MATTRESS FIRM HOLDING CORP. - FORM 10-Q

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EX-31.1 - EX-31.1 - MATTRESS FIRM HOLDING CORP.	mfrm-20141028ex311d25ed7.htm
EX-31.2 - EX-31.2 - MATTRESS FIRM HOLDING CORP.	mfrm-20141028ex312686d67.htm
EX-32.2 - EX-32.2 - MATTRESS FIRM HOLDING CORP.	mfrm-20141028ex322712b94.htm
EX-32.1 - EX-32.1 - MATTRESS FIRM HOLDING CORP.	mfrm-20141028ex32133d295.htm
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the quarterly period ended October 28, 2014


☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934.

For the transition period from to

Commission file number 001-35354

MATTRESS FIRM HOLDING CORP.

(Exact Name of Registrant as Specified in Its Charter)


Delaware		20-8185960
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)

5815 Gulf Freeway

Houston, Texas 77023

(Address of Principal Executive Offices) (Zip Code)

(713) 923-1090

(Registrant’s Telephone Number, Including Area Code)

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report.)

Indicate by check mark whether the registrant has (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES ☒ NO ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ☒ NO ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ☐	Accelerated filer ☒

Non-accelerated filer ☐	Smaller Reporting Company ☐

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act) YES ☐ NO ☒

As of November 28, 2014, 35,017,602 shares of common stock, par value $0.01 per share, of the registrant were outstanding.

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of federal securities laws that relate to future events or our future financial performance. In many cases, you can identify forward-looking statements by terminology such as “may,” “would,” “should,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “predict,” “intend,” “potential” or “continue” or the negative of these terms or other comparable terminology. These forward-looking statements are made based on our management’s expectations and beliefs concerning future events affecting us and are subject to uncertainties and factors relating to our operations and business environment, all of which are difficult to predict and many of which are beyond our control. These uncertainties and other factors could cause our actual results to differ materially from those matters expressed or implied by these forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Important factors that may cause actual results to differ materially from the results expressed or implied by these forward-looking statements are set forth under “Item 1A. Risk Factors” of Part I of the Company’s Annual Report on Form 10-K for the fiscal year ended January 28, 2014 filed with the Securities and Exchange Commission (the “SEC”) on March 27, 2014 (the “Fiscal 2013 Annual Report”) and any additional risk factors identified in our other filings with the SEC. All forward-looking statements in this Quarterly Report on Form 10-Q are based on information available to us on the date of this report. We undertake no obligation to publicly update or revise any of the forward-looking statements, whether as a result of new information, future events or otherwise.

Some of the important factors that could cause our actual results, performance or financial condition to differ materially from expectations are:

a reduction in discretionary spending by consumers;

our ability to profitably open and operate new stores;

our intent to aggressively open additional stores in our existing markets;

our relationship with certain mattress manufacturers as our primary suppliers;

our dependence on a few key employees;

the possible impairment of our goodwill or other acquired intangible assets;

the effect of our planned growth and the integration of our acquisitions on our business infrastructure;

the impact of seasonality on our financial results and comparable-store sales;

fluctuations in our comparable-store sales from quarter to quarter;

our ability to raise adequate capital to support our expansion strategy;

our future expansion into new, unfamiliar markets;

our success in pursuing strategic acquisitions;

the effectiveness and efficiency of our advertising expenditures;

our success in keeping warranty claims and comfort exchange return rates within acceptable levels;

our ability to deliver our products in a timely manner;

our status as a holding company with no business operations;

our ability to anticipate consumer trends;

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heightened competition;

changes in applicable regulations;

risks related to our franchises, including our lack of control over their operations, their ability to finance and open new stores and our liabilities if they default on note or lease obligations;

risks related to our stock; and

other factors discussed in “Item 1A. Risk Factors” of Part I of the Fiscal 2013 Annual Report, elsewhere in this report and in our other filings with the SEC.

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MATTRESS FIRM HOLDING CORP.

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		Page
PART I. FINANCIAL INFORMATION		4

Item 1.	Financial Statements (unaudited)	4
	Condensed Consolidated Balance Sheets as of January 28, 2014 and October 28, 2014	4
	Condensed Consolidated Statements of Operations for the thirteen weeks ended October 29, 2013 and October 28, 2014 and thirty-nine weeks ended October 29, 2013 and October 28, 2014	5
	Condensed Consolidated Statements of Cash Flows for the thirty-nine weeks ended October 29, 2013 and October 28, 2014	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36

PART II. OTHER INFORMATION		36

Item 1A.	Risk Factors	36
Item 2.	Unregistered Sales of Equity Securities	38
Item 6.	Exhibits	38
	Signatures	39

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PART I

FINANCIAL INFORMATION

Item 1. Financial Statements.

MATTRESS FIRM HOLDING CORP.

Condensed Consolidated Balance Sheets

(In thousands, except share amounts)

(unaudited)



	January 28,		October 28,
	2014		2014
Assets
Current assets:
Cash and cash equivalents	$	22,878	$	4,926
Accounts receivable, net		20,812		54,697
Inventories		81,507		157,688
Deferred income tax asset		4,729		4,491
Prepaid expenses and other current assets		16,348		35,227
Total current assets		146,274		257,029
Property and equipment, net		174,770		235,986
Intangible assets, net		84,391		124,462
Goodwill		366,647		910,085
Debt issue costs and other, net		12,549		28,519
Total assets	$	784,631	$	1,556,081
Liabilities and Stockholders’ Equity
Current liabilities:
Notes payable and current maturities of long-term debt	$	3,621	$	8,737
Accounts payable		72,165		140,599
Accrued liabilities		42,435		90,574
Customer deposits		9,318		20,397
Total current liabilities		127,539		260,307
Long-term debt, net of current maturities		217,587		750,190
Deferred income tax liability		37,921		36,285
Other noncurrent liabilities		73,092		87,101
Total liabilities		456,139		1,133,883

Commitments and contingencies (Note 7)

Stockholders’ equity:
Common stock, $0.01 par value; 120,000,000 shares authorized; 34,002,981 and 33,990,381 shares issued and outstanding at January 28, 2014; and 35,012,733 and 35,000,133 shares issued and outstanding at October 28, 2014, respectively		340		350
Additional paid-in capital		373,153		429,218
Accumulated deficit		(45,001)		(7,370)
Total stockholders’ equity		328,492		422,198
Total liabilities and stockholders’ equity	$	784,631	$	1,556,081

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of these interim financial statements.

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MATTRESS FIRM HOLDING CORP.

Condensed Consolidated Statements of Operations

(In thousands, except share and per share amounts)

(unaudited)



	Thirteen Weeks Ended				Thirty-Nine Weeks Ended
	October 29,		October 28,			October 29,	October 28,
	2013		2014			2013	2014

Net sales	$	326,233	$	464,278	$	904,731	$	1,207,731
Cost of sales		200,267		281,323		553,878		740,522
Gross profit from retail operations		125,966		182,955		350,853		467,209
Franchise fees and royalty income		1,655		1,238		4,342		3,516
Total gross profit		127,621		184,193		355,195		470,725
Operating expenses:
Sales and marketing expenses		74,605		109,632		214,104		285,295
General and administrative expenses		21,225		42,783		60,143		110,358
Loss on store closings and impairment of store assets		(5)		133		739		1,039
Total operating expenses		95,825		152,548		274,986		396,692
Income from operations		31,796		31,645		80,209		74,033
Other expenses:
Interest expense, net		2,543		4,067		8,185		10,352
Loss from debt extinguishment		—		2,288		—		2,288
Total other expenses		2,543		6,355		8,185		12,640
Income before income taxes		29,253		25,290		72,024		61,393
Income tax expense		11,117		9,677		27,756		23,762
Net income	$	18,136	$	15,613	$	44,268	$	37,631

Basic net income per common share	$	0.54	$	0.46	$	1.31	$	1.10
Diluted net income per common share	$	0.53	$	0.45	$	1.30	$	1.09

Basic weighted average shares outstanding		33,878,241		34,285,572		33,848,032		34,149,531
Diluted weighted average shares outstanding		34,114,147		34,724,199		34,073,307		34,562,374

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of these interim financial statements.

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MATTRESS FIRM HOLDING CORP.

Condensed Consolidated Statements of Cash Flows

(In thousands)

(unaudited)



	Thirty-Nine Weeks Ended
	October 29,		October 28,
	2013		2014
Cash flows from operating activities:
Net income	$	44,268	$	37,631
Adjustments to reconcile net income to cash flows provided by operating activities:
Depreciation and amortization		21,128		28,302
Loan fee and other amortization		1,630		3,507
Loss from debt extinguishment		—		2,288
Deferred income tax expense		4,968		2,325
Stock-based compensation		3,203		4,973
Loss on store closings and impairment of store assets		739		1,039
Construction allowances from landlords		4,391		4,813
Excess tax benefits associated with stock-based awards		(277)		(1,585)
Effects of changes in operating assets and liabilities, excluding business acquisitions:
Accounts receivable		(5,580)		(22,124)
Inventories		(16,794)		(22,029)
Prepaid expenses and other current assets		(892)		(5,426)
Other assets		(2,126)		(8,501)
Accounts payable		3,929		27,432
Accrued liabilities		7,807		26,822
Customer deposits		818		905
Other noncurrent liabilities		3,724		(816)
Net cash provided by operating activities		70,936		79,556
Cash flows from investing activities:
Purchases of property and equipment		(41,340)		(54,998)
Business acquisitions, net of cash acquired		(2,042)		(561,013)
Net cash used in investing activities		(43,382)		(616,011)
Cash flows from financing activities:
Proceeds from issuance of debt		27,000		990,800
Principal payments of debt		(54,968)		(465,551)
Debt issuance costs		—		(10,188)
Proceeds from exercise of common stock options		1,312		2,988
Excess tax benefits associated with stock-based awards		277		1,585
Purchase of vested stock-based awards		(493)		(1,131)
Net cash (used in) provided by financing activities		(26,872)		518,503
Net increase (decrease) in cash and cash equivalents		682		(17,952)
Cash and cash equivalents, beginning of period		14,556		22,878
Cash and cash equivalents, end of period	$	15,238	$	4,926
Cash paid for:
Interest	$	8,520	$	10,869
Income taxes	$	18,343	$	11,505
Supplemental disclosure of noncash investing activity:
Capital expenditures included in accounts payable and accruals at end of period	$	2,826	$	4,098

The accompanying Notes to the Unaudited Condensed Consolidated Financial Statements are an integral part of these interim financial statements.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements

1. Business and Basis of Presentation

Mattress Firm Holding Corp., through its direct and indirect subsidiaries, is engaged in the retail sale of mattresses and bedding-related products in various metropolitan markets in the United States through company-operated and franchisee-owned mattress specialty stores that operate primarily under the name Mattress Firm. Mattress Firm Holding Corp. and its subsidiaries are referred to collectively as the “Company” or “Mattress Firm.”

The accompanying unaudited condensed consolidated financial statements have been prepared pursuant to the requirements for reporting on Form 10-Q and Article 10 of Regulation S-X of the U.S. Securities and Exchange Commission (“SEC”), and they reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly the Company’s financial position as October 28, 2014, and the results of operations and cash flows for the periods presented. The Company’s historical and quarterly results of operations may not be indicative of the results that may be achieved for the full year or any future period.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with the Company’s most recent audited consolidated financial statements and related notes for the fiscal year ended January 28, 2014, which are included in the Company’s Annual Report on Form 10-K filed with the SEC on March 27, 2014 (the “Fiscal 2013 Annual Report”).

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of (i) assets and liabilities, (ii) disclosure of contingent assets and liabilities at the date of the financial statements and (iii) the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates. Estimates that are more susceptible to change in the near term are the accruals for sales returns and exchanges, product warranty costs, asset impairments, vendor incentives, self-insured liabilities, store closing costs and acquisition accounting fair values.

The Company is in the process of implementing a new computer system that provides sales tracking, inventory management, financial reporting and warehouse management capabilities (“new ERP system”) to enhance functionality and to support the Company’s growth strategy. The new ERP system utilizes the weighted average cost flow method for determining inventory cost (“Weighted Average”) and, as the new ERP system is rolled out across the Company’s markets, will replace the First-In, First-Out cost flow method (“FIFO”) utilized by our legacy system. The Weighted Average and FIFO methods are both allowable under U.S. GAAP. The Financial Accounting Standards Board (“FASB”) has issued guidance that when there are two allowable alternative accounting principles, a company must determine which one is preferable. The adoption of the Weighted Average method is considered preferable by the Company due to the fact that it aligns with the functionality of the new ERP system. The Company also considered other factors that support preferability of the Weighted Average method, including closer alignment with the physical flow of the Company’s inventories and prevalence among industry peers. Consistent with FASB requirements, if a change in accounting principle is determined to be preferable, the change shall be reported through retrospective application to the financial statements of all prior periods, unless the effects are not material. The Company determined that the effects of adopting the Weighted Average method are not material to its financial statements. This determination is supported by certain inherent characteristics of the Company’s business, including the ability to hold low inventories relative to sales levels, continuous product replenishment, the relatively short life cycles of most mattress product lines and the infrequency of vendor price changes during the life cycle of the majority of products that are carried. Therefore, the change in accounting principle has not been retrospectively applied to prior periods.

