2007 ANNUAL REPORT Sleep Country Income Fund TABLE OF CONTENTS

PROFILE ...... 1 FORWARD-LOOKING STATEMENTS ...... 1 THREE-YEAR FINANCIAL HIGHLIGHTS ...... 2 CHARITABLE PROGRAMS...... 4 SLEEP COUNTRY...... 5 DORMEZ-VOUS ...... 6 SLEEP AMERICA ...... 7 MESSAGE TO UNITHOLDERS ...... 9 TRUSTEES AND DIRECTORS ...... 10–11 OFFICERS ...... 12–13 MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS AND FINANCIAL CONDITION ...... 14–33 AUDITORS’ REPORT ...... 35 FINANCIAL STATEMENTS ...... 36–39 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS ...... 40–59 CORPORATE DATA ...... 61 PROFILE The Income Fund, through its wholly owned subsidiaries, invests in a number of retailers under the following banners: Sleep Country Canada, the largest mattress retailer in Canada; Dormez-vous, an expanding mattress retailer in ; and Sleep America, a mattress retailer in the State of Arizona in the .

FORWARD-LOOKING STATEMENTS This annual report includes statements that are ‘‘forward-looking statements’’. These forward-looking statements reflect the current internal projections, expectations or beliefs, future growth, performance and business prospects and opportunities of the Fund and are based on information currently available to the Fund. Actual results and developments may differ materially from results and developments discussed in the forward- looking statements as they are subject to a number of risks and uncertainties. Management cannot provide assurance that the actual results or developments will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, the Fund. These forward-looking statements are made as of the date of this report.

The Annual General Meeting will be held at 4:00 p.m. ( time) on Tuesday, May 6, 2008.

This year the meeting will take place at the TSX Broadcast & Conference Centre GM in the Gallery. The Exchange Tower, 130 King Street West, Toronto. A

Sleep Country Canada Income Fund 1

THREE-YEAR FINANCIAL HIGHLIGHTS (in thousands of Canadian dollars, except per unit amounts)

Operations Year ended Year ended Year ended December 31, 2007 December 31, 2006 December 31, 2005

Sales $357,182 $324,089 $223,717

Total sales growth 10.2% 44.9% 14.5%

Contribution margin $91,174 $84,440 $64,043

EBITDA (1) $41,479 $37,790 $33,897

Net earnings $28,905 $26,398 $22,443

Basic earnings per unit $2.06 $1.88 $1.60

Total assets $272,794 $271,396 $235,794

Distributable Cash and Year ended Year ended Year ended Distributions December 31, 2007 December 31, 2006 December 31, 2005

Distributions declared per unit $1.41 $1.36 $1.30

Payout ratio (2) 65.0% 80.1% 77.9%

(1) EBITDA refers to earnings before interest, taxes, depreciation, amortization and other items. EBITDA is not a recognized measure under Canadian generally accepted accounting principles (GAAP) and may not be comparable to similar measures used by other companies (See Non-GAAP measures). (2) The calculation of payout ratio includes cash flow from operations before changes in working capital.

2 2007 Annual Report During 2007, The Fund achieved the following: • The Sleep Country team continued to strengthen the execution of sales and operations and, in a weaker market, achieved record levels of sales and EBITDA. • The Dormez-vous team continued their successful expansion in the market. The team expanded the store count from 17 at the start of 2007 to finish off the year at 24 stores. More importantly, the team achieved positive EBITDA in their second year of expansion and continued to build on their market share. • The Sleep America team focused on building both processes and management depth to ready the platform for a future expansion. The market in Arizona experienced historic levels of weakness for all of 2007.

Sleep Country Canada Income Fund 3 OUR CHARITABLE PROGRAMS

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1. BC Children’s Hospital Miracle Weekend 2. Race for Charity 3. Catwalk for Charity 4. Dare to 5. Backpacks for Kids

4 2007 Annual Report The Sleep Country banner was founded 14 years distribution to children who would otherwise go ago and has achieved a leading market share without a winter coat. The Backpacks for Kids cam- in each regional market that it has entered. paign collected 6,120 backpacks filled with school Sleep Country is the largest retailer of supplies and the Adopt a Sheep campaign raised in Canada with 127 stores stretching from British over $155,000 in support of children's hospitals. Columbia to . In 2008, Sleep Country is The Donated Bed Program began when Sleep planning on opening four stores and a distribution Country first opened its doors more than 14 years center in to offer those customers ago. Upon delivering a new sleep set to their a taste of the Sleep Country experience. customers, Sleep Country offers them the opportunity At Sleep Country, community programs are an to have their old sleep set removed and donate it back important part of the corporate philosophy and into the local community where possible. In 2007, culture. These programs include on-going support Sleep Country assisted in giving approximately 26,000 of charities in local communities, annual charity mattress sets to families and individuals in need. campaigns and the Donated Bed Program. There Sleep Country is also investigating ways to make are more than 1,000 Sleep Country associates their operations more “green”. These initiatives committed to making a positive impact in commu- are in the early stages and include installing nities across Canada. energy efficient light bulbs in all stores as well as In 2007, Sleep Country provided on-going support working with interior contractors to ensure that, to 361 charities across Canada with new beds, gift where possible, materials used in their stores are baskets, and gift certificates. Annual charitable recyclable. In addition, Sleep Country is investigating campaigns focus on assisting women and children ways to reduce the Carbon Footprint in their in need and in 2007 were a great success! The Give distribution centers. a Kid a Coat campaign collected 16,427 coats for

Sleep Country Canada Income Fund 5 2007 was a tremendous year for Dormez-vous on Among other notable charity campaigns for 2007 a number of fronts. The team grew the store base, were the Adopt a Sheep program which raised increased market share and became profitable. $26,000 for local children’s hospitals, the annual Dormez-vous started 2007 with 17 stores and United Way campaign, the sponsorship of the opened an additional seven stores during the year. food awareness campaign, the Backpack for Kids The banner achieved positive EBITDA early in 2007 campaign which collected 255 backpacks full of which was a significant milestone. school supplies for children in local communities, and the Give a Kid a Coat campaign with 560 coats 2007 was also an exciting year in terms of the going to children in need in the Montreal area. expansion and the success of local charity programs. Dormez-vous also lead some unique local initiatives Dormez-vous’ Donated Bed Program was a great in 2007. The team sponsored the 2008 Fireman’s success and in 2007, on average, almost 40% of Calendar where all proceeds from calendar sales customers donated their used mattress sets through went to three major burn treatment centers in this program. In 2007, Dormez-vous became the Quebec through the Fireman’s Foundation for major first independent mattress retailer in Quebec to burn victims of Quebec. In the summer of 2007, a recycle mattresses and box springs not appropriate visit from pop star Enrique Iglesius lead to an auction for use in the Donated Bed Program. of the mattress set that he was interviewed on with proceeds donated to the Montreal Children’s Hospital.

6 2007 Annual Report In 2007, the markets in which Sleep America non-perishable items to Sleep America locations operates experienced historic levels of market to benefit a community food bank. This promotion weakness. Both sales and EBITDA results were brought in 3,626 lbs. of non-perishable items and impacted by this, however, the team continued to $3,626 in cash donations. focus on execution, building on the strong Sleep The “Dare to Dream” promotion was a great America brand and maintaining key elements of success and focused on giving those in need a the strong corporate culture they have built over the chance to receive a new mattress set donated by last 10 years, a cornerstone of which is supporting Sleep America. This promotion, in conjunction local charitable initiatives. with The United Phoenix Fire Fighters Association, For a little over a decade, Sleep America has donated gave away 150 beds to underprivileged Arizona to over 500 different organizations through bottled residents. Over 1,000 residents entered. water donations, gift certificates, and bed donations. Debbie Gaby’s Fifth Annual Catwalk for Charity Signature 2007 events include: Luncheon and Fashion Show hosted more than “Get in Bed with KSLX and Sleep America” was a 600 guests and raised over $100,000 benefiting huge success in its first year. The partnership with local charities. a local radio station featured local celebrities in Sleep America, in conjunction with Arizona bed for a three-day LIVE on-air promotion that Diamondbacks’ pitcher Randy Johnson and his motivated listeners to donate canned food and other family, hosted their Seventh Annual Shoe Drive. More than 500 pairs of new and gently used shoes were collected at Sleep America locations benefitting children who would otherwise go without new shoes.

Sleep Country Canada Income Fund 7 8 2007 Annual Report

MESSAGE TO UNITHOLDERS 2007 was again a year of solid achievement for the Fund. Each of the Fund’s retail banners contributed to another successful year. The Sleep Country banner achieved record levels of sales and continued to gain market share in a market we believe experienced little growth. The Sleep Country team also continued to provide high levels of customer satisfaction through superior levels of in-store and home delivery execution. The Dormez-vous banner also had a successful year increasing both their store count and market share, and achieved positive EBITDA as planned. They also launched a number of initiatives to provide support and reach into the local community. The Sleep America banner experienced market related sales and EBITDA declines during the year, however, the team continued to work hard to improve their processes, build infrastructure and develop leaders. During 2007, total sales grew by 10.2% in what we believe to be a historically weak year for the retail mattress industry. We were pleased to achieve positive same store sales growth in a weak market on the heels of a strong performance in 2006. The Fund’s store count also increased in 2007 – from 175 at the start of the year to 195 by the end of the year. Growth was realized under all banners with the Sleep Country banner adding five stores, Dormez-vous adding seven stores and Sleep America adding six stores. In 2008, there are 11 store openings planned across all banners, including four stores in a new market expansion in Saskatchewan. The Sleep Country team is excited to be entering the Saskatchewan market to provide a superior level of instore and home delivery experience to those customers. In 2007, new associates continued to join the Sleep Country family. The Fund now has more than 1,100 Canadian associates supporting the Sleep Country and Dormez-vous banners while Sleep America has more than 130 associates. These associates continue to deliver the financial and operating success of the Fund. Sleep Country, together with Dormez-vous, again ranked as one of the “50 Best Employers in Canada”. We are proud to continue to be an employer of choice and believe our strong culture is one of the keys to the long term success of the Fund. Finally, in addition to all the expansion related activities in 2007, we were able to increase annual distributions by $0.05 per unit while continuing to maintain a conservative pay-out ratio and a strong cash balance. Our goal continues to be to provide a steady stream of sustainable distributions with increases occurring slowly over time. In summary, 2007 was a successful year for the Fund during a time of historic market weakness. We believe we are poised well for the future with our strong brands, strong market shares and strong balance sheet.

STEPHEN GUNN Chief Executive Officer President

Sleep Country Canada Income Fund 9

TRUSTEES AND DIRECTORS At Sleep Country, good corporate governance is an intrinsic element in our success. A skilled and independent Board is essential in providing the proper oversight of corporate plans, as well as all material policies and standards. The Fund’s Trustees are highly qualified, offering extensive experience and expertise, and a variety of business and professional backgrounds. Most Trustees are “unrelated’’ to management, according to the criteria outlined by regulators. The Audit Committee is composed entirely of unrelated Trustees, each of whom has an appropriate level of experience and understanding of financial and accounting issues. Similarly, a majority of Trustees on the Compensation and Corporate Governance Committee are independent.

Standing: David Bloom, Stephen Gunn, and Andrew Moor Seated: Scott Anderson, Christine Magee, Jay Swartz

Sleep Country’s governance practices comply with all regulatory requirements. For more information on Sleep Country’s governance practices, please refer to our 2007 management information circular available on our website at www.sleepcountry.ca/investor/ or at www.sedar.com.

