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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



|x |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ---------------------------------------------------------------------------------------



For the quarterly period ended: August 31, 2003



OR



| ̈ |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- |  | ----------------------------------------------------------------------------------------



For the transition period from              to



Commission file number 1-8738



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SEALY CORPORATION

(Exact name of registrant as specified in its charter)



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



(336) 861-3500

Registrants telephone number, including area code



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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 and 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 ̈



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



The number of shares of the registrants common stock outstanding as of September 30, 2003 was 31,273,542.



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PART I.    FINANCIAL INFORMATION



Item 1.Financial Statements



SEALY CORPORATION



Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)



|                                                      |  | Quarter Ended August 31, 2003 |         |   | Quarter Ended September 1, 2002 |  
|----------------------------------------------------- |  | ----------------------------- | ------- | - | ------------------------------- | -
|Net salesNon-affiliates                              |  | $                             | 318,326 |   |                                 | $
|Net salesAffiliates                                  |  |                               | 6,615   |   |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Total net sales                                       |  |                               | 324,941 |   |                                 |  
|Costs and expenses:                                   |  |                               |         |   |                                 |  
|Cost of goods soldNon-affiliates                     |  |                               | 185,170 |   |                                 |  
|Cost of goods soldAffiliates                         |  |                               | 3,797   |   |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Total cost of goods sold                              |  |                               | 188,967 |   |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Gross profit                                          |  |                               | 135,974 |   |                                 |  
|Selling, general and administrative                   |  |                               | 105,617 |   |                                 |  
|Stock based compensation                              |  |                               | 492     |   |                                 |  
|Amortization of intangibles                           |  |                               | 287     |   |                                 |  
|Royalty income, net                                   |  |                               | (3,064  | ) |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Income from operations                                |  |                               | 32,642  |   |                                 |  
|Interest expense                                      |  |                               | 17,662  |   |                                 |  
|Other (income) expense, net (Note 6)                  |  |                               | (246    | ) |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Income before income tax expense                      |  |                               | 15,226  |   |                                 |  
|Income tax expense                                    |  |                               | 6,529   |   |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Net income                                            |  |                               | 8,697   |   |                                 |  
|Liquidation preference for common L & M shares        |  |                               | 5,114   |   |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Net income available to common shareholders           |  | $                             | 3,583   |   |                                 | $
|                                                      |  |                               |         |   |                                 |  
|Earnings per sharebasic:                             |  |                               |         |   |                                 |  
|Net income                                            |  | $                             | 0.28    |   |                                 | $
|Liquidation preference for common L & M shares        |  |                               | (0.17   | ) |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Net income available to common shareholders           |  | $                             | 0.11    |   |                                 | $
|                                                      |  |                               |         |   |                                 |  
|Earnings per sharediluted:                           |  |                               |         |   |                                 |  
|Net income                                            |  | $                             | 0.28    |   |                                 | $
|Liquidation preference for common L & M shares        |  |                               | (0.17   | ) |                                 |  
|                                                      |  |                               |         |   |                                 |  
|Net income available to common shareholders           |  | $                             | 0.11    |   |                                 | $
|                                                      |  |                               |         |   |                                 |  
|Weighted average number of common shares outstanding: |  |                               |         |   |                                 |  
|Basic                                                 |  |                               | 31,189  |   |                                 |  
|Diluted                                               |  |                               | 31,211  |   |                                 |  





See accompanying notes to condensed consolidated financial statements.



2



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SEALY CORPORATION



Condensed Consolidated Statements of Operations

(In thousands, except per share data)

(Unaudited)



|                                                      |  | Nine Months Ended August 31, 2003 |         |   | Nine Months Ended September 1, 2002 |  
|----------------------------------------------------- |  | --------------------------------- | ------- | - | ----------------------------------- | -
|Net salesNon-affiliates                              |  | $                                 | 857,348 |   |                                     | $
|Net salesAffiliates                                  |  |                                   | 25,680  |   |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Total net sales                                       |  |                                   | 883,028 |   |                                     |  
|Costs and expenses:                                   |  |                                   |         |   |                                     |  
|Cost of goods soldNon-affiliates                     |  |                                   | 501,191 |   |                                     |  
|Cost of goods soldAffiliates                         |  |                                   | 15,081  |   |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Total cost of goods sold                              |  |                                   | 516,272 |   |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Gross profit                                          |  |                                   | 366,756 |   |                                     |  
|Selling, general and administrative                   |  |                                   | 290,990 |   |                                     |  
|Stock based compensation                              |  |                                   | 1,482   |   |                                     |  
|Business closure charge (Note 4)                      |  |                                   |        |   |                                     |  
|Amortization of intangibles                           |  |                                   | 820     |   |                                     |  
|Royalty income, net                                   |  |                                   | (8,625  | ) |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Income from operations                                |  |                                   | 82,089  |   |                                     |  
|Interest expense                                      |  |                                   | 51,614  |   |                                     |  
|Other (income) expense, net (Note 6)                  |  |                                   | 1,255   |   |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Income before income tax expense                      |  |                                   | 29,220  |   |                                     |  
|Income tax expense                                    |  |                                   | 12,448  |   |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Net income                                            |  |                                   | 16,772  |   |                                     |  
|Liquidation preference for common L & M shares        |  |                                   | 15,342  |   |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Net income (loss) available to common shareholders    |  | $                                 | 1,430   |   |                                     | $
|                                                      |  |                                   |         |   |                                     |  
|Earnings per sharebasic:                             |  |                                   |         |   |                                     |  
|Net income                                            |  | $                                 | 0.54    |   |                                     | $
|Liquidation preference for common L & M shares        |  |                                   | (0.49   | ) |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Net income (loss) available to common shareholders    |  | $                                 | 0.05    |   |                                     | $
|                                                      |  |                                   |         |   |                                     |  
|Earnings per sharediluted:                           |  |                                   |         |   |                                     |  
|Net income                                            |  | $                                 | 0.54    |   |                                     | $
|Liquidation preference for common L & M shares        |  |                                   | (0.49   | ) |                                     |  
|                                                      |  |                                   |         |   |                                     |  
|Net income (loss) available to common shareholders    |  | $                                 | 0.05    |   |                                     | $
|                                                      |  |                                   |         |   |                                     |  
|Weighted average number of common shares outstanding: |  |                                   |         |   |                                     |  
|Basic                                                 |  |                                   | 31,234  |   |                                     |  
|Diluted                                               |  |                                   | 31,255  |   |                                     |  



See accompanying notes
to condensed consolidated financial statements.



3



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SEALY CORPORATION



Condensed Consolidated Balance Sheets

(In thousands)

(Unaudited)



|                                                          |  | August 31, 2003 |          |   | December 1, 2002* |  
|--------------------------------------------------------- |  | --------------- | -------- | - | ----------------- | -
|ASSETS                                                    |  |                 |          |   |                   |  
|Current assets:                                           |  |                 |          |   |                   |  
|Cash and cash equivalents                                 |  | $               | 45,003   |   |                   | $
|Accounts receivableNon-affiliates, net                   |  |                 | 197,955  |   |                   |  
|Accounts receivableAffiliates, net (Note 13)             |  |                 | 2,721    |   |                   |  
|Inventories                                               |  |                 | 56,369   |   |                   |  
|Prepaid expenses, deferred taxes and other current assets |  |                 | 44,340   |   |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  |                 | 346,388  |   |                   |  
|Property, plant and equipment, at cost                    |  |                 | 294,604  |   |                   |  
|Less: accumulated depreciation                            |  |                 | (122,610 | ) |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  |                 | 171,994  |   |                   |  
|Other assets:                                             |  |                 |          |   |                   |  
|Goodwill                                                  |  |                 | 379,977  |   |                   |  
|Other intangibles, net                                    |  |                 | 4,802    |   |                   |  
|Long-term notes receivable (Note 13)                      |  |                 | 12,022   |   |                   |  
|Investments in and advances to affiliates (Note 13)       |  |                 |         |   |                   |  
|Debt issuance costs, net, and other assets                |  |                 | 30,828   |   |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  |                 | 427,629  |   |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  | $               | 946,011  |   |                   | $
|                                                          |  |                 |          |   |                   |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)            |  |                 |          |   |                   |  
|Current liabilities:                                      |  |                 |          |   |                   |  
|Current portion of long-term obligations                  |  | $               | 23,262   |   |                   | $
|Accounts payable                                          |  |                 | 98,557   |   |                   |  
|Accrued interest                                          |  |                 | 12,189   |   |                   |  
|Accrued incentives and advertising                        |  |                 | 42,228   |   |                   |  
|Accrued compensation                                      |  |                 | 20,760   |   |                   |  
|Other accrued expenses                                    |  |                 | 43,904   |   |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  |                 | 240,900  |   |                   |  
|Long-term obligations, net                                |  |                 | 722,099  |   |                   |  
|Other noncurrent liabilities                              |  |                 | 46,966   |   |                   |  
|Deferred income taxes                                     |  |                 | 21,347   |   |                   |  
|Stockholders equity (deficit):                           |  |                 |          |   |                   |  
|Common stock                                              |  |                 | 323      |   |                   |  
|Additional paid-in capital                                |  |                 | 146,226  |   |                   |  
|Accumulated deficit                                       |  |                 | (202,994 | ) |                   |  
|Accumulated other comprehensive loss                      |  |                 | (15,792  | ) |                   |  
|Common stock held in treasury, at cost                    |  |                 | (13,064  | ) |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  |                 | (85,301  | ) |                   |  
|                                                          |  |                 |          |   |                   |  
|                                                          |  | $               | 946,011  |   |                   | $
|                                                          |  |                 |          |   |                   |  

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|* |  | Condensed from audited financial statements.
|- |  | --------------------------------------------



See accompanying notes to condensed consolidated financial statements.



4



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SEALY CORPORATION



Condensed Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)



|                                                                                                                   |  | Nine Months Ended August 31, 2003 |         |   | Nine Months Ended September 1, 2002 |  
|------------------------------------------------------------------------------------------------------------------ |  | --------------------------------- | ------- | - | ----------------------------------- | -
|Net cash provided by operating activities                                                                          |  | $                                 | 29,314  |   |                                     | $
|Cash flows from investing activities:                                                                              |  |                                   |         |   |                                     |  
|Purchase of property, plant and equipment, net                                                                     |  |                                   | (9,337  | ) |                                     |  
|Cash received from (paid on) affiliate note and investment                                                         |  |                                   | 13,611  |   |                                     |  
|Restricted cash collateralizing outstanding letters of credit                                                      |  |                                   |        |   |                                     |  
|Other                                                                                                              |  |                                   |        |   |                                     |  
|                                                                                                                   |  |                                   |         |   |                                     |  
|Net cash provided by (used in) investing activities                                                                |  |                                   | 4,274   |   |                                     |  
|                                                                                                                   |  |                                   |         |   |                                     |  
|Cash flows from financing activities:                                                                              |  |                                   |         |   |                                     |  
|Treasury stock repurchase, including direct expenses                                                               |  |                                   |        |   |                                     |  
|Proceeds from the issuance of Senior Subordinated Notes                                                            |  |                                   | 51,500  |   |                                     |  
|Prepayment of Tranche debt                                                                                         |  |                                   | (49,000 | ) |                                     |  
|Repayments of long-term obligations, net                                                                           |  |                                   | (14,756 | ) |                                     |  
|Equity contributions                                                                                               |  |                                   | 88      |   |                                     |  
|Purchase of interest rate cap agreement                                                                            |  |                                   |        |   |                                     |  
|Debt issuance costs                                                                                                |  |                                   | (3,860  | ) |                                     |  
|                                                                                                                   |  |                                   |         |   |                                     |  
|Net cash used in financing activities                                                                              |  |                                   | (16,028 | ) |                                     |  
|                                                                                                                   |  |                                   |         |   |                                     |  
|Change in cash and cash equivalents                                                                                |  |                                   | 17,560  |   |                                     |  
|Cash and cash equivalents:                                                                                         |  |                                   |         |   |                                     |  
|Beginning of period                                                                                                |  |                                   | 27,443  |   |                                     |  
|                                                                                                                   |  |                                   |         |   |                                     |  
|End of period                                                                                                      |  | $                                 | 45,003  |   |                                     | $
|                                                                                                                   |  |                                   |         |   |                                     |  
|Supplemental disclosures:                                                                                          |  |                                   |         |   |                                     |  
|Selected non-cash items:                                                                                           |  |                                   |         |   |                                     |  
|Non-cash compensation                                                                                              |  | $                                 | 1,482   |   |                                     | $
|Depreciation and amortization                                                                                      |  |                                   | 16,718  |   |                                     |  
|Business closure charge                                                                                            |  |                                   |        |   |                                     |  
|Write-off of deferred debt costs and dedesignated cash flow hedge associated with the early extinguishment of debt |  |                                   | 2,531   |   |                                     |  
|                                                                                                                   |  |                                  
|Non-cash interest expense associated with:                                                                         |  |                                   |         |   |                                     |  
|Junior Subordinated Notes                                                                                          |  |                                   | 4,196   |   |                                     |  
|Debt issuance costs                                                                                                |  |                                   | 4,275   |   |                                     |  
|Discount on Senior Subordinated Notes, net                                                                         |  |                                   | 188     |   |                                     |  
|Net interest (income) expense associated with interest rate swap and cap agreements                                |  |                                   | (549    | ) |                                     |  



