Tempur Sealy International, Inc.

Kenneth Walker - General Counsel Dave McIlquham - Chairman, CEO Jeff Ackerman - CFO Larry Rogers - President, North America

Keith Hughes - SunTrust Robinson Humphrey Kevin Sykes - Goldman Sachs Al Kabili - Goldman Sachs Mark Montanin - Citigroup Reza Vahabzadeh - Lehman Brothers Grant Jordan - Wachovia Budd Bugatch - Raymond James John Baugh - Stifel Nicolaus

Thank you. Good afternoon, everyone.

I want to thank you for joining us on Sealy's financial third quarter 2007 investor conference call. Before we begin, let me remind you that in accordance with the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995, the company knows that certain matters to be discussed by members of management during this call may constitute forward-looking statements.

Such statements are subject to risks, uncertainties, and other factors that may cause the actual performance of Sealy to be materially different from the performance indicated or implied by such statements. Such risks and factors are set forth in the company's annual report on Form 10-K for the year ending November 26, 2006.

I now turn the call over to Dave McIlquham, Chairman and Chief Executive Officer of Sealy Corporation.

Good afternoon. Thank you, Ken.

I also want to thank all of you for joining us to talk about Sealy's third quarter of fiscal 2007. Joining me on this call is Jeff Ackerman, our Chief Financial Officer; Larry Rogers, President of North America; and Mark Boehmer, our Treasurer.

I will give a brief business overview and update on key operating initiatives. Jeff will provide a financial recap on our third quarter and year-to-date results, and then I will wrap up and we will open the line for questions.

Let me begin by providing some additional context for our call. We are going to start discussing our business in a slightly different manner than we have in the past, due to the ongoing growth of our specialty business.

Through the end of the third quarter, our specialty business produced revenues in excess of $100 million. From a growth perspective, in only 30 months since we launched Sealy's specialty business, it has grown in size to equal the sixth-largest innerspring and to be the third-largest specialty bedding company in North America.

This now represents a significant element and the fastest-growing portion of our business and we believe providing additional context and differentiation from our innerspring business is very important. During the third quarter, we successfully remained focused on our strategy of driving unit volume worldwide, both in innerspring and specialty, increasing Sealy's market share and continuing to generate solid cash flow.

Our domestic unit volume grew 10.3% in the quarter while the rest of the ISPA reporting members declined 2.6% over the first two months of our quarter; clearly illustrating how Sealy has gained market share. The retail environment has remained challenging for innerspring due to weakening demand and competitive pricing pressures.

We can't predict when the market is going to turn, but as we have communicated in the past, this strategy of optimizing the velocity of our sales and securing real estate with our retailers is best positioning us to capitalize on the opportunity when the market improves. The innerspring mattress market is below historical growth levels as it is being impacted by the drag associated with the troubled housing and mortgage market.

In the context of this environment, we believe we have executed well against our chosen strategy, but we also recognize that there are areas where we must improve our performance. This includes the need to improve sales in our higher end innerspring lines above $1,000; and even more specifically, that portion of our Sealy Posturepedic product offering that has been relatively soft due to an ongoing migration of the consumer to specialty products and aggressive pricing from competitors that have been willing to let their own margins erode in order to gain share in this very important market segment.

As a result, margin softness has persisted driven primarily by two things: first, FR cost and second, a decline in average unit selling price or AUSP. We are committed to driving velocity with competitive products to maintain our growth trajectory with our promotional Sealy Posturepedic and specialty products.

Building on the momentum we have developed in driving velocity, we are focusing our efforts on identifying and implementing opportunities to improve the profitability of these sales. We are confident that we are providing a compelling value and at this time don't anticipate needing to be any more aggressive on pricing.

In addition, we believe we have the opportunity to realize higher end Stearns & Foster and Sealy Posturepedic sales through the recently released Stearns & Foster line we launched this year, and upcoming first half of 2008 Sealy Posturepedic product launches. While we are not able to predict the trends of the market, we can and are positively impacting our business by focusing our efforts on realizing opportunities to improve the mix and the profitability of our sales.

Specifically, we are pursuing further improvements through value engineering, supply chain enhancements and we're evaluating pricing. Sealy's approach continues to focus on a three prong growth strategy: domestic innerspring, specialty, and international.

Moving into specialty, the second leg of our growth engine, we continue to produce strong results. In the third quarter, specialty sales unit volume grew 73% while AUSP was down 7.3%, due primarily to pricing actions on Sealy Posturepedic TrueForm, which we took in the first quarter.

