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EXCEL - IDEA: XBRL DOCUMENT - TEMPUR SEALY INTERNATIONAL, INC.Financial_Report.xls
EX-10.1 - NON-EMPLOYEE DIRECTOR DEFERRED COMPENSATION PLAN - TEMPUR SEALY INTERNATIONAL, INC.exhibit101.htm
EX-10.2 - FORM OF NON-EMPLOYEE DIRECTOR STOCK OPTION AGREEMENT - TEMPUR SEALY INTERNATIONAL, INC.exhibit102.htm
EX-31.2 - CERTIFICATION OF CFO PURSUANT TO SECTION 302 OF THE SARBANES OXLEY ACT OF 2002 - TEMPUR SEALY INTERNATIONAL, INC.exhibit312.htm
EX-31.1 - CERTIFICATION OF CEO PURSUANT TO SECTION 302 OF THE SARBANES OXLEY ACT 0F 2002 - TEMPUR SEALY INTERNATIONAL, INC.exhibit311.htm
EX-32.1 - CERTIFICATION OF CEO AND CFO PURSUANT TO SECTION 906 OF THE SARBANES OXLEY ACT - TEMPUR SEALY INTERNATIONAL, INC.exhibit321.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
FORM 10-Q
 
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 
For the quarterly period ended June 30, 2010

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

For the transition period from   

to

 Commission file number 001-31922
 
 
TEMPUR-PEDIC INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
33-1022198
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

 
1713 Jaggie Fox Way
Lexington, Kentucky 40511
(Address, including zip code, of principal executive offices)
 
Registrant’s telephone number, including area code: (800) 878-8889
  
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes x    No 

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

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

 
Large accelerated filer x          Accelerated filer o          Non-accelerated filer o
 
(Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act.): Yes ¨  No x
 
The number of shares outstanding of the registrant’s common stock as of July 27, 2010 was 69,780,192 shares. 
 
 
         
     
  
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    This quarterly report on Form 10-Q, including the information incorporated by reference herein, contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, which include information concerning our plans; objectives; goals; strategies; future events; future revenues or performance; the impact of the macroeconomic environment in both the U.S. and internationally on sales and our business segments; investments in operating infrastructure; changes in capital expenditures; the impact of consumer confidence; litigation and similar issues; pending tax assessments; financial flexibility; the impact of initiatives to accelerate growth, expand market share and attract sales from the standard mattress market; the improvements in our Net sales; efforts to expand business within established accounts, improve account productivity, reduce costs and operating expenses and improve manufacturing productivity;  initiatives to improve gross margin; the vertical integration of our business; the development, rollout and market acceptance of new products, including the success of the TEMPUR-Cloud™ Supreme; our ability to further invest in the business and in brand awareness; our ability to meet financial obligations and continue to comply with the terms of our credit facility, including its financial ratio covenants; effects of changes in foreign exchange rates on our reported earnings; our expected sources of cash flow; our ability to effectively manage cash; our ability to align costs with sales expectations and other information that is not historical information. Many of these statements appear, in particular, under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in ITEM 2 of Part I of this report. When used in this report, the words “estimates,” “expects,” “anticipates,” “projects,” “plans,” “intends,” “believes” and variations of such words or similar expressions are intended to identify forward-looking statements. These forward-looking statements are based upon our current expectations and various assumptions. There can be no assurance that we will realize our expectations or that our beliefs will prove correct.
    
    There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report. Important factors that could cause our actual results to differ materially from those expressed as forward-looking statements are set forth in this report, including under the heading “Risk Factors” under ITEM 1A of Part II of this report and under the heading “Risk Factors” under ITEM 1A of Part 1 of our annual report on Form 10-K for the year ended December 31, 2009. There may be other factors that may cause our actual results to differ materially from the forward-looking statements.
    
    All forward-looking statements attributable to us apply only as of the date of this report and are expressly qualified in their entirety by the cautionary statements included in this report. Except as may be required by law, 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.
 
    When used in this report, except as specifically noted otherwise, the term “Tempur-Pedic International” refers to Tempur-Pedic International Inc. only, and the terms “Company,” “we,” “our,” “ours” and “us” refer to Tempur-Pedic International Inc. and its consolidated subsidiaries.
 
 
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES

(In thousands, except per common share amounts)
(Unaudited)

 
Three Months Ended
   
Six Months Ended
 
 
June 30,
   
June 30,
 
   
2010
   
2009
     
2010
   
2009
 
Net sales
$
263,044
 
$
185,176
   
$
516,933
 
$
362,280
 
Cost of sales
 
135,003
   
98,845
     
264,083
   
194,088
 
Gross profit
 
128,041
   
86,331
     
252,850
   
168,192
 
Selling and marketing expenses
 
46,827
   
35,191
     
93,058
   
69,063
 
General, administrative and other expenses
 
27,364
   
21,978
     
53,652
   
44,086
 
Operating income
 
53,850
   
29,162
     
106,140
   
55,043
 
                           
Other expense, net:
                         
Interest expense, net
 
(3,786
)
 
(4,477
)
   
(6,975
)
 
(9,048
)
Other (expense) income, net
 
(64)
   
270
     
99
   
618
 
Total other expense
 
(3,850
)
 
(4,207
)
   
(6,876
)
 
(8,430
)
                           
Income before income taxes
 
50,000
   
24,955
     
99,264
   
46,613
 
Income tax provision
 
16,485
   
8,098
     
32,506
   
16,418
 
    Net income
$
33,515
 
$
16,857
   
$
66,758
 
$
30,195
 
         Less: Net income attributable to the noncontrolling interest
 
9
   
     
104
   
 
    Net income attributable to common stockholders
$
33,506
 
$
16,857
   
$
66,654
 
$
30,195
 
                           
Earnings per common share:
                         
Basic
$
0.47
 
$
0.23
   
$
0.93
 
$
0.40
 
Diluted
$
0.46
 
$
0.22
   
$
0.90
 
$
0.40
 
Weighted average common shares outstanding:
                         
Basic
 
70,730
   
74,894
     
72,014
   
74,884
 
Diluted
 
73,152
   
75,493
     
74,438
   
75,036
 

See accompanying Notes to Condensed Consolidated Financial Statements. 

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES

(In thousands)
 
 
June 30,
2010
 
December 31,
2009
 
(Unaudited)
   
ASSETS
           
             
Current Assets:
           
     Cash and cash equivalents
$
15,367
 
$
14,042
 
     Accounts receivable, net
 
112,338
   
105,576
 
     Inventories
 
65,310
   
57,686
 
     Prepaid expenses and other current assets
 
14,174
   
11,268
 
     Deferred income taxes
 
20,462
   
20,411
 
Total Current Assets
 
227,651
   
208,983
 
     Property, plant and equipment, net
 
159,528
   
172,497
 
     Goodwill
 
210,475
   
193,391
 
     Other intangible assets, net
 
69,985
   
64,717
 
     Other non-current assets
 
4,298
   
3,791
 
Total Assets
$
671,937
 
$
643,379
 
             
LIABILITIES AND STOCKHOLDERS’ EQUITY
           
             
Current Liabilities:
           
     Accounts payable
$
48,664
 
$
47,761
 
     Accrued expenses and other current liabilities
 
79,481
   
81,452
 
     Income taxes payable
 
14,584
   
7,312
 
Total Current Liabilities
 
142,729
   
136,525
 
     Long-term debt
 
435,000
   
297,470
 
     Deferred income taxes
 
30,689
   
29,865
 
     Other non-current liabilities
 
8,211
   
7,226
 
Total Liabilities
 
616,629
   
471,086
 
             
Commitments and contingencies—see Note 9
           
             
Equity attributable to common stockholders
 
53,979
   
172,293
 
Equity attributable to the noncontrolling interest
 
1,329
   
 
Total Stockholders’ Equity
 
55,308
   
172,293
 
Total Liabilities and Stockholders’ Equity
$
671,937
 
$
643,379
 
             

See accompanying Notes to Condensed Consolidated Financial Statements. 

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES

(In thousands)
(Unaudited)
 
 
Six Months Ended
June 30,
 
2010
 
2009
       
CASH FLOWS FROM OPERATING ACTIVITIES:
             
     Net income
$
66,758
   
$
30,195
 
     Adjustments to reconcile net income to net cash provided by operating activities:
             
          Depreciation and amortization
 
15,706
     
15,514
 
          Amortization of stock-based compensation
 
5,339
     
4,093
 
          Amortization of deferred financing costs
 
345
     
345
 
          Bad debt expense
 
1,278
     
3,864
 
          Deferred income taxes
 
(2,697
)
   
(6,148
)
          Foreign currency adjustments and other
 
(2,150
)
   
148
 
  Changes in operating assets and liabilities, net of effects of acquired business
 
(16,757
)
   
17,439
 
Net cash provided by operating activities
 
67,822
     
65,450
 
               
CASH FLOWS FROM INVESTING ACTIVITIES:
             
     Acquisition of business, net of cash acquired    (18,692        
     Purchases of property, plant and equipment
 
(6,698
)
   
(4,728
)
     Payments for other
 
(184
)
   
(155
)
Net cash used by investing activities
 
(25,574
)
   
(4,883
)
               
CASH FLOWS FROM FINANCING ACTIVITIES:
             
     Proceeds from long-term revolving credit facility
 
222,336
     
83,797
 
     Repayments of long-term revolving credit facility
 
(83,313
)
   
(133,036
)
     Proceeds from issuance of common stock
 
19,470
     
 
     Excess tax benefit from stock-based compensation
 
2,613
     
 
     Treasury shares repurchased
 
(200,000
)
   
 
Net cash used by financing activities
 
(38,894
)    
(49,239
)
NET EFFECT OF EXCHANGE RATE CHANGES ON CASH AND CASH EQUIVALENTS
 
(2,029
)
   
(1,739
)
Increase in cash and cash equivalents
 
1,325
     
9,589
 
CASH AND CASH EQUIVALENTS, beginning of period
 
14,042
     
15,385
 
CASH AND CASH EQUIVALENTS, end of period
$
15,367
   
$
24,974
 
               
Supplemental cash flow information:
             
     Cash paid during the period for:
             
Interest
$
6,397
   
$
8,987
 
Income taxes, net of refunds
$
23,641
   
$
25,385
 

See accompanying Notes to Condensed Consolidated Financial Statements.