Certain reclassifications have been made to the prior year condensed consolidated statements of cash flows to segregate the cash proceeds related to construction allowances from landlords from the previously reported cash activity that was included as components of the changes in accounts receivable and noncurrent liabilities to conform to the current period financial statement presentation with no effect on the Company’s previously reported net cash provided by operating activities.

The Company’s fiscal year consists of 52 or 53 weeks ending on the Tuesday closest to January 31. The fiscal year ended January 28, 2014 (“Fiscal 2013”) consisted of 52 weeks. The fiscal year ending February 3, 2015 (“Fiscal 2014”) consists of 53 weeks.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

2. Acquisitions

The Company completed a number of acquisitions of the equity interests or operating assets of specialty mattress retailers during the thirty-nine weeks ended October 28, 2014. These acquisitions: (i) increase the Company’s store locations and market share in markets in which the Company currently operates, which generally results in expense synergies and improved leverage over market-level costs, such as advertising and warehousing, or (ii) provide an efficient way to enter new markets in which the Company did not previously operate and which provide a platform for further growth. Results of operations of the acquired businesses are included in the Company’s results of operations from the respective effective dates of acquisition.

Effective March 3, 2014, the Company acquired certain leasehold interests, store assets, distribution center assets and related inventories, and assumed certain liabilities of Yotes, Inc. (“Yotes”), a franchisee of the Company, relating to the operation of 34 mattress specialty retail stores located in Colorado and Kansas for a total purchase price of approximately $14.3 million, including working capital adjustments.

Effective March 3, 2014, the Company acquired the leasehold interests and store assets, and assumed certain liabilities, of Southern Max LLC (“Southern Max”), a franchisee of the Company, relating to the operations of three mattress specialty retail stores located in Virginia for a total purchase price of approximately $0.5 million, including working capital adjustments.

Effective April 3, 2014, the Company acquired one hundred percent of the outstanding partnership interests in Sleep Experts Partners, L.P. (“Sleep Experts”), related to the operation of 55 mattress specialty retail stores in Texas under the brand Sleep Experts, for a total purchase price of approximately $67.8 million, including working capital adjustments. The purchase price consisted of cash of $62.8 million (net of $1.6 million of cash acquired), and $3.4 million delivered in the form of 71,619 shares of common stock, par value $0.01 per share, of Mattress Firm Holding Corp. common stock as calculated in accordance with the terms of the purchase agreement.

The Company funded the cash requirements of the Yotes and Southern Max acquisitions using cash reserves and revolver borrowings. The Company raised $100 million of incremental term borrowings under the 2012 Senior Credit Facility (defined in Note 4 below) to fund the cash requirements of the Sleep Experts acquisition and to pay down outstanding revolver borrowings. The new incremental term borrowings were scheduled to mature in January 2016 and were subject to the same interest rate as the existing outstanding incremental borrowings under the 2012 Senior Credit Facility. Effective October 20, 2014, as described below, these term borrowings were repaid in full using the proceeds of the 2014 Senior Credit Facility (defined below).

Effective June 4, 2014, the Company acquired substantially all of the mattress specialty retail assets and operations of Mattress Liquidators, Inc. (“Mattress Liquidators”), which operated Mattress King retail stores in Colorado and BedMart retail stores in Arizona, related to the operation of 67 mattress specialty retail stores, for a total purchase price of approximately $33.0 million, including working capital adjustments. The purchase price consisted of cash of $29.5 million funded by cash reserves and revolver borrowings, as well as a $3.5 million seller note, payable in quarterly installments over two years.

Effective September 8, 2014, the Company acquired substantially all of the mattress specialty retail assets and operations of Best Mattress Co., Inc. (“Best Mattress”), which operated Mattress Discounters retail stores in Pennsylvania, related to the operation of 15 mattress specialty retail stores, for a total purchase price of approximately $6.2 million, giving effect to certain preliminary adjustments, and is subject to further customary adjustments. The purchase price consisted of cash of $5.6 million funded by cash reserves and revolver borrowings, as well as a $0.6 million seller note, payable in quarterly installments over two years.

Effective September 30, 2014, the Company acquired substantially all of the mattress specialty retail assets and operations of Back to Bed Inc., M World Mattress LLC, MCStores LLC and TBE Orlando LLC (collectively, “Back to Bed”), which operated Back to Bed and Bedding Experts retail stores in Illinois, Indiana and Wisconsin and Bedding Experts and Mattress Barn retail stores in Florida, related to the operation of 131 mattress specialty retail stores, for a total purchase price of approximately $60.3 million, giving effect to certain preliminary adjustments, and is subject to further customary

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

adjustments. The purchase price consisted of cash of $60.3 million funded by cash reserves and revolver borrowings, of which $19.0 million was placed in escrow.

Effective October 20, 2014, the Company acquired 100% of the outstanding equity interests in The Sleep Train, Inc., (“Sleep Train”) , which operates Sleep Train, Sleep Country, Mattress Discounters and Got Sleep retail stores in California, Washington, Oregon, Nevada, Idaho and Hawaii, related to the operation of 314 mattress specialty retail stores, for a total purchase price of approximately $448.2 million, giving effect to certain preliminary adjustments, and is subject to further customary adjustment, along with the assumption of certain additional liabilities totaling approximately $15 million. The Company expects to receive future annual cash income tax benefits of approximately $11 million over the next 15 years from deductible tax basis goodwill generated from the transaction, subject to the Company’s ability to generate future taxable income. The purchase price consisted of cash of $388.1 million (net of $15.9 million of cash acquired), of which $49.0 million was placed in escrow, and $44.2 million delivered in the form of 745,107 shares of common stock, par value $0.01 per share, of Mattress Firm Holding Corp. common stock as calculated in accordance with the terms of the purchase agreement.

Concurrently with the closing of the Sleep Train acquisition, the Company entered into a new senior secured credit facility with Barclays Bank PLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities LLC, and UBS Securities LLC, as joint bookrunning managers and joint lead arrangers. The senior secured credit facility is comprised of (i) an asset based revolver of $125 million that includes a sublimit for letters of credit and swingline loans, subject to certain conditions and limits and (ii) a term loan B borrowing of $720 million (See Note 4). Approximately $49 million of the availability under the asset based revolver were drawn at closing to fund the Sleep Train acquisition.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The allocation of the purchase price to the acquired assets and liabilities, based on management’s estimate of their fair values on the acquisition date, is as follows (in thousands):



	Yotes		Southern Max		Sleep Experts		Mattress Liquidators		Best Mattress		Back To Bed		Sleep Train		Total
Cash	$	—	$	—	$	1,637	$	5	$	9		—		15,895	$	17,546
Accounts receivable		504		—		533		260		130		763		7,555		9,745
Inventories		1,765		54		5,233		1,501		416		2,906		42,276		54,151
Prepaid expenses and other current assets		380		—		1,095		38		132		1,720		10,089		13,454
Property and equipment		1,275		232		6,743		1,681		854		7,142		19,905		37,832
Intangible assets		3,980		—		2,575		1,791		502		2,743		29,746		41,337
Goodwill		10,585		174		58,514		32,283		4,961		48,865		387,478		542,860
Deferred income tax asset		—		—		558		191		327		351		589		2,016
Other assets		143		14		346		275		14		—		954		1,746
Notes payable and current maturities of long-term debt		—		—		—		(72)		—		—		(333)		(405)
Accounts payable		(3,334)		—		(2,349)		(2,780)		(100)		(2,572)		(30,952)		(42,087)
Accrued liabilities		(470)		—		(5,477)		(1,789)		(132)		(995)		(17,665)		(26,528)
Customer deposits		(391)		—		(651)		(181)		(167)		(690)		(8,095)		(10,175)
Deferred rent liabilities		(139)		—		(917)		(106)		(771)		68		—		(1,865)
Long-term debt, net of current maturities		—		—		—		(68)		—		—		(6,219)		(6,287)
Other noncurrent liabilities		—		—		—		—		—		—		(2,980)		(2,980)
Deferred income tax liability		(16)		(22)		—		—		—		—		—		(38)
Fair value of assets and liabilities acquired		14,282		452		67,840		33,029		6,175		60,301		448,243		630,322
Reconciliation to cash used in acquisitions:
Seller note issued		—		—		—		(3,500)		(600)		—		—		(4,100)
Fair value of equity consideration transferred		—		—		(3,441)		—		—		—		(44,222)		(47,663)
Cash of acquired businesses		—		—		(1,637)		(5)		(9)		—		(15,895)		(17,546)
Cash used in acquisitions, net of cash acquired	$	14,282	$	452	$	62,762	$	29,524	$	5,566	$	60,301	$	388,126	$	561,013

The acquisitions resulted in $542.9 million of goodwill based on management’s estimate on the acquisition closing dates, of which $539.3 million will be deductible for income tax purposes over 15 years.

Intangible assets acquired in relation to the Sleep Train acquisition consist primarily of the indefinite lived Sleep Train tradename.

The net sales included in the Company’s condensed consolidated statement of operations derived from the Yotes, Southern Max, Sleep Experts, Mattress Liquidators, Best Mattress, Back to Bed and Sleep Train acquisitions from the respective acquisition dates to October 28, 2014 were $22.7 million, $0.6 million, $41.5 million, $20.5 million, $1.2 million, $4.4 million and $11.0 million, respectively. The earnings included in the Company’s condensed consolidated statement of operations derived from the Yotes, Southern Max, Sleep Experts, Mattress Liquidators, Best Mattress, Back to Bed and Sleep Train acquisitions from the respective acquisition dates to October 28, 2014 were $5.5 million, ($0.1) million, $11.4 million, $3.5 million, $0.1 million, ($0.7) million and $0.7 million, respectively.

Acquisition-related costs for U.S. GAAP purposes are costs the acquirer incurs to effect a business combination, including advisory, legal, accounting, valuation, and other professional or consulting fees. The Company incurred a total of approximately $2.7 million and $7.1 million of acquisition-related costs charged to general and administrative expenses during the thirteen and thirty-nine weeks ended October 28, 2014, respectively.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The following table presents the selected consolidated financial information of the Company on a pro forma basis, assuming the acquisitions described above had occurred as of January 28, 2014. The historical financial information has been adjusted to give effect to the pro forma items that are directly attributable to the acquisition and are expected to have a continuing impact on the consolidated results.

The unaudited financial information set forth below has been compiled from the historical financial statements and other information, but is not necessarily indicative of the results that actually would have been achieved had the transactions occurred on the dates indicated or that may be achieved in the future (amounts in thousands, except per share amounts):



	Thirteen Weeks Ended October 28, 2014						Thirty-Nine Weeks Ended October 28, 2014
	As Reported		Pro Forma Adjustments		Pro Forma		As Reported		Pro Forma Adjustments		Pro Forma
Net sales	$	464,278	$	147,553	$	611,831	$	1,207,731	$	474,996	$	1,682,727
Net income		15,613		4,273		19,886		37,631		4,237		41,868
Diluted net income per common share	$	0.45	$	0.12	$	0.57	$	1.09	$	0.12	$	1.21

Goodwill represents the future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. The Company’s goodwill is primarily related to the increase in the Company’s store locations and market share with expectations of expense synergies and leverage over costs, such as advertising and warehousing. The measurement periods for purchase price allocations end as soon as information on the facts and circumstances become available, but do not exceed 12 months. Adjustments in purchase price allocations may require a recasting of the amounts allocated to goodwill.

The Company is continuing to evaluate the fair values of the assets and liabilities acquired, and as a result, adjustments to the values presented above may be modified over the next several quarters. In the thirteen weeks ended April 29, 2014, the Company adjusted the deferred tax balance related to the fiscal 2013 acquisition of the assets and operations of Perfect Mattress of Wisconsin, LLC (“Perfect Mattress”) resulting in $0.6 million of additional goodwill. The Company has preliminarily allocated both the Back to Bed and Sleep Train purchase price among assets acquired and liabilities assumed using the information available at October 28, 2014, including the identification of certain intangible assets. The Company is continuing to evaluate fair values related to the acquisition and their related allocation which will impact the fair values presented above.

A summary of the changes in the carrying amounts of goodwill for the thirty-nine weeks ended October 28, 2014 is as follows (in thousands):



Balance at January 28, 2014	$	366,647
Prior year business acquisition adjustment		578
Current period business acquisitions		542,860
Balance at October 28, 2014	$	910,085

3. Fair Value of Financial Instruments

The amounts reported in the condensed consolidated balance sheets for cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate their respective fair values due to the short-term maturity of these instruments.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The FASB has issued guidance on the definition of fair value, the framework for using fair value to measure assets and liabilities, and disclosure regarding fair value measurements. The guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used to measure fair value. These tiers include:

Level 1: Defined as observable inputs such as quoted prices in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2: Defined as pricing inputs other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures.

Level 3: Defined as pricing inputs that are unobservable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value.

The Company measures the fair value of its nonqualified deferred compensation plan on a recurring basis. The plan’s assets are valued based on the marketable securities tied to the plan. Additionally, the Company measures the fair values of goodwill, intangible assets, and property and equipment on a nonrecurring basis if required by impairment tests applicable to these assets. Assets requiring recurring or non-recurring fair value measurements consisted of the following (in thousands):



	Net Book
	Value as of
	January 28,		Fair Value Measurements						Fiscal 2013
	2014		Level 1		Level 2		Level 3		Impairments
Nonqualified deferred compensation plan	$	1,353	$	—	$	1,353	$	—	$	—
Property and equipment requiring impairment review		321		—		—		321		464



	Net Book
	Value as of
	October 28,		Fair Value Measurements						Fiscal 2014
	2014		Level 1		Level 2		Level 3		Impairments
Nonqualified deferred compensation plan	$	1,165	$	—	$	1,165	$	—		—
Property and equipment requiring impairment review	$	—	$	—	$	—	$	—		482

The significant Level 3 unobservable input used in the fair value measurement of the Company’s property and equipment was the weighted average cost of capital (“WACC”). Increases (decreases) in WACC inputs in isolation would result in a lower (higher) fair value measurement.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The following tables are not intended to be all-inclusive, but rather provide a summary of the significant unobservable inputs used in the fair value measurement of the Company’s Level 3 assets in which impairment testing was performed.

