<PAGE>

                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D. C. 20549

                                -----------------

                                    FORM 10-K

                  ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934
                   FOR THE FISCAL YEAR ENDED DECEMBER 29, 2001

                        Commission file number 333-95945

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

                Delaware                                52-1710722
    (State or other jurisdiction of         (I.R.S. Employer Identification No.)
     incorporation or organization)

           9822 Fallard Court
           Upper Marlboro, MD                              20722
(Address of principal executive offices)                 (Zip Code)

                                 (301) 856-6755
               Registrant's telephone number, including area code

           Securities registered pursuant to Section 12(b) of the Act:

                                         Name of each exchange
Title of each class                      on which registered
-------------------                      -------------------
 None                                    None

           Securities registered pursuant to Section 12(g) of the Act:

                                         Name of each exchange
Title of each class                      on which registered
-------------------                      -------------------
12 5/8% Series B Senior Notes due 2007   None

     Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES _X_  NO__

     Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

     Indicate the number of shares outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

Outstanding at December 29, 2001                Class
--------------------------------                -----
100                                             Common Stock, $.01 Par Value

     List hereunder the following documents if incorporated by reference and the
Part of the Form 10-K (e.g., Part I, Part II, etc.) into which the document is
incorporated: (1) Any annual report to security holders; (2) Any proxy or
information statement; and (3) Any prospectus filed pursuant to Rule 424(b) or
(c) under the Securities Act of 1933. The listed documents should be clearly
described for identification purposes (e.g., annual report to security holders
for fiscal year ended December 24, 1980).

                                        1

<PAGE>

ITEM 1. BUSINESS

Our Company

     We believe we are the largest specialty retailer of mattresses (i.e.,
conventional mattresses, box springs and foundations) in the United States.
Retailers of mattresses include retail furniture stores, department store
chains, sleep shops and other regional and local specialty retailers of bedding.
Founded in 1978, we are considered the pioneers of the "specialty sleep shop"
mattress retailing concept. Specialty sleep shops are stores focused exclusively
on selling mattresses and are one of the mattress industry's fastest growing
retail distribution channels. Through our exclusive purchase contract with Sealy
Mattress Company, we are the largest retailer of Sealy branded products. In
addition to selling Sealy mattresses, we sell Factory Direct Comfort Source(R)
brand mattresses that are produced at our two manufacturing facilities. Since
our founding, we have grown our business into a nationwide network of 300 stores
in 13 markets.

     We have expanded rapidly through organic growth and acquisition. Since
1995, we have added net 134 stores to our retail network, including the 1998
acquisition of Bedding Experts, a sleep shop in the Chicago metropolitan area
and our exiting of the Denver market in August of 2001.

Store Locations and Development

     We currently operate 300 stores in 13 markets. Our average store is
approximately 4,000 square feet. Our stores are generally located in highly
visible, high-traffic commercial areas, including strip shopping centers, major
regional shopping areas and freestanding sites.

Products and Pricing

     Mattress sales currently account for approximately 90% of our store
revenues. Our stores offer an average of 35 Sealy branded and Factory Direct
Comfort Source mattresses. We also offer a variety of other bedding products,
including brass, wood and iron beds, futons, headboards, footboards, bed frames
and related items.

     We offer a broad selection of brand name products from our exclusive
manufacturer, Sealy Mattress Company. These brands include Sealy, Sealy
Posturepedic, Sealy Posturepedic Crown Jewel and Stearns & Foster. These Sealy
brands each offer distinct product characteristics and are marketed to, and
perceived by, consumers as separate brands at a broad range of price points.
These products, along with the Factory Direct Comfort Source brand, satisfy the
consumer's desire to see a wide range of models before making a purchase.

     We offer several features on our Sealy products that are unique to us,
including a proprietary cover selection on all Sealy Posturepedic models, and
"Edge Guard Plus" in our Sealy Posturepedic models except Crown Jewel. These
differentiated product features allow us to compete effectively with retailers
who offer similar products at these price points.

     The Factory Direct Comfort Source product line produced in our
manufacturing plants complements the Sealy products at mid-price ranges and
satisfies customer needs at lower price points. Name brand products typically do
not meet our gross margin targets at the lower price points. Our vertical
integration allows us to offer more product features and quality at lower
prices, while maintaining attractive margins.

Marketing and Advertising

     Our marketing programs are designed to generate high store traffic,
maintain high consumer awareness of our name, reinforce our value-pricing image
and promote our name brand mattresses. We believe that consumer awareness and
brand name recognition are critical to mattress retailing. Our marketing message
emphasizes our belief that we are the lowest price and best value in our
markets, the largest specialty bedding retailer in the United States, and the
world's largest retailer of Sealy branded products.

     Our advertising is managed by an in-house, full-service advertising
department. We manage the entire marketing process from layout through
production and placement. Our in-house capability, whose creative efforts are
supplemented by our relationship with an outside agency, gives us a competitive
advantage because we are more focused on the industry than an outside agency
would be, have the ability to react quickly to changing market conditions or
sales trends, and operate more economically because we only have to pay net
media rates.

                                        2

<PAGE>

     Our advertising program uses a multimedia approach. While print ads and
inserts in Sunday newspapers constitute a portion of our advertising spending,
we have recently devoted an increasing percentage of our marketing expenditures
to television and radio advertising. Our jingle, "Have a Good Night's Sleep On
Us!", has been cited as the most recognizable in the Washington, DC area in a
marketing survey conducted by an independent firm.

     Under our supply agreement with Sealy we receive cooperative advertising
support from Sealy. These arrangements provide for a rebate to us based on our
volume of purchases of Sealy products, as defined in the agreement. We believe
that these cooperative arrangements with Sealy are significant to our business.

Distribution

     We operate ten sales support centers and merchandise flows through these
centers from Sealy and our manufacturing facilities on a daily basis before
going to our stores or our customers. Merchandise is delivered from our sales
support centers to our customers' homes five to seven days a week, depending on
the market, and to our stores once or twice a week.

Manufacturing

     Our manufacturing operations consist of two factories, located in Maryland
and California. Mattress manufacturing is largely an assembly operation with
minimal fixed costs. We believe we have achieved high productivity and
efficiencies due to a relatively small SKU base. We produce approximately 150
SKUs compared to an estimated SKU base of over 1,000 for other major mattress
manufacturers. Our ability to manufacture long runs of a single product
minimizes down time and change-over costs. We believe we maintain sufficient
capacity to increase our manufacturing capabilities as product demand from our
store base grows.

     We centrally purchase many of our raw materials and supplies for our
manufacturing operations, including spring components, wire, foam and covers to
ensure product quality and maximize volume discounts. We purchase our raw
materials and components from a variety of vendors, including Leggett & Platt,
from whom we purchased approximately 36% of our raw materials during the year
ended December 29, 2001.

     As more fully discussed below in Item 2 - Properties, the Company closed
our Montgomery, AL plant subsequent to December 29, 2001.

Competition

     The mattress industry in the United States is very competitive. Our store
competitors include a variety of national and regional chains of retail
furniture stores, for example, Art Van in Detroit and Jordan's in Massachusetts,
department store chains, for example, The May Company and Federated Department
Stores, Inc., and sleep shops, for example, Mattress Giant and Mattress Firm.

Employees

     At December 29, 2001, we employed 1,259 people. We employed 133 people in
our three factories. We employed 1,007 people in our retail operation, including
distribution and home delivery. In addition, we employed 119 people in our
corporate offices. Our Hayward, California distribution center includes 35
employees represented by a local union.

Trademarks

     We own trademark registrations in the United States with respect to many of
our products, including our Comfort Source(R) and Royal Comfort Collection(R)
product lines, and hold various trade name and service mark registrations
including, for example, registrations of Mattress Discounters(R), The Bedding
Experts(R) and the jingle "Have a Good Night's Sleep on Us!"(R). We also have
numerous trademark applications pending in the United States and common law
rights for unregistered trademarks that are used in our business. In addition,
we own several U.S. copyright registrations.

Supply Contract with Sealy

     We are a party to a letter agreement with Sealy for the supply of Sealy and
Stearns & Foster products. Under the agreement, as amended, Sealy is our
exclusive supplier of name brand beds until June 30, 2007. Except

                                        3

<PAGE>

for a breach, the agreement does not specifically provide for its early
termination. Under this agreement we are required to purchase a minimum amount
of bedding products from Sealy, defined as a percentage of our annual sales of
retail bedding. The agreement provides for cooperative advertising support with
Sealy. Under this arrangement we receive from Sealy a rebate based on our
purchases of Sealy products.

ITEM 2. PROPERTIES

Store Locations

     We currently operate 300 stores in 13 markets. The following table sets
forth our store count by market as of December 29, 2001:

<TABLE>
<CAPTION>
                             Market                           Stores           Year Entered
          ---------------------------------------------- ----------------- -------------------
          <S>                                            <C>               <C>
          Chicago, IL .................................         61                  1998
          Los Angeles, CA .............................         45                  1994
          Washington, DC ..............................         39                  1978
          San Francisco, CA (a) .......................         39                  1992
          Boston, MA ..................................         29                  1989
          Miami, FL ...................................         16                  1998
          Detroit, MI .................................         14                  1994
          San Diego, CA ...............................         14                  1994
          Baltimore, MD ...............................         13                  1981
          Pittsburgh, PA ..............................          9                  1994
          Tampa, FL ...................................          8                  1998
          Richmond, VA ................................          7                  1983
          Orlando, FL .................................          6                  1999
                                                         -----------------
                 Total ................................        300
                                                         =================
</TABLE>

          (a)  There are 11 stores included above in the San Francisco, CA
               market that were previously disclosed separately as the
               Sacramento, CA market. The Company views San Francisco and
               Sacramento as one market.

     Subsequent to December 29, 2001, the Company entered into an agreement with
an affiliate of Sealy for the exchange and assignment of certain operating
leases. Pursuant to the terms of the agreement, the Company has assumed leases
for four stores in the Richmond, Virginia market in exchange for the affiliate
assuming leases for eight stores in the Tampa, Florida market. Further, the
Company has a continuing liability under the Tampa, Florida leases in the event
the affiliate defaults on its commitment under these lease assignments. Future
minimum rents associated with the eight Tampa, Florida leases are $484 in 2002,
$429 in 2003, $292 in 2004, $186 in 2005, $143 in 2006 and $297 thereafter.
Future minimum rents associated with the four Richmond, Virginia leases are $327
in 2002, $329 in 2003, $243 in 2004, $133 in 2005, $87 in 2006 and $403
thereafter.

Manufacturing

     At December 29, 2001, our manufacturing operations consisted of three
factories located in Maryland, California and Alabama. The following sets forth
our manufacturing facilities:

<TABLE>
<CAPTION>
                                        Square
   Location                             Footage                Ownership Status
   --------                           -----------   --------------------------------------
   <S>                                <C>           <C>
   Upper Marlboro, MD                   108,000          Leased--expires on 1/13/2012
   Montgomery, AL                        72,000          Owned
   Fontana, CA                           58,000          Leased--expires on 11/30/2004
                                      -----------
   Total                                238,000
                                      ===========
</TABLE>

     On March 8, 2002, we closed our Montgomery, Alabama plant. The Alabama
plant has historically been utilized to manufacture products for Heilig-Meyers,
which has now ceased operations in connection with its bankruptcy proceedings.
Management believes that the net carrying value of tangible assets related to
the Alabama plant approximates fair value.

                                        4

<PAGE>

Distribution

     We operate ten sales support centers, each of which services an average of
30 stores. The following sets forth our sales support centers, all of which are
leased:

                                                             Square
                            Location                         Footage
          --------------------------------------------  -----------------
          Upper Marlboro, MD ........................              88,304
          Carol Stream, IL ..........................              47,218
          Anaheim, CA ...............................              44,700
          Hayward, CA ...............................              43,580
          Sharon, MA ................................              42,000
          Taylor, MI ................................              39,215
          Pittsburgh, PA ............................              33,000
          San Diego, CA .............................              24,600
          Miami, FL .................................              24,140
          Lakeland, FL ..............................              10,200
                                                        ------------------
          Total .....................................             396,957
                                                        ==================


ITEM 3. Legal Proceedings.

     We are party to various proceedings from time to time arising in the
ordinary course of business. We do not expect that these matters, individually
or in the aggregate, will have a material adverse effect on our business,
financial condition or results of operations. Additionally, as of December 29,
2001, we are a defendant in a State Court class action lawsuit brought by
certain current or former employees. Our management is currently unable to
determine the outcome of the loss, if any, that may occur as a result of this
litigation.

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

     This Item is not applicable.

                                        5

<PAGE>

                                    PART II

ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters.

     This Item is not applicable, as the Company's common equity securities are
held by Mattress Holding Corporation, which is the parent company of Mattress
Discounters Corporation.


ITEM 6. Selected Financial Data.

SELECTED HISTORICAL FINANCIAL DATA

     Set forth below are our selected historical consolidated and combined
financial data of Mattress Discounters at the dates and for the periods
indicated (some periods of which are less than one year due to accounting
requirements for acquisition transactions and changes in the year-end). The
financial position and operating results of the entities as of dates and for
periods ended subsequent to July 2, 1997, includes Mattress Discounters and
subsequent to January 3, 1998, includes combined financial data of Mattress
Discounters and Bedding Experts, as each entity was under common ownership and
control by Heilig-Meyers through August 5, 1999. Effective August 6, 1999, the
financial statements have been prepared on a consolidated basis under the
transaction discussed elsewhere in this Annual Report on Form 10-K. Our summary
historical consolidated statement of operations data for the year ended December
29, 2001, the year ended December 30, 2000, and for the ten month period ended
January 1, 2000, and the historical consolidated balance sheet data as of
December 29, 2001 and December 30, 2000, were derived from our audited
consolidated financial statements that are included elsewhere in this Annual
Report on Form 10-K. Our selected historical combined statements of operations
data for the fiscal year ended February 28, 1999, the eight months ended
February 28, 1998, and the selected historical combined balance sheet data as of
February 28, 1998, February 28, 1999, and selected historical consolidated
balance sheet data as of January 1, 2000, were derived from our audited
financial statements. The selected historical combined statement of operations
data of Mattress Discounters (excluding Bedding Experts) for the six months
ended July 1, 1997, and the selected combined historical balance sheet data as
of July 1, 1997, were derived from the audited financial statements of Mattress
Discounters (excluding Bedding Experts). Our summary historical combined
financial data as of and for the ten-months ended December 31, 1998, are derived
from our unaudited condensed combined interim financial statements which, in the
opinion of management, include all adjustments necessary for a fair
presentation.

     On July 2, 1997, Heilig-Meyers acquired Mattress Discounters in a business
combination accounted for as a purchase. On January 3, 1998, Heilig-Meyers
acquired Bedding Experts in a business combination accounted for as a pooling of
interests. Mattress Discounters and Bedding Experts were maintained by
Heilig-Meyers as brother-sister corporations. Due to the chronology of the
acquisitions, and the fact that Mattress Discounters was the more substantial
entity based on its operations, size and management team, we believe Mattress
Discounters is considered the predecessor to the Company. Accordingly, Bedding
Experts financial data has been included herein for periods subsequent to its
acquisition by Heilig-Meyers (January 3, 1998). Due to the required purchase
accounting adjustments relating to the Mattress Discounters (excluding Bedding
Experts) acquisition, the selected historical combined financial data reflected
in the following table prior to July 2, 1997 are stated using its predecessor
basis of accounting and may not be comparable to the data for subsequent
periods. The primary differences result from the amortization of goodwill
recorded by Heilig-Meyers as a result of the purchase on July 2, 1997 and the
provision for income taxes.

     On November 5, 1999, we elected to change our fiscal year end from the last
day of February to the closest Saturday to December 31, beginning with the ten
months ended January 1, 2000.

                                        6

<PAGE>

     The selected historical financial data set forth below should be read in
conjunction with, and is qualified by reference to, "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and our audited
financial statements and accompanying notes included elsewhere in this Annual
Report on Form 10-K.

<TABLE>
<CAPTION>
                                                          Selected Historical Financial Data
                                                                (dollars in thousands)
                                                         ------------------------------------
                                                                               Eight Months
                                                            Six Months            Ended
                                                           Ended July 1,       February 28,
                                                              1997 (1)           1998 (2)
                                                         -----------------  -----------------
<S>                                                      <C>                <C>
Operating Data:
Net sales .............................................  $      84,417      $    136,360
Gross profit ..........................................         27,433            47,680
General and administrative expenses ...................         29,433            34,649
Loss on disposal of Denver assets .....................             --                --
Reserve for Heilig-Meyers receivable ..................             --                --
Other operating expenses ..............................             --                --
Income (loss) from operations .........................         (2,000)           13,031
Interest income (expense), net ........................            328                76
Other income (expense), net ...........................              8              (568)
Income (loss) before provision for income taxes .......         (1,664)           12,539
Net income (loss)(3) ..................................         (1,664)            7,143

Other Financial Data:
Depreciation and amortization .........................          1,007             2,545
Capital expenditures ..................................          1,592             1,367

Balance Sheet Data (end of period):
Working capital (deficit) .............................        (14,242)           (9,318)
Total assets ..........................................         24,546            97,394
Long-term debt and capital lease obligations ..........            268               629
Total debt and capital lease obligations ..............            454               920

Other Data (end of period):
Number of stores ......................................            170               172
Same store sales growth ...............................          ---(4)            ---(4)
</TABLE>

(1)  Financial data includes the financial position and operating results of
     Mattress Discounters, excluding Bedding Experts.

(2)  Financial data includes the financial position and operating results of
     Mattress Discounters and Bedding Experts from January 4, 1998 through
     February 28, 1998.

(3)  Prior to its acquisition by Heilig-Meyers, Mattress Discounters (excluding
     Bedding Experts) filed as an "S" Corporation for federal and state income
     tax purposes. Accordingly, no provision for federal income taxes is
     included in the statement of operations for the six months ended July 1,
     1997. Provisions were made for state income taxes in those states which do
     not recognize "S" Corporation elections. These provisions have been
     included in general and administrative expenses.

(4)  Our same store sales growth when aggregated with Mattress Discounters
     (excluding Bedding Experts) for the 12 months ended February 28, 1998 was
     2.0%.

                                        7

<PAGE>

                       Selected Historical Financial Data
                             (dollars in thousands)

<TABLE>
<CAPTION>
                                                       Fiscal Year         Ten Months Ended         Year Ended      Year Ended
                                                                       --------------------------
                                                      Ended Feb. 28,    December      January 1,    December 30,    December 29,
                                                           1999         31, 1998         2000           2000            2001
                                                     ----------------  ----------    ------------  --------------  --------------
<S>                                                  <C>               <C>           <C>           <C>             <C>
Operating Data:
Net sales .........................................     $ 247,725      $ 203,115      $ 220,677      $ 275,225     $   244,212
Gross profit ......................................        88,863         74,669         77,670         99,254          77,873
General and administrative expenses ...............        67,261         55,742         60,895         79,710          83,792
Loss on disposal of Denver assets .................            --             --             --             --           1,689
Provision for Heilig-Meyers receivable ............            --             --             --             --           1,564
Other operating expenses ..........................            --             --          4,654             --              --
Income (loss) from operations .....................        21,602         18,927         12,121         19,544          (9,172)
Interest income (expense), net ....................           128            126         (7,836)       (19,278)        (20,930)
Other income, net .................................           322            450             --             --              --
Income (loss) before provision for income taxes....        22,052         19,503          4,285            266         (30,102)
Net income (loss) .................................        12,690         11,238          2,104           (687)       (122,821)

Other Financial Data:
Depreciation and amortization .....................     $   4,541      $   3,771      $   4,063      $   4,822     $     6,052
Capital expenditures ..............................         5,162          4,297          2,615          6,761           3,426

Balance Sheet Data (end of period):
Working capital (deficit) .........................         1,137         (8,492)     $  (2,882)     $  (3,568)        (18,786)
Total assets ......................................       101,488         91,776        202,933        209,558         105,746
Long-term debt ....................................           426            448        133,374        133,869         152,182
Total debt ........................................           656            697        133,641        133,986         153,044

Other Data (end of period):
Number of stores ..................................           236            231            252            295             300
Same store sales growth ...........................           1.5%           3.8%           0.0%          (0.3%) (a)     (13.2%) (b)
</TABLE>

   (a)  Represents same store sales growth for the twelve months ended December
        30, 2000, compared to the twelve months ended January 1, 2000.

   (b)  Represents same store sales growth for the twelve months ended December
        29, 2001, compared to the twelve months ended December 30, 2000.

                                        8

<PAGE>

ITEM 7. Management's Discussion and Analysis of Financial Condition and Results
        of Operations.

Overview

     We believe we are one of the largest retailers of mattresses in the United
States. We operate in two segments: mattress retailing and mattress
manufacturing. We currently operate our retail business through a nationwide
network of 300 stores in 13 markets. Our manufacturing segment consists of two
manufacturing facilities that produce mattresses for sale in our retail stores
under the Comfort Source brand. During fiscal 2001 and 2000, and for the
ten-months ended January 1, 2000, our manufacturing facilities provided product
accounting for 29%, 31% and 30%, respectively, of the cost of our retail
purchases. The sales from our manufacturing segment to our retail operation are
eliminated in our consolidated and combined results of operations. Our business
is currently conducted through three legal entities: Mattress Discounters
Corporation, consisting of retail and manufacturing operations; Bedding Experts,
our retail store operations in the Chicago metropolitan area; and T.J.B., our
retail store operations in Washington, D.C., Virginia, and Maryland which
operate as Mattress Discounters. Bedding Experts and T.J.B. became wholly owned
subsidiaries of Mattress Discounters Corporation, effective August 6, 1999 under
the transactions discussed elsewhere in this Annual Report on Form 10-K.