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
(In thousands, except per common share amounts)
 
(1) Summary of Significant Accounting Policies
 
    (a) Basis of Presentation and Description of Business—Tempur-Pedic International Inc., a Delaware corporation, together with its subsidiaries is a U.S. based, multinational company. The term “Tempur-Pedic International” refers to Tempur-Pedic International Inc. only, and the term “Company” refers to Tempur-Pedic International Inc. and its consolidated subsidiaries.
 
    The Company manufactures, markets and sells products including pillows, mattresses and other related products. The Company manufactures essentially all its pressure-relieving TEMPUR® products at three manufacturing facilities, with one located in Denmark and two in the U.S. The Company has sales distribution subsidiaries operating in North America, Europe and Asia Pacific and has third party distribution arrangements in certain other countries where it does not have subsidiaries. The Company sells its products through four sales channels: Retail, Direct, Healthcare and Third party.
 
    The accompanying unaudited Condensed Consolidated Financial Statements have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X and include all of the information and disclosures required by generally accepted accounting principles in the United States (U.S. GAAP) for interim financial reporting. These unaudited Condensed Consolidated Financial Statements should be read in conjunction with the consolidated financial statements of the Company and related footnotes for the year ended December 31, 2009, included in the Company’s annual report on Form 10-K.
 
    The results of operations for the interim periods are not necessarily indicative of results of operations for a full year. It is the opinion of management that all necessary adjustments for a fair presentation of the results of operations for the interim periods have been made and are of a recurring nature unless otherwise disclosed herein.
 
    (b) Basis of Consolidation—The accompanying Condensed Consolidated Financial Statements include the accounts of Tempur-Pedic International, its wholly-owned subsidiaries and its majority-owned subsidiaries in which a controlling interest is held. Intercompany balances and transactions have been eliminated. The noncontrolling interest represents the portion of equity interests of consolidated affiliates not owned by the Company. On January 29, 2010, the Company established a 51% interest in Tempur Shanghai Holding Ltd (a Hong Kong company).
 
    (c) Use of Estimates—The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The Company’s results are affected by economic, political, legislative, regulatory and legal actions. Economic conditions, such as recessionary trends, inflation, interest and monetary exchange rates, government fiscal policies and changes in the prices of raw materials, can have a significant effect on operations. While the Company maintains reserves for anticipated liabilities and carries various levels of insurance, the Company could be affected by civil, criminal, regulatory or administrative actions, claims or proceedings.
 
    (d) Inventories—Inventories are stated at the lower of cost or market, determined by the first-in, first-out method, and consist of the following:
 
   
June 30,
2010
 
December 31,
2009
 
Finished goods
  $ 47,636   $ 41,805  
Work-in-process
    5,431     6,654  
Raw materials and supplies
    12,243     9,227  
    $ 65,310   $ 57,686  
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
    (e) Accrued Sales Returns—The Company allows product returns up to 120 days following a sale through certain sales channels and on certain products. Estimated sales returns are provided at the time of sale based on historical sales channel return rates. The level of sales returns differs by channel with the Direct channel typically experiencing the highest rate of return.  Estimated future obligations related to these products are provided by a reduction of sales in the period in which the revenue is recognized. Accrued sales returns are included in Accrued expenses and other current liabilities in the accompanying Condensed Consolidated Balance Sheets.
 
    The Company had the following activity for sales returns from December 31, 2009 to June 30, 2010:

Balance as of December 31, 2009
$ 4,233  
     Amounts accrued
  22,758  
     Returns charged to accrual
  (21,994 )
Balance as of June 30, 2010
$ 4,997  
 
    (f) Warranties—The Company provides a 20-year warranty for U.S. sales and a 15-year warranty for non-U.S. sales on mattresses, each prorated for the last 10 years. The Company also provides a 2-year to 3-year warranty on pillows. Estimated future obligations related to these products are charged to operations in the period in which the related revenue is recognized. Estimates of warranty expenses are based primarily on historical claim experience and product testing. Warranties are included in Accrued expenses and other current liabilities in the accompanying Condensed Consolidated Balance Sheets.
 
    The Company had the following activity for warranties from December 31, 2009 to June 30, 2010:

Balance as of December 31, 2009
$
4,052
 
     Amounts accrued
 
2,223
 
     Warranties charged to accrual
 
(2,287
Balance as of June 30, 2010
$
3,988
 
 
    (g) Revenue Recognition—Sales of products are recognized when persuasive evidence of an arrangement exists, products are shipped and title passes to customers and the risks and rewards of ownership are transferred, the sales price is fixed or determinable and collectability is reasonably assured. The Company extends volume discounts to certain customers and reflects these amounts as a reduction of sales. The Company also reports sales net of tax assessed by qualifying governmental authorities. The Company extends credit based on the creditworthiness of its customers. No collateral is required on sales made in the normal course of business.
 
    The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company regularly reviews the adequacy of its allowance for doubtful accounts. The Company determines the allowance based on historical write-off experience and current economic conditions and also considers factors such as customer credit, past transaction history with the customer and changes in customer payment terms when determining whether the collection of a receivable is reasonably assured. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts included in Accounts receivable, net in the accompanying Condensed Consolidated Balance Sheets was $8,221 and $9,030 as of June 30, 2010 and December 31, 2009, respectively.
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
    (h) Advertising Costs—The Company expenses advertising costs as incurred except for production costs and advance payments, which are deferred and expensed when advertisements run for the first time. Direct response advance payments are deferred and are amortized over the life of the program.
 
    (i) Research and Development Expenses—Research and development expenses for new products are expensed as they are incurred and included in General, administrative and other expenses in the accompanying Condensed Consolidated Statements of Income. Research and development costs charged to expense were approximately $1,699 and $1,640 for the three months ended June 30, 2010 and June 30, 2009, respectively. For the six months ended June 30, 2010 and 2009, research and development costs charged to expense were $3,549 and $3,099, respectively.
 
    (j) Subsequent Events—On July 15, 2010, the Board of Directors authorized a repurchase authorization of up to $100,000 of the Company’s common stock. Share repurchases under this authorization may be made through open market transactions, negotiated purchases or otherwise, at times and in such amounts as management and a committee of the Board deem appropriate; these repurchases may be funded by operating cash flows and/or borrowings under our credit facility. This share repurchase program may be limited, suspended or terminated at any time without prior notice.

(2) Goodwill and Other intangible assets
 
    The following summarizes changes to the Company’s Goodwill, by reportable business segment:

 
North America
 
International
 
Total
 
Balance as of December 31, 2009
$ 89,929   $ 103,462   $ 193,391  
Goodwill from acquisition
  18,822         18,822  
Foreign currency translation adjustments and other
  (897   (841 )   (1,738 )
Balance as of June 30, 2010
$ 107,854   $ 102,621   $ 210,475  
 
    On April 1, 2010, the Company acquired its third party distributor in Canada.  The total amount of cash paid for the acquisition was approximately $18,692. Additional payments may be made to the former owners if certain financial targets are met, the present value of these payments as of the acquisition date was $6,241. Accordingly, the acquisition date fair value of the consideration transferred was $24,933. We estimated the fair value of the contingent consideration using a probability-weighted discounted cash flow model, which represents Level 3 fair value measure under U.S. GAAP.
 
    The following table summarizes the estimated fair values of the assets acquired and liabilities assumed at the acquisition date. The Company is in the process of finalizing its purchase price allocation and accordingly, fair value estimates may change as valuations and assessments are completed.
 
Net working capital
  42  
Deferred tax liability    (1,782
Property, plant and equipment
  322  
Intangible assets
  7,529  
Goodwill
  18,822  
Total purchase price
24,933  
 
    Intangible assets are comprised of $5,639 related to reacquired rights with a useful life of 3 years and $1,890 related to customer relationships with a useful life of 5 years.  The goodwill was assigned to the North American segment.  None of the goodwill is expected to be deductible for income tax purposes.
 
 
9

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
    The following table summarizes information relating to the Company’s Other intangible assets:
  
       
June 30, 2010
 
December 31, 2009
 
   
Useful
 
Gross
     
Net
 
Gross
     
Net
 
   
Lives
 
Carrying
 
Accumulated
 
Carrying
 
Carrying
 
Accumulated
 
Carrying
 
   
(Years)
 
Amount
 
Amortization
 
Amount
 
Amount
 
Amortization
 
Amount
 
Unamortized indefinite life intangible assets:
                             
Trademarks
      $ 55,000   $   $ 55,000   $ 55,000   $   $ 55,000  
                                           
Amortized intangible assets:
                                         
Technology
  10   $ 16,000   $ 12,267   $ 3,733   $ 16,000   $ 11,467   $ 4,533  
Patents & other trademarks
  5-20     11,835     8,261     3,574     11,876     8,002     3,874  
Customer database
  5     4,760     4,592     168     4,855     4,593     262  
Foam formula
  10     3,700     2,837     863     3,700     2,652     1,048  
Reacquired rights
  3     5,382     448     4,934              
Customer relationships
  5     1,803     90     1,713              
Total
      $ 98,480   $ 28,495   $ 69,985   $ 91,431   $ 26,714   $ 64,717  
 
    Amortization expense relating to intangible assets for the Company was $1,233 and $604 for the three months ended June 30, 2010 and 2009, respectively. For the six months ended June 30, 2010 and 2009 amortization expense relating to intangible assets was $1,904 and $1,210 respectively. No impairments of goodwill or other intangible assets have adjusted the gross carrying amount of these assets in any historical period.