Impairment testing performed as of January 28, 2014



		Unobservable
Valuation Technique	Significant Unobservable Inputs	Input Range
Property and Equipment Impairment Testing
Income approach	WACC(1)	13.5%

Impairment testing performed as of October 28, 2014



		Unobservable
Valuation Technique	Significant Unobservable Inputs	Input Range
Property and Equipment Impairment Testing
Income approach	WACC(1)	13.5%

(1)

Weighted Average Cost of Capital

The fair value of the 2014 Senior Credit Facility term loans was estimated based on the ask and bid prices quoted from an external source. The carrying values of the 2014 Senior Credit Facility term loans other debt instruments at fixed rates are not materially different than their face value.

4. Notes Payable and Long-term Debt

Notes payable and long-term debt consists of the following (in thousands):



	January 28,		October 28,
	2014		2014
2012 Senior Credit Facility - term loans	$	198,098	$	—
2012 Senior Credit Facility - revolver borrowings		21,000		—
2014 Senior Credit Facility - term loans		—		720,000
2014 Senior Credit Facility - term loans discount		—		(7,175)
2014 Senior Credit Facility - revolver borrowings		—		35,000
Equipment financing and other notes payable		2,110		11,102
Total long-term debt		221,208		758,927
Current maturities of long-term debt		3,621		8,737
Long-term debt, net of current maturities	$	217,587	$	750,190

2012 Senior Credit Facility—On January 18, 2007, Mattress Holding Corp., an indirect consolidated subsidiary of the Company, entered into a credit agreement with UBS Securities LLC and certain of its affiliates and other lenders for a senior secured term loan and revolving credit facility, which was amended and restated on November 5, 2012 and further amended on February 27, 2014 (as amended, the “2012 Senior Credit Facility”). On October 20, 2014, the 2012 Senior Credit Facility was paid off in connection with and effective upon the closing of the 2014 Senior Credit Facility described below. All letters of credit outstanding under the 2012 Credit Agreement continued uninterrupted and were deemed to have been issued under the 2014 Senior Credit Facility. The termination of the 2012 Credit Agreement was a condition precedent to the closing of the 2014 Senior Credit Facility. There were no termination penalties incurred by the Company in connection with the termination of the 2012 Credit Agreement.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

2014 Senior Credit Facility--- Effective October 20, 2014, Mattress Holding Corp., a Delaware corporation and indirect subsidiary of Mattress Firm Holding Corp., a Delaware corporation, entered into a $125 million asset-backed loan credit agreement dated October 20, 2014, among Mattress Holding Corp., as borrower, Mattress Holdco, Inc., the lenders party thereto, and Barclays Bank PLC, as administrative agent, collateral agent and issuer (the “ABL Credit Agreement”).

The ABL Credit Agreement is a committed senior revolving credit facility, secured by the assets of the borrower and the guarantors, that permits aggregate borrowings of up to $125 million, and contains within the facility, a letter of credit facility that, at any time outstanding, is limited to $50 million and a swing line facility that, at any time outstanding, is limited to $20 million. Subject to customary conditions, the Company may request that the lenders’ aggregate commitments with respect to the revolving credit facility be increased by up to $75 million. The maturity date under the ABL Credit Agreement is October 20, 2019.

Loans under the ABL Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate, provided, that swing line loans bear interest by reference only to the base rate. The applicable margin on LIBOR rate loans varies from 1.25% to 1.75% and the applicable margin on base rate loans varies from 0.25% to 0.75%, in each case determined based upon the Company’s average excess available borrowing capacity for the prior three month period. A letter of credit issuance fee is payable by the Company equal to 0.125% per annum multiplied by the average daily amount available to be drawn under the applicable letter of credit, as well as an additional fee equal to the applicable margin for LIBOR rate loans times the daily amount available to be drawn under all outstanding letters of credit. The commitment fee rate payable to the lenders for each of the revolving facility and term facility varies from 0.25% to 0.375%. The weighted average interest rate applicable to outstanding borrowings under the ABL Credit Agreement was 5.25% as of October 28, 2014.

Mattress Holdco, Inc., the parent company of the borrower, and each domestic subsidiary of the Company other than immaterial subsidiaries will unconditionally guarantee all existing and future indebtedness and liabilities of the other guarantors and the Company arising under the ABL Credit Agreement and other loan documents.

The ABL Credit Agreement requires compliance with one financial covenant. The Company cannot permit its fixed charge coverage ratio to fall below 1.0 to 1.0. The ABL Credit Agreement generally defines the fixed charge coverage ratio as the ratio of (a) adjusted EBITDA, less capital expenditures, less all taxes paid or payable in cash by the borrower and guarantors to (b) the sum of fixed charges, in each case, determined as of the most recently ended fiscal quarter. The ABL Credit Agreement also contains customary representations, warranties and affirmative and negative covenants.

Events of default under the ABL Credit Agreement include failure to pay principal or interest when due, failure to comply with the financial and operational covenants, as well as a cross default event, Loan Document (as defined in the ABL Credit Agreement) enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then the lenders holding the majority of the outstanding loans have the right, among others, to (i) terminate the commitments under the ABL Credit Agreement, (ii) accelerate and require the Company to repay all the outstanding amounts owed under any Loan Document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic), and (iii) require the Company to cash collateralize any outstanding letters of credit.

Outstanding ABL Credit Agreement borrowings were $35.0 million at October 28, 2014. Outstanding letters of credit on the revolving facility were $3.2 million at October 28, 2014, resulting in $49.2 million of availability for revolving borrowings.

Effective October 20, 2014, Mattress Holding Corp., a Delaware corporation and indirect subsidiary of Mattress Firm Holding Corp., a Delaware corporation, entered into a $720 million term loan credit agreement dated October 20, 2014, among Mattress Holding Corp., as borrower, Mattress Holdco, Inc., the lenders party thereto, and Barclays Bank PLC, as administrative agent and collateral agent (the “Term Loan Credit Agreement”). The Term Loan Credit Agreement and the ABL Credit Agreement are collectively referred to as the “2014 Senior Credit Facility”.

Term loans in the aggregate principal amount of $720 million were issued under the Term Loan Credit Agreement on October 20, 2014. The maturity date under the Term Loan Credit Agreement is October 20, 2021. Loans under the Term Loan Credit Agreement bear interest by reference, at the Company’s election, to the LIBOR rate or base rate and varies from 3.00%

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

to 3.25%, in each case determined based upon the Company’s total net leverage ratio. The weighted average interest rate applicable to outstanding borrowings under the Term Loan Credit Agreement was 5.25% as of October 28, 2014.

Events of default under the Term Loan Credit Agreement include failure to pay principal or interest when due, failure to comply with the covenants, as well as a cross default event, Loan Document (as defined in the Term Loan Credit Agreement) enforceability event, change of control event and bankruptcy and other insolvency events. If an event of default occurs and is continuing, then the lenders holding a majority of the outstanding loans have the right, among others, to (i) terminate the commitments under the Term Loan Credit Agreement, and (ii) accelerate and require the Company to repay all the outstanding amounts owed under any Loan Document (provided that in limited circumstances with respect to insolvency and bankruptcy of the Company, such acceleration is automatic).

Equipment Financing and Other Short-Term Notes Payable—A subsidiary of the Company has an outstanding note payable related to the purchase of mattress specialty retail stores formerly operated by our franchisee, Perfect Mattress, in the aggregate principal amount of $0.5 million that bears interest at 7.75% with quarterly principal and interest payments through fiscal 2014.

A subsidiary of the Company has an outstanding note payable related to the purchase of mattress specialty retail stores formerly operated by Mattress Liquidators, in the aggregate principal amount of $2.9 million that bears interest at 6.00% with quarterly principal and interest payments through fiscal 2016.

A subsidiary of the Company has financed property and casualty insurance premiums payable in the amount of $0.3 million payable in fiscal 2014.

In conjunction with the acquisition of Sleep Train, the Company assumed notes payable in the aggregate principal amount of $6.8 million that bears interest at 2.97% with monthly principal and interest payments through fiscal 2016.

A subsidiary of the Company has an outstanding note payable related to the purchase of mattress specialty retail stores formerly operated by Best Mattress, in the aggregate principal amount of $0.6 million that bears interest at 6.00% with quarterly principal and interest payments through fiscal 2016.

5. Income Taxes

Income tax expense during interim periods is based on the estimated annual effective income tax rate plus any discrete items which are recorded in the period in which they occur. Discrete items include such events as changes in estimates due to the finalization of tax returns, tax audit settlements, tax law changes, and increases or decreases in valuation allowances related to prior year estimates. The determination of the consolidated provision for income taxes, deferred tax assets and liabilities and related valuation allowance requires management to make judgments and estimates. Although management believes that its tax estimates are reasonable, the ultimate tax determination involves significant judgments that could become subject to audit by tax authorities in the ordinary course of business, as well as the generation of sufficient future taxable income.

The Company recognized $23.8 million of income tax expense for the thirty-nine weeks ended October 28, 2014, compared to $27.8 million of income tax expense for the thirty-nine weeks ended October 29, 2013. The effective tax rate was 38.7% for the thirty-nine weeks ended October 28, 2014, compared to 38.5% for the thirty-nine weeks ended October 29, 2013. The effective tax rate of 38.7% for the current period differs from the federal statutory rate of 35.0% primarily due to state income taxes.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The Company and its subsidiaries are included in a consolidated income tax return in the U.S. federal jurisdiction and file separate income tax returns in several states. As of October 28, 2014, open tax years in federal and some state jurisdictions date back to October 2002 due to the taxing authorities’ ability to adjust operating loss carryforwards.

As of January 28, 2014, the Company had approximately $9.1 million of net operating loss carryforwards that begin expiring in fiscal 2029, if not utilized to offset future taxable income. These net operating loss carryforwards arose from the acquisition of MGHC Holding Corporation (“Mattress Giant”) during fiscal 2012, and after application of Section 382 of the Internal Revenue Code of 1986, as amended, are limited to an average use of $2.8 million per year over the next four years.

The Company has established a cumulative liability for unrecognized tax benefits of $0.4 million as of October 28, 2014 and January 28, 2014. Management does not anticipate there will be a material change in the total amount of unrecognized tax benefits within the next twelve months. Management accrued less than $0.1 million of interest on these unrecognized tax benefits as of October 28, 2014.

6. Earnings Per Share

Basic net income per common share is computed by dividing the net income applicable to common shares by the weighted average number of common shares outstanding during the period. Diluted net income per common share is computed by dividing net income by the weighted average number of common shares outstanding during the period, adjusted to reflect potentially dilutive securities using the treasury stock method for stock option awards. Diluted net income per common share adjusts basic net income per common share for the effects of stock options and other potentially dilutive financial instruments only in the periods in which such effect is dilutive.

The following table presents a reconciliation of the weighted average shares outstanding used in the earnings per share calculations:



	Thirteen Weeks Ended				Thirty-Nine Weeks Ended
	October 29,		October 28,			October 29,	October 28,
	2013		2014			2013	2014
Basic weighted average shares outstanding		33,878,241		34,285,572		33,848,032		34,149,531
Effect of dilutive securities:
Stock options		195,372		374,518		186,334		344,025
Restricted shares		40,534		64,109		38,941		68,818
Diluted weighted average shares outstanding		34,114,147		34,724,199		34,073,307		34,562,374

Diluted net income per common share for the thirteen and thirty-nine weeks ended October 28, 2014, excludes stock options for the purchase of 64,241 and 160,693 shares of common stock, respectively, as their inclusion would be anti-dilutive. Diluted net income per common share for the thirteen and thirty-nine weeks ended October 28, 2014, excludes non-vested restricted stock granted of 16,963 and 81,685 shares, respectively, as their inclusion would be anti-dilutive. Diluted net income per common share for the thirteen and thirty-nine weeks ended October 29, 2013, excludes stock options for the purchase of 327,101 shares of common stock as their inclusion would be anti-dilutive. Diluted net income per common share for the thirteen and thirty-nine weeks ended October 29, 2013, excludes non-vested restricted stock granted of 48,465 shares as their inclusion would be anti-dilutive.

Certain stock option and restricted stock awards contain vesting conditions based on specified stock price targets for the Company’s common stock as measured at each of the annual vesting dates (“market-based awards”). The Company includes such market-based awards in the determination of dilutive weighted average shares outstanding under the treasury stock method when, as of the date of determination, the specified stock price targets are met and the common stock shares pursuant to those awards become contingently issuable. Accordingly, the determination of diluted weighted average shares outstanding excludes, as of the date of determination, stock options for the purchase of 15,388 and 6,638 shares of common stock for the thirteen and thirty-nine weeks ended October 28, 2014, respectively, and 273,938 shares of common stock for the thirteen and thirty-nine weeks ended October 29, 2013, and excludes 149,161 shares of non-vested restricted stock for the

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

thirteen and thirty-nine weeks ended October 28, 2014 and 70,566 shares of non-vested restricted stock for the thirteen and thirty-nine weeks ended October 29, 2013.

