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

In this discussion and analysis, we discuss and explain the consolidated financial condition and results of operations for the years ended December 31, 2012, 2011 and 2010, including the following topics:

? An overview of our business and strategy; ? An overview of the Sealy Acquisition; ? Our net sales and costs in the periods presented as well as changes between periods;
? Discussion of new initiatives that may affect our future results of operations and financial condition; ? Expected future expenditures for capital projects and sources of liquidity for future operations; and ? The effect of the foregoing on our overall financial performance and condition, as well as factors that could affect our future performance.

Business Overview

General. We are the leading manufacturer, marketer and distributor of premium mattresses and pillows, which we sell in approximately 80 countries under the TEMPURŪ and Tempur-PedicŪ brands. We believe our premium mattresses and pillows are more comfortable than standard bedding products because our proprietary pressure-relieving TEMPURŪ material is temperature sensitive and continuously conforms to the body.

We sell our premium mattresses and pillows through four distribution channels in each operating business segment: Retail (furniture, bedding and department stores); Direct (direct response, Internet and company-owned stores); Healthcare (hospitals, nursing homes, healthcare professionals and medical retailers); and Third party distributors in countries where we do not sell directly through our own subsidiaries.

In our International segment certain of our subsidiaries sell directly through company-owned stores. Prior to 2011, these sales have not been material and were reported through our Retail channel. In 2011, and consistent with our growth initiatives, we are reporting company-owned stores in the International segment within the Direct channel. Prior period amounts have been reclassified to conform to the 2011 presentation of net sales, by channel and by segment. These changes do not impact previously reported International segment net sales totals.

Business Segments. We have two reportable business segments: North America and International. These reportable segments are strategic business units that are managed separately based on the fundamental differences in their geographies. The North American operating segment consists of two U.S. manufacturing facilities, our North American distribution subsidiaries and company-owned stores. The International segment consists of our manufacturing facility in Denmark, whose customers include all of our distribution subsidiaries and third party distributors outside the North American operating segment and company-owned stores. We evaluate segment performance based on net sales and operating income.

For a further discussion of factors that could impact operating results, including the current economic environment and the steps we are taking to address this environment, see the section entitled "Factors That May Affect Future Performance" included within this section and in ITEM 1A under Part I of this report.

Strategy

Our goal is to become the world's favorite mattress and pillow brand. In order to achieve this long-term goal while managing through the current economic and competitive environment, we plan to complete the proposed acquisition of Sealy, and to continue to pursue certain key Tempur-PedicŪ strategic goals using the related strategies discussed below.

? Make sure everyone knows that they would sleep better on a Tempur-PedicŪ mattress - we plan to continue to invest in our global brand awareness through advertising campaigns that further associate our brand name with overall sleep and premium quality products.
? Make sure there is a Tempur-PedicŪ bed and pillow that appeals to everyone - we plan to continue to maintain our focus on premium products at the high end of the category price range that are preferred by consumers.
? Make sure that Tempur-PedicŪ products are available to everyone - we plan to expand our points of distribution and the effectiveness of our distribution channels by ensuring our retailers are provided attractive incentives to sell our products.
? Make sure that Tempur-PedicŪ bedding products continue to deliver the best sleep - we plan to continue to invest in product research and development to systematically innovate and improve our products in consumer relevant ways.

In pursuing these strategic goals, we expect to continue to optimize our cost structure in order to enable these marketing and product development investments.