See accompanying notes
to condensed consolidated financial statements



5



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SEALY CORPORATION



Notes to Consolidated Financial Statements



Note 1:Basis of Presentation



The condensed consolidated interim financial statements are unaudited, and
certain information and footnote disclosures related thereto normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted in accordance with Rule
10-01 of Regulation S-X. In the opinion of management, the accompanying unaudited consolidated financial statements were prepared following the same policies and procedures used in the preparation of the audited financial statements and reflect all
adjustments (consisting of normal recurring adjustments) necessary to present fairly the financial position of Sealy Corporation and its subsidiaries (the Company). The results of operations for the interim periods are not necessarily
indicative of the results for the entire fiscal year. These condensed consolidated financial statements should be read in conjunction with the Companys Annual Report on Form 10-K for the year ended December 1, 2002.



The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that affect the amount of assets and liabilities and disclosures of contingent assets and liabilities at the end of the quarter and the reported amounts of revenue and
expenses during the reporting period. Actual results could differ from those estimates.



Certain reclassifications of previously reported financial information were made to conform to the current presentation.



Note 2:Inventories



The major components of inventories were as follows:



|                |  | August 31, 2003 |        | December 1, 2002
|--------------- |  | --------------- | ------ | ----------------
|                |  | (In thousands) 
|Raw materials   |  | $               | 26,683 |                 
|Work in process |  |                 | 21,206 |                 
|Finished goods  |  |                 | 8,480  |                 
|                |  |                 |        |                 
|                |  | $               | 56,369 |                 
|                |  |                 |        |                 



Note
3:Warranty Costs



The Company has warranty obligations in connection with the sale of its product. The warranty period for Sealy Posturepedic, Stearns & Foster, Bassett and other Sealy branded products is a 10 year non-prorated warranty service period.
The costs incurred to provide for these warranty obligations are estimated and recorded as an accrued liability at the time of sale. The Company estimates its warranty cost at the point of sale based on historical rates. The change in the
Companys accrued warranty obligations for the nine months ended August 31, 2003 are as follows:



|                                                 |  | August 31, 2003 |       
|------------------------------------------------ |  | --------------- | ------
|                                                 |  | (In thousands)  |       
|Accrued warranty obligations at December 1, 2002 |  | $               | 9,538 
|Warranty claims                                  |  |                 | (8,466
|2003 warranty provisions                         |  |                 | 8,650 
|                                                 |  |                 |       
|Accrued warranty obligations at August 31, 2003  |  | $               | 9,722 
|                                                 |  |                 |       



6



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SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



Note 4:Business Closure



During the first quarter of 2002, the Company took control of a retail
mattress company in which it had previously made investments in the form of a supply agreement and additional equity. This investment provided the Company an opportunity to determine whether the entity would be a viable distribution source for the
Companys products. It is not the Companys strategy to own or control retail operations. Based on managements assessment, evaluation and consideration of alternative business strategies of the Company, it was determined that the
acquired entity did not represent a valid business strategy and ceased its operations in May 2002. The Company recorded a non-cash charge of $5.8 million associated with this shut-down of the business in the quarter ended June 2, 2002.



Note 5:Goodwill and Other Intangible Assets



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



The changes in the carrying amount of goodwill for the nine months ended August 31, 2003, are as follows:



|Balance as of December 1, 2002               |  | $ | 374.9
|-------------------------------------------- |  | - | -----
|Increase due to foreign currency translation |  |   | 5.1  
|                                             |  |   |      
|Balance as of August 31, 2003                |  | $ | 380.0
|                                             |  |   |      



Total other
intangibles of $4.8 million (net of accumulated amortization of $14.2 million) as of August 31, 2003 primarily consist of acquired licenses, which are amortized on the straight-line method over periods ranging from 5 to 15 years.



Note 6:Other (Income) Expense



The Company previously contributed cash and other assets
to Mattress Holdings International LLC (MHI), a company which was controlled by the Companys largest stockholder, Bain Capital LLC, in exchange for a non-voting interest. The equity ownership of MHI was transferred to the Company
in November 2002. MHI acquired a minority interest in Malachi Mattress America, Inc. (Malachi), a domestic mattress retailer, in 1999. In October 2002, MHI acquired substantially all of the remaining interest in Malachi and sold 100% of
its interest to an independent third party. The Malachi investment was accounted for by MHI under the equity method. Accordingly, the Company recorded equity in the losses of Malachi of $0.2 million and $5.6 million for the three and nine months
ended September 1, 2002, respectively. See also Note 13.



Additionally, Other (income) expense, net includes interest income of $0.2 million and $1.3 million for the three and nine months ended August 31, 2003 and $0.4 million and $1.9 million for the three and nine months ended September 1, 2002,
respectively.



Other (income) expense, net in the nine months
ended August 31, 2003 also includes a $2.0 million write-off of previously deferred derivative losses recorded in accumulated other comprehensive loss and $0.5 million of deferred debt costs associated with the early extinguishment of debt in May
2003. See also Note 7.



7



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SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



Note 7:Long-Term Obligations



In May 2003, the Company completed a private placement of $50 million of
9.875% senior subordinated notes. These notes, which are due and payable on December 15, 2007 require semi-annual interest payments, commencing June 15, 2003. The proceeds from the placement were used to prepay all quarterly principal payments on
the Senior AXELs Credit Facility due through March 2004. The Company will commence quarterly principal payments on June 15, 2004. Subsequent to the issuance, the Company registered the notes with the Securities and Exchange Commission to allow them
to be exchanged for publicly traded bonds. The Company completed the exchange offer for the notes in July.



On October 9, 2003, the Company amended its Amended and Restated Credit Agreement dated November 8, 2002 to provide the Company with the ability to
repurchase up to $25 million of the outstandings of the Junior Subordinated Notes and to amend the requirements for allowing the Company to cash pay on the interest accrued. The Company was previously required to accrue interest at 12% and add such
interest to the total outstandings of the Notes. The Company will have the option, within 10 days of the end of each calendar quarter, of paying interest on the total outstandings for that quarter at a rate of 10% per annum.



Note 8:Recently Issued Accounting
Pronouncements



The FASB issued FAS 149,
Amendment of Statement No. 133 on Derivative Instruments and Hedging Activities. The statement is effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003. This
statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contacts and for hedging activities. This statement amends Statement 133 for decisions made as
part of the Derivatives Implementation Group process that effectively required amendments to Statement 133, in connection with other Board projects dealing with financial instruments and in connection with implementation issues raised in relation to
the application of the definition of a derivative. The adoption of this Statement did not have a significant impact on the Companys consolidated financial statements.



The FASB issued FAS 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and
Equity. This statement is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, the Companys fourth
quarter of fiscal 2003. This statement establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that
is within its scope as a liability. Many of those instruments have been previously classified as equity. The Company does not believe that the adoption of this Statement will have a significant impact on the Companys consolidated financial
statements.



The FASB issued FASB Interpretation No. 46
(FIN 46), Consolidation of Variable Interest Entities. The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights
(variable interest entities or VIEs) and how to determine when and which business enterprise should consolidate the VIE (the primary beneficiary). This new model for consolidation applies to an entity in which
either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entitys activities without receiving additional subordinated financial support from
other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. The Company adopted these provisions in its second quarter of 2003.
The Company is not a primary beneficiary of a VIE and does not hold any significant interests or involvement in a VIE. The adoption had no effect on the consolidated financial statements.



8



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SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



The Emerging Issues Task Force of the FASB released Issue 01-09, Accounting for Consideration
Given by a Vendor to a Customer or a Reseller of the Vendors Product to provide guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendors products, including both customers
and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically
classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative in the
Statement of Operations. The Company adopted EITF 01-09 effective March 4, 2002, the first day of fiscal second quarter of 2002, and reclassified previous period amounts to comply with the consensus. As a result of the adoption, both net sales and
selling, general and administrative expenses were reduced $14.2 million and $36.8 million for the three and nine months ended August 31, 2003 and $17.3 million and $40.0 million for the three and nine months ended September 1, 2002, respectively.
These changes did not affect the Companys financial position or results of operations.



Note 9:Hedging Strategies



In 2001, the Company entered into an interest rate swap agreement that effectively converted $236 million of its floating-rate debt to a fixed-rate basis
through December 2006, thereby hedging against the impact of interest rate changes on future interest expense (forecasted cash flows). Use of hedging contracts allows the Company to reduce its overall exposure to interest rate changes, since gains
and losses on these contracts will offset losses and gains on the transactions being hedged. The Company formally documents all hedged transactions and hedging instruments, and assesses, both at inception of the contract and on an ongoing basis,
whether the hedging instruments are effective in offsetting changes in cash flows of the hedged transaction. The fair values of the interest rate agreements are estimated by obtaining quotes from brokers and are the estimated amounts that the
Company would receive or pay to terminate the agreements at the reporting date, taking into consideration current interest rates and the current creditworthiness of the counterparties. Effective June 3, 2002, the Company dedesignated the interest
rate swap agreement for hedge accounting. As a result of the dedesignation, $12.9 million previously recorded in accumulated other comprehensive loss as of the date of dedesignation is being amortized into interest expense over the remaining life of
the interest rate swap agreement. For the three and nine months ended August 31, 2003, $0.6 million and $2.7 million and for the three and nine months ended September 1, 2002, $1.0 million and $1.0 million was amortized into interest expense,
respectively. Prior to June 3, 2002, changes in the fair market value of the interest rate swap were recorded in accumulated other comprehensive loss. Subsequent to June 3, 2002, changes in the fair market value of the interest rate swap are
recorded in interest expense. For the three and nine months ended August 31, 2003, $(3.0) million and $4.5 million and for the three and nine months ended September 1, 2002, $6.3 million and $6.3 million, respectively, was recorded as interest
expense as a result of the change in its fair market value. At August 31, 2003 and December 1, 2002, the fair value carrying amount of this instrument was $(16.7) million and $(20.2) million, respectively, which is recorded as follows:



|                             |  | August 31, 2003 |      | December 1, 2002
|---------------------------- |  | --------------- | ---- | ----------------
|                             |  | (in millions)  
|Accrued interest             |  | $               | 2.3  |                 
|Other accrued expenses       |  |                 | 7.2  |                 
|Other noncurrent liabilities |  |                 | 7.2  |                 
|                             |  |                 |      |                 
|                             |  | $               | 16.7 |                 
|                             |  |                 |      |                 



9



---

SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



During the second quarter of 2002, the Company entered into another interest rate swap agreement that
has the effect of reestablishing as floating rate debt the debt previously converted to fixed rate debt through December 2006. This interest rate swap agreement was not designated for hedge accounting and, accordingly, changes in the fair value are
recorded in interest expense. As a result of the change in fair market value, $(2.9) million and $4.3 million was recorded as a reduction of interest expense for the three and nine months ended August 31, 2003, respectively, and $7.6 million and
$7.1 million was recorded as a reduction of interest expense for the three and nine months ended September 1, 2002. At August 31, 2003 and December 1, 2002, the fair value carrying amount of this instrument was $7.5 million and $7.8 million with
$5.6 million and $5.1 million recorded in prepaid expense and other current assets and $1.9 million and $2.7 million recorded in noncurrent assets, respectively.