Our specialty business is strong and we believe there continues to be significant growth opportunities, especially in latex. The specialty business is different from innerspring in many ways, including different competitors, consumer buying habits and marketing.

We are committed to driving sustainable growth in this category as demonstrated by the progress we have made in only 30 months since we launched the business. Our Visco business grew at nearly 30% last quarter, but even more impressive was the growth of latex which generated revenues that more than doubled off a bigger base.

Given the success in growth of latex, we believe latex is going to be a major driver of our business over the long term. Our recent new product introduction activities have concentrated on providing innovative and differentiated attributes in specialty, rather than competing primarily on price.

For example, in July we introduced new Sealy Posturepedic TrueForm memory foam products, which will begin shipping this month. These products have a number of enhancements that can be measured and demonstrated to the consumer, such as providing 35% greater pressure relief than the leading memory foam mattress and incorporating a surface cooling innovation which addresses the concerns heard in the marketplace from memory foam owners that their mattresses sleep hot.

Such introductions, along with our focus on value engineering, supply chain improvements and mix should help improve the margins on our memory foam mattresses over time. In our latex product portfolio, production in our new plant has reached steady state as demand continues to grow.

In fact, every facet of our portfolio is up significantly. Now that we're fully online from an operational perspective, we are evaluating changes to the business model and our go-to-market strategy.

We will be collaborating with our retailers on a joint strategy which includes new products to be introduced by the end of the first half of fiscal 2008, a comprehensive marketing strategy under the Sealy Posturepedic brand, and a new long-term business plan for this portion of our business. The increased volume of production in our new domestic latex plant has had two positive effects: (1) we expect to fully utilize the first production line by year end and as we more fully utilize capacity by adding a second line to absorb facility costs, our latex mattress gross margins will improve.

(2)As our domestic plant has become self-sufficient, this frees up our European capacity to support higher margin finished goods as well as OEM products. To wrap up this domestic market discussion, I would like to address the dynamic change driven by retailer consolidation that will continue to put pressure on manufacturers.

This is not surprising and is something we have been anticipating and experiencing for some time, but its pace has recently accelerated with Sleepy's acquisition of Rockaway Bedding stores out of bankruptcy and Mattress Firm’s purchase of Mattress Pros, along with a few other roll-up acquisitions. In the near term, this trend has caused some unanticipated costs to integrate these stores and some interruption to the new product roll outs as retailers work through these acquisitions.

Over the foreseeable future, we expect this trend to continue and believe a more concentrated retail base will provide them with greater leverage over manufacturers. For Sealy, it allows us to be more efficiently leveraging our scale, our fixed costs and better employ the strength of our relationships and leading market position amongst these large retailers.

Moving to our international business, Canada continues to grow faster than the industry with market dynamics, challenges and opportunities similar to the U.S. However, Canada has already gone through major consolidation leaving six to seven dominant retailers and we are outpacing the market with this group.

In the third quarter, our Canadian sales increased 12.3% in local currency driven primarily by the success of our Sealy Posturepedic innerspring lines. In Europe, which is primarily an OEM business, growth has continued.

We generated a sales gain of 6.2% in local currency. Unit growth was enabled by the additional capacity that was brought online last year to support the growing OEM customer demand for latex bed cores which carry both lower prices and margins.

As we've discussed in the past, our strategy in Europe remains to build a strong foundation of OEM latex sales so that we have the scale to establish Sealy as a key player in branded finished mattresses. Despite the challenging innerspring environment, Sealy has continued to deliver stable top line growth and solid cash flow.

Since becoming a public company only 15 months ago, we have generated $125.8 million of cash flow from operations and maintained our priorities for the use of the cash. We've invested in our business with new manufacturing plants, remerchandised product lines and new product innovations such as latex.

In addition we have paid down more than $63 million in debt and have returned more than $41 million to shareholders through dividends and share buybacks. Looking ahead, we anticipate that margins and volume will remain challenging for domestic innerspring in the near term until the industry conditions stabilize, and it is difficult to determine when that may occur.

We recognize that the industry is still very competitive and current economic indicators make us cautious. Specialty demand and our developing business plan strategy will provide us a bigger opportunity for growth in this category and we are committed to taking the appropriate steps to be a leader in this business.

Long term, our initiatives to grow our innerspring and international business, coupled with our commitment to specialty, provides us with a platform for continued growth. We remain committed to strengthening our leading position in the industry by driving profitable market share.

I'll now turn the call over to Jeff.

