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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

For the fiscal year ended November 30, 2003

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 February 27, 2004: 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, 2004 is approximately: 31,360,600.

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 box springs. The Company’s conventional bedding products include the SEALY^®, SEALY POSTUREPEDIC^®, STEARNS & FOSTER^® BASSETT^® and REFLEXION^® brands and account for approximately 88.7% of the Company’s total net sales for the year ended November 30, 2003. The Company maintains its own component parts manufacturing capability and produces substantially all of its mattress innerspring requirements and approximately 45% of its boxspring component parts requirements. A subsidiary, Sealy, Inc., provides corporate and administrative services for the Company. Additional information about the Company can be found at the 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 box springs make up the U.S. conventional bedding industry, generating wholesale revenues of $4.77 billion during calendar year 2002. ISPA estimated that the industry experienced a 3.8% increase in sales in 2002—with a unit increase of 0.7%. According to ISPA, approximately 40% of conventional bedding is sold through furniture stores and 33% 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, 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 Simmons Company and Serta, Inc. 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, including the new Unicased ^® Posturepedic, 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 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 18.1% of the Company’s net sales for the year ended November 30, 2003 and no single customer accounted for over 10.0% of the Company’s net sales.

Sales and Marketing. The Company’s sales depend primarily on its ability to provide quality products with recognized brand names at competitive prices. Additionally, the Company works to build brand loyalty with its ultimate consumers, principally through targeted national advertising and cooperative advertising with its dealers, 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 program 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

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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 is dependent upon a single supplier for certain key structural components of its new Unicased ^® Posturepedic line of mattresses. Such components are purchased under a four-year supply agreement, and are manufactured in accordance with a proprietary design exclusive to the supplier. The Company has incorporated the Unicased ^® method of construction into substantially all of its Sealy brand products, and expects to have it incorporated into the Stearns & Foster branded products as well by the end of 2004. Under the terms of the supply agreement, the Company has committed to make minimum purchases of the components totaling $70 million through 2006. The Company believes that its supply requirements will exceed the minimum purchase commitments over the life of the agreement. The Company purchases its other raw materials and certain components from a variety of vendors. The Company purchases approximately 55% of its Sealy and Stearns & Foster box spring parts from a single third-party source and manufactures the remainder of these parts. Except for its dependence regarding certain structural components for the Unicased ^® mattresses, 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, Italy, Mexico, Argentina and Brazil. 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.

The Company distinguishes itself from its major competitors by internally sourcing the majority of its requirements for component parts through its component manufacturing facilities, which manufacture component parts exclusively for use by the Company’s bedding plants and licensees. The component plants currently provide substantially all of the Company’s mattress innerspring unit requirements, and supply approximately 45% of the Company’s Sealy box spring parts requirements. The three component manufacturing sites are located in Rensselaer, Indiana; Delano, Pennsylvania; and Colorado Springs, Colorado. See Item 2, “Properties,” herein.

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, Italy and Argentina 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 November 30, 2003. 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. The Company operates a sales office in Korea and uses a contract manufacturer to service the Korean market. In addition, the Company ships products directly into many small international markets.

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Licensing

At November 30, 2003, there are 17 separate license arrangements in effect with six domestic and eleven foreign independent licensees. Sealy New Jersey (a bedding manufacturer), Klaussner Corporation Services (a furniture manufacturer), Kolcraft Enterprises, Inc. (a crib mattress manufacturer), Pacific Coast Feather Company (a pillow, comforter and mattress pad manufacturer), Chairworks Manufacturing Group Limited (an office seating manufacture), 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. Pacific Coast Feather also has a license to use the Stearns & Foster brand on certain approved products. 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 group 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 November 30, 2003, December 1, 2002 and December 2, 2001, the licensing group as a whole generated gross royalties of approximately $13.7 million, $12.2 million and $12.0 million, respectively.

See the International section for international licensees.

Warranties & Accommodations

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. The Company also accepts, upon occasion, other returns from some of its retailers as an accommodation.

