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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended December 1, 2002

For the Transition Period from                 to                

Commission file number 1-8738

SEALY CORPORATION

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

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: None

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

The aggregate market value of the voting stock held by nonaffiliates of the registrant as of March 3, 2003: not applicable.

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

The number of shares of the registrant’s common stock outstanding as of January 31, 2003 is approximately: 31,255,742.

DOCUMENTS OR PARTS THEREOF INCORPORATED BY REFERENCE:    None

PART I

Item 1.    Business

General

Sealy Corporation (the “Company” or the “Parent”), through its subsidiaries, is the largest bedding manufacturer in the world and manufactures and markets a complete line of conventional bedding (innerspring) products including mattresses and foundations. The Company’s conventional bedding products include the SEALY^®, SEALY POSTUREPEDIC^®, SEALY POSTUREPEDIC CROWN JEWEL^®, STEARNS & FOSTER^® and BASSETT^® brands and account for approximately 89.1% of the Company’s total net sales for the year ended December 1, 2002. The Company has a component parts manufacturing subsidiary which produces substantially all of the Company’s mattress innerspring requirements and approximately 40% of the Company’s boxspring component parts requirements. Another subsidiary, Sealy, Inc., provides corporate and administrative services for the Company. Additional information about the Company can be found at our website: www.sealy.com.

Conventional Bedding

Industry and Competition.    According to industry sales data compiled by the International Sleep Products Association (“ISPA”), a bedding industry trade group, over 700 manufacturers of mattresses and foundations make up the U.S. conventional bedding industry, generating wholesale revenues of $4.59 billion during calendar year 2001. ISPA estimated that the industry experienced a 0.3% decline in sales in 2001—the first decline since 1990. According to ISPA, approximately 41% of conventional bedding is sold through furniture stores and 40% through specialty sleep shops. Most of the remaining conventional bedding is sold to department stores, national mass merchandisers and membership clubs. Management estimates that approximately two-thirds of conventional bedding is sold for replacement purposes, and the average time between consumer purchases of conventional mattresses is 10.2 years. Factors such as disposable income, sales of homes, a trend toward more bedrooms per home, growth in the U.S. population, and heightened consumer awareness of the bedding category also have an effect on bedding purchases.

Management believes that sales by companies with recognized national brands account for more than half of total conventional bedding sales. The Company supplies such nationally recognized brands as Sealy, Sealy Posturepedic, Sealy Posturepedic Crown Jewel, Stearns & Foster and Bassett. Sealy branded products are considered by management to be the most well recognized in the domestic conventional bedding industry. Competition in conventional bedding is generally based on quality, brand name recognition, service and price. The Company’s largest competitors include Serta, Inc. and Simmons Company. Management believes the Company derives a competitive advantage over its conventional bedding competitors as a result of strong consumer recognition of multiple nationally recognized Sealy branded products, as well as the high quality and innovative product offerings.

Products.    The Company manufactures a complete line of conventional bedding options in various sizes ranging in retail price from under $300 to approximately $5,000 per queen size set. The Sealy brand mattress is the largest selling mattress brand in North America. Approximately 93% of the Sealy brand, Stearns & Foster brand and Bassett brand conventional bedding products sold in North America are produced by the Company, with the remainder being produced by Sealy Mattress Company of New Jersey, Inc. (“Sealy New Jersey”), a licensee. The Stearns & Foster product line consists of top quality, premium mattresses sold under the Stearns & Foster brand name. The Bassett brand, licensed from Bassett Furniture Industries beginning in the fourth quarter of 2000, is sold primarily to Bassett Furniture Direct and BJ’s Wholesale Club.

Customers.    The Company’s customers include furniture stores, national mass merchandisers, specialty sleep shops, department stores, contract customers and other stores. The top five conventional bedding customers accounted for approximately 22.0% of the Company’s net sales for the year ended December 1, 2002 and no single customer accounted for over 10.0% of the Company’s net sales.

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Sales and Marketing.    The Company’s sales depend primarily on its ability to provide quality products with recognized brand names at competitive prices. Additionally, the Company works to build brand loyalty with its ultimate consumers, principally through targeted national advertising and cooperative advertising with its dealers, along with superior “point-of-sale” materials designed to emphasize the various features and benefits of the Company’s products which differentiate them from other brands.

The Company’s sales force structure is generally based on regions of the country and districts within those regions, and also includes a corporate sales staff for national and major regional accounts. The Company has a comprehensive training and development programs for its sales force, including its University of Sleep curriculum, which provides ongoing training sessions with programs focusing on advertising, merchandising and sales education, including techniques to help analyze a dealer’s business and profitability.

The Company’s sales force emphasizes follow-up service to retail stores and provides retailers with promotional and merchandising assistance, as well as extensive specialized professional training and instructional materials. Training for retail sales personnel focuses on several programs, designed to assist retailers in maximizing the effectiveness of their own sales personnel, store operations, and advertising and promotional programs, thereby creating loyalty to, and enhanced sales of, the Company’s products.

Suppliers.    The Company purchases raw materials and certain components from a variety of vendors. The Company purchases approximately 55% of its Sealy foundation parts from a single third-party source, which has patents on various interlocking wire configurations (the “Wire Patents”), and manufactures the remainder of these parts as a licensee under the Wire Patents. The Company purchases substantially all of its Stearns & Foster foundation parts from the same single third-party source. See “Components Division.” As is the case with all of the Company’s product lines, the Company does not consider itself dependent upon any single outside vendor as a source of supply to its conventional bedding business and believes that sufficient alternative sources of supply for the same, similar or alternative components are available.

Manufacturing and Facilities.    The Company manufactures most conventional bedding to order and has adopted “just-in-time” inventory techniques in its manufacturing process to more efficiently serve its dealers’ needs and to minimize their inventory carrying costs. Most bedding orders are scheduled, produced and shipped within five days of receipt. This rapid delivery capability allows the Company to minimize its inventory of finished products and better satisfy customer demand for prompt shipments.

The Company operates 18 bedding manufacturing facilities and three component manufacturing facilities in 17 states, plus three facilities in Canadian provinces, and one each in Puerto Rico, France (acquired in April 2001), Italy (acquired in April 2001), Mexico, Argentina (acquired in August, 2000) and Brazil (began operations in December, 2000). Management believes that through the utilization of extra shifts, it will be able to continue to meet growing demand for its products without a significant investment in facilities. See Item 2, “Properties,” herein. The Company also operates a Research and Development center in High Point, North Carolina with a staff which tests new materials and machinery, trains personnel, compares the quality of the Company’s products with those of its competitors and develops new products and processes. The Company has developed very advanced and proprietary methods (Digital Image Analysis) of dynamically measured spinal morphology on any human subject in any sleep position. This sophisticated technology is expected to enhance Sealy’s Posturepedic brand leadership and market position.