(3) Long-term Debt
 
    (a) Long-term Debt—Long-term debt for the Company consists of the following:
 
    June 30, 2010   December 31, 2009   
2005 Senior Credit Facility:
         
Domestic Long-Term Revolving Credit Facility payable to lenders, interest at Index Rate or LIBOR plus applicable margin (2.95% and 3.72% as of June 30, 2010 and December 31, 2009, respectively), commitment through and due June 8, 2012
  $ 435,000   $ 294,000  
Foreign Long-Term Revolving Credit Facility payable to lenders, interest at Index Rate or LIBOR plus applicable margin (2.06% as of December 31, 2009), commitment through and due June 8, 2012
        3,470  
Long-term debt
  $ 435,000   $ 297,470  
 
    (b) Secured Credit Financing—On October 18, 2005, the Company entered into a credit agreement (2005 Senior Credit Facility) with a syndicate of banks. The 2005 Senior Credit Facility, as amended, consists of domestic and foreign credit facilities (Revolvers) that provide for the incurrence of indebtedness up to an aggregate principal amount of $640,000 and matures in 2012. The domestic credit facility is a five-year, $615,000 revolving credit facility (Domestic Revolver). The foreign credit facility is a five-year $25,000 revolving credit facility (Foreign Revolver). The Revolvers provide for the issuance of letters of credit which, when issued, constitute usage and reduce availability under the Revolvers. The aggregate amount of letters of credit outstanding under the Revolvers was $11,827 at June 30, 2010. After giving effect to letters of credit and $435,000 in borrowings under the Revolvers, total availability under the Revolvers was $193,173 as of June 30, 2010. Both credit facilities bear interest at a rate equal to the 2005 Senior Credit Facility’s applicable margin, as determined in accordance with a performance pricing grid set forth in Amendment No. 3, plus one of the following indexes: London Inter-Bank Offering Rate (LIBOR) and for U.S. dollar-denominated loans only, a base rate. The base rate of U.S. dollar-denominated loans is defined as the higher of the Bank of America prime rate or the Federal Funds rate plus .50%. The Company also pays an annual facility fee on the total amount of the 2005 Senior Credit Facility.  The facility fee is calculated based on the consolidated leverage ratio and ranges from .125% to .25%.
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
    The 2005 Senior Credit Facility is guaranteed by Tempur-Pedic International, as well as certain other subsidiaries of Tempur-Pedic International, and is secured by certain fixed and intangible assets of Dan-Foam ApS and substantially all the Company’s U.S. assets. The 2005 Senior Credit Facility contains certain financial covenants and requirements affecting the Company, including a consolidated interest coverage ratio and a consolidated leverage ratio. The Company was in compliance with all covenants as of June 30, 2010.
 
    In May 2008, the Company entered into a three year interest rate swap agreement to manage interest costs and the risk associated with changing interest rates associated with the 2005 Senior Credit Facility. Refer to Note 5, “Derivative Financial Instruments” for additional information regarding the Company’s derivative instruments, including this interest rate swap.

(4) Fair Value Measurements
 
    Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset and liability in an orderly transaction between market participants at the measurement date. The Company estimates fair value of its financial instruments utilizing an established three-level hierarchy. The hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date as follows:

·  
Level 1 – Valuation is based upon unadjusted quoted prices for identical assets or liabilities in active markets.
·  
Level 2 – Valuation is based upon quoted prices for similar assets and liabilities in active markets, or other inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instruments.
·  
Level 3 – Valuation is based upon other unobservable inputs that are significant to the fair value measurements.
 
    The classification of fair value measurements within the hierarchy is based upon the lowest level of input that is significant to the measurement.  At June 30, 2010, the Company had an interest rate swap and foreign currency forward contracts recorded at fair value. The fair values of these instruments were measured using valuations based upon quoted prices for similar assets and liabilities in active markets (Level 2) and are valued by reference to similar financial instruments, adjusted for credit risk and restrictions and other terms specific to the contracts. The following table provides a summary by level of the fair value of financial instruments that are measured on a recurring basis:
 
     
Fair Value Measurements at June 30, 2010 Using:
 
 
June 30, 2010
 
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs (Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Liabilities:
               
Foreign currency forward contracts
$ 31   $   $ 31   $  
Interest rate swap
$ 4,142   $   $ 4,142   $  

     
Fair Value Measurements at December 31, 2009 Using:
 
 
December 31, 2009
 
Quoted Prices in Active
Markets for Identical
Assets (Level 1)
 
Significant Other
Observable Inputs (Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
Liabilities:
               
Foreign currency forward contracts
$ 438   $   $ 438   $  
Interest rate swap
$ 6,865   $   $ 6,865   $  

The carrying value of Cash and cash equivalents, Accounts receivable and Accounts payable approximate fair value because of the short-term maturity of those instruments. Borrowings under the 2005 Senior Credit Facility (as defined in Note 3(b)) are at variable interest rates and accordingly their carrying amounts approximate fair value.

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
(5) Derivative Financial Instruments
 
    In the normal course of business, the Company is exposed to certain risks related to fluctuations in interest rates and foreign currency exchange rates. The Company uses various derivative contracts, primarily interest rate swaps and foreign currency exchange forward contracts, to manage risks from these market fluctuations. The financial instruments used by the Company are straight-forward, non-leveraged instruments. The counterparties to these financial instruments are financial institutions with strong credit ratings. The Company maintains control over the size of positions entered into with any one counterparty and regularly monitors the credit ratings of these institutions.

Interest Rate Risk
 
    The Company is exposed to changes in interest rates on its 2005 Senior Credit Facility. In order to manage this risk, in May 2008, the Company entered into a three year interest rate swap agreement to manage interest costs and the risk associated with changing interest rates. The Company designated this interest rate swap as a cash flow hedge of floating rate borrowings and expects the hedge to be highly effective in offsetting fluctuations in the designated interest payments resulting from changes in the benchmark interest rate. The gains and losses on the designated swap agreement will offset losses and gains on the transactions being hedged. The Company formally documented the effectiveness of this qualifying hedge instrument (both at the inception of the swap and on an ongoing basis) in offsetting changes in cash flows of the hedged transaction. The fair value of the interest rate swap is calculated as described in Note 4, “Fair Value Measurements” taking into consideration current interest rates and the current creditworthiness of the counterparties or the Company, as applicable.
 
    As a result of this swap, the Company pays at a fixed rate and receives payment at a variable rate. The swap effectively fixed the floating LIBOR-based interest rate to 3.755% on $350,000 of the outstanding balance under the 2005 Senior Credit Facility, with the outstanding balance subject to the swap declining over time. The amount of the outstanding balance subject to the swap amortizes as follows: to $300,000 on November 28, 2008 (through November, 2009); to $200,000 on November 28, 2009 (through November, 2010); and to $100,000 on November 28, 2010 (through November 28, 2011). The Company will select the LIBOR-based rate on the hedged portion of the 2005 Senior Credit Facility during the term of the swap. The effective portion of the change in value of the swap is reflected as a component of Accumulated other comprehensive loss (OCL) and recognized as Interest expense, net as payments are paid or accrued. The remaining gain or loss in excess of the cumulative change in the present value of the future cash flows of the hedged item, if any (i.e., the ineffective portion) or hedge components excluded from the assessment of effectiveness are recognized as Interest expense, net during the current period.
 
    As of June 30, 2010 the total notional amount of the Company’s interest rate swap agreement is $200,000. Over the next 12 months, the Company expects to reclassify $4,142 of deferred losses on derivative instruments from Accumulated OCL to earnings due to the payment of variable interest associated with the 2005 Senior Credit Facility.

Foreign Currency Exposures
 
    The Company is exposed to foreign currency risk primarily related to intercompany debt and associated interest payments. To manage the risk associated with fluctuations in foreign currencies, the Company enters into foreign currency forward contracts. The Company does not designate any of these foreign currency forward contracts as hedging instruments, however, the Company considers the contracts as economic hedges. Accordingly, changes in the fair value of these instruments affect earnings during the current period. These foreign currency forward contracts protect against the reduction in value of forecasted foreign currency cash flows resulting from payments in foreign currencies. The fair value of foreign currency agreements are estimated as described in Note 4, “Fair Value Measurements” taking into consideration foreign currency rates and the current creditworthiness of the counterparties or the Company, as applicable.
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
  
    As of June 30, 2010, the Company had foreign currency forward contracts with expiration dates ranging from July 2, 2010 through October 26, 2010. The changes in fair value of these foreign currency hedges are included as a component of Other (expense) income, net. As of June 30, 2010 the Company had the following outstanding foreign currency forward contracts:
 
Foreign Currency
 
Currency Denomination
 
Great Britain Pound
  £ 3,625  
Japanese Yen
  ¥ 380,192  
Swedish Krona
 
kr.
6,783  
Norwegian Krone
 
kr.
717  
Australian Dollar
  $ 924  
New Zealand Dollar
  $ 653  
Singapore Dollar
  $ 252  
Canadian Dollar
  $ 5,503  
United States Dollar
  $ 4,451  
 
    As of June 30, 2010 and December 31, 2009, the fair value carrying amount of the Company’s derivative instruments were recorded as follows:

 
Liability Derivatives
 
 
June 30, 2010
 
December 31, 2009
 
 
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
 
Derivatives designated as hedging instruments
                   
Interest rate swap
Other non-current liabilities
 
$
4,142
 
Other non-current liabilities
 
$
6,865
 
Derivatives not designated as hedging instruments
                   
Foreign exchange forward contracts
Accrued expenses and other current liabilities
 
$
31
 
Accrued expenses and other current liabilities
 
$
438
 
     
$
4,173
     
$
7,303
 
 
    The effect of derivative instruments on the accompanying Condensed Consolidated Statements of Income for the three months ended June 30, 2010 was as follows:

Derivatives Designated as Cash Flow Hedging Relationships
 
Amount of Gain/(Loss)
 Recognized in Accumulated OCL on
 Derivative
 (Effective Portion)
 
Location of Gain/(Loss)
 Reclassified from
 Accumulated OCL into
 Income
 (Effective Portion)
 
Amount of Gain/(Loss)
 Reclassified from
 Accumulated OCL
 into Income
 (Effective Portion)
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative (Ineffective
 Portion and Amount
 Excluded from
 Effectiveness Testing)
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 (Ineffective Portion
 and Amount Excluded
 from Effectiveness Testing)
 
Interest rate swap
 
$
1,788
 
Interest expense, net
 
$
(1,757
Interest expense, net
 
$
 
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
Derivatives Not  Designated as Hedging Instruments
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 
Foreign exchange forward contracts
 