7. Commitments and Contingencies

The Company conducts the majority of its operations from leased store and warehouse facilities pursuant to non-cancellable operating lease agreements with initial terms general ranging from 1 to 15 years. Certain leases include renewal options generally ranging from one to five years and contain certain rent escalation clauses. Most leases require the Company to pay its proportionate share of the property tax, insurance and maintenance expenses of the property. Certain leases provide for contingent rentals based on sales volume: however, incremental rent expense resulting from such arrangements are accrued for those stores expected to surpass the sales threshold subject to their respective lease agreements.

The Company is subject to legal proceedings and claims that arise in the ordinary course of business. Management does not believe that the outcome of any of those matters will have a material adverse effect on the Company’s financial position, results of operations or cash flows.

8. Stock-Based Compensation

2011 Omnibus Incentive Plan—On November 3, 2011, the Company’s board of directors and shareholders adopted the Mattress Firm Holding Corp. 2011 Omnibus Incentive Plan to provide for the grant of equity-based awards to Company employees, directors and other service providers. A total of 4,206,000 shares of the Company’s common stock were reserved for grants under the 2011 Omnibus Incentive Plan. There were 2,321,252 shares available for future grants under the stock incentive plan as of October 28, 2014.

Stock Options—A portion of the stock options granted to the Company’s employees are subject to time-based vesting schedules, while the remaining portion of the stock options are subject to market-based vesting schedules, with such vesting based on specified stock price targets. The exercise price of the options is based upon the closing market price per share of the Company’s common stock on the date of grant, and the options have a term of 10 years.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The following table summarizes the stock option grants, exercises, and forfeitures for the thirty-nine weeks ended October 28, 2014 (in thousands, except per share amounts):



		Weighted
		Average
	Stock	Exercise Price
	Options	Per Share
Outstanding, as of January 28, 2014	1,291	$	23.32
Granted (a)	56	$	55.89
Exercised (b)	(121)	$	23.82
Forfeited	(143)	$	34.32
Outstanding, as of October 28, 2014 (c)	1,083	$	23.50
Exercisable, as of October 28, 2014 (d)	304	$	21.21

(a)

The weighted average grant date fair value of stock options granted during the thirty-nine weeks ended October 28, 2014 was $32.10.

(b)

The aggregate intrinsic value of stock options exercised during the thirty-nine weeks ended October 28, 2014 was $3.1 million. The weighted average market price of shares exercised during the thirty‑nine weeks ended October 28, 2014 was $49.57.

(c)

Stock options outstanding as of October 28, 2014 have a weighted average remaining contractual term of 7.35 years and an aggregate intrinsic value of $43.6 million based on the market value of the Company’s common stock on October 28, 2014.

(d)

Stock options exercisable as of October 28, 2014 have a weighted average remaining contractual term of 7.23 years and an aggregate intrinsic value of $12.9 million based on the market value of the Company’s common stock on October 28, 2014.

Future vesting dates on the stock options range from November 17, 2014 to September 2, 2018, and expiration dates range from November 17, 2021 to September 2, 2024 at exercise prices and average contractual lives as follows:



Range of Exercise Prices	Outstanding as of October 28, 2014 (in thousands)	Weighted Average Remaining Contractual Life (in years)	Weighted Average Exercise Price		Exercisable as of October 28, 2014 (in thousands)	Weighted Average Remaining Contractual Life (in years)	Weighted Average Exercise Price
Time Based
$19.00 - $29.26	466	7.10	$	19.55	125	7.11	$	19.72
$36.84 - $57.05	152	9.17	$	46.14	21	8.80	$	40.52
Market Based
$19.00 - $29.26	448	6.94	$	19.42	154	7.08	$	19.32
$36.84 - $57.05	17	8.49	$	36.84	4	8.49	$	36.84

The Company accounts for employee stock options under the fair value method of accounting using a Black Scholes methodology to measure time based option fair value at the date of grant and a Monte Carlo Simulation approach to measure

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

market-based option fair value at the date of grant. The fair value of the stock options at the date of grant is recognized as expense over the vesting term, which represents the requisite service period.

The following assumptions were used to calculate the fair value of the Company’s time-based stock options on the date of grant utilizing the Black- Scholes option pricing model:



	Thirty-Nine Weeks Ended October 28, 2014
Weighted average expected life (in years)	6.25
Volatility factor	60	%
Dividend yield	0	%
Risk-free interest rate	1.95 to 2.08	%

The Company bases its expected option life on the expected exercise and termination behavior of the option holders and an appropriate model of the Company’s future stock price. The expected volatility assumption is derived from the historical volatility of similar companies’ common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options, combined with other relevant factors. The dividend yield is the annual rate of dividends per share over the exercise price of the option as of the grant date.

For the thirteen and thirty-nine weeks ended October 28, 2014, the Company recognized $0.8 million and $2.0 million, respectively, of compensation expense associated with stock option awards in general and administrative expenses in the consolidated statement of operations compared to $0.8 million and $1.9 million for the thirteen and thirty-nine weeks ended October 29, 2013, respectively. The Company did not capitalize any equity-based compensation costs related to stock options during the thirteen and thirty-nine weeks ended October 28, 2014 and October 29, 2013.

As of October 28, 2014, the Company estimates that a total of approximately $6.1 million of currently unrecognized forfeiture adjusted compensation expense will be recognized over a weighted average period of 2.40 years for unvested stock option awards issued and outstanding.

Restricted Stock—The Company grants restricted stock to certain employees and to non-employee independent directors. A portion of the restricted stock granted to the Company’s employees is subject to time-based vesting schedules, while the remaining portion of the restricted stock is subject to market-based vesting schedules, with such vesting based on specified stock price targets.

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MATTRESS FIRM HOLDING CORP.

Notes to the Unaudited Condensed Consolidated Financial Statements (Continued)

The following table summarizes the restricted stock grants, vesting, and forfeitures for the thirty-nine weeks ended October 28, 2014 (in thousands, except per share amounts):



		Weighted
		Average
	Restricted	Fair
	Shares	Value
Outstanding, as of January 28, 2014	249	$	29.93
Granted (a)	209	$	39.68
Vested (b)	(92)	$	30.33
Forfeited	(16)	$	25.69
Unvested, as of October 28, 2014	350	$	35.83

(a)

The total grant-date fair value of restricted stock awards granted during the period was $8.3 million.

(b)

The total fair value of awards vested during the thirty-nine weeks ended October 28, 2014 was $5.4 million.

The Company accounts for restricted stock under the fair value method of accounting using the closing market price per share of the Company’s stock to measure time based restricted stock fair value at the date of grant and a Monte Carlo Simulation approach to measure market-based restricted stock fair value at the date of grant. The fair value of the restricted stock at the date of grant is recognized as expense over the vesting term, which represents the requisite service period.

The following assumptions were used to calculate the fair value of the Company’s market-based restricted stock on the grant date utilizing a Monte Carlo Simulation approach:



	Thirty-Nine Weeks Ended October 28, 2014
Weighted average expected life (in years)	4
Volatility factor	40	%
Dividend yield	0	%
Risk-free interest rate	1.33 to 1.34	%

For the thirteen and thirty-nine weeks ended October 28, 2014, the Company recognized $1.6 million and $3.0 million, respectively, of compensation expense associated with restricted stock awards in general and administrative expenses in the condensed consolidated statement of operations compared to $0.6 million and $1.3 million for the thirteen and thirty-nine weeks ended October 29, 2013, respectively. The Company did not capitalize any equity-based compensation costs related to restricted stock awards during the thirteen and thirty-nine weeks ended October 28, 2014 and October 29, 2013.

As of October 28, 2014, the Company estimates that a total of approximately $10.2 million of currently unrecognized forfeiture adjusted compensation expense will be recognized over a weighted average period of 2.37 years for unvested restricted stock awards.

9. Subsequent Event

On November 5, 2014, the Company entered into an agreement to acquire substantially all of the mattress specialty retail assets and operations of Sleep America LLC (“Sleep America”), which operates 47 Sleep America retail stores in Arizona, for a total purchase price of approximately $12.5 million, subject to working capital and other customary adjustments. The acquisition, which is subject to customary closing conditions, is expected to close in the fourth fiscal quarter.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The discussion in this section contains forward-looking statements that involve risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements” included elsewhere in this report for a discussion of important factors that could cause actual results to differ materially from those described or implied by the forward-looking statements contained herein.

Unless the context otherwise requires, the terms “Mattress Firm®,” “our company,” “the Company,” “we,” “us,” “our” and the like refer to Mattress Firm Holding Corp. and its consolidated subsidiaries. Unless otherwise indicated, (i) the term “our stores” refers to our company-operated stores and our franchised stores and (ii) when used in relation to our company, the terms “market” and “markets” refer to the metropolitan statistical area or an aggregation of the metropolitan statistical areas in which we or our franchisees operate.

In this report, we refer to earnings before interest, taxes, depreciation and amortization and other adjustments (such as goodwill impairment charges, loss on store closings and acquisition expenses), or “Adjusted EBITDA.” Adjusted EBITDA is not a performance measure under accounting principles generally accepted in the United States, or “U.S. GAAP.” See “Adjusted EBITDA to Net Income Reconciliation” on page 33 and 34 for a definition of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income.

We report on the basis of a 52- or 53-week fiscal year, which ends on the Tuesday closest to January 31. Each fiscal year is described by the period of the calendar year that comprises the majority of the fiscal year period. For example, the fiscal year ending February 3, 2015 is described as “fiscal 2014.” Fiscal 2014 contains 53 weeks.

Executive Summary

Net sales during the thirteen and thirty-nine weeks ended October 28, 2014 improved $138.1 million and $303.0 million, respectively, from the comparable prior year levels as a result of the addition of new and acquired store units and an increase in comparable-store sales. Key results for the thirteen and thirty-nine weeks ended October 28, 2014 include:

Net income decreased $2.5 million to $15.6 million for the thirteen weeks ended October 28, 2014, compared to $18.1 million for the comparable prior year period. Net income decreased $6.7 million to $37.6 million for the thirty-nine weeks ended October 28, 2014, compared to $44.3 million for the comparable prior year period.

Income from operations for the thirteen weeks ended October 28, 2014 was $31.6 million. Excluding $12.1 million of acquisition-related expenses, enterprise resource planning (“ERP”) system implementation costs, and impairment and severance charges, adjusted income from operations was $43.7 million, and adjusted operating margin during the thirteen weeks ended October 28, 2014 decreased 60 basis-points from 10.0% during the thirteen weeks ended October 29, 2013 to 9.4% during the thirteen weeks ended October 28, 2014. This operating margin decrease on an adjusted basis (excluding acquisition-related and ERP system implementation costs) is comprised of a 80 basis-point decrease from sales and marketing expense deleverage, a 40 basis-point decrease from general and administrative expense deleverage, offset by a 80 basis-point increase in gross margin, and 20 basis-points of combined operating margin declines in other areas. Income from operations for the thirty-nine weeks ended October 28, 2014 was $74.0 million. Excluding $27.7 million of acquisition-related expenses, ERP system implementation costs and impairment and severance charges, adjusted income from operations was $101.7 million, and adjusted operating margin during the thirty-nine weeks ended October 28, 2014 decreased 80 basis-points from 9.2% during the thirty-nine weeks ended October 29, 2013 to 8.4% during the thirty-nine weeks ended October 28, 2014. This operating margin decrease on an adjusted basis (excluding acquisition-related, ERP system implementation costs and impairment and severance charges) is comprised of a 60 basis-point decrease from general and administrative expense deleverage, a 10 basis-point decline in gross margin, and 10 basis-points of combined operating margin declines in other areas. Acquisition-related costs for purposes of management’s discussion and analysis, which are included in the results of operations, consist of the acquisition-related costs as defined under U.S. GAAP, including advisory, legal, accounting, valuation, and other professional or consulting fees and, in addition, costs of integrating store and warehouse operations and corporate functions. ERP system

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implementation costs, which are included in the results of operations, consist primarily of training costs related to the roll-out of the Microsoft Dynamics AX for Retail ERP system. Impairment charges, which are included in results of operations, consist of an impairment of store assets. Severance expense, which is included in the results of operations, resulted from our realignment of our management structure at the beginning of the second fiscal quarter of fiscal 2014. (Adjusted income from operations is not a performance measure under U.S. GAAP. See “Reconciliation of Reported (U.S. GAAP) to Adjusted Statements of Operations Data” on page 35 and 36 for a reconciliation of net income as reported to adjusted net income.)

Adjusted EBITDA increased $13.3 million to $55.7 million for the thirteen weeks ended October 28, 2014, compared with $42.4 million for the comparable prior year period. Adjusted EBITDA as a percentage of net sales decreased to 12.0% during the thirteen weeks ended October 28, 2014, compared with 13.0% for the comparable prior year period. Adjusted EBITDA increased $25.1 million to $135.7 million for the thirty-nine weeks ended October 28, 2014, compared with $110.6 million for the comparable prior year period. Adjusted EBITDA as a percentage of net sales decreased to 11.2% during the thirty-nine weeks ended October 28, 2014, compared with 12.2% for the comparable prior year period. See “Adjusted EBITDA to Net Income Reconciliation” on page 33 and 34 for a definition of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income.