10 2007 ANNUAL REPORT Scott Anderson, CA is the Executive Vice President, Chief Christine Magee is the President of the Company. She Financial Officer and Director of Listen UP! Canada, a co-founded the Company in 1994. From 1982 to 1994, business that specializes in hearing health care. He also Ms. Magee worked in the Banking and Financial Services serves as a Director of the Stevenson Memorial Hospital. industry at National Bank of Canada and Continental Bank Mr. Anderson was formerly Chief Executive Officer of of Canada. Board Appointments include Cott Corporation, The Catalyst Company and prior, the President and Chief Board of Directors of St. Mildred’s Lightbourne School, Operating Officer of The Rider Travel Group, a Canadian and the Advisory Board of the Ivey School of Business. industry leader specializing in corporate travel services. Ms. Magee has been the Major Gifts Campaign Chair for He joined Rider Travel in 1987 as the Chief Financial the Rouge Valley Health Systems from 2000-2005, and Officer having held a similar position at Vickers & Benson was a member of the Retail Cabinet of the United Way of Advertising. Mr. Anderson holds a B.Comm from the Greater Toronto in 2001 and 2002. Ms. Magee holds an University of Toronto and is a Chartered Accountant. Honours Business and Administration Degree from the University of Western Ontario. David Bloom is the President and a Director of DGRB Consultants Inc., a firm that provides consulting services Andrew Moor has been the President and Chief Executive to the business community. From 1986 to 2001 he was Officer and a Director of Equitable Group Inc. and The the Chairman and Chief Executive Officer of Shoppers Equitable Trust Company, a federally regulated financial Drug Mart Inc. Mr. Bloom has had a major impact on institution, since March 1, 2007. Prior to March 2007, retailing in as a founder of the Canadian Mr. Moor had been the President, Chief Executive Officer Association of Chain Drug Stores in Canada, as a Director of and a Director of Invis Inc., a mortgage brokerage company, the National Association of Chain Drug Stores in the USA, since February 2002. From January 2001 to February 2002 and as a former Chairman of the Retail Council of Canada. Mr. Moor worked in merchant banking and venture capital He is a Director of Swiss Herbal Remedies Ltd. and a with two organizations. Prior to 2001, Mr. Moor was the Director of the Toronto International Film Festival. He is a President and a Director of SMED International Inc., a Trustee and Chairman of the Board of Trustees of Second marketer and manufacturer of contract office interiors, having Cup Royalty Income Fund. He is a member of the Chief joined as the Chief Financial Officer in 1996. Mr. Moor is Executives Organization. He has played leadership roles in Chairman and a Director of the Canadian Association of numerous fundraising campaigns including the University of Accredited Mortgage Professionals. He holds a Bachelor of Toronto, the Ontario Science Centre, the Toronto General Science in Mechanical Engineering from University College Hospital and the Hospital for Sick Children. Mr. Bloom London and an MBA from the University of British holds a BSc in Pharmacy from the University of Toronto. Columbia.

Stephen Gunn is the Chairman of the Board of the Jay Swartz is a partner at Davies Ward Phillips & Vineberg Fund and the Company and Chief Executive Officer of the LLP where he has a diverse commercial practice with particular Company. Mr. Gunn co-founded the Company in 1994. emphasis on banking, debt financings, financial product Prior to founding the Company, he co-founded and was the development, structured finance, corporate restructuring, President of Kenrick Capital, a merchant banking business. private equity funds and private company acquisitions. He In addition, he was a management consultant with McKinsey was called to the bar in 1975. Mr. Swartz is a fellow of the & Company from 1981 to 1987. From April 2001 to April American College of Commercial Finance Lawyers and a 2003, Mr. Gunn was the Chief Executive Officer and a member of the Insolvency Institute of Canada and Insol Director of Mattress Holding Corporation. From April 2001 International. He is a director of Oshawa Public Utilities to April 2003, he was also a Director of Mattress Discounters Corporation and Pine River Institute. He holds a Bachelor Corporation, a U.S. mattress retailer, which filed under of Arts in Economics from York University and an L.L.B Chapter 11 of the U.S. Bankruptcy Code on October 23, from Osgoode Hall Law School. 2002 and was reconfirmed for re-emergence on March 3, 2003. Mr. Gunn is a Director of Golf Town and is also a member of the Board of Governors of Crescent School. He holds an honours Bachelor of Science degree in Electrical Engineering from Queen’s University and an MBA from the University of Western Ontario.

Sleep Country Canada Income Fund 11 OFFICERS

Vicki Jones, CA is the Chief Financial Officer of the Stewart Schaefer is President of Dormez-vous. He found- Company. She joined Sleep Country in August 2002 as ed Dormez-vous in 1994 and grew the business to five National Controller and became Chief Financial Officer in stores before being acquired by Sleep Country in January October 2003. Prior to joining Sleep Country, Ms. Jones 2006. In 1992, Mr. Schaefer co-founded Heritage Classic was the Vice President Finance for SoftQuad Software Ltd. Beds, a distributor of metal beds. Mr. Schaefer studied from June 2000 to August 2002. From September 1999 to Finance and Marketing at Concordia University in June 2000, she was a Consultant with Bearing Point Inc. Montreal. and, prior to that, was a Senior Manager at KPMG LLP. Ms. Jones holds a Bachelor of Commerce from the Leonard Gaby serves as Chairman of Sleep America. University of and is a Chartered Accountant. Together with his wife Ms. Gaby they co-founded Sleep America in May 1997 and Sleep America Charities Glen Antonuk is the Executive Vice President and Chief in 2004. Mr. Gaby’s career began in 1971 at the Simmons Operating Officer, Western Canada for Sleep Country, Company where he held various senior management which he joined in 1994. He started at Sleep Country in positions. In 1991, he joined Houston based Star the capacity of Corporate Controller. He then transitioned Furniture as their President, and successfully guided the to operations management in 1995 and was promoted to organization through their expansion. Mr. Gaby received General Manager for Western Canada in 1998. He has over his BS and MBA degrees from the State University of 15 years of experience in finance and corporate manage- at Buffalo. ment. Mr. Antonuk holds a Bachelor of Physical Education, with a minor in Commerce, from the University of . Debbie Gaby is President and co-founder of Sleep America. Together with her husband Mr. Gaby, they David Friesema is the Executive Vice President and Chief co-founded Sleep America in May 1997 and Sleep America Operating Officer, Eastern Canada for Sleep Country. He Charities in 2004. Prior to co-founding Sleep America, has been with the Company for over ten years and prior to Ms. Gaby was one of the top realtors in the state of joining Sleep Country, was involved in the retail mattress Texas for over fifteen years. industry in the United States. Mr. Friesema’s prior experi- ence also includes several years in the liquid petroleum industry. He is the Chairman of the Board of Directors for the Better Sleep Council Canada (BSCC). Mr. Friesema attended the University of Detroit Business School and the University of Missouri-St. Louis School of Psychology.

Serge Delannoy is the Vice President of National Real Estate for Sleep Country. He has been with the Company for more than 10 years and was instrumental in Sleep Country’s entry into the Ontario market. Mr. Delannoy has over 30 years of retail experience and prior to joining Sleep Country, was heavily involved in two successful start-up operations with the Hudson’s Bay Company and Consumers Distributing Inc.

12 2007 Annual Report

Standing: Stewart Schaefer, David Friesema, Glen Antonuk, Serge Delannoy, Len Gaby, Stephen Gunn Seated: Christine Magee, Vicki Jones, Debbie Gaby

Sleep Country Canada Income Fund 13

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

The Formation of the Fund Sleep Country Canada Income Fund (the Fund) is a limited purpose, open-ended trust that was created on March 5, 2003. The Fund holds the securities of Sleep Country Canada Inc. (Sleep Country or the Company) which in turn has a number of wholly owned subsidiaries. The Fund provides unitholders with monthly distributions that reflect the underlying strength of Sleep Country and its subsidiaries. The Fund is listed on the under the symbol Z.UN. The Fund completed an initial public offering (IPO) of trust units on April 15, 2003 and net proceeds were used to purchase the operations of Sleep Country. This Management’s Discussion and Analysis compares the results of the Fund for 2007 with 2006. The accompanying Consolidated Financial Statements of the Fund were prepared in accordance with Canadian generally accepted accounting principles (GAAP) and all amounts shown are in Canadian dollars unless otherwise indicated. Additional information about the Fund, including the Fund’s Annual Information Form, may be found on its website at www.sleepcountry.ca/investor or on SEDAR at www.sedar.com. The discussion and analysis within this MD&A are as of March 7, 2008.

Vision, Core Businesses and Strategy The Fund’s goal is to achieve reliable, consistent monthly distributions with increases occurring over time. The Fund plans to achieve this by investing in mattress retailers and currently has investments in the following mattress retail banners (the “Banners”): Sleep Country Canada, the largest specialty retailer of mattresses in Canada; Dormez-vous a rapidly expanding mattress retailer in the province of Quebec; and Sleep America, a large mattress retailer in the state of Arizona in the United States.

Sleep Country Canada Sleep Country is the largest retailer of mattresses in Canada and believes it has achieved a national market share of over 20%. Sleep Country was founded in 1994 with four stores in , B.C. As of December 31, 2007, Sleep Country had grown to 127 stores operating in eight regional markets, including Vancouver and Vancouver Island, the interior of , Calgary, Edmonton, Winnipeg, Southwestern Ontario, Toronto, and Ottawa. Mattress sets accounted for 88% of Sleep Country’s sales in 2007 (compared with 90% in 2006) with the remaining 12% generated from third-party warranty protection products and an assortment of head boards, foot boards, , mattress pads, bed frames and sheets.

14 2007 ANNUAL REPORT Dormez-vous In January 2006, the Fund completed the acquisition of Dormez-vous, a Quebec based mattress retailer with five stores and a distribution center in the Montreal area. During 2007, the Dormez-vous management team continued with their expansion program growing their store base from 17 to 24 without sacrificing their high levels of customer service both in store and on home delivery. They also achieved a significant milestone achieving positive EBITDA early in the year. Mattress sets accounted for 89% of the Dormez-vous’ sales in 2007 (compared with 85% in 2006) with the remaining 11% generated from third-party warranty protection products and an assortment of head boards, foot boards, pillows, mattress pads, bed frames and sheets.

Sleep America In March 2006, the Fund completed the acquisition of Sleep America in Arizona, U.S.A. This acquisition added 32 stores and a distribution center in the Phoenix and Tucson markets which they grew to 38 stores by the end of 2006. During 2007, Sleep America continued to grow their store base in Arizona to 44 stores. The Sleep America banner continues to focus on executing high levels of customer service in-store and on home delivery in the face of a weakening market. The Fund also continued to invest in people and processes at the Sleep America level in 2007 with a long term goal of future expansion to other cities in the United States. Mattress sets accounted for 89% of the Sleep America’s sales in 2007 (compared with 87% in 2006) with the remaining 11% generated from an assortment of head boards, foot boards, pillows, mattress pads, bed frames and sheets. The North American mattress industry is characterized by stable, long-term growth. The Fund estimates that the mattress industry has exhibited a long-term compound annual growth rate of about 5.0% to 6.0% in Canada and the United States. We believe, based on our discussions with suppliers and other industry sources that the mattress industry in 2007 experienced an unusually difficult year and overall market demand was flat or slightly up in 2007 vs. 2006.

Sleep Country Canada Income Fund 15

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

Strategy The Fund’s goal is to build on the market position of its Banners over time, enhancing distributions to unitholders by growing comparable store sales, adding new stores in existing markets (in-fill stores), and pursuing expansion opportunities into new markets. Both Sleep Country and Sleep America have used their leading market positions and strong commitment to customer service to increase share of market consistently over their histories. In 2007, Dormez-vous continued to build on its market share position. In-fill stores are usually accretive to cash flow within three months of opening. While opening in-fill stores may have an impact on the comparable store sales growth of stores in the vicinity, historically they have resulted in increased regional sales growth. In 2007, both Sleep Country and Dormez-vous opened seven in-fill stores and Sleep America opened six in-fill stores. In general, opening in-fill stores does not require an increase in advertising, regional management or fixed distribution centre costs, and thus in-fill stores generally become economic contributors very quickly.

Key Performance Drivers 1. Strong brand recognition The Fund invested significantly in its Banners (Sleep Country, Sleep America and Dormez-vous) to create “top-of-mind” brand awareness with major advertising and promotional campaigns. Through a combination of radio and television advertising featuring each Banner’s trademarked jingle and company spokesperson, each Banner conveys the message that they are an informative, convenient and trustworthy place to purchase a mattress. The Banners’ prominent positioning of well known national retail mattress brands in its advertising builds on those brands’ popularity and supports supplier advertising arrangements.

2. Superior in-store customer experience Each of the Fund’s Banners believes they distinguish themselves by creating a superior in-store experience anchored in four operating practices. First, stores are located close to residential areas, in high-traffic, highly visible locations with prominent signage and convenient access. Second, well-trained sales employees have completed a comprehensive training program focused on a low-pressure, informative sales approach. Third, customers are ensured a wide selection of comfort and price, including several mattress sets and features that are exclusive to each of the Banners. We have historically carried well known national mattress brands. Finally, the Banners strive to take the worry out of purchasing by offering 60-day price and “comfort” guarantees, and convenient payment methods and terms.

