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TMCNet:  TEMPUR SEALY INTERNATIONAL, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[February 21, 2014]

TEMPUR SEALY INTERNATIONAL, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis should be read in conjunction with ITEM 6 under Part II of this Report and the audited consolidated financial statements and accompanying notes thereto included elsewhere in this Report. Unless otherwise noted, all of the financial information in this Report is consolidated financial information for the Company. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, liquidity and capital resources and other non-historical statements in this discussion are subject to numerous risks and uncertainties. See "Special Note Regarding Forward-Looking Statements" and ITEM 1A under Part I of this Report. Our actual results may differ materially from those contained in any forward-looking statements.


In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the years ended December 31, 2013, 2012 and 2011, including the following topics: • an overview of our business, including the acquisition of Sealy Corporation and its subsidiaries ("Sealy") that closed on March 18, 2013; • the effect of the foregoing on our overall financial performance and condition; • our net sales and costs in the periods presented as well as changes between periods; and • expected sources of liquidity for future operations.

Business Overview General We are the world's largest bedding provider. We develop, manufacture, market, and distribute bedding products, which we sell globally. Our brand portfolio includes many of the most highly recognized brands in the industry, including TEMPUR®, Tempur-Pedic®, Sealy®, Sealy Posturepedic®, Optimum™, and Stearns & Foster®. Our comprehensive suite of bedding products offers a variety of products to consumers across a broad range of channels.

We sell our products through three distribution channels in each operating business segment: Retail (furniture and bedding retailers, department stores, specialty retailers and warehouse clubs); Direct (e-commerce platforms, company-owned stores, and call centers); and Other (third party distributors, hospitality and healthcare customers).

Business Segments We have three reportable business segments: Tempur North America, Tempur International, and Sealy. These reportable segments are strategic business units that are managed separately based on the fundamental differences in their operations. Our Tempur North America segment consists of two U.S. manufacturing facilities and our Tempur North America distribution subsidiaries. Our Tempur International segment consists of our manufacturing facility in Denmark, whose customers include all of our distribution subsidiaries and third party distributors outside our Tempur North America and Sealy segments. Our Sealy segment consists of company-owned and operated bedding and component manufacturing facilities located around the world, along with distribution subsidiaries, joint ventures, and licensees. We evaluate segment performance based on net sales and operating income.

Strategy We are the world's largest bedding provider and the only provider with global scale. We believe our future growth potential is significant in our existing markets and through expansion into new markets. In order to achieve our long-term growth potential while managing the current economic and competitive environment, we will focus on the key strategic growth initiatives discussed below: Product Innovation We will continue to invest in research and development to leverage the combined technologies of our comprehensive portfolio of products to deliver a stream of innovative products. Our goal is to provide consumers the best bed and best sleep of their life and to provide our retailers a complete and optimal offering across brands, products, and prices to drive growth. We will also pursue opportunities to enter or develop new product categories.

30-------------------------------------------------------------------------------- Table of Contents Marketing We will increase our investment in advertising to increase consumer awareness, preference and loyalty for each of our key brands. We will also invest in in-store marketing and direct sales to maximize our sales opportunity driven from national brand and retailer advertising.

New Market Expansion We will pursue opportunities to expand into new international markets and over time into non-consolidated markets where our brands are currently represented under licensee, joint venture or third party distributor agreements.

Supply Chain ("Easier To Do Business With") We are committed to building a world-class supply chain that is "easier to do business with." Our goal is to improve efficiencies related to purchasing and delivery, as well as inventory management to drive sales growth.

Our strategic growth initiatives will be supported by cost synergies realized from the acquisition of Sealy as well as through our ongoing cost productivity initiatives.

Factors That Could Impact Results of Operations The factors outlined below could impact our future results of operations. For more extensive discussion of these and other risk factors, please refer to "Risk Factors", under Part I, ITEM1A in this Report.

General Business and Economic Conditions Our business has been affected by general business and economic conditions, and these conditions could have an impact on future demand for our products. The global economic environment continues to be challenging, and we expect the uncertainty to continue. In light of the macroeconomic environment, we continue to take steps to further align our cost structure with our anticipated level of net sales. We continued to make strategic investments, including: introducing new products; investing in increasing our global brand awareness; extending our presence and improving our Retail account productivity and distribution; investing in our operating infrastructure to meet the requirements of our business; and taking actions to further strengthen our business.

Competition Participants in the bedding industry compete primarily on price, quality, brand name recognition, product availability, and product performance. We compete with a number of different types of mattress alternatives, including standard innerspring mattresses, viscoelastic mattresses, foam mattresses, hybrid innerspring/foam mattresses, futons, air beds and other air-supported mattresses. These alternative products are sold through a variety of channels, including furniture and bedding stores, department stores, mass merchants, wholesale clubs, Internet, telemarketing programs, television infomercials, television advertising and catalogs.

Our Tempur North America segment competes in the non-innerspring mattress category and contributes 36.9% of our net sales. Beginning in the second half of 2012, a significant number of new non-innerspring mattress products were introduced in this category and changed the competitive environment of the U.S.

bedding industry. Many of these new non-innerspring mattress products have been supported by aggressive marketing campaigns and promotions. As a result of this change, our results have been negatively impacted and we modified our business strategy to compete and expand our market share. Our results could continue to be challenged.

31-------------------------------------------------------------------------------- Table of Contents Financial Leverage As of December 31, 2013, we had $1,836.5 million of debt outstanding, and our stockholders' equity was $114.0 million. Higher financial leverage makes us more vulnerable to general adverse competitive, economic and industry conditions.

There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowing will be available. As of December 31, 2013, our ratio of funded debt less qualified cash to EBITDA was 4.4 times, within the covenant in our debt agreements which limits this ratio to 5.25 times for the year ended December 31, 2013. For more information on this non-GAAP measure, please refer to the section set forth below "Non-GAAP Financial Measures".

Sealy Integration Our Sealy Acquisition is significant, and we may not be able to successfully integrate and combine the operations, personnel and technology of Sealy with our operations. Because of the size and complexity of Sealy's business, if we do not successfully manage integration, we may experience interruptions in our business activities, a deterioration in our employee and customer relationships, increased costs of integration and harm to our reputation, all of which could have a material adverse effect on our business, financial condition and results of operations. We may also experience difficulties in combining corporate cultures, maintaining employee morale and retaining key employees. The integration may also impose substantial demands on our management. There is no assurance that improved operating results will be achieved as a result of the Sealy Acquisition or that the businesses of Sealy and Tempur-Pedic will be successfully integrated in a timely manner.

Gross Margins Our gross margin is primarily impacted by the relative amount of net sales between our business segments. The Sealy segment operates at a significantly lower gross margin than the Tempur North America and Tempur International segments. If Sealy's net sales increase as a percentage of net sales, our gross margin will be negatively impacted. Additionally, our Tempur North America gross margin has historically been lower than that of our Tempur International segment. Our gross margin is also impacted by fixed cost leverage; the cost of raw materials; operational efficiency; product, channel and geographic mix; volume incentives offered to certain retail accounts; and costs associated with new product introductions. Future increases in raw material prices could have a negative impact on our gross margin if we do not raise prices to cover increased cost.

Our gross margin can also be impacted by our operational efficiencies, including the particular levels of utilization in our manufacturing facilities. If we increase our net sales significantly the effect of this operating leverage could have a significant positive impact on our gross margin. Conversely, if we experience significant decreases in our net sales, the effect of this operating deleverage could have a significant negative impact on our gross margin. Our margins are also impacted by the growth in our Retail channel as sales in our Retail channel are at wholesale prices whereas sales in our Direct channel are at retail prices.

In 2014, we expect gross margin to benefit from cost synergies and leverage, offset by investments in new products and foreign exchange. Floor model shipments will be elevated in the first half of 2014 as we complete our new product roll-outs. However, we expect floor model shipments will be much lower in the second half of 2014. Foreign exchange is also expected to negatively impact gross margin due to our Canadian subsidiaries where a significant portion of their material costs are denominated in U.S. dollars.