Net sales increased $138.1 million, or 42.3%, to $464.3 million for the thirteen weeks ended October 28, 2014, compared to $326.2 million for the comparable prior year period primarily as the result of an increase in the number of stores we operated and an increase in comparable-store sales. Comparable-store sales increased 8.5% during the thirteen weeks ended October 28, 2014. Net sales increased $303.0 million, or 33.5%, to $1,207.7 million for the thirty-nine weeks ended October 28, 2014, compared to $904.7 million for the comparable prior year period primarily as the result of an increase in the number of stores we operated and an increase in comparable-store sales. Comparable-store sales increased 7.6% during the thirty-nine weeks ended October 28, 2014.

The components of the net sales increase for the thirteen and thirty-nine weeks ended October 28, 2014 as compared to the thirteen and thirty-nine weeks ended October 29, 2013 were as follows (in millions):



	Progression in Net Sales
	Thirteen Weeks Ended October 28, 2014		Thirty-Nine Weeks Ended October 28, 2014
Net sales for prior year period	$	326.2	$	904.7
Increase (decrease) in net sales:
Comparable-store sales		27.2		67.5
New stores		47.9		123.7
Acquired stores		67.3		126.1
Closed stores		(4.3)		(14.3)
Increase in net sales, net		138.1		303.0
Net sales for current year period	$	464.3	$	1,207.7
% increase		42.3%		33.5%

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The components of net sales by major category of product and services were as follows (in millions):



	Thirteen Weeks Ended								Thirty-Nine Weeks Ended
	October 29,		% of		October 28,		% of		October 29,		% of		October 28,		% of
	2013		Total		2014		Total		2013		Total		2014		Total
Conventional mattresses	$	151.7	46.5	%	$	208.4	44.9	%	$	421.8	46.6	%	$	567.6	47.0	%
Specialty mattresses		144.5	44.3	%		211.9	45.6	%		403.5	44.6	%		525.7	43.5	%
Furniture and accessories		24.3	7.5	%		35.7	7.7	%		62.6	6.9	%		91.4	7.6	%
Total product sales		320.5	98.3	%		456.0	98.2	%		887.9	98.1	%		1,184.7	98.1	%
Delivery service revenues		5.7	1.7	%		8.3	1.8	%		16.8	1.9	%		23.0	1.9	%
Total net sales	$	326.2	100.0	%	$	464.3	100.0	%	$	904.7	100.0	%	$	1,207.7	100.0	%

The activity with respect to the number of company-operated store units was as follows:



	Thirteen Weeks Ended October 28, 2014	Thirty-Nine Weeks Ended October 28, 2014
Store units, beginning of period	1,480	1,225
New stores	54	163
Acquired stores	460	619
Closed stores	(8)	(21)
Store units, end of period	1,986	1,986

Operating cash flows were $21.3 million and $79.6 million during the thirteen and thirty-nine weeks ended October 28, 2014.

On March 3, 2014, we acquired the leasehold interests, store assets, distribution center assets and related inventories, and assumed certain liabilities of Yotes, a franchisee of ours, relating to the operation of 34 mattress specialty retail stores located in Colorado and Kansas for a total purchase price of approximately $14.3 million, including working capital adjustments.

On March 3, 2014, we acquired the Virginia leasehold interests and store assets, and assumed certain liabilities, of Southern Max, a franchisee of ours, relating to the operations of three mattress specialty retail stores located in Virginia for a total purchase price of approximately $0.5 million, including working capital adjustments.

On April 3, 2014, we acquired one hundred percent of the outstanding partnership interests in Sleep Experts, related to the operations of 55 mattress specialty retail stores in Texas under the brand Sleep Experts, for a total purchase price of approximately $67.8 million, including working capital adjustments, subject to customary post-closing adjustments. The purchase price consisted of cash of $62.8 million (net of $1.6 million of cash acquired), and $3.4 million delivered in the form of 71,619 shares of common stock, par value $0.01 per share, of Mattress Firm Holding Corp. common stock as calculated in accordance with the terms of the purchase agreement.

We funded the cash requirements of the Yotes and Southern Max acquisitions using cash reserves and revolver borrowings. We raised $100 million of incremental term borrowings under the 2012 Senior Credit Facility to fund the cash requirements of the Sleep Experts acquisition and to pay down outstanding revolver borrowings. The new incremental term borrowings were scheduled to mature in January 2016 and were subject to the same interest rate as the existing outstanding incremental borrowings under the 2012 Senior Credit Facility. These term borrowings were repaid in October 2014 using the proceeds of the 2014 Senior Credit Facility.

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On June 4, 2014, we acquired substantially all of the mattress specialty retail assets and operations of Mattress Liquidators, Inc., which operated Mattress King retail stores in Colorado and BedMart retail stores in Arizona. The acquisition was for an aggregate purchase price of approximately $33.0 million, including working capital adjustments, and relates to the operations of 67 mattress specialty retail stores primarily in Colorado and Arizona. The purchase price consisted of cash of $29.5 million funded by cash reserves and revolver borrowings, as well as a $3.5 million seller note, payable in quarterly installments over two years. We currently operate Mattress Firm stores in these markets and substantially completed the rebranding of the acquired stores during the third fiscal quarter.

On September 8, 2014, we acquired substantially all of the mattress specialty retail assets and operations of Best Mattress Co., Inc., which operated Mattress Discounters retail stores in Pennsylvania, related to the operation of 15 mattress specialty retail stores, for a total purchase price of approximately $6.2 million, giving effect to certain preliminary adjustments, and is subject to further customary adjustments. The purchase price consisted of cash of $5.6 million funded by cash reserves and revolver borrowings, as well as a $0.6 million seller note, payable in quarterly installments over two years.

On September 30, 2014, we acquired substantially all of the mattress specialty retail assets and operations of Back to Bed Inc., M World Mattress LLC, MCStores LLC and TBE Orlando LLC, which operated Back to Bed and Bedding Experts retail stores in Illinois, Indiana and Wisconsin and Bedding Experts and Mattress Barn retail stores in Florida, related to the operation of 131 mattress specialty retail stores, for a total purchase price of approximately $60.3 million, giving effect to certain preliminary adjustments, and is subject to further customary adjustments. The purchase price consisted of cash of $60.3 million funded by cash reserves and revolver borrowings, of which $19.0 million was placed in escrow.

On October 20, 2014, we acquired 100% of the outstanding equity interests in The Sleep Train, Inc., which operates Sleep Train, Sleep Country, Mattress Discounters, America’s Mattress and Got Sleep retail stores in California, Washington, Oregon, Nevada, Idaho and Hawaii, related to the operation of 314 mattress specialty retail stores, for a total purchase price of approximately $448.2 million, giving effect to certain preliminary adjustments, and is subject to further customary adjustment, along with the assumption of certain additional liabilities totaling approximately $15 million. The Company expects to receive future annual cash income tax benefits of approximately $11 million over the next 15 years from deductible tax basis goodwill generated from the transaction, subject to the Company’s ability to generate future taxable income. The purchase price consisted of cash of $388.1 million (net of $15.9 million of cash acquired), of which $49.0 million was placed in escrow, and $44.2 million delivered in the form of 745,107 shares of common stock, par value $0.01 per share, of Mattress Firm Holding Corp. common stock as calculated in accordance with the terms of the purchase agreement.

Concurrently with the closing of the Sleep Train acquisition, we entered into a new senior secured credit facility with Barclays Bank PLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated, J.P. Morgan Securities LLC, and UBS Securities LLC, as joint bookrunning managers and joint lead arrangers. The senior secured credit facility is comprised of (i) an asset based revolver of $125 million that includes a sublimit for letters of credit and swingline loans, subject to certain conditions and limits and (ii) a term loan B borrowing of $720 million (See Note 4). Approximately $49 million of the availability under the asset based revolver were drawn at closing to fund the Sleep Train acquisition.

At October 28, 2014, there were $35 million in outstanding revolver borrowings, $3.2 million outstanding standby letters of credit, and additional borrowing capacity of $49.2 million under the 2014 Senior Credit Facility.

General Definitions for Operating Results

Net sales are recognized upon delivery and acceptance of mattresses and bedding products by our customers and include fees collected for delivery services, and are recorded net of estimated returns. Customer deposits collected prior to the delivery of merchandise are recorded as a liability. Net sales are recognized net of sales tax collected from customers and remitted to various taxing jurisdictions.

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Cost of sales consist of the following:

Costs associated with purchasing and delivering our products to our stores and customers, net of vendor incentives earned on the purchase of products subsequently sold;

Physical inventory losses;

Store and warehouse occupancy and depreciation expense of related facilities and equipment;

Store and warehouse operating costs, including warehouse (i) labor costs, (ii) utilities, (iii) repairs and maintenance, (iv) supplies and (v) store facilities; and

Estimated costs to provide for customer returns and exchanges and to service customer warranty claims.

Gross profit from retail operations is net sales minus cost of sales.

Franchise fees and royalty income represents initial franchise fees earned upon the opening of new franchisee stores and ongoing royalties based on a percentage of gross franchisee sales.

Sales and marketing expenses consist of the following:

Advertising and media production;

Payroll and benefits for sales associates; and

Merchant service fees for customer credit and debit card payments, check guarantee fees and promotional financing expense.

General and administrative expenses consist of the following:

Payroll and benefit costs for corporate office and regional management employees;

Stock-based compensation costs;

Occupancy costs of corporate facility;

Information systems hardware, software and maintenance;

Depreciation related to corporate assets;

Management fees;

Insurance; and

Other overhead costs.

Loss on store closings and impairment of store assets consists of the following:

Estimated future costs to close locations at the time of closing including, as applicable, the difference between future lease obligations and anticipated sublease rentals;

The write off of unamortized fixed assets related to store leasehold costs on closed stores; and

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Non-cash charges recognized for long-lived assets generally consisting of leasehold costs and related equipment resulting in a reduction of the carrying value to estimated fair value, based on our periodic assessment of whether projected future cash flows of individual stores are sufficient to recover the carrying value of the related assets.

Income from operations consists of gross profit from retail operations plus franchise fees and royalty income, minus (i) sales and marketing expenses, (ii) general and administrative expenses and (iii) loss (gain) on store closings and impairment of store assets.

Other expense, net includes interest income, interest expense and loss on early debt extinguishments. Interest expense includes interest on outstanding debt, amortization of debt discounts, and amortization of financing costs.

Results of Operations

The following table presents the consolidated historical financial operating data for our business for each period indicated (amounts in thousands). The historical results are not necessarily indicative of results to be expected for any future period.



	Thirteen Weeks Ended								Thirty-Nine Weeks Ended
	October 29,		% of		October 28,		% of		October 29,		% of		October 28,		% of
	2013		Sales		2014		Sales		2013		Sales		2014		Sales
Net sales	$	326,233	100.0	%	$	464,278	100.0	%	$	904,731	100.0	%	$	1,207,731	100.0	%
Costs of sales		200,267	61.4	%		281,323	60.6	%		553,878	61.2	%		740,522	61.3	%
Gross profit from retail operations		125,966	38.6	%		182,955	39.4	%		350,853	38.8	%		467,209	38.7	%
Franchise fees and royalty income		1,655	0.5	%		1,238	0.3	%		4,342	0.5	%		3,516	0.3	%
Total gross profit		127,621	39.1	%		184,193	39.7	%		355,195	39.3	%		470,725	39.0	%
Sales and marketing expenses		74,605	22.9	%		109,632	23.7	%		214,104	23.7	%		285,295	23.7	%
General and administrative expenses		21,225	6.5	%		42,783	9.2	%		60,143	6.6	%		110,358	9.1	%
Loss on store closings and impairment of store assets		(5)	—	%		133	—	%		739	0.1	%		1,039	0.1	%
Income from operations		31,796	9.7	%		31,645	6.8	%		80,209	8.9	%		74,033	6.1	%
Other expense, net		2,543	0.7	%		6,355	1.4	%		8,185	0.9	%		12,640	1.0	%
Income before income taxes		29,253	9.0	%		25,290	5.4	%		72,024	8.0	%		61,393	5.1	%
Income tax expense		11,117	3.4	%		9,677	2.0	%		27,756	3.1	%		23,762	2.0	%
Net income	$	18,136	5.6	%	$	15,613	3.4	%	$	44,268	4.9	%	$	37,631	3.1	%

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Thirteen Weeks Ended October 28, 2014 Compared to Thirteen Weeks Ended October 29, 2013

Net sales. Net sales increased $138.1 million, or 42.3%, to $464.3 million during the thirteen weeks ended October 28, 2014, compared to $326.2 million during the thirteen weeks ended October 29, 2013 primarily as a result of an increase in the number of stores we operated and an increase in comparable-store sales. The components of the net sales increase for the thirteen weeks ended October 28, 2014 as compared to the thirteen weeks ended October 29, 2013 were as follows (in millions):


	Progression in Net Sales
	Thirteen Weeks Ended October 28, 2014
Net sales for prior year period	$	326.2
Increase (decrease) in net sales:
Comparable-store sales		27.2
New stores		47.9
Acquired stores		67.3
Closed stores		(4.3)
Increase in net sales, net		138.1
Net sales for current year period	$	464.3
% increase		42.3%

Comparable-store net sales increased 8.5%, which was primarily the result of a combination of an increase in unit sales, particularly driven by conventional mattress sales and a focus on keeping stock in the stores, and an increase in average ticket, driven primarily by specialty mattress sales. The increase in our net sales from new stores was the result of 196 new stores opened at various times during the fifty-two week period ended October 28, 2014, including 54 stores opened during the thirteen week period ended October 28, 2014, prior to their inclusion in the comparable-store sales calculation which begins with the thirteenth full fiscal period of operations. The increase in net sales from acquired stores was the result of the acquisitions of five former Mattress People stores in November 2013, 39 stores formerly operated by Perfect Mattress in December 2013, two stores formerly operated by Mattress Expo in December 2013, 34 stores formerly operated by Yotes in March 2014, three stores formerly operated by Southern Max in March 2014, 55 Sleep Experts stores in April 2014, 67 stores formerly operated by Mattress Liquidators in June 2014, 15 stores formerly operated by Best Mattress in September 2014,131 stores formerly operated by Back to Bed in September 2014 and 314 Sleep Train stores in October 2014. We closed 30 stores during the fifty-two week period ended October 28, 2014, including 8 stores during the thirteen week period ended October 28, 2014. We operated 1,986 stores at October 28, 2014, compared with 1,155 stores at October 29, 2013.