Components Division

The Company operates a Components Division with headquarters in Rensselaer, Indiana. The Components Division sells its component parts at current market prices exclusively to the Company’s bedding plants and licensees. The Components Division currently provides substantially all of the Company’s mattress innerspring unit requirements. The Components Division also supplies approximately 45% of the Company’s Sealy foundation parts requirements under a license of the Wire Patents. The Components Division operates three

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owned manufacturing sites located in Rensselaer, Indiana; Delano, Pennsylvania; and Colorado Springs, Colorado. See Item 2, “Properties,” herein.

Over the last several years, the Company has made substantial commitments to ensure that the coil-making equipment at its component plants remains state-of-the-art, installing over 50 automated coil-producing machines. This equipment has resulted in higher capacity at lower per-unit costs and has increased self-production capacity for the Company’s innerspring requirements over that time period from approximately 60% to substantially all.

In addition to reducing the risks associated with relying on single sources of supply for certain essential raw materials, the Company believes the vertical integration resulting from its component manufacturing capability provides it with a competitive advantage. The Company believes that it is the only conventional bedding manufacturer in the United States with substantial innerspring and formed wire component-making capacity.

International

The Company has wholly owned subsidiaries in Canada, Mexico, Puerto Rico, Brazil, France (acquired in April 2001), Italy (acquired in April 2001) and Argentina (majority ownership acquired in August 2000 with the remaining interest acquired in May 2002) which have marketing and manufacturing responsibilities for those markets. The Company has three manufacturing facilities in Canada and one each in Mexico, Puerto Rico, Argentina, Brazil, France and Italy which comprise all of the company-owned manufacturing operations at December 1, 2002. In 2000, the Company formed a joint venture with its Australian licensee to import, manufacture, distribute and sell Sealy products in Southeast Asia.

The Company utilizes licensing agreements in certain international markets. Licensing agreements allow the Company to reduce exposure to political and economic risk abroad by minimizing investments in those markets. Eleven foreign license agreements exist, which provide exclusive rights to market the Sealy brand in Thailand, Japan, the United Kingdom, Australia, New Zealand, South Africa, Israel, Jamaica, Saudi Arabia, Bahamas and the Dominican Republic. In addition, the Company uses a Korean contract manufacturer to help service the Korean market, and distribute products directly to many small international markets.

Licensing

At December 1, 2002, there are 16 separate license arrangements in effect with five domestic and eleven foreign independent licensees. Sealy New Jersey (a bedding manufacturer), Klaussner Corporation Services (“Klaussner”, a furniture manufacturer), Kolcraft Enterprises, Inc. (a crib mattress manufacturer), Pacific Coast Feather Company (a pillow, comforter and mattress pad manufacturer), and KCB Enterprises (a futon manufacturer) are the only domestic manufacturers that are licensed to use the Sealy trademark, subject to the terms of license agreements. Under license agreements between Sealy New Jersey and the Company, Sealy New Jersey has the perpetual right to use certain of the Company’s trademarks in the manufacture and sale of Sealy brand and Stearns & Foster brand products in selected markets in the United States.

The Company’s licensing division generates royalties by licensing Sealy brand technology and trademarks to manufacturers located throughout the world. The Company also provides its licensees with product specifications, quality control inspections, research and development, statistical services and marketing programs. In the fiscal years ended December 1, 2002, December 2, 2001 and November 26, 2000, the licensing division as a whole generated gross royalties of approximately $12.2 million, $12.0 million and $11.4 million, respectively.

See the International section for international licensees.

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Warranties

Sealy, Stearns & Foster and Bassett bedding offer limited warranties on their manufactured products. The periods for “no-charge” warranty service varies among products. Prior to fiscal year 1995, such warranties ranged from one year on promotional bedding to 20 years on certain Posturepedic and Stearns & Foster bedding. All currently manufactured Sealy Posturepedic models, Stearns & Foster bedding, Bassett and some other Sealy-brand products offer a 10-year non-prorated warranty service period. In fiscal 2000, the Company amended its warranty policy to no longer require the mattress to be periodically flipped. Historically, the Company’s warranty costs have been immaterial for each of its product lines.

Trademarks and Licenses

The Company owns, among others, the Sealy and Stearns & Foster trademarks and tradenames and also owns the Posturepedic, Posturepedic Crown Jewel and University of Sleep trademarks, service marks and certain related logos and design marks. The Company also licenses the Bassett name under a fifteen year agreement which expires in 2015.

Employees

As of December 1, 2002, the Company had 6,480 full-time employees. Approximately 71% of the Company’s employees at its 27 North American plants are represented by various labor unions with separate collective bargaining agreements. Due to the large number of collective bargaining agreements, the Company is periodically in negotiations with certain of the unions representing its employees. The Company considers its overall relations with its work force to be satisfactory. The Company has only experienced two work stoppages in the last ten years due to labor disputes. Due to the ability to shift production from one plant to another, these lost workdays have not had a material adverse effect on our financial results. The Company has not encountered any significant organizing activity at its non-union facilities in that time frame.

Seasonality/Other

The Company’s business is not materially seasonal. See Note 13 to the Consolidated Financial Statements of the Company included in Part II, Item 8 herein.

Most of the Company’s sales are by short term purchase orders. Since the level of production of products is generally promptly adjusted to meet customer order demand, the Company has a negligible backlog of orders. Most finished goods inventories of bedding products are physically stored at manufacturing locations until shipped (usually within 5 days of accepting the order).

Item 2.    Properties

The Company’s principal executive offices are located on Sealy Drive at One Office Parkway, Trinity, North Carolina, 27370. Corporate and marketing services are provided to the Company by Sealy, Inc. (a wholly owned subsidiary of the Company), an Ohio Corporation.

The Company administers component operations at its Rensselaer, Indiana facility. The Company’s leased facilities are occupied under leases, which expire from fiscal 2003 to 2010, including renewal options.

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The following table sets forth certain information regarding manufacturing and distribution facilities operated by the Company at January 31, 2003:

The Company considers its present facilities to be generally well maintained and in sound operating condition.

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Regulatory Matters

The Company’s principal wastes are wood, cardboard and other non-hazardous materials derived from product component supplies and packaging. The Company also periodically disposes (primarily by recycling) of small amounts of used machine lubricating oil and air compressor waste oil. The Company, generally, is subject to the Federal Water Pollution Control Act, the Comprehensive Environmental Response, Compensation and Liability Act and amendments and regulations thereunder and corresponding state statutes and regulations. The Company believes that it is in material compliance with all applicable federal and state environmental statutes and regulations. Except as set forth in Item 3. “Legal Proceedings” below, compliance with federal, state or local provisions which have been enacted or adopted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, should not have any material effect upon the capital expenditures, earnings or competitive position of the Company. The Company is not aware of any pending federal environmental legislation which would have a material impact on the Company’s operations. Except as set forth in Item 3. “Legal Proceedings,” the Company has not been required to make, and during the next two fiscal years, does not expect to make any material capital expenditures for environmental control facilities.