Thanks, Dave. I'd now like to walk you through the third quarter results in more detail.

For the third quarter, total sales were $446.4 million, an increase of 7.5%. This increase is the result of a 16.9% increase in units, partially offset by an 8% decline in average unit selling price, or AUSP.

On a constant currency basis, sales increased 6.2%. I'll now go into more detail on the components of this growth.

Domestic sales increased $16.7 million or 5.2% to $335.1 million. The increase reflects the executional effectiveness of our plans to drive unit growth as we saw a 10.3% increase in unit volume, partially offset by a 4.6% decrease in AUSP.

We are pleased with our increase in unit volume which was driven by growth in both innerspring and specialty. Our innerspring sales growth was 3.1% for the quarter, driven by a 5.1% increase in premium branded innerspring which comprises our Sealy Posturepedic and Stearns & Foster lines.

This growth was primarily attributable to the success of our new Sealy Posturepedic Reserve bed which we began shipping in our second fiscal quarter, while sales on the balance of our innerspring business declined 2.4%. In our specialty bedding products, we continued to generate strong growth as sales increased approximately 60% over the comparable prior year period.

Relative to the industry, our Sealy Posturepedic TrueForm business continued to grow faster than the specialty sector as it was up nearly 30% and our latex business, which is comping off a larger base, was up over 100%. The decrease in average unit selling price is primarily due to a combination of reduced innerspring sales of our Sealy Posturepedic products in the $1,000 and above price range, increased sales of our Sealy Posturepedic Reserve beds and strategic pricing actions taken in the fiscal first quarter of 2007 on selected products to drive volume, partially offset by a favorable mix of higher priced specialty and Stearns & Foster sales.

Internationally, sales grew to $111.3 million, an increase of 15.1% over the same prior year period, marking our eighth consecutive quarter of double-digit growth in our international business. On a constant currency basis, revenues grew 9.2% in the quarter.

Our strong performance was the result of an increase in unit volume, which was 32.6%, partially offset by a decline in AUSP. The changes in volume in AUSP were due primarily to increased sales of lower-priced OEM latex cores in Europe.

In our European market, sales gained 14.3% in the quarter, or 6.2% on a local currency basis with a 63.2% increase in volume. Increased sales of OEM latex bed cores, which have lower prices, drove the unit growth and the decrease in average unit selling price.

Finished good sales in Europe increased 8.5% on a local currency basis. The Canadian business remains strong and was up 18.9%, or 12.3% in local currency on a 15.9% increase in unit volume.

Unit and sales growth were driven by strong performance in Sealy Posturepedic innerspring sales. Our total gross profit decreased $5.3 million from the same period a year earlier to $179.9 million.

As a percentage of sales, gross profit was 40.3% compared to 44.6% last year. 2.1% of the variance was related to the addition of $9.5 million of flame retardant materials to our products in the U.S.

The remainder was due to enhancements we made to the value of our products, shifts in the sales mix and pricing actions that contributed to the reduction in AUSP. At the same time, we continue to make improvements in manufacturing efficiencies and have improved our labor productivity and yields on raw material under our lean manufacturing journey.

However, the cost of our petroleum and steel-based input products continue to remain above their historical averages and we expect them to remain at or above these elevated levels. On a positive note, we have been able to mitigate some of the effects of the price fluctuations through various pricing agreements we have put in place with our vendors.

SG&A increased $12.9 million, or 10.1% from the same period a year ago to $140.1 million. This increase was due to a number of factors, including $7.5 million of variable expenses, such as a $5 million increase in cooperative advertising costs to support our increased revenues, and a $1.7 million increase in delivery costs due to higher unit volume.

Other cost increases included a $3.6 million increase in promotional expenses in the U.S. operations associated with sales promotions and a roll out of our new Stearns & Foster and Sealy Posturepedic Reserve products; $1.4 million associated with an organizational realignment in the U.S.; and a $1.3 million increase in spending on national advertising.

These increases were partially offset by $900,000 of net cost reductions. As a percent of net sales, SG&A expense was 31.4% and 30.6% for the quarters ending August 26, 2007 and August 27, 2006 respectively; an increase of 0.8 percentage points.

Interest expense remained essentially constant as compared with the prior year period at $15.9 million. During the quarter, we recognized an income tax benefit as the expiration of certain federal and state statutes of limitations allowed us to reduce our income tax reserves by $7 million, or $0.07 per diluted share.