On September 27, 2012, we announced we had entered into an Agreement and Plan of Merger ("Merger Agreement") to acquire Sealy Corporation ("Sealy"), by merging Sealy with a newly-formed subsidiary of the Company (the "Merger") (collectively, the "Sealy Acquisition"). Sealy, headquartered in Trinity, North Carolina, owns one of the largest bedding brands in the world, and manufactures and markets a complete line of bedding products. Subject to the terms and conditions of the Merger Agreement, at the effective time and as a result of the Merger, each share of common stock of Sealy issued and outstanding immediately prior to the effective time of the Merger will be cancelled and (other than shares held by Sealy or Tempur-Pedic or their subsidiaries or Sealy stockholders who properly exercise appraisal rights) converted into the right to receive $2.20 in cash. The Company anticipates that the total consideration to be paid, including payments on account of existing Sealy options and equity share units and the assumption of outstanding indebtedness of Sealy less cash assumed, will be approximately $1,300.0 million. The transaction is expected to be completed in the first half of calendar 2013 and is subject to regulatory clearance under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 and other customary conditions. The Merger Agreement contains certain termination rights for both the Company and Sealy and further provides that, upon termination of the Merger Agreement under certain circumstances, Sealy may be obligated to pay the Company a termination fee of $25.0 million. In addition, if antitrust enforcement agencies either commence or inform the parties that they intend to commence an action to enjoin the Merger, (i) the Company may be required to pay Sealy a termination fee of $90.0 million if both parties elect to terminate the Merger Agreement or (ii) a termination fee of $90.0 million (or $40.0 million if the Company elects to terminate the Merger Agreement but Sealy does not so elect to terminate) if the Merger does not close due to a failure to receive antitrust approval in the nine months following the execution of the Merger Agreement, subject to certain extensions.

In order to finance the Sealy Acquisition, on December 12, 2012, Tempur-Pedic International and certain subsidiaries of Tempur-Pedic International as borrowers and guarantors, entered into the 2012 Credit Agreement with a syndicate of banks. The 2012 Credit Agreement provides for (i) the $350.0 million Revolver, (ii) the Term A Facility of $550.0 million and (iii) the Term B Facility of $870.0 million. The Revolver includes a sublimit for letters of credit and swingline loans, subject to certain conditions and limits. The Revolver and the Term A Facility will mature on the fifth anniversary of the closing and the Term B Facility will mature on the seventh anniversary of the closing. The Revolver, the Term A Facility and the Term B Facility are expected to close and fund in connection with the Sealy Acquisition. The obligations of the lenders to the 2012 Credit Agreement to make the initial loans at the closing of the Sealy Acquisition and the loans subsequent to closing are subject to certain customary closing conditions. Our existing credit facilities will remain in place until the closing of the Sealy Acquisition.

In addition, on December 19, 2012, Tempur-Pedic International issued $375.0 million aggregate principal amount of 6.875% Senior Notes (the "Senior Notes") to qualified institutional buyers pursuant to Rule 144A of the Securities Act, and to certain non-U.S. persons in accordance with Regulation S under the Securities Act. The Senior Notes were issued pursuant to an Indenture among Tempur-Pedic International, the subsidiaries that guarantee the Senior Notes (the "Guarantors") and The Bank of New York Mellon Trust Company, N.A., as trustee (the "Trustee"). The Senior Notes will be the general unsecured senior obligations of Tempur-Pedic International and are guaranteed on a senior unsecured basis by the Guarantors. Following the Sealy Acquisition, Sealy and certain of its subsidiaries will become guarantors of the Senior Notes.

The Senior Notes mature of December 15, 2020, and interest is payable semi-annually in arrears on each June 15 and December 15, beginning on June 15, 2013. Tempur-Pedic International has the option to redeem all or a portion of the Senior Notes at any time on or after December 15, 2016. The initial redemption price is 103.438% of the principal amount, plus accrued and unpaid interest, if any. The redemption price will decline each year after 2016 and will be 100.0% of the principal amount beginning on December 15, 2018. In addition, Tempur-Pedic International has the option at any time prior to December 15, 2016 to redeem all or any portion of the Senior Notes at 100.0% of the original principal amount plus a "make-whole" premium and accrued and unpaid interest, if any. Tempur-Pedic International may also redeem up to 35.0% of the Senior Notes prior to December 15, 2015 under certain circumstances with the net cash proceeds from certain equity offerings at 106.875% of the principal amount plus accrued and unpaid interest, if any. Tempur-Pedic International may make such redemptions only if, after any such redemption, at least 65.0% of the aggregate principal amount of the Senior Notes issued remains outstanding.