16 2007 ANNUAL REPORT 3. Superior home delivery and customer relationships Sleep Country and Dormez-vous offer free delivery seven days a week within a specified three-hour timeframe. Sleep America offers delivery within a specified time frame and also offers same day delivery on a number of in-stock products. The Fund’s real-time, enterprise-wide management information systems enable efficient inventory control and accurate deliveries for customers. Delivery personnel are uniformed, wear “booties” over their shoes to protect customers’ homes and are trained to provide a high level of customer service. Old mattresses are removed without charge and those in good condition are offered to individuals in need through various local charities. Management believes that the entire delivery arrangement makes for a very positive experience and often leads to favourable word-of-mouth advertising.

4. Leading market position By creating a strong brand awareness and delivering high levels of customer satisfaction, the Fund believes it has achieved a leading national market share under the Sleep Country brand of over 20% in Canada. Sleep America enjoys a leading market share position in the state of Arizona while Dormez-vous has continued to expand their market share in Quebec during 2007. These strong market positions allow each Banner to effectively leverage their regional fixed costs (advertising, management and distribution) more effectively over an increasing store and sales base, which continues to sustain and create competitive advantage.

5. Leading supplier relationships Each of the Brand’s size and market leadership produce strong regional relationships with leading mattress suppliers who provide each Brand with lower product costs than most of its smaller competitors as well as the ability to obtain unique product features and high service levels.

Capability to Deliver Results The Fund’s capability to continue to deliver solid financial results is based on many factors. The most important include each Brand’s ability to deliver high levels of in-store and home delivery service on a day-to-day basis, the effectiveness of advertising programs, and our ability to execute attractive expansion opportunities. Executing superior in-store and home delivery service. Our ability to deliver high levels of customer service is a key to our continued success. We have developed comprehensive guidelines and training programs to ensure customers have a positive experience when shopping at Sleep Country, Dormez-vous or Sleep America.

Sleep Country Canada Income Fund 17

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

All customers are encouraged to fill out a response card to describe their shopping and home delivery experience. They indicate that we are developing a growing base of satisfied, happy customers – customers who refer us to their friends, family and neighbors, and who return to our stores when they need to buy a mattress. These tens of thousands of positive experiences every quarter create a large and growing reservoir of consumer goodwill which, over time, develops a momentum of its own. It has helped us successfully introduce infill stores and, consistently increase comparable store sales while keeping advertising costs and other overheads consistent.

Advertising. The strength of each of the Fund’s Banners depends on awareness of the brand and each customer’s experience when they shop and purchase from us. Our advertising programs are geared to providing a steady flow of traffic to the stores and our customer service approach is designed to ensure a high level of satisfaction, and return traffic. We invest heavily in electronic media advertising, primarily on radio and TV, in each of our markets. Use of consistent messaging (including catchy jingles “Why Buy a Mattress Anywhere Else?” for Sleep Country, “Tout le Monde Devrait Bien Dormir” for Dormez-vous and “Where America Goes to Sleep” for Sleep America) continues to reinforce our messages of trust, value, and integrity to our customers.

Expansion opportunities. The Sleep Country brand has expanded successfully every year since its founding in 1994. This capability to expand depends on our ability to choose new locations and new markets, to hire and train new employees for our stores and distribution centers and, in the case of expansion into new markets, create top-of-mind brand awareness of Sleep Country. Each of the Fund’s Banners performs detailed customer, competitor and financial analyses to identify new store and new regional opportunities. In terms of regional expansion, once a target area has been determined, our biggest focus is on ensuring that we can successfully export the Fund’s culture – our way of doing things. To help accomplish this, we have traditionally started by ensuring that the leadership group in the new region is comprised of existing employees. We seek out employees in leadership roles who are willing to relocate, and they form the core of our new regional group. We then supplement the team by hiring locally and have these new employees spend a few weeks in existing stores and distribution centers learning our approach and living our culture. In 2008, Sleep Country will execute its next regional expansion as we open 3 – 4 stores in Saskatchewan and a distribution center. As with all expansions, this expansion is expected to be EBITDA negative for a period of 12 - 24 months, however, the size of the expansion is not expected to have a material impact on the Fund’s EBITDA for 2008.

18 2007 ANNUAL REPORT

Results This discussion compares the operating results of the Fund for the year ended December 31, 2007 with those for the year ended December 31, 2006.

in thousands except Full Year Full Year Full Year Fourth Third Second First Fourth Third Second First per unit amounts Ended Ended Ended Ended Ended Ended Ended Ended Ended Ended Ended 2007 2006 2005 2007 2007 2007 2007 2006 2006 2006 2006

Sales $357,182 $324,089 $223,717 $89,096 $104,725 $83,497 $79,864 $87,053 $97,757 $74,652 $64,627 Cost of Sales 266,008 239,649 159,674 67,469 74,805 62,651 61,083 64,962 69,699 56,152 48,836 Contribution Margin 91,174 84,440 64,043 21,627 29,920 20,846 18,781 22,091 28,058 18,500 15,791 25.5% 26.1% 28.6% 24.3% 28.6% 25.0% 23.5% 25.4% 28.7% 24.8% 24.4% General and Administrative Expenses $49,695 $46,650 $30,146 $12,141 $13,901 $12,393 $11,260 $13,279 $13,186 $11,131 $9,054 EBITDA1 41,479 37,790 33,897 9,486 16,019 8,453 7,521 8,812 14,872 7,369 6,737 Net earnings $28,905 $26,398 $22,443 $7,667 $10,971 $5,459 $4,808 $5,481 $9,650 $6,827 $4,440 Basic earnings per unit2 $2.06 $1.88 $1.60 $0.55 $0.78 $0.39 $0.34 $0.39 $0.69 $0.48 $0.32 Cash distributions per unit $1.41 $1.36 $1.30 $0.36 $0.35 $0.35 $0.35 $0.35 $0.34 $0.34 $0.34 Payout ratio3 65.0% 80.1% 77.9% 69.4% 41.0% 87.4% 88.4% 94.9% 48.8% 121.6% 93.2% Total assets $272,794 $271,396 $235,474 $272,794 $283,435 $271,050 $259,716 $271,396 $279,255 $260,818 $259,239 Total long-term debt (excluding current portion) $59,953 $56,322 $40,122 $59,953 $59,996 $60,770 $51,616 $56,322 $55,667 $55,671 $56,421 Number of stores at period end 195 175 110 195 186 184 178 175 167 162 151 Sleep Country 127 120 110 127 123 122 121 120 116 116 112 Dormez-vous 24 17 - 24 22 22 18 17 15 11 7 Sleep America 44 38 - 44 41 40 39 38 36 35 32 Total Sales Growth 10.2% 44.9% 14.5% 2.3% 7.1% 11.8% 23.6% 42.2% 51.6% 42.3% 41.8% Canada 10.1% 28.0% 14.5% 4.8% 9.7% 14.3% 12.8% 23.4% 33.2% 22.2% 33.7% United States 0.1% 16.9% n/a -2.5% -2.6% -2.5% 10.8% 18.8% 18.4% 20.1% 8.1% Same Store Sales Growth4 -1.4% n/a n/a -4.4% n/a n/a n/a n/a n/a n/a n/a Canada 0.9% 10.6% 5.6% -1.3% 1.7% 3.8% -0.3% 5.3% 12.9% 6.4% 19.3% United States -15.6% n/a n/a -24.5% -12.1% -10.6 n/a n/a n/a n/a n/a

1 EBITDA refers to earnings before interest, taxes, depreciation and amortization and other items. EBITDA is not a recognized measure under Canadian generally accepted accounting principles (GAAP) and may not be comparable to similar measures used by other companies. (See “Non-GAAP Measures”) 2 Basic earnings per unit has been calculated using the “if-converted” method. Under this method, the Class A shares are treated as if converted into units for purposes of calculating basic earnings per unit. 3 Reflects the calculation of payout ratio before changes in working capital. (See “Non-GAAP Measures”) 4 Same Store Sales Growth represents only those stores with at least 13 months of sales.

Sales Sales overall for the Fund grew in 2007 10.2% to $357.2 million from $324.1 million in 2006. The increase in sales is attributable to the following:

Canada: Sales in Canada under the Sleep Country and Dormez-vous banners (“Canada”) in 2007 increased 10.1% over the same period in 2006. This was comprised of a 0.9% increase in comparable store sales, a 9.2% increase due to the incremental sales generated by the seven in-fill stores opened during the previous 12 months under the Sleep Country and Dormez-vous banners. Mattress and box spring sales increased 9.2% compared with the same period in the prior year. Volume (the number of mattress sets delivered) in the Canadian business increased 8.9% compared with the same period in 2006. The remaining increase is a result of the Sleep Country banner’s continued focus on accessory sales during 2007; sales of accessory items (including headboards, footboards, sheets and pillows) increased 17.4% over 2006.

Sleep Country Canada Income Fund 19

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

Comparable store sales increased 0.9% in 2007 over 2006. Comparable stores are those that have been open for at least 13 months and exclude the impact of any stores relocated during the year. This increase is an indication that the Canadian banners are continuing with their strong share of market in the regions in which they operate. While industry sales figures are imprecise, based on discussions with our vendors, we believe that growth in the mattress industry was basically flat in 2007 affecting both volume and average unit price. We believe this represents an unusually weak year for the industry from a growth perspective. We attribute the Canadian banners’ positive performance in unusually weak market conditions to a number of factors, but primarily to the continuing execution of our cus- tomer service commitment and the success of Dormez-vous’ continued Quebec expansion. During 2007, across the Canadian banners, sales performance was mixed. Western Canada has continued to deliver strong sales growth in 2007, however, this was offset by weaker growth in Eastern Canada due to, we believe, weaker industry conditions. Formal customer feedback indicates a high level of satisfaction which we believe translates into strong repeat and referral business. Over time, we believe this generates strong sales momentum.

United States Sales in the United States increased 11.1% due to the comparison of a full year of sales in 2007 with ten months of sales in 2006 due to the acquisition of Sleep America in March 2006. Using a full year over year comparison, Sleep America experienced a decline in comparable store sales of 15.6% due to an 11.1% decrease in US dollar sales on a com- parable store basis and the continued strengthening of the Canadian dollar. Using a full year over year comparison, volume (the number of mattress sets delivered) in the United States business decreased 6.3% compared with the same period in 2006. The markets in which Sleep America does business displayed weakening market conditions throughout 2007.

Cost of Sales and Contribution Margin Cost of sales includes product-related costs and the costs of our sales and distribution operations net of volume rebates received from vendors. Cost of sales in 2007 increased 11.0% to $266.0 million from $239.6 million for 2006. In 2007, contribution margin increased by $6.7 million or 25.5% of sales compared to 26.1% of sales in 2006. This change as a percentage of sales was the result of a number of factors:

Canada: In the Canadian business, cost of sales increased 10.3% and contribution margin was 26.5% as a percentage of sales compared with 26.6% for 2006. Factors impacting this were as follows: • Product gross margins increased by 0.5% in 2007 over the prior year. This is due to changes in vendor and product mix, lower levels of inventory write-offs (in the third quarter of 2006, a number of older demonstrator inventory items were written off from a number of our facilities), and lower freight costs due to a number of initiatives undertaken to reduce these costs.

20 2007 ANNUAL REPORT • Costs in our distribution and sales operations impacted 2007 as follows: – Overall, warehouse and distribution department costs increased 14.0%, and, as a percentage of sales, warehouse and distribution costs increased 0.2% over the prior year. This is due higher warehouse staffing costs associated with three smaller regional distribution centers opened in the last twelve months in the Sleep Country business (two in Ontario and one in British Columbia) and sales volume increases at Dormez-vous. Delivery costs were also higher as a percentage of sales in 2007 compared with 2006 due to salary and wage pressures due to labor market conditions. – Overall, sales department costs increased 12.7% however, as a percentage of sales; these costs increased 0.4% in 2007 compared with 2006. This is due to higher occupancy costs due to the 14 infill stores opened during the period in the Sleep Country and Dormez-vous businesses.

United States Sleep America cost of sales increased by 16.3% in 2007 compared with 2006. This increase is partially due to 2007 reflecting a full year of costs while 2006 reflects 10 months of costs due to the acquisition of Sleep America in March 2006. Sleep America also experienced higher store occupancy costs related to the six infill stores opened offset by lower product cost of sales, selling, warehouse and distribution costs due to lower sales levels and a reduction in the number of deliveries. Sleep America achieved a contribution margin of 18.3% for 2007 compared with 22.0% for the same period in 2006. This reduction is primarily due to lower leveraging on all fixed sales and distribution costs (including store occupancy and compensation costs) on reduced sales volumes.