At August 31, 2003 and December 1, 2002, accumulated other comprehensive loss associated with the interest rate swaps was
$(6.2) million and $(10.9) million, respectively. During the second quarter of 2003, the Company wrote off $2.0 million of previously deferred derivative losses recorded in accumulated other comprehensive loss associated with the early
extinguishment of debt. See Notes 6 and 7.



To protect against
the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, the Company has instituted a forecasted cash flow hedging program. The Company hedges portions of its purchases denominated in foreign
currencies with forward and option contracts. At August 31, 2003, the Company had forward contracts to sell a total of 19.0 million Mexican pesos and 1.1 million Canadian dollars with expiration dates ranging from September 10, 2003 to February 20,
2004, respectively.



Note 10:Net Income
Per Common Share



The following table sets
forth the computation of basic and diluted earnings per share (in thousands) for the three and nine months ended August 31, 2003 and September 1, 2002:



|                                                                                                    |  | Three months ended |        | Nine months ended |  
|--------------------------------------------------------------------------------------------------- |  | ------------------ | ------ | ----------------- | -
|                                                                                                    |  | August 31, 2003    |        | September 1, 2002 |  
|Numerator:                                                                                          |  |                    |        |                   |  
|Net income                                                                                          |  | $                  | 8,697  |                   | $
|Liquidation preference for common L & M shares                                                      |  |                    | 5,114  |                   |  
|                                                                                                    |  |                    |        |                   |  
|Net income (loss) available to common shareholders                                                  |  | $                  | 3,583  |                   | $
|                                                                                                    |  |                    |        |                   |  
|Denominator:                                                                                        |  |                    |        |                   |  
|Denominator for basic earnings per shareweighted average shares                                    |  |                    | 31,189 |                   |  
|Effect of dilutive securities:                                                                      |  |                    |        |                   |  
|Stock options                                                                                       |  |                    | 22     |                   |  
|                                                                                                    |  |                    |        |                   |  
|Denominator for diluted earnings per shareadjusted weighted-average shares and assumed conversions |  |                    | 31,211 |                   |  
|                                                                                                    |  |                    |        |                   |  

---

|* |  | The dilutive securities are antidilutive for the the nine months ended September 1, 2002.
|- |  | -----------------------------------------------------------------------------------------



10



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SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



Note 11:Comprehensive Income



Total comprehensive income for the three and nine months ended August 31,
2003 was $4.9 million and $30.4 million and for the three and nine months ended September 1, 2002 was $8.8 million and $9.0 million, respectively.



Activity in Stockholders Equity (Deficit) is as follows (dollar amounts in thousands):



|                                                                                       |  | Comprehensive Income |        | Common Stock |   | Additional Paid-in Capital |  | Accumulated Deficit |         |  | Treasury Stock |          |   | Accumulated Other Comprehensive Loss |   |         | Total | 
|-------------------------------------------------------------------------------------- |  | -------------------- | ------ | ------------ | - | -------------------------- |  | ------------------- | ------- |  | -------------- | -------- | - | ------------------------------------ | - | ------- | ----- | 
|Balances at December 1, 2002                                                           |  |                      |        |              | $ | 321                        |  | $                   | 146,140 |  | $              | (219,766 | ) |                                      | $ | (13,064 | )     | 
|Comprehensive income (loss):                                                           |  |                      |        |              |   |                            |  |                     |         |  |                |          |   |                                      |   |         |       | 
|Net income for the nine months ended August 31, 2003                                   |  | $                    | 16,772 |              |   |                           |  |                     |        |  |                | 16,772   |   |                                      |   |        |       | 
|Exercise of stock options                                                              |  |                      |       |              |   | 2                          |  |                     | 86      |  |                |         |   |                                      |   |        |       | 
|Amortization of dedesignated cash flow hedge                                           |  |                      | 2,655  |              |   |                           |  |                     |        |  |                |         |   |                                      |   |        |       | 
|Write-off of dedesignated cash flow hedge associated with early extinguishment of debt |  |                      | 2,010  |              |   |                           |  |                     |        |  |                |         |   |                                      |   |        |       | 
|Foreign currency translation adjustment                                                |  |                      | 8,914  |              |   |                           |  |                     |        |  |                |         |   |                                      |   |        |       | 
|                                                                                       |  |                      |        |              |   |                            |  |                     |         |  |                |          |   |                                      |   |         |       | 
|Balances at August 31, 2003                                                            |  | $                    | 30,351 |              | $ | 323                        |  | $                   | 146,226 |  | $              | (202,994 | ) |                                      | $ | (13,064 | )     | 
|                                                                                       |  |                      |        |              |   |                            |  |                     |         |  |                |          |   |                                      |   |         |       | 



Note
12:Contingencies



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



The Company is currently conducting an environmental cleanup at a formerly owned facility in South Brunswick, New Jersey pursuant to the New Jersey
Industrial Site Recovery Act. The Company and one of its subsidiaries are parties to an Administrative Consent Order issued by the New Jersey Department of Environmental Protection. Pursuant to that order, the Company and its subsidiary agreed to
conduct soil and groundwater remediation at the property. The Company does not believe that its manufacturing processes were the source of contamination. The Company sold the property in 1997. The Company and its subsidiary retained primary
responsibility for the required remediation. The Company has completed essentially all soil remediation with the New Jersey Department of Environmental Protection approval, and has concluded a pilot test of the groundwater remediation system. The
Company is working with the New Jersey Department of Environmental Protection to develop a remediation plan for the sediment in Oakeys Brook adjoining the site.



The Company is also remediating soil and groundwater contamination at an inactive facility located in Oakville, Connecticut. Although the Company is
conducting the remediation voluntarily, it obtained Connecticut Department of Environmental Protection approval of the remediation plan. The Company has completed essentially all soil remediation under the remediation plan and is currently
monitoring groundwater at the site. The Company believes the contamination is attributable to the manufacturing operations of previous unaffiliated occupants of the facility.



11



---

SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



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



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



Note 13:Related Party Transactions



The Company previously contributed cash and other assets to Mattress
Holdings International LLC (MHI), a company which was controlled by the Companys largest stockholder, Bain Capital LLC, in exchange for a non-voting interest. MHI was formed to invest in domestic and international loans, advances
and investments in joint ventures, licensees and retailers. The equity ownership of MHI was transferred from Bain to the Company in November 2002. In 1999, MHI acquired a minority interest in Malachi Mattress America, Inc. (Malachi), a
domestic mattress retailer, and indirectly through a Bain controlled holding company acquired a minority interest in Mattress Holdings Corporation (MHC). MHC owns an interest in Mattress Discounters Corporation, a domestic mattress retailer and sold
all of its equity interest in an international bedding retailer, previously an affiliate of Sealy, on April 15, 2003.



In October 2002, Mattress Discounters Corporation filed a voluntary joint petition with the U.S. Bankruptcy Court for the District of Maryland for
reorganization under Chapter 11 of the U.S. Bankruptcy Code and was operating as a debtor in possession under the Bankruptcy Code. Effective March 14, 2003, Mattress Discounters emerged from bankruptcy. At the time Mattress Discounters filed for
bankruptcy protection, the Company had recorded in its financial statements a $12.5 million participation in Mattress Discounters banking facility and $16.0 million in trade receivables. The Company had fully-reserved the trade receivables. As
part of the approved bankruptcy settlement, the Company received a non-controlling minority interest in Mattress Discounters and a $12.9 million secured note, guaranteed by MHC. Other entities affiliated with Bain Capital LLC also received a
minority interest in Mattress Discounters. During the bankruptcy period, Mattress Discounters exited four markets. The majority of the stores in the exited markets were acquired by other current Sealy customers. The Company and Mattress Discounters
also amended the existing long-term supply agreement to remove a requirement for Sealy to be Mattress Discounters exclusive supplier. The Company does not believe that any sales reductions, as a result of the amended supply agreement or the
markets exited, will have a material adverse effect on the Company. The Company had sales to Mattress Discounters of $6.6 million and $21.6 million for the three and nine months ended August 31, 2003 and $18.1 million and $56.8 million for the three
and nine months ended September 1, 2002, respectively, which are shown in the statement of operations as sales to affiliates. At August 31, 2003, the Company had $2.7 million of trade receivables from Mattress Discounters. Since emerging from
bankruptcy, Mattress Discounters has generally been paying within stated terms. Concurrent with the previously mentioned sale of the international bedding retailer by MHC, Sealy consummated the sale to MHC of the $12.9 million note and the equity
interest that Sealy received in the Mattress Discounters bankruptcy, as well as MHIs equity interest in MHC for $13.6 million. As a result of these transactions, the Company no longer has any direct interest in Mattress Discounters other than
trade receivables in the normal course of business.



12



---

SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



In October 2002, MHI acquired substantially all of the remaining interest in Malachi. Concurrent with
the acquisition, MHI sold 100% of its interest in Malachi to an independent third party, canceled $21.7 million in trade receivables, all of which were fully reserved, received a $17.5 million long-term note with an estimated fair value of $8.8
million, due and payable in 2009, and Malachis name was changed to Mattress Firm, Inc (MFI). MHI also loaned Mattress Firm, Inc. $3.3 million secured by all of its assets. Both the note and the loan are recorded in Long-term notes receivable
in the balance sheet. The Companys net exposure (including trade receivables) at August 31, 2003 and December 1, 2002 was $24.4 million and $19.5 million, respectively. The Company believes that the operating performance of Mattress Firm, Inc.
has improved in 2003 compared to 2002. In addition, the current owners, at the time of the transaction, made additional cash infusions in the business which improved its overall capital structure. The Company has been receiving timely payments on
its outstanding receivables assumed by MFI. Based on this, the Company believes that it has adequate reserves against its current exposure. The Company will, however, continue to monitor this business to determine whether reserve levels are
appropriate. Concurrent with the transactions, the Company entered into a new long-term, non-exclusive supply agreement with Mattress Firm, Inc. through November 1, 2008 which replaced an exclusive supply agreement. The Company does not expect that
any sales reduction as a result of the amended supply agreement will have a material adverse effect on the Company. As a result of the transactions previously described, MFI is no longer an affiliate of Bain Capital LLC or Sealy and sales since the
date of the transactions are shown in the statement of operations as sales to non-affiliates. The Company also had sales to Malachi of $17.9 million and $52.3 million for the three and nine months ended September 1, 2002 which is included in the
statement of operations as sales to affiliates.



As previously
mentioned, MHC sold its interest in an international bedding retailer on April 15, 2003. Consequently, this retailer is no longer an affiliate of Sealy. Prior to the transaction, sales to this retailer were included in sales to affiliates in the
statement of operations. Such affiliate sales were $4.0 million for the nine months ended August 31, 2003, and $2.5 million and $8.7 million for the three and nine months ended September 1, 2002, respectively. Sales to this retailer after April 15,
2003 have been included in sales to non-affiliates in the statement of operations.