New Product Development and Introduction Each year we invest significant time and resources in research and development to improve our respective product offerings. There are a number of risks inherent in our new product line introductions, including the anticipated level of market acceptance may not be realized, which could negatively impact our sales. Also, introduction costs, the speed of the rollout of the product and manufacturing inefficiencies may be greater than anticipated, which could impact profitability.

Exchange Rates As a multinational company, we conduct our business in a wide variety of currencies and are therefore subject to market risk for changes in foreign exchange rates. We use foreign exchange forward contracts to manage a portion of the risk of the eventual net cash inflows and outflows resulting from foreign currency denominated transactions between our subsidiaries and their customers and suppliers, as well as between our subsidiaries themselves. These hedging transactions may not succeed in effectively managing our foreign currency exchange rate risk.

32-------------------------------------------------------------------------------- Table of Contents Sealy Acquisition On March 18, 2013, we completed the Sealy Acquisition. Refer to Note 2, "Business Combination", in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for a discussion of the Sealy Acquisition.

Pursuant to the merger agreement, each share of common stock of Sealy issued and outstanding immediately prior to the effective time of the Sealy Acquisition was cancelled and (other than shares held by Sealy or Tempur-Pedic or their subsidiaries or Sealy stockholders who properly exercised their appraisal rights) converted into the right to receive $2.20 in cash. The total purchase price was $1,172.9 million, which was funded using available cash and financing consisting of our 2012 Credit Agreement and Senior Notes. Refer to Note 5, "Debt", in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for the definition of these terms and further discussion. The purchase price of Sealy, including debt assumed, consisted of the following items: (in millions) Cash consideration for stock $ 231.2 (1) Cash consideration for share-based awards 14.2 (2) Cash consideration for 8.0% Sealy Notes 442.1 (3) Cash consideration for repayment of Sealy Senior Notes 260.7 (4) Cash consideration for repayment of Sealy 2014 Notes 276.9 (5) Total consideration 1,225.1 Cash acquired (52.2 ) (6) Net consideration transferred $ 1,172.9 (1) The cash consideration for outstanding shares of Sealy common stock is the product of the agreed-upon cash per share price of $2.20 and total Sealy shares of 105.1 million.

(2) The cash consideration for share-based awards is the product of the agreed-upon cash per share price of $2.20 and the total number of restricted stock units ("RSUs") and deferred stock units ("DSUs") outstanding and the "in the money" stock options net of the weighted average exercise price.

(3) The cash consideration for 8.0% Sealy Notes is the result of applying the adjusted equity conversion rate to the 8.0% Sealy Notes tendered for conversion and multiplying the result by the agreed-upon cash per share price of $2.20. The 8.0% Sealy Notes that were converted represented the right to receive the same merger consideration that would have been payable to a holder of 201.0 million shares of Sealy common stock, subject to adjustment in accordance with the terms of the supplemental indenture governing the 8.0% Sealy Notes.

(4) The cash consideration for Sealy's 10.875% Senior Notes due 2016 ("Sealy Senior Notes") reflects the repayment of the outstanding obligation.

(5) The cash consideration for Sealy's 8.25% Senior Subordinated Notes due 2014 ("Sealy 2014 Notes") reflects the repayment of the outstanding obligation.

(6) Represents the Sealy cash balance acquired at acquisition.

Our Sealy segment manufactures and markets a complete line of bedding products under the Sealy®, Sealy Posturepedic®, Optimum™, and Stearns & Foster® brands.

Sealy's results of operations are reported within our Sealy reportable segment.

The combination brings together two highly complementary companies with iconic brands and significant opportunities for global innovation and growth. We will have products for almost every consumer preference and price point, distribution through all key channels, in-house expertise on most key bedding technologies, and a world-class research and development team.

33-------------------------------------------------------------------------------- Table of Contents Results of Operations A summary of our results for the year ended December 31, 2013 include: • Earnings per diluted common share ("EPS") were $1.28 for the full year 2013 compared to $1.70 per diluted share for the full year 2012. The 2013 results include Sealy results for the post-acquisition period from March 18, 2013 to December 31, 2013 and also reflect transaction and integration costs related to the Sealy Acquisition, interest and fees related to our refinancing of our Term A Facility and Term B loans under our senior secured credit facility, as well as tax provision adjustments related to the repatriation of foreign earnings utilized in connection with the Sealy Acquisition. 2012 EPS reflects the tax expense recorded in connection with the anticipated repatriation of foreign earnings together with certain transaction and integration costs related to the Sealy Acquisition, and other restructuring costs.

• Adjusted EPS were $2.38 for the full year 2013 compared to adjusted EPS $2.61 for the full year 2012. For a discussion and reconciliation of EPS to adjusted EPS, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information".

• Net income for the full year 2013 was $78.6 million as compared to net income of $106.8 million for the full year 2012. Adjusted net income was $146.4 million for the full year 2013 as compared to adjusted net income of $164.1 million for the full year 2012. For a discussion and reconciliation of net income to adjusted net income, refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information".

• Net sales increased 75.7% to $2,464.3 million for the full year 2013 compared to $1,402.9 million for the full year 2012. The net sales increase was due to the inclusion of $1,114.7 million of Sealy net sales for the post-acquisition period from March 18, 2013 to December 31, 2013.

• Gross margin was 41.2% for the full year 2013 compared to 50.9% for the full year 2012. The gross margin decreased primarily as a result of the inclusion of Sealy, which has lower margins than the Tempur North America and Tempur International segments, and changes in product mix, offset partially by lower sourcing costs.

• Operating income was $243.8 million for the full year 2013 as compared to $248.3 million for the full year 2012. Operating income for the full year 2013 included $44.6 million of transaction and integration costs related to the Sealy Acquisition. Excluding these costs, the higher operating income reflects the inclusion of Sealy.

34-------------------------------------------------------------------------------- Table of Contents The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales: Year Ended December 31, (in millions, except per common share amounts) 2013 2012 2011 Net sales $ 2,464.3 100.0 % $ 1,402.9 100.0 % $ 1,417.9 100.0 % Cost of sales 1,449.4 58.8 688.3 49.1 674.8 47.6 Gross profit 1,014.9 41.2 714.6 50.9 743.1 52.4 Selling and marketing expenses 522.9 21.2 319.1 22.7 276.9 19.5 General, administrative and other 266.3 10.8 147.2 10.5 125.7 8.9 Equity income in earnings of unconsolidated affiliates (4.4 ) (0.2 ) - - - - Royalty income, net of royalty expense (13.7 ) (0.6 ) - - - - Operating income 243.8 10.0 248.3 17.7 340.5 24.0 Other expense, net: Interest expense, net 110.8 4.5 18.8 1.3 11.9 0.8 Other expense, net 5.0 0.2 0.3 - 0.2 - Total other expense 115.8 4.7 19.1 1.3 12.1 0.8 Income before income taxes 128.0 5.3 229.2 16.4 328.4 23.2 Income tax provision (49.1 ) (2.0 ) (122.4 ) (8.7 ) (108.8 ) (7.7 ) Net income before non-controlling interest 78.9 3.3 106.8 7.7 219.6 15.5 Less: Net income attributable to non-controlling interest 0.3 - - - - - Net income attributable to Tempur Sealy International, Inc. $ 78.6 3.3 % $ 106.8 7.7 % $ 219.6 15.5 % Earnings per common share: Diluted $ 1.28 $ 1.70 $ 3.18 Weighted average common shares outstanding: Diluted 61.6 62.9 69.1 35-------------------------------------------------------------------------------- Table of Contents CONSOLIDATED SUMMARY Net sales and gross profit Percentage Percentage(in millions, except change 2013 change 2012 percentages) 2013 2012 2011 vs. 2012 vs. 2011 Net sales $ 2,464.3 $ 1,402.9 $ 1,417.9 75.7 % (1.1 )% Net sales by segment: Tempur North America 910.0 964.3 1,004.7 (5.6 )% (4.0 )% Tempur International 439.6 438.6 413.2 0.2 % 6.1 % Sealy 1,114.7 - - - % - % Gross profit 1,014.9 714.6 743.1 42.0 % (3.8 )% Gross margin 41.2 % 50.9 % 52.4 % (9.7 )% (1.5 )% Year ended December 31, 2013 compared to year ended December 31, 2012 36-------------------------------------------------------------------------------- Table of Contents Net sales increased $1,061.4 million, or 75.7%. The increase was due to the inclusion of Sealy's net sales of $1,114.7 million for the post-acquisition period from March 18, 2013 to December 31, 2013. The increase in net sales was partially offset by decreases in our Tempur North America segment in bedding net sales, driven by decreases in our Retail and Direct channels.