     On August 6, 1999, our parent company, Mattress Holding Corporation,
consummated a merger and recapitalization under a transaction agreement, dated
as of May 28, 1999, among Heilig-Meyers, Heilig-Meyers Associates, Inc. and MD
Acquisition Corporation, a Virginia corporation owned by various Bain Capital
investment funds and affiliates and other institutional investors.

     The following discussion and analysis of financial condition and results of
operations includes periods prior to the completion of the transactions
contemplated by the transaction agreement. As a result of consummating a merger
and recapitalization of our parent, we entered into a financing arrangement and
accordingly, have a different capital structure. Accordingly, the results of
operations subsequent to the consummation of the transactions contemplated by
the transaction agreement will not necessarily be comparable to prior periods.

Critical Accounting Policies

     The Company's analysis and discussion of its financial condition and
results of operations are based upon its consolidated financial statements that
have been prepared in accordance with generally accepted accounting principles
in the United States ("U.S. GAAP"). The preparation of financial statements in
conformity with U.S. GAAP requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period. U.S.
GAAP provides the framework from which to make these estimates, assumptions and
disclosures. The Company chooses accounting policies within U.S. GAAP that
management believes are appropriate to accurately and fairly report the
Company's operating results and financial position in a consistent manner.
Management regularly assesses these policies in light of current and forecasted
economic conditions. The Company's accounting policies are stated in Note 3 to
the consolidated financial statements as presented elsewhere in this Annual
Report on Form 10-K. The Company believes the following accounting policies are
critical to understanding the results of operations and affect the more
significant judgments and estimates used in the preparation of the consolidated
financial statements.

     Cooperative Advertising and Rebate Programs - Costs incurred for
advertising are expensed in the period in which the advertising takes place. As
part of the normal course of business, the Company participates in cooperative
advertising programs whereby the Company receives a rebate equal to a percentage
of its purchases from participating vendors. The Company records cooperative
advertising funds as a reduction of advertising expense when the Company has
earned the cooperative advertising income, and funds related to inventory
purchase rebates are recorded as a reduction of cost of sales when the products
are delivered and accepted by the Company's customers. Management regularly
assesses the recoverability of the related amounts receivable from the vendors
that participate in the related cooperative advertising programs.

     Revenue recognition and cost of sales - Sales revenue is recognized upon
delivery and acceptance of mattresses and bedding products by the Company's
customers. Sales are presented net of returns. The Company includes fees billed
for deliveries as revenues. Cost of sales includes occupancy and delivery
expenses.

     Income Taxes - The Company records an income tax valuation allowance when
the realization of certain deferred tax assets, including net operating loss
carryforwards, is not likely. These deferred tax items represent expenses
recognized for financial reporting purposes, which may result in tax deductions
in the future. Certain

                                        9

<PAGE>

judgments, assumptions and estimates may affect the carrying value of the
valuation allowance and income tax expense in the consolidated financial
statements.

     Goodwill and Other Intangibles - The Company amortizes goodwill on a
straight-line basis over forty years. Other intangibles, including trademarks
and copyrights, are amortized over their economic lives, which range from 3 to
20 years. Whenever the facts and circumstances indicate that the carrying
amounts of these intangibles may not be recoverable, management reviews and
assesses the future cash flows expected to be generated from the related
intangible for possible impairment. Impairment is recognized by a charge to
operating results and a reduction in the carrying value of the intangible asset.

     Inventory - Inventories are valued at the lower of cost or market.
Management has determined cost using the first-in, first-out method. The
Company's manufactured inventories include raw materials, direct labor and
manufacturing overhead. Management regularly assesses the composition of its
existing inventory for possible obsolescence. Management adjusts its reserve for
inventory obsolescence whenever the facts and circumstances indicate that the
carrying cost of certain inventory items are in excess of lower of cost or
market.

Results of Operations

     The financial position and operating results of the entities subsequent to
January 3, 1998, includes Mattress Discounters and Bedding Experts as each
entity was under common ownership and control by Heilig-Meyers through August 5,
1999. Effective August 6, 1999, the financial statements have been prepared on a
consolidated basis under the transactions discussed elsewhere in this Annual
Report on Form 10-K. The following discussion compares our results of operations
for (a) the year ended December 29, 2001 to the year ended December 30, 2000 and
(b) the year ended December 30, 2000 to the ten months ended January 1, 2000.

     The following table sets forth our statement of operations line items as a
percentage of net sales for the periods indicated and should be read in
conjunction with the "Summary Historical Financial Data," the "Selected
Historical Financial Data," and the audited consolidated financial statements,
and the accompanying notes included elsewhere in this Annual Report on Form
10-K.

<TABLE>
<CAPTION>
                                                 Ten Months
                                                   Ended       Year Ended     Year Ended
                                                 January 1,   December 30,   December 29,
                                                    2000          2000           2001
                                                ------------ -------------- --------------
<S>                                             <C>          <C>            <C>
Net sales ....................................     100.0%        100.0%         100.0%
Gross profit .................................      35.2          36.1           31.9
General and administrative expenses ..........      27.6          29.0           34.3
Loss on disposal of Denver assets ............        --            --            0.7
Provision for Heilig-Meyers receivable .......        --            --            0.6
Other operating expenses .....................       2.1            --             --
Income (loss) from operations ................       5.5           7.1           (3.8)
Interest income (expense), net ...............      (3.6)         (7.0)          (8.6)
Income (loss) before income taxes ............       1.9           0.1          (12.3)
Provision for income taxes ...................       1.0           0.3           38.0
Net income (loss) ............................       1.0%         (0.2%)        (50.3%)
                                                ============ ============== ==============
</TABLE>

                                       10

<PAGE>

Year Ended December 29, 2001 Compared to Year Ended December 30, 2000

Net Sales: Net sales for the year ended December 29, 2001 decreased $31.0
million or 11.3% to $244.2 million from $275.2 million for the year ended
December 30, 2000. The decrease results from decreased retail net sales of $18.0
million and a decrease of $13.0 million in the external net sales of our
manufacturing operation. Net sales from retail operations, manufacturing sales
to our retail operations, and manufacturing sales to external retailers totaled
$242.4 million, $36.2 million, and $1.8 million, respectively, for the year
ended December 29, 2001 and $260.4 million, $39.5 million, and $14.8 million,
respectively, for the year ended December 30, 2000.

Retail sales decreased $18.0 million or 6.9% for the year ended December 29,
2001 as compared to the year ended December 30, 2000. The decrease in retail
sales is attributable to lower comparable store and closed store sales
aggregating $41.2 million, offset by $23.2 million increase in new store sales.

Net sales from manufacturing operations decreased $16.4 million for the year
ended December 29, 2001 as compared to the year ended December 30, 2000. The
majority of our manufacturing output is now consumed by our retail operations.
Sales to external retailers decreased by $13.0 million to $1.8 million primarily
due to lower sales to Heilig-Meyers (see further discussion of this matter
below).

Effective August 2, 2001, the Company closed its Denver, Colorado retail
operations. The Denver market consisted of 14 stores and a distribution center
servicing the metro Denver area. Revenues for the Denver market included in the
accompanying statements of operations for the year ended December 29, 2001, the
year ended December 30, 2000 and the ten months ended January 1, 2000 were
$1,889, $4,816 and $5,728, respectively. The operating loss for the Denver
market included in the accompanying statements of operations for the year ended
December 29, 2001, the year ended December 30, 2000 and the ten months ended
January 1, 2000 were $1,164, $1,511 and $595 respectively. See Loss on disposal
of Denver assets for further discussion of this transaction.

Gross Profit: Gross profit for the year ended December 29, 2001 decreased $21.4
million or 21.6% from $99.3 million to $77.9 million over the year ended
December 30, 2000. Gross profit as a percentage of sales decreased 4.2
percentage points to 31.9% from the prior fiscal year. Retail gross profit for
the year ended December 29, 2001 fell to $68.8 million, a decrease of $17.3
million. Manufacturing gross profit was $9.1 million, a decrease of $4.1 million
over the year ended December 30, 2000 primarily due to the decrease in
manufacturing sales to external retailers.

Retail gross profit as a percentage of net retail sales fell from 33.1% to
28.4%. The decrease in gross profit percent is primarily due to (a) higher
occupancy costs as a result of additional store openings, (b) lower sales
volumes in the current year, (c) a decrease in purchase discounts taken during
2001 as compared to the prior year and (d) the recording of a $0.9 million
provision for inventory obsolescence. Utilizing the Company's new POS/Inventory
system, management performed a detailed review during the fourth quarter of 2001
of the composition of its existing inventory. As a result of such review, the
Company recorded a non-cash charge of $0.9 million to establish a provision for
inventory obsolescence.

Manufacturing gross profit as a percentage of manufacturing sales was 23.9% for
the year ended December 29, 2001, compared to 24.3% for the year ended December
30, 2000. The decrease in gross profit percentage is primarily due to fixed
occupancy costs as a percentage of lower sales, partially offset by decreased
payroll costs.

General and Administrative expenses: General and administrative expenses for the
year ended December 29, 2001 rose $4.1 million or 5.1% as compared to the year
ended December 30, 2000. As a percentage of net sales, general and
administrative expenses were 34.3% for the current year, as compared to 29.0%
for the year ended December 30, 2000. The $4.1 million increase is primarily
attributed to increased expenditures for advertising, legal fees, insurance
costs and increased charges for depreciation and amortization expense, net of
decreased payroll costs. The increase in 2001 depreciation and amortization
expense is primarily due to the implementation of the Company's new
POS/Inventory system. In January 2002, the Company reorganized its
workforce and recorded a severance charge of $0.1 million. This reorganization
is expected to result in annualized savings of approximately $0.8 million.

Subsequent to December 29, 2001, the Company decided to close its Montgomery,
Alabama plant. The Alabama plant has historically been utilized to manufacture
products for Heilig-Meyers, which has now ceased operations in connection with
its bankruptcy proceedings. Based upon management's review of all available
objective evidence, the recoverability of the goodwill recorded in the Company's
records for the Alabama plant is uncertain. Accordingly, the Company recorded a
non-cash charge of $0.2 million at December 29, 2001 to write-off the

                                       11

<PAGE>

unamortized goodwill related to the Alabama plant. Such charge is included in
the general and administrative expenses in the accompanying statement of
operations. Management believes that the net carrying value of tangible assets
related to the Alabama plant approximates fair value.

Loss on disposal of Denver assets: In August 2001, the Company sold
substantially all of the assets of our Denver, Colorado retail operations,
including inventories and property and equipment. Total consideration received
by the Company for the sale of the related assets aggregated $0.3 million
resulting in a loss on sale of assets of $1.7 million. Such loss included
provisions for employee severance, future minimum lease commitments and costs
associated with the closing of the transaction. The Company has a continuing
liability under these leases in the event the Buyer defaults on its commitment
under these lease assignments. Future minimum rents associated with these leases
are $898 in 2002, $756 in 2003, $439 in 2004, $320 in 2005 and $178 in 2006.

Provision for Heilig-Meyers receivable: The Company has been pursuing its rights
in the Heilig-Meyers bankruptcy proceeding to recover an outstanding receivable
in the aggregate amount of $1.6 million. While the Company continues to pursue
its rights related to this claim, events occurring in the second quarter of 2001
caused management to believe that the recoverability of this amount was
uncertain. Accordingly, a charge of $1.6 million was recorded during the second
quarter of 2001 to establish a reserve against this outstanding receivable.

Interest expense: Interest expense for the year ended December 29, 2001 was
$21.2 million, an increase of $1.2 million over the year ended December 30,
2000. The increase in interest is attributable to higher average outstanding
balances for the year ended December 29, 2001 as a direct result of the $18.0
million of incremental borrowings under the Senior Credit Facility in April
2001.

Provision for Income Taxes: During the year ended December 29, 2001, events and
circumstances caused the Company to reevaluate the recoverability of its
deferred tax assets. Based upon a number of factors, management believes that
the available objective evidence creates sufficient uncertainty regarding the
recoverability of the Company's deferred tax assets. Accordingly, a 100%
valuation allowance has been established against the deferred tax assets. This
$92.0 million non-cash charge recorded during the 2001 year resulted in a $92.7
million provision for income taxes for the year ended December 29, 2001,
inclusive of $0.7 million related to state tax liabilities. The effective income
tax rate for the year ended December 30, 2000 was 358.3% and differed from the
federal statutory rate primarily as a result of state income taxes and the
non-deductibility of goodwill amortization.

Net loss: Primarily as a result of the factors discussed above, the net loss for
the year ended December 29, 2001 was $122.8 million, an increase of $122.1
million, compared with a net loss of $0.7 million during the year ended December
30, 2000.


Year Ended December 30, 2000 Compared to Ten Months Ended January 1, 2000

Net Sales: Net sales for the twelve months ended December 30, 2000 increased
$54.5 million or 24.7% to $275.2 million from $220.7 million for the ten months
ended January 1, 2000. The increase results from greater retail net sales of
$49.4 million and an increase of $5.2 million in the external net sales of our
manufacturing operation. Net sales from retail operations, manufacturing sales
to our retail operations, and manufacturing sales to external retailers totaled
$260.4 million, $39.5 million, and $14.8 million, respectively, for the twelve
months ended December 30, 2000 and $211.1 million, $34.3 million, and $9.6
million, respectively, for the ten months ended January 1, 2000.

Retail sales rose $49.4 million or 23.4% for the twelve month period ended
December 30, 2000, over the ten month period ended January 1, 2000. The two
additional months in the year ended December 30, 2000 contributed $40.1 million
of the increase in retail sales. The remaining $9.3 million increase is
attributable to $14.4 million increase in new store sales, offset by lower
comparable store and closed store sales aggregating $5.1 million.

Net sales from manufacturing operations increased $10.5 million for the twelve
months ended December 30, 2000 versus the ten months ended January 1, 2000. The
two additional months in the fiscal year ended December 30, 2000 represented
$6.2 million of the increase in the twelve month total. The majority of our
manufacturing output is consumed by our retail operations. During the twelve
months ended December 30, 2000 there was a shift in the mix of retail sales to
include a slightly higher weighting of Sealy products, versus our manufactured
product. Sales to external retailers increased by $5.2 million to $14.8 million.

                                       12

<PAGE>

Gross Profit: Gross profit for the twelve months ended December 30, 2000
increased $21.6 million or 27.8% from $77.7 million to $99.3 million over the
ten months ended January 1, 2000. Gross profit as a percentage of sales rose 0.9
percentage points to 36.1% over the prior fiscal period. Retail gross profit for
the twelve months ended December 30, 2000 rose to $86.1 million, an increase of
$19.4 million. Manufacturing gross profit was $13.2 million, an increase of $2.2
million over the ten month period ended January 1, 2000.

Retail gross profit as a percentage of net retail sales rose from 31.6% to
33.1%. The increase in gross profit percent is primarily due to a shift in mix
to higher margin bedding products and improved margins on the new product
line-up.

Manufacturing gross profit as a percentage of manufacturing sales was 24.3% for
the twelve months ended December 30, 2000, compared to 25.1% for the ten months
ended January 1, 2000. The decrease in gross profit percentage is primarily due
to increased payroll costs as a percentage of sales.

General and Administrative expenses: General and administrative expenses for the
year ended December 30, 2000 rose $18.8 million or 30.9% over the ten months
ended January 1, 2000. As a percentage of net sales, general and administrative
expenses were 29.0% for the year, compared to 27.6% for the ten months ended
January 1, 2000. The two additional months in the year ended December 30, 2000
represented $13.9 million of the total $18.8 million increase. The remaining
increase is a result of increased payroll expense, largely from $2.0 million of
severance costs and higher sales commissions due to higher overall sales and
improved margins, along with a $0.7 million increase in consulting/management
fees.

Other operating expenses: Other operating expenses for the ten months ended
January 1, 2000 were $4.7 million. This expense was primarily the result of a
$3.8 million non-cash charge for the intrinsic value of the in-the-money stock
options granted and deferred compensation for management in connection with the
transaction agreement, a $0.4 million write-off of future operating lease
payments associated with obsolete POS system hardware, a $0.2 million reserve
for expected losses on three subleased properties given that future lease costs
would not be fully recovered, and $0.1 million for a one-time expense for D & O
insurance purchased for prior period coverage related to the consummation of the
transactions contemplated by the transaction agreement.

Interest expense: Interest expense for the twelve months ended December 30, 2000
was $20.0 million, an increase of $11.9 million over the ten-month period ended
January 1, 2000. The increase in interest is attributable to higher average
outstanding balances for the year ended December 30, 2000. The Senior Notes were
issued in August 1999 and the twelve months ended December 30, 2000 includes a
full year of interest expense.

Provision for Income Taxes: The Company's effective income tax rate for the
twelve month period ended December 30, 2000, was 358.3% compared to 50.8% for
the ten month period ended January 1, 2000. The effective tax rate differs from
the federal statutory rate primarily as a result of non-deductible goodwill. The
increase in the effective income tax rate during the twelve months ended
December 30, 2000 is a result of increased nondeductible expenses relative to
pretax income.

Net income/(loss): Net loss for the twelve month period ended December 30, 2000
was $0.7 million, a decrease of $2.8 million, compared with net income of $2.1
million during the ten months ended January 1, 2000. The decrease is primarily
attributable to higher payroll and interest expenses discussed above.

Liquidity and Capital Resources

In connection with the leveraged recapitalization, we incurred significant
amounts of debt requiring interest payments on the notes and interest payments
and principal payments under a senior credit facility. Our liquidity needs
relate to working capital, capital expenditures and potential acquisitions. Cash
and cash equivalents at December 29, 2001 and December 30, 2000 were
approximately $3.9 million and $8.2 million, respectively.

Until January 11, 2002, our liquidity needs were met primarily by our $20.0
million collateralized lending facility with a syndicate of banks (the "Prior
Senior Credit Facility") originally entered into to finance a portion of the
Recapitalization and to provide available borrowings for use in the normal
course of business. The outstanding balance at December 29, 2001 under the Prior
Senior Credit Facility was $18.0 million with a weighted average interest rate
of 8.7% for the year then ended. At December 29, 2001, the Company was not in
compliance with the total debt ratio and interest coverage ratio covenants under
the Prior Senior Credit Facility and, accordingly, sought waivers and
modifications of certain of the covenants under the Prior Senior Credit
Facility. In connection with that

                                       13

<PAGE>

process, the Company entered into an amended and restated Senior Credit Facility
(the "Amended Senior Credit Facility") on January 11, 2002, which increased
available liquidity from $20.0 million under the Prior Senior Credit Facility to
$30.0 million under the Amended Senior Credit Facility. The Amended Senior
Credit Facility provides for two tranches of revolving loans; Tranche A for up
to $17.5 million (including letters of credit of up to $5.0 million) subject to
limitations on availability pursuant to a borrowing base formula, which is based
on eligible accounts receivable, inventory and property, plant and equipment,
and Tranche B for up to $12.5 million. The interest rate under the Amended
Senior Credit Facility, which is determined by the Company for each borrowing,
is either; (1) the base rate, which is the higher of the prime lending rate
(4.75% at December 29, 2001), the secondary market rate for three month
depository certificates plus up to 1% or 0.5% in excess of the Federal funds
effective rate, plus a margin or (2) the Eurodollar rate (1.8% at December 29,
2001) plus a margin. The margins of the loans under the Amended Senior Credit
Facility are 2.5% for base rate loans and 3.5% for Eurodollar loans. Commitment
fees are payable at a rate per annum of 0.5% on the undrawn amounts of the
Tranche A revolving loans.

Pursuant to the terms of the Amended Senior Credit Facility, the Company is
required to remit quarterly principal repayments on Tranche A of $250 commencing
on March 31, 2002. Additionally, there is a corresponding quarterly $250
decrease in the Tranche A commitment. However, the Tranche B commitment has a
corresponding increase of $250 each quarter commencing on March 31, 2002 that
can be used to fund the quarterly Tranche A payments.

The Amended Senior Credit Facility requires that the Company meet certain
minimum levels of consolidated EBITDA, which is measured at the end of each
fiscal quarter, beginning with the first quarter of 2002. We currently expect to
remain in compliance with this financial covenant for at least the next twelve
months provided the Company is able to meet or exceed the 2002 operating plan or
contingency plan (see below). In addition, the Amended Senior Credit Facility
contains restrictions, subject to certain exceptions, including, but not limited
to engaging in transactions with affiliates; prepaying subordinated debt and the
Senior Notes; incurring indebtedness and liens; declaring dividends or redeeming
or repurchasing capital stock; making loans and investments, engaging in
mergers, acquisitions, consolidations and asset sales, and making capital
expenditures. The revolving loans under the Amended Senior Credit Facility are
due in February 2004.

