NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(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:

 

 

 

     (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:

 

     (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:

 

     (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 re ceivable 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.

 

 

     (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:

 

     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.

 

 

     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.

 

  

				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

 

 

     (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

 

     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

(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.

 

 

     As of June 30, 2010 and December 31, 2009, the fair value carrying amount of the Company’s derivative instruments were recorded as follows:

 

     The effect of derivative instruments on the accompanying Condensed Consolidated Statements of Income for the three months ended June 30, 2010 was as follows:

 

     For the three months ended June 30, 2009:

 

 

     For the six months ended June 30, 2009:

 

(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.

 

     (b) Accrued expenses and other current liabilities —

 

     Accrued expenses and other current liabilities consisted of the following:

 

     (c) Accumulated other comprehensive loss—

 

     Accumulated other comprehensive loss consisted of the following:

 

(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:

 

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.

 

(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.

 

 

     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:

 

 

     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