The Company’s conventional bedding product lines are subject to various federal and state laws and regulations relating to flammability and other standards. The Company believes that it is in material compliance with all such laws and regulations.

Item 3.    Legal Proceedings

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

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

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

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

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While the Company cannot predict the ultimate timing or costs of the South Brunswick, Oakville, and South Gate environmental matters, based on facts currently known, the Company believes that the accruals recorded (approximately $3.0 million at December 1, 2002) are adequate and does not believe the resolution of these matters will have a material adverse effect on the financial position or future operations of the Company; however, in the event of an adverse decision, these matters could have a material adverse effect. Annual costs associated with on going testing and monitoring at those sites are not material.

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

None.

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PART II

Item 5.    Market for Registrant’s Common Equity and Related Stockholder Matters

There is no established public trading market for any class of common equity of the Company.

As of January 31, 2003 there are 35 holders of record of the Company’s Class A shares, 8 holders of record of the Company’s Class B shares, 20 holders of record of the Company’s Class L shares and 8 holders of record of the Company’s Class M shares.

No dividend or other distribution with respect to common stock was paid during the most recent two fiscal years. Any payment of future dividends and the amounts thereof will be dependent upon the Company’s earnings, fiscal requirements and other factors deemed relevant by the Company’s Board of Directors. The Company currently does not intend to pay any cash dividends in the foreseeable future; rather, the Company intends to retain earnings to provide for the operation and expansion of its business. Certain restrictive covenants contained in the Company’s Senior Credit Agreements currently limit its ability to make dividend or other payments.

Item 6.    Selected Financial Data

The following tables set forth selected consolidated financial and other data of the Company for the years ended December 1, 2002, December 2, 2001, November 26, 2000, November 28, 1999 and November 29, 1998.

The selected consolidated financial and other data set forth in the following tables has been derived from the Company’s audited consolidated financial statements. The report of PricewaterhouseCoopers LLP, independent accountants, covering the Company’s Consolidated Financial Statements for the years ended December 1, 2002, December 2, 2001, and November 26, 2000 is included elsewhere herein. These tables should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company included elsewhere herein.

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SELECTED CONSOLIDATED FINANCIAL AND OTHER DATA

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Item 7.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis should be read in conjunction with the “Selected Financial Data” and the Company’s consolidated financial statements and related notes appearing elsewhere in this report.

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 (US GAAP). The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. US GAAP provides the framework from which to make these estimates, assumptions and disclosures. The Company chooses accounting policies within US 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 1 to the consolidated financial statements as presented herein. The Company believes the following accounting policies and estimates 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:

Revenue Recognition—The Company recognizes revenue, net of estimated returns, when title passes which is generally upon delivery of shipments. Management uses historical trend information regarding returns as well as other current economic data to reduce sales for estimated future returns. Returns have not been historically significant as a percentage of sales.

Cooperative Advertising and Rebate Programs—The Company enters into agreements with its customers to provide funds to the customer for advertising and promotion of the Companies’ products. The Company also enters into volume and other rebate programs with its customers whereby funds may be rebated to the customer. When sales are made to these customers, the Company records liabilities pursuant to these agreements. The Company regularly assesses these liabilities based on actual sales and claims to determine whether all of the cooperative advertising earned will be used by the customer or whether the customers will meet the requirements to receive rebated funds. These agreements are negotiated by the Company generally on a customer-by-customer basis, and as such, are controllable by the Company. Some of these agreements extend over several periods and are linked with supply agreements. Costs of these programs totaled $135.1 million in 2002 and were approximately 11.4 percent of net sales.

Allowance for Doubtful Accounts—The Company actively monitors the financial condition of its customers to determine the potential inability for nonpayment of trade receivables. The Company also considers other economic factors, such as consumer confidence and aging trends, in determining if other general reserves should be established. Management believes that its process of specific review of customers combined with overall analytical review provides an accurate evaluation of ultimate collectibility of trade receivables. Excluding losses associated with affiliates, the Company’s loss experience was approximately 0.5 percent of sales.

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Investments—From time to time the Company makes investments in debt, preferred stock, or other securities of manufacturers, retailers and distributors of bedding and related products both domestically and internationally to enhance business relationships and build incremental sales. The Company regularly assesses these investments for impairment when events or circumstances indicate that their carrying value may not be recoverable from future cash flows. Any necessary impairment charges are recorded when the Company does not believe the carrying value of the investment will be recoverable. Factors considered include economic trends and performance as well as actions taken to improve operational results. Such factors require significant judgment and actual results will vary. Management believes no further material losses are likely to occur related to such investments.

Impairment of Goodwill, Patents and Other Intangibles—The Company performs an annual assessment of its indefinite-lived goodwill for impairment as of the beginning of the fiscal fourth quarter. The Company bases its assessment of recoverability on a multiple of “adjusted” earnings before interest, taxes, depreciation and amortization (“Adjusted” EBITDA). The Company, at least annually, assesses its indefinite-lived goodwill and other intangible assets for impairment when events or circumstances indicate that their carrying value may not be recoverable from future cash flows. The use of the EBITDA multiple is considered by management to be the most meaningful measurement. The EBITDA multiple selected is based on comparison of other companies in the furnishings and consumer durable industry sectors. These comparable multiples ranged from 4.5 to 8.4. The Company considered comparable factors in determining which multiple should be utilized. These factors include among others, company size, estimated market share or dominance, recent trends and forecasted results. Utilizing an EBITDA measure of less than 6 times would likely result in an indication of impairment requiring a further assessment of potential impairment. Should market factors or the Company performance result in using a lower multiple or decreased EBITDA multiple such impairment could be material.

Income Taxes—The Company records an income tax valuation allowance when the realization of certain deferred tax assets, net operating losses and capital 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 judgments, assumptions and estimates may affect the carrying value of the valuation allowance and income tax expense in the consolidated financial statements.

Stock Options—The Company periodically makes grants of stock options to employees. These options typically are issued with an exercise price equal to the estimated fair market price resulting in no compensation expense for the Company as provided by Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees”. The Company’s Board of Directors determines the fair market value of the stock at the date of grant based on a multiple of “adjusted” earnings before interest, taxes, depreciation and amortization (“Adjusted” EBITDA).