The Amended Senior Credit Facility is subject to mandatory prepayment in a
variety of circumstances, including upon certain asset sales and certain equity
and debt financing transactions, and also from excess cash flow, as defined in
the agreement.

Our primary supplier, a related party, purchased a $12.5 million participation
in our Amended Senior Credit Facility.

T.J.B., Bedding Experts and Holdings have guaranteed the Company's obligations
under the Amended Senior Credit Facility. The Amended Senior Credit Facility is
collateralized by substantially all of the assets of the Company.

At December 30, 2000 and December 29, 2001, the Company had approximately $2.3
million and $3.9 million, respectively, of outstanding letters of credit,
inclusive of cash collateralized letters of credit aggregating $1.9 million at
December 29, 2001.

During the year ended December 29, 2001, the Company incurred a pre-tax loss of
$30.1 million. The Company expects to incur a pre-tax loss in 2002 before
considering gains or losses from any asset sales. As of December 29, 2001, the
Company's current assets totaled $28.7 million and current liabilities were
$47.5 million, resulting in a net working capital deficit of approximately $18.8
million. The Company's stockholder's deficiency was $97.9 million as of December
29, 2001.

The Company's liquidity has been, and continues to be, constrained. During 2001,
the Company funded capital requirements for operating and investing activities
with proceeds from borrowings under its senior credit facility, managing its net
working capital and from cash on hand. As further discussed in Note 8 to the
audited financial statements, the Company has successfully renegotiated its
senior credit facility, which has resulted in an increase in the total
commitment from $20.0 million to $30.0 million. However, at March 29, 2002, the
total outstanding borrowings under this credit facility aggregated $28.0
million, and there is no additional availability under the facility.

In order to minimize its losses from operations and to enhance its operating
cash flows, the Company continues to pursue methods to expand its business
activities and to pursue opportunities to make its operations more efficient.
The Company's 2002 operating plan calls for new store openings, reductions to
current inventory levels, increased payment terms with a related party,
improvement to gross margins, expansion of a new advertising campaign and
improved market conditions. Management believes that successful execution of the
2002 operating plan will result in the Company meeting or exceeding its 2002
budgeted cash flow projections, and being compliant with the terms of its credit
facilities. However, no assurances can be given that the Company will be able to
achieve all or part of the objectives discussed above. Further, if the Company's
operations are unable to generate cash flow levels at or above its current 2002

                                       14

<PAGE>

projections, the Company may not have sufficient funds to meet its current
obligations over the next twelve months. Should such events occur, management is
committed to implementing all or a portion of its contingency plan. Such plan
has been developed and designed to generate additional positive cash flows and
includes, but is not limited to, deferring the opening of new stores, forgoing
the remodeling of existing stores, exiting from or restructuring
under-performing markets, reducing advertising expenditures, and reducing
general and administrative expenses. The failure of the Company to achieve one
or all of the above items may have a material adverse impact on the Company's
financial position, results of operations and cash flows.

Cash Flows - Operating Activities

Net cash used in operating activities for the year ended December 29, 2001 was
$17.2 million, a decrease of $28.4 million over the cash provided by operating
activities during the year ended December 30, 2000. The primary cause of the
decreased cash flow from operations during the year ended December 29, 2001 is
the Company's pre-tax loss of $30.1 million in the current period, net of
working capital changes during the period.

Net cash provided by operating activities for the year ended December 30, 2000
was $11.2 million, a decrease of $5.3 million over the prior ten-month fiscal
year total of $16.5 million. The ten-month period ended January 1, 2000 results
from net changes in working capital. The twelve month period ended December 30,
2000 was also affected by a net loss of $0.7 million compared to net income of
$2.1 million for the ten months ended January 1, 2000, offset by a reduction in
net working capital.

Cash Flows - Investing Activities

Our principal use of cash in investing activities has historically been capital
expenditures for new store openings. The initial capital investment to open a
new store is approximately fifty thousand dollars, which includes leasehold
improvements, furniture, fixtures, and point of sale computer equipment. Total
capital expenditures for the year ended December 29, 2001, the year ended
December 30, 2000 and for the ten months ended January 1, 2000 aggregated $3.4
million, $6.8 million and $2.6 million, respectively. The spending during 2001
is primarily related to new store openings as well as to the continued
implementation of a new POS/Inventory system. Through December 29, 2001, the new
POS/Inventory system has been successfully implemented in the Pittsburgh,
Detroit, Boston, Washington, Baltimore, Richmond, San Diego, Los Angeles, San
Francisco, Chicago, Tampa and Orlando markets. The new POS/Inventory system was
successfully implemented in Miami, the one remaining market, in January 2002.
The Company anticipates that it will require approximately $3.0 million to $5.0
million for capital expenditures in 2002.

Cash Flows - Financing Activities

Net cash provided by financing activities for the year ended December 29, 2001
was $16.0 million as compared to the $3.8 million of cash used in financing
activities during the year ended December 30, 2000. Cash provided by financing
activities in fiscal 2001 primarily relates to the $18.0 million of incremental
borrowings under our senior credit facility in April 2001. Cash used in
financing activities in fiscal 2000 primarily relates to the repurchase of stock
options for $2.8 million.

Net cash used in financing activities for the ten months ended January 1, 2000
was $7.0 million and primarily related to the Recapitalization as described in
Note 1 to the audited consolidated financial statements included in this Annual
report on Form 10-K.

2002 Outlook

Except as otherwise indicated, the following does not reflect the potential
impact of any acquisitions, divestitures, or other structural changes in the
Company's continuing operations that may be completed after March 29, 2002. The
outlook for 2002 reflects the discontinuation of amortization of the Company's
goodwill in accordance with Statement of Financial Accounting Standards No. 142.
For 2002, the Company expects to realize increased same store net sales
consistent with the 3% increase projected by ISPA for the coming year.
Additionally, the Company expects year over year increases in EBITDA primarily
driven by an increase in comparable store sales and incremental sales from new
store openings coupled with expected improvements in our selling margins.

                                       15

<PAGE>

Commitments and Contingencies

Future minimum lease payments under operating leases and aggregate annual
maturities of long-term debt at December 29, 2001 are as follows:

                                     Operating          Debt
                                       Leases        Maturities       Total
                                    ------------    ------------    ---------

     2002                           $     27,723    $        862    $  28,585
     2003                                 24,695             ---       24,695
     2004                                 19,493          18,000       37,493
     2005                                 14,724             ---       14,724
     2006                                  9,709             ---        9,709
     Thereafter                           20,851         134,182      155,033
                                    -----------------------------------------
                                    $    117,195    $    153,044    $ 270,239
                                    ==========================================

Included in the above operating commitments are certain properties that the
Company has subleased to third parties. Such sublease agreements provide for
future annual rental income, used to reduce rent expense, through 2008, with
minimum sublease rental income aggregating $1,032 in 2002, $600 in 2003, $253 in
2004, $209 in 2005, $99 in 2006, and $47 thereafter.

Additionally, in connection with previous store closings in the New York and
Denver markets, the Company entered into sublease agreements for certain
locations whereby the subtenant pays the operating lease obligations directly to
the landlord. However, the Company is contingently liable for future rentals
with respect to such subleases if the subleasee defaults on their commitment.
Future minimum rents associated with these subleases are $2,461 in 2002, $2,007
in 2003, $1,477 in 2004, $1,279 in 2005, $913 in 2006 and $1,645 thereafter.

At December 30, 2000 and December 29, 2001, the Company had approximately $2.3
million and $3.9 million, respectively, of outstanding letters of credit,
inclusive of cash collateralized letters of credit aggregating $1.9 million at
December 29, 2001.

Further, pursuant to the terms of the Amended Senior Credit Facility, the
Company is required to remit quarterly principal repayments of $250 commencing
on March 31, 2002.

Seasonality

Our operations are not seasonal in nature. In the year ended December 29, 2001
we generated 24%, 25%, 29% and 22% of our retail net sales in the first through
the fourth quarter, respectively. In the year ended December 30, 2000 we
generated 25%, 24%, 28% and 23% of our retail net sales in the first through the
fourth quarter, respectively.

New Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards No. 133 ("SFAS 133"), "Accounting for
Derivative Instruments and Hedging Activities." SFAS 133, as amended,
establishes accounting and reporting standards for derivative instruments,
including certain derivative instruments embedded in their contracts,
(collectively referred to as derivatives) and for hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those instruments
at fair value. The Company adopted SFAS 133, as amended, effective December 31,
2000, and there was no impact on the Company's financial statements.

In July 2001, the FASB issued Statement of Financial Accounting Standards No.
141 ("SFAS 141"), "Business Combinations", which supersedes APB Opinion No. 16,
"Business Combinations". SFAS 141 eliminates the pooling-of-interests method of
accounting for business combinations and modifies the application of the
purchase accounting method. The elimination of the pooling-of-interests method
is effective for transactions initiated after June 30, 2001. The remaining
provisions of SFAS 141 will be effective for transactions accounted for using
the purchase method that are completed after June 30, 2001. The adoption of SFAS
141 had no impact on the Company's financial statements.

In July 2001, the FASB issued Statement of Financial Accounting Standards No.
142 ("SFAS 142"), "Goodwill and Other Intangible Assets" which supersedes APB
Opinion No. 17, "Intangible Assets". The provisions of SFAS 142 (1) prohibit the
amortization of goodwill and indefinite-lived intangible assets, (2) require
that goodwill and indefinite-lived intangible assets be tested annually for
impairment, (3) require that reporting units be identified for the purpose of
assessing potential future impairments of goodwill, and (4) remove the 40-year
limitation on the

                                       16

<PAGE>

amortization period of intangible assets that have finite lives. SFAS 142 will
apply to goodwill and other intangible assets arising from transactions
completed before and after the effective date of the Statement. The Company will
adopt the provisions of SFAS 142 in its first quarter of 2002. The Company is in
the process of preparing for its adoption of SFAS 142 and is making the
determination as to what its reporting units are and what amounts of goodwill,
intangible assets, other assets, and liabilities should be allocated to these
reporting units. The Company has not yet determined the effect these impairment
tests will have on the Company's earnings. The adoption of the nonamortization
provision of this pronouncement will result in a reduction in our amortization
expense of approximately $1.6 million in fiscal 2002, but will have no impact on
cash flow.

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment or Disposal of Long-Lived
Assets", which supersedes FASB Statement No. 121 ("SFAS 121"), "Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of". SFAS 144 provides guidance on the accounting for the impairment or disposal
of long-lived assets, and applies to all long-lived assets (including
discontinued operations) and consequently amends APB Opinion No. 30, "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business". SFAS 144 develops one accounting model (based on the model in SFAS
121) for long-lived assets that are to be disposed of by sale, as well as
addresses the principal implementation issues. SFAS 144 requires that long-lived
assets that are to be disposed of by sale be measured at the lower of book value
or fair value less cost to sell. That requirement eliminates APB 30's
requirement that discontinued operations be measured at net realizable value or
that entities include under "discontinued operations" in the financial
statements amounts for operating losses that have not yet occurred.
Additionally, SFAS 144 expands the scope of discontinued operations to include
all components of an entity with operations that (a) can be distinguished from
the rest of the entity and (b) will be eliminated from the ongoing operations of
the entity in a disposal transaction. SFAS 144 is effective for the year
commencing December 30, 2001. The Company does not believe this pronouncement
will have a material effect on the Company's consolidated financial statements.

Forward-Looking Statements

This document includes forward-looking statements. We have based these
forward-looking statements on our current expectations and projections about
future events. Although we believe that our assumptions made in connection with
the forward-looking statements are reasonable, we cannot assure you that our
assumptions and expectations will prove to have been correct. These
forward-looking statements are subject to various risks, uncertainties and
assumptions about us, including, among other things:

     .  anticipated growth strategies and pursuit of potential acquisition
        opportunities
     .  dependence upon our senior management team
     .  increased future competition
     .  possibility of fluctuations in the cost of raw materials and loss of
        suppliers
     .  changes in economic and market conditions
     .  dependence on Sealy
     .  reliance on certain trademarks and other intellectual property
     .  ability to return our stores in certain markets to profitability

The Company undertakes no obligation to publicly update or review any
forward-looking statements, whether as a result of new information, future
events or otherwise. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this Annual Report on Form 10-K might not
occur.

ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk.

We do not believe that we have material quantitative or qualitative market risk
exposures. However, the interest rate under the Amended Senior Credit Facility
fluctuates based on either the prime lending rate or the Eurodollar rate. See
Note 8 to the consolidated financial statements for further information.

                                       17

<PAGE>

ITEM 8. Financial Statements and Supplementary Data.

INDEX TO FINANCIAL STATEMENTS

Mattress Discounters Corporation and Subsidiaries

Report of Independent Accountants

Consolidated Financial Statements:

..  Consolidated Balance Sheets at December 30, 2000 and December 29, 2001

..  Consolidated Statements of Operations for the Ten-Months Ended January 1,
   2000, the Year Ended December 30, 2000 and the Year Ended December 29, 2001

..  Consolidated Statements of Cash Flows for the Ten-Months Ended January 1,
   2000, the Year Ended December 30, 2000 and the Year Ended December 29, 2001

..  Consolidated Statement of Stockholder's Equity (Deficiency) for the
   Ten-Months Ended January 1, 2000, the Year Ended December 30, 2000 and the
   Year Ended December 29, 2001

..  Notes to Consolidated Financial Statements

                                       18

<PAGE>

                        REPORT OF INDEPENDENT ACCOUNTANTS


To the Stockholder and Board of Directors of
Mattress Discounters Corporation and Subsidiaries:

In our opinion, the consolidated financial statements listed in the accompanying
index present fairly, in all material respects, the financial position of
Mattress Discounters Corporation and subsidiaries at December 29, 2001 and
December 30, 2000, and the results of their operations and their cash flows for
the year ended December 29, 2001, the year ended December 30, 2000, and the
ten-months ended January 1, 2000, in conformity with accounting principles
generally accepted in the United States of America. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States of America, which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

As discussed in Note 1 to the financial statements, the financial position and
operating results of the entities for periods prior to August 6, 1999, were
combined as each entity was under common ownership and control by Heilig-Meyers
Company ("Heilig") through August 5, 1999. Accordingly, the financial position
and operating results for periods prior to August 6, 1999, may not necessarily
be indicative of the conditions that would have existed or the results of
operations if the Company had been operated as an unaffiliated entity. As
discussed in Note 15 to the financial statements, portions of certain income and
expenses for periods prior to August 6, 1999, represent allocations made from
Heilig applicable to the Company.



PricewaterhouseCoopers LLP
McLean, Virginia
March 28, 2002

                                       19

<PAGE>

                Mattress Discounters Corporation and Subsidiaries
                           Consolidated Balance Sheets
                        (in thousands, except share data)

<TABLE>
<CAPTION>
                                                                   December 30,       December 29,
                                                                       2000               2001
                                                                 ----------------    --------------
<S>                                                              <C>                 <C>
                            Assets

Current assets:
   Cash and cash equivalents                                     $          8,195    $        3,861
   Accounts receivable                                                      8,134             5,342
   Inventories, net                                                        19,838            17,980
   Prepaid expenses and other current assets                                  989             1,499
   Due from affiliate, net                                                  1,907               ---
   Deferred tax assets                                                      4,067               ---
                                                                 ----------------    --------------
       Total current assets                                                43,130            28,682

Property and equipment, net                                                14,014            12,636
Debt issue costs and other assets                                           9,846            10,917
Goodwill and other intangibles, net                                        54,625            53,511
Deferred tax assets                                                        87,943               ---
                                                                 ----------------    --------------
       Total assets                                              $        209,558    $      105,746
                                                                 ================    ==============

       Liabilities and Stockholder's Equity (Deficiency)

Current liabilities:
   Current portion of long-term debt                             $            117    $          862
   Accounts payable and accrued expenses                                   46,581            46,606
                                                                 ----------------    --------------
       Total current liabilities                                           46,698            47,468
                                                                 ----------------    --------------

Long-term debt, excluding current portion                                 133,869           152,182
Other noncurrent liabilities                                                4,111             4,037
                                                                 ----------------    --------------
       Total liabilities                                                  184,678           203,687
                                                                 ----------------    --------------

Commitments and contingencies

Stockholder's equity (deficiency):
   Common stock, 3,000 shares authorized, 100 shares issued
     and outstanding, $0.01 par value                                        ---               ---
   Additional paid-in capital                                              27,014            27,014
   Accumulated deficit                                                     (2,134)         (124,955)
                                                                 ----------------    --------------
       Total stockholder's equity (deficiency)                             24,880           (97,941)
                                                                 ----------------    --------------
       Total liabilities and stockholder's equity (deficiency)   $        209,558    $      105,746
                                                                 ================    ==============
</TABLE>

            See accompany notes to consolidated financial statements.

                                       20

<PAGE>

                Mattress Discounters Corporation and Subsidiaries
                      Consolidated Statements of Operations
                                 (in thousands)

<TABLE>
<CAPTION>
                                                            Ten-Months          Year             Year
                                                              Ended             Ended            Ended
                                                            January 1,       December 30,     December 29,
                                                               2000              2000            2001
                                                          --------------    --------------   --------------
<S>                                                       <C>               <C>              <C>
Net sales                                                 $      220,677    $      275,225   $      244,212
Cost of sales                                                    143,007           175,971          166,339
                                                          --------------    --------------   --------------
     Gross profit                                                 77,670            99,254           77,873

General and administrative expenses                               60,895            79,710           83,792
Loss on disposal of Denver assets                                    ---               ---            1,689
Provision for Heilig-Meyers receivable                               ---               ---            1,564
Other operating expenses                                           4,654               ---              ---
                                                          --------------    --------------   --------------
     Income (loss) from operations                                12,121            19,544           (9,172)

Other income (expense):
   Interest income                                                   199               683              312
   Interest expense                                               (8,035)          (19,961)         (21,242)
                                                          --------------    --------------   --------------
     Income (loss) before provision for income taxes               4,285               266          (30,102)
Provision for income taxes                                         2,181               953           92,719
                                                          --------------    --------------   --------------
     Net income (loss)                                    $        2,104    $         (687)  $     (122,821)
                                                          ==============    ==============   ==============
</TABLE>

            See accompany notes to consolidated financial statements.

                                       21

<PAGE>

                Mattress Discounters Corporation and Subsidiaries
                      Consolidated Statements of Cash Flows
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                         Ten-Months           Year              Year
                                                                           Ended             Ended             Ended
                                                                         January 1,       December 30,      December 29,
                                                                            2000              2000              2001
                                                                     ----------------  ----------------  ----------------
<S>                                                                  <C>               <C>               <C>
Cash flows from operating activities:
  Net income (loss)                                                  $          2,104  $           (687) $       (122,821)
  Adjustments to reconcile net income (loss) to net cash provided
        by (used in) operating activities:
    Compensation expense in connection with the
      Recapitalization                                                          3,825               ---               ---
    Depreciation and amortization                                               4,063             4,822             6,052
    Amortization of discount on Senior Notes                                      242               579               633
    Amortization of debt issue costs                                              526             1,338             1,600
    Deferred income taxes                                                      (1,909)              755            92,010
    Provision for obsolete inventory                                              400               ---               926
    Provision for Heilig-Meyers receivable                                        ---               ---             1,564
    Loss (gain) on disposition of property and equipment                           41               (23)            1,732
    Changes in operating assets and liabilities:
      Accounts receivable                                                         348            (2,801)            2,792
      Inventories                                                              (1,066)           (3,580)              932
      Prepaid expenses and other assets                                          (520)             (160)             (778)
      Due to/from parent/affiliate                                             (1,071)            1,179               343
      Accounts payable and accrued expenses                                    10,031            10,110            (2,138)
      Other noncurrent liabilities                                               (546)             (311)              (74)
                                                                     ----------------  ----------------  ----------------
        Net cash provided by (used in) operating activities                    16,468            11,221           (17,227)
                                                                     ----------------  ----------------  ----------------

Cash flows from investing activities:
    Property and equipment expenditures                                        (2,615)           (6,761)           (3,426)
    Proceeds from disposition of property and equipment                           100               ---               297
    Due to/from parent/affiliate                                                 (742)              ---               ---
    Other                                                                         (72)                7               ---
                                                                     ----------------  ----------------  ----------------
        Net cash used in investing activities                                  (3,329)           (6,754)           (3,129)
                                                                     ----------------  ----------------  ----------------

Cash flows from financing activities:
    Payments on long-term debt                                                   (327)             (235)             (124)
    Increase in note payable                                                      ---               ---               549
    Increase in restricted cash                                                   ---               ---            (1,900)
    Long-term borrowings                                                      133,070               ---               ---
    Revolving line of credit borrowings                                         5,205               ---            18,000
    Payments on revolving line of credit borrowings                            (5,205)              ---               ---
    Payment of debt issue costs                                               (10,247)             (718)             (503)
    Distribution to Heilig-Meyers in connection
      with Recapitalization                                                    (1,676)              ---               ---
    Dividend to Mattress Holding Corporation                                 (130,001)              ---               ---
    Capital contributions from Mattress Holding Corporation                     2,200               ---               ---
    Repurchase of stock options                                                   ---            (2,831)              ---
    Other, net                                                                    (12)              ---               ---
                                                                     ----------------  ----------------  ----------------
        Net cash provided by (used in) financing activities                    (6,993)           (3,784)           16,022
                                                                     ----------------  ----------------  ----------------
Net increase (decrease) in cash and cash equivalents                            6,146               683            (4,334)
Cash and cash equivalents, beginning of period                                  1,366             7,512             8,195
                                                                     ----------------  ----------------  ----------------
Cash and cash equivalents, end of period                             $          7,512  $          8,195  $          3,861
                                                                     ================  ================  ================
</TABLE>

            See accompany notes to consolidated financial statements.