Trademarks and Licenses

The Company owns, among others, the Sealy and Stearns & Foster trademarks and tradenames and also owns the Posturepedic, and University of Sleep trademarks, service marks and certain related logos and design marks. The Company also licenses the Bassett and Pirelli tradenames in various territories under certain long term agreements.

Employees

As of November 30, 2003 the Company had 6,562 full-time employees. Approximately 70% of the Company’s employees at its 26 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. The Company’s current collective bargaining agreements, which are typically three years in length, expire at various times beginning in 2004 through 2007.

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).

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Item 2. Properties

The Company’s principal executive offices are located on Sealy Drive at One Office Parkway, Trinity, North Carolina, 27370. Corporate and administrative 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 operating leases, which expire from fiscal 2004 to 2033, including renewal options.

The following table sets forth certain information regarding manufacturing and distribution facilities operated by the Company at January 31, 2004:

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In addition to the locations listed above, the Company maintains additional warehousing facilities in several of the states where its manufacturing facilities are located. It also maintains approximately 10 retail outlets, which are held under operating leases by the Company’s retail subsidiary. The Company considers its present facilities to be generally well maintained and in sound operating condition.

Regulatory Matters

The state of California adopted new flame retardant regulations related to manufactured mattresses and box springs which will be effective January 1, 2005. The Company expects to be in full compliance with those regulations by the effective date. The Company does not expect the impact of those regulations to be significant to the Company’s results of operations or financial position.

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 does not expect to make any material capital expenditures for environmental control facilities in the foreseeable future.

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 and implement 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 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.

In 2000, Montgomery Ward, a customer of Sealy, declared bankruptcy and filed for protection under Chapter 7 of the U.S. Bankruptcy Code. In 2003, the bankruptcy trustee filed a claim of $3.7 million associated with certain alleged preferential payments by Montgomery Ward to Sealy. Currently, the case is in the discovery phase and the Company believes it has significant defenses against such claims. While the Company cannot predict the ultimate outcome, the Company believes it has adequate accruals recorded with respect to this claim and does not believe the resolution of this matter will have a material adverse effect on the financial position or future operations of the Company.

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, 2004, there are 40 holders of record of the Company’s Class A shares, 8 holders of record of the Company’s Class B shares, 21 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. 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 November 30, 2003, December 1, 2002, December 2, 2001, November 26, 2000, and November 28, 1999.

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 November 30, 2003, December 1, 2002, and December 2, 2001 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.

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.

Business Overview

Sealy Corporation is the largest bedding manufacturer in the world with sales of approximately $1.2 billion worldwide. The Company has operations in the United States, Canada, Mexico, Puerto Rico, France, Italy, Brazil and Argentina. Approximately, 80% of the sales are from the domestic operations. The Company manufactures and markets a full-line of mattress and boxsprings under the Sealy, Sealy Posturpedic, Stearns & Foster, Bassett and Reflexion brand names ranging in retail price from under $300 to $5,000 per queen size set. The Company’s customers include furniture stores, national mass merchandisers, specialty sleep shops, department stores, contract customers and other stores. The top five customers accounted for approximately 18.1% of the Company’s net sales for the year ended November 30, 2003 and no single customer accounted for over 10.0% of net sales.

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 when realized or realizable and earned, which is when the following criteria are met: persuasive evidence of an arrangement exists; delivery has occurred; the sales price is fixed and determinable; and collectibility is reasonably assured. The recognition criteria are generally met when title and risk of loss have transferred from the Company to the buyer, which is generally upon delivery to the customer sites or legal requirements in foreign jurisdictions. At the time revenue is recognized, the Company provides for the estimated costs of warranties and reduces revenue for estimated returns and cash discounts. As a basis for its estimate of future returns, management uses historical trend information in conjunction with the Company’s policies related to acceptance of returns. At the time revenue is recognized, the Company also records reductions to revenue for customer incentive programs offered including volume discounts, promotional allowances, slotting fees and supply agreement amortization.

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 $154.2 million in 2003 and were approximately 13.0 percent of net sales.