Other (expense) income, net
 
$
(387

    For the three months ended June 30, 2009:
 
Derivatives Designated as Cash Flow Hedging Relationships
 
Amount of Gain/(Loss)
 Recognized in Accumulated OCL on
 Derivative
 (Effective Portion)
 
Location of Gain/(Loss)
 Reclassified from
 Accumulated OCL into
 Income
 (Effective Portion)
 
Amount of Gain/(Loss)
 Reclassified from
 Accumulated OCL
 into Income
 (Effective Portion)
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative (Ineffective
 Portion and Amount
 Excluded from
 Effectiveness Testing)
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 (Ineffective Portion
 and Amount Excluded
 from Effectiveness Testing)
 
Interest rate swap
 
$
1,398
 
Interest expense, net
 
$
(2,059
Interest expense, net
 
$
 
 
 
Derivatives Not  Designated as Hedging Instruments
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 
Foreign exchange forward contracts
 
Other (expense) income, net
 
(1,405
)
 
 
    The effect of derivative instruments on the accompanying Condensed Consolidated Statements of Income for the six months ended June 30, 2010 was as follows:

Derivatives Designated as Cash Flow Hedging Relationships
 
Amount of Gain/(Loss)
 Recognized in Accumulated OCL on
 Derivative
 (Effective Portion)
 
Location of Gain/(Loss)
 Reclassified from
 Accumulated OCL into
 Income
 (Effective Portion)
 
Amount of Gain/(Loss)
 Reclassified from
 Accumulated OCL
 into Income
 (Effective Portion)
 
Location of Loss
 Recognized in Income on
 Derivative (Ineffective
 Portion and Amount
 Excluded from
 Effectiveness Testing)
 
Amount of Loss
 Recognized in Income
 on Derivative
 (Ineffective Portion
 and Amount Excluded
 from Effectiveness Testing)
 
Interest rate swap
 
$
2,723
 
Interest expense, net
 
$
(3,488
Interest expense, net
 
$
 

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)

Derivatives Not  Designated as Hedging Instruments
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 
Foreign exchange forward contracts
 
Other (expense) income, net
 
$
(1,353

    For the six months ended June 30, 2009:
 
Derivatives Designated as Cash Flow Hedging Relationships
 
Amount of
Gain/(Loss)
 Recognized in Accumulated OCL on
 Derivative
 (Effective Portion)
 
Location of Gain/(Loss)
 Reclassified from
 Accumulated OCL into
 Income
 (Effective Portion)
 
Amount of Gain/(Loss)
Reclassified from
 Accumulated OCL
 into Income
 (Effective Portion)
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative (Ineffective
 Portion and Amount
 Excluded from
 Effectiveness Testing)
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 (Ineffective Portion
 and Amount Excluded
 from Effectiveness Testing)
 
Interest rate swap
 
 $
2,218
 
Interest expense, net
 
 $
(3,470
Interest expense, net
 
 $
 

 
Derivatives Not  Designated as Hedging Instruments
 
Location of Gain/(Loss)
 Recognized in Income on
 Derivative
 
Amount of Gain/(Loss)
 Recognized in Income
 on Derivative
 
Foreign exchange forward contracts
 
Other (expense) income, net
   
(2,146

(6) Stockholders’ Equity
 
    (a) Capital Stock—Tempur-Pedic International’s authorized shares of capital stock are 300,000 shares of common stock and 10,000 shares of preferred stock. Subject to preferences that may be applicable to any outstanding preferred stock, holders of the common stock are entitled to receive ratably such dividends as may be declared from time to time by the Board of Directors out of funds legally available for that purpose. In the event of liquidation, dissolution or winding up, the holders of the common stock are entitled to share ratably in all assets remaining after payment of liabilities, subject to prior distribution rights of preferred stock, if any, then outstanding.
 
    (b) Share Repurchase Programs—On October 16, 2007, the Board of Directors authorized a repurchase authorization of up to $300,000 of the Company’s common stock. On January 13, 2010 the Board of Directors approved a share repurchase program of up to $100,000 of the Company’s common stock, which replaced the October 2007 authorization.  The Company repurchased 3,694 shares of the Company’s common stock for $100,000 from the January 2010 authorization and completed the purchases from this authorization in February 2010.  On April 15, 2010, the Board of Directors approved an additional share repurchase authorization of up to $100,000 of the Company’s common stock.  The Company repurchased 2,992 shares of the Company’s common stock for $100,000 from the April 2010 authorization and completed the purchases from this authorization in May 2010.  Share repurchases under authorizations may be made through open market transactions, negotiated purchase or otherwise, at times and in such amounts as management and a committee of the Board deem appropriate.

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
(7) Other Items
 
    (a) Property, plant and equipment—
 
    Property, plant and equipment, net consisted of the following:
 
 
June 30, 2010
 
December 31, 2009
 
Land and buildings
$
116,771
 
$
123,743
 
Machinery and equipment, furniture and fixtures and other
 
197,788
   
202,474
 
Construction in progress
 
10,340
   
8,107
 
   
324,899
   
334,324
 
Accumulated depreciation
 
(165,371
 
(161,827
 
$
159,528
 
$
172,497
 
 
    (b) Accrued expenses and other current liabilities
 
    Accrued expenses and other current liabilities consisted of the following:

   
June 30, 2010
   
December 31, 2009
 
Salary and related expenses
$
16,205
 
$
18,131
 
Accrued unrecognized tax benefits
 
13,153
   
12,544
 
Accrued sales and value added taxes
 
11,258
   
11,472
 
Warranty accrual
 
3,988
   
4,052
 
Sales returns
 
4,997
   
4,233
 
Other
 
29,880
   
31,020
 
 
$
79,481
 
$
81,452
 
             
 
    (c) Accumulated other comprehensive loss—
 
    Accumulated other comprehensive loss consisted of the following:

 
June 30, 2010
 
December 31, 2009
 
Derivative instruments accounted for as hedges, net of tax of $1,616 and $2,678, respectively 
$
(2,526
$
(4,187
Foreign currency translation
 
(17,137
 
(3,817
Accumulated other comprehensive loss
$
(19,663
$
(8,004
             
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
  
    (d) Comprehensive income
 
 
    The components of comprehensive income consisted of the following:

   
Three Months Ended
 
Six Months Ended
 
   
June 30,
 
June 30,
 
   
2010
 
2009
 
2010
 
2009
 
Net income attributable to common stockholders
  $ 33,506   $ 16,857   $ 66,654   $ 30,195  
                           
Derivative instruments accounted for as hedges, net of taxes of $698, $545, $1,063 and $865, respectively
    1,091     853     1,661     1,353  
Cumulative translation adjustment
    (7,892 )   5,003     (13,320 )   729  
Comprehensive income attributable to common stockholders
    26,705     22,713     54,995     32,277  
Comprehensive income attributable to the noncontrolling interest
    9         104      
Total comprehensive income
  26,714   22,713   55,099   32,277  
                           

(8) Stock-Based Compensation
 
    The Company currently has three stock-based compensation plans: the 2002 Option Plan (2002 Plan), the Amended and Restated 2003 Equity Incentive Plan (2003 Plan) and the 2003 Employee Stock Purchase Plan (ESPP), which are described under the caption “Stock-based Compensation” in the notes to the Consolidated Financial Statements of the Company’s Annual Report on Form 10-K for the year ended December 31, 2009. Effective February 1, 2010, the Company suspended offerings under the ESPP indefinitely.
 
    In the first quarter of 2010, the Compensation Committee of the Board of Directors approved the terms of a Long-Term Incentive Program (LTIP), established under the 2003 Plan. For 2010, the LTIP awards consist of a mix of stock options and performance-based restricted stock units (PRSUs). Shares with respect to the PRSUs will be granted and vest following the end of the applicable performance period and achievement of applicable performance metrics as determined by the Compensation Committee of the Board of Directors.
 
    The Company granted PRSUs during the three and six months ended June 30, 2010. The maximum number of shares to be awarded under the PRSUs granted during the three and six months ended June 30, 2010 will be 12 and 418 shares, respectively, and will vest, if earned, at the end of the three-year performance period ending on December 31, 2012. Actual payout under the PRSUs granted in 2010 is dependent upon the achievement of certain financial goals, based on Net sales and Earnings Before Interest and Taxes (EBIT) margin targets. The Company recognized compensation expense of $356 and $463 associated with the 2010 PRSUs during the three and six months ended June 30, 2010, respectively. Based on current estimates of the performance metrics, unrecognized compensation expense with respect to the PRSUs was $3,419, as of June 30, 2010, which is expected to be recorded over the weighted average remaining life of 2.51 years. No PRSUs were granted during the six months ended June 30, 2009.
 
    The Company granted options to purchase 33 and 162 shares of common stock during the three and six months ending June 30, 2010. The Company recognized compensation expense of $221 and $280 associated with the 2010 grants during the three and six months ended June 30, 2010, respectively. The Company granted new options to purchase 278 and 1,694 shares of common stock during the three and six months ending June 30, 2009, respectively. The Company recognized compensation expense of $406 and $477 associated with the 2009 grants during the three and six months ended June 30, 2009, respectively. As of June 30, 2010, there was $1,910 of unrecognized compensation expense associated with the options granted in 2010, which is expected to be recorded over the weighted average remaining vesting period of 2.42 years. The options granted in the three months ended June 30, 2010 had a weighted average grant-date fair value of $15.31 per option, as determined by the Black-Scholes option pricing model using the following assumptions:
 
 
17

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
Expected volatility of stock
71.8 – 84.2 %
Expected life of options, in years
2.0 – 4.0  
Risk-free interest rate
1.0 – 2.3 %
Expected dividend yield on stock
0.0 – 1.1 %
 
    The Company granted 12 and 188 awards during the three and six months ended June 30, 2010 that consisted of restricted stock units (RSUs) and deferred stock units (DSUs). The Company recognized compensation expense of $504 and $643 associated with the 2010 RSUs and DSUs during the three and six months ended June 30, 2010, respectively. As of June 30, 2010, there was $4,618 of unrecognized compensation expense associated with the RSUs and DSUs granted in 2010, which is expected to be recorded over the weighted average remaining vesting period of 2.4 years. No RSUs or DSUs were granted during the six months ended June 30, 2009.
 