                                       22

<PAGE>

                Mattress Discounters Corporation and Subsidiaries
          Consolidated Statements of Stockholder's Equity (Deficiency)
                                 (in thousands)

<TABLE>
<CAPTION>
                                                                                            Retained          Total
                                                                           Additional       earnings      stockholder's
                                                              Common        paid-in       (accumulated       equity
                                                               Stock        capital         deficit)       (deficiency)
                                                             ---------   --------------  --------------  ---------------
<S>                                                          <C>         <C>             <C>             <C>
Balances as of February 28, 1999                             $      29   $       46,047  $       19,988  $        66,064
Distribution to Heilig-Meyers                                        -           (3,541)              -           (3,541)
Capital contribution from Mattress Holding Corporation
    related to Warrants                                              -            2,200               -            2,200
Recapitalization of Mattress Discounters Corporation               (29)              29               -                -
Stepped-up tax basis related to the Recapitalization                 -           88,703               -           88,703
Compensatory stock options                                           -            2,869               -            2,869
Dividend to Mattress Holding Corporation                             -         (106,462)        (23,539)        (130,001)
Net income                                                           -                -           2,104            2,104
                                                             ---------   --------------  --------------  ---------------

Balances as of January 1, 2000                                       -           29,845          (1,447)          28,398
Repurchase of stock options                                          -           (2,831)              -           (2,831)
Net loss                                                             -                -            (687)            (687)
                                                             ---------   --------------  --------------  ---------------

Balances as of December 30, 2000                                     -           27,014          (2,134)          24,880
Net loss                                                             -                -        (122,821)        (122,821)
                                                             ---------   --------------  --------------  ---------------
Balances as of December 29, 2001                             $       -   $       27,014  $     (124,955) $       (97,941)
                                                             =========   ==============  ==============  ===============
</TABLE>

            See accompany notes to consolidated financial statements.

                                       23

<PAGE>

                Mattress Discounters Corporation and Subsidiaries
                 Notes to the Consolidated Financial Statements
                        (in thousands, except share data)


1. Organization and Basis of Financial Statement Presentation

   Mattress Discounters Corporation and subsidiaries are engaged in the
   manufacture and retail sale of mattresses and bedding products, in various
   markets throughout the United States. The accompanying consolidated financial
   statements at December 29, 2001 and December 30, 2000, and the periods
   presented herein include the accounts of Mattress Discounters Corporation
   ("Mattress Discounters"), and its wholly owned subsidiaries T.J.B., Inc.
   ("T.J.B."), and The Bedding Experts, Inc. ("Bedding Experts") (collectively
   referred to as the "Company"). All significant intercompany accounts and
   transactions of the Company have been eliminated. The financial position and
   operating results of Mattress Discounters, T.J.B. and Bedding Experts for
   periods prior to August 5, 1999, were combined in the financial statements as
   each entity was under common ownership and control by Heilig-Meyers Company
   ("Heilig-Meyers") through August 5, 1999. Immediately prior to the closing of
   the recapitalization of the Company's parent (as described below) on August
   6, 1999, Heilig-Meyers contributed all of the issued and outstanding stock of
   Mattress Discounters, T.J.B. and Bedding Experts to the capital of
   Heilig-Meyers Associates, Inc., a Virginia corporation ("HMA"). Immediately
   after this capital contribution, Mattress Discounters, T.J.B. and Bedding
   Experts became wholly owned subsidiaries of HMA. Immediately after the
   recapitalization of the Company's parent (as described below), the issued and
   outstanding stock of T.J.B. and Bedding Experts was contributed to the
   capital of Mattress Discounters. Accordingly, subsequent to August 6, 1999,
   the financial statements have been consolidated. For consistency of
   presentation, the combined financial statements in this annual report are
   referred to as consolidated, rather than combined financial statements.
   However, the existence of common ownership and control of the entities, as
   described above, could have resulted in operating results or financial
   position of the entities that would be significantly different from those
   that would have been achieved if the enterprises were autonomous.

   On May 28, 1999, Heilig-Meyers entered into a transaction agreement (the
   "Transaction Agreement") with HMA and MD Acquisition Corporation, a
   transitory Virginia merger corporation ("MDAC"). Heilig-Meyers owned 100% of
   the stock of Mattress Discounters, T.J.B. and Bedding Experts. Pursuant to
   the Transaction Agreement, upon the satisfaction of certain conditions, and
   after all of the issued and outstanding shares of Mattress Discounters,
   T.J.B. and Bedding Experts had been contributed to the capital of HMA, MDAC
   was merged with and into HMA, with HMA being the surviving corporation,
   subsequently changing its name to Mattress Holding Corporation ("Holdings"),
   effective on August 6, 1999 (the "Closing Date"). HMA was recapitalized (the
   "Recapitalization") whereby certain equity investors acquired an approximate
   92.7% economic and voting equity stake in HMA. Pursuant to the merger, the
   issued and outstanding shares of common stock of HMA were converted into the
   right to receive (i) a number of shares of fully paid and nonassessable
   shares of Holdings, the surviving corporation, that immediately following the
   Closing Date represented approximately 7.3% of each class of the issued and
   outstanding common stock of Holdings; (ii) $204.2 million in cash and (iii) a
   $10.0 million principal amount 10% junior subordinated promissory note and a
   $7.5 million principal amount 12% junior subordinated promissory note issued
   by Holdings.

   Concurrent with the Recapitalization of Holdings, the Company issued 140,000
   units consisting of $140 million of Mattress Discounters Corporation senior
   notes due 2007 (the "Senior Notes") and warrants to purchase 679,000 shares
   of Class A common stock and 75,460 shares of Class L common stock of Holdings
   (the "Warrants"); and entered into a $20 million senior credit facility (the
   "Senior Credit Facility") of which approximately $5.2 million was drawn at
   the Closing Date (see Note 8).

   In connection with the Transaction Agreement, certain of the Company's
   management were granted "in the money" stock options to purchase shares of
   Class A and Class L common stock of Holdings with an intrinsic value of
   approximately $2.9 million ("Management Stock Options") together with
   deferred compensation benefits of approximately $0.9 million. This resulted
   in a pretax charge of $3.8 million that was recognized by the Company during
   the three month period ended August 31, 1999.

                                       24

<PAGE>

   In addition to the above pretax charge, the Company recorded the following
   transactions resulting from the consummation of the Transaction Agreement:

     (i)   The deemed settlement and net distribution from capital of the note
           receivable from Heilig-Meyers of $6.0 million, the elimination and
           distribution of current taxes payable to Heilig-Meyers of $4.3
           million, and the distribution of excess cash at the Closing Date of
           $1.7 million to Heilig-Meyers;

     (ii)  The establishment of deferred income taxes and additional paid-in
           capital of approximately $88.7 million resulting from a new basis in
           the Company's assets for income tax reporting purposes as a result of
           the parties to the Transaction Agreement electing to treat the
           transactions as a taxable event pursuant to section 338(h)(10) of the
           Internal Revenue Code;

     (iii) The payment of financing fees of approximately $10.0 million, which
           have been deferred in the consolidated balance sheet;

     (iv)  The contribution of capital from Holdings representing the granting
           of the Management Stock Options to employees of the Company and the
           Warrants in Holdings' common stock issued in connection with the
           Senior Notes; and

     (v)   The dividend distribution of approximately $130.0 million from the
           Company to Holdings to partially fund the Recapitalization of
           Holdings.

   Subsequent to the Closing, Holdings submitted its claim for a working capital
   adjustment to Heilig-Meyers under the Transaction Agreement. In connection
   with the working capital adjustment, on December 22, 1999, Heilig-Meyers
   agreed to pay to Holdings $2.0 million. In addition, Heilig-Meyers agreed to
   reduce the outstanding principal amount of its $7.5 million 12% Junior
   Subordinated Promissory Note of Holdings to $5.9 million. The working capital
   adjustment transactions were accounted for by Holdings as a reduction to
   merger consideration. Heilig-Meyers also agreed to discharge certain lease
   obligations of the Company aggregating approximately $42.

2. Liquidity

   During the year ended December 29, 2001, the Company incurred a pre-tax loss
   of $30.1 million. The Company expects to incur a pre-tax loss in 2002 before
   considering gains or losses from any asset sales. As of December 29, 2001,
   the Company's current assets totaled $28.7 million and current liabilities
   were $47.5 million, resulting in a net working capital deficit of
   approximately $18.8 million. The Company's stockholder's deficiency was $97.9
   million as of December 29, 2001.

   The Company's liquidity has been, and continues to be, constrained. During
   2001, the Company funded capital requirements for operating and investing
   activities with proceeds from borrowings under its senior credit facility,
   managing its net working capital and from cash on hand. As further discussed
   in Note 8, the Company has successfully renegotiated its senior credit
   facility, which has resulted in an increase in the total commitment from
   $20.0 million to $30.0 million. However, at March 28, 2002, the total
   outstanding borrowings under this credit facility aggregated $28.0 million,
   and there is no additional availability under the facility.

   In order to minimize its losses from operations and to enhance its operating
   cash flows, the Company continues to pursue methods to expand its business
   activities and to pursue opportunities to make its operations more efficient.
   The Company's 2002 operating plan calls for new store openings, reductions to
   current inventory levels, increased payment terms with a related party,
   improvement to gross margins, expansion of a new advertising campaign and
   improved market conditions. Management believes that successful execution of
   the 2002 operating plan will result in the Company meeting or exceeding its
   2002 budgeted cash flow projections, and being compliant with the terms of
   its credit facilities. However, no assurances can be given that the Company
   will be able to achieve all or part of the objectives discussed above.
   Further, if the Company's operations are unable to generate cash flow levels
   at or above its current 2002 projections, the Company may not have sufficient
   funds to meet its current obligations over the next twelve months. Should
   such events occur, management is committed to implementing all or a portion
   of its contingency plan. Such plan has been developed and designed to
   generate additional positive cash flows and includes, but is not limited to,
   deferring the opening of

                                       25

<PAGE>

   new stores, forgoing the remodeling of existing stores, exiting from or
   restructuring under-performing markets, reducing advertising expenditures,
   and reducing general and administrative expenses. The failure of the Company
   to achieve one or all of the above items may have a material adverse impact
   on the Company's financial position, results of operations and cash flows.

3. Summary of Significant Accounting Policies

   Fiscal Year
   -----------

   On November 5, 1999, the Company elected to change its fiscal year from the
   last day of February to the closest Saturday to December 31, beginning with
   the ten-months ended January 1, 2000. Due to the periods presented, the
   financial statements presented herein are not fully comparable. Certain
   reclassifications of the 2000 financial statements and related footnotes have
   been made to conform to the financial statement presentation used in 2001.

   Use of Estimates in the Preparation of Financial Statements
   -----------------------------------------------------------

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

   Fair Value of Financial Instruments
   -----------------------------------

   The amounts reported in the consolidated balance sheets for cash and cash
   equivalents, accounts receivable, accounts payable and accrued liabilities
   approximate fair value because of the short-term maturity of these
   instruments. The fair value of Senior Notes is approximately $28 million,
   based on quoted market prices at December 29, 2001. The carrying value of the
   senior credit facility approximates fair value based on the similar terms of
   the amended senior credit facility.

   Cash and Cash Equivalents
   -------------------------

   Cash equivalents include time deposits with maturities of three months or
   less when purchased. Restricted cash and cash equivalents are included in
   other assets.

   Accounts Receivable
   -------------------

   Accounts receivable are primarily comprised of amounts due to the Company
   pursuant to vendor cooperative advertising and rebate agreements, and
   bank-financed customer sales.

   Due from Affiliate
   ------------------

   Due from affiliate at December 30, 2000 represented sales to Heilig-Meyers
   for mattresses, box springs and foundations manufactured by the Company, and
   noninterest-bearing loans to Heilig-Meyers, for periods prior to August 6,
   1999.

   Inventories
   -----------

   Inventories are valued at the lower of cost or market. Cost is determined by
   the first-in, first-out method. Manufactured inventories include raw
   materials, direct labor and manufacturing overhead.

   Property and Equipment
   ----------------------

   Property and equipment are stated at cost. Depreciation is provided on the
   straight-line method at rates based on the estimated useful lives of
   individual assets or classes of assets. Improvements to leased property are
   amortized over their estimated useful lives or lease period, whichever is
   shorter. Amortization of capitalized leased assets is computed on the
   straight-line method over the shorter of the asset life or term of the lease.
   Normal repairs and maintenance are expensed as incurred. Expenditures which
   significantly extend asset useful lives are capitalized. The estimated useful
   lives are 30 to 31.5 years for buildings, 3 to 7 years for

                                       26

<PAGE>

   furniture, fixtures, equipment and vehicles, and 2 to 15 years for leasehold
   improvements. Gains or losses on sales and retirements of property and
   equipment are reflected in results of operations.

   The Company accounts for costs of software developed or obtained for internal
   use in accordance with SOP 98-1, "Accounting For the Costs of Computer
   Software Developed or Obtained For Internal Use." SOP 98-1 requires certain
   software development costs to be capitalized. Generally, once the
   capitalization criteria of the SOP have been met, external direct costs of
   materials and services used in development of internal-use software, payroll,
   and payroll-related costs for employees directly involved in the development
   of internal-use software, and interest costs incurred when developing
   software for internal use are to be capitalized. These capitalized costs are
   amortized over the useful life of the software on a straight-line basis.

   Debt Issue Costs
   ----------------

   Debt issue costs are capitalized and amortized to interest expense over the
   terms of the related debt.

   Goodwill and Other Intangibles
   ------------------------------

   The Company amortizes goodwill on a straight-line basis over forty years.
   Other intangibles, including its trademark and copyright, are amortized over
   their economic lives, which range from 3 to 20 years. Goodwill and other
   intangible assets are reviewed for impairment whenever the facts and
   circumstances indicate that the carrying amounts may not be recoverable.
   Impairment is recognized by a charge to operating results and a reduction in
   the carrying value of the intangible asset.

   Revenues and Costs of Sales
   ---------------------------

   Sales revenue is recognized upon delivery and acceptance of mattresses and
   bedding products by the Company's customers. Sales are presented net of
   returns. The Company includes fees billed for deliveries as revenues. Cost of
   sales includes occupancy and delivery expenses.

   Advertising Costs
   -----------------

   Costs incurred for advertising are expensed in the period in which the
   advertising takes place. The Company records cooperative advertising funds as
   a reduction of advertising expense, when the Company has earned the
   cooperative advertising income. Net advertising expense recognized during the
   ten-month period ended January 1, 2000, the year ended December 30, 2000 and
   the year ended December 29, 2001 was $7,270, $9,984 and $10,795,
   respectively.

   Income Taxes
   ------------

   Deferred income taxes are recognized for the tax consequences in future years
   of differences between the tax bases of assets and liabilities and their
   financial reporting amounts at each period ended based on enacted tax laws
   and statutory tax rates applicable to the periods in which the differences
   are expected to affect taxable income. Valuation allowances are established
   when necessary to reduce deferred tax assets to the amount expected to be
   realized. The provision for income taxes in the consolidated financial
   statements for periods prior to August 6, 1999, reflect tax calculations on a
   separate company basis, and do not reflect actual taxes owed by the Company
   on the Heilig-Meyers consolidated tax return.

   Stock-Based Compensation
   ------------------------

   The Company has chosen to account for stock-based compensation using the
   intrinsic value method prescribed in Accounting Principles Board ("APB")
   Opinion No. 25, "Accounting for Stock Issued to Employees", and related
   interpretations. The Company accounts for stock-based compensation to
   non-employees using the fair value method prescribed by SFAS No. 123.
   Accordingly, compensation costs for Holdings' stock options granted to
   employees of the Company is measured as the excess, if any, of the fair value
   of Holdings' stock at the date of the grant over the amount an employee must
   pay to acquire the stock. Compensation cost for Holdings' stock options
   granted to non-employees is measured as the fair value of the option at the
   date of grant. Such compensation costs, if any, are amortized on a
   straight-line basis over the underlying option vesting terms.

                                       27

<PAGE>

      New Accounting Pronouncements
      -----------------------------

      In June 1998, the Financial Accounting Standards Board ("FASB") issued
      Statement of Financial Accounting Standards No. 133 ("SFAS 133"),
      "Accounting for Derivative Instruments and Hedging Activities." SFAS 133,
      as amended, establishes accounting and reporting standards for derivative
      instruments, including certain derivative instruments embedded in their
      contracts, (collectively referred to as derivatives) and for hedging
      activities. It requires that an entity recognize all derivatives as either
      assets or liabilities in the statement of financial position and measure
      those instruments at fair value. The Company adopted SFAS 133, as amended,
      effective December 31, 2000, and there was no impact on the Company's
      financial statements.

      In July 2001, the FASB issued Statement of Financial Accounting Standards
      No. 141 ("SFAS 141"), "Business Combinations", which supersedes APB
      Opinion No. 16, "Business Combinations". SFAS 141 eliminates the
      pooling-of-interests method of accounting for business combinations and
      modifies the application of the purchase accounting method. The
      elimination of the pooling-of-interests method is effective for
      transactions initiated after June 30, 2001. The remaining provisions of
      SFAS 141 are effective for transactions accounted for using the purchase
      method that are completed after June 30, 2001. The adoption of SFAS 141
      had no impact on the Company's financial statements.

      In July 2001, the FASB issued Statement of Financial Accounting Standards
      No. 142 ("SFAS 142"), "Goodwill and Other Intangible Assets" which
      supersedes APB Opinion No. 17, "Intangible Assets". The provisions of SFAS
      142 (1) prohibit the amortization of goodwill and indefinite-lived
      intangible assets, (2) require that goodwill and indefinite-lived
      intangible assets be tested annually for impairment, (3) require that
      reporting units be identified for the purpose of assessing potential
      future impairments of goodwill, and (4) remove the 40-year limitation on
      the amortization period of intangible assets that have finite lives. SFAS
      142 will apply to goodwill and other intangible assets arising from
      transactions completed before and after the effective date of the
      Statement. The Company will adopt the provisions of SFAS 142 in its first
      quarter of 2002. The Company is in the process of preparing for its
      adoption of SFAS 142 and is making the determination as to what its
      reporting units are and what amounts of goodwill, intangible assets, other
      assets, and liabilities should be allocated to these reporting units. The
      Company has not yet determined the effect these impairment tests will have
      on the Company's earnings. The adoption of the nonamortization provision
      of this pronouncement will result in a reduction in our amortization
      expense of approximately $1.6 million in fiscal 2002, but will have no
      impact on cash flow.

      In August 2001, the FASB issued Statement of Financial Accounting
      Standards No. 144 ("SFAS 144"), "Accounting for the Impairment or Disposal
      of Long-Lived Assets", which supersedes FASB Statement No. 121 ("SFAS
      121"), "Accounting for the Impairment of Long-Lived Assets and for
      Long-Lived Assets to Be Disposed Of". SFAS 144 provides guidance on the
      accounting for the impairment or disposal of long-lived assets, and
      applies to all long-lived assets (including discontinued operations) and
      consequently amends APB Opinion No. 30, "Reporting Results of Operations -
      Reporting the Effects of Disposal of a Segment of a Business". SFAS 144
      develops one accounting model (based on the model in SFAS 121) for
      long-lived assets that are to be disposed of by sale, as well as addresses
      the principal implementation issues. SFAS 144 requires that long-lived
      assets that are to be disposed of by sale be measured at the lower of book
      value or fair value less cost to sell. That requirement eliminates APB
      30's requirement that discontinued operations be measured at net
      realizable value or that entities include under "discontinued operations"
      in the financial statements amounts for operating losses that have not yet
      occurred. Additionally, SFAS 144 expands the scope of discontinued
      operations to include all components of an entity with operations that (a)
      can be distinguished from the rest of the entity and (b) will be
      eliminated from the ongoing operations of the entity in a disposal
      transaction. SFAS 144 is effective for the year commencing December 30,
      2001. The Company does not believe this pronouncement will have a material
      effect on the Company's consolidated financial statements.

                                       28

<PAGE>

4.    Inventories

      Inventories are summarized as follows:

                                          December 30,       December 29,
                                              2000               2001
                                       ------------------ ------------------

              Finished goods           $          18,235  $          16,803
              Work in process                        199                157
              Raw materials                        1,404              1,020
                                       ------------------ ------------------
                                       $          19,838  $          17,980
                                       ================== ==================

      During the fourth quarter of 2001, the Company recorded a provision for
      inventory obsolescence of $926. As of December 30, 2000 and December 29,
      2001, the Company had reserves for inventory obsolescence of $0 and $926,
      respectively.

