500     Owned(a)
    Illinois        Batavia                  212,700    Leased(b)
    Indiana         Rensselaer               131,000     Owned(a)
                    Rensselaer               124,000     Owned(a)
    Kansas          Kansas City              102,600    Leased(a)
    Maryland        Williamsport             144,000    Leased
    Massachusetts   Randolph                 187,000     Owned(a)
    Michigan        Taylor                   156,000    Leased
    Minnesota       St. Paul                  93,600     Owned(a)
    New York        Albany                   102,300     Owned(a)
    North Carolina  High Point               151,200     Owned(a)
                    Lexington                 97,400     Owned(a)
    Ohio            Medina                   140,000     Owned(a)
    Oregon          Portland                 140,000     Owned(a)
    Pennsylvania    Clarion                   85,000     Owned(a)
                    Delano                   143,000     Owned(a)
    Tennessee       Memphis                  225,000     Owned(a)
    Texas           Brenham                  220,000     Owned(a)
                    North Richland Hills     124,500     Owned(a)
   CANADA
    Alberta         Edmonton                 144,500     Owned
    Quebec          Saint Narcisse            76,000     Owned
    Ontario         Toronto                   80,200    Leased
   PUERTO RICO      Carolina                  58,600     Owned(a)
   MEXICO           Toluca                    95,200     Owned
                                           ---------
                                           4,085,800
                                           =========
</TABLE>
--------
 
(a) The Company has granted a mortgage or otherwise encumbered its interest in
    this facility as collateral for secured indebtedness.
(b) The Company has subleased 76,000 square feet to an unrelated tenant.
 
  The Company considers its present facilities to be generally well maintained
and in sound operating condition.
 
 Regulatory Matters
 
  The Company's principal wastes are wood, cardboard and other non-hazardous
materials derived from product component supplies and packaging. The Company
also periodically disposes (primarily by recycling) of small amounts of used
machine lubricating oil and air compressor waste oil. The Company, generally,
is subject to the Federal Water Pollution Control Act, the Comprehensive
Environmental Response, Compensation and Liability Act and amendments and
regulations thereunder and corresponding state statutes and regulations. The
 
                                       7
<PAGE>
 
Company believes that it is in material compliance with all applicable federal
and state environmental statutes and regulations. Except as set forth in Item
3. "Legal Proceedings" below, compliance with federal, state or local
provisions which have been enacted or adopted regulating the discharge of
materials into the environment, or otherwise relating to the protection of the
environment, should not have any material effect upon the capital
expenditures, earnings or competitive position of the Company. The Company is
not aware of any pending federal environmental legislation which would have a
material impact on the Company's operations. Except as set forth in Item 3.
"Legal Proceedings," the Company has not been required to make, and during the
next two fiscal years, does not expect to make any material capital
expenditures for environmental control facilities.
 
  The Company's conventional bedding product lines are subject to various
federal and state laws and regulations relating to flammability and other
standards. The Company believes that it is in material compliance with all
such laws and regulations.
 
ITEM 3. LEGAL PROCEEDINGS
 
  In accordance with procedures established under the Environmental Cleanup
Responsibility Act (now known as the Industrial Site Recovery Act), Sealy and
one of its subsidiaries are parties to an Administrative Consent Order ("ACO")
issued by the New Jersey Department of Environmental Protection ("DEP").
Pursuant to the ACO the Company and such subsidiary agreed to conduct soil and
groundwater investigation and remediation at the plant previously owned by the
subsidiary in South Brunswick, New Jersey. The Company does not believe that
its manufacturing processes were a source of the contaminants found to exist
above regulatorily acceptable levels in the groundwater. The Company and its
subsidiary have retained primary responsibility for the investigation and any
necessary clean up plan approved by the DEP under the terms of the ACO.
 
  In 1997, the Company, with DEP approval, completed essentially all soil
remediation and conducted a pilot test for a company-proposed revision to the
groundwater remediation program. The Company's revised groundwater remediation
plan was submitted in May, 1998 to the DEP for approval.
 
  While the Company cannot predict the ultimate timing or cost to remediate
this facility based on facts currently known, management believes the
previously established accrual for site investigation and remediation costs is
adequate to cover the Company's reasonably estimable liability and does not
believe the resolution of this matter will have a material adverse effect on
the Company's financial position or future operations.
 
  In March, 1994, the Company filed a claim in the U.S. District Court for the
District of New Jersey against former owners of the site and their lenders
under the Comprehensive Environmental Response, Compensation and Liability Act
seeking contribution for site investigation and remedial costs. In March,
1997, the Company received $1.7 million from a former owner of the site and
one of the lenders to the former owner in final settlement of this litigation.
 
  In January 1997, the Company filed a claim in the U.S. District Court of New
Jersey against former insurance companies for the Company under the
Comprehensive Environmental Response, Compensation and Liability Act seeking
contribution for site investigation and remedial costs. A parallel case
seeking a judgement of non-liability was filed by some (but not all) of these
insurance companies in the U.S. District Court for the Northern District of
Ohio. Both the New Jersey and Ohio District Courts have ruled that New Jersey
law applies. In November, 1998, the Company settled these cases when the
insurers paid the Company approximately $3.8 million.
 
  The Company also has begun to remediate soil and groundwater contamination
at an inactive facility located in Oakville, Connecticut. The Company
submitted a soil and groundwater remediation plan to the Connecticut
Department of Environmental Protection in December 1998. The Company believes
the contamination is attributable to the manufacturing operations of previous
unaffiliated occupants of the facility. In 1994, the Company filed a cost
recovery action in U.S. District Court of Connecticut to require these
entities to
 
                                       8
<PAGE>
 
complete the remediation and reimburse the Company for its cleanup costs.
Trial of this matter has been bifurcated with the issue of damages only going
to trial in March, 1999. Based on the facts currently known, management does
not believe that resolution of this matter will have a material adverse effect
on the Company's financial position or future operations.
 
  On May 22, 1997, the Company filed in the United States District Court for
the Northern District of Illinois a motion to terminate certain antitrust
final judgments ("the Judgments") entered on December 30, 1964 and December
26, 1967. These Judgments, among other things, prohibited the Company from
suggesting resale prices to its dealers. During the pendency of the Company's
motion to terminate the Judgments, and based upon allegations received by the
Department of Justice ("the Department") concerning a possible resale price
maintenance agreement with a Stearns & Foster dealer, the Department, on
September 8, 1997, issued to the Company a Civil Investigative Demand seeking
documents relating to, among other things, communications between the Company
and dealers concerning the retail price of mattresses. In response to the
Civil Investigative Demand, the Company produced certain documents and the
deposition of a Company executive was taken. Immediately following such
document production and deposition, the Department consented to the
termination of the Judgments and an order terminating the Judgments was
entered by the Court on September 19, 1997. After the Court terminated the
Judgments, the Department notified the Company on September 29, 1997 that it
was limiting the Civil Investigative Demand to certain narrow specifications.
In October 1997, the Company produced additional documents in response to the
Civil Investigative Demand. On November 24, 1997 the Company received a
request from the Department for clarification and additional information. The
Company has responded to that request.
 
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDER
 
  None.
 
                                       9
<PAGE>
 
                                    PART II
 
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
 
  As a result of the Recapitalization (see Note 2) effective on December 18,
1997, Merger Warrant holders, upon exercise of their Merger Warrants at a
conversion rate of 47.98 to 1, were entitled only to receive a cash payment of
$14.2927 which is the spread between the Recapitalization share price of
$14.3027 and the Merger Warrant exercise price of $0.01. As a result of the
Recapitalization, Warrants not exercised prior to such Recapitalization can no
longer be converted to Class B shares and upon subsequent exercise will
receive the same amount in cash without interest. As of December 17, 1997, the
Company forwarded to a third party paying agent the amount necessary to fund
the future cash requirements with respect to the remaining then outstanding
Merger Warrants and Class B Common Stock.
 
  The Company completed its redemption of all of the Company's Series A and
Series B warrants by February 3, 1998.
 
  As of February 23, 1999 there are 17 holders of record of the Company's
Class A shares, 7 holders of record of the Company's Class B shares, 14
holders of record of the Company's Class L shares and 7 holders of record of
the Company's Class M shares. See Note 2 to the Consolidated Financial
Statements, Part II, Item 8 herein for description of change in capital
structure.
 
  On May 17, 1996, a $35.5 million dividend was paid to all holders of record
as of May 7, 1996 of Sealy common stock and to holders of Merger Warrants. In
addition, on February 28, 1997, a $99.8 million dividend was paid to all
holders of record as of February 27, 1997 of Sealy common stock and to holders
of Merger Warrants. Prior to the May 17, 1996 dividend, no dividends had been
paid on any class of common equity of the Company during the prior three
fiscal years of the Company. The Company's Senior Credit Agreements and the
indentures governing the Notes (the "Indentures") limit the Company's ability
to pay cash dividends to its stockholders.
 
ITEM 6. SELECTED FINANCIAL DATA
 
  The following tables set forth selected consolidated financial and other
data of the Company for the years ended November 29, 1998, November 30, 1997,
December 1, 1996, November 30, 1995 and 1994.
 
  During the period from December 1, 1992 through November 29, 1998, the
Company's capital structure changed significantly, in large part as a result
of the Acquisition in February 1993. Due to required purchase accounting
adjustments relating to such transactions, and the resultant changes in
control, the consolidated financial and other data for each period reflected
in the following tables during this period are not comparable to such data for
the other such periods.
 
  The selected consolidated financial and other data set forth in the
following tables have been derived from the Company's audited consolidated
financial statements. The reports of PricewaterhouseCoopers LLP, independent
accountants, covering the Company's Consolidated Financial Statements for the
year ended November 29, 1998 and KPMG LLP, independent auditors, covering the
Company's Consolidated Financial Statements for the years ended November 30,
1997 and December 1, 1996, are included elsewhere herein. These tables should
be read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the Consolidated Financial Statements
of the Company included elsewhere herein.
 
                                      10
<PAGE>
 
                 SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA
 
<TABLE>
<CAPTION>
                          YEAR ENDED   YEAR ENDED  YEAR ENDED     YEAR ENDED   YEAR ENDED
                         NOVEMBER 29, NOVEMBER 30, DECEMBER 1,   NOVEMBER 30, NOVEMBER 30,
                             1998         1997        1996           1995         1994
                         ------------ ------------ -----------   ------------ ------------
                                              (DOLLARS IN MILLIONS)
<S>                      <C>          <C>          <C>           <C>          <C>
Statement of Operations
 Data:
 Net Sales..............   $ 891.3      $ 804.8      $ 697.6       $ 653.9      $ 697.7
 Costs and expenses.....     913.9        764.2        672.8         610.9        641.6
 Income (loss) before
  income tax,
  extraordinary item and
  cumulative effect of
  change in accounting
  principle.............     (22.6)        40.6         24.8          43.0         56.1
 Extraordinary loss(a)..      14.5          2.0           --            --           --
 Cumulative effect of
  change in accounting
  principle(b)..........        --          4.3           --            --           --
 Net income (loss)......   $ (33.8)     $  11.7      $  (0.5)(c)      19.5      $  29.2
Other Data:
 Depreciation and
  amortization of
  intangibles...........   $  24.3      $  24.1      $  26.6       $  24.2      $  23.6
 Operating income(d)....      44.9         72.0         53.6          74.0         89.5
 EBITDA(e)..............      69.2         96.1         80.2          98.2        113.1
 Adjusted EBITDA(f).....     113.1        102.7         86.8          85.0        122.8
 Capital expenditures...      33.1         29.1         12.0          11.8         12.8
 Interest expense, net..      67.5         31.4         28.8          31.0         33.4
 Ratio of EBITDA to
  interest expense, net.      1.0x         3.1x         2.8x          3.2x         3.4x
 Ratio of earnings to
  fixed charges(g)......        --         2.2x         1.8x          2.3x         2.5x
 Weighted average number
  of shares
  outstanding(h)........    30,472       30,234       29,379        30,169       30,159
 Net income/(loss) per
  common share--
  diluted(h):
 Income/(loss) before
  extraordinary item and
  cumulative effect of
  change in accounting
  principle.............   $ (0.63)     $  0.60      $ (0.02)      $  0.65      $  0.97
 Extraordinary item.....     (0.48)       (0.07)          --            --           --
 Cumulative effect of
  change in accounting
  principle.............        --        (0.14)          --            --           --
                           -------      -------      -------       -------      -------
  Net income/(loss).....   $ (1.11)     $  0.39      $ (0.02)      $  0.65      $  0.97
                           =======      =======      =======       =======      =======
<CAPTION>
                         NOVEMBER 29, NOVEMBER 30, DECEMBER 1,   NOVEMBER 30, NOVEMBER 30,
                             1998         1997        1996           1995         1994
                         ------------ ------------ -----------   ------------ ------------
                                              (DOLLARS IN MILLIONS)
<S>                      <C>          <C>          <C>           <C>          <C>
Balance Sheet Data:
 Total assets...........   $ 751.1      $ 721.1      $ 739.9       $ 776.2      $ 810.6
 Long-term obligations..     682.3        330.0        269.5         269.4        329.5
 Total debt.............     690.8        330.0        288.1         286.9        349.9
 Stockholders' equity
  (deficit).............    (138.8)       205.1        293.0         330.9        322.2
</TABLE>
--------
(a) During 1998 and 1997, the Company recorded extraordinary losses of $5.4 and
    $2.0, net of income tax benefit of $3.6 million and $1.4 million,
    respectively, representing the remaining unamortized debt issuance costs
    related to long term obligations repaid as a result of the debt
    refinancing. Also, during 1998 the Company recorded an extraordinary loss
    of $9.1 million, net of income taxes of $6.1 million, representing premiums
    paid to existing note holders and consent fees paid in connection with the
    retirement of debt.
 
                                       11
<PAGE>
 
(b) During the fourth quarter of 1997, the Company changed its accounting
    policy to comply with EITF 97-13, "Accounting for Costs Incurred in
    Connection with a Consulting Contract That Combines Business Process
    Reengineering and Information Technology Transformation," which resulted
    in a loss of $4.3 million, net of income tax of $2.9 million, representing
    the write-off of previously capitalized costs as described in the EITF.
(c) On January 15, 1997, the Company completed the sale of Woodstuff
    Manufacturing, Inc., a wholly-owned subsidiary that manufactured and
    marketed solid wood bedroom furniture under the "Samuel Lawrence" brand
    name. The divestiture resulted in an aggregate book loss of $17.6 million,
    which was recorded in the fiscal year ended December 1, 1996. The loss is
    comprised of a loss on net assets held for sale of $11.8 million and
    income tax expense of $5.8 million arising from the tax gain on the
    transaction.
(d) Operating income is calculated by adding interest expense, net to net
    sales less costs and expenses.
(e) EBITDA is calculated by adding interest expense, net, income tax expense
    (benefit) and depreciation and amortization of intangibles to net income
    (loss) before extraordinary item and cumulative effect of change in
    accounting principle. EBITDA is presented because it is a widely accepted
    financial indicator of a company's ability to service and incur debt.
    EBITDA does not represent net income or cash flows from operations as
    those terms are defined by generally accepted accounting principles
    ("GAAP") and does not necessarily indicate whether cash flows will be
    sufficient to fund cash needs.
(f) Adjusted EBITDA is calculated by adding to or deducting from EBITDA (as
    described above) certain items of income and expense consisting of: (i)
    discontinued stock-based compensation plans, (ii) executive severance and
    transition costs, (iii) loss on write-off of Montgomery Ward accounts
    receivable and related factoring expense incurred in connection with
    bankruptcy of Montgomery Ward, (iv) any expenses related to addressing the
    Company's "Year 2000" information systems issue and EITF 97-13
    reengineering efforts, (v) compensation associated with the
    Recapitalization, (vi) loss on net assets held for sale and other write-
    downs in 1998 only, (vii) High Point relocation and (viii) other relief
    items including, foreign currency losses, loss on disposal of certain
    assets, etc. Adjusted EBITDA is presented because it conforms to the
    definition of "Consolidated EBITDA" in the Notes Indenture (see
    "Description of Exchange Notes" and "Certain Definitions" within such
    section). The Company believes that the adjustment for these items is
    appropriate for such periods in order to provide an appropriate analysis
    of recent historical results. The following is a reconciliation of EBITDA
    to Adjusted EBITDA:
 
<TABLE>
<CAPTION>
                                                         FISCAL YEAR
                                              ----------------------------------
                                               1998   1997  1996   1995    1994
                                              ------ ------ ----- ------  ------
                                                    (DOLLARS IN MILLIONS)
   <S>                                        <C>    <C>    <C>   <C>     <C>
   EBITDA...................................  $ 69.2 $ 96.1 $80.2 $ 98.2  $113.1
   Adjustments:
    Stock-based compensation................     --     1.6   4.7  (13.2)    9.7
    Executive severance and transition......     --     --    1.9    --      --
    Compensation associated with Recapitali-
     zation.................................    18.9    --    --     --      --
    Montgomery Ward bad debt and factoring
     losses.................................     --     4.0   --     --      --
    Loss on net assets held for sale and
     other write-downs......................    10.6    --    --     --      --
    High Point relocation...................     7.5    --    --     --      --
    EITF 97-13 reengineering efforts........     4.1    1.0   --     --      --
    Other relief items--including foreign
     currency losses, loss on disposal of
     certain assets, etc. ..................     2.8    --    --     --      --
                                              ------ ------ ----- ------  ------
     Total adjustments......................    43.9    6.6   6.6  (13.2)    9.7
                                              ------ ------ ----- ------  ------
    Adjusted EBITDA.........................  $113.1 $102.7 $86.8 $ 85.0  $122.8
                                              ====== ====== ===== ======  ======
</TABLE>
 
(g) For purposes of calculating the ratio of earnings to fixed charges,
    earnings represent income before income taxes and extraordinary item plus
    fixed charges. Fixed charges consist of interest expense, net, including
    amortization of discount and financing costs and the portion of operating
    rental expense which management believes is representative of the interest
    component of rent expense. For the year ended November 29, 1998, earnings
    were insufficient to cover fixed charges by $22.6 million.
(h) Restated from previously published results due to the adoption of
    Financial Accounting Standards Board Statement No. 128, "Earnings Per
    Share", in fiscal 1998.
 
                                      12
<PAGE>
 
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 
 Year Ended November 29, 1998 Compared With Year Ended November 30, 1997
 
  Net Sales. Net sales for the year ended November 29, 1998 ("Fiscal 1998")
were $891.3 million, an increase of $86.5 million, or 10.7% from the year
ended November 30, 1997 ("Fiscal 1997"). This increase is attributable to a
$91.8 million increase in conventional bedding sales offset by a $5.3 million
decrease in sales of wood bedroom furniture.
 
  Conventional bedding sales increased 11.5% over the prior year, driven by a
7.0% or $55.8 million increase in conventional bedding unit shipments and a
4.2% or $36.0 million increase in average unit selling price. These increases
were due to sales growth in Posturepedic, Stearns & Foster and promotional
product lines, in addition to continued positive results from successful
strategic distribution initiatives that included sole source multi-year
arrangements of varying lengths with several retailers. The increase in
average unit selling price is primarily attributable to the introduction of
new or re-engineered higher-end products as well as the increased sales of the
luxury bedding category.
 
  The decrease in sales of wood bedroom furniture, sold under the Samuel
Lawrence brand, is due to the sale of this business on January 15, 1997. A
description of the disposition of this business unit is provided in Note 17 to
the Consolidated Financial Statements.
 
  Cost of Goods Sold. Cost of goods sold as a percentage of net sales
decreased 0.1% to 56.5%. This improvement is primarily attributable to
production economies from increased volume partially offset by higher start-up
costs associated with the integration of new products into production.
 
  Selling, General, and Administrative. Selling, general, and administrative
expenses increased $38.3 million due to increased operating expenses of $26.7
million, business system and Y2K costs of $4.1 million, and costs associated
with the Corporate Headquarters and Research & Development Center and
Lexington plant relocation to High Point, North Carolina of $7.5 million.
Increased operating costs were primarily due to increases in marketing
spending, $23.9 million, and delivery expenses, $4.8 million offset by lower
administration costs of $2.0 million. Increased marketing spending was due to
increased sales volume, along with an increased spending rate for cooperative
advertising and promotions. Administration costs were lower primarily due to
the Wards bankruptcy filing experienced in 1997. Increased delivery expenses
were due to increased sales volume, along with increased spending rate.
 
  Loss on Net Assets Held for Sale and Other Write-Downs. Loss on net assets
increased $10.6 million as a result of rationalization of certain
manufacturing processes, write-down of idled assets, and write-down of
previously capitalized software modules which will not be implemented.
 
  Compensation Associated with Recapitalization. The Company recorded a charge
of $18.9 million as a result of accelerated vesting of stock options and
restricted stock, other incentive based compensation payments and option
grants to employees in connection with the Recapitalization.
 
  Interest Expense. Interest expense, net of interest income, increased $36.1
million primarily as a result of significantly higher debt levels due to the
Recapitalization.
 
  Income Taxes. The Company's effective income tax rates for Fiscal 1998 and
1997 differ from the Federal statutory rate principally because of the
application of purchase accounting, the effect of certain foreign tax rate
differentials, and state and local income taxes. The Company's effective tax
rate for Fiscal 1998 was approximately 27.7% compared to 60.6% for Fiscal
1997. The higher effective tax rate in 1997 is primarily due to the impact of
State and Local taxes on 1997's pretax income compared to a pretax loss in
1998, permanent differences related to the 1993 Acquisition, and taxes arising
from the sale of the South Brunswick Pad Plant. See Note 9 to the Consolidated
Financial Statements.
 
                                      13
<PAGE>
 
  Extraordinary Item. The Company recorded a $14.5 million charge, net of
income tax benefit of $9.7 million, representing write-off of the remaining
unamortized debt issue costs related to long-term obligations repaid in
connection with the Recapitalization as well as consent fees and premiums paid
related to the Tender Offer of the Parent Notes in connection with the
Recapitalization and the call for redemption of all remaining outstanding
Parent Notes paid May 1, 1998.
 
  Net Loss. For the reasons set forth above, the Company recorded a net loss
of $33.8 million for Fiscal 1998 versus net income of $11.7 million for Fiscal
year 1997.
 
 Year Ended November 30, 1997 Compared With Year Ended December 1, 1996
 
  Net Sales. Net sales for the year ended November 30, 1997 ("Fiscal 1997"),
were $804.8 million, an increase of $107.2 million, or 15.4% from the year
ended December 1, 1996 ("Fiscal 1996"). This increase is attributable to a
$168.3 million increase in conventional bedding sales offset by a $61.1
million decrease in sales of wood bedroom furniture. Conventional bedding
sales increased 26.7% over the prior year, driven by a 24.1% increase in
conventional bedding unit shipments and a 2.1% increase in average unit
selling price. These increases were due to sales growth in the Posturepedic,
Stearns & Foster and promotional product lines, in addition to successful
strategic distribution initiatives. The increase in average unit selling price
is primarily attributable to the introduction of new or reengineered higher-
end products.
 
  The decrease in sales of wood bedroom furniture, sold under the Samuel
Lawrence brand, is due to the sale of this business on January 15, 1997. A
description of this business unit is provided in Note 17 to the Consolidated
Financial Statements.
 
  Cost of Goods Sold. Cost of goods sold as a percentage of net sales
decreased 0.3% to 56.6%. This improvement is primarily attributable to the
impact of lower sales of the lower margin wood bedroom furniture, partially
offset by an increase in bedding cost of goods sold. The increase in bedding
cost of goods sold as a percentage of net sales is primarily attributable to
the introduction of lower price point Posturepedic products, along with
selective pricing initiatives, partially offset by economies of scale from
increased sales volume.
 
  Selling, General and Administrative. Selling, general and administrative
expenses increased by $45.3 million, and increased as a percent of net sales
from 31.1% to 32.6%. This increase was primarily attributable to increases in
bedding marketing spending of $35.1 million, delivery expenses of $5.7 million
and incentive compensation of $3.5 million. Increased marketing spending was
due to increased sales volume, along with an increased spending rate for
cooperative advertising and promotions. The increase in delivery expense was
due to the increase in sales volume. The Company also experienced a $4.9
million increase in bad debt and other financing expenses, of which $4.0
million related to the bankruptcy filing of Montgomery Ward.
 
  Interest Expense. Interest expense, net for Fiscal 1997 increased $2.6
million primarily as a result of increased average debt levels resulting from
the February 1997 dividend and increased rate related to the February 1997
restructuring of the Parent Notes.
 
  Income Taxes. The Company's effective income tax rates for Fiscal 1997 and
1996 differ from the Federal statutory rate because of the application of
purchase accounting, the effect of certain foreign tax rate differentials and
state and local income taxes. The Company's effective tax rate for Fiscal 1997
was approximately 60.6% compared to 102.0% for Fiscal 1996. The higher
effective tax rate for Fiscal 1996 was due primarily to taxes arising from the
Samuel Lawrence Divestiture and the impact of the permanent differences
related to the 1993 Acquisition. See Note 9 to the Consolidated Financial
Statements.
 
  Extraordinary Item. The Company recorded a $2.0 million charge, net of
income tax benefit of $1.4 million, representing the write-off of the
remaining unamortized debt issuance costs related to long-term obligations
repaid as a result of the February 25, 1997 refinancing.
 
                                      14
<PAGE>
 
  Cumulative Effect of Change in Accounting Policy. During the fourth quarter
of 1997, the Company changed its accounting policy to comply with EITF 97-13,
"Accounting for Costs Incurred in Connection with a Consulting Contract that
Combines Business Process Reengineering and Information Technology
Transformation," which resulted in a loss of $4.3 million, net of income tax
benefit of $2.9 million, representing the write-off of previously capitalized
costs primarily related to the Company's new Business Systems project.
 
 Liquidity and Capital Resources
 
  The Company's principal sources of funds are cash flows from operations and
borrowings under its Revolving Credit Facility. The Company's principal use of
funds consists of payments of principal and interest on its Senior Credit
Agreements, capital expenditures and interest payments on its outstanding
Notes. The Company made capital expenditures aggregating $33.1 million and
$29.1 million during Fiscal 1998 and 1997, respectively. The increase in
capital spending in Fiscal 1998 was primarily attributable to the Company's
acquisition of property, manufacturing facility and office building and
construction of the new headquarters facility in High Point, North Carolina,
offset by lower spending on the Company's computer systems. The Company has
funded Fiscal 1998 capital expenditures with cash generated by operations and
the financing associated with the acquisition and construction of the High
Point corporate complex. Management believes that annual capital expenditure
limitations in the Senior Credit Agreements will not significantly inhibit the
Company from meeting its ongoing capital needs.
 
  On June 23, 1998, the Company secured permanent financing for the property,
manufacturing facility and office building in High Point, North Carolina as
purchased on April 13, 1998 and to fund the construction of the new Corporate
headquarters facility at this site. The initial purchase price of $8.4 million
was paid at closing and was financed on a temporary basis with a draw from the
Revolving Credit Facility. The permanent loan agreement provides for
borrowings not to exceed $14.5 million of which the Company has drawn
$12.7 million at November 29, 1998. In conjunction with the permanent
financing, senior lenders approved an amendment to the senior credit
facilities and related covenants to permit the transaction. Additionally, the
Company estimates total costs associated with the Corporate Headquarters,
Research & Development Center and Lexington plant relocation to High Point,
North Carolina will result in a pretax charge of approximately $8.5 million of
which $7.5 million was recognized in 1998 with the balance in Fiscal 1999. At
November 29, 1998, the Company had approximately $85.5 million available under
its Revolving Credit Facility with Letters of Credit issued totaling
approximately $11.7 million. The Company's net weighted average borrowing cost
was 9.0% for Fiscal 1998 and 1997.
 