The effective tax rate for the third quarter of 2007 was 19.2% compared to 28.7% in the prior year. For the full fiscal year, we expect our tax rate to be about 34.5%.

Net income was $0.22 per diluted share or $21.5 million compared to $0.30 per diluted share or $29.4 million in the same period in 2006. Let me now provide some insight into our year-to-date 2007 results.

For the nine months ended August 26, 2007, total net sales were $1.26 billion, a 6.2% increase from the same period a year earlier. Taking a look at how this performance breaks down domestically and internationally, domestic sales increased by $30.5 million, or 3.3% driven, by a 7.6% increase in unit volume partially offset by a 4% decrease in AUSP.

Internationally, sales grew $42.7 million or 16.2%. On a constant currency basis, sales increased 11.9%.

Gross profit was $529.7 million or 42% of sales compared with $530.5 million or 44.7% of sales for the same period a year earlier. Net income was $62.2 million.

Now onto our balance sheet. Sealy's cash and cash equivalent balance as of August 26, 2007 was $14.6 million compared to $22.2 million at the same time last year.

The company continues to produce significant cash from operations, with the majority of that cash historically being generated in the second half of our fiscal year. Cash flow from operations for the third quarter 2007 was $31 million, an increase of $14.3 million versus $16.7 million in 2006.

For the first nine months of fiscal 2007, cash flow from operations improved $56.6 million to $53.5 million as compared to a net use of $3.1 million last year. Now our 2006 results included a $30.8 million impact from the IPO and related debt extinguishment.

Our working capital remains at relatively low levels. Looking first at accounts receivable, our domestic days sales outstanding was 35 days which was one day better than the same period a year ago.

International days sales outstanding increased two days due to a shift in customer mix. Our domestic days inventory on hand decreased by four days to 19 days from the prior year.

This was due primarily to improvement in specialty inventory. Internationally, days on hand was three days greater than the same period last year to support the higher production level and order sizes.

Consistent with our lower inventory days, domestic days payables decreased five days as compared to the same period a year ago to 55 days. International days payable was 102 days, which represents an increase of 12 days.

Turning now to uses of cash flow, capital expenditures totaled $33.5 million for the nine months ended August 26, 2007 including $7.1 million related to the Mountaintop latex production facility. We expect total 2007 capital expenditures to be approximately $40 million.

The company's debt, net of cash, was $791.6 million at August 26, 2007 compared to net debt of $786.9 million at the beginning of the year. Net debt was impacted by $33.5 million of capital investments we made in our manufacturing facilities and other areas to support our growth, as well as $20.6 million in cash dividends and the use of $7.1 million to repurchase our common stock.

Our leverage ratio for net debt to adjusted EBITDA defined in our credit agreement stands at 3.5. On October 3, 2007 we announced that our board of directors declared a cash dividend for the third quarter in the amount of $0.075 per share of common stock.

During the quarter, we repurchased 113,100 shares of our common stock for $1.7 million. As of October 3, 2007 we had purchased an additional 529,000 shares of our common stock for $7.7 million since the quarter end.

We maintain that our use of cash flow reflects our commitment to return a portion of excess cash to our shareholders, while working toward our targeted net debt levels and preserving flexibility to fund our continued growth plans. Now since we don't give formal guidance, we still want to provide some assistance in how to think about and model our business.

In order to help you better understand what impacts our results, I'm going to provide you with some detail on our margins. We can't get more granular than this information for competitive purposes, but this should provide you with additional clarity.

Sealy's gross and operational margins are impacted by the relative strength or weakness of each of our product types and geographies. Relative to the company's average margins, our domestic innerspring business is generally accretive to margin.

This is due to the vertical integration of our domestic innerspring manufacturing process. Directionally, the higher the AUSP, the more accretive the product although our promotional lines at incremental gross profit dollars impact our gross margin.

At this time, Sealy's specialty lines have margins that are below the company average. In memory foam, we are not vertically integrated and imported some of the components, leading to a relatively more expensive supply chain.

The gross margins of our domestic latex mattresses are also currently below the average, while we are still developing this business. We expect to fully absorb the capacity of the first production line by year end and as we more fully utilize capacity by adding a second line to absorb facility costs, latex will become more accretive.

For both our memory and latex foam products we are working to improve their gross margins by improving the supply chain costs and product design. Internationally, our margins vary by location.

In Canada, the market dynamics and margins by product category are very similar to those in the U.S. In Europe, the strength in our OEM business impacts margins as OEM brings with it a lower average margin.