The Company believes that the terms on which mattresses were supplied to these affiliates were not materially more or less favorable than those that might reasonably be obtained in a comparable transaction on an
arms length basis from a person that is not an affiliate or related party.



Note 14:Stock Option and Restricted Stock Plans



As permitted by FAS 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. FAS No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure an Amendment of FASB Statement No. 123 does however require interim 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 as an expense over the options vesting period.



The Company recognized no compensation expense in the
financial statements for the three and nine months ended August 31, 2003 and September 1, 2002 as all options were granted at or above the fair market value of the stock at the date of grant.



13



---

SEALY CORPORATION



Notes To Consolidated Financial Statements(Continued)



|                                                                                                                            |  | Three months ended                    |       | Nine months ended
|--------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- | ----- | -----------------
|                                                                                                                            |  | August 31, 2003                       |       | September 1, 2002
|                                                                                                                            |  | (In thousands, except per share data)
|Net income, as reported                                                                                                     |  | $                                     | 8,697 |                  
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of
tax |  |                                       | 112   |                  
|                                                                                                                            |  |                                       |       |                  
|Pro forma net income                                                                                                        |  | $                                     | 8,585 |                  
|                                                                                                                            |  |                                       |       |                  
|Earnings per share:                                                                                                         |  |                                       |       |                  
|Basicas reported                                                                                                           |  | $                                     | 0.28  |                  
|Basicpro forma                                                                                                             |  |                                       | 0.28  |                  
|                                                                                                                            |  |                                       |       |                  
|Dilutedas reported                                                                                                         |  |                                       | 0.28  |                  
|Dilutedpro forma                                                                                                           |  |                                       | 0.28  |                  



Note
15:Segment Information



The Company operates predominately in one industry segment, that being the manufacture and marketing of conventional bedding.



Note 16:Guarantor/Non-Guarantor Financial Information



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 Senior Subordinated and Senior Subordinated Discount Notes (collectively, the Notes) of Sealy Mattress Company (the Issuer). Substantially all of the
Issuers operating income and cash flow is generated by its subsidiaries. As a result, funds necessary to meet the Issuers debt service obligations are provided in part by distributions or advances from its subsidiaries. Under certain
circumstances, contractual and legal restrictions, as well as the financial condition and operating requirements of the Issuers subsidiaries, could limit the Issuers ability to obtain cash from its subsidiaries for the purpose of meeting
its debt service obligations, including the payment of principal and interest on the 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.



The following supplemental consolidating condensed financial statements present:



| | 1. |  | Consolidating condensed balance sheets as of August 31, 2003 and December 1, 2002 and consolidating condensed statements of operations for the three months ended August 31, 2003 and
September 1, 2002 and the consolidating condensed statements of operations and cash flows for the nine months ended August 31, 2003 and September 1, 2002.
| | -- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 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.
| | -- |  | ------------------------------------------------------------------------------------



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



14



---

SEALY CORPORATION



Supplemental Consolidating Condensed Balance Sheet

August 31, 2003

(in thousands)



|                                                          |  | Sealy Corporation |         |   | Sealy Mattress Company |   |         | Combined Guarantor Subsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |         |   | Consolidated |  
|--------------------------------------------------------- |  | ----------------- | ------- | - | ---------------------- | - | ------- | ------------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------- | - | ------------ | -
|ASSETS                                                    |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Current assets:                                           |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Cash and cash equivalents                                 |  | $                 |        |   |                        | $ | 31      |                                 |  | $ | 39,699                              |   |  | $            | 5,273   |   |              | $
|Accounts receivableNon-affiliates, net                   |  |                   | 13      |   |                        |   | 20      |                                 |  |   | 144,962                             |   |  |              | 52,960  |   |              |  
|Accounts receivableAffiliates, net                       |  |                   |        |   |                        |   |        |                                 |  |   | 2,721                               |   |  |              |        |   |              |  
|Inventories                                               |  |                   |        |   |                        |   | 1,601   |                                 |  |   | 38,475                              |   |  |              | 16,293  |   |              |  
|Prepaid expenses, deferred taxes and other current assets |  |                   | (97     | ) |                        |   | 6,052   |                                 |  |   | 27,314                              |   |  |              | 11,071  |   |              |  
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|                                                          |  |                   | (84     | ) |                        |   | 7,704   |                                 |  |   | 253,171                             |   |  |              | 85,597  |   |              |  
|Property, plant and equipment, at cost                    |  |                   |        |   |                        |   | 6,314   |                                 |  |   | 230,304                             |   |  |              | 57,986  |   |              |  
|Less: accumulated depreciation                            |  |                   |        |   |                        |   | (3,286  | )                               |  |   | (107,107                            | ) |  |              | (12,217 | ) |              |  
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|                                                          |  |                   |        |   |                        |   | 3,028   |                                 |  |   | 123,197                             |   |  |              | 45,769  |   |              |  
|Other assets:                                             |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Goodwill                                                  |  |                   |        |   |                        |   | 14,816  |                                 |  |   | 314,698                             |   |  |              | 50,463  |   |              |  
|Other intangibles, net                                    |  |                   |        |   |                        |   |        |                                 |  |   | 3,472                               |   |  |              | 1,330   |   |              |  
|Net investment in and advances to (from) subsidiaries     |  |                   | (28,702 | ) |                        |   | 606,921 |                                 |  |   | (356,135                            | ) |  |              | (93,787 | ) |              |  
|Long-term notes receivable                                |  |                   |        |   |                        |   |        |                                 |  |   |                                    |   |  |              | 12,022  |   |              |  
|Debt issuance costs, net and other assets                 |  |                   | 96      |   |                        |   | 19,575  |                                 |  |   | 8,734                               |   |  |              | 2,423   |   |              |  
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|                                                          |  |                   | (28,606 | ) |                        |   | 641,312 |                                 |  |   | (29,231                             | ) |  |              | (27,549 | ) |              |  
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Total assets                                              |  | $                 | (28,690 | ) |                        | $ | 652,044 |                                 |  | $ | 347,137                             |   |  | $            | 103,817 |   |              | $
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)            |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Current liabilities:                                      |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Current portion of long-term obligations                  |  | $                 |        |   |                        | $ | 19,081  |                                 |  | $ | 4                                   |   |  | $            | 4,177   |   |              | $
|Accounts payable                                          |  |                   |        |   |                        |   | 235     |                                 |  |   | 66,102                              |   |  |              | 32,220  |   |              |  
|Accrued interest                                          |  |                   | 329     |   |                        |   | 582     |                                 |  |   | 10,909                              |   |  |              | 369     |   |              |  
|Accrued incentives and advertising                        |  |                   |        |   |                        |   | 1,617   |                                 |  |   | 35,123                              |   |  |              | 5,488   |   |              |  
|Accrued compensation                                      |  |                   |        |   |                        |   | 211     |                                 |  |   | 15,514                              |   |  |              | 5,035   |   |              |  
|Other accrued expenses                                    |  |                   | 149     |   |                        |   | 8,552   |                                 |  |   | 28,676                              |   |  |              | 6,527   |   |              |  
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|                                                          |  |                   | 478     |   |                        |   | 30,278  |                                 |  |   | 156,328                             |   |  |              | 53,816  |   |              |  
|Long-term obligations, net                                |  |                   | 49,442  |   |                        |   | 671,049 |                                 |  |   | 63                                  |   |  |              | 1,545   |   |              |  
|Other noncurrent liabilities                              |  |                   | 7,169   |   |                        |   | 7,193   |                                 |  |   | 27,130                              |   |  |              | 5,474   |   |              |  
|Deferred income taxes                                     |  |                   | (478    | ) |                        |   | 679     |                                 |  |   | 12,663                              |   |  |              | 8,483   |   |              |  
|Stockholders equity (deficit)                            |  |                   | (85,301 | ) |                        |   | (57,155 | )                               |  |   | 150,953                             |   |  |              | 34,499  |   |              |  
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  
|Total liabilities and stockholders equity (deficit)      |  | $                 | (28,690 | ) |                        | $ | 652,044 |                                 |  | $ | 347,137                             |   |  | $            | 103,817 |   |              | $
|                                                          |  |                   |         |   |                        |   |         |                                 |  |   |                                     |   |  |              |         |   |              |  



15



---

SEALY CORPORATION



Supplemental Consolidating Condensed Balance Sheet

December 1, 2002

(in thousands)



|                                                          |  | SealyCorporation |          |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Consolidated Non-Guarantor Subsidiaries |   |  | Eliminations |          |   | Consolidated |  
|--------------------------------------------------------- |  | ---------------- | -------- | - | -------------------- | - | ------- | ----------------------------- |  | - | --------------------------------------- | - |  | ------------ | -------- | - | ------------ | -
|ASSETS                                                    |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Current assets:                                           |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Cash and cash equivalents                                 |  | $                |         |   |                      | $ | 28      |                               |  | $ | 21,881                                  |   |  | $            | 5,534    |   |              | $
|Accounts receivableNon-affiliates, net                   |  |                  | 11       |   |                      |   | 16      |                               |  |   | 115,141                                 |   |  |              | 49,574   |   |              |  
|Accounts receivableAffiliates, net                       |  |                  |         |   |                      |   |        |                               |  |   | 420                                     |   |  |              | 3,333    |   |              |  
|Inventories                                               |  |                  |         |   |                      |   | 1,501   |                               |  |   | 36,377                                  |   |  |              | 15,509   |   |              |  
|Prepaid expenses, deferred taxes and other current assets |  |                  | (97      | ) |                      |   | 5,557   |                               |  |   | 29,490                                  |   |  |              | 7,748    |   |              |  
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|                                                          |  |                  | (86      | ) |                      |   | 7,102   |                               |  |   | 203,309                                 |   |  |              | 81,698   |   |              |  
|Property, plant and equipment, at cost                    |  |                  |         |   |                      |   | 5,398   |                               |  |   | 223,526                                 |   |  |              | 51,702   |   |              |  
|Less accumulated depreciation                             |  |                  |         |   |                      |   | (2,517  | )                             |  |   | (95,568                                 | ) |  |              | (8,616   | ) |              |  
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|                                                          |  |                  |         |   |                      |   | 2,881   |                               |  |   | 127,958                                 |   |  |              | 43,086   |   |              |  
|Other assets:                                             |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Goodwill                                                  |  |                  |         |   |                      |   | 14,816  |                               |  |   | 314,698                                 |   |  |              | 45,432   |   |              |  
|Other intangibles, net                                    |  |                  |         |   |                      |   |        |                               |  |   | 3,689                                   |   |  |              | 1,389    |   |              |  
|Net investment in and advances to (from) subsidiaries     |  |                  | (65,254  | ) |                      |   | 590,852 |                               |  |   | (359,727                                | ) |  |              | (110,986 | ) |              |  
|Investment in and advances to affiliates                  |  |                  |         |   |                      |   |        |                               |  |   |                                        |   |  |              | 12,950   |   |              |  
|Long-term notes receivable                                |  |                  |         |   |                      |   |        |                               |  |   |                                        |   |  |              | 12,022   |   |              |  
|Debt issuance costs, net and other assets                 |  |                  | 106      |   |                      |   | 22,318  |                               |  |   | 8,954                                   |   |  |              | 2,626    |   |              |  
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|                                                          |  |                  | (65,148  | ) |                      |   | 627,986 |                               |  |   | (32,386                                 | ) |  |              | (36,567  | ) |              |  
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Total assets                                              |  | $                | (65,234  | ) |                      | $ | 637,969 |                               |  | $ | 298,881                                 |   |  | $            | 88,217   |   |              | $
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|LIABILITIES AND STOCKHOLDERS (DEFICIT) EQUITY            |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Current liabilities:                                      |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Current portion of long-term obligations                  |  | $                |         |   |                      | $ | 29,437  |                               |  | $ |                                        |   |  | $            | 3,901    |   |              | $
|Accounts payable                                          |  |                  |         |   |                      |   | 229     |                               |  |   | 38,481                                  |   |  |              | 30,380   |   |              |  
|Accrued interest                                          |  |                  |         |   |                      |   | 1,764   |                               |  |   | 12,246                                  |   |  |              | 253      |   |              |  
|Accrued incentives and advertising                        |  |                  |         |   |                      |   | 1,059   |                               |  |   | 35,468                                  |   |  |              | 5,003    |   |              |  
|Accrued compensation                                      |  |                  |          |   |                      |   | 144     |                               |  |   | 19,589                                  |   |  |              | 4,749    |   |              |  
|Other accrued expenses                                    |  |                  | 51       |   |                      |   | 10,224  |                               |  |   | 25,238                                  |   |  |              | 7,984    |   |              |  
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|                                                          |  |                  | 51       |   |                      |   | 42,857  |                               |  |   | 131,022                                 |   |  |              | 52,270   |   |              |  
|Long-term obligations, net                                |  |                  | 45,246   |   |                      |   | 672,340 |                               |  |   | 63                                      |   |  |              | 2,247    |   |              |  
|Other noncurrent liabilities                              |  |                  | 5,687    |   |                      |   | 10,442  |                               |  |   | 25,593                                  |   |  |              | 5,083    |   |              |  
|Deferred income taxes                                     |  |                  | (478     | ) |                      |   | 679     |                               |  |   | 19,582                                  |   |  |              | 8,004    |   |              |  
|Stockholders (deficit) equity                            |  |                  | (115,740 | ) |                      |   | (88,349 | )                             |  |   | 122,621                                 |   |  |              | 20,613   |   |              |  
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  
|Total liabilities and stockholders (deficit) equity      |  | $                | (65,234  | ) |                      | $ | 637,969 |                               |  | $ | 298,881                                 |   |  | $            | 88,217   |   |              | $
|                                                          |  |                  |          |   |                      |   |         |                               |  |   |                                         |   |  |              |          |   |              |  