  On October 30, 1997, Parent entered into an agreement and plan of merger
(the "Merger Agreement") with Sandman Merger Corporation, a transitory
Delaware merger corporation ("Sandman"), and Zell/Chilmark Fund, L.P., a
Delaware limited partnership ("Zell"). Zell owned approximately 87% of the
issued and outstanding common stock of Parent (the "Existing Common Stock").
Pursuant to the Merger Agreement, upon the satisfaction of certain conditions,
Sandman was merged with and into Parent with Parent being the surviving
corporation effective on December 18, 1997 (the "Closing Date") and the
Company was recapitalized (the "Recapitalization") whereby certain equity
investors, including members of management, acquired an approximate 90.0%
economic equity stake (85.3% voting equity stake) in the Company. A portion of
the issued and outstanding shares of common stock of the Company was converted
into the right to receive aggregate cash equal to $419.3 million less (i)
certain seller fees and expenses and (ii) certain costs in connection with the
extinguishment of certain outstanding options and warrants of the Company and
the remaining portion was converted into voting preferred stock and then
reconverted into $25.0 million in aggregate principal amount of junior
subordinated notes of the Company and a retained voting common stock interest
in the Company of approximately 14.7%. Concurrent with the Recapitalization,
the Company refinanced existing indebtedness (the "Refinancing") by Sealy
Mattress Company (the "Issuer"), a wholly owned subsidiary of the Parent,
entering into and borrowing $460 million under the Senior Credit Agreements
and by issuing $125 million of Senior Subordinated Notes and $128 million of
Senior Subordinated Discount Notes.
 
                                      15
<PAGE>
 
  Upon the consummation of the Recapitalization, Parent and certain of its
stockholders, including the Bain Funds, Harvard Private Capital Holdings, Inc.
("Harvard"), Sealy Investors 1 LLC, Sealy Investors 2, LLC, Sealy Investors 3,
LLC (the "LLCs") and Zell (collectively, the "Stockholders") entered into a
stockholders agreement (the "Stockholders Agreement"). The Stockholders
Agreement (i) required that each of the parties thereto vote all of its voting
securities of Parent and take all other necessary or desirable actions to
cause the size of the Board of Directors of Parent to be established at seven
members and to cause three designees of the Bain Funds and one designee of
Harvard to be elected to the Board of Directors; (ii) granted Parent and the
Bain Funds a right of first offer on any proposed transfer of shares of
capital stock of Parent held by Zell, Harvard or the LLCs; (iii) granted
Harvard a right of first offer on any proposed transfer of shares of capital
stock of Parent held by the Bain Funds; (iv) granted tag-along rights on
certain transfers of shares of capital stock of Parent; (v) required the
Stockholders to consent to a sale of Parent to an independent third party if
such sale is approved by holders of shares constituting a majority of the then
outstanding shares of voting common stock of Parent; and (vi) except in
certain instances, prohibits Zell from transferring any shares of capital
stock of Parent until the tenth anniversary of the date of the consummation of
the Recapitalization. Certain of the foregoing provisions of the Stockholders
Agreement terminate upon the consummation of an initial Public Offering or an
Approved Sale (as each is defined in the Stockholders Agreement).
 
  Immediately prior to the closing of the Recapitalization (the "Closing"),
Parent contributed (the "Capital Contribution") all of the issued and
outstanding capital stock of Sealy, Inc., an Ohio corporation, The Stearns &
Foster Bedding Company, a Delaware corporation, Advanced Sleep Products, a
California corporation, Sealy Components-Pads, Inc., a Delaware corporation,
and Sealy Mattress Company of San Diego, a California corporation, to the
capital of the Issuer. Immediately after the Capital Contribution, the Issuer
became the only direct subsidiary of Parent and owns 100% of the operations of
Parent. At the Closing, Sandman was merged with and into Parent with Parent
the surviving corporation.
 
  On November 18, 1997, Parent commenced an offer (the "Tender Offer") to
purchase for cash up to all (but not less than a majority in principal amount
outstanding) of its Parent Notes and a related solicitation (the "Consent
Solicitation") of consents to modify certain terms of the Indenture under
which the Parent Notes were issued (the "Parent Note Indenture"). The purchase
price to be paid in respect to validly tendered Parent Notes and related
consents was determined by a formula set forth in the offer to purchase with
respect to the Tender Offer. The Offerings were conditioned upon the
consummation of the Tender Offer for, and the obtaining of consents with
respect to, at least a majority in aggregate principal amount of the Parent
Notes outstanding. Parent's obligation to accept for purchase and to pay for
the Parent Notes validly tendered pursuant to the Tender Offer was conditioned
upon, among other things, consummation of the other elements of the
Recapitalization.
 
  On March 30, 1998, the Company announced a call for redemption of all
remaining outstanding Parent Notes that were not redeemed at December 18,
1997. The redemption price of 106.33%, plus accrued interest, or $2.5 million,
was paid on May 1, 1998, after which time interest ceased to accrue on the
Notes.
 
  The Company's 1997 Credit Agreement was terminated in connection with the
Recapitalization. The 1997 Credit Agreement provided for a $275.0 million
reducing revolving credit facility and a discretionary swing loan facility of
up to $20.0 million. Upon consummation of the Recapitalization, the Issuer
entered into the AXELs credit agreement (the "Senior AXELs Credit Agreement")
and a credit agreement providing for Tranche A Term Loans and revolving
borrowings (the "Senior Revolving Credit Agreement" and, together with the
Senior AXELs Credit Agreement, the "Senior Credit Agreements"). The Senior
Credit Agreements provide for loans of up to $550.0 million, consisting of a
$450.0 million term loan facility (the "Term Loan Facility") and a $100.0
million revolving credit facility (the "Revolving Credit Facility"). The
Issuer distributed the proceeds of the Term Loan Facility and its initial
borrowings under the Revolving Credit Facility to Parent to provide a portion
of the funds necessary to consummate the Transactions. Indebtedness of the
Issuer under the Senior Credit Agreements is secured and guaranteed by Parent
and certain of the Issuer's current and all of the Issuer's future U.S.
subsidiaries and bears interest at a floating rate. See Note 18 to the
Consolidated Financial Statements for further details regarding guarantees
including consolidating condensed financial statements for guarantors and
 
                                      16
<PAGE>
 
non-guarantors. The Senior Credit Agreements require the Company to meet
certain financial tests, including minimum levels of adjusted EBITDA as
determined in the agreements, minimum interest coverage and maximum leverage
ratio. The Senior Credit Agreements also contain covenants which, among other
things, limit capital expenditures, indebtedness and/or the incurrence of
additional indebtedness, investments, dividends, transactions with affiliates,
asset sales, mergers and consolidations, prepayments of other indebtedness
(including the Notes), liens and encumbrances and other matters customarily
restricted in such agreements.
 
  Indebtedness under the Senior Credit Agreements bears interest at a floating
rate. Indebtedness under the Revolving Credit Facility and the Term Loans
initially (subject to reduction based on attainment of certain leverage ratio
levels) bears interest at a rate based upon (i) the Base Rate (defined as the
highest of (x) the rate of interest announced publicly by Morgan Guaranty
Trust Company of New York from time to time, as its base rate and (y) the
Federal funds effective rate from time to time plus 0.50%) plus 1.25% in
respect of the Tranche A Term Loans and the loans under the Revolving Credit
Facility (the "Revolving Loans"), 1.50% in respect of the AXELs Series B,
1.75% in respect of the AXELs Series C and 2.00% in respect of the AXELs
Series D, or (ii) the Adjusted Eurodollar Rate (as defined in the Senior
Credit Agreements) for one, two, three or six months (or, subject to general
availability, two weeks or twelve months), in each case plus 2.25% in respect
of Tranche A Term Loans and Revolving Loans, 2.50% in respect of AXELs Series
B, 2.75% in respect of AXELs Series C and 3.00% in respect to AXELs Series D.
 
  The Tranche A Term Loans mature in December 2002. The AXELs Series B mature
in December 2004. The AXELs Series C mature in December 2005. The AXELs Series
D mature in December 2006. The Tranche A Term Loans are subject to quarterly
amortization payments commencing in March 1999, the AXELs Series B, the AXELs
Series C and the AXELs Series D are subject to quarterly amortization payments
commencing in March 1998 with the AXELs Series B amortizing in nominal amounts
until the maturity of the Tranche A Term Loans, the AXELs Series C amortizing
in nominal amounts until the maturity of the AXELs Series B and the AXELs
Series D amortizing in nominal amounts until the maturity of the AXELs Series
C. The Revolving Credit Facility matures in December 2002. In addition, the
Senior Credit Agreements provide for mandatory repayments, subject to certain
exceptions, of the Term Loans, and reductions in the Revolving Credit
Facility, based on the net proceeds of certain asset sales outside the
ordinary course of business of the Issuer and its subsidiaries, the net
proceeds of insurance, the net proceeds of certain debt and equity issuance's,
and excess cash flow (as defined in the Senior Credit Agreements).
 
  The Notes were issued pursuant to an Indenture (the "Senior Subordinated
Note Indenture") among the Issuer, the Guarantors and The Bank of New York, as
trustee (the "Senior Subordinated Note Trustee"). The Senior Subordinated
Discount Notes were issued pursuant to an Indenture (the "Senior Subordinated
Discount Note Indenture" and, together with the Senior Subordinated Note
Indenture, the "Indentures") among the Company, the Guarantors and The Bank of
New York, as trustee (the "Senior Subordinated Discount Note Trustee" and,
together with the Senior Subordinated Note Trustee, the "Trustees").
 
  The Senior Subordinated Notes in aggregate principal amount of
$125.0 million were issued in the Offering, and mature on December 15, 2007.
Interest on the Senior Subordinated Notes accrues at the rate of 9 7/8% per
annum and is payable semi-annually in arrears on June 15 and December 15 of
each year, commencing on June 15, 1998, to Holders of record on the
immediately preceding June 1 and December 1.
 
                                      17
<PAGE>
 
  Except as provided below, the Senior Subordinated Notes are not redeemable
at the Company's option prior to December 15, 2002. Thereafter, the Senior
Subordinated Notes are subject to redemption at any time at the option of the
Company, in whole or in part, upon not less than 30 nor more than 60 days'
notice, at the redemption prices (expressed as percentages of principal
amount) set forth below plus accrued and unpaid interest and Liquidated
Damages thereon to the applicable redemption date, if redeemed during the
twelve-month period beginning on December 15 of the years indicated below:
 
<TABLE>
<CAPTION>
                                                                 PERCENTAGE OF
YEAR                                                            PRINCIPAL AMOUNT
----                                                            ----------------
<S>                                                             <C>
2002...........................................................     104.937%
2003...........................................................     103.292%
2004...........................................................     101.646%
2005 and thereafter............................................     100.000%
</TABLE>
 
  Notwithstanding the foregoing, during the first 36 months after December 11,
1997, the Company may on any one or more occasions redeem up to 35% of the
aggregate principal amount of Senior Subordinated Notes originally issued
under the Senior Subordinated Note Indenture at a redemption price of 109.875%
of the principal amount thereof, plus accrued and unpaid interest and
liquidated damages thereon, if any, to the redemption date, with the net cash
proceeds of any Equity Offerings; (as defined in the Indentures) provided that
at least $80.0 million in aggregate principal amount of Senior Subordinated
Notes remain outstanding immediately after the occurrence of such redemption
(excluding Senior Subordinated Notes held by the Company and its
Subsidiaries); and provided further that such redemption shall occur within
120 days of the date of the closing of any such Equity Offering.
 
  The Senior Subordinated Discount Notes in aggregate principal amount of
$128.0 million were issued in the Offering, and mature on December 15, 2007.
The Senior Subordinated Discount Notes were offered at a substantial discount
from their principal amount at maturity. Until December 15, 2002 (the "Full
Accretion Date"), no interest (other than liquidated damages, if applicable)
will accrue or be paid in cash on the Senior Subordinated Discount Notes, but
the Accreted Value will accrete (representing the amortization of original
issue discount) between the issuance date and the Full Accretion Date, on a
semi-annual bond equivalent basis. Beginning on the Full Accretion Date,
interest on the Senior Subordinated Discount Notes will accrue at the rate of
10 7/8% per annum and will be payable in cash semi-annually in arrears on June
15 and December 15 of each year, commencing on June 15, 2003, to Holders of
record on the immediately preceding June 1 and December 1. Interest on the
Senior Subordinated Discount Notes will accrue from the most recent date to
which interest has been paid or, if no interest has been paid, from the Full
Accretion Date.
 
  Except as provided below, the Senior Subordinated Discount Notes will not be
redeemable at the Company's option prior to December 15, 2002. Thereafter, the
Senior Subordinated Discount Notes will be subject to redemption at any time
at the option of the Company, in whole or in part, upon not less than 30 nor
more than 60 days' notice, at the redemption prices (expressed as percentages
of principal amount) set forth below plus accrued and unpaid interest and
liquidated damages thereon to the applicable redemption date, if redeemed
during the twelve-month period beginning on December 15 of the years indicated
below:
 
<TABLE>
<CAPTION>
                                                                 PERCENTAGE OF
YEAR                                                            PRINCIPAL AMOUNT
----                                                            ----------------
<S>                                                             <C>
2002...........................................................     105.437%
2003...........................................................     103.625%
2004...........................................................     101.812%
2005 and thereafter............................................     100.000%
</TABLE>
 
                                      18
<PAGE>
 
  Notwithstanding the foregoing, during the first 36 months after December 11,
1997, the Company may on any one or more occasions redeem up to 35% of the
Accreted Value of Senior Subordinated Discount Notes originally issued under
the Senior Subordinated Discount Note Indenture at redemption price of
110.875% of the Accreted Value, plus accrued and unpaid Liquidated Damages
thereon, if any, to the redemption date, with the net cash proceeds of any
Equity Offerings; provided that at least $50.0 million in aggregate Accreted
Value of Senior Subordinated Discount Notes remain outstanding immediately
after the occurrence of such redemption (excluding Senior Subordinated
Discount Notes held by the Company and its Subsidiaries); and provided,
further, that such redemption shall occur within 120 days of the date of the
closing of any such Equity Offering.
 
  At November 29, 1998, the Company was in compliance with the financial
covenants of all debt.
 
 Foreign Operations and Export Sales
 
  The Company has three manufacturing facilities in Canada and one in Mexico
which comprise all of the Company's foreign-owned manufacturing operations at
November 29, 1998. The Company's licensee for Mexico agreed to terminate its
license permitting Sealy to enter the market directly, and commence production
in May 1996. The Company began marketing its Sealy brand in South Korea
through local distributors during 1995 upon expiration of its Korean license
agreement. In addition the Company has license agreements in Thailand, Japan,
the United Kingdom, Australia, New Zealand, South Africa, Israel and Jamaica.
Additional international test markets are currently operating in Spain and
Brazil. The Company does not derive a material portion of its sales or
revenues from its foreign-owned operations or from customers in any other
foreign country.
 
 New Accounting Pronouncements
 
  On November 20, 1997 the Emerging Issues Task Force (EITF) reached a final
consensus that business process reengineering costs incurred in connection
with an overall information technology transformation project should be
expensed as incurred (EITF 97-13). The transition provisions require companies
that had previously capitalized such business process reengineering costs to
identify these costs and quantify the unamortized amounts remaining on the
balance sheet as of the beginning of the quarter which includes November 20,
1997. These unamortized amounts are required to be written off as a cumulative
effect of a change in accounting principle in such quarter. The Company has
adopted EITF 97-13 resulting in a loss of $4.3 million, net of income tax
benefit of $2.9 million, representing the cumulative write-off of previously
capitalized costs as of August 31, 1997 primarily relating to the Company's
new business systems project. All business process reengineering costs
subsequent to August 31, 1997 have been expensed.
 
  In June 1997, the Financial Accounting Standards Board ("FASB) issued
Statement of Financial Accounting Standards ("FAS") No. 130, "Reporting
Comprehensive Income", effective for the fiscal years beginning after December
15, 1997, the Company's fiscal year 1999. FAS 130 requires that the Company
report comprehensive income and its components in a full set of general-
purpose financial statements. Comprehensive income represents the change in
stockholders' equity during the period from nonowner sources. Currently, other
comprehensive income consists of foreign translation adjustments. The adoption
of FAS 130 will have no impact on the Company's net income or stockholders'
equity.
 
  In June 1997, the FASB issued FAS 131, "Disclosures about Segments of an
Enterprise and Related Information", effective for the years beginning after
December 15, 1997, the Company's fiscal year end 1999. FAS 131 establishes
standards for public companies for the reporting of financial information from
operating segments in annual and interim financial statements as well as
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company has not completed its
analysis of the effect of adoption on its financial statement disclosure,
however, the adoption of FAS 131 will not affect results of operation or
financial position, but may affect the disclosure of segment information.
 
                                      19
<PAGE>
 
  In June 1998, the FASB issued FAS 133, "Accounting for Derivative
Instruments and Hedging Activities," effective for years beginning after June
15, 1999, the Company's fiscal year 2000. FAS 133 requires that all
derivatives be recorded on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives are either offset against the change in the fair
value of assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized
in earnings. The Company has not yet determined what the effect of FAS 133
will be on the earnings and financial position of the Company.
 
 Fiscal Year
 
  Effective December 1, 1995, the Company changed its fiscal year from
November 30 to a 52-or-53-week year ending the closest Sunday to November 30.
Accordingly, the years ended November 29, 1998 and November 30, 1997 were 52-
week years. Fiscal year 1996 ended on December 1, 1996.
 
 Year 2000 Issue
 
  Until recently, computer programs were generally written using two digits
rather than four to define the applicable year. Accordingly, such programs may
be unable to distinguish properly between the Year 1900 and the Year 2000.
This could result in system failures or data corruption for the Company, its
customers or suppliers which could cause disruptions of operations, including,
among other things, a temporary inability to process transactions or engage in
business activities or to receive information, services, raw materials and
supplies, or payment from suppliers, customers or business partners or any
other companies with which the Company conducts business.
 
  The Company believes that the new business systems, including appropriate
software, being installed both alongside and as part of an upgrade of its
existing computer system will address the dating system flaw inherent in most
operating systems (the "Year 2000 Issue"). There can be no assurance, however,
that the new business systems will be installed and fully operational at all
locations and for all applications prior to the turn of the century, and
management has therefore deemed it necessary to convert its current system to
be Year 2000 compliant.
 
  The Company conducted a comprehensive impact analysis to determine what
computing platforms and date-aware functions with respect to its existing
computer operating systems will be disrupted by the Year 2000 Issue. In
January 1998, the Company completed a prioritization of the impacted areas
identified to date and commenced the detailed program code changes through a
contracted third party vendor which has experience in Year 2000 conversions
for the Company's existing system including the same release of such system.
The Company has received converted source code, from the contracted vendor and
is currently testing the converted programs. The Company's current timetable
anticipates rollout and implementation to all locations by August, 1999. At
this time, the Company has not deemed it necessary to develop contingency
plans for any of the applications being converted, however, the Company will
continue to assess this and will develop contingency plans for any
applications not converted and operating by August, 1999. Senior management
regularly reviews the status of the Year 2000 program and the Company has
hired an independent third party to review and report on the Company's status
and preparedness.
 
  The Company is currently in the process of replacing personal computers and
phone systems that are not Year 2000 compliant. The Company has confirmed that
its primary manufacturing equipment is Year 2000 compliant. Major suppliers to
the Company have been contacted and the Company has received confirmation of
Year 2000 compliance or a timetable to be compliant from such suppliers. The
Company is in the preliminary stages of assessment of its customer status with
respect to the Year 2000 Issue. Contingency plans will be developed for any
significant suppliers or customers that are not Year 2000 compliant by August
1999 or earlier if the Company becomes aware that such entities may not be
Year 2000 compliant in a timely manner.
 
                                      20
<PAGE>
 
  The Company is funding the expenditures related to the Year 2000 plan with
cash flows from operations The required code changes, testing and
implementation necessary to address the Year 2000 Issue are expected to cost
approximately $3.25 million and the Company has incurred $1.0 million through
November, 1998, the end of the Company's fiscal year. The Company estimates
that it is approximately 40% complete with the efforts required to be Year
2000 compliant.
 
  Even though the Company's Year 2000 plan should adequately address the Year
2000 Issue, there can be no assurance that unforeseen difficulties will not
arise. If the Company does not identify and fix all Year 2000 problems, or if
a major supplier or customer is unable to adequately address its Year 2000
Issue, the Company's results of operations or financial condition could be
materially impacted. A possible worst case scenario might include one or more
of the Company's significant manufacturing or information technology systems
being interrupted causing a delay or curtailment in the production and/or
distribution of goods, a delay or curtailment in the billing and collection of
revenues, an inability to maintain accounting records accurately, and/or an
inability to manage its financial resources, potentially causing a material
impact on the Company's results of operations and financial position. The
Company is engaged in extensive efforts to provide a continuous, uninterrupted
flow of goods and services to customers.
 
 Forward Looking Statements
 
  This document contains forward-looking statements within the meaning of the
safe harbor provisions of the Private Securities Litigation Reform Act of
1995. Although the Company believes its plans are based upon reasonable
assumptions as of the current date, it can give no assurances that such
expectations can be attained. Factors that could cause actual results to
differ materially from the Company's expectations include: general business
and economic conditions, competitive factors, raw materials pricing, and
fluctuations in demand.
 
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
 Foreign Currency Exposures
 
  The Company's earnings are affected by fluctuations in the value of its
subsidiaries' functional currency as compared to the currencies of its foreign
denominated purchases. Foreign currency forward contracts are used to hedge
against the earnings effects of such fluctuations. The result of a uniform 10%
change in the value of the U.S. dollar relative to currencies of countries in
which the Company manufactures or sells its products would not be material to
earnings or financial position. This calculation assumes that each exchange
rate would change in the same direction relative to the U.S. dollar.
 
  During 1998, the Company incurred a $1.3 million premium for forward foreign
exchange contracts to exchange 24.5 million Canadian Dollars and 77.0 million
Mexican Pesos for U.S. Dollars. These contracts will settle on a quarterly
basis beginning in February, 1999 and ending in November, 1999 at exchange
rates ranging between 1.5488 to 1.5493 per U.S. Dollar for the Canadian
contracts and 10.915 to 13.165 per U.S. Dollar for the Mexican contracts.
During 1998, there was no significant gain or loss recognized on these
contracts.
 
 Interest Rate Risk
 
  Because the Company's obligations under the bank credit agreement bear
interest at floating rates, the Company is sensitive to changes in prevailing
interest rates. The Company uses derivative instruments to manage its long-
term debt interest rate exposure, rather than for trading purposes. A 10%
increase or decrease in market interest rates that effect the Company's
interest rate derivative instruments would not have a material impact on
earnings during the next fiscal year.
 
  The Company has entered into interest rate cap and collar agreements to
reduce the impact of changes in interest rates on all or a portion of its
floating rate debt. The notional amounts of interest rate agreements are used
to measure interest to be paid or received and do not represent the amount of
exposure to credit loss. The net cash paid for the interest rate cap and
collar agreements is recorded in prepaid expenses in the consolidated balance
sheet and charged to interest expense over the life of the agreement.
 
                                      21
<PAGE>
 
  As of November 29, 1998, the Company had the following interest rate
instruments in effect that provide protection on the three month LIBOR rate
upon which the Company's variable rate debt is based (actual rate paid is
LIBOR plus the respective margin):
 
<TABLE>
<CAPTION>
                                           NOTIONAL AMOUNT  RANGE FOR
1998                                         (MILLIONS)    LIBOR RATE   PERIOD
----                                       --------------- ----------- ---------
<S>                                        <C>             <C>         <C>
Interest Rate Cap.........................      $150          8.00     1/98-1/03
Interest rate Collar......................      $200       6.50%-4.93% 1/98-1/01
</TABLE>
 
                                      22
<PAGE>
 
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
 
                               SEALY CORPORATION
 
                       CONSOLIDATED FINANCIAL STATEMENTS
 
                    NOVEMBER 29, 1998 AND NOVEMBER 30, 1997
         (WITH INDEPENDENT ACCOUNTANTS' AND AUDITORS' REPORTS THEREON)
 
                                       23
<PAGE>
 
                       REPORT OF INDEPENDENT ACCOUNTANTS
 
To the Board of Directors and
 Stockholders of Sealy Corporation
 
  In our opinion, the accompanying consolidated balance sheet as of November
29, 1998 and the related consolidated statements of operations, stockholders'
equity and cash flows present fairly, in all material respects, the financial
position of Sealy Corporation and its subsidiaries (the "Company") at November
29, 1998, and the results of their operations and their cash flows for the
year then ended in conformity with generally accepted accounting principles.
These financial statements are the responsibility of the Company's management;
our responsibility is to express an opinion on these financial statements
based on our audit. We conducted our audit of these statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audit provides a reasonable basis for the
opinion expressed above. The financial statements of the Company as of
November 30, 1997 and for each of the two years in the period then ended were
audited by other independent accountants whose report dated January 7, 1998
expressed an unqualified opinion on those statements.
 
PricewaterhouseCoopers LLP
Greensboro, North Carolina
January 19, 1999
 
                                      24
<PAGE>
 
                        REPORT OF INDEPENDENT AUDITORS
 
The Board of Directors and Stockholders
 Sealy Corporation:
 
  We have audited the accompanying consolidated balance sheet of Sealy
Corporation and subsidiaries as of November 30, 1997 and the related
consolidated statements of operations, stockholders' equity, and cash flows
for each of the years in the two-year period ended November 30, 1997. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
 
  We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
 
  In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Sealy
Corporation and subsidiaries as of November 30, 1997 and the results of their
operations and their cash flows for each of the years in the two-year period
ended November 30, 1997 in conformity with generally accepted accounting
principles.
 
Cleveland, Ohio                                                        KPMG LLP
January 7, 1998
 
                                      25
<PAGE>
 
                               SEALY CORPORATION
 
                          CONSOLIDATED BALANCE SHEETS
                    (IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                      NOVEMBER 29, NOVEMBER 30,
                                                          1998         1997
                                                      ------------ ------------
<S>                                                   <C>          <C>
                       ASSETS
Current assets:
 Cash and cash equivalents...........................   $ 11,234     $  6,057
 Accounts receivable, net of allowance for doubtful
  accounts
  (1998-$8,211; 1997-$7,696).........................    106,761       93,918
 Inventories.........................................     43,727       46,007
 Prepaid expenses....................................      7,257        7,935
 Prepaid taxes.......................................      1,994       14,594
 Deferred income taxes...............................     17,194           --
                                                        --------     --------
                                                         188,167      168,511
Property, plant and equipment--at cost:
 Land................................................     11,091        9,760
 Buildings and improvements..........................     60,029       53,890
 Machinery and equipment.............................     94,234       86,248
 Construction in progress............................     23,957       19,705
                                                        --------     --------
                                                         189,311      169,603
 Less accumulated depreciation.......................     53,502       43,995
                                                        --------     --------
                                                         135,809      125,608
Other assets:
 Goodwill--net of accumulated amortization (1998-
  $68,259; 1997-$57,261).............................    387,054      406,778
 Patents and other intangibles-net of accumulated
  amortization
  (1998-$7,893; 1997-$6,540).........................      3,138        4,491
 Debt issuance costs, net, and other assets..........     36,912       15,679
                                                        --------     --------
                                                         427,104      426,948
                                                        --------     --------
                                                        $751,080     $721,067
                                                        ========     ========
</TABLE>
 
 
          See accompanying notes to consolidated financial statements.
 