General and Administrative Expenses General and administrative (G&A) expenses include advertising costs, compensation costs associated with administrative personnel, warehouse occupancy, credit card and financing charges and other administrative expenses. G&A expenses in 2007 increased 6.5% to $49.7 million from $46.7 million in 2006. As a percentage of sales, G&A expenses decreased to 13.9% in 2007 compared with 14.4% in 2006. Notable changes in G&A expenses for the year were as follows:

Canada In the Canadian business, G&A expenses increased 4.5% in 2007 compared with 2006. This increase was due to the following: • Management and administrative costs decreased 4.1% in 2007 compared with 2006. This is primarily due to lower management incentive plan accruals. In the fourth quarter of 2006, management bonus accruals were higher compared to 2007 as they were accrued at stretch target levels due to the level of performance achieved in 2006.

Sleep Country Canada Income Fund 21

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

• Advertising expenses decreased by 0.3% in 2007 compared with 2006. Advertising spending was consistent in 2007 compared with 2006 due primarily to inflationary increases being offset by changes in the spending mix. This was offset by increased co-op advertising rebates received at consistent rates on higher sales levels. The Canadian business plans to continue to maintain a steady level of advertising expenditures in existing markets, which leverages these costs over a larger sales base. • Warehouse occupancy costs increased 29.1% in 2007. This was due to costs associated with three regional distribution centers opened (two in Ontario and one in British Columbia) and the expansion of our Greater Toronto Area and Vancouver Island distribution centers compared with the same period in the last twelve months. • Credit card and third party financing charges increased 14.8% in 2007. This increase is due to increased sales levels coupled with change in the credit card mix as each card charges a unique discount rate.

Sleep America G&A expenses for the Sleep America operations increased by 20.8% in 2007 compared with the ten months of 2006 from the date of acquisition in March. As a percentage of sales, Sleep America’s G&A costs were 16.7% for 2007 compared with 15.3% for the ten month period in 2006. This increase in G&A expenses is primarily due to lower co-op advertising credits on lower sales volumes and changes in vendor mix. EBITDA (see “Non-GAAP Measures”)

(in thousands of dollars) 2007 2006

Sales $357,182 $324.089

EBITDA 41,479 37,790

EBITDA margin 11.6% 11.7%

For the year ended December 31, 2007, earnings before interest, taxes, depreciation, amortization and other expenses (EBITDA) rose by $3.7 million or 9.8% to $41.5 million from $37.8 million in 2006. This was due to an increase in EBITDA from the Canadian business of $5.5 million offset by a reduction of $1.8 million due to sales weakness in the Sleep America business. The markets in which Sleep America currently operates have experienced weak market conditions throughout 2007. During the year, EBITDA margin for the Fund decreased from 11.7% in 2006 compared with 11.6% in 2007. This decrease is primarily due to sales weaknesses in the United States business. These sales weaknesses results in less leveraging of fixed advertising, real estate and management costs and therefore reduced profitability.

22 2007 ANNUAL REPORT Interest Interest expense was $3.2 million in 2007, most of which represents interest expense on the Company’s long-term debt. For 2006, interest expense was $3.6 million. This decrease is due to lower interest on the vendor promissory notes due to a scheduled repayment of US $4.0 million in March 2007 and a reduction in the balance outstanding at December 31, 2007 due to the weak EBITDA performance of Sleep America during 2007. The vendor notes were issued in connection with the acquisition of Sleep America in the first quarter of 2006.

Depreciation and amortization Sleep Country’s capital expenditure requirements are modest as all real estate and the majority of operating assets are leased. In 2007, total depreciation and amortization expense was $6.8 million, with depreciation on property and equipment accounting for $6.5 million. This compares with depreciation and amortization expense of $5.9 million for 2006, with depreciation on property and equipment accounting for $5.2 million. This increase in depreciation expense is due to higher levels of capital spending from the 20 infill stores opened across all Banners during the last twelve months and the completion of a number of IT projects during 2006 and 2007.

Income Taxes The Fund is a mutual fund trust as defined under the Income Tax Act (Canada), and as a result, is not subject to taxation on its income at this time to the extent that it is distributed to unitholders. The income tax expense relates to Sleep Country and its subsidiaries. As a result, the consolidated annualized tax rate for 2007 of 10.1% is lower than the combined statutory rate for corporations. On June 22, 2007, amendments to the Tax Act received Royal Ascent which modify the tax treatment of certain publicly traded trusts and partnerships that are specified invest- ment flow-through trusts or partnerships (“SIFTs”). Under the SIFT rules, a SIFT will generally be taxed in a manner similar to corporations on income from a business carried on in Canada by the SIFT and income (other than taxable dividends) or capital gains from non-portfolio properties (as defined in the Tax Act) at a combined federal/provincial tax rate similar to that of a corporation. Allocations or distributions of income and capital gains that are subject to the SIFT rules will be taxed as a dividend from a taxable Canadian corporation in the hands of the beneficiaries or partners of the SIFT. Subject to the normal growth guidelines issued in a press release by the Department of Finance (Canada) on December 15, 2006 (the “Normal Growth Guidelines”), the SIFT rules will not apply until the 2011 taxation year to trusts or partnerships that would have been SIFTs on October 31, 2006 if the “SIFT trust” and “SIFT partnership” definitions in the Tax Act had been in force as of that date.

Sleep Country Canada Income Fund 23

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

The gross amount of temporary differences that are expected to reverse before January 1, 2011 is approximately $0.3 million. As these temporary differences are expected to reverse before the SIFT rules are expected to apply to the Fund, no adjustment on the future income tax liability has been recorded on these temporary differences. Income tax expense was $3.3 million in 2007 compared with $2.9 million for 2006. Future income tax recovery decreased $1.2 million in 2007 due to the favorable effect of changes in future income tax rates offset by a small taxable position related to Dormez-vous.

Net Earnings In 2007, net earnings were $28.9 million, or $2.06 per unit. This represents 8.1% of sales. In 2006, net earnings were $26.4 million or $1.88 per unit representing 8.2% of sales.

Liquidity and Capital Resources At December 31, 2007, cash and cash equivalents increased by $7.6 million to $22.1 million from $14.5 million at December 31, 2006. This increase is due to cash generated from operations (before changes in working capital) of $33.8 million combined with $10.0 million in senior secured notes financing. These increases were offset by cash used to fund working capital changes of $3.9 million primarily related to changes in accounts payable balances, fund the continued expansion of Dormez-vous, investments in the Sleep America business and unitholder distributions. Cash and cash equivalents represent cash on hand and on deposit with financial institutions and does not include any asset backed commercial paper products. Cash flow from operations, together with cash and cash equivalents on hand are expected to be sufficient to meet operating requirements, capital expenditures and anticipated distributions. The Company also has a $10.0 million revolving credit facility which is undrawn at December 31, 2007. At December 31, 2007, the Fund was in compliance with all covenants contained in its note indenture, note agreement and revolving credit facility. These covenants require Sleep Country and its subsidiaries to achieve a specified senior debt to EBITDA ratio and a specified fixed charge coverage ratio.

Operating Activities Cash flow from operations was $29.9 million in 2007 compared to $27.4 million for 2006. This is due to the positive financial performance of the Fund offset by a reduction in net working capital due to year over year changes in accrued liability balances; speci- fically in taxes payable due to lower taxable income for the year and reductions in management bonus accruals due to the payout of the management equity plan in the third quarter of 2007 and lower year end management bonuses accrued.

24 2007 ANNUAL REPORT Historically, Sleep Country experiences lower sales and contribution margin in the first quarter than in other quarters. The Company expects to use working capital in the first quarter of 2008. Sleep Country believes it has sufficient working capital reserves to satisfy all cash requirements, including distributions, for 2008.

Investing Activities Capital expenditures totaled $7.9 million in 2007 versus $12.9 million in 2006. This decrease is due to 2006 representing an unusually high year for capital spending as 2006 incorporated the expansion of Dormez-vous, the store refurbishment program and the implementation of radio frequency bar coding in a number of our distribution centers. In 2007, about 42.0% of capital spending was devoted to maintenance and 58.0% to growth due to ongoing store openings and the focus on continued expansion spending in Quebec. On an annualized basis, it is expected that about roughly half of all capital spending will fund maintenance activities and half will fund growth. The ratio of capital spending varies each quarter and on a year over year basis depending on the timing of store openings and maintenance activities. In 2007, maintenance capital spending included the refurbishment of seven stores under the Sleep Country banner. In 2008, it is expected that the levels of growth and maintenance capital expenditures related to the Fund’s business will be about $7.6 million with roughly half representing growth related spending. This estimated capital spending includes continued store expansion under all banners, the refurbishment of seven stores under the Sleep Country banner and a number of IT related projects planned for 2008. The pace of the store refurbishment program has slowed as our real estate team has focused on expansion related activities and other priorities.

Financing Activities The Fund makes monthly distributions of its available cash to unitholders of record on the last business day of each month, payable on or about the 20th day of the following month. The amount of cash distributed per unit is equal to a pro rata share of interest received on the notes and dividends received on the common shares of Sleep Country, after deducting expenses of the Fund during the month for which the distribution is calculated. Distributions paid to unitholders for the year 2007 totaled $19.1 million compared to $18.4 million paid in 2006. Dividends paid to the Company’s Class A shareholders for 2007 were $0.6 million, which were consistent with 2006. The December 2007 payment of $1.6 million was accrued and paid to unitholders on January 18, 2008.

Sleep Country Canada Income Fund 25 Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

2007 Distributions Distributions

Period Record Date Payment Date Per Unit Amount (000’s)

$$ January 2007 January 31, 2007 February 20, 2007 0.1167 1,587 February 2007 February 28, 2007 March 20, 2007 0.1167 1,587 March 2007 March 30, 2007 April 20, 2007 0.1167 1,587 April 2007 April 30, 2007 May 18, 2007 0.1167 1,587 May 2007 May 31, 2007 June 20, 2007 0.1167 1,587 June 2007 June 29, 2007 July 20, 2007 0.1167 1,587 July 2007 July 31, 2007 August 20, 2007 0.1167 1,587 August 2007 August 31, 2007 September 20, 2007 0.1167 1,587 September 2007 September 28, 2007 October 19, 2007 0.1167 1,587 October 2007 October 31, 2007 November 20, 2007 0.1167 1,587 November 2007 November 30, 2007 December 20, 2007 0.1208 1,643 December 2007 December 31, 2007 January 18, 2008 0.1208 1,643 1.4086 19,156

The Fund declared distributions totaling $19.2 million or $1.4086 per unit in 2007. Of this amount, $18.8 million or 98.2% is taxable as income in the hands of unitholders while $0.3 million or 1.8% represents a return of capital that reduces the adjusted cost base of the units.

26 2007 ANNUAL REPORT Foreign Exchange For accounting purposes, the operating results of the Fund’s wholly owned U.S. subsidiary, Sleep America, are translated at the average exchange rate prevailing for the month while the balance sheet is translated at the period ending exchange rate. Sleep America is considered to be a self-sustaining foreign operation. As such, foreign exchange gains and losses arising from such translation are recorded as a separate component of unitholders’ equity on the balance sheet, rather than impacting operating results. The change between 2007 and 2006 is a result of the strengthening Canadian dollar compared with the US dollar during this period. From an operations perspective, US dollar funds generated by Sleep America are used to satisfy Sleep America’s US dollar liabilities, which limit the Fund’s exposure to exchange rate fluctuations. As part of the acquisition of Sleep America in March 2006, the Fund, through a subsidiary, borrowed US $10.0 million seven year notes to fund a portion of the purchase price. This long term debt further serves to offset the impact of the strengthening Canadian dollar on the Sleep America balance sheet.

Distributable Cash (see “Non-GAAP measures”) In any given period, distributions declared may differ from cash provided by operating activities primarily due to seasonal fluctuations in non-cash operations items (such as receivables, inventory, accounts payable and accrued liabilities and customer deposits). These seasonal or short term fluctuations may be funded by cash on hand or the revolving credit facility. In addition, distributions declared may exceed net income in a given period, as net income includes amortization and distributions are determined based on non-GAAP cash flow measures, which include the consideration of maintenance capital expenditures. For the twelve months ended December 31, 2007, distributions declared did not exceed either operating cash flow or net income as distributions were funded by operating cash flow. Management determines the Fund’s unit distribution rate by, among other considerations, its assessment of cash flow as determined using certain non-GAAP measures. As such, management feels that the cash distributions are not an economic return of capital, but a distribution of sustainable cash flow from operations. Management does not target a specific payout ratio and considers unforeseen expenditures for maintenance capital expenditures when considering changes to distribution levels.