However, as our Mountaintop latex plant is able to supply the U.S. market, it frees up capacity to support growth in OEM products and the higher margin, finished goods business.

Finally, I'd like to briefly discuss our outlook for the rest of fiscal 2007. As Dave mentioned, the innerspring mattress industry remains challenging.

The marketplace is competitive and it is taking longer to turn than we had previously anticipated. As long as such conditions persist, we anticipate that we will continue to be aggressive in order to drive market share gains and cash flow.

We are pleased with the performance of our new Stearns & Foster and Sealy Posturepedic Reserve line. As part of our ongoing product innovation strategy, we are preparing to ship our new Sealy Posturepedic TrueForm line and have begun work to enhance our higher priced Sealy Posturepedic innerspring and latex products in order to drive additional sales and margin expansion.

We intend to introduce these products in the first half of 2008 and benefit from them shipping later that year. We are running the business for the long term, and remain focused on achieving our long-term targets while continuing to produce solid sales growth and improving cash flows.

While we anticipate that margins and volume will remain challenging for innerspring until industry conditions stabilize, we are encouraged by the steadily improving trend in domestic unit volume. Our Sealy Posturepedic Reserve, Stearns & Foster lines and specialty business are performing well, in addition to the continued growth in our international business.

Furthermore, we are evaluating changes to our strategy for latex that include new products to be introduced in the first half of 2008, a comprehensive latex marketing plan for the Sealy Posturepedic brand and a long-term business model that incorporates these products. Together, these attributes and solid execution will help Sealy continue to be the industry leader.

I will now turn the call back to Dave to provide some concluding comments.

Thanks, Jeff. Let me summarize and close by saying the following: We recognize there are areas within our innerspring business where we must improve the performance.

Building on the success of our new Stearns & Foster and Posturepedic reserve products, we are committed to identifying and implementing opportunities to improve the margin and profitability of these sales as we move forward. In addition, as you have heard from me and again from Jeff, we are committed to continuing to build on our growth and profitability in our specialty portfolio, especially in our latex products and to that end, we are evaluating changes to the business model including our go-to-market strategy.

Some of these initiatives for latex include collaborating with our key retailers on a joint strategy for growth, introducing new products by the end of the first half of fiscal 2008, introducing a marketing strategy that leverages the Sealy Posturepedic brand, and a new long-term business plan for this portion of our specialty business; each of which are intended to drive long-term shareholder value. We are confident about the future and remain committed to building profitable, long-term market share.

Thanks for joining us on the call, and we will now open the line for questions.

First, numerically can you give us what the gross profit or gross margin was for the U.S. business in the quarter?

Gross profit for the U.S. was 41.5% for the quarter.

Secondly, you talked about the industry environment earlier and I think it's pretty obvious it's going to remain that way for some time. Why did SG&A costs go up a little bit sequentially and, of course, up a lot year over year?

Are you not looking at the cost structure of the business to bring that down during this difficult time?

We absolutely are. I think it's important for people as they think about our business, one of the things is that our SG&A expenses are approximately 60% variable.

So as I mentioned in my prepared comments, the single largest driver of the increase was the increase in cooperative advertising. As I said, that was about $5 million.

We also saw, with the 10.3% increase in units here in the U.S., that drove increases in the delivery costs. Beyond that, we had some marketing and promotional activities that drove about $3.6 million.

We had $1.4 million of charges related to some realignment activities associated with the salesforce, and then finally we spent an incremental $1.3 million in national advertising to build the Sealy brand.

I understand, but you have 40% that's fixed that is up $55 million in the quarter. Given the environment we're in, a 5% or 10% cut there would make a big difference.

Is that something you're looking at doing or is the fix where it's going to be in the future?

Keith, I think as I've mentioned before, one of the areas of opportunity that we've recognized is to take some of the lean manufacturing principles, the lean principles that we have in our manufacturing plant, bring that off the shop floor and into our office environment; that's one thing. The other thing is as I said, we did actually take some cost-cutting actions during the third quarter and that's actually what's driving this $1.4 million of charges that I mentioned related to the realignment activities.

On bringing the efficiencies from the shop floor, the gross margin got worse year over year in the third than it was in the second. When are those realistically going to come in to help support this gross margin erosion?

I'm sorry. Could you just repeat the question, Keith?

You talked earlier in your answer about bringing some of the efficiencies off the drawing board, I guess you would say, on the shop floor. When are those going to take effect to at least stem some of this erosion in gross margin?

Just to be clear, it's coming off the shop floor and really into the office environment.