The Indenture restricts the ability of Tempur-Pedic International and the ability of certain of its subsidiaries to, among other things: (i) incur, directly or indirectly, debt; (ii) make, directly or indirectly, certain investments and restricted payments; (iii) incur or suffer to exist, directly or indirectly, liens on its properties or assets; (iv) sell or otherwise dispose of, directly or indirectly, assets; (v) create or otherwise cause or suffer to exist any consensual restriction on the right of certain of the subsidiaries of Tempur-Pedic International to pay dividends or make any other distributions on or in respect of their capital stock; (vi) enter into transactions with affiliates; (vii) engage in sale-leaseback transactions; (viii) purchase or redeem capital stock or subordinated indebtedness; (ix) issue or sell stock of restricted subsidiaries; and (x) effect a consolidation or merger. These covenants are subject to a number of exceptions and qualifications.

Concurrently with the closing of the Senior Notes, Tempur-Pedic International entered into an escrow and security agreement (the "Escrow Agreement") with the Trustee, as escrow agent. The gross proceeds from the sale of the Senior Notes, together with additional cash necessary to fund the redemption of the Senior Notes at the stated redemption rate and pay accrued interest to October 1, 2013, have been deposited into the escrow account. If the Sealy Acquisition is consummated on or prior to September 26, 2013, the amounts held in escrow will be released to Tempur-Pedic International to finance a portion of the cash purchase price of the Sealy Acquisition. If the Sealy Acquisition is not consummated on or prior to September 26, 2013, the Senior Notes will be subject to a special mandatory redemption at a redemption price of 100.0% of the principal amount plus accrued and unpaid interest, if any, and the amounts held in the escrow account will be used to fund the redemption.

Also in conjunction with the issuance and sale of the Senior Notes, Tempur-Pedic International and the Guarantors have agreed through a Registration Rights Agreement to exchange the Senior Notes for a new issue of substantially identical registered notes under the Securities Act. Tempur-Pedic International and the Guarantors are required to pay additional interest if the Senior Notes are not registered within the specified time periods outlined within the Registration Rights Agreement.

We expect to use the net proceeds of the Senior Notes offering, together with cash on hand and borrowings under the 2012 Credit Agreement, to finance the Sealy Acquisition and to pay related fees and expenses, as well as payoff our existing credit facility and Sealy's outstanding debt.

Results of Operations

A summary of our results for the year ended December 31, 2012 include:

? Earnings per diluted common share (EPS) were $1.70 compared to $3.18 per diluted share for the full year 2011.
? Adjusted EPS were $2.61 for the year ended December 31, 2012 compared to $3.18 per diluted share for the same period in 2011. For a discussion and reconciliation of Adjusted EPS to GAAP EPS refer to the non-GAAP financial information set forth below under the heading "Non-GAAP Financial Information".
? Net sales decreased to $1,402.9 million compared to $1,417.9 million for the full year ended 2011.
? Our gross profit margin was 50.9% compared to 52.4% for the year ended December 31, 2011.
? Our operating income margin was 17.7% compared to 24.0% for the year ended December 31, 2011.

The following table sets forth the various components of our Consolidated Statements of Income, and expresses each component as a percentage of net sales:

                                                      Year Ended December 31,
(in millions, except per
common share amounts)               2012                       2011                       2010
Net sales                  $   1,402.9       100.0 % $    1,417.9       100.0 % $    1,105.4       100.0 %
Cost of sales                    688.3        49.1          674.8        47.6          550.0        49.8
Gross profit                     714.6        50.9          743.1        52.4          555.4        50.2
Selling and marketing
expenses                         319.1        22.7          276.9        19.5          199.7        18.1
General, administrative
and other                        147.2        10.5          125.7         8.9          109.8         9.9
Operating income                 248.3        17.7          340.5        24.0          245.9        22.2
Interest expense, net            (18.8 )      (1.3 )        (11.9 )      (0.8 )        (14.5 )      (1.3 )
Other (expense) income,
net                               (0.3 )         -           (0.2 )         -           (0.5 )         -
Income before income
taxes                            229.2        16.4          328.4        23.2          230.9        20.9
Income tax provision             122.4         8.7          108.8         7.7           73.7         6.7
Net income                 $     106.8         7.7 % $      219.6        15.5 % $      157.2        14.2 %
Earnings per common
share:
  Diluted                  $      1.70               $       3.18               $       2.16
Weighted average common
shares outstanding:
  Diluted                         62.9                       69.1                       72.8