Cost of sales. Cost of sales increased $81.1 million, or 40.5%, to $281.3 million during the thirteen weeks ended October 28, 2014, compared to $200.3 million during the thirteen weeks ended October 29, 2013. The major components of the increase in cost of sales are discussed below. Cost of sales as a percentage of net sales decreased to 60.6% during the thirteen weeks ended October 28, 2014, as compared to 61.4% for the comparable prior year period.

Product costs increased by $49.3 million, or 39.1%, to $175.3 million during the thirteen weeks ended October 28, 2014, compared with $126.0 million during the thirteen weeks ended October 29, 2013. The increase in the amount of product costs is primarily the result of the corresponding increase in net sales. Product costs as a percentage of net sales decreased to 37.8% during the thirteen weeks ended October 28, 2014 from 38.6% during the thirteen weeks ended October 29, 2013. The decrease in product costs as a percentage of net sales is largely the result of prior year sales initiatives which resulted in an increase in unit sales at lower product margins in the comparable prior year period.

Store and warehouse occupancy costs, consisting primarily of lease related costs of rented facilities, increased $19.4 million, or 45.1%, to $62.4 million during the thirteen weeks ended October 28, 2014, compared to $43.0 million for the corresponding prior year period. The increase in the amount of store and warehouse occupancy costs during the thirteen weeks ended October 28, 2014 was mainly attributable to the increase in the number of stores we operated and the warehouse operations in a number of new markets opened or acquired. Store and warehouse occupancy costs as a percentage of net sales increased to 13.4% during the thirteen weeks ended October 28, 2014, compared to 13.2% during the thirteen weeks ended October 29, 2013. The increase in store and warehouse occupancy costs as a percentage of net sales during the thirteen weeks ended October 28, 2014 was mostly attributable to our entrance into new markets that

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resulted in less scale and cost leverage relative to established markets, partially offset by leverage generated from comparable-store sales growth in our established markets.

Depreciation expense related to leasehold improvements and other fixed assets used in stores and warehouse operations increased $2.0 million, or 29.8%, to $8.7 million, during the thirteen weeks ended October 28, 2014, compared to $6.7 million during the thirteen weeks ended October 29, 2013. The increase in expense was primarily attributable to the increase in the number of stores we operated during the thirteen weeks ended October 28, 2014, as compared with the comparable prior year period.

Other cost of sales, consisting of store and warehouse operating and delivery costs, increased $10.4 million, or 42.2%, to $35.0 million during the thirteen weeks ended October 28, 2014, compared to $24.6 million during the thirteen weeks ended October 29, 2013, primarily as a result of the increase in net sales and in the increased number of stores we operated during the thirteen weeks ended October 28, 2014, as compared with the corresponding prior year period.

Gross profit from retail operations. As a result of the above, gross profit from retail operations increased $57.0 million, or 45.2%, to $183.0 million during the thirteen weeks ended October 28, 2014, compared with $126.0 million during the thirteen weeks ended October 29, 2013. Gross profit from retail operations as a percentage of net sales increased to 39.4% during the thirteen weeks ended October 28, 2014, as compared to 38.6% during the thirteen weeks ended October 29, 2013, for the reasons discussed above.

Franchise fees and royalty income. Franchise fees and royalty income decreased $0.5 million, or 25.2%, to $1.2 million during the thirteen weeks ended October 28, 2014, compared to $1.7 million during the thirteen weeks ended October 29, 2013 primarily as a result of our acquisitions of certain formerly franchised operations, as described above. Our franchisees operated 111 stores at October 28, 2014, compared with 171 stores at October 29, 2013.

Sales and marketing expenses. Sales and marketing expenses increased $35.0 million, or 47.0%, to $109.6 million during the thirteen weeks ended October 28, 2014, compared to $74.6 million during the thirteen weeks ended October 29, 2013. Sales and marketing expenses as a percentage of net sales increased to 23.7% during the thirteen weeks ended October 28, 2014, compared to 22.9% during the thirteen weeks ended October 29, 2013. The components of sales and marketing expenses are explained below.

Advertising expense increased $12.2 million, or 45.6%, to $39.0 million during the thirteen weeks ended October 28, 2014, from $26.8 million during the thirteen weeks ended October 29, 2013. The increase in the amount of advertising spend was a result of our expansion into new markets from acquisitions and new store additions. Advertising expense as a percentage of net sales increased to 8.4% during the thirteen weeks ended October 28, 2014, compared to 8.2% during the thirteen weeks ended October 29, 2013. We receive funds from time to time from certain vendors for the advertisement of their products, and we recognize these funds as a direct reduction of advertising expense. The amount of vendor advertising funds that were recognized as a reduction of advertising expense totaled $4.8 million during the thirteen weeks ended October 28, 2014, compared with $3.8 million during the thirteen weeks ended October 29, 2013.

Other sales and marketing expenses, consisting mainly of salesman compensation costs, but also including costs incurred to accept payments from our customers, such as credit card and third party finance fees, increased $22.8 million, or 47.7%, to $70.6 million during the thirteen weeks ended October 28, 2014, compared to $47.8 million during the thirteen weeks ended October 29, 2013, primarily as a result of the increase in net sales during the period. Other sales and marketing expenses as a percentage of net sales increased to 15.2% during the thirteen weeks ended October 28, 2014, compared to 14.7% during the thirteen weeks ended October 29, 2013.

General and administrative expenses. General and administrative expenses increased $21.6 million, or 101.6%, to $42.8 million for the thirteen weeks ended October 28, 2014, compared to $21.2 million for the thirteen weeks ended October 29, 2013. The increase in general and administrative expenses was primarily a result of our growth, including a $9.8 million increase in wages, benefits and stock-based compensation resulting from employee additions to our corporate office, a $9.5 million increase in acquisition-related costs, a $1.2 million increase in ERP implementation training costs and a $1.1 million increase in various other general and administrative expense categories. General and administrative expenses as a percentage of net sales increased to 9.2% during the thirteen weeks ended October 28, 2014, compared to 6.5% for the comparable prior year period. The increase in general and administrative expenses as a percentage of net sales is primarily due to the increase in acquisition-related costs noted above, an increase in cost of administrative labor as a percentage of

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net sales and increases in various other areas. General and administrative expenses for the thirteen weeks ended October 28, 2014 and October 29, 2013 included $12.1 million and $1.0 million, respectively, of primarily acquisition-related costs, ERP implementation training costs, and impairment and severance charges. We expect to continue making investments in our corporate infrastructure commensurate with our growth strategy.

Loss on store closings and impairment of store assets. Loss on store closings and impairment of store assets was $0.1 million for the thirteen weeks ended October 28, 2014, compared to a gain of less than $0.1 million for the thirteen weeks ended October 29, 2013.

Other expense, net. Other expense, net, for both periods consisted primarily of interest expense and a loss on early debt extinguishment. Interest expense, net increased $1.6 million, or 59.9%, to $4.1 million for the thirteen weeks ended October 28, 2014, compared to $2.5 million for the thirteen weeks ended October 29, 2013 primarily as a result of an increase in term and revolver borrowings as compared to the prior year period. We incurred a $2.3 million loss on early debt extinguishment related to the refinancing of our 2012 Senior Credit Facility.

Income tax expense. We recognized $9.7 million of income tax expense during the thirteen weeks ended October 28, 2014, compared to $11.1 million of income tax expense during the thirteen weeks ended October 29, 2013. The effective tax rate was 38.3% during the thirteen weeks ended October 28, 2014 and 38.0% during the thirteen weeks ended October 29, 2013.

Net income. As a result of the above, net income was $15.6 million during the thirteen weeks ended October 28, 2014 compared to $18.1 million during the thirteen weeks ended October 29, 2013.

Thirty-Nine Weeks Ended October 28, 2014 Compared to Thirty-Nine Weeks Ended October 29, 2013

Net sales. Net sales increased $303.0 million, or 33.5%, to $1,207.7 million during the thirty-nine weeks ended October 28, 2014, compared to $904.7 million during the thirty-nine weeks ended October 29, 2013 primarily as a result of an increase in the number of stores we operated and an increase in comparable-store sales. The components of the net sales increase for the thirty-nine weeks ended October 28, 2014 as compared to the thirty-nine weeks ended October 29, 2013 were as follows (in millions):


	Progression in Net Sales
	Thirty-Nine Weeks Ended October 28, 2014
Net sales for prior year period	$	904.7
Increase (decrease) in net sales:
Comparable-store sales		67.5
New stores		123.7
Acquired stores		126.1
Closed stores		(14.3)
Increase in net sales, net		303.0
Net sales for current year period	$	1,207.7
% increase		33.5%

Comparable-store net sales increased 7.6%, which was primarily the result of an increase in unit sales driven by sales initiatives implemented during the second half of fiscal 2013 that encouraged our sales associates to improve sales productivity and an increase in average ticket for specialty mattress sales. The increase in our net sales from new stores was the result of 196 new stores opened at various times during the fifty-two week period ended October 28, 2014, including 163 stores opened during the thirty-nine weeks ended October 28, 2014, prior to their inclusion in the comparable-store sales calculation which begins with the thirteenth full fiscal period of operations. The increase in net sales from acquired stores was the result of the acquisitions of five former Mattress People stores in November 2013, 39 stores formerly operated by Perfect Mattress in December 2013, two stores formerly owned by Mattress Expo in December 2013, 34 stores formerly operated by Yotes in March 2014, three stores formerly operated by Southern Max in March 2014, 55 Sleep Experts stores in April 2014, 67 stores formerly owned by Mattress Liquidators in June 2014, 15 stores formerly owned by Best Mattress in September 2014, 131 stores formerly owned by Back to Bed in September 2014

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and 314 Sleep Train stores in October 2014. We closed 30 stores during the fifty-two week period ended October 28, 2014, including 21 stores during the thirty-nine week period ended October 28, 2014.

Cost of sales. Cost of sales increased $186.6 million, or 33.7%, to $740.5 million during the thirty-nine weeks ended October 28, 2014, compared to $553.9 million during the thirty-nine weeks ended October 29, 2013. The major components of the increase in cost of sales are discussed below. Cost of sales as a percentage of net sales increased to 61.3% during the thirty-nine weeks ended October 28, 2014, as compared to 61.2% for the comparable prior year period.

Product costs increased by $114.4 million, or 33.6%, to $454.7 million during the thirty-nine weeks ended October 28, 2014, compared with $340.3 million during the thirty-nine weeks ended October 29, 2013. The increase in the amount of product costs was the result of the corresponding increase in net sales. Product costs as a percentage of net sales remained flat at 37.6% during both the thirty-nine weeks ended October 28, 2014 and October 29, 2013.

Store and warehouse occupancy costs, consisting primarily of lease related costs of rented facilities, increased $42.2 million, or 33.6%, to $168.0 million during the thirty-nine weeks ended October 28, 2014, compared to $125.8 million for the corresponding prior year period. The increase in the amount of store and warehouse occupancy costs during the thirty-nine weeks ended October 28, 2014 was mainly attributable to the increase in the number of stores we operated and the warehouse operations in a number of new markets opened during the previous fifty-two week period. Store and warehouse occupancy costs as a percentage of net sales remained flat at 13.9% during the thirty-nine weeks ended October 28, 2014 and October 29, 2013.

Depreciation expense related to leasehold improvements and other fixed assets used in stores and warehouse operations increased $6.0 million, or 32.4%, to $24.5 million, during the thirty-nine weeks ended October 28, 2014, compared to $18.5 million during the thirty-nine weeks ended October 29, 2013. The increase in expense was primarily attributable to the increase in the number of stores we operated during the thirty-nine weeks ended October 28, 2014, as compared to the comparable prior year period.

Other cost of sales, consisting of store and warehouse operating and delivery costs, increased $24.1 million, or 34.6%, to $93.4 million during the thirty-nine weeks ended October 28, 2014, compared to $69.3 million during the thirty-nine weeks ended October 29, 2013, primarily as a result of the increase in net sales and in the increase in the number of stores we operated during the thirty-nine weeks ended October 28, 2014, as compared to the corresponding prior year period.

Gross profit from retail operations. As a result of the above, gross profit from retail operations increased $116.3 million, or 33.2%, to $467.2 million during the thirty-nine weeks ended October 28, 2014, compared with $350.9 million during the thirty-nine weeks ended October 29, 2013. Gross profit from retail operations as a percentage of net sales decreased to 38.7% during the thirty-nine weeks ended October 28, 2014, as compared to 38.8% during the thirty-nine weeks ended October 29, 2013, for the reasons discussed above.