      Sealy is our exclusive supplier of name brand beds until June 30, 2007
      under an agreement with Sealy Mattress Company. The equity investors or
      their related parties, who are the indirect beneficial owners of
      approximately 93% of Holdings, are also the beneficial owners of
      approximately 93% of the voting common stock of Sealy, and effectively
      control both companies. During the ten-month period ended January 1, 2000,
      the year ended December 30, 2000 and the year ended December 29, 2001, the
      Company purchased approximately 64%, 68% and 63%, respectively, of its
      retail inventory purchases from this supplier.

5.    Property and Equipment

      Property and equipment consist of the following:

<TABLE>
<CAPTION>
                                                                 December 30,       December 29,
                                                                     2000               2001
                                                              ------------------ ------------------
<S>                                                           <C>                <C>
       Land and buildings                                     $           1,042  $           1,042
       Computer equipment and software                                    3,592              6,776
       Furniture, fixtures, equipment, and vehicles                      12,544             13,049
       Leasehold improvements                                            14,305             12,944
                                                              ------------------ ------------------
                                                                         31,483             33,811
       Less:  Accumulated depreciation and amortization                  17,469             21,175
                                                              ------------------ ------------------
                                                              $          14,014  $          12,636
                                                              ================== ==================
</TABLE>

      Depreciation expense for the ten-months ended January 1, 2000, the year
      ended December 30, 2000 and the year ended December 29, 2001 was $2,731,
      $3,304 and $4,233, respectively.

6.    Goodwill and Other Intangibles

      Goodwill and other intangibles consist of the following:

<TABLE>
<CAPTION>
                                                 Straight-
                                                    Line
                                                Amortization
                                                   Period          December 30,       December 29,
                Description                       (years)              2000               2001
--------------------------------------------- ---------------- ------------------- ------------------
<S>                                                  <C>       <C>                 <C>
Goodwill                                             40        $           59,541  $          59,981
Trademark                                            20                       300                300
Copyrights                                            3                        43                 43
                                                               ------------------- ------------------
                                                                           59,884             60,324
Less:  Accumulated amortization                                             5,259              6,813
                                                               ------------------- ------------------
                                                               $           54,625  $          53,511
                                                               =================== ==================
</TABLE>

                                       29


<PAGE>

      Amortization expense for the ten-months ended January 1, 2000, the year
      ended December 30, 2000 and the year ended December 29, 2001 was $1,332,
      $1,518 and $1,819, respectively.

      Subsequent to December 29, 2001, the Company ceased operations at its
      Montgomery, Alabama plant. The Alabama plant has historically been
      utilized to manufacture product for Heilig-Meyers, which has now ceased
      operations in connection with Heilig-Meyers' bankruptcy proceedings. Based
      upon management's review of all available objective evidence, the
      recoverability of goodwill recorded in the Company's records for the
      Alabama plant is uncertain. Accordingly, the Company recorded a non-cash
      charge of $243 at December 29, 2001 to write-off the unamortized goodwill
      related to the Alabama plant. Such charge is included in general and
      administrative expenses in the accompanying statement of operations.
      Management believes that the net carrying value of tangible assets related
      to the Alabama plant approximates fair value.

7.    Accounts Payable and Accrued Liabilities

      Current accounts payable and accrued expenses consists of the following:

<TABLE>
<CAPTION>
                                                                December 30,       December 29,
                                                                    2000               2001
                                                             ------------------ ------------------
<S>                                                          <C>                <C>
       Accounts payable                                      $          26,757  $          26,952
       Accrued salaries, taxes and benefits                              4,589              3,332
       Accrued sales tax                                                 1,043                999
       Accrued interest                                                  8,188              8,441
       Customer deposits and layaway                                     3,033              3,398
       Other                                                             2,971              3,484
                                                             ------------------ ------------------
       Total                                                 $          46,581  $          46,606
                                                             ================== ==================
</TABLE>


       During the year ended December 30, 2000 and the year ended December 29,
       2001, the Company recorded severance expense of approximately $2.0
       million and $0.7 million, respectively, related to the resignations of
       certain executives. Approximately $1.2 million and $0.3 million of the
       severance expense was unpaid as of December 30, 2000 and December 29,
       2001, respectively.



      Noncurrent liabilities consist of the following:

<TABLE>
<CAPTION>
                                                                December 30,       December 29,
                                                                    2000               2001
                                                             ------------------ ------------------
<S>                                                          <C>                <C>
       Accrued rent                                          $           2,231  $           1,675
       Workers compensation reserve                                      1,557              2,057
       Other                                                               323                305
                                                             ------------------ ------------------
       Total                                                 $           4,111  $           4,037
                                                             ================== ==================
</TABLE>


8.    Amended Senior Credit Facility

      Until January 11, 2002, our liquidity needs were met primarily by our
      $20.0 million collateralized lending facility with a syndicate of banks
      (the "Prior Senior Credit Facility") originally entered into to finance a
      portion of the Recapitalization and to provide available borrowings for
      use in the normal course of business. The outstanding balance at December
      29, 2001 under the Prior Senior Credit Facility was $18.0 million with a
      weighted average interest rate of 8.7% for the year then ended. At
      December 29, 2001, the Company was not in compliance with the total debt
      ratio and interest coverage ratio covenants under the Prior Senior Credit
      Facility and, accordingly, sought waivers and modifications of certain of
      the covenants under the Prior Senior Credit Facility. In connection with
      that process, the Company entered into an amended and restated Senior

                                       30

<PAGE>

      Credit Facility (the "Amended Senior Credit Facility") on January 11,
      2002, which increased available liquidity from $20.0 million under the
      Prior Senior Credit Facility to $30.0 million under the Amended Senior
      Credit Facility. The Amended Senior Credit Facility provides for two
      tranches of revolving loans; Tranche A for up to $17.5 million (including
      letters of credit of up to $5.0 million) subject to limitations on
      availability pursuant to a borrowing base formula, which is based on
      eligible accounts receivable, inventory and property, plant and equipment,
      and Tranche B for up to $12.5 million. The interest rate under the Amended
      Senior Credit Facility, which is determined by the Company for each
      borrowing, is either; (1) the base rate, which is the higher of the prime
      lending rate (4.75% at December 29, 2001), the secondary market rate for
      three month depository certificates plus up to 1% or 0.5% in excess of the
      Federal funds effective rate, plus a margin or (2) the Eurodollar rate
      (1.8% at December 29, 2001) plus a margin. The margins of the loans under
      the Amended Senior Credit Facility are 2.5% for base rate loans and 3.5%
      for Eurodollar loans. Commitment fees are payable at a rate per annum of
      0.5% on the undrawn amounts of the Tranche A revolving loans.

      Pursuant to the terms of the Amended Senior Credit Facility, the Company
      is required to remit quarterly principal repayments on Tranche A of $250
      commencing on March 31, 2002. Additionally, there is a corresponding
      quarterly $250 decrease in the Tranche A commitment. However, the Tranche
      B commitment has a corresponding increase of $250 each quarter commencing
      on March 31, 2002, that can be used to fund the quarterly Tranche A
      payments.

      The Amended Senior Credit Facility requires that the Company meet certain
      levels of consolidated EBITDA, which is measured at the end of each fiscal
      quarter, beginning with the first quarter of 2002. In addition, the
      Amended Senior Credit Facility contains restrictions, subject to certain
      exceptions, including, but not limited to engaging in transactions with
      affiliates; prepaying subordinated debt and the Senior Notes; incurring
      indebtedness and liens; declaring dividends or redeeming or repurchasing
      capital stock; making loans and investments, engaging in mergers,
      acquisitions, consolidations and asset sales, and making capital
      expenditures. The revolving loans under the Amended Senior Credit Facility
      are due in February 2004.

      The Amended Senior Credit Facility is subject to mandatory prepayment in a
      variety of circumstances, including upon certain asset sales and certain
      equity and debt financing transactions, and also from excess cash flow, as
      defined in the agreement.

      Our primary supplier, a related party, purchased a $12.5 million
      participation in our Amended Senior Credit Facility.

      T.J.B., Bedding Experts and Holdings have guaranteed the Company's
      obligations under the Amended Senior Credit Facility. The Amended Senior
      Credit Facility is collateralized by substantially all assets of the
      Company.

      At December 30, 2000 and December 29, 2001, the Company had approximately
      $2.3 million and $3.9 million, respectively, of outstanding letters of
      credit, inclusive of cash collateralized letters of credit aggregating
      $1.9 million at December 29, 2001.

9.    Long-Term Debt

      Long-term debt consists of the following:

<TABLE>
<CAPTION>
                                                                                   December 30,       December 29,
                                                                                       2000               2001
                                                                                ----------------- --------------------
<S>                                                                             <C>               <C>
      Senior notes, maturing July 15, 2007, with an effective interest rate
         of 13.71%, net of unamortized discount of $6.5 million and $5.9
         million, at December 30, 2000 and December 29, 2001, respectively.
         Interest is payable semi-annually on January 15 and July 15 of each
         year.                                                                $           133,549 $          134,182
      Senior Credit Facility, line of credit revolver expiring in February
         2004 (see Note 8)                                                                    ---             18,000
      Other                                                                                   437                862
                                                                               ------------------ -------------------
                                                                                          133,986            153,044
      Less: Current portion of long term debt                                                 117                862
                                                                               ------------------ -------------------
      Long-term debt, excluding current portion                                $          133,869 $          152,182
                                                                               ================== ===================
</TABLE>

                                       31


<PAGE>

      On August 6, 1999, the Company issued 140,000 Units consisting of $140
      million aggregate principal amount of 12 5/8% Senior Notes ("Senior
      Notes") due July 15, 2007, of Mattress Discounters and separately
      transferable warrants (the "Warrants") to purchase an aggregate of 679,000
      shares of Class A common stock and 75,460 shares of Class L common stock
      of Holdings. The discount on the Senior Notes is being amortized through
      July 15, 2007, using the interest method. The notes are guaranteed on a
      senior uncollateralized basis by T.J.B. and Bedding Experts and, to the
      extent applicable, future domestic subsidiaries of the Company. The
      Company registered the Senior Notes with the Securities and Exchange
      Commission in July 2000.

      Except as discussed below, the Company may not redeem the Senior Notes
      prior to July 15, 2004. The Company may redeem the Senior Notes, in whole
      or in part, on or after July 15, 2004, at redemption prices of 106.313%,
      103.156%, and 100%, if redeemed during the 12- month period beginning on
      July 15, 2004, 2005 and 2006, respectively, plus accrued and unpaid
      interest, if any, to the date of repurchase. In addition, any time prior
      to July 15, 2002, the Company may redeem up to 35% of the Senior Notes at
      a redemption price equal to 112.625% of the principal amount, plus accrued
      and unpaid interest, with the net proceeds of equity issuances, provided
      that at least 65% of the aggregate principal amount of the Senior Notes
      originally issued remains outstanding immediately after each such
      redemption.

      Upon the occurrence of a "Change of Control," as defined by the indenture
      related to the Senior Notes, the Company will be required to make an offer
      to repurchase each holder's Senior Notes in whole or in part at a price
      equal to 101% of the principal amount thereof, plus accrued and unpaid
      interest, if any, to the date of repurchase. In addition, upon occurrence
      of a "Change of Control" occurring prior to July 15, 2004, the Company may
      redeem all of the Senior Notes at a redemption price equal to 100% of the
      principal amount thereof plus the Applicable Premium, as defined, plus
      accrued and unpaid interest, if any, to the date of repurchase.

      The Senior Notes contain certain restrictions, including, but not limited
      to, limits on additional indebtedness and preferred stock; limits on
      restricted payments; limits on transactions with affiliates; limits on
      liens; limits on dividends and other payment restrictions affecting
      subsidiaries; and restrictions on consolidations, mergers and the sale of
      assets.

      The Warrants entitle the holders thereof to acquire an aggregate of
      679,000 shares of Holdings' Class A common stock and 75,460 shares of
      Holdings' Class L common stock, representing approximately 5% of Holdings'
      fully diluted common stock immediately after giving effect to the
      consummation of the Transaction Agreement. The Warrants will expire on
      July 15, 2007 (the "Expiration Date"). Each Warrant entitles the holder to
      acquire, on or after the Exercisability Date (as defined below) and prior
      to the Expiration Date, 4.850 shares of Holdings' Class A common stock and
      0.539 shares of Holdings' Class L common stock at a price equal to $0.01
      per share, subject to adjustment from time to time upon the occurrence of
      certain changes in the Class A common stock and Class L common stock and
      certain issuances of Class A common stock and Class L common stock,
      options or convertible securities of Holdings.

      The "Exercisability Date" means the first day that any of the following
      has occurred: (i) upon the closing of an Initial Public Offering; (ii) a
      class of equity securities of Holdings is listed on a national securities
      exchange or authorized for quotation on the Nasdaq National Market or is
      otherwise subject to registrations under the Exchange Act, or (iii) the
      date at which the Warrants become separately transferable.

      The net proceeds from the sale of the Notes and Warrants was $134.9
      million. Holdings and the Company have determined that approximately $2.2
      million of the net proceeds should be allocated to the Warrants, based on
      the relative fair values of the Notes and Warrants. Accordingly, this
      amount has been reflected in the Company's financial statements as a
      contribution of capital from Holdings. The fair value of the warrants was
      determined based on the value of Holdings' equity purchased by Bain
      Capital and the other Holdings' equity investors. This value was
      discounted by 40% to reflect the minority portion since the warrants
      issued only represent 5% of our fully diluted ownership and the
      limitations on the transferability of ownership of the minority interest.

                                       32

<PAGE>

    The aggregate maturties of long term debt are as follows:

                   Year                               Amount
                   ----                         ------------------

                   2002                         $              862
                   2004                                     18,000
                   2007                                    134,182
                                                ------------------
                   Total                        $          153,044
                                                ==================

    Interest payments of $228, $17,025 and $20,989 were made during the
    ten-month period ended January 1, 2000, the year ended December 30, 2000 and
    the ended December 29, 2001, respectively.

10. Income Taxes

    The provision for income taxes in the consolidated financial statements for
    periods prior to August 6, 1999, reflect tax calculations on a separate
    company basis and do not reflect actual taxes owed by the Company on the
    Heilig-Meyers consolidated tax return through August 5, 1999. The provision
    for income taxes for the years ended December 30, 2000 and December 29, 2001
    also reflect tax calculations on a separate company basis and do not reflect
    actual taxes owed by the Company on the Holdings consolidated tax return.


    Mattress Discounters and Heilig-Meyers entered into a Tax Agreement in
    conjunction with the Transaction Agreement. The Tax Agreement requires
    Heilig-Meyers to be responsible for and to pay all taxes resulting from
    pre-August 6, 1999 operations, including any federal and state income tax
    attributable to the making of an Internal Revenue Code section 338(h)(10)
    election. The Company shall be responsible for and pay all taxes resulting
    from post-August 5, 1999 operations.

    As a result of the 338(h)10 election, the Company stepped up the tax basis
    of its net assets which resulted in recognition of a deferred tax asset of
    $88.7 million and additional paid-in capital, comprised primarily of future
    tax goodwill amortization deductions and differences between the tax and
    book basis for inventory.

    At December 30, 2000, deferred tax assets aggregated $92.0 million. These
    deferred tax assets primarily relate to net operating loss carryforwards and
    future goodwill amortization deductions. The future utilization of these tax
    assets is dependent upon the generation of future taxable income. During the
    year ended December 29, 2001, events and circumstances caused the Company to
    reevaluate the recoverability of its deferred tax assets. Based upon a
    number of factors, management believes that the available objective evidence
    creates sufficient uncertainty regarding the recoverability of the Company's
    deferred tax assets. Accordingly, a non-cash charge in the aggregate amount
    of $92.0 million has been recorded during the year ended December 29, 2001
    to establish a 100% valuation allowance against the deferred tax assets.
    Such charge is reflected in the provision for income taxes in the
    accompanying statement of operations. The recording of the deferred tax
    asset valuation allowance for financial reporting purposes does not have any
    impact on the Company's ability to offset future taxable income. Primarily
    as a result of the Company's pre-tax loss incurred for the year ended
    December 29, 2001, additional tax net operating losses have been generated
    and, as such, give rise to an additional deferred tax asset of $18,698.
    Accordingly, the Company recorded a corresponding increase in its deferred
    tax asset valuation allowance at December 29, 2001.

    The provision for income taxes consists of the following:

<TABLE>
<CAPTION>
                                           Ten-Months
                                             Ended           Year Ended         Year Ended
                                           January 1,       December 30,       December 29,
                                              2000              2000               2001
                                        ---------------   ----------------  -----------------
<S>                                     <C>               <C>               <C>
    Current:                            $         3,446   $              -  $               -
      Federal                                       644                198                709
      State                             ---------------   ----------------  -----------------
                                                  4,090                198                709
                                        ---------------   ----------------  -----------------

    Deferred:                                    (1,622)               642             78,209
      Federal                                      (287)               113             13,801
      State                             ---------------   ----------------  -----------------
                                                 (1,909)               755             92,010
                                        ---------------   ----------------  -----------------
                                        $         2,181   $            953  $          92,719
                                        ===============   ================  =================
</TABLE>



                                       33

<PAGE>

    The temporary differences that gave rise to significant portions of the net
    deferred tax assets as of December 30, 2000 and December 29, 2001 consist of
    the following:

<TABLE>
<CAPTION>
                                                                          December 30,       December 29,
                                                                              2000              2001
                                                                      ------------------ -------------------
   <S>                                                                <C>                    <C>
   Deferred tax assets:
     Net operating loss carryforwards                                 $           10,175 $           31,274
     Goodwill                                                                     74,980             72,606
     Inventories                                                                   4,027              4,397
     Accrued liabilities and noncurrent liabilities                                2,474              2,118
     Property and equipment                                                          314                313
     Accounts receivable                                                              40                ---
                                                                      ------------------ -------------------
                                                                                  92,010            110,708
     Less: valuation allowance                                                       ---           (110,708)
                                                                      ------------------ -------------------
                                                                      $           92,010 $              ---
                                                                      ================== ===================
</TABLE>

    Net operating loss carryforwards at December 29, 2001 aggregated
    approximately $78.2 million and are available to offset future taxable
    income. Net operating loss carryforwards begin to expire in 2020. If certain
    substantial changes in the Company's ownership should occur, there would be
    an annual limitation of the amount of carryforwards that can be utilized.

    A reconciliation of the statutory federal income tax rate to the Company's
    effective rate is provided below:

<TABLE>
<CAPTION>
                                                                Ten-Months      Year           Year
                                                                  Ended         Ended          Ended
                                                                January 1,   December 30,  December 29,
                                                                   2000          2000          2001
                                                              ------------------------------------------
     <S>                                                      <C>            <C>           <C>
     Statutory federal income tax rate                             34.0%         34.0%        (34.0)%
     State income taxes, net of federal income tax benefit          7.9%        117.2%          1.6%
     Goodwill amortization                                         10.4%        194.3%          2.1%
     Valuation allowance                                            ---           ---         338.2%
     Other, net                                                    (1.5)%        12.8%          0.1%
                                                              ------------------------------------------
                                                                   50.8%        358.3%        308.0%
                                                              ==========================================
</TABLE>

    Federal and state income tax payments of $461 were made to Heilig-Meyers
    during the ten-month period ended January 1, 2000. The Company paid federal
    and state income taxes of $71 and $817 during the years ended December 30,
    2000 and December 29, 2001, respectively, of which $688 of state income
    taxes were paid in 2001 for periods prior to August 6, 1999.

11. Retirement Plans

    As of January 1, 1999 the Company began participating in the Heilig-Meyers'
    qualified profit-sharing and retirement savings plan, which included a cash
    or deferred arrangement under Section 401(k) of the Internal Revenue Code
    and covered substantially all of the Company's employees. Subsequent to the
    Recapitalization, the Company created a proto-type plan, with substantially
    the same provisions as the plan with Heilig-Meyers. The plan expense for the
    Company participants recognized in the ten-month period ended January 1,
    2000, the year ended December 30, 2000 and the year ended December 29, 2001,
    was $152, $191 and $211, respectively.

                                       34

<PAGE>

12. Commitments and Contingencies

    Leases
    ------

    The Company has entered into noncancellable lease agreements with initial
    terms ranging from 1 to 15 years for certain stores, warehouses and the
    corporate office. Certain leases include renewal options ranging from 1 to
    10 years which may be exercised at the Company's option. Most of the leases
    are net leases under which the Company pays its proportionate share of the
    taxes, insurance and maintenance costs.

    Future minimum lease payments under operating leases are as follows:

                                                                Operating
                                                                  Leases
                                                           ------------------

              2002                                         $           27,723
              2003                                                     24,695
              2004                                                     19,493
              2005                                                     14,724
              2006                                                      9,709
              Thereafter                                               20,851
                                                           ------------------
              Total minimum lease payments                 $          117,195
                                                           ==================

    Total rental expense under operating leases for the ten-month period ended
    January 1, 2000, the year ended December 30, 2000 and the year ended
    December 29, 2001, was $16,891, $21,945 and $26,215, respectively.

    Certain leases include escalation clauses for adjusting rentals to reflect
    changes in price indices or to reflect normal step increases with the
    passage of time. Rent expense is calculated on straight-line basis with the
    difference between actual cash rental payments and straight-line rental
    expense recorded as accrued rent (see Note 7). Certain leases provide for
    contingent rentals which are based on sales volumes.