    The Company recorded $2,928 and $2,190 of total stock-based compensation expense for the three months ended June 30, 2010 and June 30, 2009, respectively. The Company recorded $5,339 and $4,093 of total stock-based compensation expense for the six months ended June 30, 2010 and 2009, respectively.
 
(9) Commitments and Contingencies
 
    (a) Purchase Commitments—The Company will, from time to time, enter into limited purchase commitments for the purchase of certain raw materials. Amounts committed under these programs were not significant as of June 30, 2010 or December 31, 2009.
 
    (b) Antitrust Action—On January 5, 2007, a purported class action was filed against the Company in the United States District Court for the Northern District of Georgia, Rome Division (Jacobs v. Tempur-Pedic International, Inc. and Tempur-Pedic North America, Inc., or the Antitrust Action).  The Antitrust Action alleges violations of federal antitrust law arising from the pricing of Tempur-Pedic mattress products by Tempur-Pedic North America and certain distributors.  The action alleges a class of all purchasers of Tempur-Pedic mattresses in the United States since January 5, 2003, and seeks damages and injunctive relief. Count Two of the complaint was dismissed by the court on June 25, 2007, based on a motion filed by the Company. Following a decision issued by the United States Supreme Court in Leegin Creative Leather Prods., Inc. v. PSKS, Inc. on June 28, 2007, the Company filed a motion to dismiss the remaining two counts of the Antitrust Action on July 10, 2007. On December 11, 2007, that motion was granted and, as a result, judgment was entered in favor of the Company and the plaintiffs’ complaint was dismissed with prejudice. On December 21, 2007, the plaintiffs filed a “Motion to Alter or Amend Judgment,” which was fully briefed. On May 1, 2008, that motion was denied.  The Jacobs appealed the dismissal of their claims, and the parties argued the appeal before the United States Circuit Court for the Eleventh Circuit on December 11, 2008.  The matter has been taken under advisement by the court.  The Company continues to strongly believe that the Antitrust Action lacks merit, and intends to defend against the claims vigorously. However, due to the inherent uncertainties of litigation, we cannot predict the outcome of the Antitrust Action at this time, and can give no assurance that these claims will not have a material adverse affect on the Company’s financial position or results of operation. Accordingly, the Company cannot make an estimate of the possible ranges of loss.
 
    (c) New York Attorney General—In December 2008, the Office of the Attorney General of the State of New York, Antitrust Bureau (OAG) requested that the Company consider discontinuing its unilateral retail price policy (UPPL) in the State of New York, and informed the Company that it may bring an enforcement action against the Company under New York law if the Company chose not to do so.  On March 29, 2010, the Office of the Attorney General filed suit in New York state court against the Company with respect to this matter.  The complaint does not charge the Company with any violation of state or federal antitrust law; instead it claims the Company violated a 1975 New York state law which declares certain contractual provisions to be unenforceable.  The Company believes that its UPPL complies with state and federal law and intends to vigorously defend it.  However, due to the inherent uncertainties of this matter, the Company cannot at this time predict the outcome of the enforcement action and can give no assurance that these claims will not have a material adverse affect on its financial position or results of operation. Accordingly, the Company cannot make an estimate of the possible range of loss.
 
    The Company is involved in various other legal proceedings incidental to the operations of its business. The Company believes that the outcome of all such pending legal proceedings in the aggregate will not have a material adverse affect on its business, financial condition, liquidity or operating results.

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
(10) Income Taxes
 
    The Company’s effective tax rate for the three months ended June 30, 2010 and June 30, 2009 was 33.0% and 32.5% respectively. The Company’s effective tax rate for the six months ended June 30, 2010 and June 30, 2009 was 32.7% and 35.2% respectively. The Company’s effective income tax rate for the three and six months ended June 30, 2010 and 2009 differed from the federal statutory rate of 35.0% principally because of certain foreign tax rate differentials, state and local income taxes, foreign income currently taxable in the U.S., the production activities deduction and certain other permanent differences.
 
    The Company has not provided for U.S. federal and/or state income and foreign withholding taxes on $179,600 of undistributed earnings from non-U.S. operations as of June 30, 2010 because Tempur-Pedic International intends to reinvest such earnings indefinitely outside of the United States.  If these earnings were to be distributed, foreign tax credits may become available under current law to reduce the resulting U.S. income tax liability.
 
    On October 24, 2007, the Company received an income tax assessment from the Danish Tax Authority with respect to the 2001, 2002 and 2003 tax years and an assessment with respect to the 2004 tax year on April 29, 2010.  The tax assessments relate to the royalty paid by one of Tempur-Pedic International’s U.S. subsidiaries to a Danish subsidiary and the position taken by the Danish Tax Authority could apply to subsequent years. The total tax assessment is approximately $69,300 including interest and penalties.  On January 23, 2008 and May 26, 2010, the Company filed timely complaints with the Danish National Tax Tribunal denying the tax assessments.  The National Tax Tribunal formally agreed to place the Danish tax litigation on hold pending the outcome of a Bilateral Advance Pricing Agreement (Bilateral APA) between the United States and the Danish Tax Authority.  A Bilateral APA involves an agreement between the Internal Revenue Service (IRS) and the taxpayer, as well as a negotiated agreement with one or more foreign competent authorities under applicable income tax treaties.  On August 8, 2008 the Company filed the Bilateral APA with the IRS and the Danish Tax Authority. The IRS began analyzing the Bilateral APA in the first quarter of 2009 and expects to finalize its position during 2010. The Company believes it has meritorious defenses to the proposed adjustment and will oppose the assessment in the Danish courts, as necessary. It is reasonably possible the amount of unrecognized tax benefits may change in the next twelve months.  An estimate of the amount of such change cannot be made at this time.
 
    The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and income tax returns in various states and foreign jurisdictions.  With few exceptions, the Company is no longer subject to tax examinations by tax authorities in the U.S. for periods prior to 2006, U.S. state and local municipalities for periods prior to 2004, and in non-U.S. jurisdictions for periods prior to 2001.  Additionally, the Company is currently under examination by various tax authorities around the world.  The Company anticipates it is reasonably possible an increase or decrease in the amount of unrecognized tax benefits could be made in the next twelve months as a result of the statute of limitations expiring and/or the examinations being concluded on these returns.  However, the Company does not presently anticipate that any increase or decrease in unrecognized tax benefits will be material to the consolidated financial statements.
 
    During the three and six months ended June 30, 2010, the liability for unrecognized tax benefits increased by $609 primarily related to interest on previously recorded liabilities.
 
TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
(11) Earnings Per Common Share
 
   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Numerator:
                       
Net income attributable to common stockholders
  $ 33,506     $ 16,857     $ 66,654     $ 30,195  
                                 
Denominator:
                               
Denominator for basic earnings per common share-weighted average shares
    70,730       74,894       72,014       74,884  
Effect of dilutive securities:
                               
     Employee stock options
    2,422       599       2,424       152  
Denominator for diluted earnings per common share-adjusted weighted average shares
    73,152       75,493       74,438       75,036  
                                 
Basic earnings per common share
  $ 0.47     $ 0.23     $ 0.93     $ 0.40  
                                 
Diluted earnings per common share
  $ 0.46     $ 0.22     $ 0.90     $ 0.40  
 
    The Company excluded 22 and 4,508 shares issuable upon exercise of outstanding stock options for the three months ended June 30, 2010 and 2009, respectively, and 96 and 4,783 shares issuable upon exercise of outstanding stock options for the six month period ended June 30, 2010 and 2009, respectively, from the Diluted earnings per common share computation because their exercise price was greater than the average market price of Tempur-Pedic International’s common stock or they were otherwise anti-dilutive.

(12) Business Segment Information
 
    The Company operates in two business segments: North America and International. These reportable segments are strategic business units that are managed separately based on the fundamental differences in their operations. The North America segment consists of the two U.S. manufacturing facilities and our North American distribution subsidiaries. The International segment consists of the manufacturing facility in Denmark, whose customers include all of the distribution subsidiaries and third party distributors outside the North American segment. The Company evaluates segment performance based on Net sales and Operating income.
 
    The following table summarizes Total assets by segment:
 
   
June 30,
 
December 31,
 
   
2010
 
2009
 
Total assets:
         
     North America
  $ 553,746   $ 481,942  
     International
    282,888     274,112  
     Intercompany eliminations
    (164,697 )   (112,675 )
    $ 671,937   $ 643,379  

 
20

TEMPUR-PEDIC INTERNATIONAL INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)-(Continued)
(In thousands, except per common share amounts)
 
    The following table summarizes segment information:

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
   
June 30,
 
   
2010
 
2009
   
2010
 
2009
 
Net sales from external customers:
                   
     North America
                   
           Mattresses
  $ 136,686   $ 86,300     $ 254,072   $ 162,011  
           Pillows
    14,058     11,029       28,187     20,874  
           Other
    41,478     23,415       76,516     44,293  
    $ 192,222   $ 120,744     $ 358,775   $ 227,178  
                             
     International
                           
           Mattresses
  $ 41,936   $ 38,044     $ 93,623   $ 81,461  
           Pillows
    13,868     12,977       30,485     26,193  
           Other
    15,018     13,411       34,050     27,448  
    $ 70,822   $ 64,432     $ 158,158   $ 135,102  
                             
    $ 263,044   $ 185,176     $ 516,933   $ 362,280  
                             
Inter-segment sales:
                           
     North America
                   
     International
  $ 456   $ 346     $ 661   $ 569  
     Intercompany eliminations
    (456 )   (346 )     (661 )   (569 )
    $   $     $   $  
                             
Operating income:
                           
     North America
  $ 36,076   $ 14,223     $ 63,123   $ 22,027  
     International
    17,774     14,939       43,017     33.016  
    $ 53,850   $ 29,162     $ 106,140   $ 55,043  
                             
Depreciation and amortization (including stock-based compensation amortization):
                           
     North America
  $ 8,873   $ 7,554     $ 16,603   $ 14,876  
     International
    2,176     2,423       4,442     4,731  
    $ 11,049   $ 9,977     $ 21,045   $ 19,607  
                             
Capital expenditures:
                           
     North America
  $ 2,578   $ 1,698     $ 3,927   $ 2,088  
     International
    1,449     1,607       2,771     2,640  
 
  $ 4,027   $ 3,305     $ 6,698   $ 4,728  
                             
 
 
    The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying notes included in this Form 10-Q. Unless otherwise noted, all of the financial information in this report is condensed consolidated information for Tempur-Pedic International Inc. or its predecessor. 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 include numerous risks and uncertainties, as described under “Special Note Regarding Forward-Looking Statements” and “Risk Factors” elsewhere in this quarterly report on Form 10-Q and in our annual report on Form 10-K for the year ended December 31, 2009. Our actual results may differ materially from those contained in any forward-looking statements. Except as may be required by law, we undertake no obligation to publicly update or revise any of the forward-looking statements contained herein.
 