                                       26
<PAGE>
 
                               SEALY CORPORATION
 
                          CONSOLIDATED BALANCE SHEETS
                    (IN THOUSANDS, EXCEPT PAR VALUE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                      NOVEMBER 29, NOVEMBER 30,
                                                          1998         1997
                                                      ------------ ------------
<S>                                                   <C>          <C>
   LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
Current liabilities:
 Current portion-long-term obligations...............   $  8,576     $     --
 Accounts payable....................................     46,094       49,676
 Accrued expenses:
  Customer incentives and advertising................     32,451       30,704
  Compensation.......................................     15,883       17,771
  Interest...........................................     13,432        2,038
  Other..............................................     26,390       18,162
  Deferred income taxes..............................         --        1,936
                                                        --------     --------
                                                         142,826      120,287
                                                        --------     --------
Long-term obligations................................    682,271      330,000
Other noncurrent liabilities.........................     36,069       35,713
Deferred income taxes................................     28,740       30,001
Stockholders' equity (deficit):
 Preferred stock, $0.01 par value; Authorized (1998-
  100,000; 1997-10,000) shares; Issued, none.........         --           --
 Class L common stock, $0.01 par value; Authorized,
  6,000 shares; Issued
  (1998-2,169; 1997-0)...............................         22           --
 Class M common stock, $0.01 par value; Authorized,
  2,000 shares; Issued
  (1998-866;1997-0)..................................          9           --
 Class A common stock, $0.01 par value; Authorized
  (1998-600,000;
  1997-49,500) shares; Issued (1998-20,528; 1997-
  29,932)............................................        205          299
 Class B common stock, $0.01 par value; Authorized
  (1998-200,000; 1997-500) shares; Issued (1998-
  7,791; 1997-11)....................................         78           --
 Additional paid-in capital..........................    134,530      257,320
 Retained (deficit) earnings.........................   (261,833)     (50,614)
 Foreign currency translation adjustment.............    (11,837)      (1,939)
                                                        --------     --------
                                                        (138,826)     205,066
                                                        --------     --------
Commitment and contingencies.........................         --           --
                                                        --------     --------
                                                        $751,080     $721,067
                                                        ========     ========
</TABLE>
 
 
 
          See accompanying notes to consolidated financial statements.
 
                                       27
<PAGE>
 
                               SEALY CORPORATION
 
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
 
<TABLE>
<CAPTION>
                                                        YEAR ENDED
                                           -------------------------------------
                                           NOVEMBER 29, NOVEMBER 30, DECEMBER 1,
                                               1998         1997        1996
                                           ------------ ------------ -----------
<S>                                        <C>          <C>          <C>
Net sales................................    $891,302     $804,834    $697,638
                                             --------     --------    --------
Cost and expenses:
 Cost of goods sold......................     503,500      455,905     397,259
 Selling, general and administrative
  (including provisions for bad debts of
  $1,800, $4,528 and $918, respectively).     300,356      262,023     216,674
 Loss on net assets held for sale and
  other write-downs......................      10,634           --      11,762
 Compensation associated with
  recapitalization.......................      18,886           --          --
 Stock based compensation................          --        1,635       4,779
 Amortization of intangibles.............      13,029       13,264      13,594
 Interest expense, net...................      67,451       31,396      28,797
                                             --------     --------    --------
  Income/(loss) before income taxes, ex-
   traordinary item and cumulative effect
   of change in accounting principle.....     (22,554)      40,611      24,773
Income taxes (benefit)...................      (3,318)      22,509      25,279
                                             --------     --------    --------
 Income/(loss) before extraordinary item
  and cumulative effect of change in
  accounting principle...................     (19,236)      18,102        (506)
Extraordinary item-loss from early
 extinguishment of debt (net of income
 tax benefit of $9,693 and $1,353,
 respectively)(Note 2)...................      14,537        2,030          --
Cumulative effect of change in accounting
 principle (net of income tax benefit of
 $2,885) (Note 1)........................          --        4,329          --
                                             --------     --------    --------
  Net income/(loss)......................    $(33,773)    $ 11,743    $   (506)
                                             ========     ========    ========
Earnings/(loss) per common share--Basic:
 Before extraordinary item and cumulative
  effect of change in accounting
  principle..............................    $  (0.63)    $   0.61    $  (0.02)
 Extraordinary item......................       (0.48)       (0.07)         --
 Cumulative effect of change in
  accounting principle...................          --        (0.15)         --
                                             --------     --------    --------
  Net earnings/(loss) per common share--
   Basic.................................    $  (1.11)    $   0.39    $  (0.02)
                                             ========     ========    ========
Earnings/(loss) per common share--
 Diluted:
 Before extraordinary item and cumulative
  effect of change in accounting
  principle..............................    $  (0.63)    $   0.60    $  (0.02)
Extraordinary item.......................       (0.48)       (0.07)         --
 Cumulative effect of change in
  accounting principle...................          --        (0.14)         --
                                             --------     --------    --------
  Net earnings/(loss) per common share--
   Diluted...............................    $  (1.11)    $   0.39    $  (0.02)
                                             ========     ========    ========
Weighted average number of common shares
 outstanding:
  Basic..................................      30,472       29,575      29,379
  Diluted................................      30,472       30,234      29,379
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       28
<PAGE>
 
                               SEALY CORPORATION
 
                CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                        CLASS L       CLASS M       CLASS A          CLASS B
                     ------------- ------------- ---------------  --------------
                                                                                                         FOREIGN
                                                                                 ADDITIONAL RETAINED    CURRENCY
                     COMMON STOCK  COMMON STOCK  COMMON   STOCK   COMMON  STOCK   PAID-IN   EARNINGS   TRANSLATION
                     SHARES AMOUNT SHARES AMOUNT SHARES   AMOUNT  SHARES  AMOUNT  CAPITAL   (DEFICIT)  ADJUSTMENT    TOTAL
                     ------ ------ ------ ------ -------  ------  ------  ------ ---------- ---------  ----------- ---------
 <S>                 <C>    <C>    <C>    <C>    <C>      <C>     <C>     <C>    <C>        <C>        <C>         <C>
 November 30,
 1995............       --   $--     --    $--    29,451  $ 295       9    $--    $258,336  $  73,387   $ (1,137)  $ 330,881
 Net loss........       --    --     --     --        --     --      --     --          --       (506)        --        (506)
 Performance
 share plan......       --    --     --     --        --     --      --     --       4,510         --         --       4,510
 Management stock
 award...........       --    --     --     --        68     --      --     --         269         --         --         269
 Valuation
 adjustment on
 common stock and
 warrants subject
 to repurchase...       --    --     --     --        --     --      --     --        (308)        --         --        (308)
 Warrants
 exercised.......       --    --     --     --        --     --       2     --          --         --         --          --
 Repurchase of
 management
 stock...........       --    --     --     --      (110)    (1)     --     --          --         --         --          (1)
 Dividend........       --    --     --     --        --     --      --     --          --    (35,463)        --     (35,463)
 Withdrawals from
 performance
 share plan......       --    --     --     --        --     --      --     --      (3,498)        --         --      (3,498)
 Shares tendered
 under
 performance
 share plan......       --    --     --     --        --     --      --     --      (2,820)        --         --      (2,820)
 Foreign currency
 translation.....       --    --     --     --        --     --      --     --          --         --        (70)        (70)
                     -----   ---    ---    ---   -------  -----   -----    ---    --------  ---------   --------   ---------
 December 1,
 1996............       --    --     --     --    29,409    294      11     --     256,489     37,418     (1,207)    292,994
 Net income......       --    --     --     --        --     --      --     --          --     11,743         --      11,743
 Management stock
 award...........       --    --     --     --       285      3      --     --       1,299         --         --       1,302
 Performance
 share plan......       --    --     --     --       233      2      --     --        (134)        --         --        (132)
 Exercised stock
 options.........       --    --     --     --         5     --      --     --          29         --         --          29
 Valuation
 adjustment on
 common stock and
 warrants subject
 to repurchase...       --    --     --     --        --     --      --     --        (363)        --         --        (363)
 Dividend........       --    --     --     --        --     --      --     --          --    (99,775)        --     (99,775)
 Foreign currency
 translation.....       --    --     --     --        --     --      --     --          --         --       (732)       (732)
                     -----   ---    ---    ---   -------  -----   -----    ---    --------  ---------   --------   ---------
 November 30,
 1997............       --    --     --     --    29,932    299      11     --     257,320    (50,614)    (1,939)    205,066
 Net Income......       --    --     --     --        --     --      --     --          --    (33,773)        --     (33,773)
 Stock
 compensation
 related to
 Recapitalization.      --    --     --     --        --     --      --     --      16,413         --         --      16,413
 Treasury stock
 repurchase......      339     4     --     --   (26,885)  (269)    (11)    --    (260,367)  (177,446)        --    (438,078)
 Equity
 issuances.......    1,830    18    866      9    16,472    164   7,791     78     121,048         --         --     121,317
 Exercised stock
 options.........       --    --     --     --     1,009     11      --     --         116         --         --         127
 Foreign currency
 translation.....       --    --     --     --        --     --      --     --          --         --     (9,898)     (9,898)
                     -----   ---    ---    ---   -------  -----   -----    ---    --------  ---------   --------   ---------
 November 29,
 1998............    2,169   $22    866    $ 9    20,528  $ 205   7,791    $78    $134,530  $(261,833)  $(11,837)  $(138,826)
                     =====   ===    ===    ===   =======  =====   =====    ===    ========  =========   ========   =========
</TABLE>
 
 
         See accompanying notes to consolidated financial statements.
 
                                       29
<PAGE>
 
                               SEALY CORPORATION
 
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                       YEAR ENDED
                                          -------------------------------------
                                          NOVEMBER 29, NOVEMBER 30, DECEMBER 1,
                                              1998         1997        1996
                                          ------------ ------------ -----------
<S>                                       <C>          <C>          <C>
Cash flows from operating activities:
 Net income/(loss).......................  $ (33,773)    $ 11,743    $   (506)
 Adjustments to reconcile net
  income/(loss) to net cash provided by
  operating activities:
 Depreciation............................     11,290       10,851      13,037
 Cumulative effect of change in
  accounting principle...................         --        7,214          --
 Extraordinary item-early extinguishment
  of debt................................     24,230        3,383          --
 Loss on net assets held for sale and
  other write-downs......................     10,634           --      11,762
 Loss on disposal of assets..............      1,545        1,061         178
 Non-cash compensation associated with
  Recapitalization.......................     16,413           --          --
 Non-cash compensation...................         --        1,165       4,779
 Non-cash interest on Junior Subordinated
 Note....................................      3,022           --          --
 Deferred income taxes...................    (19,265)       8,528       5,781
 Amortization of:
 Intangibles.............................     13,029       13,264      13,594
 Debt issuance costs.....................      4,056        1,841       2,683
 Discount on Senior Subordinated Notes...      8,050           --          --
 Other, net..............................     (5,171)      (4,449)        922
Changes in operating assets and
 liabilities:
 Accounts receivable.....................    (12,843)     (16,739)     (4,119)
 Inventories.............................      2,280      (12,015)     (5,543)
 Prepaid expenses........................        678       (5,348)       (821)
 Prepaid taxes...........................     12,600       (3,119)     (1,522)
 Accounts payable/accrued expenses/other
  noncurrent liabilities.................     16,255       24,669       4,192
                                           ---------     --------    --------
   Net cash provided by operating
    activities...........................     53,030       42,049      44,417
                                           ---------     --------    --------
Cash flows from investing activities:
 Purchase of property, plant and
  equipment..............................    (33,112)     (29,140)    (12,045)
 Proceeds from sale of subsidiary........         --       35,000          --
 Proceeds from sale of property, plant
  and equipment..........................        216        5,561       1,089
                                           ---------     --------    --------
   Net cash provided by (used in)
    investing activities.................    (32,896)      11,421     (10,956)
                                           ---------     --------    --------
Cash flows from financing activities:
 Treasury stock repurchase, including
  direct expenses........................   (413,078)          --          --
 Proceeds from long-term debt............    462,653           --          --
 Proceeds from issuance of long-term
  public notes...........................    200,447           --          --
 Repayment of long-term obligations......   (211,125)     (63,127)    (23,727)
 Net borrowings from current Revolving
  Credit Facility........................      2,800           --          --
 Net borrowings from prior Revolving
  Credit Facility........................   (130,000)     105,000      25,000
 Dividend................................         --      (99,775)    (35,463)
 Equity issuances........................    121,444           --          --
 Costs associated with tender offer of
  prior debt.............................    (15,361)          --          --
 Debt issuance costs.....................    (32,737)      (6,130)         --
                                           ---------     --------    --------
   Net cash used in financing activities.    (14,957)     (64,032)    (34,190)
                                           ---------     --------    --------
Change in cash and cash equivalents......      5,177      (10,562)       (729)
Cash and cash equivalents:
 Beginning of period.....................      6,057       16,619      17,348
                                           ---------     --------    --------
 End of period...........................  $  11,234     $  6,057    $ 16,619
                                           =========     ========    ========
Supplemental disclosures:
 Taxes paid (received), net..............  $  (7,171)    $ 12,432    $ 14,334
 Interest paid, net......................  $  40,929     $ 29,523    $ 26,487
 Other non-cash activity:
 Goodwill reduction resulting from pre-
  acquisition net operating loss
  utilization............................  $      --     $  9,953    $     --
 Issuance of Junior Subordinated Notes
  as part of Recapitalization proceeds...  $  25,000     $     --    $     --
</TABLE>
 
          See accompanying notes to consolidated financial statements.
 
                                       30
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 
  Significant accounting policies used in the preparation of the consolidated
financial statements are summarized below.
 
 (a) Business and Basis of Presentation
 
  Sealy Corporation (the "Company" or the "Parent"), is engaged in the home
furnishings business and manufactures, distributes and sells conventional
bedding products including mattresses and foundations. Substantially all of
the Company's trade accounts receivable are from retail businesses. As
described in Note 2, the Company incurred substantial debt and issued new
equity to certain equity investors in connection with a leveraged
recapitalization transaction effective December 18, 1997. The consolidated
financial statements of the Company reflect the Company's historical basis of
accounting with the leveraged recapitalization transaction presented as a
repurchase of stock and issuance of new equity.
 
 (b) Principles of Consolidation
 
  The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
 
 (c) Fiscal Year
 
  Effective December 1, 1995, the Company changed its fiscal year from
November 30 to a 52-or-53-week year ending on the closest Sunday to November
30. Accordingly, the years ended November 29, 1998 and November 30, 1997 were
52-week years. Fiscal year 1996 ended on December 1, 1996.
 
 (d) Reclassification
 
  The Company has reclassified the presentation of certain prior year
information to conform with the current year presentation.
 
 (e) Use of Estimates
 
  The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates.
 
 (f) Revenue Recognition
 
  The Company recognizes all revenue at the time shipments are made.
 
 (g) Cash and Cash Equivalents
 
  For purposes of the statements of cash flows, the Company considers all
highly liquid debt instruments with a maturity at the time of purchase of
three months or less to be cash equivalents. Cash equivalents are stated at
cost which approximates market value.
 
 (h) Property, Plant and Equipment
 
  Property, plant and equipment are depreciated over their expected useful
lives principally by the straight-line method for financial reporting purposes
and by both accelerated and straight-line methods for tax reporting purposes.
 
                                      31
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 (i) Amortization of Intangibles
 
  The excess of the purchase cost over the fair value of assets acquired is
being amortized on a straight-line basis over 40 years. The Company evaluates
whether events and circumstances have occurred that indicate that the
remaining estimated useful life of goodwill may warrant revision or that the
remaining balance of goodwill may not be recoverable. When factors indicate
that goodwill should be evaluated for possible impairment, the Company uses an
estimate of the undiscounted future cash flows over the remaining life to
determine whether goodwill is recoverable. The Company believes that no
impairment of goodwill existed at November 29, 1998.
 
  Other intangibles include patents and trademarks which are amortized on the
straight-line method over periods ranging from 5 to 20 years.
 
  The costs related to the issuance of debt (gross costs of $32,737 at
November 29, 1998, net of accumulated amortization of $4,056) are capitalized
and amortized to interest expense over the lives of the related debt.
 
 (j) Earnings Per Common Share
 
  Net earnings per common share data is computed based on the average number
of shares of Common Stock and Common Stock equivalents outstanding during the
period. In February 1997, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("FAS") No. 128, "Earnings
Per Share", which was adopted by the Company on December 1, 1997. At the time,
the Company was required to change the method currently used to compute
earnings per share and to restate all prior periods. Under the requirement for
calculating basic earnings per share, the dilutive effect of stock options is
excluded. Diluted earnings per share continues to reflect the assumed
conversion of all potentially diluted securities. Net earnings per common
share is based upon the weighted average number of shares of the Company's
common stock and common stock equivalents outstanding for the periods
presented. Common stock equivalents included in the computation, using the
treasury stock method, represent shares issuable upon the assumed exercise of
warrants, stock options and performance shares that would have a dilutive
effect in periods in which there were earnings.
 
 (k) Income Taxes
 
  Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for future tax consequences
attributable to differences between the financial statement carrying amounts
of existing assets and liabilities and their respective tax bases and
operating loss and tax credit carryforwards. Deferred tax assets and
liabilities are measured using enacted tax rates expected to apply to taxable
income in the years in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date.
 
 (l) Advertising Costs
 
  The Company expenses all advertising costs as incurred. Advertising expenses
for the years ended November 29, 1998, November 30, 1997, and December 1, 1996
amounted to $114,492, $97,314 and $74,649, respectively.
 
 (m) Recent Accounting Pronouncements
 
On November 20, 1997 the Emerging Issues Task Force (EITF) reached a final
consensus that business process reengineering costs incurred in connection
with an overall information technology transformation project should
 
                                      32
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
be expensed as incurred (EITF 97-13). The transition provisions require
companies that had previously capitalized such business process reengineering
costs to identify these costs and quantify the unamortized amounts remaining
on the balance sheet as of the beginning of the quarter which includes
November 20, 1997. These unamortized amounts are required to be written off as
a cumulative effect of a change in accounting principle in such quarter. The
Company adopted EITF 97-13 in fiscal 1997 resulting in a loss of $4.3 million,
net of income tax benefit of $2.9 million, representing the cumulative write-
off of previously capitalized costs as of August 31, 1997 primarily relating
to the Company's new business systems project. All business process
reengineering costs subsequent to August 31, 1997 have been expensed.
 
  In June 1997, the FASB issued FAS 130, "Reporting Comprehensive Income",
effective for the fiscal years beginning after December 15, 1997, the
Company's fiscal year 1999. FAS 130 requires that the Company report
comprehensive income and its components in a full set of general-purpose
financial statements. Comprehensive income represents the change in
stockholders' equity during the period from nonowner sources. Currently, other
comprehensive income consists of foreign currency translation adjustments. The
adoption of FAS 130 will have no impact on the Company's net income or
stockholders' equity.
 
  In June 1997, the FASB issued FAS 131, "Disclosures about Segments of an
Enterprise and Related Information", effective for years beginning after
December 15, 1997, the Company's fiscal year end 1999. FAS 131 establishes
standards for public companies for the reporting of financial information from
operating segments in annual and interim financial statements as well as
establishes standards for related disclosures about products and services,
geographic areas and major customers. The Company has not completed its
analysis of the effect of adoption on its financial statement disclosure,
however, the adoption of FAS 131 will not affect results of operations or
financial position, but may affect the disclosure of segment information.
 
  In June 1998, the FASB issued FAS 133, "Accounting for Derivative
Instruments and Hedging Activities," effective for years beginning after June
15, 1999, the Company's fiscal year 2000. FAS 133 requires that all
derivatives be recorded on the balance sheet at fair value. Derivatives that
are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives are either offset against the change in the fair
value of assets, liabilities, or firm commitments through earnings or
recognized in other comprehensive income until the hedged item is recognized
in earnings. The Company has not yet determined what the effect of FAS 133
will be on the earnings and financial position of the Company.
 
(2) RECAPITALIZATION
 
  On October 30, 1997, Sealy Corporation entered into an agreement and plan of
merger (the "Merger Agreement") with Sandman Merger Corporation, a transitory
Delaware merger corporation ("Sandman"), and Zell/Chillmark, Fund, L.P., a
Delaware limited partnership ("Zell"). Zell owned approximately 87% of the
issued and outstanding common stock of Parent (the "Existing Common Stock").
Pursuant to the Merger Agreement, upon the satisfaction of certain conditions,
Sandman was merged with and into Parent with Parent being the surviving
corporation effective on December 18, 1997 (the "Closing Date") and the
Company was recapitalized (the "Recapitalization") whereby certain equity
investors, including members of management, acquired an approximate 90.0%
economic equity stake (85.3% voting equity stake) in the Company. A portion of
the issued and outstanding shares of common stock of the Company was converted
into the right to receive aggregate cash equal to $419.3 million less (i)
certain seller fees and expenses and (ii) certain costs in connection with the
extinguishment of certain outstanding options and warrants of the Company and
the remaining portion was converted into voting preferred stock and then
reconverted into $25.0 million in aggregate principal amount of a junior
subordinated note of the Company ("Junior Note") and a retained voting common
stock interest in the Company of approximately 14.7%. Concurrent with the
Recapitalization, the Company refinanced existing indebtedness (the
"Refinancing") by Sealy Mattress Company, a wholly owned subsidiary of the
Parent, issuing
 
                                      33
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
$125 million principal amount of 9 7/8% Senior Subordinated Notes due 2007
(the "Senior Subordinated Notes") and $128 million principal amount of 10 7/8%
Senior Subordinated Discount Notes due 2007 (the "Senior Subordinated Discount
Notes", and, together with the Senior Subordinated Notes, the "Notes"), with
net proceeds to the Company of $75.4 million, and by entering into and
borrowing $460 million under the Senior Credit Agreements.
 
  After the Recapitalization, the issued and outstanding capital stock of the
Company consists of Class A common stock, par value $0.01 per share ("Class A
Common"), Class B common stock, par value $0.01 per share ("Class B Common"),
Class L common stock, par value $0.01 per share ("Class L Common"), and Class
M common stock, par value $0.01 per share ("Class M Common") and collectively
with the Class A Common, Class B Common and Class L Common, ("Common Stock").
The Class L Common and the Class M Common are senior in right of payment to
the Class A Common and Class B Common. Holders of Class B Common and Class M
Common have no voting rights except as required by law. The holders of Class A
Common and Class L Common are entitled to one vote per share on all matters to
be voted upon by the stockholders of the Company, including the election of
directors. The Board of Directors of the Company is authorized to issue
preferred stock, par value $0.01 per share, with such designations and other
terms as may be stated in the resolutions providing for the issue of any such
preferred stock adopted from time to time by the Board of Directors.
 
  After the Recapitalization, the outstanding stock options of the Company
("Recapitalization Stock Options") consist of fully-vested ten-year stock
options to acquire 1,309,644 shares of Class A Common Stock at an exercise
price of $0.125 per share and 145,516 shares of Class L Common Stock at an
exercise price of $10.125 per share.
 
  Upon the consummation of the Recapitalization, Parent and certain of its
stockholders, including the Bain Funds, Harvard Private Capital, Inc."
(Harvard"), Sealy Investors 1, LLC, Sealy Investors 2, LLC, Sealy Investors 3,
LLC (the "LLCs") and Zell (collectively, the "Stockholders") entered into a
stockholders agreement (the "Stockholders Agreement"). The Stockholders
Agreement (i) required that each of the parties thereto vote all of its voting
securities of Parent and take all other necessary or desirable actions to
cause the size of the Board of Directors of Parent to be established at seven
members and to cause three designees of the Bain Funds and one designee of
Harvard to be elected to the Board of Directors; (ii) granted Parent and the
Bain Funds a right of first offer on any proposed transfer of shares of
capital stock of Parent held by Zell, Harvard or the LLCs, (iii) granted
Harvard a right of first offer on any proposed transfer of shares of capital
stock of Parent held by the Bain Funds; (iv) granted tag-along rights on
certain transfers of shares of capital stock of Parent; (v) required the
Stockholders to consent to a sale of Parent to an independent third party if
such sale is approved by holders constituting a majority of the then
outstanding shares of voting common stock of Parent; and (vi) except in
certain instances, prohibits Zell from transferring any shares of capital
stock of Parent until the tenth anniversary of the date of the consummation of
the Recapitalization. Certain of the foregoing provisions of the Stockholders
Agreement terminate upon the consummation of an Initial Public Offering or an
approved Sale (as each is defined in the Stockholders Agreement).
 
  Immediately prior to the closing of the Recapitalization (the "Closing"),
Parent contributed (the "Capital Contribution") all of the issued and
outstanding stock of Sealy, Inc., an Ohio corporation, the Stearns & Foster
Bedding Company, a Delaware corporation, Advanced Sleep Products, a California
corporation, Sealy Components-Pad, Inc., a Delaware corporation and Sealy
Mattress Company of San Diego, a California corporation, to the capital of
Sealy Mattress Company (the "Issuer"). Immediately after the Capital
Contribution, the Issuer became the only direct subsidiary of Parent and owns
100% of the operations of Parent. At the Closing, Sandman was merged with and
into Parent with Parent the surviving corporation.
 
  The Recapitalization transaction resulted in an aggregate direct net charge
to APIC and retained deficit totaling $438.1 million primarily comprised of
the costs associated with the purchase of the then outstanding Class A and
Class B Common Stock, the repurchase of Merger Warrants and the repurchase of
Series A and Series B Restructure Warrants. The Recapitalization transaction
also resulted in a pretax charge of $18.9 million, of which
 
                                      34
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
$16.4 million was non-cash and charged directly to APIC, comprised of
accelerated vesting of stock options and restricted stock and other incentive
based compensation payments to employees in connection with the transaction.
The Company recorded a $14.5 million charge, net of income tax benefit of $9.6
million, representing the write-off of the remaining unamortized debt issue
costs related to long-term obligations repaid in connection with the
Recapitalization as well as consent fees and premiums paid related to the
Tender Offer of the Parent Notes (each of which as defined in Note 4) in
connection with the Recapitalization.
 
(3) INVENTORIES
 
  Inventories are valued at cost not in excess of market, using the first-in,
first-out (FIFO) method. The major components of inventory as of November 29,
1998 and November 30,1997 were as follows:
 
<TABLE>
<CAPTION>
                                                                  1998    1997
                                                                 ------- -------
                                                                 (IN THOUSANDS)
<S>                                                              <C>     <C>
Raw materials................................................... $25,511 $26,251
Work in process.................................................  14,140  12,594
Finished goods..................................................   4,076   7,162
                                                                 ------- -------
                                                                 $43,727 $46,007
                                                                 ======= =======
</TABLE>
 
(4) LONG-TERM OBLIGATIONS
 
  Long-term debt as of November 29, 1998 and November 30, 1997 consisted of
the following:
 
<TABLE>
<CAPTION>
                                                                1998     1997
                                                              -------- --------
                                                               (IN THOUSANDS)
<S>                                                           <C>      <C>
Senior AXELs Credit Agreement................................ $328,875 $     --
Senior Revolving Credit Agreement:
 Tranche A...................................................  110,000       --
 Revolving Credit Facility                                       2,800       --
High Point Corporate Complex Mortgage........................   12,653       --
Senior Subordinated Notes....................................  125,000       --
Senior Subordinated Discount Notes (net of discount of
 $44,503)....................................................   83,497       --
Junior Subordinated Note.....................................   28,022       --
$275,000,000 Second Restated Secured Credit Agreement
 Revolving Credit Facility...................................       --  130,000
10 1/4% Senior Subordinated Notes............................       --  200,000
                                                              -------- --------
                                                               690,847  330,000
 Less current portion........................................    8,576       --
                                                              -------- --------
                                                              $682,271 $330,000
                                                              ======== ========
</TABLE>
 
  On November 18, 1997 Parent commenced an offer (the "Tender Offer") to
purchase for cash up to all (but not less than a majority in principal amount
outstanding) of its 10 1/4% Senior Subordinated Notes due 2003 (the "Parent
Notes") and a related solicitation (the "Consent Solicitation") of consents to
modify certain terms of the Indenture under which the Parent Notes were issued
(the "Parent Note Indenture"). The purchase price to be paid in respect to
validly tendered Parent Notes and related consents was determined by a formula
set forth in the offer to purchase with respect to the Tender Offer. The
Offerings were conditioned upon the consummation of the Tender Offer for, and
the obtaining of consents with respect to, at least a majority in aggregate
principal amount of the Parent Notes outstanding. Parent's obligation to
accept for purchase and to pay for the Parent Notes validly tendered pursuant
to the Tender Offer was conditioned upon, among other things, consummation of
the other elements of the Recapitalization.
 