Gross profit increased $300.3 million, or 42.0%. Gross margin decreased 9.7%.

The increase in gross profit was due to the inclusion of Sealy's gross profit of $352.4 million at a gross margin of 31.6% for the post-acquisition period from March 18, 2013 through December 31, 2013. Sealy's gross profit also included an incremental cost of $7.7 million associated with the revaluation of finished goods inventory related to the purchase price allocation of the Sealy Acquisition. The increase in gross profit was also offset by Tempur North America's gross profit decrease of $56.6 million and gross margin decline of 3.4%. Our gross margin was impacted by the relative amount of net sales between our business segments. The Sealy segment operates at a lower gross margin than the Tempur North America and Tempur International segments. Our gross margin has been negatively impacted as Sealy's net sales have increased as a percentage of our consolidated net sales. Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in this process. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.

Year ended December 31, 2012 compared to year ended December 31, 2011 Net sales decreased $15.0 million, or 1.1%. The decrease was due to a $40.4 million decrease in Tempur North America's net sales, which was partially offset by a $25.4 million increase in Tempur International's net sales. Tempur North America's net sales decline was attributed to increased competition in the non-innerspring mattress category and led to several initiatives designed to stabilize Tempur North America's net sales. Tempur International net sales increased primarily in the Retail channel as a result of expanding points of distribution and investments in our brand awareness.

Gross profit decreased $28.5 million, or 3.8%. Gross margin decreased 1.5%.

Tempur North America's gross profit decreased $50.5 million and gross margin declined 3.1%. Tempur International's gross profit increased $22.0 million and gross margin increased 1.6%. Our gross margin was impacted by the relative amount of net sales between our business segments. Historically, our Tempur North America gross margin has been lower than that of our Tempur International segment, due in part to the royalty paid by the Tempur North America segment.

This intercompany royalty expense was $12.7 million and $12.3 million for the years ended 2012 and 2011, respectively. Costs associated with net sales are recorded in cost of sales and include the costs of producing, shipping, warehousing, receiving and inspecting goods during the period, as well as depreciation and amortization of long-lived assets used in this process. The principal factors impacting gross profit and gross margin for each segment are discussed below in the respective segment discussions.

OPERATING EXPENSESSelling and Marketing Expenses Percentage (in millions, except change 2013 vs. Percentage change percentages) 2013 2012 2011 2012 2012 vs. 2011 Total selling and marketing $ 522.9 $ 319.1 $ 276.9 63.9 % 15.2 % As a percent of net sales 21.2 % 22.7 % 19.5 % (1.5 )% 3.2 % Advertising expenses 274.2 164.5 148.8 66.7 % 10.6 % As a percent of net sales 11.1 % 11.7 % 10.5 % (0.6 )% 1.2 % Selling and marketing other 248.7 154.6 128.1 60.9 % 20.7 % As a percent of net sales 10.1 % 11.0 % 9.0 % (0.9 )% 2.0 % Selling and marketing expenses include advertising and media production associated with our Direct channel, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials, and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing.

37-------------------------------------------------------------------------------- Table of Contents Year ended December 31, 2013 compared to year ended December 31, 2012 Selling and marketing expenses increased $203.8 million, or 63.9%, and decreased 1.5% as a percentage of net sales. Our advertising expenses increased $109.7 million, or 66.7%, and remained relatively flat as a percentage of net sales.

Sealy's selling and marketing expenses were $204.5 million, including advertising expenses of $124.8 million, for the post-acquisition period from March 18, 2013 through December 31, 2013. The increase due to Sealy was offset by decreased advertising expenses in our Tempur North America and Tempur International segments. During the first half of 2013, we reduced our Tempur North America advertising expense to align with Tempur North America's lower net sales. Throughout the second half of 2013 we increased Tempur North America advertising expenses and reintroduced the "Ask Me" campaign as part of our strategic initiatives.

All other selling and marketing expenses increased $94.1 million, or 60.9%, and decreased 0.9% as a percentage of net sales. Sealy's other selling and marketing expenses was $79.6 million for the post-acquisition period from March 18, 2013 through December 31, 2013. In the current year, we also incurred $3.4 million of other selling and marketing expenses related to the integration of Sealy. The additional increase was due to costs associated with the growth in Tempur International company-owned stores and e-commerce.

Year ended December 31, 2012 compared to year ended December 31, 2011 Selling and marketing expenses increased $42.2 million, or 15.2%, and increased 3.2% as a percentage of net sales. Our advertising expenses increased $15.7 million, or 10.6%, and increased 1.2% as a percentage of net sales. During 2012, consistent with our strategy to align advertising expenses with net sales, we made additional investments in advertising to increase brand awareness to drive future growth in certain key Tempur North America and Tempur International markets.

All other selling and marketing expenses increased $26.5 million, or 20.7%, and increased 2.0% as a percentage of net sales. The increase was due to increases in promotional related expenses of $11.8 million, costs associated with opening additional company-owned stores of $5.0 million, salaries and associated expense of $4.5 million related to additional headcount, and $1.1 million of restructuring charges related to severance. This was offset by a benefit recorded for our performance restricted share units ("PRSUs") of $2.3 million following our re-evaluation of the probability of meeting certain required financial metrics related to the grants.

General, Administrative and Other Expenses (in millions, except Percentage change Percentage change percentages) 2013 2012 2011 2013 vs. 2012 2012 vs. 2011 General, administrative and other expenses $ 266.3 $ 147.2 $ 125.7 80.9 % 17.1 % As a percent of net sales 10.8 % 10.5 % 8.9 % 0.3 % 1.6 % General, administrative and other expenses include salaries and related expenses, information technology, professional fees, depreciation of buildings, furniture and fixtures, machinery, leasehold improvements and computer equipment, expenses for administrative functions and research and development costs.

Year ended December 31, 2013 compared to year ended December 31, 2012 General, administrative and other expenses increased $119.1 million, or 80.9%.

The increase was primarily due to the inclusion of Sealy's $97.3 million of general, administrative and other expenses for the post-acquisition period from March 18, 2013 through December 31, 2013. We also recorded additional expenses of $10.8 million in professional fees related to the Sealy Acquisition and integration of the business. Additionally, salaries and related expenses increased $14.5 million, with the majority of the increase driven by increased stock-based compensation expense. In 2012, we recorded a benefit of $8.0 million for the PRSUs granted in 2011 and 2012 following the re-evaluation of the probability of meeting certain required financial metrics related to the grants.

Research and development expenses for 2013 were $21.0 million compared to $15.6 million for 2012, an increase of $5.4 million, or 34.6%. We plan to continue to invest in research and development to leverage the combined technologies of our portfolio to deliver innovative products.

38-------------------------------------------------------------------------------- Table of Contents Year ended December 31, 2012 compared to year ended December 31, 2011 General, administrative and other expenses increased $21.5 million, or 17.1%.

The increase was primarily a result of increased legal and professional fees of $16.1 million, driven by transaction costs related to the Sealy Acquisition of $8.9 million and integration costs of $2.2 million, along with an increase of $5.0 million related to increased litigation costs and strategic initiatives.

During 2012, we also incurred an additional $5.2 million related to incremental investments in information technology and associated depreciation expense. Also, in 2011, we recorded a benefit for favorable settlements of indirect taxes with certain regulatory authorities of $3.5 million that did not recur in 2012. These increases were offset by an $8.0 million benefit recorded for PRSUs following our re-evaluation of the probability of meeting certain required financial metrics related to the grants. We expect general, administrative and other expenses to continue to be impacted by transaction and integration costs related to the proposed Sealy Acquisition.