    Included in the above future minimum lease payments are certain properties
    that the Company has subleased to third parties. Such sublease agreements
    provide for future annual rental income, used to reduce rent expense,
    through 2008, with minimum sublease rental income aggregating $1,032 in
    2002, $600 in 2003, $253 in 2004, $209 in 2005, $99 in 2006, and $47
    thereafter.

    Additionally, in connection with previous store closings in the New York and
    Denver markets, the Company entered into sublease agreements for certain
    locations whereby the subtenant pays the operating lease obligations
    directly to the landlord. However, the Company is contingently liable for
    future rentals with respect to such subleases if the subleasee defaults on
    their commitment. Future minimum rents associated with these subleases are
    $2,461 in 2002, $2,007 in 2003, $1,477 in 2004, $1,279 in 2005, $913 in 2006
    and $1,645 thereafter.

    Subsequent to December 29, 2001, the Company entered into an agreement with
    an affiliate of Sealy for the exchange and assignment of certain operating
    leases. Pursuant to the terms of the agreement, the Company has assumed
    leases for four stores in the Richmond, Virginia market in exchange for the
    affiliate assuming leases for eight stores in the Tampa, Florida market.
    Further, the Company has a continuing liability under the Tampa, Florida
    leases in the event the affiliate defaults on its commitment under these
    lease assignments. Future minimum rents associated with the eight Tampa,
    Florida leases are $484 in 2002, $429 in 2003, $292 in 2004, $186 in 2005,
    $143 in 2006 and $297 thereafter. Future minimum rents associated with the
    four Richmond, Virginia leases are $327 in 2002, $329 in 2003, $243 in
    2004, $133 in 2005, $87 in 2006 and $403 thereafter.

                                       35

<PAGE>

    Legal Matters
    -------------

    The Company is party to various proceedings from time to time arising in the
    ordinary course of business. The Company does not expect that these matters,
    individually or in the aggregate, will have a material adverse effect on the
    business, financial condition or results of operations. Additionally, as of
    December 29, 2001, the Company is a defendant in a State Court class action
    lawsuit brought by certain current or former employees. The Company is
    currently unable to determine the outcome or the loss, if any, that may
    occur as a result of this litigation.

    Employment Contracts and Separation Agreements
    ----------------------------------------------

    The Company has employment agreements with certain executive officers. The
    agreements automatically extend for one-year periods if not canceled before
    the expiration dates. Such agreements provide for certain minimum salary
    levels, adjusted annually for cost-of-living changes, fringe benefits and
    performance bonuses, as defined in the agreements.

13. Stock Option and Performance Stock Award Plans

    In August 1999, in connection with the Recapitalization, 637,500 options
    were granted to certain of the Company's executives by Holdings, to purchase
    Holdings' Class A and Class L common stock. These options ("Management Stock
    Options") were immediately exercisable with exercise prices below fair
    value, resulting in a non-cash compensation charge of approximately $2.9
    million at the grant date. During the year ended December 30, 2000,
    Management Stock Options for 629,167 shares were repurchased by the Company
    in connection with the resignations of certain executives for approximately
    $2.8 million, and the Company recorded compensation expense of $90,000
    related to the repurchase of the Management Stock Options. The repurchase of
    the stock options has been recorded as a reduction of additional paid-in
    capital. The Management Stock Options expire ten years from the date of
    grant. There were no Management Stock Options exercised during the year
    ended December 29, 2001, 7,500 options exercised in fiscal 2000, and no
    options exercised during the ten-months ended January 1, 2000.

    During the year ended December 29, 2001, the year ended December 30, 2000,
    and the ten-months ended January 1, 2000, non-qualified options for 20,000,
    899,760 and 1,560,057 shares, respectively, were granted to employees
    ("Employee Stock Options") to purchase Holdings' Class A common stock for
    $0.67 per share and are generally exercisable beginning one year from the
    date of grant in cumulative yearly amounts of 20% of the shares under option
    and generally expire ten years from the date of grant. During the year ended
    December 29, 2001, the year ended December 30, 2000, and the ten-months
    ended January 1, 2000, Employee Stock Options for 528,537, 1,264,960 and
    zero shares, respectively, were forfeited by employees. No Employee Stock
    Options have been exercised.

    The fair value of options granted (which is amortized to expense over the
    option-vesting period in determining the pro forma impact) are estimated on
    the date of grant using the Black-Scholes option-pricing model with the
    following weighted-average assumptions:

<TABLE>
<CAPTION>
                                                                For the
                                                               Ten-month        For the         For the
                                                              Period ended     Year ended      Year ended
                                                               January 1,     December 30,    December 29,
                                                                  2000            2000            2001
                                                           ------------------------------------------------
        <S>                                                <C>               <C>            <C>
        Expected life of option                                5.7 years       6.0 years       6.0 years
        Risk free interest rate                                     6.07%           6.35%           5.18%
        Expected volatility of Holdings' stock                     39.81%          37.74%          40.26%
        Expected dividend yield                                     0.00%           0.00%           0.00%
</TABLE>

    The weighted-average fair value of Management Stock Options and
    non-qualified options granted to employees was $44.05 and $0.33,
    respectively, during the ten-months ended January 1, 2000. The
    weighted-average fair value of non-qualified options granted to employees
    was $0.32 during each of the years ended December 30, 2000 and December 29,
    2001. If the Company used the fair value-based method of accounting

                                       36

<PAGE>

    for these stock options and charged compensation cost against operations,
    over the vesting period, based on the fair value of options at the date of
    grant, net income (loss) would have changed to the following pro forma
    amounts:

<TABLE>
<CAPTION>
                                                 For the
                                                Ten-month           For the            For the
                                               Period ended        Year ended         Year ended
                                                January 1,        December 30,       December 29,
                                                   2000               2000               2001
                                             ----------------  -----------------------------------
        <S>                                  <C>               <C>                 <C>
        Net income (loss):
           As reported                        $         2,104   $          (687)   $      (122,821)
           Pro forma                          $         1,825   $          (782)   $      (122,909)
</TABLE>

    The following table summarizes information about stock options outstanding
    at December 30, 2000 and December 29, 2001:

<TABLE>
<CAPTION>
                                                                   December 30,     December 29,
        Description of Option and Exercise Price                       2000             2001
        ----------------------------------------                  --------------  ----------------
        <S>                                                       <C>             <C>
        Holdings' Class A Common Stock Options - $ 0.67                1,205,981           697,444
        Holdings' Class L Common Stock Options - $13.50                      833               833
                                                                  --------------  ----------------
                                                                       1,206,814           698,277
                                                                  ==============  ================
</TABLE>

    As of December 29, 2001, 833 Management Stock Options and 249,600
    non-qualified options were exercisable. The weighted average remaining
    contractual life for stock options outstanding at December 29, 2001 is
    approximately 8 years.

14. Segment Information

    Retail
    ------

    Sale of mattresses and bedding products through 300 retail locations at
    December 29, 2001.

    Manufacturing
    -------------

    Manufacture and sale of mattresses, box springs and foundations to the
    retail segment and an affiliate and to unrelated third parties.

    The accounting policies of these segments are the same as those described in
    the summary of significant accounting policies. All intersegment sales
    prices are market-based. The Company evaluates performance based on the
    operating earnings of the respective business units.

    Summarized financial information concerning the Company's reportable
    segments is shown in the following table:

<TABLE>
<CAPTION>
                                                             Manufacturing
                                                 ---------------------------------------
                                                   Retail      Affiliates /                 Interco.
                  Period (1)           Retail      Segment    Third Parties     Total        Elim.       Consolidated
              ---------------------  ----------  -----------  -------------  -----------  -----------  ----------------
  <S>           <C>                <C>           <C>          <C>            <C>          <C>          <C>
  Net Sales     December 29, 2001  $   242,455   $    36,238        $ 1,757  $    37,995  $    36,238  $        244,212
                December 30, 2000      260,414        39,545         14,811       54,356       39,545           275,225
                  January 1, 2000      211,062        34,262          9,615       43,877       34,262           220,677
</TABLE>

                                       37

<PAGE>

<TABLE>
<CAPTION>
                                                                                     Corporate /
                                Period (1)           Retail       Manufacturing         Other        Consolidated
                        -------------------------- ----------  -------------------- -------------- ----------------
<S>                             <C>                <C>               <C>             <C>           <C>
  Segment profit (2)            December 29, 2001  $ (16,916)        $    7,744     $     -        $      (9,172)
                                December 30, 2000      7,999             11,545           -               19,544
                                  January 1, 2000      2,459              9,662           -               12,121

  Depreciation                  December 29, 2001      4,942              1,110           -                6,052
      and amortization          December 30, 2000      3,865                957           -                4,822
                                  January 1, 2000      3,196                867           -                4,063

  Capital expenditures          December 29, 2001      3,396                 30           -                3,426
                                December 30, 2000      6,564                197           -                6,761
                                  January 1, 2000      2,150                465           -                2,615

  Identifiable assets(3)        December 29, 2001     27,881              2,735         75,130           105,746
                                December 30, 2000     30,105              3,747        175,706           209,558

  -----------------------------------------------------------------------------------------------------------------
</TABLE>

(1)  Periods are as follows: year ended December 29, 2001, year ended December
     30, 2000 and ten-months ended January 1, 2000.
(2)  Segment profit represents income (loss) from operations.
(3)  Identifiable assets represent only inventories and net property and
     equipment in the retail and manufacturing segments. All other assets are
     included in Corporate/Other. For management purposes, depreciation and
     amortization of corporate identifiable assets are allocated to the retail
     and manufacturing segments.

15.  Related Party

     The Company currently accrues an annual advisory fee of $1.0 million to
     Bain Capital for management and advisory services, plus out-of-pocket
     expenses. During the ten-month period ended January 1, 2000, the year
     ended December 30, 2000 and the year ended December 29, 2001, the Company
     recognized expense for approximately $0.4 million, $1.2 million and $1.2
     million, respectively.

     Revenues from sales to Heilig-Meyers of mattresses, box springs and
     foundations were $9,615, $14,811 and $1,739 for the ten-month period ended
     January 1, 2000, the year ended December 30, 2000 and the year ended
     December 29, 2001, respectively.

     The Company has been pursuing its rights in the Heilig-Meyers bankruptcy
     proceeding to recover an outstanding receivable in the aggregate amount of
     $1,564. While the Company continues to pursue its rights related to this
     claim, events occurring in the second quarter of 2001 caused management to
     believe that the recoverability of this amount was uncertain. Accordingly,
     a charge of $1,564 was recorded during the second quarter of 2001 to
     establish a reserve against this outstanding receivable.

     Prior to August 6, 1999, Heilig-Meyers allocated costs to the Company for
     certain services including cash management, real estate, tax and
     accounting, and information technology support. In addition, Heilig-Meyers
     allocated other corporate overhead costs including executive management and
     the treasury department based on the Company's budgeted sales and bonuses.
     Amounts allocated to the Company were approximately $707 for the period of
     March 1, 1999 through August 5, 1999. Management believes the allocation of
     these costs is reasonable.

                                       38

<PAGE>

16.  Consolidating Financial Information

     The Company's Amended Senior Credit Facility and Senior Notes are
     guaranteed, fully, jointly and severally, and unconditionally by all of the
     Mattress Discounters' current and future, direct and indirect subsidiaries.
     The following is summarized condensed consolidating financial information
     of the Company, segregating the parent company (Mattress Discounters) and
     its guarantor subsidiaries. As described in Note 1--Organization and Basis
     of Financial Statement Presentation, each of Mattress Discounters'
     subsidiaries are wholly-owned. Separate financial statements of the
     guarantor subsidiaries are not presented because management believes that
     separate financial statements would not be beneficial to investors.

          Index to Condensed Consolidating Information
          --------------------------------------------

          .  Consolidating Balance Sheets at December 29, 2001
          .  Consolidating Statements of Operations for the year ended December
             29, 2001
          .  Condensed Consolidating Statements of Cash Flows for the year ended
             December 29, 2001
          .  Consolidating Balance Sheets at December 30, 2000
          .  Consolidating Statements of Operations for the year ended December
             30, 2000
          .  Condensed Consolidating Statements of Cash Flows for the year ended
             December 30, 2000
          .  Consolidating Statements of Operations for the ten-month period
             ended January 1, 2000
          .  Condensed Consolidating Statements of Cash Flows for the ten-month
             period ended January 1, 2000.

                                       39

<PAGE>

                          Consolidating Balance Sheets
                                December 29, 2001
                                 (in thousands)

<TABLE>
<CAPTION>
                                                           Mattress
                                                          Discounters
                                                          Corporation
                                                            (Parent        Guarantor        Consolidating     Consolidated
                                                           Company)       Subsidiaries       Adjustments         Totals
                                                        --------------- ---------------- ------------------ ----------------
                        Assets
<S>                                                     <C>             <C>              <C>                <C>
Cash and cash equivalents                               $        3,556  $           305  $        -         $         3,861
Accounts receivable                                              3,684            1,658           -                   5,342
Inventories, net                                                12,348            5,840               (208)          17,980
Prepaid expenses and other current assets                        1,486               13           -                   1,499
Intercompany receivable                                          4,038            4,765             (8,803)         -
                                                        --------------- ---------------- ------------------ ----------------
      Total current assets                                      25,112           12,581             (9,011)          28,682

Property and equipment, net                                      9,798            2,838           -                  12,636
Debt issue costs and other assets                               10,382              535           -                  10,917
Goodwill and other intangibles, net                             45,507            8,004           -                  53,511
Investment in subsidiaries                                         927         -                      (927)         -
                                                        --------------- ---------------- ------------------ ----------------
      Total assets                                      $       91,726  $        23,958  $          (9,938) $       105,746
                                                        =============== ================ ================== ================

  Liabilities and Stockholder's Equity (Deficiency)
Current portion of long-term debt                       $          549  $           313  $        -         $           862
Accounts payable and accrued expenses                           34,210           12,396           -                  46,606
Intercompany payable                                           -                  9,011             (9,011)         -
                                                        --------------- ---------------- ------------------ ----------------
      Total current liabilities                                 34,759           21,720             (9,011)          47,468
                                                        --------------- ---------------- ------------------ ----------------

Long-term debt, excluding current portion                      152,182         -                  -                 152,182
Other noncurrent liabilities                                     2,726            1,311                               4,037
                                                        --------------- ---------------- ------------------ ----------------
      Total liabilities                                        189,667           23,031             (9,011)         203,687
                                                        --------------- ---------------- ------------------ ----------------

Stockholder's equity (deficiency):
  Common stock                                                 -               -                  -                 -
  Additional paid-in capital                                    27,014         -                  -                  27,014
  Retained earnings (accumulated deficit)                     (124,955)             927               (927)        (124,955)
                                                        --------------- ---------------- ------------------ ----------------
      Total stockholder's equity (deficiency)                  (97,941)             927               (927)         (97,941)
                                                        --------------- ---------------- ------------------ ----------------
      Total liabilities and stockholder's equity
      (deficiency)                                      $       91,726  $        23,958  $          (9,938) $       105,746
                                                        =============== ================ ================== ================
</TABLE>

                                       40

<PAGE>

                     Consolidating Statements of Operations
                      For the Year Ended December 29, 2001
                                 (in thousands)

<TABLE>
<CAPTION>

                                                      Mattress
                                                    Discounters
                                                    Corporation
                                                      (Parent         Guarantor      Consolidating      Consolidated
                                                      Company)       Subsidiaries     Adjustments          Totals
                                                  ---------------  ----------------  ---------------  ----------------
<S>                                               <C>              <C>               <C>              <C>
Net sales                                         $      168,234   $        89,232   $      (13,254)  $       244,212
Cost of sales                                            111,239            62,151           (7,051)          166,339
                                                  ---------------  ----------------  ---------------  ----------------
  Gross profit                                            56,995            27,081           (6,203)           77,873
General and administrative expenses                       57,585            29,460                -            87,045
                                                  ---------------  ----------------  ---------------  ----------------

  Loss from operations                                      (590)           (2,379)          (6,203)           (9,172)

Interest income                                              311                 1                -               312
Interest expense                                         (21,209)              (33)               -           (21,242)
Other income/(expense), net                               (2,428)                -            2,428                 -
                                                  ---------------  ----------------  ---------------  ----------------
Loss before income taxes                                 (23,916)           (2,411)          (3,775)          (30,102)
Provision for income taxes                                92,702                17                -            92,719
                                                  ---------------  ----------------  ---------------  ----------------
Net loss                                          $     (116,618)  $        (2,428)  $       (3,775)  $      (122,821)
                                                  ===============  ================  ===============  ================
</TABLE>


                     Consolidating Statements of Cash Flows
                      For the Year Ended December 29, 2001
                                 (in thousands)

<TABLE>
<CAPTION>

                                                      Mattress
                                                    Discounters
                                                    Corporation
                                                      (Parent           Guarantor     Consolidating      Consolidated
                                                      Company)        Subsidiaries     Adjustments          Totals
                                                  ---------------  ----------------  ---------------- ------------------
<S>                                               <C>              <C>               <C>              <C>
Cash flows provided by (used in) operating
   activities                                     $      (17,961)  $           734                -         $   (17,227)
Cash flows used in investing activities                   (2,345)             (784)               -              (3,129)
Cash flows provided by (used in) financing
   activities                                             16,076               (54)               -              16,022
                                                  ---------------  ----------------  ---------------- ------------------
Net decrease in cash and cash equivalents                 (4,230)             (104)               -              (4,334)
Cash and cash equivalents, beginning of year               7,786               409                -               8,195
                                                  ---------------  ----------------  ---------------- ------------------
Cash and cash equivalents, end of year            $        3,556   $           305   $            -         $     3,861
                                                  ===============  ================  ================ ==================
</TABLE>

                                       41

<PAGE>

                          Consolidating Balance Sheets
                                December 30, 2000
                                 (in thousands)

<TABLE>
<CAPTION>

                                                      Mattress
                                                    Discounters
                                                    Corporation
                                                      (Parent         Guarantor      Consolidating      Consolidated
                                                      Company)       Subsidiaries     Adjustments          Totals
                                                  --------------- ----------------  ---------------- ------------------
                        Assets
 <S>                                              <C>             <C>               <C>              <C>
Cash and cash equivalents                         $        7,786  $            409                -  $           8,195
Accounts receivable                                        5,102             3,032                -              8,134
Inventories, net                                          13,033             7,067  $          (262)            19,838
Prepaid expenses and other current assets                    950                39                -                989
Due from affiliate, net                                    1,907                 -                -              1,907
Intercompany receivable                                    3,270             1,993           (5,263)                 -
Deferred tax assets                                        3,693               374                               4,067
                                                    ------------- ----------------  ---------------- ------------------
      Total current assets                                35,741            12,914           (5,525)            43,130

Property and equipment, net                               10,202             3,812                -             14,014
Debt issue costs and other assets                          9,503               343                -              9,846
Goodwill and other intangibles, net                       46,372             8,253                -             54,625
Investment in subsidiaries                                 3,355                 -           (3,355)                 -
Deferred tax assets                                       87,785               158                -             87,943
                                                  --------------- ----------------  ---------------- ------------------
      Total assets                                $      192,958  $         25,480  $        (8,880) $         209,558
                                                  =============== ================  ================ ==================

      Liabilities and Stockholder's Equity
Current portion of long-term debt                 $           69  $             48  $             -  $             117
Accounts payable and accrued expenses                     32,076            14,505                -             46,581
Intercompany payable                                           -             5,525           (5,525)                 -
                                                  --------------- ----------------  ---------------- ------------------
      Total current liabilities                           32,145            20,078           (5,525)            46,698
                                                  --------------- ----------------  ---------------- ------------------

Long-term debt, excluding current portion                133,550               319                -            133,869
Other noncurrent liabilities                               2,383             1,728                -              4,111
                                                  --------------- ----------------  ---------------- ------------------
      Total liabilities                                  168,078            22,125           (5,525)           184,678

Stockholder's equity:
  Common stock                                                 -                 -                -                  -
  Additional paid-in capital                              27,014                 -                -             27,014
  Retained earnings (accumulated deficit)                 (2,134)            3,355           (3,355)            (2,134)
                                                  --------------- ----------------  ---------------- ------------------
      Total stockholder's equity                          24,880             3,355           (3,355)            24,880
                                                  --------------- ----------------  ---------------- ------------------
      Total liabilities and stockholder's equity  $      192,958  $         25,480  $        (8,880) $         209,558
                                                  =============== ================  ================ ==================
</TABLE>

                                       42

<PAGE>

                     Consolidating Statements of Operations
                      For the Year Ended December 30, 2000
                                 (in thousands)

<TABLE>
<CAPTION>

                                                      Mattress
                                                    Discounters
                                                    Corporation
                                                      (Parent         Guarantor      Consolidating      Consolidated
                                                      Company)       Subsidiaries     Adjustments          Totals
                                                    -------------   ---------------  ---------------  ----------------
<S>                                                 <C>             <C>              <C>              <C>
Net sales                                           $    188,945    $      100,757   $      (14,477)  $       275,225
Cost of sales                                            116,399            67,401           (7,829)          175,971
                                                    -------------   ---------------  ---------------  ----------------
   Gross profit                                           72,546            33,356           (6,648)           99,254
General and administrative expenses                       49,866            29,844                -            79,710
                                                    -------------   ---------------  ---------------  ----------------