Year Ended December 31, 2012 Compared with Year Ended December 31, 2011

A summary of net sales, by channel and by segment, is set forth below:

                       CONSOLIDATED                  NORTH AMERICA                  INTERNATIONAL
                        Year Ended                     Year Ended                    Year Ended
                       December 31,                   December 31,                  December 31,
(in millions)      2012           2011            2012           2011            2012           2011
Retail         $    1,228.0   $     1,245.6   $      876.5   $       917.6   $      351.5   $      328.0
Direct                113.2           100.1           76.2            76.0           37.0           24.1
Healthcare             31.1            34.0           11.6            11.1           19.5           22.9
Third party            30.6            38.2              -               -           30.6           38.2
               $    1,402.9   $     1,417.9   $      964.3   $     1,004.7   $      438.6   $      413.2

A summary of net sales, by product and by segment, is set forth below:

                       CONSOLIDATED                  NORTH AMERICA                  INTERNATIONAL
                        Year Ended                     Year Ended                    Year Ended
                       December 31,                   December 31,                  December 31,
(in millions)      2012           2011            2012           2011            2012           2011
Mattresses     $      934.6   $       944.3   $      666.6   $       693.4   $      268.0   $      250.9
Pillows               158.3           151.7           73.0            75.6           85.3           76.1
Other                 310.0           321.9          224.7           235.7           85.3           86.2
               $    1,402.9   $     1,417.9   $      964.3   $     1,004.7   $      438.6   $      413.2

Net sales. Net sales for the year ended December 31, 2012 decreased to $1,402.9 million from $1,417.9 million, a decrease of $15.0 million, or 1.1%. Our decreased revenues were driven primarily by increased competition in our North American segment during the year ended December 31, 2012. Consolidated mattress sales decreased $9.7 million, or 1.0%, compared to the full year 2011. The decrease in mattress sales occurred primarily in our Retail channel with net sales decreasing to $1,228.0 million from $1,245.6 million in the same period in 2011, a decrease of $17.6 million, or 1.4%. Consolidated pillow sales increased approximately $6.6 million, or 4.4% compared to the year ended December 31, 2011. Consolidated other, which primarily includes adjustable bed bases and foundations, decreased $11.9 million, or 3.7%. Many of our other products are sold with mattress purchases. Therefore, when mattress sales decrease, other products are also negatively impacted. Direct sales increased $13.1 million, or 13.1%. The principal factors that impacted net sales for each segment are discussed below, in the respective segment discussion.

North America. North American net sales for the year ended December 31, 2012 decreased to $964.3 million from $1,004.7 million for the same period in 2011, a decrease of $40.4 million, or 4.0%. Our North American Retail channel contributed $876.5 million in net sales for the year ended December 31, 2012, for a decrease of $41.1 million, or 4.5%. We believe the significant increase in the number of competitive product introductions supported by aggressive marketing and incentives was the primary cause of our decreased net sales for the year ended December 31, 2012. North American mattress sales decreased $26.8 million, or 3.9%, over the same period in 2011. Other net sales decreased $11.0 million, or 4.7%, compared to the same period in 2011, consistent with the decrease in mattress sales.

We expect our current competitive environment to continue into the foreseeable future. During the third and fourth quarters of 2012, we undertook several initiatives to stabilize North American net sales. These initiatives include the following:

? six new product introductions, including five new mattresses and a new adjustable foundation;
? wholesale mattress price reductions on certain U.S. models to improve the margins of our U.S. retail customers; ? extension of our warranty of all U.S. mattress models to 25 years to improve the competitiveness of our products in the marketplace; and ? various other initiatives to realign dealer incentives.

The above initiatives were primarily implemented at the end of our third quarter 2012 and into the fourth quarter 2012. Thus, they did not have a material impact on results of operations for the year ended December 31, 2012.