Year Ended December 1, 2002 Compared With Year Ended December 2, 2001

Net Sales.    Net sales for the year ended December 1, 2002, were $1,189.2 million, an increase of $35.1 million, or 3.0% from the year ended December 2, 2001. Net sales were reduced by $51.5 million and $42.7 million for the year ended December 1, 2002 and December 2, 2001, respectively, as a result of the adoption of EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product”, as of March 4, 2002. EITF 01-09 provides guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative. Fiscal 2001 represented a 53-week year compared to 52-week year for fiscal 2002. Excluding the effects of the 53rd week, sales increased $59.6 million or 5.3% over 2001. Total domestic sales were $972.4 million for fiscal 2002 compared to $966.4 million for fiscal 2001. The domestic growth

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included a 1.2% increase in average unit selling price and a 0.6% decrease in volume. Total international sales were $216.8 million in fiscal 2002 compared to $187.7 million for fiscal 2001. Growth of $23.7 million in the international operations was primarily attributable to the acquisition of Sapsa Bedding S.A. in Europe in the second quarter of 2001. As a result of the deteriorating economic conditions in Argentina and the resulting Peso devaluation, sales for the Argentine business decreased $11.8 million. Other existing international operations experienced sales growth of $17.2 million.

Cost of Goods Sold.    Cost of goods sold for the year, as a percentage of net sales, decreased 0.7 percentage points to 57.2%. Cost of goods sold for the domestic business decreased 0.8 percentage points to 55.9%. This decrease is primarily the result of increased sales of higher end beds and lower material costs, partially offset by increased variable costs and increased customer rebates and other promotional allowances reclassed under EITF 01-09. Cost of goods sold for the international business decreased 1.6 percentage points to 62.9%. This decrease is primarily related to purchase accounting adjustments associated with the Sapsa acquisition in 2001 and increased margins in the Canadian business, partially offset by increased material costs in the Mexican business.

Selling, General, and Administrative.    Selling, general, and administrative expense increased $23.6 million to $410.5 million, or 34.5% of net sales in 2002, compared to $386.9 million, or 33.5% of net sales in 2001. This increase is primarily due to higher bad debt expenses of $12.7 million primarily associated with affiliated customers (as discussed more fully in Note 18 to the consolidated financial statements) and increased provisions as a result of accounts receivable conversion difficulties (as discussed more fully in “Liquidity and Capital Resources”). Additionally, the increase is attributable to increased compensation expenses of $11.5 million primarily related to increased incentive compensation costs and higher profit sharing plan costs. The Company also incurred increased costs due to the inclusion of Sapsa Bedding S.A. for a full year in 2002. Additionally, the Company incurred $2.0 million of costs associated with the acquisition of Malachi Mattress America. These increased costs were partially offset by a $5.7 million decrease in national advertising as the Company shifted more focus to effective cooperative advertising with individual customers. The Company also incurred decreased promotional expenses as a result of increased costs in 2001 due to the Sealy Posturepedic and Stearns & Foster product introduction costs and new store rollout costs associated with Sears increasing its participation in the bedding category. Selling, general, and administrative expenses were reduced by $51.5 million and $42.7 million for the year ended December 1, 2002 and December 2, 2001, respectively, as a result of the adoption of EITF  01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product”, as of March 4, 2002. EITF 01-09 provides guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative.

Stock Based Compensation.    The Company has an obligation to repurchase certain securities of the Company held by an officer at the greater of fair market value or original cost. The Company recorded $0.8 million of expense for the year ended December 1, 2002, compared to a $(2.7) million reduction of expense for the year ended December 2, 2001, to revalue this obligation to reflect the change in the fair market value of the securities.

Business Closure Charge.    During the first quarter of 2002, the Company took control of a retail mattress company in which it had previously made investments in the form of a supply agreement and additional equity. This investment provided the Company an opportunity to determine whether the entity would be a viable distribution source for the Company’s products. It is not the Company’s strategy to own or control retail operations. Based on management’s assessment, evaluation and consideration of alternative business strategies of the Company, it was determined that the acquired entity did not represent a valid business strategy and ceased its operations in May 2002. The Company recorded a non-cash charge of $5.8 million associated with this shut-down of the business representing a write-off of previously recorded goodwill of $5.3 million and a write-down of other assets to their estimated liquidation value.

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Plant Closings and Restructuring Charges.    During 2002, the Company shutdown its Lake Wales and Taylor facilities. The Company recorded a $2.5 million charge associated with the Lake Wales shutdown to writedown the land, building and equipment to its estimated fair market value and a $0.3 million charge associated with the Taylor shutdown largely for severance. During 2001, the Company shutdown its Memphis facility and recorded a $0.5 million charge primarily for severance. Additionally in fiscal 2001, the Company recorded a $0.7 million charge for severance due to a management reorganization.

Amortization Expense.    Amortization expense was $1.1 million and $13.5 million for the years ended December 1, 2002 and December 2, 2001, respectively. The decrease of $12.4 million is due to the adoption of FAS 142 during the first quarter 2002, as the Company no longer records amortization expense for indefinite lived goodwill.

Interest Expense.    Interest expense decreased $5.5 million primarily due to lower effective interest rates partially offset by increased average debt levels. In 2000, the Company entered into an interest rate swap agreement that effectively converted $234.8 million of its floating-rate debt to a fixed-rate basis through December 2006. In the second quarter of 2002, the Company entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the $234.8 million of debt previously converted to fixed rate debt through December 2006. The Company is required under its credit agreements to hedge at least 50% of its floating rate term debt.

Other (Income) Expense, net.    The Company previously contributed cash and other assets to Mattress Holdings International LLC (“MHI”), a company controlled by the Company’s largest stockholder, Bain Capital LLC, in exchange for a non-voting interest. MHI was formed to invest in domestic and international loans, advances and investments in joint ventures, licensees and retailers. The equity ownership of MHI was transferred to the Company in November 2002. MHI acquired minority interests in Malachi Mattress America, Inc. (“Malachi”), a domestic mattress retailer, and Mattress Holdings Corporation (MHC) in 1999. MHC, controlled by Bain Capital, is a holding company which owns substantially all of the common stock of Mattress Discounters Corporation, a domestic mattress retailer, and the common stock of an international mattress retailer. The Malachi investment was accounted for by MHI under the equity method. Accordingly, the Company recorded equity in the (losses) earnings of Malachi of $(5.6) million and $(4.0) million for the years ended December 1, 2002 and December 2, 2001. The MHC investment was accounted for by MHI under the cost method. Various operating factors combined with weak economic conditions during 2001, resulted in a review by Company management of the equity values related to these affiliates. The Company determined that the decline in the value of such investments was other than temporary and, as a consequence, recognized a non-cash impairment charge of $26.3 million to write-down the investments to their estimated fair values as of the end of the third quarter of 2001. (See “Liquidity and Capital Resources” for additional discussion concerning these investees).

In May 2001, the Company and one of its licensees terminated its existing contract that allowed the licensee to manufacture and sell certain products under the Sealy brand name and entered into a new agreement for the sale of certain other Sealy branded products. In conjunction with the termination of the license agreement, Sealy received a $4.6 million termination fee that is recorded as other income.