16



---

SEALY CORPORATION



Supplemental Consolidated Condensed Statements of Operations

Three Months Ended August 31, 2003

(in thousands)



|                                                    |  | SealyCorporation |        |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |        |   | Consolidated |  
|--------------------------------------------------- |  | ---------------- | ------ | - | -------------------- | - | ------- | ----------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------ | - | ------------ | -
|Net salesNon-affiliates                            |  | $                |       |   |                      | $ | 13,687  |                               |  | $ | 248,354                             |   |  | $            | 60,479 |   |              | $
|Net salesAffiliates                                |  |                  |       |   |                      |   |        |                               |  |   | 6,615                               |   |  |              |       |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Total net sales                                     |  |                  |       |   |                      |   | 13,687  |                               |  |   | 254,969                             |   |  |              | 60,479 |   |              |  
|Costs and expenses:                                 |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Cost of goods sold Non-affiliates                  |  |                  |       |   |                      |   | 9,267   |                               |  |   | 142,125                             |   |  |              | 37,972 |   |              |  
|Cost of goods sold Affiliates                      |  |                  |       |   |                      |   |        |                               |  |   | 3,797                               |   |  |              |       |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Total cost of goods sold                            |  |                  |       |   |                      |   | 9,267   |                               |  |   | 145,922                             |   |  |              | 37,972 |   |              |  
|Gross profit                                        |  |                  |       |   |                      |   | 4,420   |                               |  |   | 109,047                             |   |  |              | 22,507 |   |              |  
|Selling, general and administrative                 |  |                  | 38     |   |                      |   | 3,954   |                               |  |   | 84,200                              |   |  |              | 17,425 |   |              |  
|Stock based compensation                            |  |                  | 492    |   |                      |   |        |                               |  |   |                                    |   |  |              |       |   |              |  
|Amortization of intangibles                         |  |                  |       |   |                      |   |         |                               |  |   | 72                                  |   |  |              | 215    |   |              |  
|Royalty income, net                                 |  |                  |       |   |                      |   |        |                               |  |   | (3,323                              | ) |  |              | 259    |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Income (Loss) from operations                       |  |                  | (530   | ) |                      |   | 466     |                               |  |   | 28,098                              |   |  |              | 4,608  |   |              |  
|Interest expense                                    |  |                  | 1,493  |   |                      |   | 15,809  |                               |  |   | 1                                   |   |  |              | 359    |   |              |  
|Other (income) expense, net                         |  |                  | 1      |   |                      |   |        |                               |  |   | (81                                 | ) |  |              | (166   | ) |              |  
|(Income) loss from equity investees                 |  |                  | (8,973 | ) |                      |   | (8,099  | )                             |  |   |                                    |   |  |              |       |   |              |  
|Loss (income) from nonguarantor equity investees    |  |                  |       |   |                      |   | 322     |                               |  |   | (2,274                              | ) |  |              |       |   |              |  
|Capital charge and intercompany interest allocation |  |                  | (1,531 | ) |                      |   | (17,376 | )                             |  |   | 17,940                              |   |  |              | 967    |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Income (loss) before income taxes                   |  |                  | 8,480  |   |                      |   | 9,810   |                               |  |   | 12,512                              |   |  |              | 3,448  |   |              |  
|Income tax (benefit) expense                        |  |                  | (217   | ) |                      |   | 837     |                               |  |   | 4,413                               |   |  |              | 1,496  |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Net income (loss)                                   |  | $                | 8,697  |   |                      | $ | 8,973   |                               |  | $ | 8,099                               |   |  | $            | 1,952  |   |              | $
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  



17



---

SEALY CORPORATION



Supplemental Consolidated Condensed Statements of Operations

Three Months Ended September 1, 2002

(in thousands)



|                                                    |  | SealyCorporation |        |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |        |   | Consolidated |  
|--------------------------------------------------- |  | ---------------- | ------ | - | -------------------- | - | ------- | ----------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------ | - | ------------ | -
|Net salesNon-affiliates                            |  | $                |       |   |                      | $ | 10,953  |                               |  | $ | 216,305                             |   |  | $            | 51,480 |   |              | $
|Net salesAffiliates                                |  |                  |       |   |                      |   |        |                               |  |   | 36,009                              |   |  |              | 2,533  |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Total net sales                                     |  |                  |       |   |                      |   | 10,953  |                               |  |   | 252,314                             |   |  |              | 54,013 |   |              |  
|Costs and expenses:                                 |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Cost of goods soldNon-affiliates                   |  |                  |       |   |                      |   | 7,472   |                               |  |   | 125,829                             |   |  |              | 31,245 |   |              |  
|Cost of goods sold Affiliates                      |  |                  |       |   |                      |   |        |                               |  |   | 19,418                              |   |  |              | 2,065  |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Total cost of goods sold                            |  |                  |       |   |                      |   | 7,472   |                               |  |   | 145,247                             |   |  |              | 33,310 |   |              |  
|Gross profit                                        |  |                  |       |   |                      |   | 3,481   |                               |  |   | 107,067                             |   |  |              | 20,703 |   |              |  
|Selling, general and administrative                 |  |                  | 45     |   |                      |   | 2,627   |                               |  |   | 79,349                              |   |  |              | 15,058 |   |              |  
|Stock based compensation                            |  |                  | 491    |   |                      |   |        |                               |  |   |                                    |   |  |              |       |   |              |  
|Amortization of intangibles                         |  |                  |       |   |                      |   |         |                               |  |   | 120                                 |   |  |              | 24     |   |              |  
|Royalty income, net                                 |  |                  |       |   |                      |   |        |                               |  |   | (3,089                              | ) |  |              | 189    |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Income (loss) from operations                       |  |                  | (536   | ) |                      |   | 854     |                               |  |   | 30,687                              |   |  |              | 5,432  |   |              |  
|Interest expense                                    |  |                  | 1,335  |   |                      |   | 14,981  |                               |  |   | 68                                  |   |  |              | 500    |   |              |  
|Other expense                                       |  |                  |       |   |                      |   |        |                               |  |   |                                    |   |  |              | (149   | ) |              |  
|(Income) loss from equity investees                 |  |                  | (8,534 | ) |                      |   | (9,386  | )                             |  |   |                                    |   |  |              |       |   |              |  
|Loss (income) from nonguarantor equity investees    |  |                  |       |   |                      |   | 792     |                               |  |   | (2,870                              | ) |  |              |       |   |              |  
|Capital charge and intercompany interest allocation |  |                  | (1,380 | ) |                      |   | (14,000 | )                             |  |   | 14,466                              |   |  |              | 914    |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Income (loss) before income taxes                   |  |                  | 8,043  |   |                      |   | 8,467   |                               |  |   | 19,023                              |   |  |              | 4,167  |   |              |  
|Income tax expense (benefit)                        |  |                  | (311   | ) |                      |   | (67     | )                             |  |   | 9,637                               |   |  |              | 2,089  |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  
|Net income (loss)                                   |  | $                | 8,354  |   |                      | $ | 8,534   |                               |  | $ | 9,386                               |   |  | $            | 2,078  |   |              | $
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |        |   |              |  



18



---

SEALY CORPORATION



Supplemental Consolidating Condensed Statements of Operations

Nine Months Ended August 31, 2003

(in thousands)



|                                                    |  | SealyCorporation |         |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |         |   | Consolidated |  
|--------------------------------------------------- |  | ---------------- | ------- | - | -------------------- | - | ------- | ----------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------- | - | ------------ | -
|Net salesNon-affiliates                            |  | $                |        |   |                      | $ | 39,721  |                               |  | $ | 665,404                             |   |  | $            | 164,295 |   |              | $
|Net salesAffiliates                                |  |                  |        |   |                      |   |        |                               |  |   | 21,636                              |   |  |              | 4,044   |   |              |  
|                                                    |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Total net sales                                     |  |                  |        |   |                      |   | 39,721  |                               |  |   | 687,040                             |   |  |              | 168,339 |   |              |  
|Costs and expenses:                                 |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Cost of goods soldNon-affiliates                   |  |                  |        |   |                      |   | 27,314  |                               |  |   | 382,349                             |   |  |              | 103,600 |   |              |  
|Cost of goods sold Affiliates                      |  |                  |        |   |                      |   |        |                               |  |   | 12,419                              |   |  |              | 2,662   |   |              |  
|                                                    |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Total cost of goods sold                            |  |                  |        |   |                      |   | 27,314  |                               |  |   | 394,768                             |   |  |              | 106,262 |   |              |  
|Gross profit                                        |  |                  |        |   |                      |   | 12,407  |                               |  |   | 292,272                             |   |  |              | 62,077  |   |              |  
|Selling, general and administrative                 |  |                  | 113     |   |                      |   | 11,721  |                               |  |   | 228,483                             |   |  |              | 50,673  |   |              |  
|Stock based compensation                            |  |                  | 1,482   |   |                      |   |        |                               |  |   |                                    |   |  |              |        |   |              |  
|Amortization of intangibles                         |  |                  |        |   |                      |   |        |                               |  |   | 217                                 |   |  |              | 603     |   |              |  
|Royalty income, net                                 |  |                  |        |   |                      |   |        |                               |  |   | (9,349                              | ) |  |              | 724     |   |              |  
|                                                    |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Income (loss) from operations                       |  |                  | (1,595  | ) |                      |   | 686     |                               |  |   | 72,921                              |   |  |              | 10,077  |   |              |  
|Interest expense                                    |  |                  | 4,356   |   |                      |   | 46,134  |                               |  |   | 5                                   |   |  |              | 1,119   |   |              |  
|Other (income) expense                              |  |                  |        |   |                      |   | 2,531   |                               |  |   | (300                                | ) |  |              | (976    | ) |              |  
|Loss (income) from equity investees                 |  |                  | (17,623 | ) |                      |   | (19,543 | )                             |  |   |                                    |   |  |              |        |   |              |  
|Loss (income) from nonguarantor equity investees    |  |                  |        |   |                      |   | 834     |                               |  |   | (4,920                              | ) |  |              |        |   |              |  
|Capital charge and intercompany interest allocation |  |                  | (4,469  | ) |                      |   | (46,087 | )                             |  |   | 47,740                              |   |  |              | 2,816   |   |              |  
|                                                    |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Income (loss) before income taxes                   |  |                  | 16,141  |   |                      |   | 16,817  |                               |  |   | 30,396                              |   |  |              | 7,118   |   |              |  
|Income tax (benefit) expense                        |  |                  | (631    | ) |                      |   | (806    | )                             |  |   | 10,853                              |   |  |              | 3,032   |   |              |  
|                                                    |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Net income (loss)                                   |  | $                | 16,772  |   |                      | $ | 17,623  |                               |  | $ | 19,543                              |   |  | $            | 4,086   |   |              | $
|                                                    |  |                  |         |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  