    In this discussion and analysis, the Company discusses and explains the financial condition and results of operations for Tempur-Pedic International Inc. for the three and six month periods ended June 30, 2010 and 2009 that includes the following points:

·  
An overview of our business and strategy; 

·  
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.
 
Executive Overview
 
    General—We are the leading manufacturer, marketer and distributor of premium mattresses and pillows which we sell in approximately 80 countries under the TEMPUR® and Tempur-Pedic® brands. We believe our premium mattresses and pillows are more comfortable than standard bedding products because our proprietary pressure-relieving TEMPUR® material is temperature sensitive, has a high density and therapeutically conforms to the body.
 
    We sell our premium mattresses and pillows through four distribution channels in each operating business segment: Retail (furniture and bedding, specialty and department stores); Direct (direct response and internet); Healthcare (chiropractors, medical retailers, hospitals and other healthcare markets); and Third party distributors in countries where we do not sell directly through our own subsidiaries.
 
    Business Segment Information—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 and our North American distribution subsidiaries. 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. We evaluate segment performance based on Net sales and Operating income.
 
    On April 1, 2010, we purchased our third party distributor in Canada. Accordingly, net sales in the Canadian market are reported in the appropriate channels within the North American segment. As Canada represented essentially all sales through the North American third party channel, we will no longer be reporting third party sales in this segment.

Strategy and Outlook
 
    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 environment, we expect to continue to pursue the key strategic goals using the related goals using the related strategies discussed below.

·  
Make sure everyone knows that they would sleep better on a Tempur-Pedic – we plan to continue to invest in increasing 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-Pedic bed and pillow that appeals to everyone – we plan to continue to maintain our focus on premium mattresses and pillows and regularly introducing new products.

·  
Make sure that Tempur-Pedic is available to everyone – we plan to expand our points of distribution and the effectiveness of our distribution channels.

·  
Make sure that Tempur-Pedic continues to deliver the best sleep – we plan to continue to invest in product research and development.
 
In pursuing these strategic goals, we expect to continue to optimize our cost structure in order to enable these marketing and product development investments.

Results of Operations

Key financial highlights for the three and six months ended June 30, 2010 include the following:

·  
Earnings per common share (EPS) were $0.46 per diluted common share for the three months ended June 30, 2010 compared to $0.22 for the three months ended June 30, 2009. For the six months ended June 30, 2010 EPS were $0.90 compared to $0.40 for the same period in 2009.

·  
Net sales for the three months ended June 30, 2010 rose to $263.0 million from $185.2 million for the three months ended June 30, 2009. Net sales for the six months ended June 30, 2010 increased to $516.9 million from $362.3 million for the same period in 2009.

·  
Our Gross profit margin for the three months ended June 30, 2010 was 48.7% compared to 46.6% for the three months ended June 30, 2009. For the six months ended June 30, 2010 our Gross profit margin was 48.9% compared to 46.4% for the same period in 2009.

·  
During the six months ended June 30, 2010, we repurchased 6.7 million shares of our common stock at a total cost of $200.0 million. These purchases were funded by increased borrowings under our domestic revolving credit facility and operating cash flow.


(In thousands, except per common share amounts)
 
Three Months Ended
June 30,
   
Six Months Ended
June 30,
 
   
2010
   
2009
   
2010
   
2009
 
Net sales
  $ 263,044     100.0 %   $ 185,176     100.0 %   $ 516,933     100.0 %   $ 362,280     100.0 %
Cost of sales
    135,003     51.3       98,845     53.4       264,083     51.1       194,088     53.6  
Gross profit
    128,041     48.7       86,331     46.6       252,850     48.9       168,192     46.4  
Selling and marketing expenses
    46,827     17.8       35,191     19.0       93,058     18.0       69,063     19.1  
General, administrative and other expenses
    27,364     10.4       21,978     11.9       53,652     10.4       44,086     12.1  
Operating income
    53,850     20.5       29,162     15.7       106,140     20.5       55,043     15.2  
Interest expense, net
    (3,786 )   (1.5 )     (4,477 )   (2.3 )     (6,975 )   (1.3 )     (9,048 )   (2.5 )
Other (expense) income, net
    (64 )         270     0.1       99           618     0.2  
Income before income taxes
    50,000     19.0       24,955     13.5       99,264     19.2       46,613     12.9  
Income tax provision
    16,485     6.3       8,098     4.4       32,506     6.3       16,418     4.6  
Net income
    33,515     12.7       16,857     9.1       66,758     12.9       30,195     8.3  
  Less: Net income attributable to the noncontrolling interest
    9                     104                
Net income attributable to common stockholders
  $ 33,506     12.7 %   $ 16,857     9.1 %   $ 66,654     12.9 %   $ 30,195     8.3 %
                                                         
Earnings per common share:
                                                       
Basic
  $ 0.47           $ 0.23           $ 0.93           $ 0.40        
Diluted
    0.46             0.22             0.90             0.40        
Weighted average common shares outstanding:
                                                       
Basic
    70,730             74,894             72,014             74,884        
Diluted
    73,152             75,493             74,438             75,036        

Three Months Ended June 30, 2010 Compared with Three Months Ended June 30, 2009
 
    A summary of Net sales, by channel and by segment, is set forth below:

 
CONSOLIDATED
 
NORTH AMERICA
 
INTERNATIONAL
 
 
Three Months Ended
 
Three Months Ended
 
Three Months Ended
 
 
June 30,
 
June 30,
 
June 30,
 
(in thousands)
2010
 
2009
 
2010
 
2009
 
2010
 
2009
 
Retail
$ 227,151   $ 155,575   $ 173,166   $ 105,576   $ 53,985   $ 49,999  
Direct
  18,127     10,785     16,203     9,428     1,924     1,357  
Healthcare
  7,898     8,261     2,853     2,686     5,045     5,575  
Third Party
  9,868     10,555         3,054     9,868     7,501  
  $ 263,044   $ 185,176   $ 192,222   $ 120,744   $ 70,822   $ 64,432  
                                     
 
    A summary of Net sales, by product and by segment, is set forth below:

 
CONSOLIDATED
 
NORTH AMERICA
 
INTERNATIONAL
 
 
Three Months Ended
 
Three Months Ended
 
Three Months Ended
 
 
June 30,
 
June 30,
 
June 30,
 
(in thousands)
2010
 
2009
 
2010
 
2009
 
2010
 
2009
 
Mattresses
$ 178,622   $ 124,344   $ 136,686   $ 86,300   $ 41,936   $ 38,044  
Pillows
  27,926     24,006     14,058     11,029     13,868     12,977  
Other
  56,496     36,826     41,478     23,415     15,018     13,411  
  $ 263,044   $ 185,176   $ 192,222   $ 120,744   $ 70,822   $ 64,432  

 
24

    Net sales. Net sales for the three months ended June 30, 2010 increased to $263.0 million from $185.2 million for the same period in 2009, an increase of $77.9 million, or 42.1%. During the second quarter of 2010, we experienced a significant improvement in Net sales. We believe our revenues are gaining momentum primarily as a result of investments made in marketing, research and development and product introductions. We were well positioned to make these investments because we maintained our financial flexibility during the economic downturn. In 2009 our industry was adversely affected by an unstable macroeconomic environment which had an adverse impact on our Net sales, however, at the end of 2009 and into 2010 we have experienced signs of improvement. Consolidated Mattress sales increased $54.3 million, or 43.7% compared to the second quarter of 2009. The increase in Mattress sales occurred primarily in our Retail channel, with Net sales increasing to $227.2 million from $155.6 million for the same period in 2009, an increase of $71.6 million, or 46.0%. Consolidated Pillow sales increased approximately $3.9 million, or 16.3%, from the second quarter of 2009. Consolidated Other, which includes adjustable bed bases, foundations and other related products, increased $19.7 million, or 53.4%. Many of our Pillows and Other products are sold with mattress purchases. Therefore, when Mattress sales increase, Pillows and Other products are also impacted. 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 three months ended June 30, 2010 increased to $192.2 million from $120.7 million for the same period in 2009, an increase of $71.5 million, or 59.2%. Our North American Retail channel contributed $173.2 million in Net sales for the three months ended June 30, 2010 for an increase of $67.6 million, or 64.0%, compared to the same period in 2009. The introduction of our new product line, the TEMPUR-CloudTM collection, in the third quarter of 2009 has been well received by retailers and consumers. We believe these products appeal to a new consumer segment and has increased our Net sales. Additionally, we have experienced revenue growth in our pre-existing product line in the second quarter of 2010. North American mattress sales in the second quarter of 2010 increased $50.4 million, or 58.4%, over the same period in 2009, driven by an increase in our Retail channel. Net sales in the Direct channel increased by $6.8 million, or 71.9%. We believe increased sales in the Direct channel are a result of our focus on generating internet leads and investing in internet and direct mail advertising. Pillow sales increased $3.0 million, or 27.5% for the three months ended June 30, 2010. Other Net sales increased $18.1 million, or 77.1%, compared to the same period in 2009. Many of our Pillows and Other products are sold with mattress purchases. Therefore, when Mattress sales increase, Pillows and Other products are also impacted. Additionally, we have emphasized improved attach rates on adjustable bed bases which are sold at a higher price point than traditional foundations.
 