Sleep Country Canada Income Fund 27

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

Distributable cash per unit (see “Non-GAAP measures”) For the For the (in thousands of dollars except unit and per unit amounts) year ended year ended December 31, December 31, 2007 2006

$$

Cash flow from operating activities before changes in non-cash items related to operating activities 33,834 29,672

Changes in non-cash items related to operating activities (working capital) (2) (3,921) (2,278)

Cash flow from operating activities 29,913 27,394

Maintenance capital expenditures (1) (3,303) (5,653)

Decrease in capital lease obligations (88) (199)

Distributable cash from operations 26,522 21,542

Number of units and Class A shares outstanding 14,045,577 14,045,577

Distributable cash per unit and Class A share $1.8883 $1.5337

Distributions declared per unit and Class A share $1.4086 $1.3584

Payout ratio 74.6% 88.6%

Payout ratio excluding the impact of working capital (2) 65.0% 80.1%

1 Maintenance capital expenditures are those expenditures related to maintaining and upgrading of existing facilities and information systems. Maintenance capital expenditures also include renovated and relocated stores. In 2007, 42.0% of all capital expenditures related to maintenance activities. In 2006, 44.0% related to maintenance activities. 2 The Fund reconciles distributable cash flow from operations activities before and after changes to working capital due to the seasonal fluctuations in the Fund’s working capital balances.

For the year ended December 31, 2007, the Fund used $3.9 million in working capital compared with $2.3 million in 2006. This was a result of increases in inventory of $1.3 million due primarily to the opening of 19 infill stores along with lower accrued liabilities balances at December 31, 2007 compared with 2006 due to the payment made under the management equity plan in July 2007.

Cumulative Distributable Cash Since inception on April 15, 2003, the Fund has paid $83.5 million in cash distributions to unitholders. During this period, the Fund has generated distributable cash from opera- tions of $116.1 million (including changes in working capital). This results in a cumulative payout ratio of 71.9%. Without considering changes in working capital during this period, the cumulative payout ratio would have been 74.1%.

28 2007 ANNUAL REPORT Non-GAAP measures

Distributable cash and distributable cash per unit Distributable cash is defined by management as cash flow from operating activities adjusted for maintenance capital expenditures, and repayment of capital lease obligations. Distributable cash is not a recognized measure under Canadian GAAP and may not be comparable to similar measures used by other companies. The Fund believes that distributable cash is a useful financial measure as it represents a starting point for investors to determine cash available for distributions. Investors should be cautioned, however, that distributable cash should not be construed as an alternative to net earnings or cash flow from operations as determined in accordance with GAAP. Please see the table under “Distributable cash per unit” for a reconciliation of distributable cash to the comparable GAAP measure which is cash flow from operating activities in the Fund’s consolidated financial statements for 2007.

EBITDA EBITDA is defined by management as earnings before interest, taxes, depreciation and amortization and other items. EBITDA is not a recognized measure under Canadian GAAP and may not be comparable to similar measures used by other companies. The Fund believes that EBITDA is a useful financial metric as it represents a starting point in the determination of free cash flow available for distribution to unitholders. Investors should be cautioned however, that EBITDA should not be construed as an alternative to net earnings as determined in accordance with GAAP. The following table reconciles EBITDA to net earnings in the consolidated financial statements for 2007:

(in thousands of dollars) For the year ended For the year ended December 31, 2007 December 31, 2006

$$

EBITDA 41,479 37,790

Interest expense (3,198) (3,605)

Financing expense on long-term debt (136) -

Depreciation and amortization (6,781) (5,884)

Other 807 1,018

Provision for income taxes (3,266) (2,921)

Net earnings for the year 28,905 26,398

Sleep Country Canada Income Fund 29

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

Disclosure Controls and Procedures Disclosure controls are procedures designed to provide reasonable assurance that material information is gathered and reported to senior management including the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate to permit timely decisions regarding public disclosures. Due to the inherent limitations in all control systems, an evaluation of the disclosure controls can only provide reasonable assurance over the effectiveness of the controls. The disclosure controls are not expected to prevent and detect all misstatements due to error or fraud. Management, including the CEO and CFO, has evaluated the effectiveness of the design and operation of the Fund’s disclosure controls and procedures as of December 31, 2007. Based on this evaluation, the CEO and CFO have concluded that the Fund’s disclosure controls and procedures, as defined in Multilateral Instrument 52-109 – Certification of Disclosure in Issuer’s Annual and Interim Filings, are designed effectively to ensure that the information required to be disclosed in reports that are filed or submitted under Canadian securities legislation are recorded, processed, summarized and reported within the time period specified in those rules. Based on the review and evaluation of disclosure controls, the CEO and CFO have concluded that, subject to the inherent limitations noted above, the Company’s disclosure controls are operating effectively as of December 31, 2007.

Internal Controls over Financial Reporting The Fund’s management under the supervision of, and with the participation of the Fund’s CEO and CFO, has designed internal controls over financial reporting, as defined under MI 52-109 of the Canadian Securities Administrators. The purpose of internal controls over financial reporting is to provide reasonable assurance regarding the reliability of financial reporting, in accordance with GAAP, focusing in particular on controls over information contained in the annual and interim financial statements and MD&A. The internal controls are not expected to prevent and detect all misstatements due to error or fraud. There have been no changes in the Fund’s internal controls over financial reporting during the fourth quarter ended December 31, 2007, that have materially affected or are reasonably likely to materially affect the Fund’s internal controls over financial reporting.

30 2007 ANNUAL REPORT Contractual Obligations The following table outlines the Fund’s contractual obligations and commitments:

Payments due by period (in thousands of dollars)

Contractual Obligations Total Less than 1 - 3 4 - 5 More than 1 year years years 5 years

Senior secured five year notes due 2010 $ 40,000 $ - $ 40,000 $ - $ -

Senior secured seven year notes due 2013 $ 9,913 $ - $ - $ - $ 9,913

Senior secured six year notes due 2013 $ 10,000 $ - $ - $ - $ 10,000

Sleep America promissory notes (1) $ 766 $ 766 $ - $ - $ -

Capital lease obligations $80 $42 $38 $ - $ -

Operating leases (2) $154,300 $27,025 $ 50,349 $ 35,637 $ 41,289

Total $215,059 $27,833 $ 90,387 $ 35,637 $ 61,202

(1) In March 2006, Sleep Country issued promissory notes of US $7,845 as part of the consideration for the acquisition of Sleep America. Under the share purchase agreement, payment of the promissory notes in two annual installments are based upon the maintenance of certain earnings targets for two years from the date of the acquisition. (2) Most of the operating lease obligations relate to real estate leases. All retail stores and distribution centers and leased, typically under five to 10 year agreements that contain options for renewal or permit continuation on a monthly basis.

Critical Accounting Estimates The preparation of the consolidated financial statements, upon which this MD&A is based, requires the Fund to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Fund believes the following critical accounting policy affects its more significant judgments and estimates used in the preparation of its consolidated financial statements. Goodwill is recorded at cost and is not amortized. Intangible assets comprise employment contracts and the Sleep Country, Dormez-vous and Sleep America corporate brand names. These brand names are not amortized as they have an indefinite life as manage- ment’s strategy is to continue to use and invest in these corporate brands indefinitely. Management reviews the carrying value of its intangible assets annually, or more frequently if events of changes in circumstances indicate that the asset might be impaired. Management has determined there was no impairment in goodwill or intangible asset balances at December 31, 2007.

Sleep Country Canada Income Fund 31

Management’s Discussion and Analysis of Results and Financial Condition For the Year Ended December 31, 2007

Changes in Accounting Policies As required by the Canadian Institute of Chartered Accountants (“CICA”), the Fund adopted CICA Handbook Section 1530, Comprehensive Income, Section 3855, Financial Instruments – Recognition and Measurement; Section 3861, Financial Instruments – Disclosure and Presentation and Section 3865, Hedges; on January 1, 2007. The adoption of these new Financial Instruments standards resulted in changes in the accounting for financial instruments as well as the recognition of certain transitional adjustments that have been recorded in opening cumulative earnings or opening accumu- lated other comprehensive income. As required by the implementation of these new standards, the comparative Consolidated Financial Statements have not been restated. The CICA issued three new accounting standards: section 1535, Capital Disclosures, section 3862, Financial Instruments-Disclosures, and section 3863, Financial Instruments- Presentation. Section 1535 establishes disclosure requirements about an entity’s capital and how it is managed. The purpose will be to enable users of the financial statements to evaluate objectives, policies and processes for managing capital. Sections 3862 and 3863 will replace section 3861, Financial Instruments – Disclosure and Presentation, revising and enhancing its disclosure requirements while carrying forward its presentation require- ments. These new sections will place increased emphasis on disclosure about the nature and extent of risks arising from financial instruments and how the entity manages those risks. The mandatory effective date is for annual and interim periods in fiscal years beginning on or after October 1, 2007. The Trust will begin application of these sections effective December 31, 2007.

Outlook Management of the Fund is committed to delivering its 2008 business plan including continued execution of the in-fill strategy and achieving positive sales growth in the Sleep Country, Dormez-vous and Sleep America banners. Distributions remain subject to review throughout the year and any changes to the monthly distribution amounts are subject to the approval of the board of trustees.

32 2007 ANNUAL REPORT Risks and Uncertainties The Fund is subject to various risks and uncertainties related to its operations. A summary of these risks is listed below. Additional details are contained in the Fund’s 2007 Annual Information Form filed on SEDAR, which can be found at www.sedar.com. • Retail mattress sales affected by the regional economy • Effectiveness and efficiency of advertising expenditures • Dependence of key personnel • Competition • Seasonality • Ability to maintain profitability and manage growth • Fluctuations in comparable store sales • Dependence on management information system • Sources of supply • Insurance • Labor relations • Expansion of the business • Foreign currency translations • Unpredictability and volatility of unit price • Nature of units • Leverage and restrictive covenants • Unitholder liability • Income tax matters in Canada, including the taxation of income trusts, and the United States

Outstanding Unit and Share Data At December 31, 2007, the Fund had 13,602,997 trust units outstanding and Sleep Country had 442,580 Class A shares outstanding. See note 12 of the consolidated financial statements for further discussion of the terms of the Class A shares.

Fourth Quarter Management’s discussion and analysis of the fourth quarter of 2007 was filed with our year end press release. This was filed at www.sedar.com on March 7, 2008.

Sleep Country Canada Income Fund 33 34 2007 Annual Report Sleep Country Canada Income Fund 35 Sleep Country Canada Income Fund Consolidated Balance Sheets As at December 31 (expressed in thousands of Canadian dollars)

2007 2006 $$ Assets

Current assets Cash and cash equivalents 22,139 14,488 Accounts receivable (note 5) 7,879 7,350 Inventories 19,684 18,866 Prepaid expenses and deposits 1,231 1,307 50,933 42,011

Property and equipment (note 6) 22,440 21,150 Other assets (note 7) 773 1,849 Intangible assets (note 8) 72,392 74,898 Goodwill 126,256 131,488 272,794 271,396

Liabilities and Unitholders’ Equity

Current liabilities Accounts payable and accrued liabilities 29,017 32,868 Customer deposits 8,418 8,110 Distribution payable to unitholders (note 13) 1,643 1,587 Current portion of long-term debt (note 9) 808 4,650 39,886 47,215

Long-term debt (note 9) 59,953 56,322 Other liabilities (note 10) 6,932 6,115 Future income taxes (note 11) 13,197 15,007 119,968 124,659

Unitholders’ Equity

Capital contributions (note 12) 132,356 132,526 Cumulative earnings 106,637 78,436 Cumulative distributions (81,200) (62,044) Cumulative dividends on Class A shares (2,903) (2,279) Accumulated other comprehensive income (loss) (2,064) 98 152,826 146,737 272,794 271,396

On behalf of the Trustees and the Board:

Stephen K. Gunn – Trustee Scott Anderson –Trustee

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

36 2007 ANNUAL REPORT Sleep Country Canada Income Fund Consolidated Statements of Earnings and Comprehensive Income For the Years Ended December 31, 2007 and December 31, 2006 (expressed in thousands of Canadian dollars, except per unit amounts)

2007 2006 $$

Sales 357,182 324,089 Cost of sales 266,008 239,649 Contribution margin 91,174 84,440

General and administrative expenses 49,695 46,650 Earnings before the under-noted: 41,479 37,790 Interest expense (note 9) 3,198 3,605 Financing expense on long-term debt (note 9) 136 - Depreciation and amortization 6,781 5,884 Interest income and other, net (807) (1,018)