Allowance for Doubtful Accounts—The Company actively monitors the financial condition of its customers to determine the potential for any nonpayment of trade receivables. In determining its general reserve for bad debts, the Company also considers other economic factors, such as consumer confidence and aging trends. 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. The Company’s loss experience was approximately 0.4 percent of sales in 2003.

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Warranties—The Company’s warranty policy provides a 10-year non-prorated warranty service period on all currently manufactured Sealy Posturepedic, Stearns & Foster and Bassett bedding products and some other Sealy-branded products. The Company’s policy is to accrue the estimated cost of warranty coverage at the time the sale is recorded based on historical trends of warranty costs. Accrued warranty totaled $9.1 million and $9.5 million as of November 30, 2003 and December 1, 2002, respectively.

Impairment of Goodwill, Patents and Other Intangibles—The Company performs an annual assessment of its goodwill for impairment as of the beginning of the fiscal fourth quarter. The Company bases its assessment of recoverability on a multiple of earnings before interest, taxes, depreciation and amortization (EBITDA). The Company, at least annually, assesses its goodwill and other intangible assets for impairment when events or circumstances indicate that their carrying value may not be recoverable from future cash flows. The 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 5.0 to 9.6. 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 5.5 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, including 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 earnings before interest, taxes, depreciation and amortization (EBITDA) adjusted for stock-based compensation.

Year Ended November 30, 2003 Compared With Year Ended December 1, 2002

Net Sales. Net sales for the year ended November 30, 2003, were $1,189.9 million, an increase of $0.7 million from the year ended December 1, 2002. Total domestic sales were $950.7 million for fiscal 2003 compared to $972.4 million for fiscal 2002. The domestic sales decline of $21.7 million was attributable to a 3.7% decrease in volume partially offset by a 1.6% increase in average unit selling price. This unit volume decrease was primarily due to lower sales to current and prior affiliates as they transitioned from single vendor to multi-vendor supply relationships. Additionally, year to date sales have been negatively impacted by slower economic activity during the first half of 2003. Improving economic conditions and the success of the new product launch during the second half of 2003 contributed to a 2.0% increase in sales volume over the corresponding period in 2002. Excluding the effects of lower sales from current and former affiliates, sales volume increased 6.0% over the second half of the year. The increase in average unit selling price is due primarily to an improved sales mix from both the Company’s existing core Posturepedic line and the new Unicased ^® Posturepedic line, partially offset by lower sales of other higher-end products and increased price roll-backs on existing products in conjunction with the roll-out of the Unicased ^® Posturepedic line. For the year ended November 30, 2003, sales to affiliates included sales to one affiliate for the entire period and sales to a prior affiliate for approximately four and a half months, while sales to affiliates for the year ended December 1, 2002 included sales to three affiliates. Total international sales were $239.1 million in fiscal 2003 compared to $216.8 for fiscal 2002. Increases of $22.3 million, or 10.3%, were primarily attributable to favorable currency fluctuations in Canada and Europe and volume gains in Argentina and Brazil, partially offset by continued weakness in the Mexican market.

Cost of Goods Sold. Cost of goods sold for the year ended November 30, 2003, as a percentage of net sales, increased 1.2 percentage points to 58.4%. Cost of goods sold for the domestic business, as a percentage of net sales, increased 1.3 percentage points to 57.2%. This increase is primarily due to lower absorption of fixed costs due to lower unit sales, higher variable costs associated with health insurance costs, higher costs associated with product returns, a lower mix of higher-end products that typically carry a higher margin than other products, costs associated with the shutdown of the Taylor facility in December 2002, manufacturing costs and roll-back pricing related to the roll out of the Company’s new Unicased ^® design for its Posturepedic bedding line. Cost of goods sold for the international business, as a percentage of net sales, increased 0.4 percentage points to 63.3%. This increase is primarily due to labor increases in the European business partially offset by lower material costs in the Canadian business, due primarily to the weakening US dollar to the Canadian dollar as the Company’s Canadian business purchases a large percentage of its raw materials payable in US dollars.