    International. International Net sales for the three months ended June 30, 2010 increased to $70.8 million from $64.4 million for the same period in 2009, an increase of $6.4 million, or 9.9%. On a constant currency basis, our International Net sales increased approximately 14.4%. We have experienced some stabilization of the global economic slowdown in our international markets, which also impacted Net sales in the second quarter of 2009. The International Retail channel increased $4.0 million, or 8.0%, for the three months ended June 30, 2010. Third party Net sales increased $2.4 million or 31.6%. Our introduction of the Sensation mattress line in the International segment has continued to be well accepted by retailers and consumers. As a result, International Mattress sales in the second quarter of 2010 increased $3.9 million, or 10.2%, over the second quarter of 2009. Pillow sales for the second quarter of 2010 increased $0.9 million, or 6.9%, as compared to the second quarter of 2009. Other Net sales increased $1.6 million, or 12.0%, as compared to the second quarter of 2009. Many of our Pillows and Other products are sold with mattress purchases. Therefore, when Mattress sales increase, Pillows and Other products are also impacted.
 
    Gross profit. Gross profit for the three months ended June 30, 2010 increased to $128.0 million from $86.3 million for the same period in 2009, an increase of $41.7 million, or 48.3%. The Gross profit margin for the three months ended June 30, 2010 was 48.7% as compared to 46.6% for the same period in 2009. The principal factors that impacted Gross profit margin during the quarter are identified and discussed below in the respective segment discussions. Additionally, Gross profit margin is impacted by geographic mix between segments.
 
    North America. North American Gross profit for the three months ended June 30, 2010 increased to $88.0 million, an improvement of $37.5 million, or 74.2%.  The Gross profit margin in our North American segment was 45.8% and 41.8% for the three months ended June 30, 2010 and June 30, 2009, respectively. Improvements in our North American Gross profit margin were primarily driven by fixed cost leverage related to higher production volumes and improved efficiencies in manufacturing. These factors were partially offset by new product introductions and higher commodity costs. Additionally, the North American segment pays a royalty to our International segment based on its production volume, which has the effect of lowering the segment's reported Gross profit margin. North American Cost of sales for the three months ended June 30, 2010 increased to $104.3 million from $70.3 million for the same period in 2009, an increase of $34.0 million, or 48.4%.
 
    International. International Gross profit for the three months ended June 30, 2010 increased to $40.1 million, an improvement of $4.2 million, or 11.8%. The Gross profit margin in our International segment was 56.6% and 55.6% for the three months ended June 30, 2010 and June 30, 2009, respectively. Improvements in our International Gross profit margin were primarily driven by fixed cost leverage related to higher production volumes and improved efficiencies in manufacturing. These factors were partially offset by new product introductions and higher commodity costs. Additionally, the International segment receives a royalty from our North American segment based on their production volume, which has the effect of increasing the segment's reported Gross profit margin. Our International Cost of sales for the three months ended June 30, 2010 increased to $30.7 million from $28.6 million for the same period in 2009, an increase of $2.2 million, or 7.6%.

 
25

    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. In the second quarter of 2010, Selling and marketing expenses increased to $46.8 million as compared to $35.2 million for the three months ended June 30, 2009. Selling and marketing expenses as a percentage of Net sales were 17.8% and 19.0% for the three months ended June 30, 2010 and June 30, 2009, respectively. Our objective is to align advertising costs to reflect our sales expectations. During the second quarter of 2010 we continued to make investments in advertising to support future growth. For example, our new marketing and advertising campaign “Ask Me,” which launched in 2009, focuses on increasing awareness of our products and the benefits they offer through word-of-mouth and social networking outlets.
 
    General, administrative and other expenses. General, administrative and other expenses include management compensation, information technology, professional fees, depreciation of furniture and fixtures, leasehold improvements and computer equipment, expenses for administrative functions and research and development costs. General, administrative and other expenses increased to $27.4 million for the three months ended June 30, 2010 as compared to $22.0 million for the three months ended June 30, 2009. The increase in General, administrative and other expenses are primarily a result of a larger bonus pool in the second quarter of 2010 compared to 2009 and an increase in legal fees incurred in the same period related to the acquisition of our former third party distributor in Canada. The effects of these items have been partially offset by a lower level of bad debt expense in 2010 compared to 2009. Additionally, in 2010 we have increased our investment in research and development in order to improve our existing product lines and continue to introduce new and differentiated products. General, administrative and other expenses as a percentage of Net sales were 10.4% and 11.9% in the second quarter of 2010 and 2009, respectively.
 
    Interest expense, net. Interest expense, net, includes the interest costs associated with our borrowings and the amortization of deferred financing costs related to those borrowings. Interest expense, net, decreased to $3.8 million for the three months ended June 30, 2010, as compared to $4.5 million for the three months ended June 30, 2009, a decrease of $0.7 million, or 15.4%.  The decrease in interest expense is primarily attributable to a decrease in the underlying debt related to our interest rate swap, offset slightly by an increase in debt outstanding not subject to the interest rate swap. As we increase our borrowings, we are subject to variable rate debt that is not protected under the interest rate swap described below. Accordingly, if interest rates increase we may incur a higher level of interest expense. The variable interest rate and certain fees that we pay in connection with the 2005 Senior Credit Facility are subject to periodic adjustment based on changes in our consolidated leverage ratio. In May 2008, we entered into an interest rate swap agreement to manage interest costs and the risk associated with changing interest rates. Under this swap, we pay at a fixed rate and receive payments at a variable rate. The swap effectively fixes the floating London Inter-bank Offering Rate (LIBOR) based interest rate to 3.755% on $200.0 million of the outstanding balance as of June 30, 2010 under the 2005 Senior Credit Facility, with the outstanding balance subject to the swap declining over time. The amount of the outstanding balance subject to the swap amortizes as follows: to $300.0 million on November 28, 2008 (through November 2009); to $200.0 million on November 28, 2009 (through November 28, 2010); and to $100.0 million on November 28, 2010 (through November 28, 2011).

    Income tax provision. Income tax provision includes income taxes associated with taxes currently payable and deferred taxes, and it includes the impact of net operating losses for certain of our domestic and foreign operations. Our effective tax rate for the three months ended June 30, 2010 and June 30, 2009 was 33.0% and 32.5% respectively.  The difference between the June 30, 2010 and June 30, 2009 effective tax rate is primarily related to the mix of earnings before taxes between U.S. and International with the U.S. making up a greater percent during the three months ended June 30, 2010.
 
    On October 24, 2007, we received an income tax assessment from the Danish Tax Authority with respect to the 2001, 2002 and 2003 tax years and an assessment with respect to the 2004 tax year on April 29, 2010.  The tax assessments relate to the royalty paid by one of Tempur-Pedic International’s U.S. subsidiaries to a Danish subsidiary and the position taken by the Danish Tax Authority could apply to subsequent years. The total tax assessment is approximately $69.3 million including interest and penalties.  On January 23, 2008 and May 26, 2010 we filed timely complaints with the Danish National Tax Tribunal denying the tax assessments.  The National Tax Tribunal formally agreed to place the Danish tax litigation on hold pending the outcome of a Bilateral Advance Pricing Agreement (Bilateral APA) between the United States and the Danish Tax Authority.  A Bilateral APA involves an agreement between the Internal Revenue Service (IRS) and the taxpayer, as well as a negotiated agreement with one or more foreign competent authorities under applicable income tax treaties.  On August 8, 2008 we filed the Bilateral APA with the IRS and the Danish Tax Authority. The IRS began analyzing the Bilateral APA in the first quarter of 2009 and expects to finalize its position during 2010. We believe we have meritorious defenses to the proposed adjustment and will oppose the assessment in the Danish courts, as necessary.

Six Months Ended June 30, 2010 Compared with Six Months Ended June 30, 2009
 
    A summary of Net sales, by channel and by segment, is set forth below:

 
CONSOLIDATED
 
NORTH AMERICA
 
INTERNATIONAL
 
 
Six Months Ended
 
Six Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
June 30,
 
(In thousands)
2010
 
2009
 
2010
 
2009
 
2010
 
2009
 
Retail
$ 439,891   $ 306,097   $ 316,383   $ 198,987   $ 123,508   $ 107,110  
Direct
  34,741     20,514     30,758     17,906     3,983     2,608  
Healthcare
  17,796     17,163     6,291     5,380     11,505     11,783  
Third Party
  24,505     18,506     5,343     4,905     19,162     13,601  
  $ 516,933   $ 362,280   $ 358,775   $ 227,178   $ 158,158   $ 135,102  
                                     
 
    A summary of Net sales, by product and by segment, is set forth below:

 
CONSOLIDATED
 
NORTH AMERICA
 
INTERNATIONAL
 
 
Six Months Ended
 
Six Months Ended
 
Six Months Ended
 
 
June 30,
 
June 30,
 
June 30,
 
(In thousands)
2010
 
2009
 
2010
 
2009
 
2010
 
2009
 
Mattresses
$ 347,695   $ 243,472   $ 254,072   $ 162,011   $ 93,623   $ 81,461  
Pillows
  58,672     47,067     28,187     20,874     30,485     26,193  
Other
  110,566     71,741     76,516     44,293     34,050     27,448  
  $ 516,933   $ 362,280   $ 358,775   $ 227,178   $ 158,158   $ 135,102  