Research and development expenses for 2012 were $15.6 million compared to $9.9 million for 2011, an increase of $5.7 million, or 57.6%.

OPERATING INCOME (in millions, Percentage Percentage except change 2013 vs. change 2012 percentages) 2013 2012 2011 2012 vs. 2011 Operating income $ 243.8 $ 248.3 $ 340.5 (1.8 )% (27.1 )% Operating margin 9.9 % 17.7 % 24.0 % (7.8 )% (6.3 )% Year ended December 31, 2013 compared to year ended December 31, 2012 Operating income decreased $4.5 million, or 1.8%, and was primarily impacted by the factors discussed above. During the full year 2013, we also recorded royalty income, net of royalty expense, of $13.7 million and equity income in earnings of unconsolidated affiliates of $4.4 million. Our royalty income is based on sales of Sealy® and Stearns & Foster® branded products by various licensees and is offset by royalty expenses we pay to other entities for the use of their names on our Sealy branded products. Our equity income in earnings of unconsolidated affiliates represents our 50.0% interest in the earnings of our Asia-Pacific joint ventures whose purpose is to develop markets for Sealy branded products.

During the full year 2013, we incurred $18.7 million of transaction expenses and $25.9 million of integration expenses in connection with the Sealy Acquisition. During the full year 2012, we incurred $8.9 million of transaction expenses and $3.7 million of integration expenses in connection with the Sealy Acquisition.

Year ended December 31, 2012 compared to year ended December 31, 2011 Operating income decreased $92.2 million, or 27.1%, and was primarily impacted by the factors discussed above.

INTEREST EXPENSE, NET (in millions, except Percentage change Percentage change percentages) 2013 2012 2011 2013 vs. 2012 2012 vs. 2011 Interest expense, net $ 110.8 $ 18.8 $ 11.9 489.4 % 58.0 % Year ended December 31, 2013 compared to the year ended December 31, 2012 Interest expense, net, increased $92.0 million, or 489.4%. In 2013, we incurred $19.9 million of incremental interest expense and fees on the Senior Notes and 2012 Credit Agreement for the period prior to March 18, 2013, commitment fees associated with financing for the closing of the Sealy Acquisition, and write off of deferred financing costs associated with the 2011 Credit Facility. In addition, we incurred $8.7 million in prepayment fees related to the refinancing of our Term B Facility in the second quarter of 2013. The remaining increase was due to higher debt levels as a result of the Sealy Acquisition.

39-------------------------------------------------------------------------------- Table of Contents Year ended December 31, 2012 compared to the year ended December 31, 2011 Interest expense, net, increased $6.9 million, or 58.0%. The increase in interest expense was primarily attributable to an increase in our debt outstanding as of December 31, 2012 compared to our debt outstanding as of December 31, 2011 and an increase in our effective interest rate. Our debt levels increased in anticipation of the Sealy Acquisition, which occurred on March 18, 2013.

INCOME BEFORE INCOME TAXES (in millions, Percentage Percentage except change 2013 change 2012 percentages) 2013 2012 2011 vs. 2012 vs. 2011 Income before income taxes $ 128.0 $ 229.2 $ 328.4 (44.2 )% (30.2 )% Year ended December 31, 2013 compared to year ended December 31, 2012 Income before income taxes decreased $101.2 million, or 44.2%. This decrease was a result of the factors discussed above.

Year ended December 31, 2012 compared to year ended December 31, 2011 Income before income taxes decreased $99.2 million, or 30.2%. This decrease was a result of the factors discussed above.

INCOME TAXES (in millions, Percentage except change 2013 Percentage change percentages) 2013 2012 2011 vs. 2012 2012 vs. 2011 Income tax $ 49.1 $ 122.4 $ 108.8 (59.9 )% 12.5 % Effective tax rate 38.4 % 53.4 % 33.1 % (15.0 )% 20.3 % Income tax provision includes income taxes associated with taxes currently payable and deferred taxes, and includes the impact of net operating losses for certain of our foreign operations.

Year ended December 31, 2013 compared to year ended December 31, 2012 Our income tax provision decreased $73.3 million and our effective tax rate decreased 15.0%. During 2012, we recorded $48.1 million of additional income tax expense related to our undistributed earnings from non-U.S. operations, which increased our effective tax rate by 21.0%. This was recorded as deferred income tax expense in 2012 and a deferred tax liability at December 31, 2012. During 2013, we undertook a taxable transaction in which we recognized current taxable income based on the earnings of certain of our foreign subsidiaries. The resulting income tax payable was approximately $51.7 million. Consequently, we reclassified the $48.1 million deferred tax liability recorded at December 31, 2012 to current tax payable at December 31, 2013 and recognized an incremental $3.6 million current income tax expense in 2013.

Year ended December 31, 2012 compared to year ended December 31, 2011 Our income tax provision increased $13.6 million and our effective tax rate increased 20.3%.We had made no historical provision for U.S. federal and/or state income tax and foreign withholdings on our undistributed earnings from non-U.S. operations because we intended to reinvest such earnings indefinitely outside of the United States. During 2012, we changed the classification of our undistributed earnings to reflect a change in management's strategic objectives that could require the repatriation of foreign earnings. As a result of this change, we recognized $48.1 million of additional income tax expense in 2012 to record the applicable U.S. deferred income tax liability. We repatriated non-U.S. cash holdings upon the closing of the proposed Sealy Acquisition.

40-------------------------------------------------------------------------------- Table of Contents TEMPUR NORTH AMERICA SEGMENT SUMMARY (in millions, Percentage Percentage except change 2013 change 2012 percentages) 2013 2012 2011 vs. 2012 vs. 2011 Net sales $ 910.0 $ 964.3 $ 1,004.7 (5.6 )% (4.0 )% Net sales by channel: Retail 845.6 876.5 917.6 (3.5 )% (4.5 )% Direct 49.2 76.2 76.0 (35.4 )% 0.3 % Other 15.2 11.6 11.1 31.0 % 4.5 % Net sales by product: Bedding 830.4 882.3 916.7 (5.9 )% (3.8 )% Other products 79.6 82.0 88.0 (2.9 )% (6.8 )% Gross profit 392.7 449.2 499.8 (12.6 )% (10.1 )% Gross margin 43.2 % 46.6 % 49.7 % (3.4 )% (3.1 )% Operating income 67.6 144.4 236.9 (53.2 )% (39.0 )% Operating Margin 7.4 % 15.0 % 23.6 % (7.6 )% (8.6 )% Year ended December 31, 2013 compared to year ended December 31, 2012 Tempur North America net sales decreased $54.3 million, or 5.6%. The decline was driven by a decrease in bedding net sales of $51.9 million, or 5.9%. Retail channel net sales decreased $30.9 million, or 3.5%. Direct channel net sales also decreased $27.0 million, or 35.4%. During the first half of 2013, Tempur North America decreased advertising expenses to better align with lower net sales. We believe this reduction in advertising had a negative impact on the Retail and Direct channel net sales. Retail net sales decreased in the first half of 2013 as compared to the prior year due to continued competition and decreased advertising spend, but Retail net sales stabilized in the second half of 2013 as we implemented additional strategic initiatives and increased our investments in advertising. The Direct channel performance also declined throughout 2013 due to lower direct to consumer advertising.

Operating income decreased $76.8 million, or 53.2%, and was primarily impacted by the following factors: • Gross profit decreased $56.6 million, or 12.6%. Gross margin decreased 3.4%. The decrease in gross margin was due to a 5.3% unfavorable product mix, which includes the impact of initiatives implemented to drive net sales growth. Unfavorable product mix was partially offset by a 2.2% increase as a result of lower sourcing costs and improved supply chain and manufacturing efficiencies.

• Operating expenses were $325.1 million for the full year 2013, as compared to $304.8 million for the full year 2012, and increased 4.2% as a percentage of net sales due to increased selling and marketing activities, as well as professional fees and stock-based compensation expense incurred following the Sealy Acquisition.