Additionally, Other (income) expense, net includes interest income of $2.2 million and $1.9 million for the years ended December 1, 2002 and December 2, 2001.

Other (income) expense, net also includes $(0.3) million and $(0.5) million for minority interest associated with the Argentina operations in 2002 and 2001, respectively. During the second quarter of 2002, the Company acquired the remaining 30% interest of the Argentina operations and will no longer record minority interest. See also Note 14.

Income Tax.    The Company’s effective income tax rates in 2002 and 2001 differ from the Federal statutory rate principally because of the effect of certain foreign tax rate differentials, state and local income taxes and the

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application of purchase accounting in 2001. In addition, no tax benefit was recorded in 2001 on the $26.3 million impairment charge recognized due to the uncertainty at that time concerning the recoverability of such loss. In 2002, the Company reduced a portion of the loss for tax purposes as MHI sold its equity interest in Malachi Mattress America, Inc. The Company also recorded a $4.4 million asset impairment charge in 2001 that will not be deductible for tax purposes. The Company’s effective tax rate for 2002 is approximately 29.9% compared to approximately (176.6)% in 2001. Excluding the effects of these items, the Company’s effective tax rate for 2002 and 2001 was approximately 47.8% and 55.5%, respectively. This lower effective tax rate for 2002 compared to 2001 is primarily due to the fact that the Company no longer amortizes goodwill which was previously a non-deductible item for tax purposes.

Year Ended December 2, 2001 Compared With Year Ended November 26, 2000

Net Sales.    Net sales for the year ended December 2, 2001, were $1,154.1 million, an increase of $83.9 million, or 7.8% from the year ended November 26, 2000. Net sales were reduced by $42.7 million and $31.4 million for the year ended December 2, 2001 and November 26, 2000, respectively, as a result of the adoption of EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product”, as of March 4, 2002. EITF 01-09 provides guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative. Total domestic sales were $966.4 million for fiscal 2001 compared to $959.1 million for fiscal 2000. Total international sales were $187.7 million in fiscal 2001 compared to $111.0 for fiscal 2000. Growth of $65.3 million in the international operations was primarily attributable to the acquisitions of Sapsa Bedding S.A. in Europe in the second quarter of 2001 and Rozen S.R.L. in Argentina in the third quarter of 2000. Existing international operations also experienced sales growth of $11.4 million. The domestic growth included a 0.4% increase in average unit selling price and a 0.3% increase in volume. The impact for the year of including a 53rd week was $24.5 million. In addition, the Company’s revenues were reduced by $27.5 million from 2000 due to customers filing bankruptcy in 2001. Industry observers are forecasting sales growth of 3% for the industry in 2002. The Company believes it can exceed the industry’s growth rate and increase its market share.

Cost of Goods Sold.    Cost of goods sold for the year, as a percentage of net sales, increased 1.5 percentage points to 57.9%. Cost of goods sold for the domestic business increased 1.0 percentage points to 56.7%. This increase is primarily related to a $2.9 million physical inventory adjustment recorded in the quarter end May 27, 2001 due primarily to understating material usage. Cost of goods sold for the international business increased 1.5 percentage points to 64.5%. This increase is primarily related to purchase accounting adjustments associated with the Sapsa acquisition and higher manufacturing costs in Brazil as it continued to operate in a start-up mode.

Selling, General, and Administrative.    Selling, general, and administrative expense increased $51.9 million to $386.9 million, or 33.5% of net sales in 2001, compared to $335.0 million, or 31.3% of net sales in 2000. Selling, general, and administrative expenses were reduced by $42.7 million and $31.4 million for the year ended December 2, 2001 and November 26, 2000, respectively, as a result of the adoption of EITF 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product”, as of March 4, 2002. EITF 01-09 provides guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative. This increase is

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primarily due to $21.4 million in additional costs associated with the businesses acquired in the international operations. Promotional and advertising expenses increased $15.7 million due to Sealy Posturepedic and Stearns & Foster product introduction costs, Sears new store rollout costs and mix shift to customers with higher cooperative advertising rates. Bad debt expense increased $14.9 million due to $4.2 million in bad debt costs associated with the bankruptcy of Homelife, $4.7 million to general bad debt reserves due to the negative impact on customers of the general slowdown in the economy and $6.0 million associated with affiliate accounts receivable.

Stock Based Compensation.    The Company has an obligation to repurchase certain securities of the Company held by an officer at the greater of fair market value or original cost. The Company recorded $(2.7) million of reduced expense for the year ended 2001, compared to $6.8 million of expense for the year ended 2000, to revalue this obligation to reflect the change in the fair market value of the securities.

Restructuring Charges.    During 2001, the Company shutdown its Memphis facility and recorded a $0.5 million charge primarily for severance. Additionally, the Company recorded a $0.7 million charge for severance due to a management reorganization.

Asset Impairment Charge.    During 2001, the operations of Rozen, the Company’s Argentine subsidiary, were negatively impacted by deteriorating economic conditions in Argentina resulting in a loss from operations. As a result of these economic conditions, the Argentine government allowed the peso, previously pegged 1 to 1 to the U.S. dollar, to freely float at a market exchange rate subsequent to December 2, 2001. In addition, the Argentine government imposed a restriction that severely limited cash withdrawals from the country. On January 31, 2002, the peso was trading at approximately 1.8 pesos to the dollar. As a result of the operating loss incurred by Rozen, the deteriorating economic conditions and the uncertainty surrounding the peso devaluation, the Company reviewed the carrying value of its investment in Rozen S.R.L. As a consequence, the Company has recorded a non-cash impairment charge of $4.4 million to write off all remaining unamortized goodwill. Management believes the value of the remaining assets are recoverable.

Interest Expense.    Interest expense increased $9.0 million primarily due to increased average debt levels. The Company has entered into interest rate swap agreements that effectively converts all of the floating-rate debt to a fixed-rate basis through March 2002 and $235.9 million of floating-rate debt to a fixed-rate basis through December 2006, thereby hedging against the impact of interest rate changes on future interest expense (forecasted cash flows). The Company is required under its credit agreements to hedge at least 50% of its floating rate term debt.