That's what I meant.

We are just continuously evaluating that. One of the big drivers this year is the amount we're spending related to our Sarbanes-Oxley cost, but that is something we would not have next year but the other productivity initiatives that we have are things that we're teeing up now and the executive team is meeting on and we would expect to be implementing those in the coming quarters.

In addition to the answer that Jeff has just provided, the reorganization in the salesforce, you will start to see it take hold now. Just to give you a little bit of color around that, it probably is in the neighborhood of 9%, 10% of our salesforce that we have restructured.

So we are paying attention to the SG&A and that's somewhat the direction of your question.

You had mentioned $100 million in specialty business. Is that year-to-date specialty business, big orders?

That's correct, Keith.

Thanks for taking the questions. You talked about on one hand taking price increases or at least evaluating taking price increases.

I was just wondering if you could talk about where? You've also talked about your comfort with price levels and then on the other hand that the environment remains tough and that you'll continue to be active.

I just want to get a sense for where you think price is going and where are you versus your main competitors?

Listen, we are committed to improving margins. Jeff just talked about some elements and we're focused on every aspect of the product assortment.

We're looking at value engineering opportunities. We're looking at supply chain efficiencies and you'll see some of those implemented as we roll out the new Posturepedic TrueForm.

Clearly we'll start to see those in latex now that Mountaintop is at a steady state. We're looking at the new line merchandising associated with the Posturepedic launch that we're going to effect in the first half of the 2008.

We're clearly looking at a new strategy as to how we drive the business and pricing and margins and specialty on a go-forward basis and we're developing that now. Finally, we're looking at a pricing on every aspect of our business in trying to evaluate it.

The market is tough and we can't control the external market. We are gaining market share in slots and as we've said before, Larry and I have been through this before and we're going to be positioned to take advantage when the industry rebounds but we are looking at pricing actions.

The fact is that our industry and we have incurred significant cost increases because of FR and we've got to figure out if it's possible and how we can pass some of that on. So we're looking at every aspect of the business.

As I said in my opening remarks, we do believe we've got very competitive values. We have picked up slots, but we've got to find a way to improve margins over the long term in this business.

With the roll-out costs that may be incurred for next year's new product launches and the new strategy on specialty, I was just wondering, you talked before about a debt target of 2.5 to 3 times; is that still the target and when do you think you can get there?

That is still our target and it's our policy not to give guidance on that. But, Kevin, let me just reiterate.

As I mentioned in my prepared remarks, we generated $31 million of operating cash flow in the quarter, despite the tough environment that we're going through and that was a $14 million improvement over the prior year. So we've been able to continue paying down debt, paying dividends and buying back stock.

You're not going say if you expect that to continue. Thanks for the color.

Good afternoon, a question on the specialty business. What kind of actions are you taking and when can we see the gross margins there equal the innerspring business?

We've built a terrific business in the last 30 months, obviously. As you heard Jeff say, it's more than $100 million year-to-date.

I think there are a number of keys to success for us, particularly in latex as we think about the future, but also across our whole specialty category. Clearly you have to have the right supply chain.

You have to have innovative and differentiated product. We believe you've got to have scale to compete.

You've got to have a selling strategy that works in that market and we believe you've got to have a brand-building plan. Now we've put the right supply chain in place with our new TrueForm introduction.

We clearly put it in place with the Latex plant. Our new TrueForm launch gives you an indication of our thinking in terms of innovative and differentiated product from the competitors there.

We clearly have the scale now that we've built in the last couple years and quite candidly, we believe that this new plan has to focus on selling strategies and brand building. We're committed to be a leader in this category, and as I said in my earlier comments, we think specialty is different from innerspring.

The competitors clearly are different. The consumer buying process is different.

The marketing approach is different and the retailers treat the category differently and so we're in the early stages of development of this plan, but we are committed to building a business plan that will drive long term profitable growth and that growth has to include, over time, growth in margins. We've been putting the building blocks in place and you'll start to see that in the second quarter of 2008.

Is it just scale that's going to drive the margin expansion or is there other stuff?

Oh, no. I think it's having the right supply chain.

It's got to be innovative and differentiated product; scale is a part of it. But I think a key is our selling strategies and our brand-building plan.

We clearly feel really good about latex. You heard Jeff say that our latex business last quarter more than doubled and that was off a base that was bigger than Visco and we think it's the key.

It's all about reaching the consumer, selling the product differently. I think it involves different SG&A approaches to the business versus the traditional innerspring business and it's why we say that we're in the early stages of development and it's why it's going to require collaboration with our retailers.