41-------------------------------------------------------------------------------- Table of Contents Year ended December 31, 2012 compared to year ended December 31, 2011 Tempur North America net sales decreased $40.4 million, or 4.0%. The decline was driven by a decrease in bedding net sales of $34.4 million, or 3.8%. Retail channel net sales decreased $41.1 million, or 4.5%. Direct channel net sales remained flat. The net sales decline was attributed to increased competition in the non-innerspring mattress category and led to several initiatives designed to stabilize Tempur North America's net sales. To drive growth in our Tempur North America segment, we implemented various strategic initiatives, which included new product introductions, wholesale mattress price reductions, extension of our mattress warranty to 25 years, and various other initiatives to realign dealer incentives. These initiatives were implemented during the second half of 2012.

Operating income decreased $92.5 million, or 39.0%, and was primarily impacted by the following factors: • Gross profit decreased $50.5 million, or 10.1%. Gross margin decreased 3.1%. The decrease in gross margin was due to a 1.7% decrease related to additional promotions and discounts and new product introductions, a 1.4% decrease related to unfavorable product mix and a 0.5% decrease due to fixed cost de-leverage related to lower production volumes. These decreases were partially offset by a 0.5% increase related to sourcing costs.

• Operating expenses were $304.8 million for the full year 2012, as compared to $262.9 million for the full year 2011, and increased 5.5% as a percentage of net sales. During 2012, we made additional investments in advertising to increase brand awareness to drive growth in certain key Tempur North America markets. In addition, operating expenses increased as a result of transaction costs incurred for the Sealy Acquisition.

42-------------------------------------------------------------------------------- Table of Contents TEMPUR INTERNATIONAL SEGMENT SUMMARY (in millions, Percentage Percentage except change 2013 vs. change 2012 percentages) 2013 2012 2011 2012 vs. 2011 Net sales $ 439.6 $ 438.6 $ 413.2 0.2 % 6.1 % Net sales by channel: Retail 344.3 351.5 328.0 (2.0 )% 7.2 % Direct 49.5 37.0 24.1 33.8 % 53.5 % Other 45.8 50.1 61.1 (8.6 )% (18.0 )% Net sales by product: Bedding 327.7 332.4 309.8 (1.4 )% 7.3 % Other products 111.9 106.2 103.4 5.4 % 2.7 % Gross profit 269.8 265.2 243.3 1.7 % 9.0 % Gross margin 61.4 % 60.5 % 58.9 % 0.9 % 1.6 % Operating income 107.5 103.9 103.6 3.5 % 0.3 % Operating margin 24.5 % 23.7 % 25.1 % 0.8 % (1.4 )% Year ended December 31, 2013 compared to year ended December 31, 2012 Tempur International net sales remained flat. On a constant currency basis (1), our Tempur International net sales increased approximately 1.0%. Retail channel net sales decreased $7.2 million, or 2.0%, primarily due to macroeconomic pressure in Europe which was partially offset by growth in our Asia-Pacific and Latin American businesses. Direct channel net sales increased $12.5 million, or 33.8%, due to expanding our points of distribution through an increase in the number of company-owned stores and e-commerce.

Operating income increased $3.6 million, or 3.5%, and was primarily impacted by the following factors: • Gross profit increased $4.6 million, or 1.7%. Gross margin increased 0.9%.

The increase in gross margin was due to a 1.8% increase related to favorable product mix and a 0.9% decrease related to floor model discounts for new product introductions.

• Operating expenses were $162.3 million for the full year 2013 and $161.3 million for the full year 2012, remaining flat as a percentage of net sales.

(1) The references to "constant currency basis" in this Management Discussion & Analysis do not include operational impacts that could result from fluctuations in foreign currency rates. Certain financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior year period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Refer to ITEM 7A under Part II of this Report.

43-------------------------------------------------------------------------------- Table of Contents Year ended December 31, 2012 compared to year ended December 31, 2011 Tempur International net sales increased $25.4 million, or 6.1%. On a constant currency basis (1), our Tempur International net sales increased approximately 11.3%. Retail channel net sales increased $23.5 million, or 7.2%, primarily due to expanding points of distribution and investments in our brand awareness. As a result, bedding net sales increased $22.6 million, or 7.3%.

Operating income increased $0.3 million, or 0.3%, and was primarily impacted by the following factors: • Gross profit increased $21.9 million, or 9.0%. Gross margin increased 1.6%. The increase in gross margin was due to a 1.3% increase driven by efficiencies in manufacturing and fixed cost leverage related to higher production volumes, as well as a 0.3% increase driven by costs associated with an information technology upgrade at our manufacturing facility in Denmark during 2011 that did not recur in 2012.

• Operating expenses were $161.3 million for the full year 2012, as compared to $139.7 million for the full year 2011, and increased 3.0% as a percentage of net sales. During 2012, we made additional investments in advertising to increase brand awareness to drive growth in certain key Tempur International markets.

(1) The references to "constant currency basis" in this Management Discussion & Analysis do not include operational impacts that could result from fluctuations in foreign currency rates. Certain financial results are adjusted based on a simple mathematical model that translates current period results in local currency using the comparable prior year period's currency conversion rate. This approach is used for countries where the functional currency is the local country currency. This information is provided so that certain financial results can be viewed without the impact of fluctuations in foreign currency rates, thereby facilitating period-to-period comparisons of business performance. Refer to ITEM 7A under Part II of this Report.

SEALY SEGMENT SUMMARY (in millions, Percentage Percentage except change 2013 vs. change 2012 vs.

percentages) 2013 2012 2011 2012 2011 Net sales $ 1,114.7 $ - $ - - % - % Net sales by channel: Retail 1,041.4 - - - % - % Direct 20.5 - - - % - % Other 52.8 - - - % - % Net sales by product: Bedding 1,040.3 - - - % - % Other products 74.4 - - - % - % Gross profit 352.4 - - - % - % Gross margin 31.6 % - % - % - % - % Operating income 68.7 - - - % - % Operating margin 6.2 % - % - % - % - % Sealy's results are only presented for the post-acquisition period from March 18, 2013 to December 31, 2013.

44-------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources Liquidity Our principal sources of funds are cash flows from operations, borrowings made pursuant to our credit facilities and cash and cash equivalents on hand.

Principal uses of funds consist of payments of principal and interest on our debt facilities, business combinations, capital expenditures and working capital needs. At December 31, 2013, we had working capital of $286.0 million, including cash and cash equivalents of $81.0 million as compared to working capital of $611.9 million including $179.3 million in cash and cash equivalents as of December 31, 2012. Working capital as of December 31, 2012 included a $375.0 million receivable from escrow account that was funded with the issuance of proceeds of the Senior Notes. This escrow was released at the closing of the Sealy Acquisition and was used to fund a portion of the purchase price cash consideration. This decrease was primarily offset by the assumption of working capital due to the Sealy Acquisition.

The table below presents net cash provided by (used in) operating, investing and financing activities for the full years 2013, 2012 and 2011.

(in millions) 2013 2012 2011 Net cash provided by (used in): Operating activities $ 98.5 $ 189.9 $ 248.7 Investing activities (1,213.0 ) (55.0 ) (36.1 ) Financing activities 1,013.4 (70.8 ) (148.9 ) Cash provided by operating activities decreased $91.4 million to $98.5 million for the year ended December 31, 2013, as compared to $189.9 million for the same period in 2012. The decrease in cash provided by operating activities was due to a decrease in net income of $27.9 million, which was primarily impacted in 2013 by transaction, integration and other expenses related to the Sealy Acquisition and partially offset by Sealy net income. Our cash flow provided by operating activities was also impacted by decreases due to income tax payments associated with the repatriation of cash of our non-U.S. subsidiaries resulting from the Sealy Acquisition and other working capital changes during the year ended December 31, 2013. Inventories used cash primarily due to new product launches scheduled for 2014 in our Tempur North America and Sealy segments, which was offset by cash provided from accounts payable. Prepaid expenses and other current assets provided cash due primarily to the return of prepaid interest associated with our Senior Notes. Accounts receivable used cash due primarily to timing of payments from our customers.