Other (Income) Expense, net.    The Company previously contributed cash and other assets to Mattress Holdings International LLC (“MHI”), a company controlled by the Company’s largest stockholder, Bain Capital LLC, in exchange for a non-voting interest. MHI was formed to invest in domestic and international loans, advances and investments in joint ventures, licensees and retailers. MHI acquired minority interests in Malachi Mattress America, Inc. (“Malachi”), a domestic mattress retailer, and Mattress Holdings Corporation (MHC) in 1999. MHC, controlled by Bain Capital, is a holding company which owns substantially all of the common stock of Mattress Discounters Corporation, a domestic mattress retailer, and the common stock of an international mattress retailer. The Malachi investment was accounted for by MHI under the equity method. Accordingly, the Company recorded equity in the (losses) earnings of Malachi of $(4.0) million and $0.5 million for the years ended December 2, 2001 and November 26, 2000. The MHC investment was accounted for by MHI under the cost method. Various operating factors combined with weak economic conditions during 2001, resulted in a review by Company management of the equity values related to these affiliates. The Company determined that the decline in the value of such investments was other than temporary and, as a consequence, recognized a non-cash impairment charge of $26.3 million to write-down the investments to their estimated fair values as of the end of the third quarter of 2001. (See “Liquidity and Capital Resources” for additional discussion concerning these investees).

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In May 2001, the Company and one of its licensees terminated its existing contract that allowed the licensee to manufacture and sell certain products under the Sealy brand name and entered into a new agreement for the sale of certain other Sealy branded products. In conjunction with the termination of the license agreement, Sealy received a $4.6 million termination fee that is recorded as other income.

Additionally, Other (income) expense, net includes interest income of $1.9 million and $3.2 million for the year ended December 2, 2001 and November 26, 2000.

Other (income) expense, net also includes $(0.5) million and $0.2 million for minority interest associated with the Argentina operations in 2001 and 2000, respectively. See also Note 14.

Income Tax.    The Company’s effective income tax rates in 2001 and 2000 differ from the Federal statutory rate principally because of the application of purchase accounting, the effect of certain foreign tax rate differentials and state and local income taxes. In addition, no tax benefit was recorded in 2001 on the $26.3 million impairment charge recognized due to the uncertainty concerning the recoverability of such loss. Also, the Company recorded a $4.4 million asset impairment charge in 2001 that will not be deductible for tax purposes. The Company’s effective tax rate for 2001 is approximately (176.6)% compared to 47.5% in 2000. Excluding the effects of both impairment charges, the Company’s effective tax rate for 2001 is approximately 55.5%. This higher effective tax rate for 2001 is due to lower pretax income (after considering the effects of the impairment charges) for the year compared to 2000 which increases the impact of non-deductible goodwill.

Liquidity and Capital Resources

The Company’s principal sources of funds are cash flows from operations and borrowings under its Revolving Credit Facility. The Company’s principal use of funds consists of payments of principal and interest on its Senior Credit Agreements, capital expenditures and interest payments on its outstanding Notes. Capital expenditures totaled $16.8 million for the year ended December 1, 2002. The Company expects 2003 capital expenditures to be approximately $26.0 million. Management believes that annual capital expenditure limitations in its current debt agreements will not significantly inhibit the Company from meeting its ongoing capital needs. In November 2002, the Company renegotiated its Revolving Credit Facility. Previously the Company had the ability to borrow $100.0 million under the facility, which was to expire on December 15, 2002. This facility was replaced with a $50.0 million Revolving Credit Facility, which expires on November 15, 2004. At December 1, 2002, the Company had approximately $35.4 million available under its Revolving Credit Facility including Letters of Credit issued totaling approximately $14.6 million. The Company’s net weighted average borrowing cost was 9.0% and 10.1% for the years ended December 1, 2002 and December 2, 2001, respectively. The Company’s average interest rate has been positively impacted by the Company’s interest rate derivatives as the Company’s interest rate derivatives have effectively offset each other to reestablish the floating rate debt during a period of declining interest rates. In November of 2002, the Company prepaid the outstanding balance of the Tranche A Term Loans which were scheduled to mature in December 2002. The Company is subject to certain restrictive financial covenants under its credit facility. The Company is in compliance and anticipates continued compliance with these covenants. A material deterioration of operating results could impact compliance with such covenants and cause the Company to seek amendments or waivers of such covenants. Failure to obtain waivers or amendments of covenants would also adversely affect the Company’s ability to fund its operations.

The Company’s cash flow from operations increased $88.7 million from $11.3 million for 2001 to $100.0 million for the year ended December 1, 2002. This increase is primarily the result of improved working capital management. The Company recognized expense of approximately $6.1 million in the fourth quarter associated with accounts receivable system conversion difficulties. These issues resulted principally in delays in processing of certain transactions and the Company also experienced a deterioration in the aging of trade receivables. The Company has taken remedial actions to address these issues and does not believe that there will be a material adverse affect on its liquidity and cash flow. The Company also had increased payments in the first half of 2001 associated with stock based compensation and other incentive compensation as compared to 2002.

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Cash used in investing activities decreased approximately $23.4 million primarily due to reductions in acquisitions of businesses in 2002. The company looks for strategic business acquisitions, and is unable to predict when or if any future acquisitions may occur.

Cash flow used in financing activities changed $90 million between 2002 and 2001. The company used $45 in financing activities principally to repay long-term obligations in 2002. See Notes 4, 6 and 7 to the Consolidated Financial Statements for a description of the Company’s long-term obligations and related hedging strategy.

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

The Company’s ability to make scheduled payments of principal, or to pay the interest or liquidated damages, if any, on, or to refinance, our indebtedness, or to fund planned capital expenditures will depend on the Company’s future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. Based upon the current level of operations and certain anticipated improvements, the Company believes that cash flow from operations and available cash, together with available borrowings under the senior credit agreement, will be adequate to meet our future liquidity needs throughout 2003. The Company’s long-term obligations contain various financial tests and covenants. The Company was in compliance with such covenants as of year end 2002. The most restrictive covenants relate to ratios of adjusted EBITDA to interest coverage and total debt to adjusted EBITDA all as defined in the agreements. Those ratios change under the agreement over time and are less restrictive in 2003 versus those at the end of 2002. The Company does not foresee an inability to meet such covenants in 2003. The Company will, however, need to refinance all or a portion of the principal of the notes on or prior to maturity. As of December 1, 2002, the Company recognized an additional increase of $6.3 million in the current portion of long term debt due to mandatory repayments required under the excess cash flow provision of its credit agreement. Historically, no such payments have been required; however, the Company is unable to predict with certainty whether such mandatory repayments may be required in the future. Under the terms of its Senior Subordinated Note Agreement, cash payments of interest expense will increase by approximately $13.3 million in 2003. Management believes that the Company will have the necessary liquidity through cash flow from operations, and availability under the Revolving Credit Facility for the next several years to fund its expected capital expenditures, obligations under its credit agreement and subordinated note indentures, environmental liabilities, and for other needs required to manage and operate its business. The Company’s scheduled principal payments on its borrowings will increase by approximately $44.1 million from 2003 to 2004. There can be no assurance that our business will generate sufficient cash flow from operations, that anticipated revenue growth and operating improvements will be realized or that future borrowings will be available under the senior credit agreements in an amount sufficient to enable the Company to service its indebtedness, including the notes, or to fund our other liquidity needs. In addition, there can be no assurance that the Company will be able to effect any such refinancing on commercially reasonable terms or at all.