19



---

SEALY CORPORATION



Supplemental Consolidating Condensed Statements of Operations

Nine Months Ended September 1, 2002

(in thousands)



|                                                    |  | SealyCorporation |        |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |         |   | Consolidated |  
|--------------------------------------------------- |  | ---------------- | ------ | - | -------------------- | - | ------- | ----------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------- | - | ------------ | -
|Net salesNon-affiliates                            |  | $                |       |   |                      | $ | 34,727  |                               |  | $ | 617,028                             |   |  | $            | 144,111 |   |              | $
|Net salesAffiliates                                |  |                  |       |   |                      |   |        |                               |  |   | 109,170                             |   |  |              | 8,670   |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Total net sales                                     |  |                  |       |   |                      |   | 34,727  |                               |  |   | 726,198                             |   |  |              | 152,781 |   |              |  
|Costs and expenses:                                 |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Cost of goods soldNon-affiliates                   |  |                  |       |   |                      |   | 23,136  |                               |  |   | 348,917                             |   |  |              | 90,375  |   |              |  
|Cost of goods soldAffiliates                       |  |                  |       |   |                      |   |        |                               |  |   | 57,899                              |   |  |              | 5,872   |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Total cost of goods sold                            |  |                  |       |   |                      |   | 23,136  |                               |  |   | 406,816                             |   |  |              | 96,247  |   |              |  
|Gross profit                                        |  |                  |       |   |                      |   | 11,591  |                               |  |   | 319,382                             |   |  |              | 56,534  |   |              |  
|Selling, general and administrative                 |  |                  | 135    |   |                      |   | 8,249   |                               |  |   | 251,172                             |   |  |              | 50,880  |   |              |  
|Stock based compensation                            |  |                  | 1,719  |   |                      |   |        |                               |  |   |                                    |   |  |              |        |   |              |  
|Business closure charge                             |  |                  |       |   |                      |   |        |                               |  |   |                                    |   |  |              | 5,802   |   |              |  
|Amortization of intangibles                         |  |                  |       |   |                      |   |        |                               |  |   | 264                                 |   |  |              | 148     |   |              |  
|Royalty income, net                                 |  |                  |       |   |                      |   |        |                               |  |   | (9,076                              | ) |  |              | 578     |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Income (loss) from operations                       |  |                  | (1,854 | ) |                      |   | 3,342   |                               |  |   | 77,022                              |   |  |              | (874    | ) |              |  
|Interest expense                                    |  |                  | 4,033  |   |                      |   | 48,577  |                               |  |   | (631                                | ) |  |              | 2,395   |   |              |  
|Other expense                                       |  |                  |       |   |                      |   |        |                               |  |   | 12                                  |   |  |              | 3,427   |   |              |  
|Loss (income) from equity investees                 |  |                  | (9,137 | ) |                      |   | (245    | )                             |  |   |                                    |   |  |              |        |   |              |  
|Loss (income) from nonguarantor equity investees    |  |                  |       |   |                      |   | (8,824  | )                             |  |   | 12,834                              |   |  |              |        |   |              |  
|Capital charge and intercompany interest allocation |  |                  | (4,168 | ) |                      |   | (45,395 | )                             |  |   | 46,807                              |   |  |              | 2,756   |   |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Income (loss) before income taxes                   |  |                  | 7,418  |   |                      |   | 9,229   |                               |  |   | 18,000                              |   |  |              | (9,452  | ) |              |  
|Income tax (benefit) expense                        |  |                  | (990   | ) |                      |   | 92      |                               |  |   | 17,755                              |   |  |              | (5,442  | ) |              |  
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  
|Net income (loss)                                   |  | $                | 8,408  |   |                      | $ | 9,137   |                               |  | $ | 245                                 |   |  | $            | (4,010  | ) |              | $
|                                                    |  |                  |        |   |                      |   |         |                               |  |   |                                     |   |  |              |         |   |              |  



20



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SEALY CORPORATION



Supplemental Consolidating Condensed Statements of Cash Flows

Nine Months Ended August 31, 2003

(in thousands)



|                                                                  |  | SealyCorporation |     |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |         | Consolidated | 
|----------------------------------------------------------------- |  | ---------------- | --- | - | -------------------- | - | ------- | ----------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------- | ------------ | 
|Net cash (used in) provided by operating activities               |  | $                |    |   |                      | $ | (2,388  | )                             |  | $ | 23,004                              |   |  | $            | 8,698   |              | 
|                                                                  |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Cash flows from investing activities:                             |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Purchase of property, plant and equipment, net                    |  |                  |    |   |                      |   | (224    | )                             |  |   | (8,074                              | ) |  |              | (1,039  | )            | 
|Cash received from affiliate note and investment                  |  |                  |    |   |                      |   |        |                               |  |   |                                    |   |  |              | 13,611  |              | 
|Net activity in investment in and advances to (from) subsidiaries |  |                  | (88 | ) |                      |   | 18,308  |                               |  |   | 2,901                               |   |  |              | (21,121 | )            | 
|                                                                  |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Net proceeds provided by (used in) investing activities           |  |                  | (88 | ) |                      |   | 18,084  |                               |  |   | (5,173                              | ) |  |              | (8,549  | )            | 
|                                                                  |  |                  |     |   |                      |  
|Cash flows from financing activities:                             |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Proceeds from issuance of long-term obligations                   |  |                  |    |   |                      |   | 51,500  |                               |  |   |                                    |   |  |              |        |              | 
|Prepayment of Tranche debt                                        |  |                  |    |   |                      |   | (49,000 | )                             |  |   |                                    |   |  |              |        |              | 
|Repayment of long-term obligations, net                           |  |                  |    |   |                      |   | (14,333 | )                             |  |   | (13                                 | ) |  |              | (410    | )            | 
|Equity issuances                                                  |  |                  | 88  |   |                      |   |        |                               |  |   |                                    |   |  |              |        |              | 
|Debt issuance costs                                               |  |                  |    |   |                      |   | (3,860  | )                             |  |   |                                    |   |  |              |        |              | 
|                                                                  |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Net cash (used in) financing activities                           |  |                  | 88  |   |                      |   | (15,693 | )                             |  |   | (13                                 | ) |  |              | (410    | )            | 
|                                                                  |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Change in cash and cash equivalents                               |  |                  |    |   |                      |   | 3       |                               |  |   | 17,818                              |   |  |              | (261    | )            | 
|Cash and cash equivalents:                                        |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Beginning of period                                               |  |                  |    |   |                      |   | 28      |                               |  |   | 21,881                              |   |  |              | 5,534   |              | 
|                                                                  |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|End of period                                                     |  | $                |    |   |                      | $ | 31      |                               |  | $ | 39,699                              |   |  | $            | 5,273   |              | 
|                                                                  |  |                  |     |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 



21



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SEALY CORPORATION



Supplemental Consolidating Condensed Statements of Cash Flows

Nine Months Ended September 1, 2002

(in thousands)



|                                                                  |  | SealyCorporation |      |   | SealyMattressCompany |   |         | CombinedGuarantorSubsidiaries |  |   | Combined Non-Guarantor Subsidiaries |   |  | Eliminations |         | Consolidated | 
|----------------------------------------------------------------- |  | ---------------- | ---- | - | -------------------- | - | ------- | ----------------------------- |  | - | ----------------------------------- | - |  | ------------ | ------- | ------------ | 
|Net cash provided by operating activities                         |  | $                |     |   |                      | $ | 324     |                               |  | $ | 59,693                              |   |  | $            | 8,961   |              | 
|                                                                  |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Cash flows from investing activities:                             |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Purchase of property, plant and equipment, net                    |  |                  |     |   |                      |   | (136    | )                             |  |   | (8,627                              | ) |  |              | (2,745  | )            | 
|Purchase of businesses, net of cash acquired                      |  |                  |     |   |                      |   |        |                               |  |   |                                    |   |  |              | (1,636  | )            | 
|Restricted cash collateralizing outstanding letters of credit     |  |                  |     |   |                      |   |        |                               |  |   | (14,930                             | ) |  |              |        |              | 
|Advances to affiliate                                             |  |                  |     |   |                      |   |        |                               |  |   |                                    |   |  |              | (12,500 | )            | 
|Net activity in investment in and advances to (from) subsidiaries |  |                  | 369  |   |                      |   | 10,120  |                               |  |   | (19,672                             | ) |  |              | 9,183   |              | 
|                                                                  |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Net proceeds provided by (used in) investing activities           |  |                  | 369  |   |                      |   | 9,984   |                               |  |   | (43,229                             | ) |  |              | (7,698  | )            | 
|                                                                  |  |                  |      |   |                      |  
|Cash flows from financing activities:                             |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Treasury stock repurchase, including direct expenses              |  |                  | (801 | ) |                      |   |        |                               |  |   |                                    |   |  |              |        |              | 
|Repayment of long-term obligations, net                           |  |                  |     |   |                      |   | (9,704  | )                             |  |   | (64                                 | ) |  |              | (4,239  | )            | 
|Equity issuances                                                  |  |                  | 432  |   |                      |   |        |                               |  |   |                                    |   |  |              |        |              | 
|Purchase of interest rate cap                                     |  |                  |     |   |                      |   | (625    | )                             |  |   |                                    |   |  |              |        |              | 
|                                                                  |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Net cash used in financing activities                             |  |                  | (369 | ) |                      |   | (10,329 | )                             |  |   | (64                                 | ) |  |              | (4,239  | )            | 
|                                                                  |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Change in cash and cash equivalents                               |  |                  |     |   |                      |   | (21     | )                             |  |   | 16,400                              |   |  |              | (2,976  | )            | 
|Cash and cash equivalents:                                        |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|Beginning of period                                               |  |                  |     |   |                      |   | 55      |                               |  |   | 6,442                               |   |  |              | 5,513   |              | 
|                                                                  |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 
|End of period                                                     |  | $                |     |   |                      | $ | 34      |                               |  | $ | 22,842                              |   |  | $            | 2,537   |              | 
|                                                                  |  |                  |      |   |                      |   |         |                               |  |   |                                     |   |  |              |         |              | 



22



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SEALY CORPORATION



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



Quarter Ended August 31, 2003
compared with Quarter Ended September 1, 2002



Net
Sales.    Net sales for the quarter ended August 31, 2003, were $324.9 million, an increase of $11.3 million, or 3.6% from the quarter ended September 1, 2002. Total domestic sales were $262.7 million for the third quarter of
2003 compared to $257.6 million for the third quarter of 2002. Domestic sales increase of $5.1 million was attributable to a 4.1% increase in average unit selling price, partially offset by a 2.1% decrease in unit volume. The increase in average
unit selling price is due primarily to an improved sales mix from the Companys new Unicased Posturepedic design and lower promotional spending required to be recorded as a reduction of sales, partially offset by lower sales of other higher-end
products. The unit volume decrease was primarily attributable to lower sales to current and prior affiliates as they transition from single vendor to multi-vendor retailers, partially offset by increased floor sample sales with the roll out of the
new Posturepedic product. For the quarter ended August 31, 2003, sales to affiliates included sales to only one affiliate for the entire quarter, while sales to affiliates for the quarter ended September 1, 2002 included sales to three affiliates.
Total international sales were $62.2 million for the third quarter of 2003 compared to $56.0 for the third quarter of 2002. Growth of $6.2 million in the international operations was primarily attributable to sales growth in the European, Canadian,
Argentinean and Brazilian markets, partially offset by continued weakness in the Mexican market.