Earnings before income taxes 32,171 29,319

Provision for (recovery of) income taxes (note 11) Current 4,930 5,752 Future (1,664) (2,831) 3,266 2,921

Net earnings for the year 28,905 26,398

Basic earnings per unit (note 12) $2.06 $1.88

Net earnings for the year 28,905 26,398 Other comprehensive income (loss): Unrealized gain (loss) on translation of foreign operations (2,162) 98

Comprehensive income for the year 26,743 26,496

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

Sleep Country Canada Income Fund 37 Sleep Country Canada Income Fund Consolidated Statements of Changes in Unitholders’ Equity For the Years Ended December 31, 2007 and December 31, 2006 (expressed in thousands of Canadian dollars)

2007 2006 $$

Trust units Balance at beginning of year 136,030 135,658 Issued on conversion of Class A shares - 372 Balance at end of year 136,030 136,030

Class A shares Balance at beginning of year 4,426 4,798 Conversion of shares to units - (372) Balance at end of year 4,426 4,426 Unit and share issuance costs (7,254) (7,254)

Long-term incentive plan Balance at beginning of year (676) (435) Additional obligations 222 271 Change in contributions (392) (512) Balance at end of year (846) (676) 132,356 132,526

Cumulative earnings Balance at beginning of year 78,436 52,038 Impact of adopting new accounting policy (note 3) (704) - Net earnings 28,905 26,398 Balance at end of year 106,637 78,436

Cumulative distributions Balance at beginning of year (62,044) (43,586) Distributions declared (note 13) (19,156) (18,458) Balance at end of year (81,200) (62,044)

Cumulative dividends on Class A shares Balance at beginning of year (2,279) (1,660) Dividends declared (624) (619) Balance at end of year (2,903) (2,279)

Accumulated other comprehensive income (loss) Balance at beginning of year 98 - Other comprehensive income (loss) (2,162) 98 Balance at end of year (2,064) 98

Unitholders’ equity at end of year 152,826 146,737

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

38 2007 ANNUAL REPORT Sleep Country Canada Income Fund Consolidated Statements of Cash Flows For the Years Ended December 31, 2007 and December 31, 2006 (expressed in thousands of Canadian dollars)

2007 2006 $$ Cash provided by (used in) Operating activities Net earnings for the year 28,905 26,398 Items not affecting cash Depreciation of property and equipment 6,501 5,192 Amortization of intangible assets 280 692 Amortization of deferred financing costs - 252 Amortization of deferred lease inducements (919) (790) Other non-cash expenses 731 759 Future income taxes (1,664) (2,831) 33,834 29,672 Changes in non-cash items related to operating activities (note 15) (3,921) (2,278) 29,913 27,394 Investing activities Acquisitions, net of cash acquired (note 2) - (20,356) Purchase of property and equipment (7,938) (12,899) (7,938) (33,255) Financing activities Issuance of senior notes 10,000 11,565 Financing costs - (763) Repayment of promissory notes (4,330) - Repayment of capital lease obligations (88) (199) Dividends paid on Class A shares (623) (621) Distributions paid to unitholders (19,100) (18,397) (14,141) (8,415) Exchange rate difference on cash and cash equivalents (183) 74 Increase (decrease) in cash and cash equivalents 7,651 (14,202) Cash and cash equivalents, beginning of year 14,488 28,690 Cash and cash equivalents, end of year 22,139 14,488

Supplemental cash flow information Interest paid 3,606 2,709 Income taxes paid 5,970 6,012 Non-cash investing and financing activities Dividends payable included in accounts payable and accrued liabilities 53 52 Issuance of units on retraction of Class A shares - 372 Sleep America Promissory notes (notes 2 and 9) (3,911) 9,073

SEE ACCOMPANYING NOTES TO CONSOLIDATED FINANCIAL STATEMENTS.

Sleep Country Canada Income Fund 39

Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

1. Organization Sleep Country Canada Income Fund (the “Fund”) is an unincorporated open-ended limited purpose trust established under the laws of the province of Ontario pursuant to the Declaration of Trust dated March 5, 2003, as amended and restated on April 3, 2003. The Fund is authorized to issue an unlimited number of trust units. The Fund owns all of the common shares and the unsecured subordinated notes of Sleep Country Canada Inc. (“Sleep Country”). The Fund, through a number of wholly owned subsidiaries, operates within the retail marketplace, offering mattresses and related products. During the first quarter of 2006, the Fund completed two acquisitions which provide it with a presence in the Quebec market (under the Dormez-vous banner) and the United States market in Arizona (under the Sleep America banner). As of December 31, 2007, the Fund’s retail operations, including home delivery, consist of 127 stores and 12 distribution centres located in British Columbia, Prairies and Ontario under the Sleep Country Canada banner, 24 stores and a distribution centre under the Dormez-vous banner in Quebec, and 44 stores and one distribution centre located in Arizona under the Sleep America banner.

2. Business acquisitions On January 11, 2006, the Fund acquired 100% of the shares of Dormez-vous Sleep Centres Inc. (“Dormez-vous”), a mattress retailer in Montreal, Quebec. On March 7, 2006, the Fund acquired 100% of the shares of Sleep America Inc. (“Sleep America”), a mattress retailer located in Arizona, United States. The acquisitions were accounted for by the purchase method with the results of operations included in the Fund’s earnings from the date of acquisition. The purchase price was allocated to the assets acquired and liabilities assumed based on management’s best estimate of fair values. The acquisitions were funded through a combination of cash on hand and the issuance of senior secured notes and promissory notes to the vendors based on maintenance of certain earnings targets for two years from the date of acquisition. The full value of the promissory notes to the vendors was recorded at the date of acquisition. At that date, the purchase price was $29,429. During 2007, Sleep America did not meet the earnings targets and, as a result, the value of the amount owing on promissory notes and related goodwill were reduced by US $3,382. This, in turn, reduced the purchase price paid from $29,429 to $25,518. The estimated fair values of the assets acquired and liabilities assumed after the goodwill and promissory notes reduction are as follows:

40 2007 ANNUAL REPORT $ Accounts receivable 560 Inventories 3,717 Prepaid expenses and deposits 29 Property and equipment 945 Intangible assets Brands 16,958 Employment contracts 1,076 Goodwill (net of reduction US $3,382) 9,510 Other assets 24 Accounts payable and accrued liabilities (5,325) Customer deposits (654) Long-term debt (145) Other liabilities (364) Future income taxes (913) Net assets acquired 25,518 Consideration given: Cash 8,791 Issuance of senior secured notes 11,565 Promissory notes (net of reduction US $3,382) 5,162 Total consideration 25,518

The acquired brand assets of $16,958 are not subject to amortization. The employment contracts are amortized over their related terms. Goodwill of US $7,419 is expected to be deductible for income tax purposes.

3. Summary of significant accounting policies These consolidated financial statements have been prepared in accordance with accounting principles generally accepted in Canada and reflect the following accounting principles:

Principles of consolidation The consolidated financial statements include the accounts of the Fund and its wholly- owned subsidiaries. All significant inter-group transactions and balances are eliminated on consolidation.

Sleep Country Canada Income Fund 41

Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

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

Foreign currency translation The Fund accounts for its self-sustaining foreign operations using the current rate method, whereby assets and liabilities are translated at the exchange rate in effect at the balance sheet date, while revenues and expenses are translated at an appropriate weighted average rate. Any resulting translation gains or losses are included in the statement of comprehensive income.

Inventories Inventories are valued at the lower of cost determined on a specific item basis and estimated net realizable value. Trade discounts and volume rebates earned are deducted in determining the cost of inventory purchases.

Accounts receivable Accounts receivable balances are recognized initially at fair value and a provision for impairment is established when there is evidence that the Fund will not be able to collect all the amounts due according to the original terms of the receivable balance.

Property and equipment Property and equipment are recorded at cost less accumulated depreciation and net of any impairment loss. Depreciation is computed on a straight-line basis at annual rates based on the estimated useful lives of the related assets as follows: Computer equipment – hardware and software 36 months Furniture, fixtures and office equipment 60 months Leasehold improvements over the term of the lease Delivery trucks under lease over the term of the lease

Goodwill Goodwill is recorded at cost and is not amortized. Management tests goodwill for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. Goodwill is written down when the carrying value exceeds the fair value. Subsequent to the adjustment of goodwill as described in note 2, management has determined, using appropriate valuation methodologies, that there was no goodwill impairment at December 31, 2007.

42 2007 ANNUAL REPORT Intangible assets Intangible assets, other than goodwill, are assets acquired that lack physical substance and that meet the specified criteria for recognition. Intangible assets acquired comprise employment contracts and the Sleep Country, Dormez-vous and Sleep America corporate brands. Employment contracts are amortized on a straight-line basis over their related terms. Brands are not amortized as they have an indefinite life and management’s strategy is to continue to use and invest in these corporate brands indefinitely. Management reviews the carrying value of its intangible assets annually, or more fre- quently if events or changes in circumstances indicate that the asset might be impaired. The intangible asset relating to the corporate brands will be written down if the carrying amount of the asset exceeds its fair value. The employment contracts, with a finite life, will be written down if the named executive ceases to be employed. Management has determined, using appropriate valuation methodologies, that there was no impairment at December 31, 2007.

Valuation of long-lived assets The Fund periodically evaluates the carrying value of its long-lived assets including, but not limited to, property and equipment, intangible assets, and other assets. The carrying value of a long-lived asset is considered impaired when the undiscounted cash flow is estimated to be less than its carrying value. In that event, a loss is recognized based on the amount by which the carrying value exceeds the fair market value of the long-lived asset. Fair market value is determined primarily using the anticipated cash flows discounted at a rate commensurate with the risk involved. Losses on long-lived assets to be disposed of would be determined in a similar manner, except the fair market values would be reduced by the cost of disposal.

Stock-based compensation The Fund has a long-term incentive plan (LTIP) for certain of its senior executives. In accordance with Section 3870 of the CICA Handbook, the Fund uses the fair value based method of accounting for stock-based compensation. Under the LTIP, units purchased by a third party trustee on the open market on behalf of the plan participants are recorded at cost as a reduction of the unitholders’ equity. The Fund records annual awards under the LTIP as compensation expense over the vesting period.

Revenue recognition Revenue is recognized either upon the customer picking up the product or upon delivery of the product to the customer’s home. Provisions for refunds relating to the Fund’s various customer satisfaction programs are accrued based on historical experience.

Sleep Country Canada Income Fund 43

Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

Capital leases Certain long-term lease transactions relating to the financing of delivery trucks are accounted for as capital leases. Obligations recorded under capital leases are reduced by rental payments net of imputed interest. Operating leases Scheduled rent increases are recognized in rent expense over the term of the related leases on a straight-line basis. Lease inducements, including rent-free periods and the reimbursement of costs incurred by the Fund for leasehold improvements, are deferred and recorded as a reduction of rent expense over the term of the related leases on a straight-line basis. Asset retirement obligations The fair value of the asset retirement obligations is recorded as a liability with the same amount recorded as an increase in the carrying value of the related long-lived asset. The cost included in the long-lived assets is allocated to expense on a straight-line basis over the average useful life of the related assets. The liability is adjusted for accretion expense representing the increase in the fair value of the obligations due to the passage of time. Cash and cash equivalents Cash and cash equivalents consist of cash on hand and balances with banks. Cash and cash equivalents are valued at cost plus accrued interest, which approximates market value. Income taxes Income taxes are not currently provided for by the Fund, as the policy of the Fund is to distribute all available cash to unitholders to the maximum extent possible, and, under current income tax legislation, this amount is deductible by the Fund. Approximately 98% of the distribution is considered to be income of the unitholder for Canadian tax purposes. On June 12, 2007, amendments to the Tax Act were substantively enacted, which would cause this amount to be taxable by the Fund from 2011 onwards at an income tax rate approximating the combined federal and provincial rates. Income taxes provided for by Sleep Country and its subsidiaries are accounted for using the liability method. Future income taxes arise due to the temporary differences in the financial reporting and tax bases of assets and liabilities. Changes in these temporary differences are reflected in the provision for future income taxes using substantively enacted income tax rates and regulations. A valuation allowance is recognized to the extent that the recoverability of future income tax assets is not considered more likely than not. Financial instruments Effective January 1, 2007, The Fund adopted the new accounting standard of the CICA Handbook Section 3855, “Financial Instruments – Recognition and Measurement”, retroactively without restatement of prior year balances. The new standard provides guid- ance on the recognition and measurement of financial instruments and the recognition of transaction costs related to any financial asset or financial liability.