We're going to run the specialty business differently than we run the innerspring business.

Regarding the flame retardant compliance, assuming the $9.5 million increase in raw material costs this quarter is an increase over those recorded in the second quarter, holding volume levels steady do you believe the increase in material costs associated with making your products compliant has plateau'd? Or should we expect potential for additional material cost pressures going forward?

Mark, could you just repeat the last part of your question? I didn't quite catch that.

Holding volume levels steady just to get rid of that variable, are your costs associated with making your products flame retardant compliant, do you believe that they've plateau'd on a constant volume level?

Mark, they have. I just want to correct your assumption on the costs.

The $9.5 million is not an increase sequentially with the second quarter. It's an increase over the prior year.

So year-to-date, though, our FR costs are just north of $19 million in material costs.

Have they been increasing steadily sequentially?

No. Remember in the second quarter we were still rolling out the promotional line which was becoming FR compliant and then we've gone to some new product designs.

So we're now I think at a fairly steady state.

Also regarding the possible change to your latex business model, in particular your go-to-market strategy and collaborating with some of your key retailers, could you expand on that a little bit?

Mark, not at this time. Listen, we understand the business.

We understand what the keys to success are. We've spent 30 months putting the building blocks in place.

The reality is that the marketing approach in specialty is different from innerspring and retailers treat the category differently. We have been great partners with our retailers in the past.

We intend to be in the future, but we believe to be a leader in the category, particularly given where Tempur and Select are, that it's going to involve different strategies and we're committed to developing and implementing them on a go-forward basis.

On co-op spending, you touched on co-op spending increase in the SG&A line. If you just ignore the classification of it, was co-op spending higher as a percentage of gross sales or flat or how should I think about that?

Here's how to think about it: it is slightly higher as a percent of sales and what drives that is a little bit of the mix of customers. But again, it's volume variable and so as the sales and revenues increase, then we're going to see an increase in that.

But the co-op spending went up some. It sounds like it was up 50 to 100 basis points.

I didn't say.

Would you anticipate your overall co-op and advertising spending to continue as you're trying to gain shelf space, introduce new products, grow your specialty business? Or was this a one quarter front-ended spending?

I'm just trying to find out the run rate in the spending you have right now.

Reza, every quarter that we have sales growth we'll have an increase in co-op. We've got contractual obligations to provide those funds to our retail partners and so every year, every quarter we have sales growth you're going to see an increase.

On material costs I don't know if I heard you right, but you said material costs were up 7.9% on a per unit basis. Is that including the FR costs or is that just the material costs on a standalone basis?

That does include the FR costs and the FR cost makes up probably over 60% of that number.

Just to follow up, $9.5 million of FR costs, when will that be anniversaried? I mean when will that not be major year-over-year increase?

It will be really as we move into next year. As I mentioned previously, we had a few products during the first half of the year that were still not FR compliant, so really the third quarter is really the first time we're at the full run rate with FR costs.

But let me also just point out that we recognize the magnitude of this and we recognize the impact it's having on our margins. So just like this team has done in the past, we're very focused on value engineering efforts.

We're already onto the second and third generation solutions for FR. So we're going to continue to look for ways to reduce those costs and offset that increase.

My next question, you touched on this a little bit, but it looks like inventory days are down a good bit year over year. Is there something driving that?

Should we expect that to remain going forward?

No. Our operations team has done a great job focusing on managing the inventory, but as I mentioned in my comments, the biggest driver of that was last year we did not have our latex plant online and the biggest delta was the amount of raw materials associated with our specialty bedding products.

As Dave mentioned, we've made changes to our supply chain on the Visco side and now we have the latex beds where we're now producing cores here in the U.S.

I understand the margin pressure from the competition and the move to specialty and FR, but I am confused about the SG&A. I think like Keith, to see a 70 basis point deleverage.

Jeff, I think you said 60% of the SG&A is variable which if my math is right, would imply about a 25% or a 24% variable to sales ratio? If that's true, then you had about a 10% increase in fixed costs?

Could you give us any granularity or color there?

Correct. I did say we had a 10% increase in really just in our total costs, but the fixed components that went up, that was what I mentioned before was about $3.6 million related to some promotional activities as well as some product launch costs; $1.4 million charges related to our realignment activities that Larry mentioned, associated really with the salesforce; and then another $1.3 million of incremental national advertising to build the brand.

That will continue at that rate then, going forward?

