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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


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


Large accelerated filer ☐	Accelerated filer ☒

Non-accelerated filer ☐	Smaller Reporting Company ☐


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


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