   Income from operations                                 22,680             3,512           (6,648)           19,544

Interest income                                              683                 -                -               683
Interest expense                                         (19,924)              (37)               -           (19,961)
Other income/(expense), net                                2,085                 -           (2,085)                -
                                                    -------------   ---------------  ---------------  ----------------
Income before income taxes                                 5,524             3,475           (8,733)              266
Provision for (benefit from) income taxes                   (437)            1,390                -               953
                                                    -------------   ---------------  ---------------  ----------------
Net income (loss)                                   $      5,961    $        2,085   $       (8,733)  $          (687)
                                                    =============   ===============  ===============  ================
</TABLE>


                     Consolidating Statements of Cash Flows
                      For the Year Ended December 30, 2000
                                 (in thousands)

<TABLE>
<CAPTION>

                                                      Mattress
                                                    Discounters
                                                    Corporation
                                                      (Parent          Guarantor     Consolidating      Consolidated
                                                      Company)       Subsidiaries     Adjustments          Totals
                                                    -------------   ---------------  ---------------  ----------------
<S>                                                 <C>             <C>              <C>              <C>
Cash flows provided by operating activities         $     10,057    $       1,164                 -   $        11,221
Cash flows used in investing activities                   (5,407)          (1,347)                -            (6,754)
Cash flows used in financing activities                   (3,751)             (33)                -            (3,784)
                                                    -------------   ---------------  ---------------  ----------------
Net increase (decrease) in cash and cash
  equivalents                                                899             (216)                -               683
Cash and cash equivalents, beginning of year               6,888              624                 -             7,512
                                                    -------------   ---------------  ---------------  ----------------
Cash and cash equivalents, end of year              $      7,787    $         408    $            -   $         8,195
                                                    =============   ===============  ===============  ================
</TABLE>

                                       43

<PAGE>

                     Consolidating Statements of Operations
                 For the Ten-Month Period Ended January 1, 2000
                                 (in thousands)

<TABLE>
<CAPTION>

                                                          Mattress
                                                         Discounters
                                                         Corporation
                                                           (Parent        Guarantor       Consolidating     Consolidated
                                                          Company)       Subsidiaries      Adjustments         Totals
                                                       --------------- ---------------- ----------------- -----------------
<S>                                                    <C>             <C>              <C>               <C>
Net sales                                              $      145,024  $        89,552  $        (13,899) $        220,677
Cost of sales                                                  86,480           62,448            (5,921)          143,007
                                                       --------------- ---------------- ----------------- -----------------
   Gross profit                                                58,544           27,104            (7,978)           77,670

General and administrative expenses                            36,246           24,649                 -            60,895
Other operating expenses                                        4,654                -                 -             4,654
                                                       --------------- ---------------- ----------------- -----------------
   Income from operations                                      17,644            2,455            (7,978)           12,121

Interest income                                                   199                -                 -               199
Interest expense                                               (8,000)             (35)                -            (8,035)
Other income/(expense), net                                     1,268                -            (1,268)                -
                                                       --------------- ---------------- ----------------- -----------------
Income before income taxes                                     11,111            2,420            (9,246)            4,285
Provision for income taxes                                      1,029            1,152                 -             2,181
                                                       --------------- ---------------- ----------------- -----------------
Net income                                             $       10,082  $         1,268  $         (9,246) $          2,104
                                                       =============== ================ ================= =================
</TABLE>


                     Consolidating Statements of Cash Flows
                 For the Ten-Month Period Ended January 1, 2000
                                 (in thousands)

<TABLE>
<CAPTION>

                                                          Mattress
                                                         Discounters
                                                         Corporation
                                                           (Parent        Guarantor        Consolidating      Consolidated
                                                          Company)       Subsidiaries       Adjustments          Totals
                                                       --------------- ---------------- ----------------- -----------------
<S>                                                    <C>             <C>              <C>               <C>
Cash flows provided by operating activities            $       10,752  $        14,963            (9,247) $         16,468
Cash flows provided by (used in) investing activities           2,799          (15,375)            9,247            (3,329)
Cash flows used in financing activities                        (6,844)            (149)                -            (6,993)
                                                       --------------- ---------------- ----------------- -----------------
Net increase (decrease) in cash and cash equivalents            6,707             (561)                -             6,146
Cash and cash equivalents, beginning of period                    180            1,186                 -             1,366
                                                       --------------- ---------------- ----------------- -----------------
Cash and cash equivalents, end of period               $        6,887  $           625  $              -  $          7,512
                                                       =============== ================ ================= =================
</TABLE>

                                       44

<PAGE>

17.   Quarterly Results of Operations (Unaudited)

<TABLE>
<CAPTION>

                                                          First      Second       Third      Fourth
                 (in millions of dollars)                Quarter     Quarter     Quarter     Quarter      Total
      ------------------------------------------------  ----------  ----------  ----------  ----------  ----------
      <S>                                               <C>         <C>         <C>         <C>         <C>
      Net sales:
         Year ended December 30, 2000                        72.4        66.8        73.4        62.6       275.2
         Year ended December 29, 2001                        60.0        61.4        69.1        53.7       244.2

      Gross profit:
         Year ended December 30, 2000                        24.9        24.8        27.8        21.8        99.3
         Year ended December 29, 2001                        17.7        20.3        24.0        15.9        77.9

      Net income (loss):
         Year ended December 30, 2000                        (0.5)        0.3         1.1        (1.6)       (0.7)
         Year ended December 29, 2001                        (4.4)       (6.5)     (102.9)       (9.0)     (122.8)
</TABLE>

ITEM 9.  Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure.

      None.


                                    PART III

ITEM 10. Directors and Executive Officers of the Registrant.

      The following table sets forth information about our directors and the
executive officers at year end.

                 Name                 Age               Position
                 ----                 ---               --------

Stephen J. Newton                      45               Chief Executive Officer
Rick Frier                             40               Chief Financial Officer
Andrew S. Janower                      32               Director
Josh Bekenstein                        43               Director
Steven Barnes                          41               Director
James B. Hirshorn                      35               Director
Joe L. Gonzalez                        45               Director
Stephen K. Gunn                        46               Director


      Stephen J. Newton has been Chief Executive Officer since April 2001 and
was our Chief Operating Officer from May 2000 to April 2001. Prior to joining
Mattress Discounters, Mr. Newton spent 1998 to 2000 as Chief Operating Officer
with WH Smith USA, an Atlanta based specialty retailer owned by WH Smith Plc.
From 1991 to 1998 Mr. Newton held the position of Vice President-- Store
Operations for the Wall Music Inc., also owned by WH Smith Plc.

      Rick Frier has been Chief Financial Officer since November 2001. Prior
to joining Mattress Discounters, Mr. Frier spent 1998 to 2001 in Chief Financial
Officer positions at two high technology companies; Caliber Learning Network and
Concept Five Technologies. He successfully led Caliber's IPO in 1998. From 1991
to 1997, Mr. Frier was Vice President - Finance and Treasurer of Treasure Chest
Advertising Company, a manufacturer of advertising inserts based in Baltimore,
MD.

      Steve Barnes is a Managing Director of Bain Capital, LLC (`Bain"), and
has been affiliated with Bain since 1988. Since 1988, he has been involved with
various leveraged acquisitions and has served in various leadership positions
with Bain Companies, including CEO of Dade Behring, President of Executone
Business Solutions and President of The Holson Burnes Group. Mr. Barnes
presently serves on several boards including Dade Behring,

                                       45

<PAGE>

Sealy, and the Board of Overseers of Children's Hospital in Boston. Prior to
1988, Mr. Barnes was with PricewaterhouseCoopers, where he worked in the Mergers
and Acquisitions Support Group.

         Andrew S. Janower, has been a Managing Director of Charlesbank Capital
Partners LLC, and has been affiliated with it since its formation in July 1998.
Previously, he had been employed as an Associate by Harvard Private Capital
Group, Inc. Prior to joining Harvard Private Capital Group, Inc., Mr. Janower
was a Consultant at Bain & Company and a research associate at Harvard Business
School. Mr. Janower serves on the Board of Directors of Sealy.

         Josh Bekenstein is a Managing Director of Bain. Mr. Bekenstein  helped
start Bain in 1984 and has been involved in numerous venture capital and
leveraged acquisitions since 1984. Mr. Bekenstein presently serves on the Board
of Directors of a number of public and private companies, including Waters
Corporation and Bright Horizons Childrens Centers, Inc. Prior to Bain, Mr.
Bekenstein was a consultant at Bain & Company, where he worked on strategic
consulting projects for a number of Fortune 500 clients.

         James B. Hirshorn has been a Vice President at Bain since 1998 working
with portfolio companies on a variety of operational and strategic issues. Mr.
Hirshorn has been actively involved in the management of the Mattress
Discounters since its acquisition. From 1993 to 1998, he was a Manager and
Consultant at Bain & Company focusing in the areas of consumer products and
technology. From 1988 to 1991, Mr. Hirshorn was with Procter & Gamble in their
Product Development Group. He received his MBA from the Harvard Business School
in 1993.

         Joe L. Gonzalez has been a Limited Partner of JP Morgan Partners since
1998. Previously, he was with KPMG from 1978 to 1998. He serves on the Board of
Directors of M2 Automotive, Inc., Airbase Services, Inc., Quivox Systems and
Sealy Corporation.

         Stephen K. Gunn has been the Chief Executive Officer of Mattress
Holding Corporation (the majority investor in Mattress Discounters Corporation)
since April 2001. He is also the Chairman and CEO of Sleep Country Canada,
Canada's leading specialty mattress retailer, a company he co-founded in 1994.

Employment Agreements

         We have entered into employment agreements with each of the following
executives of the Company: Steve Newton, Chief Executive Officer and Rick Frier,
Chief Financial Officer. The agreements for Messrs. Newton and Frier have an
initial one year term and perpetual 12 month terms thereafter unless terminated
by either party. Mr. Newton's and Mr. Frier's agreements provide that if we
terminate their employment without cause, we will continue to pay their base
salary for a period of twelve and six months from termination, respectively.

                                       46

<PAGE>

ITEM 11. Executive Compensation.

Summary Compensation Table

         The following table sets forth, for the year ended December 30, 2001,
the year ended December 30, 2000 and the ten months ended January 1, 2000, the
compensation paid to all individuals who performed the functions of chief
executive officer, and our next most highly compensated executive officers
during those periods (collectively referred to as the "Named Executives").

<TABLE>
<CAPTION>

                                                                         Annual
            Name : Title                         Year                 Compensation            Number of Securities

-------------------------------------    ----------------------      ---------------------    -------------------------
                                                                         (in dollars)                (options)

                                                                     ---------------------    -------------------------
<S>                                      <C>                         <C>                      <C>
Stephen  J. Newton                               2001                        313,404                            -
    Chief Executive Officer                      2000                        163,462                      166,430
                                                 1999                              -                            -

Rick Frier (1)                                   2001                         27,192                            -
    Chief Financial Officer                      2000                              -                            -
                                                 1999                              -                            -

Stephen  A. Walker (2)(4)                        2001                         75,000                            -
    Chief Executive Officer                      2000                        300,000                            -
                                                 1999                         23,077                      250,000

Bryan J. Flanagan (3)(4)                         2001                        208,333                            -
    Chief Financial Officer                      2000                        105,769                      166,430
                                                 1999                              -                            -
</TABLE>

(1)   Mr. Frier commenced employment on November 5, 2001.
(2)   Mr. Walker's employment terminated on April 2, 2001.
(3)   Mr. Flanagan's employment terminated on November 5, 2001.
(4)   Options granted to these former executive officers were forfeited under
      the terms of their separation agreements.

                                       47


<PAGE>

         The following table discloses, for the Named Executives (a) the number
of shares as to which options and/or warrants were granted for the years ended
December 29, 2001 and December 30, 2000 and the ten months ended January 1, 2000
and (b) the option exercise price (which was in all cases, not less than the
market price on the date of the grant).

                          Fiscal Year End Option Grants

<TABLE>
<CAPTION>

                                                                                                 Potential Realized
                                   Percent of                                                    Value at Assumed
                                     Total                                                        Annual Dates of
                                    Options                                                         Stock Price
                                   Granted to      Number of                                     Appreciation for
                                   Employees      Securities      Exercise of                       Option Term (1)
                                    in Fiscal     Underlying      Base Price      Expiration    ---------------------
  Name                               Year          Options         ($ Share)         Date         5% ($)      10% ($)
-------------------------          --------    --------------     -----------     ----------    ---------   ---------
<S>                                <C>         <C>                <C>             <C>           <C>         <C>

Stephen J. Newton ....... 2001           --                --              --             --           --          --
                          2000        13.82%          166,430            0.67         5/8/10       26,629      53,258
                          1999           --                --              --             --           --          --

Rick Frier .............. 2001           --                --              --             --           --          --
                          2000           --                --              --             --           --          --
                          1999           --                --              --             --           --          --

Stephen A. Walker (2) ... 2001           --                --              --             --           --          --
                          2000           --                --              --             --           --          --
                          1999        10.98%          250,000            0.67        12/6/09       40,000      80,000

Bryan J. Flanagan (2) ... 2001           --                --              --             --           --          --
                          2000        13.82%          166,430            0.67        7/24/10       26,629      53,258
                          1999           --                --              --             --           --          --
</TABLE>


 (1) Amounts represent hypothetical gains that could be achieved for options if
     exercised at the end of the option term. These gains are based on assumed
     rates of stock price appreciation of 5% and 10% compounded annually from
     the date options are granted. Actual gains, if any, on share option
     exercises will depend on the future performance of the ordinary shares on
     the date on which the options are exercised.

 (2) Options granted to these former executive officers were forfeited under the
     terms of their separation agreements.

                                       48

<PAGE>

Option Exercises and Year End Values as of and during the year ended December
29, 2001

         The following table shows information regarding the exercise of stock
options during the year ended December 29, 2001 by the Named Executives and the
number and value of any unexercised stock options held by them as of December
29, 2001:

<TABLE>
<CAPTION>


                                                                                       Value of Unexercised
                                                            Number of Unexercised        in the Money
                                  Shares                      Options/Warrants at       Options/Warrants at
                                 Acquired         Value        Fiscal Year End            Fiscal Year End
                                on Exercise     Realized       (#) Exercisable/           ($) Exercisable/
           Name                    (#)             ($)          Unexercisable               Unexercisable
------------------------------  ----------     ------------ ----------------------   -----------------------
<S>                             <C>            <C>          <C>                      <C>
Stephen J. Newton ............       --             --            33,286/166,430               --
Rick Frier ...................       --             --               --/--                     --
Stephen A. Walker (1) ........       --             --               --/--                     --
Bryan J. Flanagan (1) ........       --             --               --/--                     --
</TABLE>

(1) Options granted to these former executive officers were forfeited under the
    terms of their separation agreements.


Compensation of Directors

         We reimburse directors for any out-of-pocket expenses incurred by them
in connection with services they provide in their capacities as directors. We do
not compensate, or have plans to compensate, our directors for services they
provide in their capacities as directors. We may, however, elect to do so in the
future.

Qualified 401(k) and Profit Sharing Plan

         We maintain a qualified 401(k) and profit sharing plan. All employees
of 21 years of age and over and employed for at least one year are eligible to
participate in the plan. Employees are permitted to contribute up to 15% of
their annual compensation, subject to the IRS limits. Under the plan, we have
discretion to make matching contributions. We currently anticipate making
matching contributions equal to 2% of gross compensation.

ITEM 12.   Security Ownership of Certain Beneficial Owners and Management.

PRINCIPAL SHAREHOLDERS

         We are a wholly owned subsidiary of Mattress Holding Corporation. The
outstanding equity securities of Mattress Holding consist of 16,436,717 shares
of Class A common stock and 1,826,323 shares of Class L common stock. The Class
L common stock is senior in right of payment to the Class A common stock. The
holders of Class A common stock and Class L common stock are entitled to one
vote per share on all matters to be voted upon by the stockholders of Mattress
Holding, including the election of directors. Mattress Holding also has
authorized Class B common stock and Class M common stock. The Class B common
stock and Class M common stock are identical to the Class A common stock and
Class L common stock, respectively, except that they have no voting rights
except as required by law. The Board of Directors of Mattress Holding is
authorized to issue preferred stock, par value of $0.01 per share, with such
designations and other terms as may be stated in the resolutions providing for
the issue of any of our directors and executive officers preferred stock adopted
from time to time by the board of directors.

         The following tables set forth information regarding the approximate
beneficial ownership of: (1) the Class A common stock and Class L common stock
by each person known to us to own more than 5% of any class of our outstanding
voting securities and (2) the Class A common stock and Class L common stock by
each of our directors and named executive officers and all of the directors and
executive officers as a group. In the table set forth below, beneficial
ownership means the sole or shared power to vote, or to direct the voting of, a
security, or the sole or shared power to dispose, or direct the disposition of,
a security and includes options exercisable within sixty days.

                                       49

<PAGE>

No warrants are exercisable within sixty days. Unless otherwise noted, to our
knowledge, each of the following shareholders has sole voting and investment
power as to the shares shown.

<TABLE>
<CAPTION>
                                                                    Shares Beneficially Owned
                                      --------------------------------------------------------------------------------------
                                                Class A Common Stock                         Class L Common Stock
                                      ------------------------------------------   -----------------------------------------
        Name and Address               Number of Shares     Percentage of Class     Number of Shares    Percentage of Class
------------------------------------- ------------------   ---------------------   ------------------  ---------------------
<S>                                   <C>                  <C>                     <C>                 <C>
Principal Shareholders
Bain Funds (1)(2) ..................      15,256,763               92.8%                1,695,216              92.8%
   c/o Bain Capital, Inc.
   Two Copley Place
   Boston, MA 02116
Heilig-Meyers Company ..............         903,000                5.5                   100,333               5.5
   12560 West Creek Parkway
   Richmond, VA 23238

Directors and Executive Officers:
Stephen J. Newton ..................              --               --                          --              --
Rick Frier .........................              --               --                          --              --
Josh Bekenstein (3) ................       1,248,393                7.6                   138,712               8.3
Steven Barnes (4) ..................       1,248,393                7.6                   138,712               8.3
James B. Hirshorn (5) ..............       1,232,377                7.5                   136,932               8.2
Andrew S. Janower (6) ..............       2,437,120               14.8                   270,794              14.8
Joe L. Gonzalez (7) ................              --               --                          --              --
Stephen K. Gunn ....................         204,908                1.2                    22,769               1.2
Directors and all Officers as a
   group (8 persons) ...............       3,890,121               23.7                   432,275              26.0
</TABLE>

_________________________________
*    represents less than 1%

(1)  Amount shown represents the aggregate number of shares held by Mattress
     Discounters Holding L.L.C. ("Holdings LLC"), Bain Capital V Mezzanine Fund,
     L.P., BCM Capital Partners, L.P., BCIP Trust Associates II ("BCIP Trust"),
     Sankaty High Yield Asset Partners, L.P. and Sankaty High Yield Partners II,
     L.P. The members of Holdings LLC are Bain Capital Fund VI, L.P. ("Bain Fund
     VI"), BCIP Associates II ("BCIP"), BCIP Associates II-B ("BCIP-B"), BCIP
     Associates II-C ("BCIP-C"), BCIP Trust, BCIP Trust Associates II-B ("BCIP
     Trust-B" and, together with BCIP, BCIP-B, BCIP-C and BCIP Trust, the
     "BCIPs"), PEP Investment PTY Ltd. ("PEP"), Harvard Private Capital
     Holdings, Inc. ("HPC"), Mattress Discounters Investors 1, LLC ("MDLLC 1"),
     Mattress Discounters Investors 2, LLC ("MDLLC 2"), Mattress Discounters
     Investors 3, LLC ("MDLLC 3"), Mattress Discounters Investors 4, LLC ("MDLLC
     4" and collectively, with MDLLC 1, MDLLC 2, and MDLLC 3 (the "LLCs"),
     Mattress Holding International, LLC and certain other investors who each
     own less than 1% of the Class A and Class L common stock. Bain Fund VI, PEP
     and the BCIPs are collectively referred to as the "Bain Funds."

(2)  The members of MDLLC 1 are Chase Equity Associates, L.P. ("Chase Equity")
     and Bain Capital Partners VI, L.P. ("BCP"). The members of MDLLC 2 are
     affiliates of Canadian Imperial Bank of Commerce ("CIBC"), and BCP. The
     members of MDLLC 3 are BancBoston Capital Inc. ("BancBoston") and BCP. BCP
     is the administrative member of each LLC and beneficially owns 1% of the
     equity of each LLC. By virtue of their investment in the LLCs, Chase
     Equity, CIBC and BancBoston indirectly own approximately 22.5%, 11.2% and
     3.7%, respectively, of the Class A common stock and the Class L common
     stock.