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The Company’s contractual obligations and other commercial commitments as of December 1, 2002 are summarized below:

Foreign Operations and Export Sales

The Company has three manufacturing facilities in Canada, and one each in Mexico, Argentina and Brazil. In addition, the Company completed in 2001 the acquisition of Sapsa Bedding S.A., a leading manufacturer of latex bedding products in Europe, with headquarters and manufacturing operations in France and Italy, as well as sales organizations in Spain, Germany, Belgium and the Netherlands. In 2000, the Company formed a joint venture with its Australian licensee to import, manufacture, distribute and sell Sealy products in South East Asia. The Company uses a Korean contract manufacturer to help service the Korean market, distribute products directly in many small international markets, and has license agreements in Thailand, Japan, the United Kingdom, Australia, New Zealand, South Africa, Israel, Jamaica, Saudi Arabia, the Bahamas and the Dominican Republic.

In January 2002, the Argentine peso experienced a significant devaluation. Previously pegged 1 to 1 to the U.S. dollar, the peso was trading at approximately 3.5 pesos to the dollar at December 1, 2002. This devaluation did not have a significant affect on the Company’s financial statements due to the relative immateriality of the operation, as total assets at December 1, 2002 were $6.4 million.

Impact of Recently Issued Accounting Pronouncements

The Company adopted FAS 133, “Accounting for Derivative Instruments and Hedging Activities,” which requires that all derivatives be recorded on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. The Company recorded a $0.2 million gain, upon adoption as of November 27, 2000, net of income tax expense, which is recorded in the consolidated statement of operations as a cumulative effect of a change in accounting principle.

The FASB issued FAS 143, “Accounting for Asset Retirement Obligations”, effective for years beginning after June 15, 2002, the Company’s first quarter of fiscal year 2003. FAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. Upon adoption, this pronouncement will have no effect on the Company’s consolidated financial statements.

The FASB issued FAS 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”, effective for years beginning after December 15, 2001 and interim periods within those years, the Company’s first quarter of fiscal 2003. The objectives of FAS 144 are to address significant issues relating to the implementation of FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of”, and to develop a single accounting model, based on the framework established in FAS 121, for long-lived assets to be disposed of by sale, whether previously held and used or newly acquired. The Company

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early adopted the provisions of this pronouncement for related transactions. This did not have a significant impact on the consolidated financial statements.

In April 2002, the FASB issued FAS 145, “Recission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections”, effective for fiscal years beginning after, transactions entered into after and financial statements issued on or subsequent to May 15, 2002. FAS 145 rescinds both FAS 4, “Reporting Gains and Losses from Extinguishment of Debt,” and the amendment of FAS 4, FAS 64, “Extinguishments of Debt Made to Satisfy Sinking-Fund Requirements”. This Statement also rescinds FAS 44, “Accounting for Intangible Assets of Motor Carriers”. This Statement amends FAS 13, “Accounting for Leases”, to eliminate an inconsistency between the accounting for sale-leaseback transactions and the accounting for certain lease modifications that have economic effects that are similar to sale-leaseback transactions. This Statement also amends other existing authoritative pronouncements to make various technical corrections, clarify meanings, or describe their applicability under changed conditions. The Company adopted the provisions of this pronouncement for related transactions subsequent to May 15, 2002. This did not have a significant impact on the consolidated financial statements.

In July 2002, the FASB issued FAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities.” This Statement addresses financial accounting and reporting for costs associated with exit or disposal activities and supercedes Emerging Issues Task Force (EITF) Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” The Statement requires that a liability for a cost associated with an exit or disposal activity be recognized when the liability is incurred. Under EITF 94-3, a liability for an exit cost, as defined in EITF 94-3, was recognized at the date of commitment to an exit or disposal plan. This Statement also establishes that fair value is the objective for initial measurement of the liability. The provisions of this Statement are effective for exit or disposal activities initiated after December 31, 2002. The adoption of this Statement will not have a significant impact on the Company’s consolidated financial statements.

In November 2002, the FASB issued FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtness of Others—an interpretation of FASB Statements No. 5, 57, and 107 and a recission of FASB Interpretation No. 34.” FIN 45 elaborates on the disclosures to be made regarding obligations under certain issued guarantees by a guarantor in interim and annual financial statements. It also clarifies the requirement of a guarantor to recognize a liability at the inception of the guarantee at the fair value of the obligation. FIN 45 does not provide specific guidance for subsequently measuring the guarantor’s recognized liability over the term of the guarantee. The provisions relating to the initial recognition and measurement of a liability are applicable on a prospective basis for guarantees issued or modified subsequent to December 31, 2002. The disclosure requirements of FIN 45 are effective for interim and annual financial statements for periods ending after December 15, 2002, the Company’s first quarter of fiscal 2003. The Company will adopt the provisions of this statement effective December 2, 2002 and does not expect it to have a significant impact on the consolidated financial statements.

In January 2003, the FASB issued FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities.” The primary objectives of FIN 46 are to provide guidance on the identification of entities for which control is achieved through means other than through voting rights (“variable interest entities” or “VIEs”) and how to determine when and which business enterprise should consolidate the VIE (the “primary beneficiary”). This new model for consolidation applies to an entity which either (1) the equity investors (if any) do not have a controlling financial interest or (2) the equity investment at risk is insufficient to finance that entity’s activities without receiving additional subordinated financial support from other parties. In addition, FIN 46 requires that both the primary beneficiary and all other enterprises with a significant variable interest in a VIE make additional disclosures. FIN 46 is effective for the Company’s 2nd quarter of 2003 with transitional disclosure required with these financial statements. The Company will adopt these provisions in its 2nd quarter, however the Company does not believe it is a primary beneficiary of a VIE or holds any significant interests or

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involvement in a VIE and does not expect there to be an impact on the Company’s consolidated financial statements.

In December 2002, the FASB issued FAS 148, “Stock—Based Compensation—Transition and Disclosure”, an amendment of FAS 123, “Accounting for Stock-Based Compensation”. The transition guidance and annual disclosure provisions are effective for fiscal years ending after December 15, 2002 and the interim disclosure provisions are effective for interim periods beginning after December 15, 2002, the Company’s fiscal year end 2003 and second quarter of 2003, respectively. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. In addition, this Statement amends the disclosure requirements of FAS 123 to require more prominent disclosures in both annual and interim financial statements regarding the method of accounting for stock-based employee compensation and the effect of the method used on reported results. The Company does not believe that the adoption of this Statement will have a significant impact on the Company’s consolidated financial statements.