    Net sales. Net sales for the six months ended June 30, 2010 increased to $516.9 million from $362.3 million for the same period in 2009, an increase of $154.7 million, or 42.7%. During 2010 we have experienced a significant improvement in Net sales. We believe our revenues are gaining momentum primarily as a result of investments made in marketing, research and development and product introductions. We were well positioned to make these investments because we maintained our financial flexibility during the economic downturn. In 2009 our industry was adversely affected by an unstable macroeconomic environment which had an adverse impact on our Net sales, however, at the end of 2009 and into 2010 we have experienced signs of improvement. Consolidated Mattress sales increased $104.2 million, or 42.8% compared to the six months ended June 30, 2009. The increase in Mattress sales occurred primarily in our Retail channel with net sales for the six months increasing to $439.9 million from $306.1 million for the same period in 2009, an increase of $133.8 million, or 43.7%. Consolidated Pillow sales increased to $58.7 million from $47.1 million for the same period in 2009, an increase of $11.6 million, or 24.7%. Consolidated Other Net sales increased to $110.6 million from $71.7 million for the same period in 2009, an increase of $38.8 million or 54.1%. Many of our Pillows and Other products are sold with mattress purchases. Therefore, when Mattress sales increase, Pillows and Other products are also impacted. 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 six months ended June 30, 2010 increased to $358.8 million from $227.2 million for the same period in 2009, an increase of $131.6 million, or 57.9%. Our North American Retail channel contributed $316.4 million in Net sales for the six months ended June 30, 2010 for an increase of $117.4 million, or 59.0%, compared to the same period in 2009. The introduction of our new product line, the TEMPUR-Cloud™ collection, in the third quarter of 2009 has been well received by retailers and consumers. We believe these products appeal to a new consumer segment and has increased our Net sales. Additionally, we have experienced revenue growth in our pre-existing product line in 2010. In January 2010, we launched the second mattress in this line, the TEMPUR-Cloud™.  North American mattress sales increased $92.1 million, or 56.8%, over the same period in 2009, driven by the increase in our Retail channel. Net sales in the Direct channel increased to $30.8 million from $17.9 million during the same period in 2009, an increase of $12.9 million, or 71.8%. We believe increased sales in the Direct channel are a result of our focus on generating internet leads and investing in internet and direct mail advertising. Pillow sales increased $7.3 million, or 35.0%, over the same period in 2009.  Other Net sales increased $32.2 million, or 72.7%, compared to the same period in 2009. Many of our Pillows and Other products are sold with mattress purchases. Therefore, when Mattress sales increase, Pillows and Other products are also impacted. Additionally, we have emphasized improved attach rates on adjustable bed bases which are sold at a higher price point than traditional foundations.
 
    International. International Net sales for the six months ended June 30, 2010 increased to $158.2 million from $135.1 million for the same period in 2009, an increase of $23.1 million, or 17.1%. On a constant currency basis, our International Net sales increased approximately 14.8%. We have experienced some stabilization of the global economic slowdown in our international markets, which also impacted Net sales in 2009. The International Retail channel increased $16.4 million, or 15.3%, for the six months ended June 30, 2010. Third party Net sales increased $5.6 million or 40.9%. Our introduction of the Sensation mattress line in the International segment has continued to be well accepted by retailers and consumers. As a result, International mattress sales increased $12.2 million, or 14.9%, as compared to 2009. Pillow sales for 2010 increased $4.3 million, or 16.4%, compared to the same period in 2009. Other product Net sales increased $6.6 million, or 24.1%, as compared to 2009. Many of our Pillows and Other products are sold with mattress purchases. Therefore, when Mattress sales increase, Pillows and Other products are also impacted
 
    Gross profit. Gross profit for the six months ended June 30, 2010 increased to $252.9 million from $168.2 million for the same period in 2009, an increase of $84.7 million, or 50.3%.  The Gross profit margin for the six months ended June 30, 2010 was 48.9% as compared to 46.4% for the same period in 2009. The principal factors that affected Gross profit margin during the year are identified and discussed below, in the respective segment discussion. Additionally, Gross profit margin is impacted by geographic mix between segments.

    North America. North American Gross profit for the six months ended June 30, 2010 increased to $161.9 million from $93.2 million for the same period in 2009, an increase of $68.7 million, or 73.6%.  The Gross profit margin in our North American segment was 45.1% and 41.0% for the six months ended June 30, 2010 and June 30, 2009, respectively. Improvements in our North American Gross profit margin were primarily driven by fixed cost leverage related to higher production volumes and improved efficiencies in manufacturing. These factors were partially offset by new product introductions and higher commodity costs. Additionally, the North American segment pays a royalty to our International segment based on its production volume, which has the effect of lowering the segment's reported Gross profit margin. Our North American cost of sales increased to $196.9 million for the six months ended June 30, 2010 as compared to $133.9 million for the six months ended June 30, 2009, an increase of $62.9 million, or 47.0%.
 
    International. International Gross profit for the six months ended June 30, 2010 increased to $90.9 million from $74.9 million for the same period in 2009, an increase of $16.0 million, or 21.3%. The Gross profit margin in our International segment was 57.5% and 55.5% for the six months ended June 30, 2010 and June 30, 2009, respectively. For the six months ended June 30, 2010, improvements in our International Gross profit margin were primarily driven by fixed cost leverage related to higher production volumes and improved efficiencies in manufacturing. These factors were partially offset by new product introductions and higher commodity costs. Additionally, the International segment receives a royalty from our North American segment based on their production volume, which has the effect of increasing the segment's reported Gross profit margin. Our International Cost of sales for the six months ended June 30, 2010 increased to $67.2 million from $60.2 million for the same period in 2009, an increase of $7.1 million, or 11.7%.
 
    Selling and marketing expenses. Selling and marketing expenses increased to $93.1 million for the six months ended June 30, 2010 as compared to $69.1 million for the six months ended June 30, 2009. Selling and marketing expenses as a percentage of Net sales decreased to 18.0% for the six months ended June 30, 2010 from 19.1% for the same period for 2009. During 2010 we have continued to make investments in advertising to support future growth. For example, our new marketing and advertising campaign “Ask Me,” which launched in 2009, focuses on increasing awareness of our products and the benefits they offer through word-of-mouth and social networking outlets.
 
    General, administrative and other expenses. General, administrative and other expenses increased to $53.7 million for the six months ended June 30, 2010 as compared to $44.1 million for the six months ended June 30, 2009, an increase of $9.6 million, or 21.7%. The increase in General, administrative and other expenses are primarily a result of a larger bonus pool in 2010 compared to 2009 and an increase in legal fees incurred in the same period related to the acquisition of our former third party distributor in Canada. The effects of these items have been partially offset by a lower level of bad debt expense in 2010 compared to 2009. Additionally, in 2010 we have increased our investment in research and development in order to improve our existing product lines and continue to introduce new and differentiated products. General, administrative and other expenses as a percentage of Net sales was 10.4% and 12.1% for the six months ended June 30, 2010 and June 30, 2009, respectively.
 
    Interest expense, net. Interest expense, net, decreased to $7.0 million for the six months ended June 30, 2010, as compared to $9.0 million for the six months ended June 30, 2009, a decrease of $2.1 million, or 22.9%.  The decrease in interest expense is primarily attributable to a decrease in the underlying debt related to our interest rate swap, offset slightly by an increase in debt outstanding not subject to the interest rate swap. As we increase our borrowings, we are subject to variable rate debt that is not protected under the interest rate swap described below. Accordingly, if interest rates increase we may incur a higher level of interest expense. The variable interest rate and certain fees that we pay in connection with the 2005 Senior Credit Facility are subject to periodic adjustment based on changes in our consolidated leverage ratio. In May 2008, we entered into an interest rate swap agreement to manage interest costs and the risk associated with changing interest rates. Under this swap, we pay at a fixed rate and receive payments at a variable rate. The swap effectively fixes the floating London Inter-bank Offering Rate (LIBOR) based interest rate to 3.755% on $200.0 million of the outstanding balance as of June 30, 2010 under the 2005 Senior Credit Facility, with the outstanding balance subject to the swap declining over time. The amount of the outstanding balance subject to the swap amortizes as follows: to $300.0 million on November 28, 2008 (through November 2009); to $200.0 million on November 28, 2009 (through November 28, 2010); and to $100.0 million on November 28, 2010 (through November 28, 2011).
 
    Income tax provision. Our effective tax rate for the six months ended June 30, 2010 was 32.7%.  For the same period in 2009, the effective tax rate was 35.2%.  The decrease in the effective tax rate is primarily due to the tax charge on a previously recognized foreign tax benefit taken in the first quarter of 2009.
 
Liquidity and Capital Resources
 
Liquidity
 
    Our principal sources of funds are cash flows from operations and borrowings made pursuant to our credit facility. Principal uses of funds consist of share repurchases made from time to time pursuant to share repurchase authorizations, acquisition of certain former third party distributors, payments of principal and interest on our debt facilities and capital expenditures. At June 30, 2010, we had working capital of $84.9 million including Cash and cash equivalents of $15.4 million compared to working capital of $72.5 million including $14.0 million in Cash and cash equivalents as of December 31, 2009.  Working capital increased in the second quarter of 2010 primarily as a result of increased levels of both Accounts receivable and Inventory, slightly offset by an increase in Income taxes payable.

    Our cash flow from operations increased to $67.8 million for the six months ended June 30, 2010 from $65.5 million for the six months ended June 30, 2009. The increase in operating cash flow for the six months ended June 30, 2010 compared to compared to the six month period ended June 30, 2009 was primarily driven by Net income growth, offset by changes in operating assets and liabilities. The increases in Accounts receivable, Inventories and Income taxes payable are related to increased sales.
 
    Net cash used in investing activities increased to $25.6 million for the six months ended June 30, 2010 as compared to $4.9 million for the six months ended June 30, 2009, primarily related to the acquisition of our former third party distributor in Canada and an increase in capital expenditures. In 2010 we are investing in capital projects that we believe will create operational efficiencies and support future growth.
 
    Cash flow used by financing activities was $38.9 million for the six months ended June 30, 2010 as compared to $49.2 million used for the six months ended June 30, 2009, representing a decrease in cash flow used of $10.3 million, primarily related to an increase in current borrowings under our credit facility. These borrowings were utilized to complete $200.0 million in share repurchases of our common stock.  Additionally, we received $19.5 million in proceeds from stock option exercises during the six months ended June 30, 2010 as compared to no proceeds for the same period in 2009.

Capital Expenditures
 
    Capital expenditures totaled $6.7 million for the six months ended June 30, 2010 and $4.7 million for the six months ended June 30, 2009. We currently expect our 2010 capital expenditures to