(3)  Represents shares indirectly held by the BCIPs and PEP. Mr. Bekenstein is a
     Managing Director of Bain Capital, Inc. In addition, (i) Bain Capital,
     Inc., of which Mr. Bekenstein is a Managing Director, has voting and
     investment power with respect to the shares indirectly owned by PEP and
     (ii) Mr. Bekenstein (or affiliated entities) is a general partner of one or
     more of the BCIPs. Accordingly, Mr. Bekenstein may be deemed to
     beneficially own some or all of the shares indirectly owned by the BCIPs
     and PEP through his interest in Holdings LLC. Mr. Bekenstein disclaims
     beneficial ownership of any such shares.

(4)  Represents shares indirectly held by the BCIPs and PEP. Mr. Barnes is a
     Managing Director of Bain Capital, Inc. In addition, (i) Bain Capital,
     Inc., of which Mr. Barnes is a Managing Director, has voting and investment
     power with respect to the shares indirectly owned by PEP and (ii) Mr.
     Barnes (or affiliated entities) is a general partner of one or more of the
     BCIPs. Accordingly, Mr. Barnes may be deemed to beneficially own some or
     all of the shares indirectly owned by the BCIPs and PEP through his
     interest in Holdings LLC. Mr. Barnes disclaims beneficial ownership of any
     such shares.

(5)  Represents shares indirectly held by the BCIPs. Mr. Hirshorn is a Vice
     President of Bain Capital, Inc. and he (or an affiliated entity) is a
     general partner of one or more of the BCIPs. Accordingly, Mr. Hirshorn may
     be deemed to own some or all of the shares indirectly owned by the BCIPs
     through their interest in Holdings LLC. Mr. Hirshorn disclaims beneficial
     ownership of any such shares.

                                       50

<PAGE>

(6)  Mr. Janower is a Vice President of Charlesbank Capital Partners, LLC which
     serves as investment adviser to HPC. Accordingly, Mr. Janower may be deemed
     to beneficially own some or all of the shares indirectly owned by HPC
     through its interest in Holdings LLC. Mr. Janower disclaims beneficial
     ownership of any such shares.

(7)  Excludes 2,769,053 shares of Class A common stock and 307,673 shares of
     Class L common stock indirectly owned by MDLLC 1, which shares BCP has the
     right to vote. Mr. Gonzalez is a Limited Partner of JP Morgan Partners
     Capital Partners, an affiliate of Chase Equity.


ITEM 13. Certain Relationships and Related Transactions.

RELATIONSHIPS AND RELATED TRANSACTIONS

Stockholders Agreement

Mattress Holding Corporation and all holders of shares of its common stock
entered into a Stockholders Agreement on August 6, 1999.

     The Stockholders Agreement provides:

     .    that the boards of directors of Mattress Holding will consist of five
          members, four of whom shall be selected by Bain Capital and one of
          whom shall be selected by HPC,

     .    for restrictions on transfer of the common stock, including provisions
          providing that other holders of common stock will have rights of first
          offer and participation rights in any proposed sale of common stock,

     .    that if Mattress Holding authorizes the issuance or sale of any common
          stock to any holder of its common stock (other than as a dividend on
          the outstanding common stock), Mattress Holding will first offer to
          sell to the other holders of common stock their percentage of the
          shares of issued equal to the percentage of common stock held by each
          holder of common stock at the time of issue,

     .    that upon the board of directors of Mattress Holding and holders of a
          majority of outstanding shares of common stock approving a sale of
          substantially all the assets of Mattress Holding or substantially all
          the outstanding capital stock of Mattress Holding, each holder of
          common stock will consent to this sale and sell their common stock as
          so requested, and

     .    in the event that the board of directors of Mattress Holding and
          holders of a majority of outstanding shares of common stock approves
          an initial public offering, each holder of common stock will be
          required to take all necessary or desirable actions in connection with
          the consummation of the initial public offering, including consenting
          to and voting for a recapitalization, reorganization and/or exchange
          of their common stock into other securities.

Registration Rights Agreement

     Mattress Holding Corporation and the holders of its common stock entered
into a Registration Rights Agreement on August 6, 1999. The Registration Rights
Agreement provides that Bain Capital has the right to three long-form demand
registrations and unlimited short-form demand registrations under the Securities
Act of shares of common stock held by them.

     The Registration Rights Agreement also provides for piggyback registration
rights, allowing the holders of common stock to include their common stock in
any registration. However, if the piggyback registration is an underwritten
primary registration on behalf of Mattress Holding, and the managing
underwriters advise Mattress Holding that in their opinion the aggregate number
of shares of common stock which Mattress Holding and the holders of its common
stock elect to include in the registration offering exceeds the number which can
be sold in the offering without adversely affecting the marketability of such
offering, the number of shares to be sold in such offering shall be allocated:
(1) first, the securities Mattress Holding proposed to sell, (2) second, the
shares of

                                       51

<PAGE>

common stock requested to be included in the registration, pro rata among the
holders of shares on the basis of the number of shares owned by each holder of
shares, and (3) third, other securities requested to be included in the
registration.

     In addition, the holders of common stock are prohibited from selling their
shares seven days prior to and within 180 days after the effectiveness of any
demand registration or piggyback registration, except as part of an underwritten
registration, unless the underwriters managing the registered offering otherwise
agree.

Advisory Agreement

     In connection with the transactions, we entered into an advisory agreement
with Bain Capital under which it provides financial advisory and consulting
services. In exchange for these services, Bain Capital is entitled to an
aggregate annual shareholder advisory fee of $1.0 million (to be adjusted upon
the occurrence of future acquisitions) and their out-of-pocket expenses. In
addition, Bain Capital will receive an aggregate fee not to exceed 1.0% of the
aggregate value of any acquisition, divestiture or financing transaction of
Mattress Holding Corporation and all its subsidiaries (including Mattress
Discounters) in which it is involved. The advisory agreement will remain in
effect for an initial term of ten years, and shall be automatically extended
thereafter on a year-to-year basis, subject to termination by Bain Capital or us
upon written notice 90 days prior to the expiration of the initial term or any
extension thereof. The advisory agreement includes customary indemnification
provisions in favor of Bain Capital.

Mattress Holding Corporation Junior Subordinated Notes

     Mattress Holding Corporation junior subordinated notes were issued to
Heilig-Meyers as a non-cash portion of the consideration due to Heilig-Meyers at
closing. The principal amount of these notes were $10.0 million and $7.5 million
and interest will accrue at the rates of 10% and 12% per annum, respectively,
payable quarterly. At the option of Mattress Holding, interest may be paid in
cash or by increasing the amount of principal due under these notes, but the
indenture governing the exchange notes and the amended senior credit facility
limits the payment of cash interest, either directly or through the restricted
payments test. The Mattress Holding junior subordinated notes are scheduled to
mature one year after the scheduled maturity of the exchange notes. The Mattress
Holding junior subordinated notes are structurally subordinate to the exchange
notes and contractually subordinated to the indebtedness under the amended
senior credit facility. In connection with the settlement of the transactions,
the $7.5 million 12% junior subordinated promissory note was reduced to $5.875
million.

Sealy Supply Contract

     Sealy is our exclusive supplier of name brand beds until June 30, 2007
under an agreement with Sealy Mattress Company. The equity investors or their
related parties, who are the indirect beneficial owners of approximately 93% of
Mattress Holding, are also the beneficial owners of approximately 93% of the
voting common stock of Sealy, and effectively control both companies. For the
year ended December 29, 2001 and December 30, 2000, purchases by the Company
from Sealy under this agreement amounted to $78.7 million and $88.2 million,
respectively.


DESCRIPTION OF CAPITAL STOCK OF MATTRESS HOLDING CORPORATION

     Set forth below is information concerning Mattress Holding Corporation's
capital stock and all material information relating to the provisions of its
Articles of Incorporation and the Stock Corporation Act of the Commonwealth of
Virginia. This description is qualified in its entirety by reference to the
Articles of Incorporation of Mattress Holding (a copy of which is available from
Mattress Holding) and the Virginia Act.

Common Stock

     The common stock of Mattress Holding consists of four classes of shares,
par value $.01 per share: Class L Common Stock, Class M Common Stock, Class A
Common Stock and Class B Common Stock. There are 4 million authorized shares of
Class L, 2 million authorized shares of Class M, 300 million authorized shares
of Class A, and 100 million authorized shares of Class B, and 1,433,333 shares
of Class L and 12,900,000 shares of Class A issued and outstanding (including
management options exercisable within 60 days of the closing of the
transactions) and no shares of Class M or Class B are issued and outstanding.

                                       52

<PAGE>

     In the event of any distribution (including those made in connection with a
liquidation of Mattress Holding), holders of the Class L are entitled to first
priority with respect to distributions up to an amount which would generate an
internal rate of return on the unreturned cost of a share of Class L (initially
$54 per share) of 12% per year. After this preference has been satisfied,
holders of Class L are entitled to first priority with respect to distributions
up to an amount of the unreturned cost of the Class L. After this preference has
been satisfied, holders of Class A and Class L shares share in any remaining
amounts based on the number of shares of common stock held by each shareholder
as of the applicable record date.

     Upon a public offering of shares of Class A, each share of Class L shall
automatically convert into a number of shares of Class A equal to (a) 1.0, plus
(b) the quotient obtained by dividing (x) the unreturned cost of a share of
Class L plus an amount sufficient to generate an internal rate of return on $54
of 12% per year, by (y) the price per share received by Holdings for its Class A
issued in the public offering.

     The Class L and Class A vote together as a single class on all matters,
with each share of Class L and Class A entitled to one vote. The holders of
Class L and Class A are not entitled to cumulate their votes in the election of
directors, which means that holders of more than a majority of the total
outstanding Class L and Class A can elect all the directors of Mattress Holding.

     Except as described above, the holders of shares of the common stock of
Mattress Holding are not entitled to any preemptive, subscription or conversion
rights. There are no redemption or sinking fund provisions applicable to any of
the classes of Mattress Holding common stock. The holders of shares of common
stock are not subject to further calls or assessments by Mattress Holding.

     Class B is identical in all respects to Class A, and Class M is identical
in all respects to Class L, except that Class B and Class M have no right to
vote on any matter to be voted on by holders of Mattress Holding's capital
stock, other than in limited circumstances or as required by law. At any time
and from time to time, Class B shares may be converted into Class A shares and
Class M shares may be converted into Class L shares, subject to limited
restrictions, and holders who are subject to bank holding regulations may
convert Class A shares into Class B shares and Class L shares into Class M
shares.

Preferred Stock

     There are 10 million shares of preferred stock, par value $.01 per share,
of Mattress Holding authorized for issuance, and no shares of preferred stock
have been issued and are outstanding. Mattress Holding's board of directors may
issue from time to time, in one or more series, shares of preferred stock, with
those rights and preferences as permitted by law.

Warrants

     In connection with the issuance of the old notes, Mattress Holding also
issued to the holders thereof warrants to acquire an aggregate of 679,000 shares
of Class A common stock and 75,460 shares of Class L common stock, representing
approximately 5% of Mattress Holding's fully diluted common stock at the
issuance date. The warrants expire on July 15, 2007.

     Each warrant entitles the holder to acquire, on or after the exercisability
date (i.e. an initial public offering of our common stock) and prior to the
expiration date, 4.850 shares of Class A common stock and 0.539 shares of Class
L common stock at a price equal to $0.01 per share, subject to adjustment from
time to time upon the occurrence of changes in the Class A common stock and
Class L common stock and issuances of Class A common stock and Class L common
stock, options or convertible securities of Mattress Holding.

     Holders of warrants do not, by virtue of being warrant holders, have any
rights of stockholders of Mattress Holding, except that holders are entitled to
receive distributions in respect of any Class A common stock or Class L common
stock of Mattress Holding as though the warrants had been exercised.

Liability and Indemnification

     Mattress Holding's articles of incorporation provides that Mattress Holding
shall, to the fullest extent permitted by the provisions of the Virginia Act, as
the same may be amended and supplemented, indemnify any and all persons whom it
shall have power to indemnify under said provisions from and against any and all
of the

                                       53

<PAGE>

expenses, or other matters referred to in or covered by said provisions. The
Virginia Act permits a corporation to indemnify a person party to a proceeding
by reason of him being or having been a director against liability incurred in
the proceeding if he conducted himself in good faith, and he believed that his
conduct was in its best interest. This indemnification is not exclusive of other
indemnification rights arising under any bylaw, vote of disinterested directors
or shareholders or otherwise.

                                    PART IV

ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.

     See Item 8 within Part II of this Annual Report on Form 10-K for the
Company's consolidated financial statements.

     During the period covered by this report, the Company filed the following
Reports on Form 8-K:

     (1) Form 8-K dated April 2, 2001, and filed with the Commission on April
         10, 2001, reporting information under Items 5 and 7.

EXHIBIT INDEX

2.1     Transaction Agreement, dated May 28, 1999 by and among Heilig-Meyers
        Company, Heilig-Meyers Associates, Inc., and Mattress Discounters
        Acquisition Corporation.*

2.2     Amendment No. 1 to the Transaction Agreement, dated July 15, 1999 by and
        among Heilig-Meyers Company, Heilig-Meyers Associates, and Mattress
        Discounters Acquisition Corporation.*

2.3     Amendment No. 2 to the Transaction Agreement, dated July 27, 1999 by and
        among Heilig-Meyers Company, Heilig-Meyers Associates, and Mattress
        Discounters Acquisition Corporation.*

2.4     Articles of Merger merging Mattress Discounters Acquisition Corporation
        into Heilig-Meyers Associates, Inc., dated as of August 6, 1999 as filed
        with the Commonwealth of Virginia State Corporation Commission.*

3.1     Articles of Incorporation of Mattress Discounters Corporation, dated
        March 4, 1996.*

3.2     By-laws of Mattress Discounters Corporation dated March 5, 1996.*

3.3     Articles of Incorporation of The Bedding Experts, Inc. dated July 1,
        1984.*

3.4     By-laws of The Bedding Experts, Inc. dated July 1, 1984.*

3.5     Articles of Incorporation of T.J.B., Inc. dated April 3, 1980.*

3.6     By-laws of T.J.B., Inc. dated April 3, 1980.*

3.7     By-laws of Mattress Discounters Acquisition Corporation, dated August 6,
        1999.*

4.1     Indenture, dated as of August 6, 1999 by and among Mattress Discounters
        Corporation, as the Issuer, the Guarantors named therein and State
        Street Bank and Trust Company, as the Trustee.*

9.1     Stockholders Agreement, dated August 6, 1999 by and among Mattress
        Discounters Corporation (previously Mattress Discounters Holding
        Corporation), Mattress Discounters Holding L.L.C., Heilig-Meyers
        Company, and certain other stockholders of Mattress Holding Corporation
        who are from time to time a party thereto.*

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<PAGE>

10.1    Registration Rights Agreement, dated August 6, 1999 by and among
        Mattress Holding Corporation, Mattress Holding L.L.C., Heilig-Meyers
        Corporation, and certain other stockholders of Mattress Discounters
        Holding Corporation who are from time to time a party thereto.*

10.2    Common Stock Registration Rights Agreement, dated as of August 6, 1999
        by and among Mattress Discounters Corporation, Mattress Discounters
        Holding L.L.C., and Chase Securities, Inc, CIBC World Markets Corp., and
        BancBoston Robertson Stephens, Inc.*

10.3    Purchase Agreement, dated August 3, 1999 by and among Mattress
        Discounters Corporation, Mattress Discounters Corporation, the
        Guarantors and the Initial Purchasers.*

10.4    Supply Agreement, dated March 17, 1997 by and among Mattress Discounters
        Corporation and Sealy, Inc.# *

10.5    Amendment No. 1 to the Supply Agreement, dated March 17, 1997 by and
        among Mattress Discounters Corporation and Sealy, Inc.# *

10.6    Amendment No. 2 to the Supply Agreement, dated March 17, 1997 by and
        among Mattress Discounters Corporation and Sealy, Inc.# *

10.7    Amendment No. 3 to the Supply Agreement dated March 17, 1997 by and
        among Mattress Discounters Corporation and Sealy, Inc.# *

10.8    Amendment No. 4 to the Supply Agreement dated March 17, 1997 by and
        among Mattress Discounters Corporation and Sealy, Inc.# *

10.9    Supply Agreement, dated August 6, 1999 by and among Heilig-Meyers
        Company, Mattress Discounters Corporation, and Mattress Holding
        Corporation (previously MD Acquisition Corporation.)# *

10.10   Amendment No. 1 to the Supply Agreement, dated August 6, 1999 by and
        among Heilig-Meyers Company, Mattress Discounters Corporation, and
        Mattress Holding Corporation.# *

10.11   Indemnity Agreement, dated May 28, 1999 by and among Heilig-Meyers
        Company, Bain Capital, Inc., and Mattress Discounters Acquisition
        Corporation.*

10.12   Amendment No. 1 to the Indemnity Agreement, dated July 29, 1999 by and
        among Heilig-Meyers Company, Bain Capital, Inc., and Mattress
        Discounters Acquisition Corporation.*

10.13   Assignment and Assumption Agreement, dated August 6, 1999 by and between
        Heilig-Meyers Company and Mattress Discounters Corporation.*

10.14   Tax Agreement, dated August 6, 1999 by and among Heilig-Meyers Company,
        Heilig-Meyers Associates, Inc., Mattress Discounters Acquisition
        Corporation, T.J.B., Inc., and The Bedding Experts, Inc.**

10.15   Tax Sharing Agreement, dated August 6, 1999 by and among Mattress
        Discounters Holding, LLC, Mattress Holding Corporation, Mattress
        Discounters Corporation, The Bedding Experts, Inc., T.J.B., Inc., and
        Comfort Source Mattress Company.*

10.16   Landlord Agreement, dated July 27, 1999 by O.J.B./ Mid Atlantic Realty
        IV, LLC.*

10.17   Management Services Agreement, dated August 6, 1999 by and among
        Mattress Holding Corporation, Mattress Discounters Corporation, and Bain
        Capital, Inc.*

10.18   Executive Stock and Option Agreement, dated May 1, 2000 between Mattress
        Holding Corporation and Steve Newton.*

10.19   Executive Stock and Option Agreement, between Mattress Holding
        Corporation and Stephen A. Walker.*

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<PAGE>

10.20   Letter Agreement dated January 1, 2000 by and between Mattress
        Discounters Corporation and Sealy, Inc.*

10.22   Executive Stock and Option Agreement, dated January 13, 2000 between
        Mattress Holding Corporation and Michael Mauler.*

10.24   Employment Agreement, dated May 1, 2000 between Mattress Discounters
        Corporation and Steve Newton.*

10.25   Employment Agreement, dated December 6, 1999 between Mattress
        Discounters Corporation and Stephen A. Walker.*

10.28   Employment Agreement, dated January 10, 2000 between Mattress
        Discounters Corporation and Michael Mauler.*

10.29   Warrant Agreement, dated August 6, 1999 between Mattress Discounters
        Holding Corporation and State Street Bank and Trust Company.*

10.30   Credit Agreement, dated August 6, 1999 by and between Mattress
        Discounters Holding Corporation, Mattress Discounters Corporation,
        BancBoston, N.A., Canadian Imperial Bank of Commerce, and the Chase
        Manhattan Bank.*

10.31   Guarantee and Collateral Agreement, dated August 6, 1999 by and between
        Mattress Holding Corporation, Mattress Discounters Corporation, and
        Chase Manhattan Bank.*

10.32   Employment Agreement dated July 24, 2000 between Mattress Discounters
        Corporation and Bryan Flanagan.+

10.33   Executive Stock and Option Agreement dated July 24, 2000 between
        Mattress Holding Corporation and Bryan Flanagan.+

10.34   Employment Agreement dated November 5, 2001 between Mattress Discounters
        Corporation and Rick Frier.

10.35   Amendment No. 4 to the Supply Agreement dated March 17, 1997 by and
        among Mattress Discounters Corporation and Sealy, Inc.##

10.36   Credit Agreement, dated January 11, 2002 by and between Mattress
        Holding Corporation, Mattress Discounters Corporation and JP
        Morgan Chase Bank.

21.1    Subsidiaries of the Registrant.*

24.1    Powers of Attorney (included in signature pages of original registration
        statement).*

*  Incorporated by reference from our registration statement on Form S-4
(Registration No. 333-95945)

+  Incorporated by reference from our Annual Report on Form 10-K for year
ended December 30, 2000.

#  Confidential treatment granted as to parts of this document.

## Omitted due to confidentiality concerns

                                       56

<PAGE>

                                   SIGNATURES
                                   ----------

Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.

                                                MATTRESS DISCOUNTERS CORPORATION

                                                   /s/ Rick Frier
                                                ------------------

March 29, 2002                                  Name: Rick Frier
                                                Title: Chief Financial Officer


     Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated on the 29th day of March, 2002.

/s/ Stephen J. Newton         Chief Executive Officer
----------------------
Stephen J. Newton

/s/ Rick Frier                Chief Financial Officer (Chief Accounting Officer)
---------------
Rick Frier

/s/ Andrew S. Janower         Director
----------------------
Andrew S. Janower

/s/ Joshua Bekenstein         Director
---------------------
Joshua Bekenstein

/s/ Steven Barnes             Director
------------------
Steven Barnes

/s/ Jim Hirshorn              Director
----------------
Jim Hirshorn

/s/ Joe L. Gonzalez           Director
--------------------
Joe L. Gonzalez

/s/ Steven Gunn               Director
---------------
Steven Gunn

                                       57