Summary of TEMPUR PEDIC INTERNATIONAL INC

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying notes included in this quarterly report on Form 10-Q. The forward-looking statements in this discussion regarding the mattress and pillow industries, our expectations regarding our future performance, financial flexibility, 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. 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.

Executive Overview

General-We are the leading manufacturer, marketer and distributor of premium mattresses and pillows which we sell in approximately 80 countries globally 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.

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

Strategy

We believe we are the industry leader in terms of profitability. Our long-term goal is also to become the world's largest bedding company in terms of revenue. In order to achieve this goal, we expect to continue to pursue certain key strategies:

• Maintain our focus on premium mattresses and pillows and to regularly introduce new products.

• Invest in increasing our global brand awareness through advertising campaigns that further associate our brand name with better overall sleep and premium quality products.

• Extend our presence and improve our account productivity in both the Domestic and International Retail segments.

• Invest in our operating infrastructure to meet the requirements of our business, including investments in research and development.

• Take actions to further improve our financial flexibility and strengthen the business.

Results of Operations

A summary of our results for the period ended September 30, 2008 includes the following:

• Earnings per share (EPS) was $0.32 per diluted common share in the third quarter of 2008.

• As of September 30, 2008, we have reduced Inventories by approximately $36.8 million to $69.7 million, compared to $106.5 million as of December 31, 2007.

• We reduced total debt by $83.3 million to $518.8 million as of September 30, 2008 from $602.0 from December 31, 2007.

• Operating cash flow increased 30.0% to $168.9 million for the nine-months ended September 30, 2008 from $129.9 million for the same nine-month period in 2007.

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(Millions, except earnings                Three Months Ended                                 Nine Months Ended
        per share)                           September 30,                                     September 30,
                                     2008                     2007                     2008                     2007
Net sales                    $  252.8       100.0 %   $  294.1       100.0 %   $  738.7       100.0 %   $  817.8       100.0 %
Cost of sales                   147.3        58.3        152.5        51.8        419.1        56.7        424.0        51.8

Gross profit                    105.5        41.7        141.6        48.2        319.6        43.3        393.8        48.2
Selling and marketing
expenses                         40.0        15.8         48.9        16.6        137.8        18.7        144.6        17.7
General, administrative
and other expenses               22.6         9.0         25.2         8.6         73.2         9.9         72.8         8.9

Operating income                 42.9        17.0         67.5        23.0        108.6        14.7        176.4        21.6

Interest expense, net            (6.3 )      (2.5 )       (8.2 )      (2.8 )      (19.6 )      (2.7 )      (21.4 )      (2.6 )
Other income (expense),
net                               0.1           -            -           -         (1.0 )      (0.1 )       (0.5 )      (0.1 )

Income before income taxes       36.7        14.5         59.3        20.1         88.0        11.9        154.5        18.9
Income tax provision             12.6         5.0         20.5         6.9         30.1         4.1         53.0         6.5
Net income                   $   24.1         9.5 %   $   38.8        13.2 %   $   57.9         7.8 %   $  101.5        12.4 %

Earnings per common share:
Basic                        $   0.32                 $   0.50                 $   0.77                 $   1.25
Diluted                      $   0.32                 $   0.49                 $   0.77                 $   1.22

Cash dividend per share:     $   0.08                 $   0.08                 $   0.24                 $   0.22

Weighted average per
common share outstanding:
Basic                          74,815                   77,725                   74,704                   81,522
Diluted                        74,992                   79,173                   74,944                   83,069

Three Months Ended September 30, 2008 Compared with Three Months Ended September 30, 2007

We sell our premium mattresses and pillows through four distribution channels:
Retail, Direct, Healthcare, and Third party. The Retail channel sells to furniture and bedding, specialty and department stores. The Direct channel sells directly to consumers. The Healthcare channel sells to hospitals, nursing homes, healthcare professionals and medical retailers. The Third party channel sells to distributors in countries where we do not operate our own wholly owned subsidiaries. A summary of Net sales by channel is set forth below:

                  CONSOLIDATED                 DOMESTIC                INTERNATIONAL
               Three Months Ended         Three Months Ended         Three Months Ended
                 September 30,              September 30,              September 30,
(Millions)      2008         2007          2008         2007          2008          2007
Retail         $   216.2     $ 251.5      $   148.0     $ 177.4      $    68.2      $ 74.1
Direct              11.3        18.0            9.2        15.2            2.1         2.8
Healthcare          11.6        12.4            3.7         4.2            7.9         8.2
Third Party         13.7        12.2            5.0         3.7            8.7         8.5
               $   252.8     $ 294.1      $   165.9     $ 200.5      $    86.9      $ 93.6

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A summary of Net sales by product is set forth below:

                   CONSOLIDATED                 DOMESTIC                INTERNATIONAL
                Three Months Ended         Three Months Ended         Three Months Ended
                  September 30,              September 30,              September 30,
(Millions)       2008         2007          2008         2007          2008          2007
Net sales:
  Mattresses    $   174.9     $ 207.3      $   121.4     $ 149.2      $    53.5      $ 58.1
  Pillows            31.4        34.4           14.5        18.1           16.9        16.3
  Other              46.5        52.4           30.0        33.2           16.5        19.2
                $   252.8     $ 294.1      $   165.9     $ 200.5      $    86.9      $ 93.6

Net sales. Net sales for the three months ended September 30, 2008 decreased to $252.8 million from $294.1 million for the same period in 2007, a decrease of $41.3 million, or 14.0%. The primary area of sales weakness was in the U.S., coupled with a slowdown in certain European markets. For the three months ended September 30, 2008, our Retail channel Net sales decreased to $216.2 million from $251.5 million for the same period in 2007, a decrease of $35.2 million, or 14.0%. Our Direct channel Net sales decreased to $11.3 million from $18.0 million for the same period in 2007, a decrease of $6.8 million, or 37.6%. Our Healthcare channel Net sales decreased to $11.6 million from $12.4 million for the same period in 2007, a decrease of $0.7 million, or 6.0%. Our Third Party Net sales increased to $13.7 million from $12.2 million for the same period in 2007, an increase of $1.5 million, or 12.0%. The factors that impacted Net sales for each segment are discussed below, in the respective segment discussion. We believe we are facing a challenging economic environment, and are not assuming the economic climate will recover in the short term.

Domestic. Domestic Net sales for the three months ended September 30, 2008 decreased to $165.9 million from $200.5 million for the same period in 2007, a decrease of $34.6 million, or 17.2%. Our Domestic Retail channel contributed $148.0 million in Net sales for the three months ended September 30, 2008, a decrease of $29.4 million, or 16.6%, as compared to the same period in 2007. We believe that the macroeconomic environment adversely impacted our Domestic Retail channel with many consumers deferring high-end product purchases. Net sales in the Direct channel decreased by $6.0 million, or 39.4%. We believe the macroeconomic environment also negatively impacted Net sales in the Direct channel, as this channel attracts a customers which have also been adversely affected by the economic environment. The Domestic Third Party channel Net sales increased $1.3 million, or 34.5%, to $5.0 million, primarily related to the addition of new customers and the introduction of new products by our North American third party distributor.

As a result of the macroeconomic environment, mattress sales in the third quarter of 2008 decreased $27.9 million, or 18.7%, over the same period in 2007. Pillow sales decreased $3.5 million, or 19.4%. As many of our pillows are sold along with a mattress, when mattress sales decline, pillow sales also are traditionally impacted. Other sales, which include adjustable bedbases, foundations and other related products, decreased by $3.2 million, or 9.7%. This decrease is primarily related to the decrease in mattress sales, the effects of which have been offset by the emphasized sales of adjustable bedbases.

International. International Net sales for the three months ended September 30, 2008 decreased to $86.9 million from $93.6 million for the same period in 2007, a decrease of $6.7 million, or 7.2%. On a constant currency basis, our International sales declined approximately 12.8%. Our International segment was primarily impacted by macroeconomic factors in certain European markets. The International Retail channel decreased $5.8 million, or 7.9%, for the three months ended September 30, 2008. International mattress sales in the third quarter of 2008 decreased $4.6 million, or 7.9%, over the third quarter of 2007. Pillow sales for the third quarter of 2008 increased $0.5 million, or 2.9%, as compared to the third quarter of 2007.