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Selling, General, and Administrative. Selling, general, and administrative expenses decreased $13.4 million to $397.1 million, or 33.4% of net sales, compared to $410.5 million or 34.5% of net sales. This decrease is primarily attributable to a $26.2 million decrease in bad debt expense. During 2002 the Company recorded a charge of $22.6 million for bad debt expense associated with affiliated customers (as discussed fully in Note 18 to the consolidated financial statements). Also, during 2002 the Company recorded a charge of $6.1 million for bad debts as a result of difficulties in an accounts receivable system conversion (as discussed fully in “Liquidity and Capital Resources”). The difficulties negatively impacted the Company’s collections during 2002 and through the second quarter of 2003. Accordingly, during the second quarter of 2003 the Company reassessed the progress of its collection efforts and determined that it was necessary to record an increase of $2.0 million in its reserve for bad debts. Since then the Company has made significant progress in resolving its accounts receivable processing issues and its accounts receivable statistics have improved significantly as of November 30, 2003. No additional charges were necessary during the second half of the year. The decrease in bad debt expense was partially offset by increased employment costs of $10.3 million. Salaries increased $8.5 million, of which $2.4 million was due to normal merit and cost of living increases, with the remaining $6.1 million primarily attributable to increased head count. Fringe benefits increased $1.8 million over 2002, attributable mainly to increased headcount. The remaining increase of $3.3 million is primarily associated with increased promotional and advertising costs, including those incurred to support the Company’s roll out of the new Unicased ^® Posturepedic line.

Stock Based Compensation. The Company has an obligation to repurchase certain securities of the Company held by an officer at the estimated fair market value subject to a maximum and minimum share value stated in the officer’s agreement. As of November 30, 2003, the maximum share value had been reached. Accordingly, the Company has no additional exposure to future stock based compensation expense resulting from this agreement. Should the fair value of the stock fall back below the capped amount, the Company would record income associated with revaluation, limited to the floor value in the agreement. The Company recorded a $1.3 million expense for the year ended November 30, 2003, compared to a $0.8 million of expense for the year ended December 1, 2002, to revalue this obligation to reflect increases in the fair market value of the securities.

Restructuring Charge. Due to continued weak performance and the fact that it is not the Company’s strategy to own or control retail operations, the Company committed to a plan in the fourth quarter of 2003 to dispose of its wholly-owned retail subsidiary by sale or liquidation in early 2004. Accordingly, the Company recognized a non-cash impairment charge of $1.8 million during the fourth quarter, which included the $1.6 million write-off goodwill on the books of the subsidiary plus impairment charges for leasehold improvements likely to be abandoned. Following the disposal of this subsidiary, the Company will no longer have a direct interest in any domestic mattress retailer.

Interest Expense. Interest expense decreased $4.0 million primarily due to lower effective interest rates. This lower rate is primarily due to the favorable impact from the interest rate swaps as the interest rate on the majority of the Company’s bank debt floated during a time of declining interest rates. In 2000, the Company entered into an interest rate swap agreement that effectively converted $236 million of its floating-rate debt to a fixed-rate basis through December 2006. In the second quarter of 2002, the Company entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the debt previously converted to fixed rate debt through December 2006. While the $236 million of the Company’s bank debt was fixed at approximately 6% for the first half of 2002, the entire balance was at a floating rate for all of 2003 during a time of declining interest rates. This had the effect of reducing the weighted average cost of the Company’s bank debt from 5.6% in 2002 to 3.7% in 2003. In May 2003, the Company issued an additional $50.0 million of 9.875% senior subordinated notes, due in December, 2007 (“public debt”). The proceeds were used to prepay all quarterly principal payments on the Company’s Senior AXELs Credit Facility (“bank debt”) through March, 2004. The exchange of bank debt for public debt increased the Company’s interest expense by approximately $1.8 million for 2003.

Income Tax. The Company’s effective income tax rates in 2003 and 2002 differ from the Federal statutory rate principally because of the effect of certain foreign tax rate differentials 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 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’s effective tax rate for the year ended November 30, 2003 is approximately 49.9% compared to 29.9% in 2002.