                                      35
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
  On March 30, 1998, the Company announced a call for redemption of all
remaining outstanding Parent Notes that were not tendered on December 17,
1998. The redemption price of 106.33%, plus accrued interest, or $2.5 million,
was paid on May 1, 1998, after which time interest ceased to accrue on the
Parent Notes.
 
  The Company's 1997 Credit Agreement was terminated in connection with the
Recapitalization. The 1997 Credit Agreement provided for a $275.0 million
reducing revolving credit facility inclusive of a discretionary swing loan
facility of up to $20.0 million. Upon consummation of the Transactions, the
Issuer entered into the AXELs credit agreement (the "Senior AXELs Credit
Agreement") and a credit agreement providing for Tranche A Term Loans and
revolving borrowings (the "Senior Revolving Credit Agreement and, together
with the Senior AXELs Credit Agreement, the "Senior Credit Agreements"). The
Senior Credit Agreements provide for loans of up to $550.0 million, consisting
of a $450.0 million term loan facility (the "Term Loan Facility") and a $100.0
million revolving credit facility (the "Revolving Credit Facility"). The
Issuer distributed the proceeds of the Term Loan Facility and its initial
borrowings under the Revolving Credit Facility to Parent to provide a portion
of the funds necessary to consummate the Recapitalization. Indebtedness of the
Issuer under the Senior Credit Agreements is secured and guaranteed by Parent
and certain of the Issuer's current and all of the Issuer's future U.S.
subsidiaries and will bear interest at a floating rate. See Note 18 for
further details regarding guarantees including consolidating condensed
financial statements for guarantors and non-guarantors. The Senior Credit
Agreements require the Company to meet certain financial tests, including
minimum levels of adjusted EBITDA as determined in the agreements, minimum
interest coverage and maximum leverage ratio. The Senior Credit Agreements
also contain covenants which, among other things, limit capital expenditures,
indebtedness and/or the incurrence of additional indebtedness, investments,
dividends, transactions with affiliates, asset sales, mergers and
consolidations, prepayments of other indebtedness (including the Notes), liens
and encumbrances and other matters customarily restricted in such agreements.
 
  Indebtedness under the Senior Credit Agreements bears interest at a floating
rate. Indebtedness under the Revolving Credit Facility and the Term Loans
initially bears interest at a rate (subject to reduction based on attainment
of certain leverage ratio levels) based upon (i) the Base Rate (defined as the
highest of (x) the rate of interest announced publicly by Morgan Guaranty
Trust Company of New York from time to time, as its base rate or (y) the
Federal funds effective rate from time to time plus 0.50%) plus 1.25% in
respect of the Tranche A Term Loans and the loans under the Revolving Credit
Facility (the "Revolving Loans"), 1.50% in respect of the AXELs Series B,
1.75% in respect of the AXELs Series C and 2.00% in respect of the AXELs
Series D, or (ii) the Adjusted Eurodollar Rate (as defined in the Senior
Credit Agreements) for one, two, three or six months (or, subject to general
availability, two weeks to twelve months), in each case plus 2.25% in respect
of Tranche A Term Loans and Revolving Loans, 2.50% in respect of AXELs Series
B, 2.75% in respect of AXELs Series C and 3.00% in respect to AXELs Series D.
 
  The Tranche A Term Loans mature in December 2002. The AXELs Series B mature
in December 2004. The AXELs Series C mature in December 2005. The AXELs Series
D mature in December 2006. The Tranche A Term Loans are subject to quarterly
amortization payments commencing in March 1999, the AXELs Series B, the AXELs
Series C and the AXELs Series D are subject to quarterly amortization payments
commencing in March 1998 with the AXELs Series B amortizing in nominal amounts
until the maturity of the Tranche A Term Loans, the AXELs Series C amortizing
in nominal amounts until the maturity of the AXELs Series B and the AXELs
Series D amortizing in nominal amounts until the maturity of the AXELs Series
C. The Revolving Credit Facility matures in December 2002. In addition, the
Senior Credit Agreements provide for mandatory repayments, subject to certain
exceptions, of the Term Loans, and reductions in the Revolving Credit
Facility, based on the net proceeds of certain asset sales outside the
ordinary course of business of the Issuer and its subsidiaries, the net
proceeds of insurance, the net proceeds of certain debt and equity issuance's,
and excess cash flow (as defined in the Senior Credit Agreements).
 
                                      36
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 
  The Notes were issued pursuant to an Indenture (the "Senior Subordinated
Note Indenture") among the Issuer, the Guarantors and The Bank of New York, as
trustee (the "Senior Subordinated Note Trustee"). The Senior Subordinated
Discount Notes were issued pursuant to an Indenture (the "Senior Subordinated
Discount Note Indenture" and together with the Senior Subordinated Note
Indenture, the "Indentures") among the Issuer, the Guarantors, and The Bank of
New York, as trustee (the "Senior Subordinated Discount Note Trustee" and,
together with the Senior Subordinated Note Trustee, the "Trustees").
 
  Notes in aggregate principal amount of $125.0 million were issued in the
Offering, and mature on December 15, 2007. Interest on the Notes accrues at
the rate of 9 7/8% per annum and is payable semi-annually in arrears on June
15 and December 15 of each year, commencing on June 15, 1998, to Holders of
record on the immediately preceding June 1 and December 1.
 
  Except as provided below, the Notes are not redeemable at the Company's
option prior to December 15, 2002. Thereafter, the Notes are subject to
redemption at any time at the option of the Company, in whole or in part, upon
not less than 30 nor more than 60 days' notice, at the redemption prices
(expressed as percentages of principal amount) set forth below plus accrued
and unpaid interest and Liquidated Damages thereon to the applicable
redemption date, if redeemed during the twelve-month period beginning on
December 15 of the years indicated below:
 
<TABLE>
<CAPTION>
                                          PERCENTAGE OF
            YEAR                         PRINCIPAL AMOUNT
            ----                         ----------------
            <S>                          <C>
            2002                             104.937%
            2003........................     103.292%
            2004........................     101.646%
            2005 and thereafter.........     100.000%
</TABLE>
 
  Notwithstanding the foregoing, during the first 36 months after December 11,
1997, the Company may on any one or more occasions redeem up to 35% of the
aggregate principal amount of Senior Subordinated Notes originally issued
under the Senior Subordinated Note Indenture at a redemption price of 109.875%
of the principal amount thereof, plus accrued and unpaid interest and
liquidated damages thereon, if any, to the redemption date, with the net cash
proceeds of any Equity Offerings; (as defined in the Indentures) provided that
at least $80.0 million in aggregate principal amount of Senior Subordinated
Notes remain outstanding immediately after the occurrence of such redemption
(excluding Senior Subordinated Notes held by the Company and its
Subsidiaries); and provided further that such redemption shall occur within
120 days of the date of closing of any such Equity Offering.
 
  The Senior Subordinated Discount Notes in aggregate principal amount of
$128.0 million were issued in the Offering, and mature on December 15, 2007.
The Senior Subordinated Discount Notes were offered at a substantial discount
from their principal amount at maturity. Until December 15, 2002 (the "Full
Accretion Date"), no interest (other than liquidated damages, if applicable)
will accrue or be paid in cash on the Senior Subordinated Discount Notes, but
the Accreted Value will accrete (representing the amortization of original
issue discount) between the issuance date and the Full Accretion Date, on a
semi-annual bond equivalent basis. Beginning on the Full Accretion Date,
interest on the Senior Subordinated Discount Notes will accrue at the rate of
10 7/8% per annum and will be payable in cash semi-annually in arrears on June
15 and December 15 of each year, commencing on June 15, 2003, to Holders of
record on the immediately preceding June 1 and December 1. Interest on the
Senior Subordinated Discount Notes will accrue from the most recent date to
which interest has been paid or, if no interest has been paid, from the Full
Accretion Date.
 
                                      37
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
  Except as provided below, the Senior Subordinated Discount Notes will not be
redeemable at the Company's option prior to December 15, 2002. Thereafter, the
Senior Subordinated Discount Notes will be subject to redemption at any time
at the option of the Company, in whole or in part, upon not less than 30 nor
more than 60 days' notice, at the redemption prices (expressed as percentages
of principal amount) set forth below plus accrued and unpaid interest and
liquidated damages thereon to the applicable redemption date, if redeemed
during the twelve-month period beginning on December 15 of the years indicated
below:
 
<TABLE>
<CAPTION>
                                          PERCENTAGE OF
                                         PRINCIPAL AMOUNT
                                         ----------------
            <S>                          <C>
            2002........................     105.437%
            2003........................     103.625%
            2004........................     101.812%
            2005 and hereafter..........     100.000%
</TABLE>
 
  Notwithstanding the foregoing, during the first 36 months after December 11,
1997, the Company may on any one or more occasions redeem up to 35% of the
Accreted Value of Senior Subordinated Discount Notes originally issued under
the Senior Subordinated Discount Note Indenture at a redemption price of
110.875% of the Accreted Value, plus accrued and unpaid liquidated damages
thereon, if any, to the redemption date, with the net cash proceeds of any
Equity Offerings; (as defined in the Indentures) provided that at least $50.0
million in aggregate Accreted Value of Senior Subordinated Discount Notes
remain outstanding immediately after the occurrence of such redemption
(excluding Senior Subordinated Discount Notes held by the Company and its
Subsidiaries); and provided, further, that such redemption shall occur within
120 days of the date of the closing of any such Equity Offering.
 
  On June 23, 1998, the Company secured permanent financing for the property,
manufacturing facility and office building in High Point, North Carolina
("High Point Corporate Complex") purchased on April 13, 1998 and to fund the
construction of the new Corporate headquarters facility at this site. The
initial purchase price of $8.4 million was paid at closing and was financed on
a temporary basis with a draw from the Revolving Credit Facility. The
permanent loan arrangement provides for borrowings not to exceed $14.5
million. The loan arrangement requires monthly principal payments based on a
twenty year amortization commencing three months after the completion of
construction, with a balloon payment at the end of year seven of all then
outstanding principal and interest. Interest accrues at LIBOR plus 3.25% and
is payable monthly.
 
  The Junior Note had an initial principal balance outstanding of $25.0
million and matures on December 18, 2008. Interest on the Junior Note accrues
at 10% per annum if paid within ten days of the end of each calendar quarter
or at 12% if the Company elects to add accrued interest for such quarter to
the then outstanding principal balance. The Company has the option, at each
quarter end, to elect to pay the interest due for the quarter or add such
interest to the principal balance through the term of the Note. From inception
to November 29, 1998, the Company has elected to add accrued interest to the
principal balance increasing the total outstanding balance to $28.0 million at
November 29, 1998.
 
                                      38
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
(5) LEASE COMMITMENTS
 
  The Company leases certain operating facilities, offices and equipment. The
following is a schedule of future minimum annual lease commitments and
sublease rentals at November 29, 1998.
 
<TABLE>
<CAPTION>
                                                            COMMITMENTS UNDER
                                                         -----------------------
                                                         OPERATING   SUBLEASE
FISCAL YEAR                                               LEASES   RENTAL INCOME
-----------                                              --------- -------------
                                                             (IN THOUSANDS)
<S>                                                      <C>       <C>
1999....................................................   $8,456      $266
2000....................................................    6,882       266
2001....................................................    5,475        44
2002....................................................    4,102        --
2003....................................................    2,737        --
Later years.............................................    7,975        --
                                                          -------      ----
                                                          $35,627      $576
                                                          =======      ====
</TABLE>
 
  Rental expense charged to operations is as follows:
 
<TABLE>
<CAPTION>
                                        YEAR ENDED    YEAR ENDED    YEAR ENDED
                                       NOV. 29, 1998 NOV. 30, 1997 DEC. 1, 1996
                                       ------------- ------------- ------------
                                                    (IN THOUSANDS)
<S>                                    <C>           <C>           <C>
Minimum rentals.......................    $10,214       $ 9,153      $ 9,096
Contingent rentals (based upon
 delivery equipment mileage)..........      1,430         1,361        1,067
                                          -------       -------      -------
                                          $11,644       $10,514      $10,163
                                          =======       =======      =======
</TABLE>
 
  The Company has the option to renew certain plant operating leases, with the
longest renewal period extending through 2008. Most of the operating leases
provide for increased rent through increases in general price levels.
 
(6) LOSS ON NET ASSETS HELD FOR SALE AND OTHER WRITE-DOWNS
 
  During 1998, the Company recorded a loss on certain manufacturing assets of
$8,453 as a result of the Company's on-going strategy to improve operational
efficiencies. This loss resulted from the rationalization of certain
manufacturing processes and the write-down of other idled assets. These assets
were written-down to their fair values and production from these assets
primarily will be phased-out over the first two quarters of 1999. The
estimated fair values of these assets are not material. The Company plans to
dispose of such assets by end of 1999.
 
  During 1998, the Company also recorded a loss of $2,181 for the write-down
of previously capitalized software development costs. Such costs were
originally capitalized as a result of the Companies on-going project to
upgrade its management information systems to improve manufacturing operations
and profitability analysis. As a result of a change in the direction of the
project, certain software modules for which costs of $2,181 were incurred will
not be implemented.
 
  Also, see Note 17 related to the disposition of Woodstuff Manufacturing,
Inc. in 1996.
 
                                      39
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
(7) FINANCIAL INSTRUMENTS
 
  The Company utilizes interest rate agreements and foreign exchange contracts
to manage interest rate and foreign currency exposures. The principal
objective of such contracts is to minimize the risks and/or costs associated
with financial and global operating activities. The Company does not utilize
financial instruments for trading or other speculative purposes. The
counterparties to these contractual arrangements are a diverse group of major
financial institutions with which the Company also has other financial
relationships. These counterparties expose the Company to the risk of credit
loss in the event of nonperformance. However, the Company does not anticipate
nonperformance by the other parties, and no material loss would be expected
from their nonperformance.
 
  Interest Rate Instruments: The Company has entered into interest rate cap
and collar agreements to reduce the impact of changes in interest rates on all
or a portion of its floating rate debt. The notional amounts of interest rate
agreements are used to measure interest to be paid or received and do not
represent the amount of exposure to credit loss. The net cash paid for the
interest rate cap and collar agreements ($0.6 million) is recorded in prepaid
expenses in the consolidated balance sheet and charged to interest expense
over the life of the agreement.
 
  As of November 29, 1998, the Company had the following interest rate
instruments in effect that provide protection on the three month LIBOR rate
upon which the Company's variable rate debt is based (actual rate paid is
LIBOR plus the respective margin):
 
<TABLE>
<CAPTION>
                                           NOTIONAL AMOUNT  RANGE FOR
1998                                         (MILLIONS)    LIBOR RATE   PERIOD
----                                       --------------- ----------- ---------
<S>                                        <C>             <C>         <C>
Interest Rate Cap.........................      $150          8.00%    1/98-1/03
Interest rate Collar......................      $200       6.50%-4.93% 1/98-1/01
</TABLE>
 
  The Company had no interest rate instruments at November 30, 1997.
 
  Foreign Exchange Instruments: The Company enters into forward currency
exchange contracts in the regular course of business to manage its exposure
against foreign currency fluctuations primarily on raw material purchase
transactions denominated in U.S. Dollars and originated in other countries.
During 1998, the Company incurred a $1.3 million premium for forward foreign
exchange contracts to exchange 24.5 million Canadian Dollars and 77.0 million
Mexican Pesos for U.S. Dollars. These contracts will settle on a quarterly
basis beginning in February, 1999 and ending in November, 1999 at exchange
rates ranging between 1.5488 to 1.5493 per U.S. Dollar for the Canadian
contracts and 10.915 to 13.165 per U.S. Dollar for the Mexican contracts.
During 1998, there was no significant gain or loss recognized on these
contracts. The Company had no significant contracts outstanding at November
30, 1997.
 
(8) STOCK OPTION AND RESTRICTED STOCK PLANS
 
  Post-Recapitalization: On December 18, 1997, the Company's Board of
Directors adopted the 1998 Stock Option Plan ("1998 Plan") and reserved
5,000,000 shares of Class A Common Stock of the Company for issuance. Options
under the 1998 Plan may be granted either as Incentive Stock Options as
defined in Section 422A of the Internal Revenue Code or Nonqualified Stock
Options subject to the provisions of Section 83 of the Internal Revenue Code.
During the year the Company granted ten-year stock options under the 1998 plan
to acquire 2,243,750 shares of Class A Common Stock at an exercise price of
$0.50 per share (representing fair market value at the time of grant), and
1,185,000 shares of Class A Common Stock at an exercise price of $4.18 per
share (representing a premium to fair market value at the time of grant). The
options vest 40% upon the second anniversary, and 20% on the third, fourth and
fifth anniversary dates of the grant. Due to employee resignations, 214,250
and 50,000 of the options with exercise prices of $0.50 and $4.18 per share,
respectively, were cancelled subsequent to issuance.
 
                                      40
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
  Effective Date of Recapitalization: As a result of the Recapitalization
effective on December 18, 1997, the Human Resources Committee of the Company's
Board of Directors removed all restrictions on the then outstanding restricted
stock issued under the 1996 Transitional Plan and those shares were paid out
as a result of the Recapitalization at the Recapitalization share price of
$14.3027. In addition, a special transaction bonus was approved for key
members of management. Furthermore, as of December 18, 1997, the Human
Resources Committee accelerated vesting of the Company issued and then
outstanding stock options under the 1989 Plan, 1992 Plan, 1993 Plan and 1997
Plan (collectively the "Terminated Stock Option Plans"); terminated the
Terminated Stock Option Plans; and paid each holder of options under the
Terminated Stock Option Plans compensation for such terminations which
compensation was equal to the spread between the Merger share price of
$14.3027 and the respective per share exercise price for the terminated stock
options. Prior to December 18, 1997, certain members of senior management were
offered and elected to cancel their options under the Terminated Stock Option
Plans and their restricted stock under the 1996 Transitional Plan. Those
senior executives received nonqualified stock options which were subsequently
cancelled and exchanged on December 18, 1997 for fully-vested ten-year stock
options to acquire 145,516 shares of the Company's Class L Common Stock at an
exercise price of $10.125 per share and ten-year stock options to acquire
1,309,644 shares of the Company's Class A Common Stock at an exercise price of
$0.125 per share ("Recapitalization Stock Options"). One executive has the
right to require the Company to repurchase certain securities of the Company
at the greater of fair market value or original cost, as defined. As a result
of all recapitalization date activity, the Company recorded an aggregate $18.9
million in compensation expense, and $3.6 million in other non-current
liabilities.
 
  Recapitalization stock options to purchase 1,008,504 Class A Common shares
were exercised during the year ended November 29, 1998.
 
  Pre-Recapitalization: The Company adopted the 1989 Stock Option Plan ("1989
Plan") in 1989, the 1992 Stock Option Plan ("1992 Plan") in 1992 and the 1997
Stock Option Plan ("1997 Plan") in 1997 and reserved 100,000 shares, 600,000
shares and 2,400,000 shares, respectively, of Class A Common Stock of the
Company (the "Shares") for future issuance. Options under the 1989 Plan, the
1992 Plan and the 1997 Plan could have been granted either as Incentive Stock
Options as defined in Section 422A of the Internal Revenue Code or
Nonqualified Stock Options subject to the provisions of Section 83 of the
Internal Revenue Code. There were no options outstanding relating to the 1989,
1992, or 1997 Plans as of November 29, 1998.
 
  During Fiscal 1993, the Company adopted the 1993 Non-Employee Director Stock
Option Plan (the "1993 Plan"), which was subsequently amended on April 6, 1994
and June 27, 1995. The 1993 Plan provides for the one-time automatic grant of
ten-year options to acquire up to 10,000 shares to all current and future
directors who are not employed by the Company, by Zell or by their respective
affiliates ("Non-Employee Directors"). Options granted under the 1993 Plan
vest immediately and were initially exercisable at a price equal to the fair
market value of the shares on the date of grant. For options granted prior to
March 1, 1994, the exercise price of options granted pursuant to this Plan
increased on the first anniversary date of such grant by 4%, which became the
fixed exercise price for all such options. Options issued thereafter, were
exercisable over their term at the fair market value on the date of grant.
Pursuant to the 1993 Plan, the Company granted options to acquire up to 50,000
shares to Non-Employee Directors in fiscal year 1993 at an initial exercise
price of $9.05 per share. The 1993 Plan was amended on June 27, 1995 to
provide for the grant of an additional option to purchase 5,000 shares to each
eligible director and thereafter providing for the automatic annual grant of
an option to each eligible director to purchase an additional 5,000 shares at
fair market value on the date of grant. Pursuant to the 1993 Plan, the Company
granted options to acquire up to 5,000 shares to each eligible director in
fiscal 1995, 1996 and 1997 with a fixed exercise price of $15.95, $10.63 and
$9.60 per share, respectively. All options under the 1993 Plan were exercised
on December 18, 1997.
 
 
                                      41
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
  In 1996, pursuant to an employment agreement with the Company's CEO, the
Company granted him an aggregate of 67,635 shares of restricted stock with a
fair value of $637,800 at date of grant. The restricted stock was to vest at a
rate of approximately 25% at each anniversary date of the grant. The Company
also awarded a grant of ten-year stock options to acquire up to an aggregate
of 587,342 shares at an exercise price of $7.23 per share (representing fair
market value at the time of grant) adjusted for the dividends paid on May 17,
1997 and February 28, 1997. The stock options were to vest at a rate of 25% at
each anniversary date of the grant. On May 31, 1997 the Human Resources
Committee, under the 1997 Plan, granted the CEO a ten-year stock option to
acquire up to 75,000 shares at an exercise price of $9.60 per Share
(representing fair market value at the time of grant).
 
  In 1996, the Company adopted the 1996 Transitional Restricted Stock Plan
(the "1996 Transitional Plan") effective December 1, 1996 which terminates on
January 3, 2000, and no grants shall thereafter be awarded under the Plan. All
grants awarded under the Plan prior to such date shall remain in effect until
they have been exercised or terminated in accordance with the terms and
provisions of the Plan. On January 6, 1997, 281,400 shares, which vest on
January 3, 2000, were granted under the Plan with a fair value of $3,632,874
at date of grant. The Plan provides for partial vesting at a rate of 50% if a
grantee incurs a "termination" (as defined in the Plan) from January 3, 1999
to January 2, 2000. During Fiscal 1997, 35,800 shares were forfeited and
39,700 additional shares were issued. All options under the 1996 Transitional
Plan were exercised on December 18, 1997.
 
  In May 1997, the Company granted ten-year stock options to acquire 921,400
shares at an exercise price of $9.60 per share (representing fair market value
at the time of grant). The options were to vest 50% on the third anniversary
date of the grant and 50% on the fourth anniversary date of the grant.
 
  SFAS No. 123 Disclosures: As permitted by SFAS No. 123, Accounting for
Stock-Based Compensation, the Company continues to account for its stock
option and stock incentive plans in accordance with Accounting Principles
Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees, and
makes no charges (except to the extent required by APB Opinion No. 25) against
earnings with respect to options granted. SFAS No. 123 does however require
the disclosure of pro forma information regarding net income and earnings per
share determined as if the Company had accounted for its stock options under
the fair value method.
 
  For purposes of this pro forma disclosure the estimated fair value of the
options is amortized to expense over the options' vesting period.
 
<TABLE>
<CAPTION>
                                                        1998     1997    1996
                                                      --------  ------- ------
<S>                                       <C>         <C>       <C>     <C>
Net income (loss) (in thousands)......... As reported $(33,773) $11,743 $ (506)
                                            Pro forma $(31,468) $10,814 $ (892)
Net earnings (loss) per share............ As reported $  (1.11) $  0.39 $(0.02)
                                            Pro forma $  (1.03) $  0.35 $(0.03)
</TABLE>
 
  Because the SFAS No. 123 method of accounting has not been applied to
options granted prior to Fiscal 1996 and all related Plans were terminated
effective December 18, 1997, the above pro forma effect may not be
representative of that to be expected in future years.
 
  The fair value for all options granted in Fiscal 1998 and 1997 were
estimated at the date of grant using a Black-Scholes option pricing model with
the following weighted-average assumptions: the expected life for all options
is seven years; the expected dividend yield for all stock is zero percent and
the expected volatility of all stock is zero percent. Adjustments were made to
the then outstanding options and related stock prices as a result of the
dividends paid on May 17, 1996 and February 28, 1997 relating to all the
option plans in effect as of November 30, 1997. Such adjustments were treated
as modifications of outstanding awards in accordance with
 
                                      42
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
SFAS No. 123. The risk free interest rates utilized for the grants made during
fiscal 1998 and 1997 and for the May 1996 and February 1997 modification of
all then outstanding grants are as follows:
 
<TABLE>
<CAPTION>
                                                   RISK FREE INTEREST RATE
                                             -----------------------------------
                                             ORIGINAL MODIFICATION MODIFICATION
OPTION GRANT DATE                             GRANT     MAY 1996   FEBRUARY 1997
-----------------                            -------- ------------ -------------
<S>                                          <C>      <C>          <C>
1989 Plan:
 December 1989..............................     --         --         5.15%
1992 Plan:
 June 1992..................................     --         --         6.06%
 June 1993..................................     --         --         6.22%
 June 1994..................................     --         --         6.31%
 June 1995..................................     --         --         6.38%
 June 1996..................................  6.77%         --         6.46%
1993 Plan:
 March 1993.................................     --      6.26%         6.46%
 June 1995..................................     --      6.51%         6.46%
 June 1996..................................  6.77%         --         6.46%
 May 1997...................................  6.64%         --            --
CEO Award:
 March 1996.................................  5.82%         --         6.46%
1997 Plan:
 June 1997..................................  6.64%         --            --
1998 Plan:
 Fiscal 1998................................  5.55%         --            --
</TABLE>
 
  A summary of the status and changes of shares subject to options and the
related average price per share is as follows:
 
<TABLE>
<CAPTION>
                                                  SHARES SUBJECT AVERAGE OPTION
                                                    TO OPTIONS   PRICE PER SHARE
                                                  -------------- ---------------
<S>                                               <C>            <C>
Outstanding December 1, 1996.....................      848,072       $11.19
                                                    ----------
 Granted.........................................      941,400         9.40
 Adjustment......................................      341,478           --
 Exercised.......................................       (4,958)        5.82
 Canceled........................................      (41,700)       10.81
                                                    ----------
Outstanding November 30, 1997....................    2,084,292         8.52
                                                    ----------
 Granted.........................................    4,883,910         1.58
 Adjustment......................................           --           --
 Exercised.......................................   (3,092,796)        5.78
 Canceled........................................     (264,250)        1.20
                                                    ----------
Outstanding November 29, 1998....................    3,611,156       $ 2.01
                                                    ==========
</TABLE>
 
  Options exercisable and shares available for future grant were:
 
<TABLE>
<CAPTION>
                                                         FISCAL YEAR ENDED
                                                    ---------------------------
                                                      1998      1997     1996
                                                    --------- --------- -------
<S>                                                 <C>       <C>       <C>
Options exercisable................................   446,656   641,895 312,447
Weighted-average option price per share of options
 exercisable....................................... $    3.38 $    7.91 $ 11.29
Weighted-average fair value of options granted
 during the year................................... $    1.69 $    9.60 $ 10.63
Shares available for grant......................... 1,835,500 1,741,086 339,550
</TABLE>
 
                                      43
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
  The ranges of exercise prices and the remaining contractual life of options
as of November 29, 1998 were:
 
<TABLE>
<CAPTION>
                                                    CLASS A            CLASS L
                                          ---------------------------- --------
EXERCISE PRICES                           $ 0.125   $ 0.50    $ 4.18   $ 10.125
---------------                           -------- --------- --------- --------
<S>                                       <C>      <C>       <C>       <C>
Options outstanding:
 Outstanding as of November 29, 1998.....  301,140 2,029,500 1,135,000  145,516
 Weighted-average remaining contractual
  life................................... 9.0 Yrs.   9.3 Yrs  9.7 Yrs. 9.0 Yrs.
 Weighted-average exercise price.........   $0.125 $    0.50 $    4.18 $ 10.125
Options exercisable:
 Outstanding as of November 29, 1998.....  301,140        --        --  145,516
 Weighted-average remaining contractual
  life................................... 9.0 Yrs.        --        -- 9.0 Yrs.
 Weighted-average exercise price.........   $0.125        --        -- $ 10.125
</TABLE>
 
(9) INCOME TAXES
 
  The Company and its domestic subsidiaries file a consolidated U.S. Federal
income tax return. Income tax expense (benefit) consists of:
 
<TABLE>
<CAPTION>
                                         YEAR ENDED    YEAR ENDED    YEAR ENDED
                                        NOV. 29, 1998 NOV. 30, 1997 DEC. 1, 1996
                                        ------------- ------------- ------------
<S>                                     <C>           <C>           <C>
Current:
Federal...............................    $  1,737       $ 6,913      $15,494
State and local.......................         948         2,197        1,196
Foreign...............................       3,569         3,963        2,808
                                          --------       -------      -------
                                             6,254        13,073       19,498
Deferred:
Federal...............................     (16,541)        4,507        5,092
State and local.......................      (2,363)          644          727
Foreign...............................        (361)           47          (38)
                                          --------       -------      -------
                                           (19,265)        5,198        5,781
                                          --------       -------      -------
Total.................................     (13,011)       18,271       25,279
Allocated to loss from early extin-
 guishment of debt....................      (9,693)       (1,353)          --
Allocated to effect of change in ac-
 counting principle...................          --        (2,885)          --
                                          --------       -------      -------
Income tax expense (benefit) before
 extraordinary item and cumulative ef-
 fect of change in accounting princi-
 ple..................................    $ (3,318)      $22,509      $25,279
                                          ========       =======      =======
</TABLE>
 
  Net income before taxes from foreign operations amounted to $6,355, $8,785,
and $5,955 for the years ended November 29, 1998, November 30, 1997, and
December 1, 1996, respectively.
 