Cash used by investing activities increased to $1,213.0 million for the year ended December 31, 2013 as compared to $55.0 million for the year ended December 31, 2012, an increase of $1,158.0 million. This increase is due to the Sealy Acquisition. Refer to Note 2, "Business Combination", in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of the Sealy Acquisition.

Cash provided by financing activities was $1,013.4 million for the year ended December 31, 2013 as compared to $70.8 million for the year ended December 31, 2012. This increase is primarily due to new debt facilities put in place in December 2012 in anticipation of the Sealy Acquisition, which provided $375.0 million from our Senior Notes and $1,525.0 million from our 2012 Credit Agreement and was funded in connection with the closing of the Sealy Acquisition on March 18, 2013. Proceeds from the Senior Notes and 2012 Credit Agreement were used for the Sealy Acquisition and to repay the 2011 Credit Facility outstanding balance of $696.5 million. During 2013, we also repriced certain portions of the 2012 Credit Agreement. On May 16, 2013, we completed a repricing of our Term B Facility under the 2012 Credit Agreement, and this repricing was effected through a full repayment of $867.8 million and new borrowing of $742.8 million at the new lower interest rate. On July 11, 2013, we completed a repricing of our Term A Facility under the 2012 Credit Agreement, and this repricing was effected through a full repayment of $536.3 million and new borrowing of $536.3 million at the new lower interest rate. Additional borrowings made pursuant to the 2012 Credit Agreement in the year ended December 31, 2013 also provided $178.5 million and were used primarily to fund capital expenditures and our working capital needs. Additional repayments made pursuant to the 2012 Credit Agreement in the current period were $204.0 million and were funded by operating activities. Refer to Note 5, "Debt", in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.

45-------------------------------------------------------------------------------- Table of Contents Capital Expenditures Capital expenditures totaled $40.0 million for the year ended December 31, 2013 and $50.5 million for the year ended December 31, 2012. Capital expenditures in 2013 were lower than expected due to the integration focus of our business.

Capital expenditures in 2012 included the new corporate headquarters in Lexington, Kentucky. We currently expect our 2014 capital expenditures to be approximately $65.0 million, and relate to continued strategic investments which we believe will support our future plans.

Non-GAAP Financial Information We provide information regarding earnings before interest, taxes, depreciation and amortization ("EBITDA"), adjusted EBITDA, consolidated funded debt less qualified cash, adjusted net income and adjusted earnings per share, which are not recognized terms under U.S. GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt. Because not all companies use identical calculations, these presentations may not be comparable to other similarly titled measures of other companies. A reconciliation of our adjusted earnings per share is provided below. We believe that the use of this non-GAAP financial measure provides investors with additional useful information with respect to the impact of transaction and integration costs, and interest expense incurred related to the Sealy Acquisition. A reconciliation of our net income to EBITDA and adjusted EBITDA and a reconciliation of total debt to consolidated funded debt less qualified cash are also provided below. We believe the use of these non-GAAP financial measures provides investors with additional useful information with respect to our debt agreements and our compliance with the related debt covenants.

Reconciliation of net income to adjusted net income The following table sets forth the reconciliation of our reported net income to the calculation of adjusted net income for the year ended December 31, 2013 and 2012, respectively: Year Ended Year Ended December 31, December 31, (in millions, except per share amounts) 2013 2012 Net income $ 78.6 $ 106.8 Plus: Transaction costs, net of tax (2) 13.2 6.7 Integration costs, net of tax (1) 37.2 2.5 Long term debt refinance, net of tax (2) 6.5 - Adjustment of taxes to normalized rate (3) 10.9 - Tax provision related to repatriation of foreign earnings(4) - 48.1 Adjusted net income $ 146.4 $ 164.1 Earnings per share, diluted $ 1.28 $ 1.70 Transaction costs, net of tax (1) 0.21 0.11 Integration costs, net of tax (1) 0.60 0.04 Long term debt refinance, net of tax (2) 0.11 - Adjustment of taxes to normalized rate (3) 0.18 - Tax provision related to repatriation of foreign earnings (4) - 0.76 Adjusted earnings per share, diluted $ 2.38 $ 2.61 Diluted shares outstanding 61.6 62.9 (1) Transaction and integration represents costs, including legal fees, professional fees and other charges to align the businesses related to the Sealy Acquisition.

(2) Refinance costs represents the interest fees incurred in connection with the refinancing of the Term A Facility which occurred in July 2013.

(3) Adjustment of taxes to normalized rate represents adjustments associated with the tax impacts of transaction costs.

(4) Represents tax provision recorded in connection with the repatriation of foreign earnings related to the Sealy Acquisition.

46-------------------------------------------------------------------------------- Table of Contents Debt Service Our debt increased to $1,836.5 million as of December 31, 2013 from $1,025.0 million as of December 31, 2012. Our debt as of December 31, 2012 included $375.0 million of Senior Notes issued in December 2012 to finance a portion of the cost of the Sealy Acquisition. The increase in debt is due to funding of the 2012 Credit Agreement in conjunction with the closing of the Sealy Acquisition, partially offset by the payoff of the remaining balance under the 2011 Credit Facility. After giving effect to $74.5 million in borrowings under the revolver portion of the 2012 Credit Agreement and letters of credit outstanding of $22.9 million, total availability under the revolver was $252.6 million as of December 31, 2013. Refer to Note 5, "Debt", in our Consolidated Financial Statements included in Part II, ITEM 8 for further discussion of our debt.

As of December 31, 2013, we were in compliance with all of the financial covenants in our debt agreements. The table below sets forth the calculation of our compliance with the covenant in the 2012 Credit Agreement that requires that we maintain a ratio of less than 5.25 times of consolidated funded debt less qualified cash to adjusted EBITDA from October 1, 2013 through December 31, 2013. During 2014, we are required to maintain this ratio at less than: 5.00 times through March 31, 2014; 4.75 times through June 30, 2014; and 4.50 times through December 31, 2014. Both consolidated funded debt and adjusted EBITDA are terms that are not recognized under U.S. GAAP and do not purport to be alternatives to net income as a measure of operating performance or total debt.

Under the terms of our consolidated interest coverage ratio covenant, we are required to maintain a ratio greater than 3.00 times adjusted EBITDA to adjusted interest expense. As of December 31, 2013, our consolidated interest coverage ratio was 4.0 times. In the first quarter of 2014, we will be required to pay $21.9 million as a result of the covenant in the 2012 Credit Agreement that requires we make prepayments based on excess cash flow amounts.

Reconciliation of net income to EBITDA and adjusted EBITDA The following table sets forth the reconciliation of our reported net income to the calculation of EBITDA for the year ended December 31, 2013: Year Ended December 31, (in millions) 2013 Net income attributable to Tempur Sealy International, Inc. $ 75.6 Interest expense 133.2 Income taxes 39.0 Depreciation & amortization 98.6 EBITDA $ 346.4 Adjustments for financial covenant purposes: Transaction costs (1) 25.2 Integration costs (1) 15.3 Refinancing charges (2) 2.4 Non-cash compensation (3) 5.8 Restructuring and impairment related charges (4) 7.8 Discontinued operations (5) 0.6 Other 7.6 Adjusted EBITDA $ 411.1 (1) Transaction and integration represent costs related to the Sealy Acquisition, including legal fees, professional fees and costs to align the businesses.

(2) Refinancing charges represent costs associated with debt refinanced by Sealy prior to the Sealy Acquisition.

(3) Non-cash compensation represent costs associated with various share-based awards.

(4) Restructuring and impairment represent costs related to restructuring the Tempur Sealy business and asset impairment costs recognized by Sealy prior to the Sealy Acquisition.

(5) Discontinued operations represent losses from Sealy's divested operation prior to the Sealy Acquisition.

47-------------------------------------------------------------------------------- Table of Contents Reconciliation of long-term debt to consolidated funded debt less qualified cash The following table sets forth the reconciliation of our reported debt to the calculation of consolidated funded debt less qualified cash as of December 31, 2013. "Consolidated funded debt" and "qualified cash" are terms used in our 2012 Credit Agreement for purposes of certain financial covenants.