Gross profit. Gross profit for the three months ended September 30, 2008 decreased to $105.5 million from $141.6 million for the same period in 2007, a decrease of $36.1 million, or 25.5%. Several factors impacted our Gross profit margin during the quarter. These factors are identified and discussed below in the respective segment discussions.

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Domestic. Domestic Gross profit for the three months ended September 30, 2008 decreased to $58.8 million from $87.7 million for the same period in 2007, a decrease of $28.9 million, or 33.0%. The Gross profit margin in our Domestic segment was 35.4% and 43.7% for the three months ended September 30, 2008 and September 30, 2007, respectively. For the three months ended September 30, 2008, the gross margin declined resulting from a combination of lower Direct channel Net sales, raw material cost inflation and lower production volumes related to the decrease in Net sales and our efforts to reduce inventories. Domestic Cost of sales for the three months ended September 30, 2008 decreased to $107.1 million from $112.8 million for the same period in 2007, a decrease of $5.6 million, or 5.0%.

International. International Gross profit for the three months ended September 30, 2008 decreased to $46.7 million from $53.9 million for the same period in 2007, a decrease of $7.2 million, or 13.4%. The Gross profit margin in our International segment was 53.8% and 57.6% for the three months ended September 30, 2008 and September 30, 2007, respectively. The Gross profit margin for our International segment was impacted by raw material cost inflation and lower production volumes related to the decrease in Net sales and our efforts to reduce inventories. Our International Cost of sales for the three months ended September 30, 2008 increased to $40.2 million from $39.7 million for the same period in 2007, an increase of $0.5 million, or 1.2%.

Selling and marketing expenses. Selling and marketing expenses include advertising and media production; other marketing materials such as catalogs, brochures, videos, product samples, direct customer mailings and point of purchase materials; and sales force and customer service compensation. We also include in Selling and marketing expenses certain new product development costs, including market research and testing for new products. Selling and marketing expenses decreased to $40.0 million for the three months ended September 30, 2008 as compared to $48.9 million for the three months ended September 30, 2007. Selling and marketing expenses as a percentage of Net sales were 15.8% and 16.6% for the three months ended September 30, 2008 and 2007, respectively. During the third quarter of 2008, we aligned Selling and marketing expenses with our revised full-year sales expectations primarily through leveraging advertising expenditures and cost control initiatives put in place earlier in the year.

General, administrative and other expenses. General, administrative and other expenses include management salaries, 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 decreased to $22.6 million for the three months ended September 30, 2008 as compared to $25.2 million for the three months ended September 30, 2007, a decrease of $2.6 million, or 10.3%. General, administrative and other expenses as a percentage of Net sales was 9.0% and 8.6% for the three months ended September 30, 2008 and 2007, respectively. We decreased our expenditures consistent with the cost control initiatives that were introduced earlier in the year. This effect was offset by an increase in our bad debt expense associated with the accounts-receivable from a U.S. customer seeking to reorganize its operations under Chapter 11 of the Bankruptcy Code.

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 $6.3 million for the three months ended September 30, 2008, as compared to $8.2 million for the three months ended September 30, 2007, a decrease of $2.0 million, or 23.8%. The decrease is primarily attributable to a decrease in overall debt as well as a decrease in interest rates. The 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. On May 29, 2008, we entered into an interest rate swap agreement effective May 30, 2008, to manage interest costs and the risk associated with changing interest rates. Under this swap, the Company pays at a fixed rate and receives payments at a variable rate. The swap effectively fixes the floating LIBOR-based interest rate to 3.755% on $350.0 million of the outstanding balance under the 2005 Senior Credit Facility, with the outstanding balance subject to the swap declining over time.

Income tax provision. Our Income tax provision includes income taxes associated with taxes currently payable and deferred taxes and includes the impact of net operating losses for certain of our foreign operations. Our effective income tax rates for the three months ended September 30, 2008 and for the three months ended September 30, 2007 differed from the federal statutory rate principally because of certain foreign tax rate differentials, state and local income taxes, valuation allowances on certain net operating losses, foreign income currently taxable in the U.S., the production activities deduction and certain other permanent differences.

Our effective tax rate for the three months ended September 30, 2008 was 34.4%. For the same period in 2007, the effective tax rate was 34.5%.