                                      44
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
  The differences between the effective tax rate and the statutory U.S.
Federal tax rate are explained as follows:
 
<TABLE>
<CAPTION>
                                        YEAR ENDED    YEAR ENDED    YEAR ENDED
                                       NOV. 29, 1998 NOV. 30, 1997 DEC. 1, 1996
                                       ------------- ------------- ------------
<S>                                    <C>           <C>           <C>
Income tax expense (benefit) computed
 at statutory
 U.S. Federal income tax rate.........     (35.0%)       35.0%         35.0%
State and local income taxes, net of
 federal tax benefit..................      (2.9%)        7.9%          6.1%
Foreign tax rate differential and ef-
 fects of foreign earnings repatria-
 tion.................................       1.0%         0.5%          6.5%
Sale of subsidiary....................       0.0%         2.4%         37.3%
Other items, net......................       0.2%         1.9%          1.0%
                                           -----         ----         -----
Effective income tax rate before per-
 manent differences resulting from
 purchase accounting..................     (36.7%)       47.7%         85.9%
Permanent differences resulting from
 purchase accounting..................       9.0%        12.9%         16.1%
                                           -----         ----         -----
Effective income tax rate.............     (27.7%)       60.6%        102.0%
                                           =====         ====         =====
</TABLE>
 
  Deferred income taxes reflect the tax effect of temporary differences
between carrying amounts of assets and liabilities for financial reporting
purposes and the amounts for income tax purposes. The Company's total deferred
tax assets and liabilities and their significant components are as follows:
 
<TABLE>
<CAPTION>
                                          1998                    1997
                                 ----------------------- -----------------------
                                   CURRENT   NONCURRENT    CURRENT   NONCURRENT
                                    ASSET       ASSET       ASSET       ASSET
                                 (LIABILITY) (LIABILITY) (LIABILITY) (LIABILITY)
                                 ----------- ----------- ----------- -----------
<S>                              <C>         <C>         <C>         <C>
Accrued salaries and benefits..    $ 5,320    $  3,123     $ 5,249    $  1,748
Allowance for doubtful ac-
 counts........................      3,185          --       3,028          --
Plant shutdown, idle facili-
 ties, and environmental costs.      1,398       1,322       6,777      (4,171)
Alternative minimum tax credit
 carryforward..................      2,743          --          --          --
Accrued warranty reserve.......      1,745          --       1,691       1,691
Book versus tax differences re-
 lated to property, plant, and
 equipment.....................         --     (18,270)         --     (21,419)
Book versus tax differences re-
 lated to intangible assets....         --     (11,454)         --     (12,262)
Book versus tax differences re-
 lated to recapitalization ex-
 penses and related financing
 costs.........................         --        (311)    (13,467)         --
All other......................      2,803      (3,150)     (5,214)      4,412
                                   -------    --------     -------    --------
                                   $17,194    $(28,740)    $(1,936)   $(30,001)
                                   =======    ========     =======    ========
</TABLE>
 
  A provision has not been made for U.S. or foreign taxes on undistributed
earnings of subsidiaries which operate in Canada and Puerto Rico. Upon
repatriation of such earnings, withholding taxes might be imposed that are
then available for use as credits against a U.S. Federal income tax liability,
subject to certain limitations. The amount of taxes that would be payable on
repatriation of the entire amount of undistributed earnings is immaterial.
 
  The Company reduced goodwill by $0, $9,953 and $0 for the utilization of
previously unrecognized pre-acquisition net operating loss carryforwards in
1998, 1997 and 1996, respectively.
 
                                      45
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
(10) RETIREMENT PLANS
 
  Substantially all employees are covered by defined contribution profit
sharing plans, where specific amounts are set aside in trust for retirement
benefits. The total profit sharing expense was $6.6 million, $5.9 million, and
$5.0 million for the years ended November 29, 1998, November 30, 1997, and
December 1, 1996, respectively.
 
(11) COMMON STOCK
 
  Prior to the Recapitalization, holders of Class A Common Stock were entitled
to one vote per share on all matters submitted to a vote of stockholders while
the holders of Class B Common Stock were entitled to one-half vote per share.
Except with respect to voting rights, the terms of the Class A Common Stock
and the Class B Common Stock were identical. Shares of Class B Common Stock,
under certain circumstances, were convertible into shares of Class A Common
Stock. In connection with the Recapitalization (see Note 2), the terms of
Class A and B Common Stock were amended and new classes of Class L and M
Common Stock were issued.
 
(12) PERFORMANCE SHARE PLAN
 
  Effective April 1, 1992, the Company adopted a Performance Share Plan
("Plan") for certain employees of the Company. Under the Plan, the Board of
Directors could have approved the issuance of up to 3.0 million performance
share units each representing the right to receive up to one share if the
Company met specified cumulative operating cash flow targets over the five-
year period ending December 1, 1996. During Fiscal 1996, two participants
withdrew from the Plan resulting in an adjustment to additional paid-in
capital. As of December 1, 1996, the conclusion of the Plan, 451,740 Shares
were awarded under the Plan of which 218,368 Shares were tendered to the
Company by Plan participants to cover their estimated tax liability, resulting
in the issuance of 233,372 Shares in January 1997.
 
  The Plan was a variable stock compensation plan pursuant to which the fair
value of shares issuable under the Plan was recorded as compensation expense
over the Plan's five-year term ending December 1, 1996. In addition to the
annual amount of compensation expense under the Plan, such amounts were
adjusted to give cumulative effect to any change in the amount of non-cash
compensation expense previously recorded in prior reporting periods, resulting
from subsequent increases or decreases in the fair value of the shares or the
number of performance share units outstanding since such reporting period and
to any change in management's estimate of its ability to achieve the
cumulative operating cash flow targets as defined in the Plan. Performance
Share Plan expense for the year ended December 1, 1996 amounted to $4.5
million. The plan was not renewed after its termination in December 1, 1996.
 
                                      46
<PAGE>
 
                               SEALY CORPORATION
 
                   NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
(13) EARNINGS PER SHARE
 
  The following table sets forth the computation of basic and diluted earnings
per share (in thousands):
 
<TABLE>
<CAPTION>
                                                        1998     1997    1996
                                                      --------  ------- ------
<S>                                                   <C>       <C>     <C>
Numerator:
Income (loss) before extraordinary item and cumula-
 tive effect of change
 in accounting principle............................. $(19,236) $18,102 $ (506)
Extraordinary item, net..............................   14,537    2,030     --
Cumulative effect of change in accounting principle,
 net.................................................       --    4,329     --
                                                      --------  ------- ------
Net income (loss).................................... $(33,773) $11,743 $ (506)
                                                      ========  ======= ======
Denominator:
Denominator for basic earnings per share--weighted
 average shares......................................   30,472   29,575 23,379
Effect of dilutive securities:
Stock options........................................       --      124     --
Merger warrants......................................       --      204     --
Restricted stock.....................................       --      311     --
Other................................................       --       20     --
                                                      --------  ------- ------
Denominator for diluted earnings per share--adjusted
 weighted-average shares and assumed conversions.....   30,472   30,234 23,379
                                                      ========  ======= ======
</TABLE>
 
Due to loss from continuing operations in 1998 and 1996, the dilutive
securities would have been antidilutive. Accordingly, they were excluded from
the calculation in dilutive earnings per share.
 
                                       47
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
 (14) SUMMARY OF INTERIM FINANCIAL INFORMATION (UNAUDITED)
 
  Quarterly financial data for the years ended November 29, 1998 and November
30, 1997, is presented below:
 
<TABLE>
<CAPTION>
                                          FIRST     SECOND    THIRD    FOURTH
                                         QUARTER   QUARTER   QUARTER  QUARTER
                                         --------  --------  -------- --------
                                          (AMOUNTS IN THOUSANDS, EXCEPT FOR
                                                     SHARE DATA)
<S>                                      <C>       <C>       <C>      <C>
1998:
 Net sales.............................. $209,259  $213,572  $242,603 $225,868
 Gross profit...........................   87,775    92,405   108,595   99,027
 Income (loss) before extraordinary
  item..................................  (17,765)   (1,650)    4,363   (4,184)
 Extraordinary item--loss from early ex-
  tinguishment of debt, net of tax......   14,455        82        --       --
 Net income (loss)......................  (32,220)   (1,732)    4,363   (4,184)
 Income/(loss) before extraordinary
  item--basic...........................    (0.59)    (0.06)     0.14    (0.12)
 Income/(loss) before extraordinary
  item--diluted.........................    (0.59)    (0.06)     0.14    (0.12)
 Net income/(loss)--basic...............    (1.06)    (0.06)     0.14    (0.13)
 Net income/(loss)--diluted.............    (1.06)    (0.06)     0.14    (0.13)
1997:
 Net sales.............................. $168,904  $180,625  $229,919 $225,386
 Gross profit...........................   72,890    80,951   101,864   93,224
 Income before extraordinary item and
  cumulative effect of change in ac-
  counting principle....................    3,188     3,282     7,917    3,715
 Extraordinary item--loss from early ex-
  tinguishment of debt, net of tax......    2,030        --        --       --
 Cumulative effect of change in account-
  ing principle, net of tax.............       --        --        --    4,329
 Net income (loss)......................    1,158     3,282     7,917     (614)
 Income/(loss) before extraordinary item
  and cumulative effect of change in ac-
  counting principle--basic.............     0.11      0.11      0.26     0.13
 Income/(loss) before extraordinary item
  and cumulative effect of change in ac-
  counting principle--diluted...........     0.11      0.11      0.26     0.12
 Net income/(loss)--basic...............     0.04      0.11      0.26    (0.02)
 Net income/(loss)--diluted.............     0.04      0.11      0.26    (0.02)
</TABLE>
 
  During the first quarter of Fiscal 1998, the Company recorded an after tax
charge of $14.5 million ($0.47 per share), representing the write-off of the
remaining unamortized debt issuance costs related to long-term obligations
repaid in connection with the Recapitalization as well as consent fees and
premiums paid related to the Tender Offer of the Parent Notes in connection
with the Recapitalization. Also, during the first quarter the Company recorded
an after tax charge of $11.1 million ($0.37 per share), related to costs
associated with the Recapitalization. The Recapitalization costs were
primarily comprised of accelerated vesting of stock and restricted stock and
other incentives based on compensation payments to employees in connection
with the transaction. During the fourth quarter of Fiscal 1998, the Company
recorded an after tax loss of $5.1 million ($0.17 per share), for the loss on
net assets available for sale and other write-downs. Such assets are primarily
related to the rationalization of certain manufacturing processes and the
write-down of other underperforming assets (See Note 6). In addition, the
Company recorded an after tax loss of $1.3 million ($0.04 per share) due to
the write-down of capitalized software development costs (See Note 6). During
the first and fourth quarters of Fiscal 1997, the Company recorded an after-
tax loss of $2.0 million ($0.07 per share), from early extinguishment of debt
in connection with the Refinancing, and $4.3 million ($0.14 per share), from
write-offs in connection with EITF 97-13, respectively.
 
                                      48
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
 
(15) CONTINGENCIES
 
  In accordance with procedures established under the Environmental Cleanup
Responsibility Act (now known as the Industrial Site Recovery Act), Sealy and
one of its subsidiaries are parties to an Administrative Consent Order ("ACO")
issued by the New Jersey Department of Environmental Protection ("DEP").
Pursuant to the ACO, the Company and such subsidiary agreed to conduct soil
and groundwater investigation and remediation at the plant previously owned by
the subsidiary in South Brunswick, New Jersey. The Company does not believe
that its manufacturing processes were a source of the contaminants found to
exist above regulatorily acceptable levels in the groundwater. The Company and
its subsidiary have retained primary responsibility for the investigation and
any necessary clean up plan approved by the DEP under the terms of the ACO.
 
  In 1997, the Company, with DEP approval, completed essentially all soil
remediation and conducted a pilot test for a company-proposed revision to the
groundwater remediation program. The Company's revised groundwater remediation
plan was submitted in May, 1998 to the DEP for approval.
 
  While the Company cannot predict the ultimate timing or cost to remediate
this facility based on facts currently known, management believes the
previously established accrual for site investigation and remediation costs is
adequate to cover the Company's reasonably estimable liability and does not
believe the resolution of this matter will have a material adverse effect on
the Company's financial position or future operations.
 
  In March, 1994, the Company filed a claim in the U.S. District Court for the
District of New Jersey against former owners of the site and their lenders
under the Comprehensive Environmental Response, Compensation and Liability Act
seeking contribution for site investigation and remedial costs. In March,
1997, the Company received $1.7 million from a former owner of the site and
one of the lenders to the former owner in the final settlement of this
litigation which was recorded as an increase to other noncurrent liabilities.
 
  In January 1997, the Company filed a claim in the U.S. District Court of New
Jersey against former insurance companies for the Company under the
Comprehensive Environmental Response, Compensation and Liability Act seeking
contribution for site investigation and remedial costs. A parallel case
seeking a judgment of non-liability was filed by some (but not all) of these
insurance companies in the U.S. District Court for the Northern District of
Ohio. Both the New Jersey and Ohio District Courts have ruled that New Jersey
law applies. In November, 1998, the Company settled these cases when the
insurers paid the Company approximately $3.8 million which was recorded as an
increase to other noncurrent liabilities.
 
  The Company also has begun to remediate soil and groundwater contamination
at an inactive facility located in Oakville, Connecticut. The Company
submitted a soil and groundwater remediation plan to the Connecticut
Department of Environmental Protection in December 1998. The Company believes
the contamination is attributable to the manufacturing operations of previous
unaffiliated occupants of the facility. In 1994, the Company filed a cost
recovery action in U.S. District Court of Connecticut to require these
entities to complete the remediation and reimburse the Company for its cleanup
costs. Trial of this matter has been bifurcated with the issue of damages only
going to trial in March, 1999. Based on the facts currently known, management
does not believe that resolution of this matter will have a material adverse
effect on the Company's financial position or future operations.
 
  On May 22, 1997, the Company filed in the United States District Court for
the Northern District of Illinois a motion to terminate certain antitrust
final judgments (the "Judgments") entered on December 30, 1964 and December
26, 1967. These Judgments, among other things, prohibited the Company from
suggesting resale prices to its dealers. During the pendency of the Company's
motion to terminate the Judgments the Department of Justice (the "Department")
on September 8, 1997, issued to the Company a Civil Investigative Demand
 
                                      49
<PAGE>
 
                               SEALY CORPORATION
 
                  NOTES TO FINANCIAL STATEMENTS--(CONTINUED)
("CID") seeking documents relating to, among other things, communications
between the Company and dealers concerning the retail prices of mattresses. In
response to the CID, the Company produced certain documents and the deposition
of a Company executive was taken. Immediately following such document
production and deposition, the Department consented to the termination of the
Judgments and an order terminating the Judgments was entered by the Court on
September 19, 1997. The Company has produced additional documents in response
to the CID, and is cooperating with the Department in its investigation.
 
(16) FAIR VALUE OF FINANCIAL INSTRUMENTS
 
  Due to the short maturity of cash and cash equivalents, accounts receivable,
accounts payable and accrued expenses, their carrying values approximate fair
value. The carrying amount of long-term debt under the Senior AXELs Credit
Agreement and the Senior Revolving Credit Agreement approximates fair value
because the interest rate adjusts to market interest rates. The fair value of
long-term debt under the Senior Subordinated Notes and Senior Subordinated
Discount Notes, based on a quoted market price, was $120.6 million and $76.8
million at November 29, 1998 and November 30, 1997, respectively.
 
(17) DISPOSITION
 
  On January 15, 1997, the Company completed the sale of Woodstuff
Manufacturing, Inc., a wholly owned subsidiary that manufactured and marketed
solid wood bedroom furniture under the "Samuel Lawrence" brand name. The
divestiture produced cash proceeds of $35.0 million and resulted in a net of
tax book loss of $17.6 million. The loss on sale of this subsidiary includes
income tax expense of $5.8 million arising from the tax gain on the
transaction, as well as transaction costs related to the sale. A summary of
the net assets held for sale at December 1, 1996 is as follows (amounts in
thousands):
 
<TABLE>
<S>                                                                    <C>
Accounts receivable................................................... $  9,228
Inventory.............................................................    6,907
Other current assets..................................................      480
Property, plant and equipment, net....................................   10,329
Other assets..........................................................   26,246
Accounts payable and accrued expenses.................................   (4,939)
Other liabilities.....................................................   (1,998)
Excess of net assets over proceeds from sale..........................  (10,761)
                                                                       --------
Net assets held for sale.............................................. $ 35,492
                                                                       ========
</TABLE>
 
(18) GUARANTOR/NON-GUARANTOR FINANCIAL INFORMATION
 
  As discussed in Note 4, the Parent and each of the Guarantor Subsidiaries
has fully and unconditionally guaranteed, on a joint and several basis, the
obligation to pay principal and interest with respect to the Notes.
Substantially all of the Issuer's operating income and cashflow 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 Notes. Although holders
of the Notes will be direct creditors of the Issuer's principal direct
subsidiaries by virtue of the guarantees, the Issuer has subsidiaries ("Non-
Guarantor Subsidiaries") that are not included among the Guarantor
Subsidiaries, and such subsidiaries will not be obligated with respect to the
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 Notes.
 
                                      50
<PAGE>
 
  The following supplemental consolidating condensed financial statements
present:
 
  1. Consolidating condensed balance sheets as of November 29, 1998 and
     November 30, 1997, consolidating condensed statements of operations and
     cash flows for each of the years in the three-year period ended November
     29, 1998.
 
  2. Sealy Corporation (the "Parent" and a "Guarantor"), Sealy Mattress
     Company (the "Issuer"), combined Guarantor Subsidiaries and combined
     Non-Guarantor Subsidiaries with their investments in subsidiaries
     accounted for using the equity method.
 
  3. Elimination entries necessary to consolidate the Parent and all of its
     subsidiaries.
 
                                      51
<PAGE>
 
                               SEALY CORPORATION
 
               SUPPLEMENTAL CONSOLIDATING CONDENSED BALANCE SHEET
 
                               NOVEMBER 29, 1998
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                        SEALY      COMBINED     COMBINED
                             SEALY     MATTRESS   GUARANTOR   NON-GUARANTOR
                          CORPORATION  COMPANY   SUBSIDIARIES SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                          ----------- ---------- ------------ ------------- ------------ ------------
<S>                       <C>         <C>        <C>          <C>           <C>          <C>
ASSETS
Current assets:
Cash and cash
 equivalents............   $      --  $       22  $   9,162     $  2,050       $   --     $  11,234
Accounts receivable,
 net....................          --       3,404     92,644       10,713           --       106,761
Inventories.............          --       1,216     38,123        4,388           --        43,727
Prepaid expenses and
 other assets...........         714         341     22,190        3,200           --        26,445
                           ---------  ----------  ---------     --------       ------     ---------
                                 714       4,983    162,119       20,351           --       188,167
Property, plant and
 equipment, at cost.....          --       4,796    172,375       12,140           --       189,311
Less accumulated
 depreciation...........          --       1,730     49,189        2,583           --        53,502
                           ---------  ----------  ---------     --------       ------     ---------
                                  --       3,066    123,186        9,557           --       135,809
Other assets:
Goodwill and other
 intangibles, net.......          --      14,050    350,291       25,851           --       390,192
Net investment in and
 advances to (from)
 subsidiaries and
 affiliates.............    (108,153)    493,268   (364,090)     (26,614)       5,589            --
Debt issuance costs, net
 and other assets.......          --      28,929      7,959           24           --        36,912
                           ---------  ----------  ---------     --------       ------     ---------
                            (108,153)    536,247     (5,840)        (739)       5,589       427,104
                           ---------  ----------  ---------     --------       ------     ---------
Total assets............   $(107,439) $  544,296  $ 279,465     $ 29,169       $5,589     $ 751,080
                           =========  ==========  =========     ========       ======     =========
LIABILITIES AND
 STOCKHOLDERS' EQUITY
Current liabilities:
Current portion-long-
 term obligations.......   $      --  $    8,375  $     201     $     --       $   --     $   8,576
Accounts payable........          --          93     41,067        4,934           --        46,094
Accrued incentives and
 advertising............          --       1,626     28,685        2,140           --        32,451
Accrued compensation....          --         357     14,576          950           --        15,883
Other accrued expenses..       1,985         391     36,598          848           --        39,822
                           ---------  ----------  ---------     --------       ------     ---------
                               1,985      10,842    121,127        8,872           --       142,826
Long-term obligations...      28,023     641,796     12,452           --           --       682,271
Other noncurrent
 liabilities............       3,585          --     32,484           --           --        36,069
Deferred income taxes...      (2,206)        755     26,467        3,724           --        28,740
Stockholders' equity....    (138,826)  (109,097)     86,935       16,573        5,589      (138,826)
                           ---------  ----------  ---------     --------       ------     ---------
Total liabilities and
 stockholders' equity...   $(107,439) $  544,296  $ 279,465     $ 29,169       $5,589     $ 751,080
                           =========  ==========  =========     ========       ======     =========
</TABLE>
 
                                       52
<PAGE>
 
                               SEALY CORPORATION
 
               SUPPLEMENTAL CONSOLIDATING CONDENSED BALANCE SHEET
 
                               NOVEMBER 30, 1997
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                       SEALY     COMBINED     COMBINED
                             SEALY    MATTRESS  GUARANTOR   NON-GUARANTOR
                          CORPORATION COMPANY  SUBSIDIARIES SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                          ----------- -------- ------------ ------------- ------------ ------------
<S>                       <C>         <C>      <C>          <C>           <C>          <C>
ASSETS
Current assets:
Cash and cash equiva-
 lents..................   $     --   $    20    $  2,062      $ 3,975     $      --     $  6,057
Accounts receivable,
 net....................         --     3,434      79,150       11,334            --       93,918
Inventories.............         --     1,912      39,240        5,190          (335)      46,007
Prepaid expenses and
 other assets...........     (9,206)      294      29,819        1,622            --       22,529
                           --------   -------    --------      -------     ---------     --------
                             (9,206)    5,660     150,271       22,121          (335)     168,511
Property, plant and
 equipment--at cost.....         --     4,664     152,045       12,894            --      169,603
Less accumulated depre-
 ciation................         --     1,254      40,603        2,138            --       43,995
                           --------   -------    --------      -------     ---------     --------
                                 --     3,410     111,442       10,756            --      125,608
Other assets:
Goodwill and other in-
 tangibles, net.........         --    14,461     361,976       34,832            --      411,269
Net investment in and
 advances to (from)
 subsidiaries and
 affiliates.............    543,783     2,636    (357,823)     (28,591)     (160,005)          --
Debt issuance costs, net
 and other assets.......      8,918        35       6,641           85            --       15,679
                           --------   -------    --------      -------     ---------     --------
                            552,701    17,132      10,794        6,326      (160,005)     426,948
                           --------   -------    --------      -------     ---------     --------
Total assets............   $543,495   $26,202    $272,507      $39,203     $(160,340)    $721,067
                           ========   =======    ========      =======     =========     ========
LIABILITIES AND STOCK
 HOLDERS' EQUITY
Current liabilities:
Current portion--long-
 term obligations.......   $     --   $    --    $     --      $    --     $      --     $     --
Accounts payable........         --     2,086      40,743        6,847            --       49,676
Accrued incentives and
 advertising............         --     1,473      26,782        2,449            --       30,704
Accrued compensation....         --       246      16,244        1,281            --       17,771
Other accrued expenses..      2,287       222      18,172        1,573          (118)      22,136
                           --------   -------    --------      -------     ---------     --------
                              2,287     4,027     101,941       12,150          (118)     120,287
Long-term obligations...    330,000        --          --           --            --      330,000
Other noncurrent liabil-
 ities..................      2,969        --      32,744           --            --       35,713
Deferred income taxes...      3,173       896      22,693        3,239            --       30,001
Stockholders' equity....    205,066    21,279     115,129       23,814      (160,222)     205,066
                           --------   -------    --------      -------     ---------     --------
Total liabilities and
 stockholders' equity...   $543,495   $26,202    $272,507      $39,203     $(160,340)    $721,067
                           ========   =======    ========      =======     =========     ========
</TABLE>
 
                                       53
<PAGE>
 
                               SEALY CORPORATION
 
         SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
 
                          YEAR ENDED NOVEMBER 29, 1998
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                      SEALY      COMBINED     COMBINED
                            SEALY    MATTRESS   GUARANTOR   NON-GUARANTOR
                         CORPORATION COMPANY   SUBSIDIARIES SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                         ----------- --------  ------------ ------------- ------------ ------------
<S>                      <C>         <C>       <C>          <C>           <C>          <C>
Net sales...............  $     --   $ 42,472    $792,878      $73,265      $(17,313)    $891,302
Costs and expenses:
Cost of goods sold......        --     26,973     448,186       45,538       (17,197)     503,500
Selling, general and
 administrative.........       717     13,434     265,859       20,346            --      300,356
Loss on net assets held
 for sale and other
 write-downs............        --        229      10,158          247            --       10,634
Compensation associated
 with recapitalization..    17,114        332          --        1,440            --       18,886
Amortization of
 intangibles............        --        411      11,684          934            --       13,029
Interest expense, net...     4,967     62,504         245         (265)           --       67,451
Loss (income) from
 equity
 investees..............     3,136      1,894          --           --        (5,030)          --
Loss (income) from non-
 guarantor equity
 investees..............        --        (27)     (2,417)          --         2,444           --
Capital charge and
 intercompany interest
 allocation.............  (10,279)   (59,656)      69,935           --            --           --
                          --------   --------    --------      -------      --------     --------
Income/(loss) before
 income taxes,
 extraordinary item and
 cumulative effect of a
 change in accounting
 principle..............   (15,655)    (3,622)    (10,772)       5,025         2,470      (22,554)
Income taxes............     3,581       (486)     (8,878)       2,581          (116)      (3,318)
                          --------   --------    --------      -------      --------     --------
Income/(loss) before
 extraordinary item and
 cumulative effect of
 change in accounting
 principle..............   (19,236)    (3,136)     (1,894)       2,444         2,586      (19,236)
Extraordinary item......    14,537         --          --           --            --       14,537
                          --------   --------    --------      -------      --------     --------
Net income/(loss).......  $(33,773)  $ (3,136)   $ (1,894)     $ 2,444      $  2,586     $(33,773)
                          ========   ========    ========      =======      ========     ========
</TABLE>
 