New Product Launch

The Company annually invests significantly in research and development to improve its product offerings. In June 2003, the Company launched an entirely new line of mattresses and box springs for its Sealy Posturepedic brand. All Sealy Posturepedic brand mattresses are now manufactured with “Unicased ^® Construction” utilizing new proprietary processes and materials incorporated into a single-sided design. In 2004, the Company will incorporate this new design into all of its Stearns & Foster branded products. The Company estimates it incurred increased costs of approximately $11.3 million during the second half of 2003 associated with labor inefficiencies due to manufacturing and design changes and increased promotional spending (largely roll-back pricing) associated with the roll-out of the new product. While the Company does not expect such labor inefficiencies to continue into 2004, additional close-out pricing and promotional costs are expected to be incurred as customers transition to the new Stearns & Foster lines.

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Total close-out and promotional costs for 2004, including those associated with the Stearns & Foster product transition, are expected to be slightly above pre-2003 levels. The Company is dependent upon a single supplier for certain key structural components of its new Unicased ^® design. Such components are purchased under a four-year supply agreement, and are manufactured in accordance with a proprietary process of the supplier. Under the terms of the supply agreement, the Company is required to make minimum purchases of the components totaling $70 million through 2006. The Company believes that its supply requirements will exceed the minimum purchase commitments over the life of the agreement.

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. 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 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. 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.

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.

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 goodwill.

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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 $236 million of its floating-rate debt to a fixed-rate basis through December 2006. In the second quarter of 2002, the Company entered into another interest rate swap agreement that has the effect of reestablishing as floating rate debt the $236 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 a minority interest in Malachi Mattress America, Inc. (“Malachi”), a domestic mattress retailer, and, indirectly through a Bain-controlled holding company, acquired a minority interest in Mattress Holdings Corporation (MHC) 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.

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.

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 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.

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 $13.4 million for the year ended November 30, 2003. The Company expects 2004 capital expenditures to be approximately $25.0 million. Management believes that annual capital expenditure limitations in its current debt agreements will not significantly inhibit the Company from meeting its ongoing capital needs. At November 30, 2003, the Company had approximately $33.2 million available under its Revolving Credit Facility including Letters of Credit issued totaling approximately $16.8 million. The Company’s net weighted average borrowing cost was 9.1% and 9.3% for the years ended November 30, 2003 and December 1, 2002, respectively.

The Company’s cash flow from operations decreased $12.1 million from $100.0 million for 2002 to $87.9 million for the year ended November 30, 2003. This decrease in operating cash flows is primarily the result of lower operating margins, higher cash tax payments, and higher payments in the first quarter associated with incentive compensation that were not made in the first quarter of 2002, partially offset by improved working capital management.

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The Company’s cash flow from investing activities increased primarily due to $13.6 million received in 2003 on an affiliate note and investment. In 2002, the Company loaned this affiliate $12.5 million in the form of a long-term note. The Company also made $6.8 million in cash payments in 2002 associated with business acquisitions. No such acquisitions were completed in 2003.

The Company recorded a minimum liability associated with an under-funded pension plan equal to the excess of the accumulated benefit obligation over the fair value of plan assets. The minimum liability at November 30, 2003 was $4.5 million, and the Company will be required to make a minimum funding contribution of $1.2 million in 2004.

The Company also experienced difficulties in an accounts receivable system conversion in the fourth quarter of 2002 that negatively impacted collection efforts primarily through the first half of 2003. These issues resulted principally in delays of processing of certain transactions and the deterioration in the aging of trade receivables. As a result, the Company increased its allowance for doubtful accounts $6.1 million in the fourth quarter of 2002. In the second quarter of 2003, the Company reassessed the progress of its collection efforts and determined an incremental $2.0 million reserve was necessary. The Company made significant progress in the second half of the year and no additional charges were necessary as a result of this issue and the Company believes adequate controls and processes are now in place and functioning to reasonably ensure accurate and timely processing of accounts receivable and cash collection transactions.