No. The realignment costs are really a one-time.

Yes, but the other two, the national advertising and if you put them into the fixed bucket, we should assume they're going to continue, to build a model? Is that how we should do it?

Because they would have, I would have thought, been more in the variable bucket.

These are specific marketing promotional activities that we did with some of our products and they were discreet actions, so I would not necessarily assume that those would continue.

My final question has to do with tax rate. You talk about a favorable tax reserve, I think off the balance sheet onto the income statement or onto the tax account.

How much is that? Have you quantified that?

Did I miss that?

I did. It's $7 million.

That would have brought the nominal tax rate to that 34% you talked about?

That's what I said we will finish the year, about 34.5%.

For the full year. So the tax rate, how do we get there for the full year, then?

Will the fourth quarter be a significant tax expense?

I don't know of really any unusual items. Again, I would just kind of plug for your modeling purposes to get to the 34.5%.

That's probably the best I can do for you.

It sounds like there's price pressure on the $1,000 and up innerspring products. Is that due to Specialty Sleep just being the primary competitor?

Really, what can you do to stabilize that or arguably get prices back up?

I think the price pressure is driven by a couple of things. One is Specialty as you mentioned and clearly all that growth and activity is above $1,000.

Two is the softness in terms of the market. Really as we've said, the growth in the category has largely been in specialty for the last 12 months.

Third is most of our competitors are being really aggressive as they try to protect their slots and their business and so I think there's more competition in innerspring, demand is soft and then specialty is an issue and that's all come at a time where we've had to confront this conversion to FR as well as some material inflation over the last 24 months in foam and steel.

As a follow-up, you mentioned collaborative efforts. Are you currently with your Visco or latex doing the co-op model?

Are you going to be asking the retailers effectively that they won't get co-op money and that you'll spend the advertising? Any clarity there?

I would say you have articulated it properly in that up until this point in time, for the most part, we've run our specialty business the way we've run our entire business and it has got us to this stage. Some nice scale given where the business is, a good platform for growth, but as Jeff mentioned, the margins are less than our average and cooperative advertising costs are a big part of our SG&A and they just keep going up.

So we think we're at the point where we've got the right supply chain. We are developing innovative and differentiated product.

We've got scale to compete but the marketing approach in specialty is different. Retailers are treating the category and some competitors differently.

To be a leader in this category -- because we think it is a great long-term profitable business -- we've got to have the appropriate selling strategies and brand-building plans that allow us to be a leader. I think to get there is going to involve a collaboration with our customers; to get there is going to involve innovative and different thinking and we're starting that.

At this time I'm telling you that as an organization we're committed to being a leader in specialty.

On the consolidation that you talked about, have you yet seen any pressure from those retailers trying to leverage their larger size?

Kevin, we see leverage every day.

A question as you think about market share versus pricing. At what point do you think that it may make sense to limit pricing declines and try to hold margins at the expense of maybe gaining some market share?

Secondly, any concerns on the Reserve about consumers stepping down, cannibalizing sales and margins at the lower price points on Reserve?

Listen, I think that as we've said, we believe we've got incredibly compelling values out there so we're not looking at more aggressive pricing. We're actually, as we've said, evaluating what pricing actions and opportunities there are.

We don't have an innerspring demand issue below $1,000. Overall we're gaining share in innerspring.

Last quarter our sales were up. I think we're well-positioned when the market rebounds, but as we've said, our performance above $1,000 has been weak.

I think we talked about it on the last call. The good news is our Stearns & Foster sales were up last quarter and our new Posturepedic line will be launched in the first half of '08 and we've got to find opportunities to recover the costs of FR and the costs of a soft market, and the competitiveness out there.

That's value engineering, it is supply chain changes, it is new line merchandising to better mix up and it is evaluating price actions. All those things we're looking at to improve our innerspring margin.

I'll just close by saying that I thought this was a good discussion. I hope you appreciate and understand where we're focused.

As I mentioned before, we've been through this before and while we can't control the external market, we can control and gain market share in slots and we can do things to improve our margins. We're going to look at innerspring in every aspect of that and we're going to look at specialty different.

We've got a terrific and growing latex business. We're excited and confident about the future and we've got a lot of work and a lot of collaboration in front of us.

But at the end of the day as you think about specialty and particularly latex, the keys to success are having the right supply chain, having innovative and differentiated product, having the scale to compete, having the right selling strategies and the right brand-building plan. That is what we're focused on and we look forward to sharing that progress with you on our next call.

Thanks a lot.