Franchise fees and royalty income. Franchise fees and royalty income decreased $0.8 million, or 19.0%, to $3.5 million for the thirty-nine weeks ended October 28, 2014, compared to $4.3 million during the corresponding prior year period. The decrease in income was primarily a result of our acquisitions of certain formerly franchised operations, as described above.

Sales and marketing expenses. Sales and marketing expenses increased $71.2 million, or 33.3%, to $285.3 million during the thirty-nine weeks ended October 28, 2014, compared to $214.1 million during the thirty-nine weeks ended October 29, 2013. Sales and marketing expenses as a percentage of net sales remained flat at 23.7% during both the thirty-nine weeks ended October 28, 2014 and the thirty-nine weeks ended October 29, 2013. The components of sales and marketing expenses are explained below.

Advertising expense increased $23.5 million, or 29.8%, to $102.4 million during the thirty-nine weeks ended October 28, 2014, from $78.9 million during the thirty-nine weeks ended October 29, 2013. The increase in the amount of advertising spend was mainly attributable to increased spending to enhance our market share in many of our established markets and, to a lesser extent, our expansion into new markets. Advertising expense as a percentage of net sales decreased to 8.5% during the thirty-nine weeks ended October 28, 2014, compared to 8.7% during the thirty-nine weeks ended October 29, 2013, primarily due to generating greater leverage from the increase in net sales in certain markets. We receive

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funds from time to time from certain vendors for the advertisement of their products, and we recognize these funds as a direct reduction of advertising expense. The amount of vendor advertising funds that were recognized as a reduction of advertising expense totaled $9.4 million during the thirty-nine weeks ended October 28, 2014, compared with $7.4 million during the thirty-nine weeks ended October 29, 2013.

Other sales and marketing expenses, consisting mainly of salesman compensation costs, but also including costs incurred to accept payments from our customers, such as credit card and third party finance fees, increased $47.7 million, or 35.3%, to $182.9 million during the thirty-nine weeks ended October 28, 2014, compared to $135.2 million during the thirty-nine weeks ended October 29, 2013, primarily as a result of the increase in net sales during the period. Other sales and marketing expenses as a percentage of net sales increased to 15.1% during the thirty-nine weeks ended October 28, 2014, as compared to 14.9% during the thirty-nine weeks ended October 29, 2013.

General and administrative expenses. General and administrative expenses increased $50.3 million, or 83.5%, to $110.4 million for the thirty-nine weeks ended October 28, 2014, compared to $60.1 million for the thirty-nine weeks ended October 29, 2013. The increase in general and administrative expenses was primarily a result of our growth, including a $22.5 million increase in wages, benefits and stock-based compensation resulting from employee additions to our corporate office, a $19.5 million increase in acquisition-related costs, a $2.9 million increase in ERP implementation training costs and a $5.4 million increase in various other general and administrative expense categories. General and administrative expenses as a percentage of net sales increased to 9.1% during the thirty-nine weeks ended October 28, 2014, compared to 6.6% for the comparable prior year period. The increase in general and administrative expenses as a percentage of net sales is primarily due to the increase in acquisition-related costs noted above, an increase in cost of administrative labor as a percentage of net sales and increases in various other areas. General and administrative expenses for the thirty-nine weeks ended October 28, 2014 and October 29, 2013 included $27.7 million and $3.0 million, respectively, of acquisition-related costs, ERP implementation training costs, and impairment and severance charges. We expect to continue making investments in our corporate infrastructure commensurate with our growth strategy.

Loss on store closings and impairment of store assets. Loss on store closings and impairment of store assets increased $0.3 million to $1.0 million during the thirty-nine weeks ended October 28, 2014, compared to $0.7 million for the thirty-nine weeks ended October 29, 2013, primarily as a result of an increase of $0.4 million in store-level fixed asset impairment charges over the prior year period, offset by a decrease of $0.1 million in the amount of remaining lease commitments on stores that we closed during respective periods.

Other expense, net. Other expense, net, for both periods consisted primarily of interest expense and a loss on early debt extinguishment. Interest expense increased $2.2 million, or 26.5%, to $10.4 million during the thirty-nine weeks ended October 28, 2014, compared to $8.2 million during the thirty-nine weeks ended October 29, 2013, primarily as a result of an increase in term and revolver borrowings as compared to the prior year period. We incurred a $2.3 million loss on early debt extinguishment related to the refinancing of our 2012 Senior Credit Facility.

Income tax expense. We recognized $23.8 million of income tax expense during the thirty-nine weeks ended October 28, 2014, compared to $27.8 million of income tax expense during the thirty-nine weeks ended October 29, 2013. The effective tax rate was 38.7% during the thirty-nine weeks ended October 28, 2014, compared to 38.5% during the thirty-nine weeks ended October 29, 2013.

Our estimated full year effective tax rate for Fiscal 2014 is 39.2%, which is above the federal statutory rate of 35.0% primarily due to state income taxes.

Net income. As a result of the above, net income was $37.6 million during the thirty-nine weeks ended October 28, 2014 compared to $44.3 million during the thirty-nine weeks ended October 29, 2013.

Off-Balance Sheet Arrangements

Except for a guarantee of approximately $0.7 million that we have provided with respect to one real estate lease of a franchisee, we do not have any “off-balance sheet arrangements” (as such term is defined in Item 303 of Regulation S-K) that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

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Liquidity and Capital Resources

The following table summarizes the principal elements of our cash flows (in thousands):



	Thirty-Nine Weeks Ended
	October 29,		October 28,
	2013		2014
Total cash provided by (used in):
Operating activities	$	70,936	$	79,556
Investing activities		(43,382)		(616,011)
Financing activities		(26,872)		518,503
Net increase (decrease) in cash and cash equivalents		682		(17,952)
Cash and cash equivalents, beginning of period		14,556		22,878
Cash and cash equivalents, end of period	$	15,238	$	4,926

Operating cash flows. Net cash provided by operating activities was $79.6 million for the thirty-nine weeks ended October 28, 2014, compared to $70.9 million for the thirty-nine weeks ended October 29, 2013. The $8.7 million increase in cash flows from operating activities as compared to the prior year period was primarily due to changes in operating assets and liabilities related to normal fluctuations in the timing of cash collections and cash requirements which provided an additional $4.5 million in cash. Although net income decreased by $6.7 million from the thirty-nine weeks ended October 28, 2014 compared to the thirty-nine weeks ended October 29, 2013, the add-back of non-cash charges such as depreciation expense resulted in an additional $10.9 million increase resulting in a net increase to cash of $4.2 million.

Investing cash flows. Net cash used in investing activities was $616.0 million for the thirty-nine weeks ended October 28, 2014, compared to net cash used of $43.4 million for the thirty-nine weeks ended October 29, 2013. The $572.6 million increase was primarily due to a $559.0 million increase in cash used for acquisitions during the thirty-nine weeks ended October 28, 2014. In addition, capital expenditures increased $13.6 million primarily due to new store openings. We opened 163 new stores during the thirty-nine weeks ended October 28, 2014, compared to 121 new stores in the thirty-nine weeks ended October 29, 2013.

Financing cash flows. Net cash provided by financing activities was $518.5 million for the thirty-nine weeks ended October 28, 2014, compared to net cash used of $26.9 million for the thirty-nine weeks ended October 29, 2013. The $545.4 million increase in cash provided by financing activities was primarily the result of net increased borrowings of $553.2 million which were used to finance acquisitions, an increase of $1.7 million of cash provided by the exercise of common stock options, and a $1.3 million increase of cash provided by the excess tax benefits associated with stock-based awards, partially offset by debt issuance costs of $10.2 million related to the 2014 Senior Credit Facility and an increase of $0.6 million of cash used for the purchase of vested stock-based awards.

Covenant Compliance

The 2014 Senior Credit Facility requires us to comply on a quarterly basis with one financial covenant, which is a minimum fixed charge coverage ratio. This financial covenant is measured using, among other things, Adjusted EBITDA of Mattress Holding Corp. and its subsidiaries, as adjusted to include pro forma results of new stores.

At October 28, 2014, there were $35 million in outstanding revolver borrowings under the 2014 Senior Credit Facility. There were standby letters of credit outstanding in the amount of $3.2 million and additional borrowing capacity of $49.2 million.

For more information about the restrictive covenants imposed on us by the 2014 Senior Credit Facility, please see “Risk Factors” in this Quarterly Report on Form 10-Q.

We were in compliance with the sole financial covenant required under the 2014 Senior Credit Facility as of October 28, 2014. We believe that we will be able to maintain compliance with the covenant required under our debt facilities for the next twelve months without amending the credit facility or requesting waivers from the lenders that are party to the agreement.

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Seasonality

Our business is subject to seasonal fluctuations. We generally have experienced more sales and a greater portion of income during the second and third quarters of our fiscal year due to a concentration of summer season holidays, including Memorial Day, the Fourth of July and Labor Day, and other seasonal factors.

Adjusted EBITDA to Net Income Reconciliation

Adjusted EBITDA is defined as net income before income tax expense, interest income, interest expense, depreciation and amortization (“EBITDA”), without giving effect to non-cash goodwill and intangible asset impairment charges, gains or losses on store closings and impairment of store assets, gains or losses related to the early extinguishment of debt, financial sponsor fees and expenses, non-cash charges related to stock-based awards and other items that are excluded by management in reviewing the results of operations. We have presented Adjusted EBITDA because we believe that the exclusion of these items is appropriate to provide additional information to investors about our ongoing operating performance excluding certain non-cash and other items and to provide additional information with respect to our ability to comply with various covenants in documents governing our indebtedness and as a means to evaluate our period-to-period results. In evaluating Adjusted EBITDA, you should be aware that in the future we may incur expenses that are the same as or similar to some of the adjustments in this presentation. Our presentation of Adjusted EBITDA should not be construed to imply that our future results will be unaffected by any such adjustments. We have provided this information to analysts, investors and other third parties to enable them to perform more meaningful comparisons of past, present and future operating results and as a means to evaluate the results of our ongoing operations. Management also uses Adjusted EBITDA to determine executive incentive compensation payment levels. In addition, our compliance with certain covenants under our 2014 Senior Credit Facility that are calculated based on similar measures and differ from Adjusted EBITDA primarily by the inclusion of pro forma results for acquired businesses in those similar measures. Other companies in our industry may calculate Adjusted EBITDA differently than we do. Adjusted EBITDA is not a measure of performance under U.S. GAAP and should not be considered as a substitute for net income prepared in accordance with U.S. GAAP. Adjusted EBITDA has significant limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Some of the additional limitations to the use of Adjusted EBITDA are:

Adjusted EBITDA does not reflect our cash expenditures, or future requirements, for capital expenditures or contractual commitments;

Adjusted EBITDA does not reflect interest expense or the cash requirements necessary to service interest or principal payments on our debt;

Adjusted EBITDA does not reflect tax expense or the cash requirements necessary to pay for tax obligations;

Although depreciation and amortization are non-cash charges, the asset being depreciated and amortized will often have to be replaced in the future, and Adjusted EBITDA does not reflect any cash requirements for such replacements;

Adjusted EBITDA does not reflect the cash requirements of closing underperforming stores; and

Adjusted EBITDA does not reflect certain other costs that may recur in future periods.

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We compensate for these limitations by relying primarily on our U.S. GAAP results and using Adjusted EBITDA only as a supplemental measure. The following table contains a reconciliation of our net income determined in accordance with U.S. GAAP to EBITDA and Adjusted EBITDA for the periods indicated (in thousands):



	Thirteen Weeks Ended				Thirty-Nine Weeks Ended
	October 29,			October 28,	October 29,		October 28,
	2013		2014		2013		2014
Net income	$	18,136	$	15,613	$	44,268	$	37,631
Income tax expense		11,117		9,677		27,756		23,762
Interest expense, net		2,543		4,067		8,185		10,352
Depreciation and amortization		7,687		10,101		21,128		28,302
Intangible assets and other amortization		660		917		1,813		2,528
EBITDA		40,143		40,375		103,150		102,575
Loss on store closings and impairment of store assets		(5)		133		739		1,039
Loss from debt extinguishment		—		2,288		—		2,288
Stock-based compensation		1,349		2,416		3,203		4,973
Vendor new store funds(a)		229		(391)		1,212		(834)
Acquisition-related expenses(b)		8		10,058		458		20,759
Other(c)		697		856		1,885		4,882
Adjusted EBITDA	$	42,421	$	55,735	$	110,647	$	135,682

(a)

We receive cash payments from certain vendors for each new incremental store that we open (“new store funds”). New store funds are initially recorded in other noncurrent liabilities when received and are then amortized as a reduction of cost of sales over 36 months in our financial statements. Historically, we have considered new store funds as a component of Adjusted EBITDA when received since new store funds are included in cash provided from operations. The adjustment includes the amount of new store funds received during the period presented and eliminates the non-cash reduction in cost of sales included in our results of operations.

(b)

Reflects both non-cash effects included in net income related to acquisition accounting adjustments made to inventories and other acquisition-related cash costs included in net income, such as direct acquisition costs and costs related to integration of acquired businesses.

(c)

Consists of various items that management excludes in reviewing the results of operations, including $1.9 million and $0.7 million of ERP system implementation costs incurred during the thirteen weeks ended October 28, 2014 and October 29, 2013, respectively, and $4.8 million and $1.9 million of such costs incurred during the thirty-nine weeks ended October 28, 2014 and October 29, 2013, respectively.