(in millions, except ratio) As of December 31, 2013 Total debt $ 1,836.5 Plus: Letters of credit outstanding 22.9 Consolidated funded debt 1,859.4 Less: Domestic qualified cash (1) $ 30.9 Foreign qualified cash (1) $ 30.1 Consolidated funded debt less qualified cash $ 1,798.4 (1) Qualified cash as defined in the credit agreement equals 100.0% of unrestricted domestic cash plus 60.0% of unrestricted foreign cash. For purposes of calculating leverage ratios, qualified cash is capped at $150.0 million.

Calculation of consolidated funded debt less qualified cash to Adjusted EBITDA The following table calculates our consolidated funded debt less qualified cash to adjusted EBITDA as of December 31, 2013: (in millions) As of December 31, 2013 Consolidated funded debt less qualified cash $ 1,798.4 Adjusted EBITDA 411.1 4.4 times (1) The ratio of consolidated debt less qualified cash to adjusted EBITDA was 4.4 times, within our covenant, which requires this ratio be less than 5.25 times from October 1, 2013 through December 31, 2013.

Stockholders' Equity Share Repurchase Program.

During 2013, we did not repurchase any shares of our common stock, and we do not expect that we will complete any additional share repurchases for the foreseeable future. During 2012, we purchased 5.0 million shares of our common stock for a total cost of $150.0 million pursuant to authorizations made by our Board of Directors. On January 23, 2012, our Board of Directors terminated the existing authority under the July 2011 authorization, as amended in October 2011, and approved a new share repurchase authorization of up to $250.0 million of our common stock. Share repurchases under this authorization may be made through open market transactions, negotiated purchases or otherwise, at times and in such amounts as management and a committee of the Board deem appropriate; these repurchases may be funded by operating cash flows and/or borrowings under our debt arrangements. This share repurchase program may be limited, suspended or terminated at any time without notice.

Future Liquidity Sources Our primary sources of liquidity are cash flow from operations and borrowings under our debt facilities. We expect that ongoing requirements for debt service and capital expenditures will be funded from these sources. As of December 31, 2013, we had $1,836.5 million in total debt outstanding, and our stockholders' equity was $118.6 million. Our debt service obligations could, under certain circumstances, have material consequences to our security holders. Total cash interest payments related to our borrowings is expected to be approximately $75.0 million in 2014. Interest expense in the periods presented also includes non-cash amortization of deferred financing costs and accretion on the 8.0% Sealy Notes.

48-------------------------------------------------------------------------------- Table of Contents In connection with the income tax assessments from the Danish Tax Authority ("SKAT") with respect to the tax years 2001 through 2007 relating to the royalty paid by one of Tempur Sealy International's U.S. Subsidiaries, we were notified that SKAT has granted the deferral to 2017 of the requirement to post a cash deposit or other form of security for taxes that have been assessed for the period 2001 through 2007. The cumulative total tax assessment for all years is approximately $206.1 million including interest and penalties. We are currently contesting the matter through the Danish National Tax Tribunal. Refer to Note 13, "Income Taxes" in our Consolidated Financial Statements included elsewhere in this Report for further discussion of the matter.

As of December 31, 2013, the fair value of the 8.0% Sealy Notes was $99.9 million, which includes $3.7 million of accreted discount. As of December 31, 2013, the 8.0% Sealy Notes had a carrying value of $99.6 million, which includes $3.7 million of accreted discount less conversion payments made to holders of certain 8.0% Sealy Notes that were tendered for conversion. Holders of the 8.0% Sealy Notes may choose to convert to cash the amount outstanding at their discretion prior to maturity. Upon conversion prior to maturity, we would be required to pay the holders within 3 business days after the receipt of the notice of conversion. The conversion of the 8.0% Sealy Notes prior to maturity could have a significant impact on our liquidity.

During the second quarter of 2013, we received $92.7 million in funds from an escrow receivable related to that portion of the 8.0% Sealy Notes which were not converted during the Make-Whole Period, which ended April 12, 2013. We used these funds to reduce our outstanding debt under the 2012 Credit Agreement.

We improved our capital structure in the second quarter of 2013 by repricing the Term B Facility of our 2012 Credit Agreement. Additionally, we made a prepayment of $125.0 million on the Term B Facility. Because a smaller amount of 8.0% Sealy Notes were converted than originally anticipated, we require less debt under our 2012 Credit Agreement than we had originally anticipated when we arranged the financing for the Sealy Acquisition. During the third quarter of 2013, the favorable interest rate environment provided us with an attractive opportunity to reprice the Term A Facility of our 2012 Credit Agreement. As a result of the repricing, current interest rates on the Term A Facility have been reduced by 75 basis points. We believe that these repricings and the lower debt levels will reduce our estimated annual interest expense. We expect that the fees associated with these repricings will have a payback period of less than one year.

Based upon the current level of operations, we believe that cash generated from operations and amounts available under our 2012 Credit Agreement will be adequate to meet our anticipated debt service requirements, capital expenditures, share repurchases, and working capital needs for the foreseeable future. There can be no assurance, however, that our business will generate sufficient cash flow from operations or that future borrowings will be available under facilities or otherwise enable us to service our indebtedness or to make anticipated capital expenditures.

At December 31, 2013, total cash and cash equivalents were $81.0 million, of which $30.9 million was held in the U.S. and $50.1 million was held by subsidiaries outside of the U.S. The Company repatriated $130.0 million of foreign cash during the year ended December 31, 2013. The amount of cash and cash equivalents held by subsidiaries outside of the U.S. and not readily convertible into other major foreign currencies, or the U.S. Dollar, is not material to our overall liquidity or financial position. At December 31, 2013, the tax basis of the Company's investment in its foreign subsidiaries exceeds the Company's book basis. Accordingly, no deferred taxes have been recorded related to this basis difference as it is not apparent that the difference will reverse in the foreseeable future.

Off-Balance Sheet Arrangements We occupy premises and utilize equipment under operating leases that expire at various dates through 2043. In accordance with generally accepted accounting principles, the obligations under those leases are not recorded on our balance sheet. Many of these leases provide for payment of certain expenses and contain renewal and purchase options. During the year ended December 31, 2013, we recognized lease expenses of $12.1 million.

We are involved in a group of joint ventures to develop markets for Sealy branded products around the world. These joint ventures are not considered to be variable interest entities and are therefore not consolidated for financial statement purposes. We account for our interest in the joint ventures under the equity method, and our net investment of $4.4 million is recorded as a component of other non-current assets within the Consolidated Balance Sheet at December 31, 2013. We believe that any possible commitments arising from these joint ventures will not be significant to our consolidated financial position or results of operations.

49-------------------------------------------------------------------------------- Table of Contents Contractual Obligations Our contractual obligations and other commercial commitments as of December 31, 2013 are summarized below: (in millions) Payment Due By Period Contractual After Total Obligations 2014 2015 2016 2017 2018 2018 Obligations Senior Notes $ - $ - $ - $ - $ - $ 375.0 $ 375.0 Revolving Credit Facility - - - - - 350.0 350.0Term A Facility 27.5 55.0 55.0 55.0 330.0 - 522.5 Term B Facility 7.4 7.4 7.4 7.4 7.4 700.3 737.3 Sealy 8.0% Notes - - - - - - 0.0 Letters of Credit 22.9 - - - - - 22.9 Interest payments (1) 76.4 75.0 73.1 70.6 61.2 71.7 428.0 Operating leases 8.9 5.5 5.0 2.9 2.5 5.9 30.7 Capital leases 4.7 4.7 4.3 4.3 2.6 1.5 22.1 Total $ 147.8 $ 147.6 $ 144.8 $ 140.2 $ 403.7 $ 1,504.4 $ 2,488.5 (1) Represents interest payments under our debt agreements outstanding as of December 31, 2013, assuming debt outstanding as of the end of 2013 is not repaid until debt matures.

Critical Accounting Policies and Estimates Our management is responsible for our financial statements and has evaluated the accounting policies to be used in their preparation. Our management believes these policies are reasonable and appropriate. The following discussion identifies those accounting policies that we believe are critical in the preparation of our financial statements, the judgments and uncertainties affecting the application of those policies and the possibility that materially different amounts will be reported under different conditions or using different assumptions.