International. International net sales for the year ended December 31, 2012 increased to $438.6 million from $413.2 million for the same period in 2011, an increase of $25.4 million, or 6.1%. On a constant currency basis(1), our International net sales increased approximately 11.3%. The International Retail channel increased $23.5 million, or 7.2%, for the year ended December 31, 2012. International Retail net sales increased primarily due to expanding points of distribution and investments in our brand awareness. As a result, International mattress sales in 2012 increased $17.1 million, or 6.8%, compared to 2011. Pillow sales in 2012 increased $9.2 million, or 12.1%, as compared to 2011. Many of our pillows are sold with mattress purchases. Therefore, when mattress sales increase, pillows are also impacted.

Gross profit. Gross profit for the year ended December 31, 2012 decreased to $714.6 million from $743.1 million for the same period in 2011, a decrease of $28.5 million, or 3.8%. Gross profit margin for the year ended December 31, 2012 was 50.9%, as compared to 52.4% in the same period of 2011. Our gross profit margin is impacted by, among other factors, geographic mix between segments. Historically, our North American gross profit margin has been substantially lower than that of our International segment, due in part to the royalty paid by the North American segment as described below. For the year ended December 31, 2012, our North American net sales decreased 4.0% as compared to the same period in 2011, whereas our International net sales increased 6.1%. These changes in geographic mix from 2011 to 2012 resulted in a 0.3% increase in our gross profit margin for the year ended December 31, 2012. Additionally, our gross profit margin includes a royalty paid by the North American segment to our International segment based on production volume, which has the effect of lowering the North American segment's reported gross profit margin, and increasing the International segment's reported gross profit margin as the North American segment's net sales increase. For the years ended December 31, 2012 and 2011, royalties paid by our North American segment to our International segment were $12.7 million and $12.3 million, respectively, which decreased the North American segment's gross profit margin percentage 1.3% for the years ended December 31, 2012 and 2011. Royalties received by the International segment increased their respective gross profit margin percentage 2.9% and 3.0% for the years ended December 31, 2012 and 2011, respectively. Costs associated with net sales are recorded in cost of sales. Costs of sales includes the costs of receiving, producing, inspecting, warehousing, insuring, and shipping goods during the period, as well as depreciation and amortization of long-lived assets used in these processes. The principal factors that impacted gross profit margin during the year are identified and discussed below in the respective segment discussions.

North America. North American gross profit for the year ended December 31, 2012 decreased to $449.3 million from $499.8 million for the same period in 2011, a decrease of $50.5 million, or 10.1%. The gross profit margin in our North American segment was 46.6% and 49.7% for the year ended December 31, 2012 and 2011, respectively. Our North American gross profit margin was most significantly impacted by a 1.7% decrease related to additional promotions and discounts and new product introductions, a 1.4% decrease related to unfavorable mix and a 0.5% decrease due to fixed cost de-leverage related to lower production volumes. These decreases were partially offset by a 0.5% increase related to lower commodity prices. Our North American cost of sales increased to $515.0 million for the year ended December 31, 2012 as compared to $504.9 million for the year ended December 31, 2011, an increase of $10.1 million, or 2.0%.

International. International gross profit for the year ended December 31, 2012 increased to $265.3 million from $243.3 million for the same period in 2011, an increase of $22.0 million, or 9.0%. The gross profit margin in our International segment was 60.5% and 58.9% for the years ended December 31, 2012 and 2011, respectively. Our International gross profit margin was most significantly impacted by a 1.3% increase driven by efficiencies in manufacturing and fixed cost leverage related to higher production volumes, as well as a 0.3% increase driven by costs associated with an information technology upgrade at our manufacturing facility in Demark during 2011 that did not recur in 2012. Our International cost of sales for the year ended December 31, 2012 increased to $173.3 million, as compared to $169.9 million for the year ended December 31, 2011, an increase of $3.4 million, or 2.0%.

Selling and marketing expenses. Selling and marketing expenses include advertising and media production associated with our Direct channel, other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials, and sales force compensation. We also include in selling and marketing expense certain new product development costs, including market research and new product testing. Selling and marketing expenses increased to $319.1 million for the year ended December 31, 2012 as compared to $276.9 million for the year ended December 31, 2011, an increase of . . .