On October 9, 2003, the Company amended its Amended and Restated Credit Agreement dated November 8, 2002 to provide the Company with the ability to repurchase up to $25 million of the outstanding amount of the Junior Subordinated Notes and to amend the requirements for allowing the Company to make cash payments on the interest accrued. The Company was previously required to accrue interest at 12% and add such interest to the total outstanding amount of the Notes. The Company will now have the option within 10 days of the end of each calendar quarter to pay interest on the total outstanding amount for that quarter at a rate of 10% per annum. The Company made its first cash interest payment on these notes for the calendar quarter ended December 31, 2003.

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

In May 2003, the Company completed a private placement of $50 million of 9.875% senior subordinated notes. These notes, which are due and payable on December 15, 2007 require semi-annual interest payments, commencing June 15, 2003. The proceeds from the placement were used to prepay all quarterly principal payments on the Senior AXELs Credit Facility through March 2004. The Company will commence quarterly principal payments on June 15, 2004. Subsequent to the issuance, the Company registered the notes with the Securities and Exchange Commission to allow them to be exchanged for publicly traded bonds. The Company commenced an exchange offer in June which was completed in July 2003. In connection with the note issuance, the Company incurred $2.8 million in debt financing costs. The Company also paid $1.2 million during the first quarter for previously accrued debt issuance costs associated with the refinancing of the Revolving Credit Facility in November 2002.

The Company’s ability to make scheduled payments of principal, or to pay the interest or liquidated damages, if any, on, or to refinance our indebtedness, or to fund planned capital expenditures will depend on the Company’s future performance, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond the Company’s control. Based upon the current level of operations and certain anticipated improvements, the Company believes that cash flow from operations and available cash, together with available borrowings under the senior credit agreement, will be adequate to meet the future liquidity needs throughout 2004. The current domestic revolving credit agreement matures on November 15, 2004. The Company expects to have a new revolving facility in place prior to its maturity. The current Canadian revolver, originally to expire February 14, 2004, has been extended through the end of March 2004. The Company is currently in negotiations to renew this facility and expects to complete the negotiations during the Company’s second quarter of 2004. The Company also will need to refinance all or a portion of the principal of the notes on or prior to maturity. The Company will make regularly scheduled principal payments of $41.9 million in 2004. On February 27, 2004, the Company obtained a waiver for 2004 from its lending institutions of the Mandatory Prepayment requirements under the excess cash flow provisions of its credit agreement (as more fully discussed in Note 4 to the Company’s Consolidated Financial Statements included elsewhere in this Annual Report). There can be no assurance that the Company will generate sufficient cash flow from operations, that anticipated revenue growth and operating improvements will be realized or that future borrowings will be available under the senior credit agreements in an amount sufficient to enable the Company to service its indebtedness, including the notes, or to fund other liquidity needs. In addition, there can be no assurance that the Company will be able to effect any such refinancing on commercially reasonable terms or at all.

The Company’s long-term obligations contain various financial tests and covenants. The Company was in compliance with such covenants as of the year ended November 30, 2003. The most restrictive covenants relate to ratios of adjusted EBITDA to interest coverage and total debt to adjusted EBITDA all as defined in the senior and revolving credit agreements. The specific

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ratio requirements can be found in the credit agreements previously filed with the Securities and Exchange Commission. The Company expects to meet such covenants in 2004. Adjusted EBITDA (as defined in the senior and revolving credit agreements) differs from the term “EBITDA” as it is commonly used. In addition to adjusting net income to exclude income taxes, interest expense and depreciation and amortization, adjusted EBITDA (as defined in the senior and revolving credit agreements) also adjusts net income by excluding items or expenses not typically excluded in the calculation of “EBITDA.” Adjusted EBITDA is presented herein as it is a material component of the covenants contained within the aforementioned credit agreements. Non-compliance with such covenants could result in the requirement to immediately repay all amounts outstanding under such agreements. While the determination of “unusual and nonrecurring losses” is subject to interpretation and requires judgment, the Company believes the items listed below are in accordance with the stated credit agreements. EBITDA does not represent net income or cash flow from operations as those terms are defined by generally accepted accounting principles (“GAAP”) and does not necessarily indicate whether cash flows will be sufficient to fund cash needs.