44 2007 Annual Report The Fund has classified its cash and cash equivalents as held-for-trading financial assets; accounts receivable as loans and receivables; accounts payable and accrued liabilities, distribution payable to unitholders and long-term debt as other financial liabilities. The Fund will recognize all transaction costs related to non-trading financial liabilities in net income in the period incurred. As a result of the adoption of this new standard, the Fund wrote off deferred financing costs of $704 (net of income tax) related to the senior secured notes issued to cumulative earnings in the first quarter of 2007. The Fund’s financial assets designated as held for trading are typically acquired for resale prior to maturity. They are measured at fair value at the balance sheet date. Interest earned, interest accrued, gains and losses realized on disposal and unrealized gains and losses from market fluctuations are included in interest income and other, net. Loans and receivables are accounted for at amortized cost. Other liabilities are recorded at amortized cost and include all liabilities, other than derivatives or liabilities to which fair value has been applied. The Fund does not have any outstanding contracts or financial instruments with embedded derivatives that require bifurcation. Comprehensive income Effective January 1, 2007, the Fund adopted the new standard of the CICA Handbook Section 1530, “Comprehensive Income”. A new consolidated statement of comprehensive income now forms part of the Fund’s consolidated financial statements. The Fund’s comprehensive income is comprised of net earnings and other comprehensive income (which includes changes in unrealized gains or losses on foreign currency translation of self-sustaining foreign operations). Equity Effective January 1, 2007, the Fund applied the new requirement of the CICA Handbook Section 3251, “Equity”, and included “accumulated other comprehensive income (loss)” as a separate component of unitholders’ equity in its consolidated balance sheet. As a result, the Fund restated prior year’s unrealized gains and losses on foreign currency translation of self-sustaining subsidiaries as required. Adoption of new changes in accounting policies Effective for interim periods and year ends commencing on or after October 31, 2007, the CICA released new Handbook Section 3862, “Financial Instruments – Disclosures”, Section 3863, “Financial Instruments – Presentation” and Section 1535, “Capital Disclosures”. The Fund has chosen to early adopt these new standards for the year ended December 31, 2007. Section 3862 establishes standards for the disclosure of financial instruments including disclosing the significance of financial instruments and the nature and extent of risks arising from financial instruments. Section 3863 carries forward unchanged presentation requirements for financial instruments.

Sleep Country Canada Income Fund 45

Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

Section 1535 establishes standards for disclosing aspects of the entity’s capital management strategy. This standard requires disclosure of both qualitative and quantitative disclosures around the entity’s objectives, policies and processes for managing requirements and the consequences of non-compliance. The adoption of these new standards will not have any significant effect on the Fund’s financial position or results of operations. Adoption of Section 1506 On January 1, 2007, the Fund adopted CICA Section 1506, Accounting Changes, which prescribes the criteria for changing accounting policies, together with the accounting treat- ment and disclosure of changes in accounting policies, changes in accounting estimates and corrections or errors. This standard did not affect the Fund’s financial position or results of operations. In complying with Section 1506, the following has yet to be adopted by the Fund: The new CICA Section 3031, Inventories, related to the accounting for inventories and revises and enhances the requirements for assigning costs to inventories. The new standard applies to interim and annual financial statements to fiscal years beginning on or after January 1, 2008, and will be effective for the Fund as of that date. The Fund is currently evaluating the impact of this standard on its financial statements.

4. Financial Risk Management Financial Risk Factors The Fund’s activities expose it to a variety of financial risks: market risk (including foreign currency risk), credit risk and liquidity risk. The Fund’s overall risk management program and prudent business practices seek to minimize any potential adverse effects on the Fund’s financial performance. Risk management is carried out by the senior management team under policies approved by the Board of Directors. (a) Market Risk (i) Foreign exchange risk The Fund operates in Canada and the United States and is exposed to foreign exchange risk arising from exposure to fluctuations in the United States dollar exchange rate. Foreign exchange risk arises primarily from its net investment in United States operations. A small amount of exposure relates to United States dollar balances held by Canadian operations to fund payments to a small number of United States suppliers. The Fund has a self-sustaining investment in the United States whose net assets are exposed to foreign currency translation risk. This risk is managed primarily through

46 2007 Annual Report local cash flows funding United States operations and borrowings denominated in the United States dollars. At December 31, 2007, the Canadian dollar had strengthened 15% against the United States dollar year over year, however, this primarily impacted the net investment and thus has no impact on the net earnings for the year. Given the Fund’s limited exposure to fluctuations in the United States dollar exchange rate, there is no active hedging program currently in place. (ii) Cash flow and fair value interest rate risk The Fund has no significant interest-bearing assets. The Fund’s income and operating cash flows are substantially independent of changes in market interest rates. The Fund’s interest rate risk arises from long term debt. The Fund uses a combina- tion of fixed interest rate debt and variable interest rate debt. Long term debt issued at variable rates exposes the Fund to cash flow interest rate risk. These include a small amount of capital leases and the promissory notes issued in connection with the Sleep America acquisition. Long term debts issued at fixed rates expose the Fund to fair value interest rate risk. These include the three issuances of senior secured notes and represent the significant long term debt balances. As a result, the Fund has limited exposure to cash flow interest rate fluctuations. (b) Credit Risk Credit risk arises from deposits with banks, as well as credit exposures from mattress vendors for the payment of volume and advertising rebates amounts and balances owed from third party financing companies under the various financing plans the Fund offers its customers. For banks, in accordance with the Fund’s Investment Policy, all deposits are held at banks possessing a credit rating of an AA or better. Balances outstanding from mattress vendors are offset, on a periodic basis, against liability balances. Sales to retail customers are settled in cash, financed by third party financing companies or using major credit cards. The third party financing companies that the Fund deals with carry a minimum rating of AA or better. (c) Liquidity Risk Prudent liquidity management implies maintaining sufficient cash and cash equivalents and the availability of funding through an adequate amount of committed credit facilities. Management of the Fund ensures that adequate cash is on hand to meet all future obligations. To maintain further flexibility, the Fund strives to keep the committed credit facility available at all times. The table below analyzes the Fund’s financial liabilities which will be settled on a net basis into relevant maturity groupings based on the remaining period at the balance sheet to the contractual maturity date. The amounts discussed in the table are contrac- tual undiscounted cash flows. The carrying value of balances due within 12 months approximates their fair value as the impact of discounting is not significant.

Sleep Country Canada Income Fund 47

Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

At December 31, 2007 Less than Between Between Over 1 year 1 and 2 years 2 and 5 years 5 years $$ $$ Accounts payable and accrued liabilities 29,017 - - - Distribution payable to unitholders 1,643 - - - Long term debt 808 39 40,000 19,914 31,468 39 40,000 19,914

At December 31, 2006 Less than Between Between Over 1 year 1 and 2 years 2 and 5 years 5 years $$ $$ Accounts payable and accrued liabilities 32,868 - - - Distribution payable to unitholders 1,587 - - - Long term debt 4,650 4,639 40,029 11,654 39,105 4,639 40,029 11,654

Capital Risk Management The Fund’s objectives when managing capital are to safeguard the Fund’s ability to continue as a going concern in order to provide returns for unitholders and Class A shareholders in the form of cash distributions and dividends, benefits to other stakeholders and to maintain an optimal capital structure to minimize the cost of capital. Sleep Country’s policy is to distribute all available cash from operations to the Fund for distribution to unitholders after provision for cash required for capital expenditures, working capital reserves, growth capital reserves and other reserves considered advisable by Sleep Country’s Board of Directors. The Trustees of the Fund have eliminated the impact of seasonal fluctuations by equalizing monthly distributions. The Fund’s distributions are limited by long-term debt covenants which require that accumulated distributions to unitholders do not exceed accumulated distributable cash, as defined by the agreements. In order to maintain or adjust the capital structure, the Fund may adjust the amount of distributions paid to unitholders, dividends paid to Class A shareholders, return capital to unitholders, issue new units or sell assets to reduce long term debt.

48 2007 Annual Report 5. Accounts receivable The Fund’s receivable balances consist of balances due from vendors related to volume and co-op advertising rebates and balances due from the third party financing companies. Certain receivable balances from suppliers related to volume and co-op advertising rebates have a right of offset against accounts payable balances. The Fund transfers the credit risk for its financing plans to the third party financing companies as there is no recourse for future uncollectible amounts. As of December 31, 2007 and 2006, no accounts receivable balances were considered impaired. The carrying amounts of the Fund’s accounts receivable balances, which approximate their fair value, are denominated in the following currencies:

2007 2006 $$

Canadian dollars 7,315 6,469

United States dollars 564 881

7,879 7,350

The maximum exposure to credit risk at the reporting date is the fair value of the receivable balances. The Fund does not hold any collateral as security with the exception of the right of offset for certain supplier payables.

6. Property and equipment

December 31, 2007

Accumulated Cost depreciation Net $$$

Computer equipment 4,845 2,711 2,134

Furniture, fixtures and office equipment 4,522 2,335 2,187

Leasehold improvements 25,348 7,293 18,055

Delivery trucks under lease 265 201 64

34,980 12,540 22,440

Sleep Country Canada Income Fund 49 Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

Cost depreciation Net $$$

Computer equipment 3,621 1,388 2,233

Furniture, fixtures and office equipment 4,321 1,398 2,923

Leasehold improvements 22,154 6,258 15,896

Delivery trucks under lease 306 208 98

30,402 9,252 21,150

7. Other assets

December 31, 2007 December 31, 2006 Cost Net $$

Security deposits and other 773 745 Deferred financing costs on Senior secured notes - 1,104

773 1,849

Effective January 1, 2007, the Fund adopted the provisions of CICA Handbook Section 3855, “Financial Instruments – Recognition and Measurement”. The Fund’s policy is to recognize the related transaction costs in net earnings in the period incurred. As a result, the Fund recorded a net reduction of $704 (net of income tax) related to previously recorded deferred financing costs to the opening balance of cumulative earnings in the first quarter of 2007. Prior period’s financial statements have not been restated. 8. Intangible assets

December 31, 2007 December 31, 2006 $$

Brands (a) 71,943 74,067

Employment contracts 922 1,084

72,865 75,151 Less: accumulated amortization - employment contracts (473) (253)

72,392 74,898

50 2007 Annual Report (a) The carrying value of the Sleep America brand as of December 31, 2007 has decreased by $2,123 from December 31, 2006 due to strengthening of the Canadian dollar during the year. The impact of this strengthening is reflected in the other comprehensive loss for the year. 9. Long-term debt

December 31, 2007 December 31, 2006 $$

Senior secured five-year notes (a) 40,000 40,000

Senior secured seven-year notes (b) 9,913 11,654

Series B senior secured six-year note (c) 10,000 -

Promissory notes 766 9,142

Capital lease obligations and other 82 176

60,761 60,972

Less: current portion of long-term debt (808) (4,650)

59,953 56,322

Senior secured notes (a) On June 14, 2005, Sleep Country issued $40,000 senior secured five-year notes at a fixed interest rate of 5.191% in a private placement to a number of Canadian institutional investors. The proceeds were used to repay an earlier term bank loan with the balance for general corporate purposes. Interest is payable quarterly in arrears. For the years ended December 31, 2007 and 2006, Sleep Country incurred interest expense of $2,076. At December 31, 2007, the fair value of these notes was $39,369. (b) On March 7, 2006, a subsidiary of Sleep Country issued US $10,000 senior secured seven year notes at a fixed interest rate of 6.83% in a private placement to certain Canadian and United States institutional investors. The notes are guaranteed by Sleep Country and its subsidiaries. The proceeds were used to fund the acquisition of Sleep America. Interest is payable quarterly in arrears. For the year ended December 31, 2007, the subsidiary incurred interest expense of US $683 (US $559 for the year ended December 31, 2006). At December 31, 2007, the fair value of these notes was $10,400. (c) On June 18, 2007, Sleep Country issued $10,000 Series B senior secured six-year notes at a fixed interest rate of 6.521% in a private placement to a Canadian institutional investor. The proceeds were used for general corporate purposes. Interest is payable quarterly in arrears. Interest of $349 was incurred for the year ended December 31, 2007. Finance fees of $136 were incurred and expensed. At December 31, 2007, the fair value of these notes was $10,131.

Sleep Country Canada Income Fund 51

Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

The fair value determination of these notes is based on the future value of the payment on maturity at future Bank of Canada interest rates for comparable debt plus a risk premium.