The Emerging Issues Task Force of the FASB released Issue 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product” to provide guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative in the Statement of Operations. The Company adopted EITF 01-09 effective March 4, 2002, the first day of our fiscal second quarter, and reclassified previous period amounts to comply with the consensus. As a result of the adoption, both net sales and selling, general and administrative expenses were reduced $51.5 million, $42.7 million and $31.4 million for the years ended December 1, 2002, December 2, 2001 and November 26, 2000, respectively. These changes did not affect the Company’s financial position or results of operations.

Fiscal Year

The Company uses a 52-53 week fiscal year ending on the closest Sunday to November 30, but no later than December 2. The fiscal year ended December 1, 2002 was a 52-week year, the fiscal year ended December 2, 2001 was a 53-week year and the fiscal year ended November 26, 2000 was a 52-week year.

Forward Looking Statements

This document contains forward-looking statements within the meaning of the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Although the Company believes its plans are based upon reasonable assumptions as of the current date, it can give no assurances that such expectations can be attained. Factors that could cause actual results to differ materially from the Company’s expectations include: general business and economic conditions, competitive factors, raw materials pricing, and fluctuations in demand.

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Item 7a.    Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exposures

The Company’s earnings are affected by fluctuations in the value of its subsidiaries’ functional currency as compared to the currencies of its foreign denominated purchases. Foreign currency forward, swap and option contracts are used to hedge against the earnings effects of such fluctuations. The result of a uniform 10% change in the value of the U.S. dollar relative to currencies of countries in which the Company manufactures or sells its products would not be material to earnings or financial position. This calculation assumes that each exchange rate would change in the same direction relative to the U.S. dollar.

To protect against the reduction in value of forecasted foreign currency cash flows resulting from purchases in a foreign currency, the Company has instituted a forecasted cash flow hedging program. The Company hedges portions of its purchases denominated in foreign currencies with forward and option contracts. At December 1, 2002, the Company had forward contracts to sell a total of 19.4 million Mexican pesos with expiration dates of February 27, 2003 and February 28, 2003, forward contracts to sell a total of 4.8 million Canadian dollars with expiration dates ranging from December 11, 2002 through February 26, 2003 and an option contract to sell a total of 2.6 million Canadian dollars with an expiration date of December 6, 2002.

In January 2002, the Argentine peso experienced a significant devaluation. Previously pegged 1 to 1 to the U.S. dollar, the peso was trading at approximately 3.5 pesos to the dollar at December 1, 2002. This devaluation did not have a significant affect on the Company’s financial statements due to the relative immateriality of the operation, as total assets at December 1, 2002 were $6.4 million. Based upon the volatility of the Argentine peso, future inflation charges may have to be recorded through the income statement due to hyperinflation rules under FAS 52, “Foreign Currency Translation”.

Interest Rate Risk

In 2000, the Company entered into an interest rate swap agreement that effectively converted $234.8 million of its floating-rate debt to a fixed-rate basis through December 2006, thereby hedging against the impact of interest rate changes on future interest expense (forecasted cash flows). Use of hedging contracts allows the Company to reduce its overall exposure to interest rate changes, since gains and losses on these contracts will offset losses and gains on the transactions being hedged. The Company formally documents all hedged transactions and hedging instruments, and assesses, both at inception of the contract and on an ongoing basis, whether the hedging instruments are effective in offsetting changes in cash flows of the hedged transaction. The fair values of the interest rate agreements are estimated by obtaining quotes from brokers and are the estimated amounts that the Company would receive or pay to terminate the agreements at the reporting date, taking into consideration current interest rates and the current creditworthiness of the counterparties. A 10% increase or decrease in market interest rates that effect the Company’s interest rate derivative instruments would not have a material impact on earnings during the next fiscal year.

Effective June 3, 2002, the Company dedesignated the interest rate swap agreement for hedge accounting. As a result of the dedesignation, $12.9 million previously recorded in accumulated other comprehensive loss as of the date of dedesignation is being amortized into interest expense over the remaining life of the interest rate swap agreement. For the year ended December 1, 2002, $2.0 million was amortized into interest expense. Prior to June 3, 2002, the changes in the fair market value of the interest rate swap were being recorded in accumulated other comprehensive loss. Subsequent to June 3, 2002, changes in the fair market value of the interest rate swap are being recorded in interest expense. For the year ended December 1, 2002, $15.0 million was recorded as interest expense as a result of the change in its fair market value. At December 1, 2002 and December 2, 2001,

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the fair value carrying amount of this instrument was $(20.2) million and $(15.7) million, respectively, which is recorded as follows:

During the second quarter of 2002, the Company entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the $234.8 million of debt previously converted to fixed rate debt through December 2006. This interest rate swap agreement has not been designated for hedge accounting and, accordingly, any changes in the fair value are to be recorded in interest expense. For the year ended December 1, 2002, $10.4 million was recorded as a reduction of interest expense as a result of the change in its fair market value. At December 1, 2002, the fair value carrying amount of this instrument is $7.8 million with $5.1 million recorded in prepaid expense and other current assets and $2.7 million recorded in noncurrent assets.

The Company also entered into an interest rate cap agreement during the second quarter of 2002 with a notional amount of $175.0 million that caps the LIBOR rate on which the floating rate debt is based at 8% through December 2006. This agreement has not been designated for hedge accounting and, accordingly, any changes in the fair value are recorded in interest expense. The Company recorded $29 thousand as a reduction to interest expense for the year ended December 1, 2002. At December 1, 2002, the fair value carrying amount of this instrument, which is included in noncurrent assets, was an asset of $29 thousand.

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Item 8.    Financial Statements and Supplementary Data

SEALY CORPORATION

Consolidated Financial Statements

December 1, 2002 and December 2, 2001

(With Independent Accountants’ Report Thereon)

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Report of Independent Accountants

To the Board of Directors and

    Stockholders of Sealy Corporation:

In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a)(1) on page 77 presents fairly, in all material respects, the financial position of Sealy Corporation and its subsidiaries (the “Company”) at December 1, 2002 and December 2, 2001, and the results of their operations and their cash flows for each of the three years in the period ended December 1, 2002 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 14 (a) (2) on page 77 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management; our responsibility is to express an opinion on these financial statements and financial statement schedule 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 3 to the consolidated financial statements, the Company adopted the provisions of Statement on Financial Accounting Standards No. 142 effective the beginning of the year ended December 1, 2002.

/s/  PricewaterhouseCoopers LLP

Greensboro, North Carolina

March 3, 2003

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SEALY CORPORATION

Consolidated Balance Sheets

(in thousands, except par value amounts)

See accompanying notes to consolidated financial statements.

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SEALY CORPORATION

Consolidated Balance Sheets

(in thousands, except par value amounts)

See accompanying notes to consolidated financial statements.

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SEALY CORPORATION

Consolidated Statements Of Operations

(in thousands, except per share amounts)