The following is a calculation of the Company’s adjusted EBITDA for the years ended November 30, 2003 and December 1, 2002:

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The Company’s contractual obligations and other commercial commitments as of November 30, 2003 are summarized below:

The Company has an obligation to repurchase certain securities of the Company held by an officer at the estimated fair market value subject to a maximum and minimum share value stated in the officer’s agreement. As of November 30, 2003 the maximum share value had been reached. Accordingly, the Company has no additional exposure to future stock based compensation expense resulting from this agreement. At November 30, 2003, the Company had $6.7 million recorded for the obligation. The officer’s rights to sell his shares are fully vested and may be exercised at any time.

Foreign Operations and Export Sales

The Company owns 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 European manufacturer of latex bedding products in Europe, with headquarters in Italy and manufacturing operations in France and Italy, along with sales organizations in Spain, 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 operates a Korean sales office and uses a contract manufacturer to help service the Korean market. The Company also exports products directly into 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.

Impact of Recently Issued Accounting Pronouncements

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

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

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

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disclosures. The Company will adopt these provisions in its second quarter of 2004. The Company is not a primary beneficiary of a VIE and does not hold any significant interests or have any involvement in a VIE. The Company does not expect the adoption to have an effect on the consolidated financial statements.

The FASB issued FAS 132 (Revised), “Employers’ Disclosure about Pensions and Other Postretirement Benefits.” A revision of the pronouncement originally issued in 1998, FAS 132R expands employers’ disclosure requirements for pension and postretirement benefits to enhance information about plan assets, obligations, benefit payments, contributions, and net benefit cost. FAS 132R does not change the accounting requirements for pensions and other postretirement benefits. This statement is effective for fiscal years ending after December 15, 2003, with interim-period disclosure requirements effective for interim periods beginning after December 15, 2003. Accordingly, the Company will implement FAS 132R beginning with its first fiscal quarter of 2004. The adoption of this statement will not have an impact on the Company’s financial position or results of operations.

The Emerging Issues Task Force of the FASB released Issue 01-09, “Accounting for Consideration Given by a Vendor to a Customer or a Reseller of the Vendor’s Product” to provide guidance primarily on income statement classification of consideration from a vendor to a purchaser of the vendor’s products, including both customers and consumers. Generally, cash consideration is to be classified as a reduction of revenue, unless specific criteria are met regarding goods or services that the vendor may receive in return for this consideration. The Company has historically classified certain costs such as volume rebates, promotional money and amortization of supply agreements covered by the provisions of EITF 01-09 as marketing and selling expenses which are recorded in selling, general and administrative in the Statement of Operations. The Company adopted EITF 01-09 effective March 4, 2002, the first day of fiscal second quarter of 2002, and reclassified previous period amounts to comply with the consensus. As a result of the adoption, both net sales and selling, general and administrative expenses were reduced $50.3 million, $51.5 million and $42.7 million for the years ended November 30, 2003, December 1, 2002, and December 2, 2001, 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 November 30, 2003 was a 52-week year, December 1, 2002 was a 52-week year, and the fiscal year ended December 2, 2001 was a 53-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.

Item 7a. Quantitative and Qualitative Disclosures About Market Risk

General Business Risk

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. The Company is dependent upon a single supplier for certain key structural components of its new Unicased ® design. Such components are purchased under a four-year supply agreement, and are manufactured in accordance with a proprietary design exclusive to the supplier. Any of these factors could have a material adverse effect on business, financial condition or results of operations.

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 November 30, 2003, the Company had forward contracts

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to sell a total of 2.0 million Mexican pesos with expiration dates of February 20, 2004, and forward contracts to sell a total of 30.0 million Canadian dollars with expiration dates ranging from December 9, 2003 through November 12, 2004. At November 30, 2003, the fair value of the Company’s net obligation under the forward contracts was $0.8 million.