                                       54
<PAGE>
 
                               SEALY CORPORATION
 
         SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
 
                          YEAR ENDED NOVEMBER 30, 1997
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                      SEALY      COMBINED     COMBINED
                            SEALY    MATTRESS   GUARANTOR   NON-GUARANTOR
                         CORPORATION COMPANY   SUBSIDIARIES SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                         ----------- --------  ------------ ------------- ------------ ------------
<S>                      <C>         <C>       <C>          <C>           <C>          <C>
Net sales...............   $    --   $37,973     $708,914      $75,042      $(17,095)    $804,834
Costs and expenses:
 Cost of goods sold.....        --    23,256      400,785       48,878       (17,014)     455,905
 Selling, general and
  administrative........     1,336    11,464      231,877       17,346            --      262,023
 Stock based Compensa-
  tion..................        --        --        1,635           --            --        1,635
 Amortization of intan-
  gibles................        --       411       11,764        1,089            --       13,264
 Interest expense, net..    32,114        --          (75)        (643)           --       31,396
 Loss (income) from
  equity Investees......     8,969     8,258           --           --       (17,227)          --
 Income from non-
  guarantor equity
  investees.............        --        20       (4,104)          --         4,084           --
 Capital charge and
  intercompany interest
  allocation............   (69,376)    3,689       64,821          866            --           --
                           -------   -------     --------      -------      --------     --------
Income/(loss) before
 income taxes,
 extraordinary item and
 cumulative effect of a
 change in accounting
 principle..............    26,957    (9,125)       2,211        7,506        13,062       40,611
Income taxes............    13,103      (156)       6,140        3,422            --       22,509
                           -------   -------     --------      -------      --------     --------
Income/(loss) before
 extraordinary item and
 cumulative effect of
 change in accounting
 principle..............    13,854    (8,969)      (3,929)       4,084        13,062       18,102
Extraordinary item......     2,030        --           --           --            --        2,030
Cumulative effect of a
 change in accounting
 principle..............        --        --        4,329           --            --        4,329
                           -------   -------     --------      -------      --------     --------
Net income/(loss).......   $11,824   $(8,969)    $ (8,258)     $ 4,084      $ 13,062     $ 11,743
                           =======   =======     ========      =======      ========     ========
</TABLE>
 
                                       55
<PAGE>
 
                               SEALY CORPORATION
 
         SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF OPERATIONS
 
                          YEAR ENDED DECEMBER 1, 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                               COMBINED
                                       SEALY      COMBINED       NON-
                             SEALY    MATTRESS   GUARANTOR    GUARANTOR
                          CORPORATION COMPANY   SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
                          ----------- --------  ------------ ------------ ------------ ------------
<S>                       <C>         <C>       <C>          <C>          <C>          <C>
Net sales...............    $    --   $33,296     $560,540     $120,223     $(16,421)    $697,638
Costs and expenses:
 Cost of goods sold.....         --    19,867      305,100       88,592      (16,300)     397,259
 Selling, general and
  administrative........        150     9,082      185,849       21,593           --      216,674
 Loss on net assets held
  for sale..............         --    11,762           --           --           --       11,762
 Stock based
  Compensation..........         --        --        4,779           --           --        4,779
 Amortization of
  intangibles...........         --       411       11,450        1,733           --       13,594
 Interest expense, net..     30,364        --           91       (1,658)          --       28,797
 Loss (income) from
  equity investees......     (2,608)    1,796           --           --          812           --
 Income from non-
  guarantor equity
  investees.............         --   (15,829)      (2,920)          --       18,749           --
 Capital charge and
  intercompany Interest
  allocation............    (35,043)    3,209       41,595       (9,761)          --           --
                            -------   -------     --------     --------     --------     --------
Income/(loss) before in-
 come taxes.............      7,137     2,998       14,596       19,724      (19,682)      24,773
Income taxes............      7,522       390       16,392          975           --       25,279
                            -------   -------     --------     --------     --------     --------
Net income/(loss).......    $  (385)  $ 2,608     $ (1,796)    $ 18,749     $(19,682)    $   (506)
                            =======   =======     ========     ========     ========     ========
</TABLE>
 
                                       56
<PAGE>
 
                               SEALY CORPORATION
 
         SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
 
                          YEAR ENDED NOVEMBER 29, 1998
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                               COMBINED
                                       SEALY      COMBINED       NON-
                            SEALY    MATTRESS    GUARANTOR    GUARANTOR
                         CORPORATION  COMPANY   SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
                         ----------- ---------  ------------ ------------ ------------ ------------
<S>                      <C>         <C>        <C>          <C>          <C>          <C>
Net cash provided by
 (used in) operating
 activities.............  $    (478) $  (1,923)   $56,210       $ (176)      $(603)      $ 53,030
                          ---------  ---------    -------       ------       -----       --------
Cash flows from
 investing activities:
 Purchase of property,
  plant and equipment...         --       (203)   (32,909)          --          --        (33,112)
 Proceeds from sale of
  property, plant and
  equipment.............         --         --        216           --          --            216
 Net activity in
  investment in and
  advances to (from)
  subsidiaries and
  affiliates............    637,473   (607,445)   (28,882)      (1,749)        603             --
                          ---------  ---------    -------       ------       -----       --------
 Net proceeds provided
  by (used in) investing
  activities............    637,473   (607,648)   (61,575)      (1,749)        603        (32,896)
Cash flows from
 financing activities:
 Treasury stock
  repurchase............   (413,078)        --         --           --          --       (413,078)
 Proceeds (repayment) of
  long-term obligations,
  net...................   (330,000)   642,122     12,653           --          --        324,775
 Equity issuances ......    121,444         --         --           --          --        121,444
 Costs associated with
  tender offer of prior
  debt..................    (15,361)        --         --           --          --        (15,361)
 Debt issuance costs....         --    (32,549)      (188)          --          --        (32,737)
                          ---------  ---------    -------       ------       -----       --------
Net cash provided by
 (used in) financing
 activities.............   (636,995)   609,573     12,465           --          --        (14,957)
                          ---------  ---------    -------       ------       -----       --------
Change in cash and cash
 equivalents............         --          2      7,100       (1,925)         --          5,177
Cash and cash equiva-
 lents:
 Beginning of period....         --         20      2,062        3,975          --          6,057
                          ---------  ---------    -------       ------       -----       --------
 End of period..........  $      --  $      22    $ 9,162       $2,050       $  --       $ 11,234
                          =========  =========    =======       ======       =====       ========
</TABLE>
 
                                       57
<PAGE>
 
                               SEALY CORPORATION
 
         SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
 
                          YEAR ENDED NOVEMBER 30, 1997
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                                              COMBINED
                                      SEALY      COMBINED       NON-
                            SEALY    MATTRESS   GUARANTOR    GUARANTOR
                         CORPORATION COMPANY   SUBSIDIARIES SUBSIDIARIES ELIMINATIONS CONSOLIDATED
                         ----------- --------  ------------ ------------ ------------ ------------
<S>                      <C>         <C>       <C>          <C>          <C>          <C>
Net cash provided by
 (used in) operating
 activities............    $29,901   $(40,205)   $ 7,532      $44,782        $39        $42,049
                           -------   --------    -------      -------        ---        -------
Cash flows from
 investing activities:
  Purchase of property,
   plant and equipment.         --       (450)   (27,109)      (1,581)        --        (29,140)
  Proceeds from sale of
   subsidiary..........         --     35,000         --           --         --         35,000
  Proceeds from sale of
   property, plant and
   equipment...........         --      5,150        410            1         --          5,561
  Net activity in
   investment in and
   advances to (from)
   subsidiaries and
   affiliates..........     34,131        471     18,111      (52,674)       (39)            --
                           -------   --------    -------      -------        ---        -------
    Net proceeds
     provided by (used
     in) investing
     activities........     34,131     40,171     (8,588)     (54,254)       (39)        11,421
Cash flows from
 financing activities:
  Repayment of long-
   term obligations,
   net.................    (63,127)        --         --           --         --        (63,127)
  Net borrowing-
   revolving credit
   facility............    105,000         --         --           --         --        105,000
  Dividend.............    (99,775)        --         --           --         --        (99,775)
  Debt issuance costs..     (6,130)        --         --           --         --         (6,130)
                           -------   --------    -------      -------        ---        -------
Net cash provided by
 (used in) financing
 activities............    (64,032)        --         --           --         --        (64,032)
                           -------   --------    -------      -------        ---        -------
Change in cash and cash
 equivalents...........         --        (34)    (1,056)      (9,472)        --        (10,562)
Cash and cash
 equivalents:
  Beginning of period..         --         54      3,118       13,447         --         16,619
                           -------   --------    -------      -------        ---        -------
  End of period........    $    --   $     20    $ 2,062      $ 3,975        $--        $ 6,057
                           =======   ========    =======      =======        ===        =======
</TABLE>
 
                                       58
<PAGE>
 
                               SEALY CORPORATION
 
         SUPPLEMENTAL CONSOLIDATING CONDENSED STATEMENTS OF CASH FLOWS
 
                          YEAR ENDED DECEMBER 1, 1996
                                 (IN THOUSANDS)
 
<TABLE>
<CAPTION>
                                      SEALY      COMBINED     COMBINED
                            SEALY    MATTRESS   GUARANTOR   NON-GUARANTOR
                         CORPORATION COMPANY   SUBSIDIARIES SUBSIDIARIES  ELIMINATIONS CONSOLIDATED
                         ----------- --------  ------------ ------------- ------------ ------------
<S>                      <C>         <C>       <C>          <C>           <C>          <C>
Net cash provided by
 (used in) operating
 activities.............  $ 15,398   $16,923     $ 32,242     $ 19,105      $(39,251)    $ 44,417
                          --------   -------     --------     --------      --------     --------
Cash flows from
 investing activities:
  Purchase of property,
   plant and equipment..        --      (134)     (11,581)        (870)          540      (12,045)
  Proceeds from sale of
   property, plant and
   equipment............        --        --        1,579           50          (540)       1,089
  Net activity in
   investment in and
   advances to (from)
   subsidiaries and
   affiliates...........    17,267    (8,175)     (26,695)       1,888        15,715           --
                          --------   -------     --------     --------      --------     --------
    Net proceeds
     provided by (used
     in) investing
     activities.........    17,267    (8,309)     (36,697)       1,068        15,715      (10,956)
Cash flows from
 financing activities:
  Repayment of long-term
   obligations, net.....   (22,202)       --       (1,608)          83            --      (23,727)
  Net borrowing-
   revolving credit
   facility.............    25,000        --           --           --            --       25,000
  Dividend..............   (35,463)       --           --           --            --      (35,463)
  Net equity activity
   with Parent..........        --    (8,569)      (4,830)     (10,137)       23,536           --
                          --------   -------     --------     --------      --------     --------
    Net cash provided by
     (used in) financing
     activities.........   (32,665)   (8,569)      (6,438)     (10,054)       23,536      (34,190)
                          --------   -------     --------     --------      --------     --------
Change in cash and cash
 equivalents............        --        45      (10,893)      10,119            --         (729)
Cash and cash
 equivalents:
  Beginning of period...        --         9       14,011        3,328            --       17,348
                          --------   -------     --------     --------      --------     --------
  End of period.........  $     --   $    54     $  3,118     $ 13,447      $     --     $ 16,619
                          ========   =======     ========     ========      ========     ========
</TABLE>
 
                                       59
<PAGE>
 
ITEM 9. CHANGES IN AND DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
 
  None.
 
                                   PART III
 
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT DIRECTORS
 
  The following sets forth the name, age, principal occupation and employment
and business experience during the last five years of each of the Company's
directors:
 
  Josh Bekenstein. Mr. Bekenstein, age 40, is a Managing Director of Bain
Capital, Inc. ("Bain"). Mr. Bekenstein helped start Bain in 1984 and has been
involved in numerous venture capital and leveraged acquisitions over the past
thirteen years. Mr. Bekenstein presently serves on the Board of Directors of a
number of public and private companies, including Waters Corporation, Bright
Horizons Childrens Centers, Inc. and Small Fry Snack Foods. Prior to Bain, Mr.
Bekenstein was a consultant at Bain & Company, where he worked on strategy
consulting projects for a number of Fortune 500 clients.
 
  Paul Edgerley. Mr. Edgerley, age 42, has been Managing Director of Bain
since 1993. From 1990 to 1993 he was a General Partner of Bain Venture
Capital, and from 1988 to 1990 he was a Principal of Bain Capital Partners. He
serves on the Boards of Directors of Steel Dynamics, Inc. and GS Industries,
Inc.
 
  Andrew S. Janower. Mr. Janower, age 30, since 1996 has been a Vice President
of Charlesbank Capital Partners LLC, since its formation in July, 1998.
Previously, he had been employed as an Associate by Harvard Private Capital
Group, Inc. ("HPCG"), Charlesbank's predecessor organization. Prior to joining
HPCG, Mr. Janower was a Consultant at Bain & Company and a research associate
at Harvard Business School.
 
  James W. Johnston. Mr. Johnston, age 52, is President and Chief Executive
Officer of Stonemarker Enterprises, Inc., a consulting and investment company.
He has been a director of Sealy, Inc. since March 4, 1993. Mr. Johnston was
Vice Chairman RJR Nabisco, Inc. from 1995 to 1996. He also served as Chairman
and CEO of R. J. Reynolds Tobacco Co. from 1989 to 1995, Chairman R. J.
Reynolds Tobacco Co. from 1995 to 1996 and Chairman R. J. Reynolds Tobacco
International from 1993 to 1996. Mr. Johnston served on the board of RJR
Nabisco, Inc. and RJR Nabisco Holdings Corp. from 1992 to 1996. From 1984
until joining Reynolds, Mr. Johnston was Division Executive, Northeast
Division, of Citibank, N.A., a subsidiary of Citicorp, where he was
responsible for Citibank's New York Banking Division, its banking activities
in upstate New York, Maine and Mid-Atlantic regions, and its national student
loan business. Mr. Johnston is also a director of The Wachovia Corporation.
 
  Ronald L. Jones. Mr. Jones, age 56, since March 17, 1998 has been Chairman,
Chief Executive Officer and President of the Company. From March 2, 1996 until
March 17, 1998 Mr. Jones was President and Chief Executive Officer of the
Company. From October, 1988 until joining the Company, Mr. Jones served as
President of Masco Home Furnishings. From 1983 to 1988, Mr. Jones was
President of HON Industries.
 
  Michael Krupka. Mr. Krupka, age 33, joined Bain in 1991 and became a
Managing Director in 1997. Prior to joining Bain, Mr. Krupka spent several
years as a consultant at Bain & Company where he focused on technology and
technology-related companies. In addition, he has served in several senior
operating roles at Bain portfolio companies. He serves on the Board of
Directors of Jostens Learning Corp. and J Tech, Inc.
 
  Jonas Steinman. Mr. Steinman, age 33, since June, 1995 has been a Principal
at Chase Capital Partners. Previously he was employed as an Associate by Chase
Capital Partners and its predecessor, Chemical Venture Partners.
 
                                      60
<PAGE>
 
EXECUTIVE OFFICERS
 
  The following sets forth the name, age, title and certain other information
with respect to the executive and certain other appointed officers of the
Company:
 
  Bruce G. Barman. Dr. Barman, age 53, since March, 1998 has been Corporate
Vice President Research and Development of the Company. From January, 1995
until March, 1998 he was Vice President of Research and Development of the
Company. From 1991 until he joined the Company, Dr. Barman was Vice President
-- Research and Development of Griffith Laboratories N.A., a custom food
products producer.
 
  Jeffrey C. Claypool. Mr. Claypool, age 51, since March 1998 has been
Corporate Vice President Human Resources of the Company. From September, 1991
until March, 1998 he was Vice President Human Resources of the Company.
 
  Gary T. Fazio. Mr. Fazio, age 48, since March 1998 has been Corporate Vice
President/General Manager Domestic Bedding Group of the Company. From 1990
until, March 1998 he was Vice President Sales.
 
  Douglas E. Fellmy. Mr. Fellmy, age 49, since March, 1998 has been Corporate
Vice President/General Manager Domestic Bedding of the Company. From July,
1992 until March, 1998 he was Vice President Operations of the Company.
Previously, Mr. Fellmy served as Regional Vice President-Operations since
April 1990 and also as President of the Components Division since December
1989. Mr. Fellmy has served, since 1971, in numerous other capacities with the
Company's Components Division.
 
  James F. Goughenour. Mr. Goughenour, age 61, since March 1998 has been
Corporate Vice President Technology, Planning and Operations Support of the
Company. From June, 1997 until March, 1998 he was Vice President Technology
and Strategic Planning of the Company. From 1979 until he joined the Company,
Mr. Goughenour had been with the HON Company, serving as Vice President.
 
  David J. McIlquham. Mr. McIlquham, age 44, since March, 1998 has been
Corporate Vice President Sales and Marketing of the Company. From April, 1990
until March, 1998 he was Vice President-Marketing of the Company.
 
  Lawrence J. Rogers. Mr. Rogers, age 50, since March, 1998 has been Corporate
Vice President/General Manager International Group of the Company. From
February, 1994 until March, 1998 he was Vice President International of the
Company. Previously, Mr. Rogers has served, since 1979, in numerous other
capacities within the Company's operations, including President-Sealy Canada.
 
  Richard F. Sowerby. Mr. Sowerby, age 44, since March, 1998 has been
Corporate Vice President Finance of the Company. From April, 1995 until March,
1998 he was Vice President Controller of the Company. Previously, from 1991,
Mr. Sowerby served as Corporate Controller of Elliott Company, a manufacturer
and servicer of turbo machinery equipment.
 
  Kenneth L. Walker. Mr. Walker, age 50, since March, 1998 has been Corporate
Vice President, General Counsel and Secretary of the Company. From May, 1997
until March, 1998 he was Vice President, General Counsel and Secretary of the
Company. Previously, from 1991, Mr. Walker served as Vice President, General
Counsel and Secretary of Varity Corporation, a manufacturer of automotive
components, diesel engines and farm machinery.
 
  E. Lee Wyatt. Mr. Wyatt, age 46, since October 1998 has been Corporate Vice
President Administration of the Company. From 1983 until he joined the
Company, Mr. Wyatt was with Brown Group Inc., a wholesaler and retailer of
footwear, in numerous positions, most recently as Senior Vice President
Finance and Administration of its Brown Shoe Company subsidiary.
 
                                      61
<PAGE>
 
COMPLIANCE WITH SECTION 16(A) OF THE EXCHANGE ACT
 
  The Company is not aware of any person that is subject to section 16 of the
Securities Exchange Act of 1934 (The "Exchange Act") with respect to the
Company, that has failed to file on a timely basis reports required by Section
16(a) of the Exchange Act during Fiscal 1998.
 
ITEM 11. EXECUTIVE COMPENSATION
 
  The following table sets forth information concerning the annual and long-
term compensation for services in all capacities to the Company for each of
the years ended November 29, 1998, November 30, 1997, and December 1, 1996, of
those persons who served as (i) the chief executive officer during Fiscal 1998
and 1997, and (ii) the other four most highly compensated executive officers
of the Company for Fiscal 1998 (collectively, the "Named Executive Officers"):
 
                          SUMMARY COMPENSATION TABLE
 
<TABLE>
<CAPTION>
                                   ANNUAL COMPENSATION                     LONG-TERM COMPENSATION
                              ------------------------------  -----------------------------------------------------
                                                              RESTRICTED    SECURITIES
NAME AND PRINCIPAL                              OTHER ANNUAL    STOCK       UNDERLYING       LTIP       ALL OTHER
POSITION                 YEAR  SALARY   BONUS   COMPENSATION   AWARD($)    OPTIONS/SARS   PAYOUTS(A) COMPENSATION(B)
------------------       ---- -------- -------- ------------  ----------   ------------   ---------  --------------
<S>                      <C>  <C>      <C>      <C>           <C>          <C>            <C>        <C>
Ronald L. Jones(c)...... 1998 $571,252 $632,458   $965,602(i)        --        99,070(c)        --     $1,136,150
Chairman, Chief                                                             1,971,630(c)
Executive Officer        1997  527,516  633,052      1,168           --        75,000(d)        --         21,583
and President            1996  381,262  423,584    456,168(e)  $637,800(f)    400,000(g)        --          2,476
Gary T. Fazio........... 1998  227,542  110,234    435,318(i)        --         8,365(c)        --        111,899
VP General Mgr.                                                               180,000(c)
Bedding                  1997  203,833  182,289        248      203,978(h)     32,000(d)        --         16,524
                         1996  196,226   86,559         --           --            --      426,030         15,864
Douglas Fellmy.......... 1998  219,067  106,129    336,785(i)        --         8,365(c)        --        111,267
VP General Mgr. of                                                            180,000(c)
Bedding                  1997  197,333  177,739         --      203,978(h)     32,000(d)        --         16,016
                         1996  188,134   83,135         --           --            --      426,030         15,237
David J. McIlquham...... 1998  223,167  108,114    684,175(i)        --       180,000(c)        --        111,573
VP of Sales and          1997  199,167  179,023        242      203,978(h)     32,000(d)        --         16,165
Marketing............... 1996  188,505   83,302         --           --            --      426,030         15,268
Lawrence J. Rogers...... 1998  189,266  101,403    375,855(i)        --         8,365(c)        --        110,253
VP General Mgr. of                                                            180,000(c)
International Ops.       1997  180,305  158,953         --      203,978(h)     32,000(d)        --         14,271
                         1996  175,812  100,385         --           --            --      295,046         13,884
</TABLE>
--------
(a) Such amount reflects the value of Shares earned under the Performance
    Share Plan which concluded on December 1, 1996.
(b) Represents amounts paid on behalf of each of the Named Executive Officers
    for the following four respective categories of compensation: (i) Company
    premiums for life and accidental death and dismemberment insurance (ii)
    Company premiums for long-term disability benefits, (iii) Company
    contributions to the Company's defined contribution plans and (iv) in
    fiscal 1998 deferred compensation agreements with respective officers.
    Amounts for each of the Named Executive Officers for each of the four
    respective preceding categories is as follows: Mr. Jones: (1998-$2,364,
    $1,049, $18,200, $1,114,537; 1997-$3,083, $1,000, $17,500; 1996-$1,943,
    $533, $0); Mr. Fazio: (1998-$883, $983, $15,928, $94,105; 1997-$1,257,
    $999, $14,268; 1996-$1,305, $849, $13,710); Mr. McIlquham: (1998-$866,
    $980, $15,622, $94,105; 1997-$1,227, $996, $13,942; 1996-$1,255, $817,
    $13,195; Mr. Fellmy: 1998-$850, $976, $15,336, $94,105; 1997-$1,216, $987,
    $13,813; 1996-$1,252, $816, $13,169; Mr. Rogers (1998-$368, $385, $15,395,
    $94,105; 1997-$622, $1,027, $12,621; 1996-$747, $763, $12,374.
 
                                      62
<PAGE>
 
(c) On December 18, 1997, the Company issued to certain of the named Executive
    Officers, among others, ten-year fully vested non-qualified stock options
    to acquire (i) shares of the Company's Class A Common Stock at the then
    current fair market value of $0.50, with an exercise price of $.125 per
    share; and (ii) shares of the Company's Class L Common stock at the then
    current fair market value of $40.50, with an exercise price of $10.125 per
    share. In the December 1997, the indicated Named Executive Officers
    received options for the following A and L shares: Mr. Jones 891,630 A
    Shares and 99,070 L Shares; Mr. Fazio 75,285 A Shares and 8,365 L Shares;
    Mr. Fellmy 75,285 A Shares and 8,365 L Shares; and Mr. Rogers 75,285 A
    Shares and 8,365 L Shares. On March 17, 1998, pursuant to the 1998 Stock
    Option Plan, the Company issued to the Named Executive Officers, among
    others, ten-year non-qualified stock options to acquire shares of the
    Company's Class A Common Stock at the then current fair market value
    exercise price of $.50 per share and also additional options to acquire
    shares of Company's Class A Common Stock at an exercise price of $4.18 per
    share. In March, 1998, the Named Executive Officers received the following
    stock options: Mr. Jones 600,000 options at $.50 and 480,000 options at
    $4.18; Mr. Fazio 100,000 options at $.50 and 80,000 options at $4.18; Mr.
    McIlquham 100,000 options at $.50 and 80,000 options at $4.18; Mr. Fellmy
    100,000 options at $.50 and 80,000 options at $4.18; and Mr. Rogers
    100,000 options at $.50 and 80,000 options at $4.18.
(d) On May 31, 1997, the Company issued ten-year non-qualified stock options
    at an exercise price of $9.60, pursuant to the Company's 1997 Stock Option
    Plan to the Named Executive Officers, among others, as follows: Ronald L.
    Jones: 75,000 shares; Gary T. Fazio: 32,000 shares; David J. McIlquham:
    32,000 shares; Douglas Fellmy: 32,000 shares; and Lawrence J. Rogers:
    32,000 shares. As of November 29, 1998, none of these stock options
    remained outstanding.
(e) Pursuant to his Employment Agreement, Mr. Jones commenced employment with
    the Company as of February 27, 1996. The terms of the Employment Agreement
    are described more fully in "Compensation Pursuant to Plans and Other
    Arrangements--Executive Employment Agreements." Such amount primarily
    consists of a $250,000 payment upon commencement of employment and
    $205,000 in relocation and other transitional matters.
(f) Such amount reflects the Company's determination of the fair value at the
    date of grant of 67,635 restricted shares issued to Mr. Jones, pursuant to
    his Employment Agreement. Although the 1997 Credit Agreement and Note
    Indenture contain restrictions on the Company's ability to pay dividends,
    if declared and paid on the Company's Shares, such dividends would be paid
    on such Shares issued to Mr. Jones. The February 28,1997 Dividend was paid
    on such shares. Prior to December 18, 1997 Mr. Jones waived all his rights
    to such restricted stock. As of November 30 1998, none of these restricted
    shares remained outstanding.
(g) Pursuant to his Employment Agreement, the Company granted Mr. Jones ten-
    year options to acquire up to 400,000 Shares at an exercise price of
    $10.63 per Share as further described in "Compensation Pursuant to Plans
    and Other Arrangements--Executive Employment Agreements."
(h) Such amount reflects the Company's determination of the fair value at the
    date of grant of restricted stock issued, on January 6, 1997, pursuant to
    the Company's 1996 Transitional Restricted Stock Plan to, among others,
    certain Named Executive Officers as follows: Gary T. Fazio: 15,800 shares;
    David J. McIlquham: 15,800 shares; Douglas Fellmy: 15,800 shares; and
    Lawrence J. Rogers: 15,800 shares. On December 16, 1997 Mrssrs Fazio,
    Fellmy, and Rogers waived all of their right to such restricted stock. On
    December 18, 1997, as part of the Refinancing of the Company, Mr.
    McIlquham's restricted shares vested and he received the Merger Price of
    approximately $14.30 per share for each restricted share for a total of
    $225,900. As of November 29, 1998, none of these shares of restricted
    stock remained outstanding.
(i) Represents amounts paid on behalf of each of the Named Executive Officers
    for the following seven respective categories of other annual
    compensation: (i) transaction bonus associated with the Recapitalization,
    (ii) vesting of restricted stock associated with the Recapitalization,
    (iii) compensation associated with vested stock options paid out in
    connection with the Recapitalization, (iv) compensation recorded
    associated with the exercise of stock options, (v) relocation expenses
    incurred, (vi) car and financial planning allowances paid on behalf of the
    Named executives and (vii) special bonuses. Amounts for each of the Named
    Executive Officers for each of the seven respective preceeding categories
    is as follows: Mr. Jones: ($385,000, $162,326, $0, $334,361, $6,801,
    $67,139, $9,975); Mr. Fazio ($306,750, $0, $0, $28,232, $100,336, $0, $0);
    Mr. Fellmy ($297,000, $0, $0, $0, $39,785, $0, $0); Mr. McIlquham
    ($300,000, $150,486, $225,983, $0, $7,706, $0, $0); Mr. Rogers ($254,115,
    $0, $0, $28,232, $81,508, $0, $12,000).
 