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Reconciliation of Reported (U.S. GAAP) to Adjusted Statements of Operations Data

(In thousands, except share and per share amounts)

The following table provides a reconciliation of our “As Adjusted” statements of operations data for the thirteen and thirty-nine weeks ended October 29, 2013 and October 28, 2014 with the most directly comparable financial measures in our “As Reported”, or U.S. GAAP, statements of operations data. Our “As Adjusted” data is considered a non-U.S. GAAP financial measure and is not in accordance with, or preferable to, “As Reported,” or U.S. GAAP, financial data. However, we are providing this information as we believe it may enhance year-over-year comparisons for investors and financial analysts



	Thirteen Weeks Ended
	October 29, 2013												October 28, 2014
	Income From Operations			Income Before Income Taxes			Net Income			Diluted Weighted Shares	Diluted EPS*		Income From Operations			Income Before Income Taxes			Net Income			Diluted Weighted Shares	Diluted EPS*
As Reported	$	31,796		$	29,253		$	18,136		34,114,147	$	0.53	$	31,645		$	25,290		$	15,613		34,724,199	$	0.45
% of sales		9.7	%		9.0	%		5.6	%					6.8	%		5.4	%		3.4	%
Acquisition-related costs (1)		—			—			—				—		10,058			10,058			6,140				0.18
ERP system implementation costs (2)		986			986			605				0.02		1,982			1,982			1,209				0.03
Other (3)		—			—			—				—		18			2,306			1,408				0.04
Total adjustments		986			986			605		—		0.02		12,058			14,346			8,757		—		0.25
As Adjusted	$	32,782		$	30,239		$	18,741		34,114,147	$	0.55	$	43,703		$	39,636		$	24,370		34,724,199	$	0.70
% of sales		10.0	%		9.3	%		5.7	%					9.4	%		8.5	%		5.2	%

	Thirty-Nine Weeks Ended
	October 29, 2013												October 28, 2014
	Income From Operations			Income Before Income Taxes			Net Income			Diluted Weighted Shares	Diluted EPS*		Income From Operations			Income Before Income Taxes			Net Income			Diluted Weighted Shares	Diluted EPS*
As Reported	$	80,209		$	72,024		$	44,268		34,073,307	$	1.30	$	74,033		$	61,393		$	37,631		34,562,374	$	1.10
% of sales		8.9	%		8.0	%		4.9	%					6.1	%		5.1	%		3.1	%
Acquisition-related costs (1)		450			450			276				0.01		20,759			20,759			12,680				0.37
ERP system implementation costs (2)		2,831			2,831			1,736				0.05		5,071			5,071			3,097				0.09
Other (3)		—			—			—				—		1,851			4,139			2,528				0.07
Total adjustments		3,281			3,281			2,012		—		0.06		27,681			29,969			18,305		—		0.53
As Adjusted	$	83,490		$	75,305		$	46,280		34,073,307	$	1.36	$	101,714		$	91,362		$	55,936		34,562,374	$	1.62
% of sales		9.2	%		8.3	%		5.1	%					8.4	%		7.6	%		4.6	%

*Due to rounding to the nearest cent, totals may not equal the sum of the lines in the table above.

(1) Acquisition-related costs, which are included in the “As Reported” results of operations, consist of acquisition-related costs as defined under U.S. GAAP, including advisory, legal, accounting, valuation, and other professional or consulting fees and, in addition, costs of integrating store and warehouse operations and corporate functions that are not expected to recur as acquisitions are absorbed. On June 14, 2013, we acquired the assets and operations of Olejo, Inc., an online retailer primarily focused on mattresses and bedding-related products. On November 13, 2013, we acquired the equity interests of NE Mattress People, LLC (“Mattress People”), including five mattress specialty retail stores. On December 10, 2013, we acquired the assets and operations of Perfect Mattress of Wisconsin, LLC (“Perfect Mattress”), including 39 mattress specialty retail stores. On December 31, 2013, we acquired the assets and operations of two mattress specialty retail stores in Houston, Texas (“Mattress Expo”). On March 3, 2014, we acquired the assets and operations of Yotes, Inc. (“Yotes”), including 34 mattress specialty retail stores. On March 3, 2014, we acquired the Virginia assets and operations of Southern Max LLC (“Southern Max”), including three mattress specialty retail stores. On April 3, 2014, we acquired the outstanding partnership interests in Sleep Experts Partners, L.P. (“Sleep Experts”), including 55 mattress specialty retail stores. On June 4, 2014, we acquired substantially all of the mattress specialty retail assets and operations of Mattress Liquidators, Inc., including 67 mattress specialty retail stores, which operated Mattress King retail stores in Colorado and BedMart retail stores in Arizona. On September 8, 2014, we acquired substantially all of the mattress specialty retail assets and operations of Best Mattress Co., Inc., related to the operation of 15 mattress specialty retail stores. On September 30, 2014, we acquired substantially all of the mattress specialty retail assets and operations of Back to Bed Inc., M World Mattress LLC, MCStores LLC and TBE Orlando LLC, related to the operation of 131 mattress specialty retail stores. On October 20, 2014, we acquired 100% of the outstanding equity interests in The Sleep Train, Inc., related to the operation of 314 mattress specialty retail stores. Acquisition-related costs, consisting of direct transaction costs and integration costs, are included in the results of operations as incurred. We incurred approximately $10.1 million and no acquisition-related costs during the thirteen weeks ended October 28, 2014 and October 29, 2013, respectively. We incurred approximately $20.8 million and $0.5 million of acquisition-related costs during the thirty-nine weeks ended October 28, 2014 and October 29, 2013, respectively.

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(2) Reflects implementation costs included in the results of operations as incurred, consisting primarily of training-related costs, related to the roll-out of the Microsoft Dynamics AX for Retail ERP system. During the thirteen weeks ended October 28, 2014 and October 29, 2013, we incurred approximately $2.0 million and $1.0 million, respectively, of ERP system implementation costs which includes $0.1 million and $0.3 million, respectively, of accelerated depreciation expense on our legacy ERP system. During the thirty-nine weeks ended October 28, 2014 and October 29, 2013, we incurred approximately $5.1 million and $2.8 million, respectively, of ERP system implementation costs which includes $0.3 million and $0.9 million, respectively, of accelerated depreciation expense on our legacy ERP system.

(3) Reflects expensed legal fees relating to our February 2014 debt amendment and extension recorded in the thirteen weeks ended April 29, 2014, an impairment of store assets and severance expense resulting from the Company's realignment of its management structure at the beginning of the second fiscal quarter recorded in the thirteen weeks ended July 29, 2014 and a $2.3 million loss on debt extinguishment we incurred in the thirteen weeks ended October 28, 2014.

Item 3. Quantitative and Qualitative Disclosures about Market Risk.

There have been no material changes in the interest rate risk and inflation risk discussed in “— Item 7A. Quantitative and Qualitative Disclosures About Market Risk” included in the Fiscal 2013 Annual Report.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the Company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based on the evaluation of our disclosure controls and procedures as of the end of the period covered by this report, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective.

Changes in Internal Control

During the thirteen weeks ended October 28, 2014, there were no changes in the Company’s internal controls over financial reporting that materially affected or are reasonably likely to materially affect the Company’s internal control over financial reporting.

Part II.

OTHER INFORMATION

Item 1A. Risk Factors

Our substantial debt could adversely affect us, make us more vulnerable to adverse economic or industry conditions and prevent us from fulfilling our debt obligations or from funding our expansion strategy.

We have a substantial amount of debt outstanding. On October 20, 2014, our subsidiary, Mattress Holding Corp., entered into a $125 million asset-backed loan credit agreement dated October 20, 2014, among Mattress Holding Corp., as borrower, Mattress Holdco, Inc., the lenders party thereto, and Barclays Bank PLC, as administrative agent, collateral agent and issuer (the “ABL Credit Agreement”). Additionally, on October 20, 2014, Mattress Holding Corp. entered into a $720 million term loan credit agreement dated October 20, 2014, among Mattress Holding Corp., as borrower, Mattress Holdco, Inc., the lenders party thereto, and Barclays Bank PLC, as administrative agent and collateral agent (the “Term Loan Credit Agreement”). The Term Loan Credit Agreement and the ABL Credit Agreement are collectively referred to as the “2014 Senior Credit Facility”. As of October 28, 2014, we had $758.9 million of total indebtedness, consisting

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primarily of $747.8 million outstanding under the 2014 Senior Credit Facility. Our substantial indebtedness could have serious consequences, such as:

• limiting our ability to obtain additional financing to fund our working capital, capital expenditures, debt service requirements, expansion strategy or other purposes;

• placing us at a competitive disadvantage compared to competitors with less debt;

• increasing our vulnerability to, and reducing our flexibility in planning for, adverse changes in economic, industry and competitive conditions; and

• increasing our vulnerability to increases in interest rates because borrowings under the 2014 Senior Credit Facility are subject to variable interest rates.

The potential consequences of our substantial indebtedness make us more vulnerable to defaults and place us at a competitive disadvantage. A substantial or extended increase in interest rates could significantly affect our cash available to make scheduled payments on the 2014 Senior Credit Facility or to fund our expansion strategy.

We may be unable to generate sufficient cash to service all of our indebtedness and other liquidity requirements and may be forced to take other actions to satisfy such requirements, which may not be successful.

We will be required to repay borrowings under the ABL Credit Agreement on October 20, 2019 and term borrowings under the Term Loan Credit Agreement on October 20, 2021. Our ability to make payments on and to refinance our indebtedness and to fund planned capital expenditures will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control.

Our debt agreements contain restrictions that limit our flexibility in operating our business.

The 2014 Senior Credit Facility contains negative covenants that limit our ability to engage in specified types of transactions. These covenants limit our ability and the ability of our restricted subsidiaries to, among other things:

• incur indebtedness;

• create liens;

• engage in mergers or consolidations;

• sell assets (including pursuant to sale and leaseback transactions);

• pay dividends and distributions or repurchase our capital stock;

• make investments, acquisitions, loans or advances;

• repay, prepay or redeem certain indebtedness;

• engage in certain transactions with affiliates;

• amend material agreements governing certain indebtedness; and

• change our lines of business.

A breach of any of these covenants could result in an event of default under the 2014 Senior Credit Facility. Upon the occurrence of an event of default under the 2014 Senior Credit Facility, the lenders could elect to declare all amounts outstanding under such facility to be immediately due and payable and terminate all commitments to extend further credit, or seek amendments to our debt agreements that would provide for terms more favorable to such lenders and that we may have to accept under the circumstances. If we were unable to repay those amounts, the lenders under the 2014 Senior Credit Facility could proceed against the collateral granted to them to secure that indebtedness. We have pledged a significant portion of our assets as collateral under the 2014 Senior Credit Facility. If the lenders under the 2014 Senior Credit Facility accelerate the repayment of borrowings, we cannot guarantee that we will have sufficient assets to repay the 2014 Senior Credit Facility.

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Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

On October 20, 2014, the Company issued 745,107 shares of common stock, par value $0.01 per share, of the Company to the shareholders of The Sleep Train, Inc. in exchange for 100% of the equity interests held by such shareholders in The Sleep Train, Inc. pursuant to the terms of the Purchase and Sale Agreement dated September 3, 2014, among The Sleep Train, Inc., Mattress Firm, Inc., Mattress Firm Holding Corp., the shareholders of The Sleep Train, Inc., Dale Carlsen, individually, Robert Killgore, individually, and Dale Carlsen, in his capacity as shareholder representative. The issuance and exchange of the shares was exempt from registration pursuant to Section 4(2) of the Securities Act of 1933, as amended. See Note 2 to the Company’s Unaudited Condensed Consolidated Financial Statements filed herewith for more information regarding this acquisition.

Item 6. Exhibits.

(a)

Exhibits: Reference is made to the Exhibit List filed as a part of this report beginning on page E-1. Each of such exhibits is incorporated by reference herein.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	MATTRESS FIRM HOLDING CORP.


Date: December 2, 2014	By:	/s/ R. Stephen Stagner
		R. Stephen Stagner
		President and Chief Executive Officer (principal executive officer)


Date: December 2, 2014	By:	/s/ Alex Weiss
		Alex Weiss
		Executive Vice President and Chief Financial Officer (principal financial officer)


Date: December 2, 2014	By:	/s/ Cathy Hauslein
		Cathy Hauslein
		Senior Vice President and Chief Accounting Officer (principal accounting officer)

Table of Contents

EXHIBIT LIST


Exhibit
Number	Exhibit Title
		Master Retailer Agreement between Tempur-Pedic North America LLC and Mattress Firm, Inc., effective January 1, 2014.
31.1	Principal Executive Officer Certification Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to the Section 302 of the Sarbanes-Oxley Act of 2002.

31.2	Principal Financial Officer Certification Pursuant to Securities Exchange Act Rules 13a-14 and 15d-14 as Adopted Pursuant to the Section 302 of the Sarbanes-Oxley Act of 2002.

32.1	Principal Executive Officer Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2	Principal Financial Officer Certification Pursuant to 18 U.S.C. Section 1350 as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

101.INS	XBRL Instance Document

101.SCH	XBRL Taxonomy Extension Schema Document

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB	XBRL Taxonomy Extension Labels Linkbase Document

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document

E-1

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MATTRESS FIRM HOLDING CORP. Reports