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 3.0 pesos to the dollar at November 30, 2003. This devaluation did not have a significant affect on the Company’s financial statements due to the relative immateriality of the operation. 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 $236 million of its floating-rate debt to a fixed-rate basis through December 2006, thereby hedging against the impact of interest rate changes on future interest expense (forecasted cash flows). Use of hedging contracts allows the Company to reduce its overall exposure to interest rate changes, since gains and losses on these contracts will offset losses and gains on the transactions being hedged. The Company formally documents all hedged transactions and hedging instruments, and assesses, both at inception of the contract and on an ongoing basis, whether the hedging instruments are effective in offsetting changes in cash flows of the hedged transaction. The fair values of the interest rate agreements are estimated by obtaining quotes from brokers and are the estimated amounts that the Company would receive or pay to terminate the agreements at the reporting date, taking into consideration current interest rates and the current creditworthiness of the counterparties. Effective June 3, 2002, the Company dedesignated the interest rate swap agreement for hedge accounting. As a result of the dedesignation, $12.9 million previously recorded in accumulated other comprehensive loss as of the date of dedesignation is being amortized into interest expense over the remaining life of the interest rate swap agreement. For the years ended November 30, 2003 and December 1, 2002, $3.3 million and $2.0 million was amortized into interest expense, respectively. Prior to June 3, 2002, the changes in the fair market value of the interest rate swap were recorded in accumulated other comprehensive income (loss). Subsequent to June 3, 2002, changes in the fair market value of the interest rate swap are recorded in interest expense. For the years ended November 30, 2003 and December 1, 2002, $5.4 million and $15.0 million, respectively, was recorded as net interest expense as a result of the cash requirements of the swap net of the non-cash interest associated with the change in its fair market value. At November 30, 2003 and December 1, 2002, the fair value carrying amount of this instrument was $(14.9) million and $(20.2) 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 $236 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 years ended November 30, 2003 and December 1, 2002, $5.2 million and $10.4 million, respectively, was recorded as a reduction of net interest expense as a result of the cash interest received on the swap net of the non-cash interest associated with the change in its fair market value. At November 30, 2003 and December 1, 2002, the fair value carrying amount of this instrument was $6.8 million and $7.8 million, respectively, with $5.1 million and $5.1 million recorded in prepaid expenses and other current assets, and $1.7 million 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 fair value of this instrument is not material.

The impact of a one percentage point change in interest rates would changed the Company’s interest expense by approximately $2.6 million dollars.

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Worldwide Steel Prices

The world demand for steel over the last two years has increased due to a number of factors, including increased steel imports into Asia. In addition, there has been a significant reduction in U.S. steel capacity. Furthermore, the weakening of the U.S. Dollar has raised the relative price of steel imported into the United States. Consequently, the Company believes that the cost of cold rolled steel and steel drawn wire which are used in the production of the spring units and other components within the mattress and box springs will increase significantly during 2004. Although the Company is still evaluating the forecasted impact on the operating margins, the Company does not believe such impact will ultimately materially impact its long-term operations and financial position. The Company is also evaluating its possible responses to these potential cost increases, which may include increases in the prices charged to its customers.

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Item 8. Financial Statements and Supplementary Data

SEALY CORPORATION

Consolidated Financial Statements

November 30, 2003 and December 1, 2002

(With Independent Auditors’ Report Thereon)

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Report of Independent Auditors

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 70 presents fairly, in all material respects, the financial position of Sealy Corporation and its subsidiaries (the “Company”) at November 30, 2003 and December 1, 2002, and the results of their operations and their cash flows for each of the three years in the period ended November 30, 2003 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 70 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 of Financial Accounting Standards No. 142 effective the beginning of the year ended December 1, 2002.

23

SEALY CORPORATION

Consolidated Balance Sheets

(in thousands, except par value amounts)

See accompanying notes to consolidated financial statements.

24

SEALY CORPORATION

Consolidated Balance Sheets

(in thousands, except par value amounts)

See accompanying notes to consolidated financial statements.

25

SEALY CORPORATION

Consolidated Statements Of Operations

(in thousands, except per share amounts)