Cost of Goods Sold.    Cost of goods sold for the quarter, as a percentage of net sales, increased 0.1 percentage points to
58.2%. Cost of goods sold for the domestic business, as a percentage of net sales, decreased 0.4 percentage points to 57.0%. This decrease is primarily the result of decreased customer rebates and other promotional allowances under EITF 01-09,
Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendors Product, in the current quarter as compared to the 2002 third quarter. This decrease was partially offset by increased manufacturing costs
tied to the Companys roll out of the new Posturepedic line and a lower mix of other higher-end products which typically carry a higher margin than other products offered. Cost of goods sold for the international business, as a percentage of
net sales, increased 1.2 percentage points to 62.9%. This increase is primarily due to higher labor and fringe benefit costs in the European operations and higher material costs in Europe and Brazil, partially offset by lower material costs in the
Canadian and Argentinean businesses.



Selling, General, and
Administrative.    Selling, general, and administrative expenses increased $8.5 million to $105.6 million, or 32.5% of net sales, compared to $97.1 million, or 31.0% of net sales. This increase is primarily due to a $6.9
million increase in promotional and advertising costs primarily to support the Companys roll out of the new Posturepedic line and more of the Companys promotional spending for the quarter ended September 1, 2002 was required to be
recorded as a reduction of sales under EITF 01-09 as compared to the quarter ended August 31, 2003. The Company also had decreased bad debt expenses, partially offset by higher corporate overhead expenses.



Stock Based Compensation.    The Company has an
obligation to repurchase certain securities of the Company held by an officer at the greater of estimated fair market value or original cost. The Company recorded a $0.5 million charge during each of the quarters ended August 31, 2003 and September
1, 2002, respectively, to revalue this obligation to reflect an increase in the fair market value of the securities.



Interest Expense.    Interest expense increased $0.8 million primarily due to higher effective interest rates, partially offset
by lower average debt levels. In 2001, the Company entered into an interest rate swap agreement that effectively converted $236 million of its floating-rate debt to a fixed-rate basis through December 2006. In the second quarter of 2002, the Company
entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the debt previously converted to fixed rate debt through December 2006. The Company is required under its credit agreements to hedge at
least 50% of its floating rate term debt.



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Income Tax.    The Companys effective income tax rates in 2003 and 2002
differ from the Federal statutory rate principally because of the effect of certain foreign tax rate differentials, state and local income taxes and operating losses in 2002 from a prior equity investee for which no tax benefit had been recorded.
The Companys effective tax rate for the quarter ended August 31, 2003 is approximately 42.9% compared to 57.6% for quarter ended September 1, 2002.



Nine Months Ended August 31, 2003 compared with Nine Months Ended September 1, 2002



Net Sales.    Net sales for the nine months ended
August 31, 2003, were $883.0 million, a decrease of $22.1 million, or 2.4% from the nine months ended September 1, 2002. Total domestic sales were $710.3 million for the nine months of 2003 compared to $747.2 million for the nine months of 2002.
Domestic sales decline of $36.9 million was attributable to a 6.7% decrease in volume partially offset by a 2.0% increase in average unit selling price. This unit volume decrease was primarily due to lower sales to current and prior affiliates as
they transition from single vendor to multi-vendor retailers and a decrease in floor sample shipments primarily in the second quarter of 2003 as the Company was providing floor samples for the new Stearns & Foster roll-out in 2002, partially
offset by current year floor sample shipments related to the new Posturepedic design which commenced during the third quarter of 2003 and will continue until the end of the fiscal year. Additionally, year to date sales volumes have also been
negatively impacted by a general economic slow down during the first two quarters of the current year. The increase in average unit selling price is due primarily to an improved sales mix from both the Companys existing core Posturepedic line
and the new Posturepedic line, partially offset by lower sales of other higher-end product. For the nine months ended August 31, 2003, sales to affiliates included sales to one affiliate for the entire period and sales to a prior affiliate for
approximately four and half months, while sales to affiliates for the nine months ended September 1, 2002 included sales to three affiliates. Total international sales were $172.7 million for the nine months ended August 31, 2003 compared to $157.9
for the nine months ended September 1, 2002. Growth of $14.8 million in the international operations was primarily attributable to sales growth in the European, Canadian, Argentinean and Brazilian markets which has been partially offset by continued
weakness in the Mexican market.



Cost of Goods
Sold.    Cost of goods sold for the nine months ended August 31, 2003, as a percentage of net sales, increased 1.3 percentage points to 58.5%. Cost of goods sold for the domestic business, as a percentage of net sales,
increased 1.4 percentage points to 57.3%. This increase is primarily due to lower absorption of fixed costs due to lower unit sales, higher variable costs associated with increased workers compensation and health insurance costs, a lower mix of
higher-end products that typically carry a higher margin than other products, costs associated with the shutdown of the Taylor facility in December and manufacturing costs related to the roll out of the Companys new design for its Posturepedic
bedding line. Cost of goods sold for the international business, as a percentage of net sales remained flat at 63.2% year over year. For the nine months, the Company has seen lower material costs in the Canadian and European businesses, offset by
increased labor and fringe benefit costs in the European operations.



Selling, General, and Administrative.    Selling, general, and administrative expenses decreased $19.4 million to $291.0 million, or 33.0% of net sales, compared to $310.4 million or 34.3% of net sales. This
decrease is primarily due to a $22.1 million decrease in bad debt expense as the Company recorded specific bad debt charges in the second quarter of 2002 primarily associated with affiliated customers. The Company also had decreased promotional and
advertising costs, partially offset by higher corporate overhead expenses.



Stock Based Compensation.    The Company has an obligation to repurchase certain securities of the Company held by an officer at the greater of estimated fair market value or original cost.
The Company recorded a $1.5 million and $1.7 million charge for the nine months ended August 31, 2003 and September 1, 2002, respectively, to revalue this obligation to reflect an increase in the fair market value of the securities.



24



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Interest Expense.    Interest expense decreased $0.9 million due to lower
average debt levels, partially offset by higher effective interest rates. In 2001, the Company entered into an interest rate swap agreement that effectively converted $236 million of its floating-rate debt to a fixed-rate basis through December
2006. In the second quarter of 2002, the Company entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the debt previously converted to fixed rate debt through December 2006. The Company is
required under its credit agreements to hedge at least 50% of its floating rate term debt.



Income Tax.    The Companys effective income tax rates in 2003 and 2002 differ from the Federal statutory rate principally because of the effect of certain foreign tax rate
differentials, state and local income taxes and operating losses in 2002 from a prior equity investee for which no tax benefit had been recorded. The Companys effective tax rate for the nine months ended August 31, 2003 is approximately 42.6%
compared to 57.6% for the nine months ended September 1, 2002.



New Sealy Product Launch



The Company
annually invests significantly in research and development to improve its product offerings. In June 2003, the Company launched an entirely new line of mattresses and box springs for its Sealy Posturepedic brand. All Sealy Posturepedic brand
mattresses will be manufactured with UniCased Construction utilizing new proprietary processes and materials incorporated into a single-sided design. The Company incurred increased costs during the third quarter in the plant
manufacturing process and also increased promotional spending associated with the roll-out of the new product which cannot be fully quantified. The Company believes such costs are not expected to materially affect long-term operating trends and
margins.



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. Capital expenditures totaled $9.7 million for the nine months ended August 31, 2003. The Company expects 2003 capital expenditures to be approximately $17.0 million. Management believes that annual capital expenditure
limitations in its current debt agreements will not significantly inhibit the Company from meeting its ongoing capital needs. At August 31, 2003, the Company had approximately $34.5 million available under its Revolving Credit Facility including
Letters of Credit issued totaling approximately $15.5 million. The Companys net weighted average borrowing cost was 9.2% and 8.9% for the nine months ended August 31, 2003 and September 1, 2002, respectively. While effectively deferring
principal payments, the Companys average interest rate has been negatively impacted by the Companys prepayment of a portion of the Senior AXELs Credit Facility, bearing interest at approximately 3.25%, with proceeds from newly issued
senior subordinated notes bearing interest at 9.875%.



The
Companys cash flow from operations decreased $39.7 million from $69.0 million for the nine months ended September 1, 2002 to $29.3 million for the nine months ended August 31, 2003. This decrease in operating cash flows is primarily the result
of deterioration in operating margins, higher cash interest requirements and significant payments in the first quarter associated with incentive compensation that were not made in the first quarter of 2002. The Company also has experienced
difficulties in an accounts receivable system conversion in the fourth quarter of 2002 that negatively impacted collection efforts primarily through the first half of the year. These issues resulted principally in delays of processing of certain
transactions and the deterioration in the aging of trade receivables. As a result, the Company increased its allowance for doubtful accounts $6.1 million in the fourth quarter of 2002. In the second quarter of 2003, the Company reassessed the
progress of its collection efforts and determined an incremental $2.0 million reserve was necessary. The Company has increased the resources committed to this issue and believes processes are in place to provide for more control and stability in the
processing of receivable transactions and the cash collection process. During the third quarter, the Company has made significant progress in resolving the accounts receivable processing issue and has also seen accounts receivable aging statistics
improve. Although there can be no assurance, based on the rate of progress to date, the



25



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Company expects that the level of days sales outstanding in the accounts receivable will at least return to the levels prior to the system conversion
by the end of the fourth quarter. While the Company does not believe any further provisions for doubtful accounts are necessary, the Company will continue to monitor remedial actions to ensure that the allowance is adequate and to improve future
cash collections. The Companys failure to adequately resolve these issues could result in a material adverse affect to its liquidity and cash flow and future charges to earnings.



On October 9, 2003, the Company amended its Amended and Restated Credit Agreement dated November 8, 2002 to provide the
Company with the ability to repurchase up to $25 million of the outstandings of the Junior Subordinated Notes and to amend the requirements for allowing the Company to cash pay on the interest accrued. The Company was previously required to accrue
interest at 12% and add such interest to the total outstandings of the Notes. The Company will have the option within 10 days of the end of each calendar quarter to pay interest on the total outstandings for that quarter at a rate of 10% per annum.



As a result of declines in the value of the assets held in the
Companys defined benefit pension plan, the Company expects to record an additional minimum pension liability during the Companys fourth quarter ranging from $3 to $4 million. Recording the additional liability would require a non-cash
adjustment to accumulated other comprehensive income in stockholders deficit along with the creation of an intangible asset. Although the Company expects increased funding requirements in fiscal 2004 as a result of these declines, such
requirements will not have a material impact on the Companys overall liquidity position.



In the first quarter of 2002, the Company advanced $12.5 million to Mattress Discounters Corporation, an affiliate of the Company. As part of Mattress Discounters bankruptcy settlement in March 2003, the Company
received a non-controlling minority interest in Mattress Discounters and a $12.9 million secured note, guaranteed by Mattress Holdings Corporation (MHC), a company in which Sealy had a minority equity interest and was controlled by the Sealys
principal owners. In April 2003, the Company sold to MHC the $12.9 million note and the equity interest Sealy received in the Mattress Discounters bankruptcy, as well as the Companys equity interest in MHC for $13.6 million.