The preparation of financial statements in conformity with U.S. GAAP requires that management make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of commitments and contingencies at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our actual results could differ from those estimates.

Revenue Recognition. Sales of product are recognized when persuasive evidence of an arrangement exists, title passes to customers and the risks and rewards of ownership are transferred, the sales price is fixed or determinable, and collectability is reasonably assured. We extend volume discounts to certain customers and reflect these amounts as a reduction of net sales.

Our estimates of sales returns are a critical component of our revenue recognition. We recognize sales, net of estimated returns, when the risks and rewards of ownership are transferred to our customers. Estimated sales returns are provided at the time of sale, based on our level of historical sales returns. We allow returns following a sale, depending on the channel and promotion. Our level of sales returns differs by channel, with our Direct channel typically experiencing the highest rate of returns. Our level of returns has been consistent with our estimates and prior years.

We do not recognize revenue unless collectability is reasonably assured at the time of sale. We extend credit based on the creditworthiness of our customers, and generally no collateral is required at the time of sale. Our allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing accounts receivable. We regularly review the adequacy of our allowance for doubtful accounts. We determine the allowance based on historical write-off experience and current economic conditions and also consider factors such as customer credit, past transaction history with the customer and changes in customer payment terms when determining whether the collection of a receivable is reasonably assured. Historically, less than 1.0% of net sales ultimately prove to be uncollectible. Account balances are charged off against the allowance after all reasonable means of collection have been exhausted and the potential for recovery is considered remote.

50-------------------------------------------------------------------------------- Table of Contents Business Combinations. Accounting for acquisitions requires us to recognize separately from goodwill the assets acquired and the liabilities assumed at their acquisition date fair values. Goodwill as of the acquisition date is measured as the excess of consideration transferred over the net of the acquisition date fair values of the assets acquired and the liabilities assumed.

While we use our best estimates and assumptions to accurately value assets acquired and liabilities assumed at the acquisition date as well as contingent consideration, where applicable, our estimates are inherently uncertain and subject to refinement. As a result, during the measurement period, which may be up to one year from the acquisition date, we record adjustments to the assets acquired and liabilities assumed with the corresponding offset to goodwill. Upon the conclusion of the measurement period or final determination of the values of assets acquired or liabilities assumed, whichever comes first, any subsequent adjustments are recorded to our consolidated statements of operations. Refer to Note 2, "Business Combination", in our Consolidated Financial Statements included in Part II, ITEM 8 of this Report for a discussion of the Sealy Acquisition.

Cooperative Advertising, Rebate and Other Promotional Programs. We enter into agreements with our customers to provide funds for advertising and promotion of our products. We also enter into volume and other rebate programs with our customers. When sales are made to these customers, we record liabilities pursuant to these agreements. We periodically assess these liabilities based on actual sales and claims to determine whether all of the cooperative advertising earned will be used by the customer or whether the customers will meet the requirements to receive rebate funds. We generally negotiate these agreements on a customer-by-customer basis. Some of these agreements extend over several periods. Significant estimates are required at any point in time with regard to the ultimate reimbursement to be claimed. Subsequent revisions to such estimates are recorded and charged to earnings in the period in which they are identified.

Rebates and cooperative advertising are classified as a reduction of revenues and presented within net sales on the accompanying Consolidated Statements of Income. Certain cooperative advertising expenses are reported as a component of selling and marketing expenses in the accompanying Consolidated Statements of Income because we receive an identifiable benefit and the fair value of the advertising benefit can be reasonably estimated.

Warranties. Cost of sales includes estimated costs to service warranty claims.

Our estimate is based on our historical claims experience and extensive product testing that we perform from time to time. We provide warranties ranging from 10 to 25 years for mattresses and 3 years for pillows. Because the majority of our products have not been in use by our customers for the full warranty period, we rely on the combination of historical experience and product testing for the development of our estimate for warranty claims. Our estimate of warranty claims could be adversely affected if our historical experience differs materially from the performance of the product in our product testing. Estimated future obligations related to these products are provided by charges to operations in the period in which the related revenue is recognized.

Long-Lived Assets. The cost of plant and equipment is depreciated by the straight-line method over the estimated useful lives of the assets. Useful lives are based on historical experience and are adjusted when changes in planned use, technological advances or other factors show that a different life would be more appropriate. Such costs are periodically reviewed for recoverability when impairment indicators are present. Such indicators include, among other factors, operating losses, unused capacity, market value declines and technological obsolescence. Recorded values of property, plant and equipment that are not expected to be recovered through undiscounted future net cash flows are written down to current fair value, which generally is determined from estimated discounted future net cash flows (assets held for use) or net realizable value (assets held for sale).

Goodwill and intangible assets with indefinite lives are subject to an annual impairment test as of October 1 and whenever events or circumstances make it more likely than not that impairment may have occurred. Such tests are completed separately with respect to the goodwill of each of our reporting units. Because market prices of our reporting units are not readily available, we make various estimates and assumptions in determining the estimated fair values of those units. Fair value is based on a discounted cash flow approach, with an appropriate risk adjusted discount rate, and a market approach. Significant assumptions inherent in the methodologies are employed and include such estimates as discount rates, growth rates and the selection of peer company multiples. The use of alternative estimates or adjusting the discount rate could affect the estimated fair value of the assets and potentially result in impairment.

51-------------------------------------------------------------------------------- Table of Contents We have determined that our reporting units for allocation of goodwill are our Tempur North America, Tempur International and Sealy operating segments. In conducting the impairment test for the Tempur North America and Tempur International operating segments, the fair value of each of the Company's reporting units is compared to its respective carrying amount including goodwill. The most recent annual impairment tests performed as of October 1, 2013, indicated that the fair values of each of our reporting units and trade names (which has an indefinite life) were substantially in excess of their carrying values. Despite that excess, however, impairment charges could still be required if a divestiture decision were made or other significant economic event were made or occurred with respect to one of our reporting units. Subsequent to our October 1, 2013 annual impairment test, no indications of an impairment were identified. We performed a qualitative analysis of our Sealy operating segment which considered indicators of impairment to evaluate whether the fair value was more-likely-than-not in excess of its carrying value. The key indicators considered include macroeconomic conditions, industry/market considerations, financial performance, cash flow, changes in management, and composition of net assets.

Income Taxes. Accounting for income taxes requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax assets and liabilities are determined based on the difference between the financial statement and tax bases of assets and liabilities. These deferred taxes are measured by applying the provisions of tax laws in effect at the balance sheet date.

We recognize deferred tax assets in our Consolidated Balance Sheets, and these deferred tax assets typically represent items deducted currently from operating income in the financial statements that will be deducted in future periods in tax returns. A valuation allowance is recorded against certain deferred tax assets to reduce the consolidated deferred tax asset to an amount that will, more likely than not, be realized in future periods. The valuation allowance is based, in part, on our estimate of future taxable income, the expected utilization of foreign and state tax loss carryforwards, and credits and the expiration dates of such tax loss carryforwards. Significant assumptions are used in developing the analysis of future taxable income for purposes of determining the valuation allowance for deferred tax assets which, in our opinion, are reasonable under the circumstances. At December 31, 2013, we have provided valuation allowances for substantially all subsidiaries in a cumulative three year loss position.

Our consolidated effective tax rate and related tax reserves are subject to uncertainties in the application of complex tax regulations from numerous tax jurisdictions around the world. We recognize liabilities for anticipated taxes in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, taxes are and could be due. This liability is estimated based on a prescribed recognition threshold and measurement attributes for the financial statement recognition and measurements of a tax position taken or expected to be taken in a tax return. The resolution of tax matters for an amount that is different than the amount reserved would be recognized in our effective tax rate during the period in which such resolution occurs.

Impact of Recently Issued Accounting Pronouncements Refer to ITEM 8 under Part II of this Report for a full description of recent accounting pronouncements, including the expected dates of adoption and estimated effects on results of operations and financial condition, which is incorporated herein by reference.

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