                                      63
<PAGE>
 
                     OPTION/SAR GRANTS IN LAST FISCAL YEAR
 
POTENTIAL REALIZABLE VALUE
 
<TABLE>
<CAPTION>
                                                                             AT ASSUMED ANNUAL RATES
                                                                           OF STOCK PRICE APPRECIATION
                                        INDIVIDUAL GRANTS                      FOR OPTION TERM (A)
                         ------------------------------------------------- ----------------------------
                          NUMBER OF     % OF TOTAL
                          SECURITIES   OPTIONS/SARS
                          UNDERLYING    GRANTED TO  EXERCISE OR
                         OPTIONS/SARS  EMPLOYEES IN BASE PRICE  EXPIRATION
NAME                     GRANTED (#)   FISCAL YEAR    ($/SH)       DATE       5% ($)        10% ($)
----                     ------------  ------------ ----------- ---------- ------------- --------------
<S>                      <C>           <C>          <C>         <C>        <C>           <C>
Ronald L. Jones.........   891,630(b)     18.3%       $ 0.125    12/17/07  $     614,300 $   1,045,000
Chairman, Chief
 Executive                 600,000(c)     12.3%       $  0.50     3/17/08  $     188,400 $     478,200
Officer and President      480,000(d)      9.8%       $  4.18     3/17/08
                            99,070(e)      2.0%       $10.125    12/17/07  $   5,532,600 $   9,403,900
Gary T. Fazio...........    75,285(b)      1.5%       $ 0.125    12/17/07  $      51,900 $      88,200
VP General Mgr. of
 Bedding                   100,000(c)      2.0%       $  0.50     3/17/08  $      31,400 $      79,700
                            80,000(d)      1.6%       $  4.18     3/17/08
                             8,365(e)       .2%       $10.125    12/17/07  $     467,100 $     794,000
Douglas Fellmy..........    75,285(b)      1.5%       $ 0.125    12/17/07  $      51,900 $      88,200
VP General Mgr. of
 Bedding                   100,000(c)      2.0%       $  0.50     3/17/08  $      31,400 $      79,700
                            80,000(d)      1.6%       $  4.18     3/17/08
                             8,365(e)       .2%       $10.125    12/17/07  $     467,100 $     794,000
David McIlquham.........   100,000(c)      2.0%       $  0.50     3/17/08  $      31,400 $      79,700
VP of Sales and
 Marketing                  80,000(d)      1.6%       $  4.18     3/17/08
Lawrence J. Rogers......    75,285(b)      1.5%       $ 0.125    12/17/07  $      51,900 $      88,200
VP General Mgr. of         100,000(c)      2.0%       $  0.50     3/17/08  $      31,400 $      79,700
International Ops.          80,000(d)      1.6%       $  4.18     3/17/08
                             8,365(e)       .2%       $10.125    12/17/07  $     467,100 $     794,000
</TABLE>
--------
(a) Potential Realizable Value is based on certain assumed rates of
    appreciation pursuant to rules prescribed by the Securities and Exchange
    Commission and are not intended to be a forecast of the Company's stock
    price. Actual gains, if any, on stock option exercises are dependent on
    the future performance of the stock. There can be no assurance that the
    amounts reflected in this table will be achieved. In accordance with rules
    promulgated by the Securities and Exchange Commission, Potential
    Realizable Value is based upon the exercise price of the options.
(b) Represent options issued to senior management on December 18, 1997 to
    acquire Class A Common Stock of the Company. These options were
    immediately vested and are exercisable at $0.125 per share. The fair
    market value of the Class A Common Stock at the date of grant was $0.50
    per share.
(c) Represent options issued on March 18, 1998 to acquire Class A Common Stock
    of the Company. These options vest 40% on the second anniversary date and
    20% each year for the next three years. The fair market value of the Class
    A Common Stock and option exercise price on the date of grant were each
    $0.50 per share.
(d) Represents options issued on March 18, 1998 to acquire Class A Common
    Stock of the Company. These options vest 40% on the second anniversary
    date and 20% each year for the next three years. The fair market value of
    the Class A Common Stock and option exercise price on the date of grant
    were $0.50 and $4.18, respectively. The annual increase in the fair market
    value of the options over the options ten year life at both 5% and 10%
    would not exceed the exercise price.
(e) Represents options issued to senior management on December 18, 1997 to
    acquire Class L Common Stock of the Company. These options were
    immediately vested and are exercisable at $10.125 per share. The fair
    market value of the options at the grant date was $40.125 per share.
 
                                      64
<PAGE>
 
   AGGREGATED OPTION/SAR EXERCISED IN LAST FISCAL YEAR AND FY-END OPTION/SAR
                                    VALUES
 
<TABLE>
<CAPTION>
                                              NUMBER OF SECURITIES UNDERLYING   VALUE OF UNEXERCISED
                           SHARES                UNEXERCISED OPTIONS/SARS     IN-THE-MONEY OPTIONS/SARS
                          ACQUIRED                     AT FY-END (#)                AT FY-END ($)
                         ON EXERCISE  VALUE      EXERCISABLE/UNEXERCISABLE    EXERCISABLE/UNEXERCISABLE
NAME                         (#)     REALIZED               (A)                        (B) (C)
----                     ----------- -------- ------------------------------- -------------------------
<S>                      <C>         <C>      <C>                             <C>
Ronald L. Jones.........
 Chairman, Chief
 Executive Officer and
 President                 891,630   334,361         99,070/1,080,000               $3,009,250/0
Gary T. Fazio...........
 VP General Mgr.
 Domestic Bedding           75,285    28,232            8,365/180,000               $  254,087/0
Douglas Fellmy..........
 VP General Mgr.
 Domestic Bedding               --        --            8,365/180,000               $  254,087/0
David McIlquham.........
 VP of Sales and
 Marketing                      --        --               --/180,000                       --/0
Lawrence J. Rogers......
 VP General Mgr. of
 International Ops.         75,285    28,232            8,365/180,000               $  254,087/0
</TABLE>
--------
(a) Includes options exercisable within 60 days after November 29, 1998.
(b) Options are in-the-money if the fair market value of the Common Stock
    exceeds the exercise price.
(c) Represents the total gain which would be realized if all in-the-money
    options beneficially held at November 29, 1998 were exercised, determined
    by multiplying the number of Shares underlying the options by the
    difference between the per share option exercise price and the estimated
    fair market value as of November 29, 1998.
 
COMPENSATION PURSUANT TO PLANS AND OTHER ARRANGEMENTS
 
  Severance Benefit Plans. Effective December 1, 1992, the Company established
the Sealy Executive Severance Benefit Plan (the "Executive Severance Plan")
for employees in certain salary grades. Benefit eligibility includes, with
certain exceptions, termination as a result of a permanent reduction in work
force or the closing of a plant or other facility, termination for inadequate
job performance, termination of employment by the participant following a
reduction in base compensation, reduction in salary grade which would result
in the reduction in potential plan benefits or involuntary transfer to another
location. Benefits include cash severance payments calculated using various
multipliers varying by salary grade, subject to specified minimums and
maximums depending on such salary grades. Such cash severance payments are
made in equal semi-monthly installments calculated in accordance with the
Executive Severance Plan until paid in full. Certain executive-level officers
would be entitled to a minimum of one-year's salary and a maximum of two-
year's salary under the Executive Severance Plan. However, if a Participant
becomes employed prior to completion of the payment of benefits, such semi-
monthly installments shall be reduced by the Participant's base compensation
for the corresponding period from the Participant's new employer. Participants
receiving cash severance payments under the Executive Severance Plan also
would receive six months of contributory health and dental coverage and six
months of group term life insurance coverage.
 
  The Company currently follows the terminal accrual approach to accounting
for severance benefits under the Executive Severance Plan and records the
estimated cost of these benefits as expense at the date of the event giving
rise to payment of the benefits.
 
  Executive Employment Agreements. Ronald Jones has entered into an employment
agreement with Parent providing for his employment as Chief Executive Officer
and President. The agreement has an initial term of
 
                                      65
<PAGE>
 
three years and a perpetual two-year term thereafter. The agreement currently
provides for an annual base salary of US $530,000, subject to annual increase
by Parent's Board of Directors, plus a performance bonus and grants Mr. Jones
the right to require Parent to repurchase certain securities of Parent held by
Mr. Jones. In addition, nine employees of the Company, including Gary T.
Fazio, Douglas Fellmy, Lawrence J. Rogers, and David J. McIlquham, have
entered into employment agreements that provide, among other things, for an
initial employment term of two years and a perpetual one-year employment term
thereafter, during which such employees will received base salary
(respectively of at least US$204,500, US$198,000, Canadian$249,500, and
US$200,000) and a performance bonus between zero and seventy percent of their
base salary and substantially the same benefits as they received as of the
date of such agreements. For the fiscal year ending November 29, 1998, the
compensation committee of the Company's Board of Directors determined that the
bonuses to be paid pursuant to those employment agreements were to be based
75% on the Company's achievement of an Adjusted EBITDA target and 25% on the
Company's achievement of a Return on Net Tangible Assets target. Each such
target represented an improvement over the Company's prior year performance.
Several members of management were parties to agreements that provide, for a
period of one year following consummation of the Transactions, that their
annual base salary and benefits could not be reduced. Each of those one year
agreements expired on December 18, 1998.
 
  Deferred Compensation Agreements. On December 18, 1997, Mr. Jones entered
into a deferred compensation agreement with Parent pursuant to which Mr. Jones
elected to defer $1,114,538 of compensation until either December 18, 2007 or,
in certain instances, such earlier date as provided in such deferred
compensation agreement. In addition, on December 18, 1997, six employees,
including Gary T. Fazio, Douglas Fellmy, and Lawrence J. Rogers, entered into
deferred compensation agreements with Parent pursuant to which such employees
elected to defer an aggregate $522,518 of compensation, in each case, until
either December 18, 2007 or, in certain instances, such earlier date as
provided in such deferred compensation agreements.
 
  Management Incentive Plan. The Company provides performance-based
compensation awards to executive officers and key employees for achievement
each year as part of a bonus plan. Such compensation awards are a function of
individual performance and corporate results. The qualitative and quantitative
criteria will be determined from time to time by Parent's Board of Directors.
 
  Management Equity Participation in the Transactions. In connection with the
Transactions, in order to provide financial incentives for certain of the
Company's employees, the Management Investors acquired common stock of Parent
and/or fully vested options to acquire common stock of Parent in exchange for
either (i) cash or (ii) preferred stock and/or options held by such Management
Investors prior to the Merger. Upon a Management Investor's termination of
employment with the Company, the exercise period of such options held by such
Management Investor will be reduced to a period ending no later than six
months after such Management Investor's termination. If such termination
occurs prior to a qualified initial public offering of Parent's common stock,
then Parent shall have the right to repurchase the common stock of Parent held
by such Management Investor and only if the Management Investor is terminated
without "cause" (as defined in their employment agreements), such Management
Investor shall have the right to require Parent to repurchase the common stock
of Parent held by such Management Investor.
 
  Sealy Corporation 1998 Stock Option Plan. In order to provide additional
financial incentives for certain of the Company's employees, subsequent to the
consummation of the December 18, 1997 transaction the Management Investors and
certain other employees of the Company were granted and are expected to
periodically be granted options to purchase additional common stock of Parent
pursuant to the Sealy Corporation 1998 Stock Option Plan. Such options vest
and become exercisable upon (i) certain threshold dates or (ii) a change of
control or sale of Parent. Upon an employee's termination of employment with
the Company, all of such employee's unvested options will expire, the exercise
period of all such employee's vested options will be reduced to a period
ending no later than six months after such employee's termination, and if such
termination occurs prior to a qualified initial public offering of the
Parent's common stock, then Parent shall have the right to repurchase the
common stock of Parent held by such employee.
 
 
                                      66
<PAGE>
 
  Remuneration of Directors. Mr. Johnston is being compensated on the same
basis as he was for being a Company director prior to December 18, 1997. For
his services as a director he received a retainer at the rate of $30,000 on an
annual basis, reduced by $1,000 for each Board meeting not attended, plus
$1,000 ($1,250 if he is Committee Chairman) for each Board of Directors
committee meeting attended if such meeting is on a date other than a Board
meeting date. The Company reimburses all director for any out-of-pocket
expenses incurred by them in connection with services provided in such
capacity.
 
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
 
  As of February 15, 1999, the issued and outstanding capital stock of the
Company consists of 20,585,750 shares of Class A common stock, par value $0.01
per share ("Class A common"), 7,791,327.6440 shares of Class B Common stock,
par value $0.01 per share ("Class B Common"), 2,168,772.5555 shares of Class L
common stock, par value $0.01 per share ("Class L Common"), and 863,815.0716
shares of Class M common stock, par value $0.01 per share ("Class M Common"
and collectively with the Class A Common, Class B Common and Class L Common,
"Common Stock"). The shares of Class A Common and Class L Common each entitle
the holder thereof to one vote per share on all matters to be voted upon by
the stockholders of the Company, including the election of directors, and are
otherwise identical, except that the shares of Class L Common are entitled to
a preference over Class A Common with respect to any distribution by the
Company to holders of its capital stock equal to the original cost of such
share ($40.50) plus an amount which accrues on a daily basis at a rate of 10%
per annum, compounded annually. The Class B Common is identical to the Class A
Common and the Class M Common is identical to the Class L Common except that
the Class B Common and the Class M Common are nonvoting. The Class B Common
and the Class M Common are convertible into Class A Common and Class L Common,
respectively, automatically upon consummation of an initial public offering by
the Company. The Board of Directors of the Company is authorized to issue
preferred stock, par value $0.01 per share, with such designations and other
terms as may be stated in the resolutions providing for the issue of any such
preferred stock adopted from time to time by the Board of Directors.
 
                                      67
<PAGE>
 
  The following table sets forth certain information regarding the beneficial
ownership of each class of common stock held by each person (other than
directors and executive officers of the company) known to the Company to own
more than 5% of the outstanding voting common stock of the Company. To the
knowledge of the Company, each of such stockholders has sole voting and
investment power as to the shares shown unless otherwise noted. Beneficial
ownership of the securities listed in the table has been determined in
accordance with the applicable rules and regulations promulgated under the
Exchange Act.
 
<TABLE>
<CAPTION>
                                                 SHARES BENEFICIALLY
                                                        OWNED
                                               -----------------------
                             CLASS A COMMON        CLASS B COMMON          CLASS L COMMON          CLASS M COMMON
                          -------------------- ----------------------- ----------------------- -------------------------
                           NUMBER   PERCENTAGE    NUMBER    PERCENTAGE    NUMBER    PERCENTAGE    NUMBER      PERCENTAGE
                           SHARES    OF CLASS     SHARES     OF CLASS     SHARES     OF CLASS     SHARES       OF CLASS
                          --------- ---------- ------------ ---------- ------------ ---------- ------------   ----------
<S>                       <C>       <C>        <C>          <C>        <C>          <C>        <C>            <C>
Principal Stockholders:
Bain Funds(1)(2)........  9,450,000    45.9%     612,284.54     7.9%      1,050,000    48.5%      68,031.62       7.9%
 c/o Bain Capital, Inc.
 Two Copley Place
 Boston, MA 02116
Harvard Private Capital
 Holdings, Inc..........  4,000,000    19.4              --      --    444,444.4444    20.5              --        --
 c/o Harvard Management
 Company, Inc.
 600 Atlantic Avenue
 Boston, MA 02210
Sealy Investors 1,
 LLC(2).................    973,989     4.7    5,086,617.06    65.3         108,221     5.0    565,179.6733      65.3
 c/o Bain Capital, Inc.
 Two Copley Place
 Boston, MA 02116
Sealy Investors 2,
 LLC(2).................    973,989     4.7    2,056,314.03    26.4         108,221     5.0    228,479.3367      26.4
 c/o Bain Capital, Inc.
 Two Copley Place
 Boston, MA 02116
Sealy Investors 3,
 LLC(2).................    973,989     4.7       36,112.01       *         108,221     5.0      4,012.4456 *
 c/o Bain Capital, Inc.
 Two Copley Place
 Boston, MA 02116
Zell/Chilmark Fund, L.P.
 .......................  2,862,000    13.9              --      --         318,000    14.7              --        --
 Two North Riverside
  Drive
 Suite 1500
 Chicago, IL 60606
</TABLE>
--------
 
* Less than one percent
  (1) Amounts shown reflect the aggregate number of shares of Class A Common
and Class L Common held by Bain Capital Fund V, L.P. ("Fund V"), Bain
CapitalFund V-B, L.P., BCIP Trust Associates, L.P. ("BCIP Trust") and BCIP
Associates ("BCIP") (collectively, the "Bain Funds"), for the Bain Funds and
Messrs. Bekenstein, Edgerley and Krupka.
  (2) The members of Sealy Investors 1, LLC ("SI1") are Chase Equity
Associates, L.P. and Bain Capital Partners V, L.P. ("BCPV"). The members of
Sealy Investors 2, LLC ("SI2") are CIBC WG Argosy Merchant Fund 2, L.L.C. and
BCPV. The members of Sealy Investors 3, LLC ("SI3" and, collectively with SI1
and SI2, the "LLCs") are BancBoston Investments, Inc. and BCPV. BCPV is the
administrative member of each LLC and beneficially owns 1% of the equity of
each LLC. Accordingly, BCPV may be deemed to beneficially own certain shares
owned by the LLCs, although BCPV disclaims such beneficial ownership.
 
                                      68
<PAGE>
 
  The following table sets forth certain information regarding the beneficial
ownership of each class of common stock held by each director of the Company,
each Named Executive Officer, the Management Investors, and the Company's
directors and executive officers as group. To the knowledge of the Company,
each of such stockholders has sole voting and investment power as to the
shares shown unless otherwise noted. Beneficial ownership of the securities
listed in the table has been determined in accordance with the applicable
rules and regulations promulgated under the Exchange Act.
 
<TABLE>
<CAPTION>
                                                       SHARES BENEFICIALLY OWNED
                          -----------------------------------------------------------------------------------
                             CLASS A COMMON      CLASS B COMMON        CLASS L COMMON        CLASS M COMMON
                          --------------------- ----------------- ------------------------- -----------------
                            NUMBER   PERCENTAGE NUMBER PERCENTAGE                PERCENTAGE NUMBER PERCENTAGE
                            SHARES    OF CLASS  SHARES  OF CLASS  NUMBER SHARES   OF CLASS  SHARES  OF CLASS
                          ---------- ---------- ------ ---------- -------------- ---------- ------ ----------
<S>                       <C>        <C>        <C>    <C>        <C>            <C>        <C>    <C>
Directors & Executive
Officers:
Josh Bekenstein(1)(2)...   9,450,000    45.9%     --       --          1,050,000    48.5%     --       --
c/o Bain Capital, Inc.
Two Copley Place Boston,
MA 02116
Paul Edgerley(1)(2).....   9,450,000    45.9      --       --          1,050,000    48.5      --       --
c/o Bain Capital, Inc.
Two Copley Place Boston,
MA 02116
Michael Krupka(1)(2)....   9,450,000    45.9      --       --          1,050,000    48.5      --       --
c/o Bain Capital, Inc.
Two Copley Place Boston,
MA 02116
Andrew S. Janower (3)...   4,000,000    19.4      --       --       444,444.4444    20.5      --       --
c/o Charlesbank Capital
Partners LLC
600 Atlantic Avenue
Boston, MA 02210
Ronald Jones(4).........     939,996     4.6      --       --            104,444     4.6      --       --
c/o Sealy Corporation
1228
One Office Parkway,
Trinity, NC 27230
Gary T. Fazio(5)........      75,285       *      --       --              8,365       *      --       --
c/o Sealy Corporation
1228
One Office Parkway,
Trinity, NC 27230
Douglas Fellmy (5)......      75,285       *      --       --              8,365       *      --       --
c/o Sealy Corporation
1228
One Office Parkway,
Trinity, NC 27230
David McIlquham (5).....      41,994       *      --       --              4,666       *      --       --
c/o Sealy Corporation
1228
One Office Parkway,
Trinity, NC 27230
Lawrence J. Rogers (5)..      75,285       *      --       --              8,365       *      --       --
c/o Sealy Corporation
1228
One Office Parkway,
Trinity, NC 27230
Management investors       1,447,638     7.2      --       --            164,182     7.1      --       --
(6).....................
as a group (11 persons)
All directors and
executive officers as a
group (15 persons)......  14,944,630   71.7%      --       --     1,658,626.4444   71.7%      --       --
</TABLE>
--------
*Less than one percent
(1) Amounts shown reflect the aggregate number of shares of Class A Common and
    Class L Common held by Bain Capital Fund V, L.P. ("Fund V"), Bain
    CapitalFund V-B, L.P., BCIP Trust Associates, L.P. ("BCIP Trust") and BCIP
    Associates ("BCIP") (collectively, the "Bain Funds"), for the Bain Funds
    and Messrs. Bekenstein, Edgerley and Krupka.
(2) Messrs. Bekenstein, Edgerley and Krupka are each Managing Directors of
    Bain Capital Investors V., Inc., the sole general partner of BCPV, and are
    limited partners of BCPV, the sole general partner of Fund V and Fund V-B.
    Accordingly, Messrs. Bekenstein, Edgerley and Krupka may be deemed to
    beneficially own shares owned by Fund V and Fund V-B. In addition, Messrs.
    Bekenstein, Edgerley and Krupka are each
 
                                      69
<PAGE>
 
   general partners of BCIP and BCIP Trust and, accordingly, may be deemed to
   beneficially own shares owned by such funds. Each such person disclaims
   beneficial ownership of any such shares in which he does not have a
   pecuniary interest.
(3) Mr. Janower is a Vice President of Charlesbank Capital Partners LLC, an
    affiliate of Harvard Private Capital Holdings, Inc. ("Harvard").
    Accordingly, Mr. Janower may be deemed to beneficially own shares owned by
    Harvard. Mr. Janower disclaims beneficial ownership of any such shares in
    which he does not have a pecuniary interest.
(4) Includes 99,070 shares of Class L Common issuable upon exercise of
    outstanding and currently exercisable options.
(5) Amounts shown reflect shares issuable upon exercise of outstanding and
    currently exercisable options.
(6) The Management Investors consists of Messrs. Jones, Fazio, Fellmy,
    McIlquham, and Rogers and Bruce Barman, Jeffrey Claypool, James
    Goughenour, Richard Sowerby, and Kenneth Walker. Includes 1,309,644 shares
    of Class A Common and 145,516 shares of Class L Common issuable upon
    exercise of currently exercisable options.
 
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
 
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION
 
  From March 17, 1998 through December 9, 1998 the Compensation Committee of
the Company's Board of Directors consisted of Messrs. Johnston, Bekenstein and
former director John Sallay. Mr. Sallay has not yet been replaced on the
committee since his resignation as a director. From December 18, 1997 through
March 17, 1998 two compensation matters were considered by a temporary
compensation committee made up of all the Company's directors other than Mr.
Jones.
 
  In Fiscal 1997, the Human Resources Committee (which functioned as the
Compensation Committee) of the Board of Directors consisted of Mr. Johnston
and former directors Mr. Rod Dammeyer (an officer of Zell/Chilmark) and Mr.
Rolf H. Towe.
 
  Pursuant to the stock purchase agreement (defined below), Zell/Chilmark,
MBLP and the Company in 1993 entered into a registration rights agreement
relating to the Acquired Shares, including the 27,630 Shares purchased by Mr.
Towe. Pursuant to the Stock Purchase Agreement, prior to December 18, 1997,
the holders of a majority of such Acquired Shares had the right to demand, up
to five times but no more than once every six months, registration of their
Acquired Shares under the Securities Act of 1933 as amended. In addition,
under certain conditions, the holders of the Acquired Shares had a right to
include some or all of their Acquired Shares in any subsequent registration
statement filed by the Company with respect to the sale of Shares. The Company
agreed to bear all expenses associated with any registration statement
relating to the Acquired Shares other than any underwriting discounts or
commissions, brokerage commissions and fees.
 
  Stockholders Agreement. In December 1997, the Company and certain of its
stockholders, including the Bain Funds, Harvard, the LLCs and Zell
(collectively, the "Stockholders") entered into a stockholders agreement (the
"Stockholders Agreement"). The Stockholders Agreement: (i) requires that each
of the parties thereto vote all of its voting securities of the Company to be
established at seven members and to cause three designees of the Bain Funds
and one designee of Harvard to be elected to the Board of Directors; (ii)
grants the Company and the Bain Funds a right of first offer on any proposed
transfer of shares of capital stock of the Company held by Zell, Harvard or
the LLCs; (iii) grants Harvard a right of first offer on any proposed transfer
of shares of capital stock of the Company held by the Bain Funds; (iv) grants
tag-along rights (rights to participate on a pro rata basis in sales of stock
by other shareholders) on certain transfers of shares of capital stock of the
Company; (v) requires the Stockholders to consent to a sale of the Company to
an independent third party if such sale is approved by holders constituting a
majority of the then outstanding shares of voting common stock of the Company,
and (vi) except in certain instances, prohibits Zell from transferring any
shares of capital stock of the Company until the tenth anniversary of the date
of the consummation of the Transactions. Certain of the foregoing provision of
the Stockholders Agreement will terminate upon the consummation of an initial
Public
 
                                      70
<PAGE>
 
Offering or an Approved Sale (as each is defined in the Stockholders
Agreement). Certain of the Stockholders, including Bain, received one-time
transaction fees aggregating $8.9 million upon consummation of the
Transactions.
 
  Management Services Agreement. In December 1997, the Company entered into a
Management Services Agreement with Bain pursuant to which Bain has agreed to
provide: (i) general management services; (ii) identification, support,
negotiation and analysis of acquisitions and dispositions; (iii) support,
negotiation and analysis of financial alternatives; and (iv) other services
agreed upon by the Company and Bain. In exchange for such services, Bain will
receive: (i) an annual management fee of $2.0 million, plus reasonable out-of-
pocket expenses (payable quarterly); and (ii) a transaction fee in an amount
equal to 1.0% of the aggregate transaction value in connection with the
consummation of any additional acquisition or divestiture by the Company and
of each financing or refinancing. The Management Services Agreement has an
initial term of five years, subject to automatic one-year extensions unless
the Company or Bain provides written notice of termination.
 