In May 2003, the Company completed a private placement of $50 million of
9.875% senior subordinated notes. These notes, which are due and payable on December 15, 2007 require semi-annual interest payments, commencing June 15, 2003. The proceeds from the placement were used to prepay all quarterly principal payments on
the Senior AXELs Credit Facility through March 2004. The Company will commence quarterly principal payments on June 15, 2004. Subsequent to the issuance, the Company registered the notes with the Securities and Exchange Commission to allow them to
be exchanged for publicly traded bonds. The Company commenced an exchange offer in June which was completed in July 2003. In connection with the note issuance, the Company incurred $2.6 million in debt financing costs, of which $2.3 million was paid
in the second quarter and $0.3 million was paid in the third. The Company also paid $1.2 million during the first quarter for previously accrued debt issuance costs associated with the refinancing of the Revolving Credit Facility in November 2002.



The Companys ability to make scheduled payments of
principal, or to pay the interest or liquidated damages, if any, on, or to refinance our indebtedness, or to fund planned capital expenditures will depend on the Companys future performance, which, to a certain extent, is subject to general
economic, financial, competitive, legislative, regulatory and other factors that are beyond control. Based upon the current level of operations and certain anticipated improvements, the Company believes that cash flow from operations and available
cash, together with available borrowings under the senior credit agreement, will be adequate to meet the future liquidity needs throughout 2003. The Companys long-term obligations contain various financial tests and covenants. The Company was
in compliance with such covenants as of the nine months ended August 31, 2003. The most restrictive covenants relate to ratios of adjusted EBITDA to interest coverage and total debt to adjusted EBITDA all as defined in the agreements. Those ratios
change under the agreement over time and are less restrictive in 2003 versus those at the end of 2002. The Company does not foresee an inability to meet such covenants in 2003. The Company will, however, need to refinance all or a portion of the
principal of the notes on



26



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or prior to maturity. In 1997, under the terms of the Companys Senior Subordinated Note Agreement the Company issued $128.0 million at a substantial
discount from their principal amount at maturity. From the date of issuance until December 15, 2002 no interest accrued or was paid. On December 16, 2002 the Company started accruing interest with payment to be made semi-annually in June and
December. Cash interest payments will increase approximately $13.3 million during 2003. However, management believes that the Company will have the necessary liquidity through cash flow from operations, and availability under the Revolving Credit
Facility through 2004 to fund its expected capital expenditures, obligations under its credit agreement and subordinated note indentures, environmental liabilities, and for other needs required to manage and operate its business. The Companys
scheduled principal payments on its borrowings will increase by approximately $25.6 million from 2003 to 2004. There can be no assurance that the Company will generate sufficient cash flow from operations, that anticipated revenue growth and
operating improvements will be realized or that future borrowings will be available under the senior credit agreements in an amount sufficient to enable the Company to service its indebtedness, including the notes, or to fund our other liquidity
needs. In addition, there can be no assurance that the Company will be able to effect any such refinancing on commercially reasonable terms or at all.



The Companys customers include furniture stores, national mass merchandisers, specialty sleep shops, department stores, contract customers and other
stores. In the future, these retailers may consolidate, undergo restructurings or reorganizations, or realign their affiliations, any of which could decrease the number of stores that carry our products. These retailers are also subject to changes
in consumer spending and the overall state of the economy both domestically and internationally. Any of these factors could have a material adverse effect on business, financial condition or results of operations.



Forward Looking Statements



This document contains forward-looking statements within the meaning of the
safe harbor provisions of the Private Securities Litigation Report 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 3.Quantitative and Qualitative Disclosures About
Market Risk



Information relative to the
Companys market risk sensitive instruments by major category at December 1, 2002 is presented under Item 7a of the registrants Annual Report on Form 10-K for the fiscal year ended December 1, 2002.



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, swap and option 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.



Interest Rate Risk



In 2001, the
Company entered into an interest rate swap agreement that effectively converted $236 million of its floating-rate debt to a fixed-rate basis through December 2006, thereby hedging against the impact of interest rate changes on future interest
expense (forecasted cash flows). Use of hedging contracts allows the Company to reduce its overall exposure to interest rate changes, since gains and losses on these contracts will



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offset losses and gains on the transactions being hedged. The Company formally documents all hedged transactions and hedging instruments, and assesses, both
at inception of the contract and on an ongoing basis, whether the hedging instruments are effective in offsetting changes in cash flows of the hedged transaction. The fair values of the interest rate agreements are estimated by obtaining quotes from
brokers and are the estimated amounts that the Company would receive or pay to terminate the agreements at the reporting date, taking into consideration current interest rates and the current creditworthiness of the counterparties.



Effective June 3, 2002, the Company dedesignated the interest rate swap
agreement for hedge accounting. As a result of the dedesignation, $12.9 million previously recorded in accumulated other comprehensive loss as of the date of dedesignation is being amortized into interest expense over the remaining life of the
interest rate swap agreement. For the three and nine months ended August 31, 2003, $0.6 million and $2.7 million and for the three and nine months ended September 1, 2002, $1.0 million and $1.0 million was amortized into interest expense,
respectively. Prior to June 3, 2002, changes in the fair market value of the interest rate swap were recorded in accumulated other comprehensive loss. Subsequent to June 3, 2002, changes in the fair market value of the interest rate swap are
recorded in interest expense. For the three and nine months ended August 31, 2003, $(3.0) million and $4.5 million and for the three and nine months ended September 1, 2002, $6.3 million and $6.3 million, respectively, was recorded as interest
expense as a result of the change in its fair market value. At August 31, 2003 and December 1, 2002, the fair value carrying amount of this instrument was $(16.7) million and $(20.2) million, respectively, which is recorded as follows:



|                             |  | August 31, 2003 |      | December 1, 2002
|---------------------------- |  | --------------- | ---- | ----------------
|                             |  | (in millions)  
|Accrued interest             |  | $               | 2.3  |                 
|Other accrued expenses       |  |                 | 7.2  |                 
|Other noncurrent liabilities |  |                 | 7.2  |                 
|                             |  |                 |      |                 
|                             |  | $               | 16.7 |                 
|                             |  |                 |      |                 



During the second
quarter of 2002, the Company entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the debt previously converted to fixed rate debt through December 2006. This interest rate swap agreement has
not been designated for hedge accounting and, accordingly, any changes in the fair value are to be recorded in interest expense. As a result of the change in fair market value, $(2.9) million and $4.3 million was recorded as a reduction of interest
expense for the three and nine months ended August 31, 2003, respectively, and $7.6 million and $7.1 million was recorded as a reduction of interest expense for the three and nine months ended September 1, 2002. At August 31, 2003 and December 1,
2002, the fair value carrying amount of this instrument was $7.5 million and $7.8 million with $5.6 million and $5.1 million recorded in prepaid expense and other current assets and $1.9 million and $2.7 million recorded in noncurrent assets,
respectively.



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.



To protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in foreign currency, the Company has
instituted a forecasted cash flow hedging program. The Company hedges portions of its purchases denominated in foreign currencies with forward and options contracts. See also Note 9 to the unaudited condensed consolidated financial statements.



Item 4.Internal Control and
Procedures



Within the 90 days prior to the
date of this Quarterly Report on Form 10-Q, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures (Disclosure Controls), and its internal controls and procedures for financial
reporting (Internal Controls). This evaluation was done under the supervision and with the participation of management, including the Chief Executive Officer (CEO) and Chief



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Financial Officer (CFO). Rules adopted by the SEC require that in this section of our Quarterly Report on Form 10-Q we present the conclusions of the CEO and
CFO about the effectiveness of our Disclosure Controls and Internal Controls.



Disclosure Controls are procedures that are designed with the objective of ensuring that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, such as this Quarterly
Report, is recorded, processed, summarized and reported within the time period specified in the SEC rules and forms. Disclosure Controls are also designed with the objective of ensuring that such information is accumulated and communicated to our
management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure. Internal Controls are procedures which are designed with the objective of providing reasonable assurance that our transactions are
properly authorized; our assets are safeguarded against unauthorized or improper use; and our transactions are properly recorded and reported, all to permit the preparation of our consolidated financial statements in conformity with United States
generally accepted accounting principles.



The Companys
management, including the CEO and CFO, does not expect that the Companys Disclosure Controls or its Internal Controls will prevent all errors and all fraud. Control systems, can provide only reasonable, not absolute, assurance that the
objectives of the control system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been
detected. These inherent limitations include factors such as judgments in decision-making that can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts, by
collusion of others, or by override of the control by management. The design of any system of controls also is based in part upon assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in
achieving its stated goals under all potential future conditions; controls may become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Accordingly, because of these inherent
limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.



The CEO and CFO evaluation of our Disclosure Controls and Internal Controls included a review of the controls objectives and design, the
controls implementation by the Company and the effect of the controls on the information generated for use in this Quarterly Report on Form 10-Q. In the course of this evaluation, the CEO and CFO sought to identify data errors, controls
problems or acts of fraud and to confirm that appropriate corrective action, including process improvements, were undertaken.



Based on this evaluation, the CEO and CFO concluded that the Companys Disclosure Controls require improvement as a result of findings from the
evaluation. These findings, similar to those disclosed and discussed in the Companys Form 10-K filed March 3, 2003, included certain deficiencies (e.g. reportable conditions) related to the timely processing of customer transactions, the
matching of customer transactions and the accuracy of the aging of certain accounts receivable. Management, together with the CEO and CFO attribute the conditions identified above to a data processing and information technology conversion undertaken
during fiscal 2002. The Company has taken various corrective actions that address the identified conditions, including increasing resources devoted to resolving these issues and improving collections. Although additional corrective actions may be
required to fully resolve these issues, the Company believes significant progress has been made. The Company believes that control procedures implemented during the third quarter have stabilized the process and are facilitating the clean up of the
backlog of transactions. The accounts receivable aging statistics have improved and the Company has seen increased cash collections. The Company also has contracted with a consulting firm that specializes in accounts receivable and revenue cycle
redesigns to assist in the redesign of the accounts receivable process and to review and enhance the controls over the revenue cycle.



Except as described above, there are no significant changes in the Companys internal controls or in other factors that could significantly affect
internal controls subsequent to the date the Company carried out its evaluation.



29



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PART II.    OTHER INFORMATION



Item 1.Legal Proceedings.



See Note 12 to the Condensed Consolidated Financial Statements, Part I, Item
1 included herein.



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



None



Item 6.Exhibits and Reports on Form
8-K



| | (a) |  | Exhibits:
| | --- |  | ---------



| | 10.1 |  | Second Amendment to Amended and Restated Credit Agreement
| | ---- |  | ---------------------------------------------------------



| | 31.1 |  | Chief Executive Officer Certification of the Quarterly Financial Statements
| | ---- |  | ---------------------------------------------------------------------------



| | 31.2 |  | Chief Financial Officer Certification of the Quarterly Financial Statements
| | ---- |  | ---------------------------------------------------------------------------



| | 32 |  | Certification Pursuant to 18 U.S.C. Section 1350
| | -- |  | ------------------------------------------------



| | (b) |  | Reports on Form 8-K:
| | --- |  | --------------------



| | Press |  | release announcing second quarter 2003 financials filed July 21, 2003
| | ----- |  | ---------------------------------------------------------------------



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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                                                                                 
|------------------------------------------- |  | --------------------------------------------------------------------------------------------------
|                                            | 
|Signature                                   |  | Title                                                                                             
|                                            | 
|/S/    DAVID J.
MCILQUHAMDavid J.
McIlquham |  | Chief Executive Officer (Principal Executive Officer)                                             
|                                            | 
|/S/    JAMES B.
HIRSHORNJames B.
Hirshorn   |  | Corporate Vice PresidentAdministration and Chief Financial Officer (Principal Accounting Officer)



Date: October 15, 2003



31