Sleep America Promissory notes In March 2006, Sleep Country issued promissory notes of US $7,845 as part of the consideration for the acquisition of Sleep America. Under the share purchase agreement, payment of the promissory notes in two annual instalments is based upon the mainte- nance of certain earnings targets for two years from the date of the acquisition. Interest is calculated at the average prime rate during the period and is payable when the promissory notes are due. In March 2007, the first instalment of US $3,996 including accrued interest was paid with the remaining balance of US $773 payable in March 2008. During 2007, Sleep America did not meet the earnings targets and, as a result, the values of the promissory notes and related goodwill were reduced by US $3,382. For the year ended December 31, 2007, a net interest recovery of US $103 was recorded (interest expense of US $522 was recorded for the year ended December 31, 2006).

Revolving credit facility Sleep Country has available a revolving credit facility of $10,000 amended upon the issuance of the Series B senior secured notes on June 18, 2007. The revolving credit maturity date is extendable on an annual basis. Sleep Country pays a stand-by fee of 0.75% and an extension fee of $24 per annum for the facility. There were no amounts outstanding at December 31, 2007 or December 31, 2006 under the revolving credit facility. Under the terms of the senior secured notes and revolving credit facility, certain financial covenants and financial ratios must be maintained. At December 31, 2007, Sleep Country and its subsidiaries were in compliance with all covenants. The senior secured notes and amended revolving credit facility described above are secured by a first fixed floating charge on the assets of Sleep Country and its subsidiaries, except for specified permitted encumbrances. The provisions under these facilities provide for restrictions on the operations and activities of Sleep Country and its subsidiaries. Generally, the most significant restrictions relate to permitted investments as well as the incurrence and maintenance of certain financial ratios primarily linked to operating earnings before interest, taxes, depreciation and amortization.

52 2007 Annual Report 10. Other liabilities

December 31, 2007 December 31, 2006 $$

Deferred lease inducements: Beginning of year 6,858 4,865 Additions during the year 1,323 1,993 End of year 8,181 6,858 Accumulated amortization (3,374) (2,461) 4,807 4,397 Less: foreign currency translation difference (41) - 4,766 4,397 Asset retirement obligations 625 551 Rent escalation accrual 1,282 863 Management equity plan 259 1,461 Accrued interest on promissory notes (note 2) 107 608 7,039 7,880 Less: current portion included in accounts payable and accrued liabilities (107) (1,765) 6,932 6,115

11. Income taxes Components of income tax provision Significant components of the income tax provision (recovery) are as follows:

December 31, 2007 December 31, 2006 $$

Current income tax expense 4,930 5,752 Future income tax expense (recovery) relating to: Temporary differences 175 (263) Loss carry-forwards (330) (1,347) Effect of change in tax rates (2,103) (1,819) Share issuance costs 594 598 Provision for income taxes 3,266 2,921

Sleep Country Canada Income Fund 53 Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

Reconciliation to statutory rate The overall income tax provision differs from the amount that would be obtained by applying the combined statutory income tax rate to earnings due to the following:

Year ended Year ended December 31, 2007 December 31, 2006 $$

Net earnings before income taxes 32,171 29,319 Combined Canadian and United States income tax rate 34.9% 37.1% Income tax expense based on statutory income tax rate 11,228 10,877 Increase (decrease) resulting from: Net earnings of the Fund subject to income tax in the hands of unitholders (5,832) (6,177) Recognition of income tax rate decreases on future income taxes (2,103) (1,819) Effect of non-taxable income and non-deductible expenses (27) 40 Income tax expense 3,266 2,921 Effective income tax rate 10.2% 10.0%

Future income tax liability Significant components of the net future income tax liability are as follows:

December 31, 2007 December 31, 2006 $$

Excess of carrying value of intangible assets over tax values (16,691) (18,887)

Excess of carrying value of property and equipment over tax values (3) (344)

Benefit of share issuance costs deductible in future years 135 696

Unrealized gain on foreign currency debt (236) -

Other temporary differences 2,162 2,181

Loss carry-forwards (a) 1,436 1,347

Net future income tax liability (13,197) (15,007)

54 2007 Annual Report (a) No valuation allowance has been applied to the loss carry-forwards as the recoverability of these balances is considered to be more likely than not. The earliest expiry date of these losses is 2026. On June 12, 2007, amendments to the Tax Act were substantively enacted, which will result in the Fund being taxed from 2011 onwards in a manner similar to the corporations. The gross amount of temporary differences at the Fund level is $0.1 million and is expected to be fully reversed by 2011. As such, no adjustment on the Future Income Tax balance has been recorded.

12. Capital contributions Included in capital contributions are 13,602,997 trust units and 442,580 Class A shares of Sleep Country.

Trust Units The Declaration of Trust provides that an unlimited number of units of the Fund may be issued. Each unit is transferable and represents an equal undivided beneficial interest in any distributions of the Fund and in the net assets of the Fund. All units have equal rights and privileges. Each unit entitles the holder to participate equally in allocations and distri- butions and to one vote at all meetings of unitholders for each whole unit held. The units issued are not subject to future calls or assessments. Units are redeemable at any time at the option of the holder at amounts related to market prices at the time, subject to certain factors including a maximum of $50 in cash redemptions by the Fund in any particular month. This limitation may be waived at the discretion of the Trustees of the Fund. Redemptions in excess of this amount, assuming no waiving of the limitation, shall be paid by way of a distribution in specie of a pro rata number of Company securities held by the Fund.

Class A shares of Sleep Country Canada Inc. The Class A shares of Sleep Country are non-voting and retractable at any time by the holder and redeemable by the company in certain circumstances, in each case on a one-for-one basis for units of the Fund. The holders of Class A shares are entitled to receive monthly dividends per share equal to the monthly distributions per unit declared and paid by the Fund. For the year ended December 31, 2007, dividends of $624 were declared ($619 for the year ended December 31, 2006).

Long-term incentive plan Sleep Country has adopted a long-term incentive plan to enhance its ability to attract, retain and motivate key personnel and reward these key employees for significant performance and associated per unit cash flow growth. Bonuses, in the form of units of the Fund, are provided to eligible employees annually where the cash distributed by the Fund exceeds certain specified threshold amounts.

Sleep Country Canada Income Fund 55 Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

If distributed cash per unit exceeds threshold amounts, a percentage of the excess distributed cash (the participation rate) is contributed by Sleep Country into a long-term incentive pool. The funds in this pool are used to purchase units of the Fund in the open market, to be provided to eligible employees as bonus compensation. Threshold amounts and participation rates are as follows:

Amount of Gross Distributions per unit in excess Participation of $1.075 per unit per fiscal year rate

Less than $0.05 10% $0.05 or more but less than $0.10 15% $0.10 or more 20%

For the year ending December 31, 2007, the distributed cash per unit of the Fund exceeded the threshold amount. Thus, bonuses of $907 were provided under the plan ($770 for the year ended December 31, 2006). The bonus amounts are amortized on a graded basis over the vesting period of the plan which is three years. For the year ended December 31, 2007, $737 was amortized to compensation expense under the plan ($529 for the year ended December 31, 2006).

Earnings per Unit Basic earnings per unit are calculated using the “if-converted” method. Under this method, the Class A shares issued are considered units for purposes of calculating basic earnings per unit. The calculation of earnings per unit is as follows:

Year ended Year ended December 31, December 31, 2007 2006 Earnings Earnings Net earnings Units per unit per unit $$$ Basic earnings 28,905 14,045,577 2.06 1.88

56 2007 Annual Report 13. Distributions The Fund makes regular monthly distributions to unitholders of record as of the last business day of each month. Distributions to unitholders are calculated and recorded on the accrual basis. Distributions for the year ended December 31, 2007 are as follows:

Period Record Date Payment Date Per Unit Amount $$ January 2007 January 31, 2007 February 20, 2007 0.1167 1,587 February 2007 February 28, 2007 March 20, 2007 0.1167 1,587 March 2007 March 30, 2007 April 20, 2007 0.1167 1,587 April 2007 April 30, 2007 May 18, 2007 0.1167 1,587 May 2007 May 31, 2007 June 20, 2007 0.1167 1,587 June 2007 June 29, 2007 July 20, 2007 0.1167 1,587 July 2007 July 31, 2007 August 20, 2007 0.1167 1,587 August 2007 August 31, 2007 September 20, 2007 0.1167 1,587 September 2007 September 28, 2007 October 19, 2007 0.1167 1,587 October 2007 October 31, 2007 November 20, 2007 0.1167 1,587 November 2007 November 30, 2007 December 20, 2007 0.1208 1,643 December 2007 December 31, 2007 January 18, 2008 0.1208 1,643 1.4086 19,156

For the year ended December 31, 2006, total distributions of $18,458 were declared. Sleep Country and its subsidiaries distribute all available cash to the Fund based on cash provided by operations less cash required for capital expenditures, working capital reserves, growth capital reserves and other reserves considered advisable by the Board of Directors of Sleep Country. For the year ended December 31, 2007, Sleep Country and its subsidiaries distributed all of their available cash to the Fund.

Sleep Country Canada Income Fund 57 Sleep Country Canada Income Fund Notes to Consolidated Financial Statements As at December 31, 2007 and 2006 (expressed in thousands of Canadian dollars, unless otherwise specified and except per unit and per share amounts)

14. Commitments Operating leases Sleep Country and its subsidiaries conduct all of their operations from leased stores and distribution centres. The Fund has entered into operating lease arrangements for leased premises, delivery trucks, passenger vehicles and office equipment with terms varying from three to ten years. For the year ended December 31, 2007, the total amount paid under these operating leases was $24,495 ($19,381 for the year ended December 31, 2006). These leases terminate at various dates to 2018. The minimum annual payments are as follows:

Year ending December 31 $

2008 27,025 2009 26,576 2010 23,773 2011 20,121 2012 15,516 Thereafter 41,289 154,300

15. Changes in non-cash items related to operating activities

December 31, December 31, 2007 2006 $$

Accounts receivable (870) (2,187)

Inventories (1,297) (3,374)

Prepaid expenses and deposits (138) (64)

Accounts payable and accrued liabilities (3,302) 918

Customer deposits 381 975

Deferred lease inducements 1,305 1,454

(3,921) (2,278)

58 2007 Annual Report 16. Segmented information The Fund’s operations, under the three banners of Sleep Country Canada, Dormez-vous and Sleep America, fall into one dominant industry segment being mattress retailing. The Fund manages its operations, and accordingly determines its operating segments, on a geographic basis. The following is a breakdown by reporting segment:

Year ended Year ended December 31, December 31, 2007 2006 $$ Sales: Canada 315,361 286,453 United States (a) 41,821 37,636 Consolidated 357,182 324,089

(a) Sales in the United States for the year ended December 31, 2006 represents sales from the date of acquisition in March 2006.

As as As as December 31, December 31, 2007 2006 $$ Property and equipment, intangible assets and goodwill: Canada 199,612 198,641 United States 21,476 28,895 Consolidated 221,088 227,536

17. Seasonal nature of the business Sleep Country and its subsidiaries historically experience a higher level of sales and contribution margins during the third and fourth quarters, while the first and second quarters experience lower sales levels and contribution margins due to seasonal shopping patterns. Occupancy related expenses, certain fixed delivery expenses, general and administrative expenses, depreciation and amortization and interest expense remain relatively steady throughout the year.

Sleep Country Canada Income Fund 59 60 2007 Annual Report

CORPORATE DATA

Head Office Legal Counsel

Unit #1, 140 Wendell Avenue Davies Ward Phillips Vineberg LLP Toronto, Ontario 44th Floor Canada 1 First Canadian Place M9N 3R2 Toronto, Ontario 1-888-SLEEP88 M5X 1B1 www.sleepcountry.ca (416) 863-0900 www.dwpv1.com Shares Listed Investor Relations Toronto Stock Exchange Stock Symbol: Z.UN For investor relations related inquiries please contact: Vicki Jones Transfer Agent Chief Financial Officer and Computershare Trust Company of Canada Corporate Secretary 9th Floor, 100 University Avenue 416-242-4774 Toronto, Ontario email: [email protected] Canada www.sleepcountry.ca/investor M5J 2Y1 416-263-9200 www.computershare.com

Auditors

PricewaterhouseCoopers LLP 5700 Yonge Street Suite 1900 Toronto, ON M2M 4K7 Canada (416) 228-4228 www.pwc.com/ca

Sleep Country Canada Income Fund 61 www.sleepcountry.ca