  Registration Rights Agreement. In December 1997, the Company and certain of
its stockholders, including the Bain Funds, Harvard, the LLCs and Zell entered
into a registration rights agreement (the "Registration Rights Agreement").
Under the Registration Rights Agreement, the holders of a majority of the
Registrable Securities (as defined in the Registration Rights Agreement) owned
by the Bain Funds have the right, subject to certain conditions, to require
the Company to register any or all of their shares of common stock of the
Company under the Securities Act at the Company's expense. In addition, all
holders of Registrable Securities are entitled to request the inclusion of any
share of common stock of the Company subject to the Registration Rights
Agreement in any registration statement at the Company's expense whenever the
Company proposes to register any of its common stock under the Securities Act.
In connection with all such registrations, the Company has agreed to indemnify
all holders of Registrable Securities against certain liabilities, including
liabilities under the Securities Act.
 
                                      71
<PAGE>
 
                                    PART IV
 
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
 
  (a)(1) The following consolidated financial statements of Sealy Corporation
and its subsidiaries are included in Part II, Item 8:
 
  Sealy Corporation
 
  Report of Independent Accountants (PricewaterhouseCoopers LLP) and Report
  of Independent Auditors (KPMG LLP)
 
  Consolidated Balance Sheets at November 29, 1998 and November 30, 1997
 
  Consolidated Statements of Operations for the years ended November 29,
  1998, November 30, 1997 and, December 1, 1996.
 
  Consolidated Statements of Stockholders' Equity for the years ended
  November 29, 1998, November 30, 1997 and, December 1, 1996.
 
  Consolidated Statements of Cash Flows for the years ended November 29,
  1998, November 30, 1997 and, December 1, 1996.
 
  Notes to Consolidated Financial Statements
 
  (a)(2) The exhibits to this report are listed in section (c) of Item 14
below.
 
  (b) A Form 8-K was filed December 30, 1997 to report merger of the Company
with Sandman Merger Corporation, the Company's tender for all of its 10 1/4%
Senior Subordinated Notes due in 2003, a related solicitation of consents to
modify certain terms of those notes, as well as to report actions by Sealy
Mattress Company, a wholly owned subsidiary of the Company, entering into
senior credit agreements providing for loans of up to $550 million, and
issuing $253 million in notes due December 15, 2007.
 
  (c) Exhibits
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
 2.1     Agreement and Plan of Merger, dated as of October 30, 1997, by and
         among the Registrant, Sandman Merger Corporation and Zell/Chilmark
         Fund, L.P. (Incorporated herein by reference to the appropriate
         exhibit to the Form 8-K filed December 30, 1997 (File No. 1-8738)).
 2.2     First Amendment to the Agreement and Plan of Merger, dated as of
         December 18, 1997, by and among the Registrant, Sandman Merger
         Corporation and Zell/Chilmark Fund, L.P. (Incorporated herein by
         reference to the appropriate exhibit to the Form 8-K filed December
         30, 1997 (File No. 1-8738)).
 3.1     Restated Certificate of Incorporation of Sealy Corporation dated as of
         November 5, 1991. (Incorporated herein by reference to the appropriate
         exhibit to Sealy Corporation's Annual Report on Form 10-K for the
         fiscal year ended November 30, 1991 (File No. 1-8738)).
 3.2     By-Laws of Sealy Corporation adopted as of November 4, 1991.
         (Incorporated herein by reference to the appropriate exhibit to Sealy
         Corporation's Annual Report on Form 10-K for the fiscal year ended
         November 30, 1991 (File No. 1-8738)).
 4.1     Warrant Agreement, dated as of November 6, 1991 between Sealy
         Corporation and Sealy, Inc., Warrant Agent, including the form of
         Series A and Series B Warrant. (Incorporated herein by reference to
         the appropriate exhibit to Sealy Corporation's Annual Report on Form
         10-K for the fiscal year ended November 30, 1991 (File No. 1-8738)).
 4.2     Form of Series A and Series B Warrant (included as Exhibit A to the
         Warrant Agreement filed as Exhibit 4.1). (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended November 30, 1991 (File
         No. 1-8738)).
</TABLE>
 
                                      72
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
 4.3     Warrant Agreement, dated as of August 1, 1989 between GGvA Holding
         Corp. (renamed Sealy Holdings, Inc. and merged with and into Sealy
         Corporation) and First Chicago Trust Company of New York, Warrant
         Agent, including the form of Merger Warrant (Incorporated herein by
         reference to Exhibit 4.1 to Annual Report on Form 10-K of The Ohio
         Mattress Holding Company and The Ohio Mattress Company for the year
         ended November 30, 1989, File No. 33-29246, filed March 2, 1990.)
 4.4     Form of Merger Warrant (included as Exhibit A to the Warrant Agreement
         filed as Exhibit 4.3) (Incorporated herein by reference to Exhibit 4.2
         to Annual Report on Form 10-K of Sealy Holdings, Inc. and Sealy
         Holdings, Inc. (merged with and into Sealy Corporation) for the year
         ended November 30, 1990, File No. 33-29246, filed February 28, 1991.)
 4.5     Indenture dated as of November 1, 1991, among Sealy Corporation,
         certain subsidiaries of Sealy Corporation listed on the signature
         pages thereto and Ameritrust Company National Association.
         (Incorporated herein by reference to the appropriate exhibit to Sealy
         Corporation's Annual Report on Form 10-K for the fiscal year ended
         November 30, 1991 (File No. 1-8738.)
 4.6     Stock Subscription Agreement, dated as of March 30, 1989 by and among
         GGvA Holding Corp. (renamed Sealy Holdings, Inc. and merged with and
         into Sealy Corporation) and the purchasers listed therein.
         (Incorporated herein by reference to Exhibit 4.4 to Registration
         Statement of The Ohio Mattress Holding Company and The Ohio Mattress
         Company of Form S-4, File no. 33-29246, filed June 13, 1989.)
 4.7     Management Stock Subscription Agreement, dated as of March 30, 1989 by
         and among GGvA Holding Corp. (renamed Sealy Holdings, and merged with
         and into Sealy Corporation) and the management purchasers listed
         therein. (Incorporated herein by reference to Exhibit 4.5 to
         Registration Statement of The Ohio Mattress Holding Company on Form S-
         4, File No. 33-29246, filed June 13, 1989.)
 4.8     First Supplemental Indenture, dated as of February 12, 1993, by and
         among Sealy Corporation, certain subsidiaries of Sealy Corporation
         listed on the signature pages thereto as Ameritrust Company National
         Association (n.k.a. Society National Bank). (Incorporated herein by
         reference to the appropriate exhibit to the Form 10-K for the fiscal
         year ended November 30, 1992, File No. 1-8738.)
 4.9     Indenture, dated as of May 7, 1993, by and between Sealy Corporation
         and Society National Bank relating to the Sealy Corporation's 9 1/2%
         Senior Subordinated Notes. (Incorporated herein by reference to the
         appropriate exhibit to the Form 8-K Current Report of Sealy
         Corporation dated May 7, 1993).
 4.10    Form of 9 1/2% Senior Subordinated Note Due 2003. (Incorporated herein
         by reference to the appropriate exhibit to the Form 8-K Current Report
         of Sealy Corporation dated May 7, 1993.)
 4.11    Restated Secured Credit Agreement, dated as of May 27, 1994, by and
         among Sealy Corporation, Certain Banks and Other Financial
         Institutions and Banque Paribas, Citicorp USA, Inc., Bank of America
         (formerly Continental Bank N.A.) and General Electric Capital
         Corporation, as Managing Agents. (Incorporated herein by reference to
         the appropriate exhibit to the Form 10-Q Quarterly Report of Sealy
         Corporation dated May 31, 1994, File No. 1-8738.)
 4.12    Amendment No. 1 to Warrant Agreement between Sealy Corporation and
         Society National Bank as Warrant Agent, dated April 1, 1995.
         (Incorporated herein by reference to the appropriate exhibit to the
         Form 10-Q, Quarterly Report of Sealy Corporation dated August 31, 1995
         (File No. 1-8738)).
</TABLE>
 
                                       73
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
   4.13  First Amendment and consent to Restated Secured Credit Agreement,
         dated May 27, 1994 by and among Sealy Corporation, Certain Banks and
         Other Financial Institutions and Banque Paribas, Citicorp USA, Inc.,
         Bank of America and General Electric Capital Corporation, as Managing
         Agents. (Incorporated herein by reference to the appropriate exhibit
         to the Form 10-K for the fiscal year ended November 30, 1995 (File No.
         1-8738)).
   4.14  Second Amendment to Restated Secured Credit Agreement, dated May 27,
         1994 by and among Sealy Corporation, Certain Banks and Other Financial
         Institutions and Banque Paribas, Citicorp USA, Inc., Bank of America
         and General Electric Capital Corporation, as Managing Agents.
         (Incorporated herein by reference to the appropriate exhibit to the
         Form 10-K for the fiscal year ended November 30, 1995 (File No. 1-
         8738)).
   4.15  Third Amendment to the Restated Secured Credit Agreement, dated as of
         May 27, 1994, by and among Sealy Corporation, Certain Banks and Other
         Financial Institutions and Banque Paribas, Citicorp USA, Inc., Bank of
         America and General Electric Capital Corporation, as Managing Agents.
         (Incorporated herein by reference to the appropriate exhibit to the
         Form 10-Q Quarterly Report of Sealy Corporation dated June 2, 1996
         (File No. 1-8738)).
   4.16  Supplemental Indenture dated as of February 21, 1997, by and between
         Sealy Corporation and Mellon Bank, F.S.B. (as successor trustee to Key
         Bank National Association, formerly known as Society National Bank).
         (Incorporated herein by reference to the appropriate exhibit to Sealy
         Corporation's Annual Report on Form 10-K for the fiscal year ended
         December 1, 1996 (File No. 1-8738)).
   4.17  $275,000,000 Second Restated Credit Agreement dated as of February 25,
         1997 among Sealy Corporation, as Borrower, Various Financial
         Institutions, as Banks, Banque Paribas, as Documentation Agent,
         Nationsbank, N.A., as Syndication Agent, and Bank of America Illinois,
         as Administrative Agent. (Incorporated herein by reference to the
         appropriate exhibit to Sealy Corporation's Annual Report on Form 10-K
         for the fiscal year ended December 1, 1996 (File No. 1-8738)).
   4.18  Indenture, dated as of December 18, 1997, by and among Sealy Mattress
         Company, the Guarantors named therein and The Bank of New York, as
         trustee, with respect to the Series A and Series B 9 7/8% Senior
         Subordinated Notes due 2007. (Incorporated herein by reference,
         Exhibit 4.1, to the Form 8-K filed December 30, 1997 (File No. 1-
         8738)).
   4.19  Indenture, dated as of December 18, 1997, by and among Sealy Mattress
         Company, the Guarantors named therein and The Bank of New York, as
         trustee, with respect to the Series A and Series B 10 7/8% Senior
         Subordinated Discount Notes due 2007. (Incorporated herein by
         reference, Exhibit 4.2, to the Form 8-K filed December 30, 1997 (File
         No. 1- 8738)).
   4.20  Second Supplemental Indenture, dated as of December 5, 1997, by and
         between the Registrant and The Bank of New York, as trustee.
         (Incorporated herein by reference, Exhibit 4.3, to the Form 8-K filed
         December 30, 1997 (File No. 1-8738)).
 *10.1   Sealy Profit Sharing Plan, Amended and Restated Date: December 1,
         1989. (Incorporated herein by reference to the appropriate exhibit to
         the Form 10-K for the fiscal year ended November 30, 1995 (File No. 1-
         8738)).
 *10.2   Sealy Benefit Equalization Plan, dated December 1, 1994. (Incorporated
         herein by reference to the appropriate exhibit to the Form 10-K for
         the fiscal year ended November 30, 1995 (File No. 1-8738)).
 *10.3   Sealy Trust Agreement dated June 1, 1990. (Incorporated herein by
         reference to the appropriate Exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended November 30, 1991 (File
         No. 1-8738)).
</TABLE>
 
                                       74
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
 *10.4   The Ohio Mattress Holding Company 1989 Stock Option Plan.
         (Incorporated herein by reference to Exhibit 10.16 to Annual Report on
         Form 10-K of The Ohio Mattress Holding Company and The Ohio Mattress
         Company for the year ended November 30, 1989, File No. 33-29246, filed
         March 2, 1990).
 *10.5   Sealy Corporation Bonus Program. (Incorporated herein by reference to
         the appropriate exhibit to the Form 10-K for the fiscal year ended
         November 30, 1995 (File No. 1-8738)).
  10.6   Severance Agreement dated March 1, 1996 by and between Sealy
         Corporation and Lyman M. Beggs. (Incorporated herein by reference to
         the appropriate exhibit to the Form 10-Q Quarterly Report of Sealy
         Corporation dated March 3, 1996 (File No. 1-8738)).
 *10.7   Sealy Corporation 1992 Stock Option Plan. (Incorporated herein by
         reference to the appropriate Exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended November 30, 1992 (File
         No. 1-8738)).
 *10.8   Sealy Corporation Performance Share Plan. (Incorporated herein by
         reference to the appropriate Exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended November 30, 1992 (File
         No. 1-8738)).
 *10.9   Employment Agreement dated as of October 31, 1992, by and between
         Sealy Corporation and Lyman M. Beggs. (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended November 30, 1992 (File
         No. 1-8738)) .
 *10.10  Letter Agreement, dated as of October 31, 1992 by and between Sealy
         Corporation and Lyman M. Beggs. (Incorporated herein by reference to
         the appropriate exhibit to Sealy Corporation's Annual Report on Form
         10-K for the fiscal year ended November 30, 1992 (File No. 1-8738)).
 *10.11  Stockholder Agreement, dated as of October 31, 1992 by and between
         Sealy Corporation and Lyman M. Beggs. (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended November 30, 1992 (File
         No. 1-8738)).
 *10.12  Letter Agreement, dated June 5, 1991 by and between Sealy Corporation
         and Sam F. Smith, Jr. (Incorporated herein by reference to the
         appropriate exhibit to Sealy Corporation's Annual Report on Form 10-K
         for the fiscal year ended November 30, 1992 (File No. 1-8738)).
  10.13  Sealy Corporation 1993 Non-Employee Director Stock Option Plan.
         (Incorporated herein by reference to the appropriate exhibit to the
         Form S-1 Registration Statement of Sealy Corporation (File No. 33-
         59134)). (As amended by Amendment No. 1 dated April 6, 1994.)
  10.14  Amendment No. 2 to Sealy Corporation 1993 Non-Employee Director Stock
         Option Plan, dated June 27, 1995. (Incorporated herein by reference to
         the appropriate exhibit to Sealy Corporation's Annual Report on Form
         10-K for the fiscal year ended December 1, 1996 (File No. 1-8738)).
  10.15  Amendment No. 3 to Sealy Corporation 1993 Non-Employee Director Stock
         Option Plan dated as of May 1, 1996. (Incorporated herein by reference
         to the appropriate exhibit to Sealy Corporation's Annual Report on
         Form 10-K for the fiscal year ended December 1, 1996 (File No. 1-
         8738)).
 *10.16  Employment Agreement dated March 4, 1996 by and between Sealy
         Corporation and Ronald L. Jones. (Incorporated herein by reference to
         the appropriate exhibit to the Form 10-Q Quarterly Report of Sealy
         Corporation dated March 3, 1996 (File No. 1-8738)).
 *10.17  Amendment No. 1 to Sealy Bonus Plan. (Incorporated herein by reference
         to the appropriate exhibit to Sealy Corporation's Annual Report on
         Form 10-K for the fiscal year ended December 1, 1996 (File No. 1-
         8738)).
 *10.18  Sealy Corporation Bonus Plan. (Incorporated herein by reference to the
         appropriate exhibit to Sealy Corporation's Annual Report on Form 10-K
         for the fiscal year ended December 1, 1996 (File No. 1-8738)).
</TABLE>
 
                                       75
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
 *10.19  Amendment No. 1 to Sealy Corporation 1992 Stock Option Plan.
         (Incorporated herein by reference to the appropriate exhibit to Sealy
         Corporation's Annual Report on Form 10-K for the fiscal year ended
         December 1, 1996 (File No. 1-8738)).
 *10.20  Amendment No. 1 to Sealy Corporation Performance Share Plan.
         (Incorporated herein by reference to the appropriate exhibit to Sealy
         Corporation's Annual Report on Form 10-K for the fiscal year ended
         December 1, 1996 (File No. 1-8738)).
 *10.21  Amendment No. 1 to Sealy Profit Sharing Plan. (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended December 1, 1996 (File
         No. 1-8738)).
 *10.22  Amendment No. 2 to Sealy Profit Sharing Plan. (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended December 1, 1996 (File
         No. 1-8738)).
 *10.23  1996 Transitional Restricted Stock Plan. (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended December 1, 1996 (File
         No. 1-8738)).
 *10.24  Sealy Corporation 1997 Stock Option Plan. (Incorporated herein by
         reference to the appropriate exhibit to Sealy Corporation's Annual
         Report on Form 10-K for the fiscal year ended December 1, 1996 (File
         No. 1-8738)).
 *10.25  Stock Option Agreement dated March 4, 1996 by and between Sealy
         Corporation and Ronald L. Jones. (Incorporated herein by reference to
         the appropriate exhibit to Sealy Corporation's Annual Report on Form
         10-K for the fiscal year ended December 1, 1996 (File No. 1-8738)).
 *10.26  Stockholder Agreement dated March 4, 1996 by and among Sealy
         Corporation and Ronald L. Jones. (Incorporated herein by reference to
         the appropriate exhibit to Sealy Corporation's Annual Report on Form
         10-K for the fiscal year ended December 1, 1996 (File No. 1-8738)).
 *10.27  Restricted Stock Agreement dated March 4, 1996 by and between Sealy
         Corporation and Ronald L. Jones. (Incorporated herein by reference to
         the appropriate exhibit to Sealy Corporation's Annual Report on Form
         10-K for the fiscal year ended December 1, 1996 (File No. 1-8738)).
  10.28  Dealer Manager Agreement, dated as of November 18, 1997, among Sandman
         Merger Corporation, the Registrant and Goldman, Sachs & Co.
         (Incorporated herein by reference, Exhibit 10.1, to the Form 8-K filed
         December 30, 1997 (File No. 1-8738)).
  10.29  Purchase Agreement, dated as of December 11, 1997, by and among Sealy
         Mattress Company, the Guarantors named therein, Goldman, Sachs & Co.
         (Incorporated herein by reference, Exhibit 10.2, to the Form 8-K filed
         December 30, 1997 (File No. 1-8738)).
  10.30  Registration Rights Agreement, dated as of December 18, 1997, by and
         among Sealy Mattress Company, the Guarantors named therein, Goldman,
         Sachs & Co., J.P. Morgan Securities Inc. and BT Alex. Brown
         Incorporated. (Incorporated herein by reference, Exhibit 10.3, to the
         Form 8-K filed December 30, 1997 (File No. 1-8738)).
  10.31  Credit Agreement, dated as of December 18, 1997, among Sealy Mattress
         Company, the Guarantors named therein, Goldman Sachs Credit Partners
         L.P., as arranger and syndication agent, Morgan Guaranty Trust Company
         of New York, as administrative agent, Bankers Trust Company, as
         Documentation agent, and the other institutions named therein.
         (Incorporated herein by reference, Exhibit 10.4, to the Form 8-K filed
         December 30, 1997 (File No. 1-8738)).
</TABLE>
 
                                       76
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
  10.32  AXEL Credit Agreement, dated as of December 18, 1997, among Sealy
         Mattress Company, the Guarantors named therein, Goldman Sachs Credit
         Partners L.P., as arranger and syndication agent, Morgan Guaranty
         Trust Company of New York, as administrative agent, Bankers Trust
         Company, as documentation agent, and the other institutions named
         therein. (Incorporated herein by reference, Exhibit 10.5, to the Form
         8-K filed December 30, 1997 (File No. 1-8738)).
 *10.33  Amended and Restated Employment Agreement, dated as of August 1, 1997,
         by and between Sealy Corporation and Ronald L. Jones. (Incorporated
         herein by reference, Exhibit 10.6, to the Form 8-K filed December 30,
         1997 (File No. 1-8738)).
 *10.34  Employment Agreement, dated as of August 25, 1997, by and between
         Sealy Corporation and Bruce G. Barman. (Incorporated herein by
         reference, Exhibit 10.7, to the Form 8-K filed December 30, 1997 (File
         No. 1-8738)).
 *10.35  Employment Agreement, dated as of August 25, 1997, by and between
         Sealy Corporation and Jeffrey C. Claypool. (Incorporated herein by
         reference, Exhibit 10.8, to the Form 8-K filed December 30, 1997 (File
         No. 1-8738)).
 *10.36  Employment Agreement, dated as of August 25, 1997, by and between
         Sealy Corporation and Gary T. Fazio. (Incorporated herein by
         reference, Exhibit 10.9, to the Form 8-K filed December 30, 1997 (File
         No. 1-8738)).
 *10.37  Employment Agreement, dated as of August 25, 1997, by and between
         Sealy Corporation and Douglas E. Fellmy. (Incorporated herein by
         reference, Exhibit 10.10, to the Form 8-K filed December 30, 1997
         (File No. 1-8738)).
 *10.38  Employment Agreement, dated as of August 25, 1997, by and between
         Sealy Corporation and David J. McIlquham. (Incorporated herein by
         reference, Exhibit 10.11, to the Form 8-K filed December 30, 1997
         (File No. 1-8738)).
 *10.39  Employment Agreement, dated as of August 25, 1997, by and between
         Sealy Corporation and Lawrence J. Rogers. (Incorporated herein by
         reference, Exhibit 10.12, to the Form 8-K filed December 30, 1997
         (File No. 1-8738)).
 *10.40  Change of Control Agreement, dated as of September 3, 1997 by and
         between Sealy Corporation and John G. Bartik. (Incorporated herein by
         reference, Exhibit 10.13, to the Form 8-K filed December 30, 1997
         (File No. 1-8738)).
 *10.41  Change of Control Agreement, dated as of September 3, 1997 by and
         between Sealy Corporation and James F. Goughenour. (Incorporated
         herein by reference, Exhibit 10.14, to the Form 8-K filed December 30,
         1997 (File No. 1- 8738)).
 *10.42  Change of Control Agreement, dated as of September 3, 1997 by and
         between Sealy Corporation and Richard F. Sowerby. (Incorporated herein
         by reference, Exhibit 10.15, to the Form 8-K filed December 30, 1997
         (File No. 1- 8738)).
 *10.43  Change of Control Agreement, dated as of September 3, 1997 by and
         between Sealy Corporation and Ronald H. Stolle. (Incorporated herein
         by reference, Exhibit 10.16, to the Form 8-K filed December 30, 1997
         (File No. 1-8738)).
 *10.44  Change of Control Agreement, dated as of September 3, 1997 by and
         between Sealy Corporation and Kenneth L. Walker. (Incorporated herein
         by reference, Exhibit 10.17, to the Form 8-K filed December 30, 1997
         (File No. 1-8738)).
</TABLE>
 
                                       77
<PAGE>
 
<TABLE>
<CAPTION>
 EXHIBIT
 NUMBER                            EXHIBIT DESCRIPTION
 -------                           -------------------
 <C>     <S>
 *10.45  Amendment to Amended and Restated Employment Agreement and Termination
         of Stockholders Agreement, dated as of December 17, 1997, between
         Ronald L. Jones and the Registrant. (Incorporated herein by reference,
         Exhibit 10.18, to the Form 8-K filed December 30, 1997 (File No. 1-
         8738)).
 *10.46  Amendment to Employment Agreements, dated as of December 17, 1997,
         between the employees named therein and the Registrant. (Incorporated
         herein by reference, Exhibit 10.19, to the Form 8-K filed December 30,
         1997 (File No. 1- 8738)).
 *10.47  Form of Amendment to Change of Control Agreements, dated as of
         December 17, 1997. (Incorporated herein by reference, Exhibit 10.20,
         to the Form 8-K filed December 30, 1997 (File No. 1-8738)).
  10.48  Change in Registrants Certified Accountant, dated March 23, 1998 (File
         No. 1-8738).
  10.49  Stockholders Agreement dated as of December 18, 1997 by and among
         Sealy Corporation and the Stockholders named therein. (Incorporated
         herein by reference to Exhibit 10.27 to Sealy Mattress Company's -
         Form S-4 Registration Statement filed May 5, 1998 (File No. 1-8738)).
  10.50  Registration Rights Agreement dated as of December 18, 1997 by and
         among Sealy Corporation and the Stockholders named therein.
         (Incorporated herein by reference to Exhibit 10. To Sealy Mattress
         Company's Form S-4 Registration Statement filed May 5, 1998 (File No.
         1-8738)).
  10.51  Management Services Agreement dated as of December 18, 1997 by and
         between Sealy Corporation, Sealy Mattress and Bain Capital, Inc.
         (Incorporated herein by reference to Exhibit 10.50 to Sealy Mattress
         Company's Form S-4 Registration Statement filed May 5, 1998 (File No.
         1-8738)).
  10.52  First Amendment to Credit Agreement (Incorporated herein by reference,
         Exhibit 10.1, to the Form 8-K filed October 14, 1998 (File No. 1-
         8738)).
 *10.53  Employment Agreement, dated as of October 15, 1998 by and between
         Sealy Corporation and E. Lee Wyatt.
 *10.54  Employment Agreement, dated as of October 15, 1998 by and between
         Sealy Corporation and James Goughenour.
 *10.55  Employment Agreement, dated as of October 15, 1998 by and between
         Sealy Corporation and Richard Sowerby.
 *10.56  Employment Agreement, dated as of December 18, 1998 by and between
         Sealy Corporation and Kenneth L. Walker.
  27.1   Financial Data Schedule.
  99.1   Certificate of Ownership and Merger merging Sealy Holdings, Inc. with
         and into Sealy Corporation dated as of November 5, 1991. (Incorporated
         herein by reference to the appropriate exhibit to Sealy Corporation's
         Annual Report on Form 10-K for the fiscal year ended November 30, 1991
         (File No. 1-8738)).
  99.2   Sealy Corporation Executive Severance Benefit Plan dated January 25,
         1993. (Incorporated herein by reference to the appropriate exhibit to
         Sealy Corporation's Annual Report on Form 10-K for the fiscal year
         ended November 30, 1992 (File No. 1-8738)).
</TABLE>
 
                                       78
<PAGE>
 
                                  SIGNATURES
 
  PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, SEALY CORPORATION HAS DULY CAUSED THIS REPORT TO BE
SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
 
                                          Sealy Corporation
 
                                          By: Ronald L. Jones
                                                 RONALD L. JONES CHAIRMAN,
                                               PRESIDENT AND CHIEF EXECUTIVE
                                               OFFICER (PRINCIPAL EXECUTIVE
                                                         OFFICER)
 
Date: March 1, 1999
 
  PURSUANT TO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS
REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE
REGISTRANT AND IN THE CAPACITIES AND ON THE DATES INDICATED:
 
<TABLE>
<S>  <C>
         SIGNATURE                        TITLE
                                                                     DATE
 
     /s/ E. Lee Wyatt        Corporate Vice President--         March 1, 1999
---------------------------   Administration (Principal
        E. LEE WYATT          Accounting Officer)
 
/s/ Josh Bekenstein          Director                           March 1, 1999
---------------------------
       JOSH BEKENSTEIN
 
/s/ Paul Edgerley            Director                           March 1, 1999
---------------------------
        PAUL EDGERLEY
 
/s/ Andrew S. Janower        Director                           March 1, 1999
---------------------------
      ANDREW S. JANOWER
 
   /s/ James W. Johnston     Director                           March 1, 1999
---------------------------
      JAMES W. JOHNSTON
 
    /s/ Ronald L. Jones      Director                           March 1, 1999
---------------------------
       RONALD L. JONES
 
/s/ Michael Krupka           Director                           March 1, 1999
---------------------------
       MICHAEL KRUPKA
 
/s/ Jonas Steinman           Director                           March 1, 1999
---------------------------
       JONAS STEINMAN
</TABLE>
 
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