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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. The tax assessment relates 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 $39.3 million including interest and underpayment penalties. On January 23, 2008 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 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. We believe we have meritorious defenses to the proposed adjustment and will oppose the assessment in the Danish courts, as necessary. For the three months ended September 30, 2008, the gross amount of tax reserves relating to this matter was increased by $2.5 million, of which $0.8 million impacted the effective tax rate with $1.6 million was recorded as a component of Goodwill as it related to periods prior to the acquisition of Tempur World, Inc. in November 2002.

In addition to the impact of the above matter on the gross amount of the Company's unrecognized tax benefits, it is reasonably possible under FIN 48 that the amount of the total unrecognized tax benefits may change in the next twelve months. An estimate of the amount of such change cannot be made at this time. There have been no significant changes to the status of any other unrecognized tax benefits during the quarter ended September 30, 2008.

Nine Months Ended September 30, 2008 Compared with Nine Months Ended September 30, 2007

A summary of Net sales by channel is set forth below:

                 CONSOLIDATED                DOMESTIC                INTERNATIONAL
               Nine Months Ended         Nine Months Ended         Nine Months Ended
                 September 30,             September 30,             September 30,
(Millions)     2008         2007         2008         2007         2008         2007
Retail         $  623.5     $ 681.4      $  407.2     $ 472.4      $  216.3     $ 209.0
Direct             37.5        60.7          31.2        52.8           6.3         7.9
Healthcare         36.4        35.4          12.1        10.8          24.3        24.6
Third Party        41.3        40.3          11.9        10.6          29.4        29.7
               $  738.7     $ 817.8      $  462.4     $ 546.6      $  276.3     $ 271.2

A summary of Net sales by product is set forth below:

                  CONSOLIDATED                DOMESTIC                INTERNATIONAL
                Nine Months Ended         Nine Months Ended         Nine Months Ended
                  September 30,             September 30,             September 30,
(Millions)      2008         2007         2008         2007         2008         2007
Net sales:
  Mattresses    $  506.6     $ 572.0      $  336.6     $ 406.7      $  170.0     $ 165.3
  Pillows           91.8       101.1          40.1        48.4          51.7        52.7
  Other            140.3       144.7          85.7        91.5          54.6        53.2
                $  738.7     $ 817.8      $  462.4     $ 546.6      $  276.3     $ 271.2

Net sales. Net sales for the nine months ended September 30, 2008 decreased to $738.7 million from $817.8 million for the same period in 2007, a decrease of $79.1 million, or 9.7%. The primary area of sales weakness was in the U.S., coupled with a slowdown in certain European markets. For the nine months ended September 30, 2008, our Retail channel Net sales decreased to $623.5 million from $681.4 million for the same period in 2007, a decrease of $57.9 million, or 8.5%. Our Direct channel Net sales decreased to $37.5 million from $60.7 million for the same period in 2007, a decrease of $23.3 million, or 38.3%. Our Healthcare channel Net sales increased to $36.4 million from $35.4 million for the same period in 2007, an increase of $1.0 million, or 2.9%. Our Third Party Net sales increased to $41.3 million from $40.3 million for the same period in 2007, an increase of $1.0 million, or 2.6%. The factors that impacted Net sales for each segment are discussed below in the respective segment discussion.

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Domestic. Domestic Net sales for the nine months ended September 30, 2008 decreased to $462.4 million from $546.6 million for the same period in 2007, a decrease of $84.3 million, or 15.4%. Our Domestic Retail channel contributed $407.2 million in Net sales for the nine months ended September 30, 2008 for a decrease of $65.2 million, or 13.8%, over the prior year same period. This decrease is due primarily to a challenging U.S. macroeconomic environment. The Healthcare channel Net sales increased $1.2 million, or 11.3%, as a result of our distribution partnerships and strategic relationships with healthcare companies who market joint product offerings through their established distribution, offset by the elimination of certain small Healthcare partners. Our Third Party channel Net sales increased $1.3 million, or 12.7%, as a result of certain new customers and new product introductions by our North American third party distributor. Our Direct channel Net sales decreased 40.9%, which was a result of the challenges in the U.S. macroeconomic environment. Domestic mattress sales decreased $70.1 million, or 17.2%, over the same period in 2007, driven by the decreases in our Retail channel. Pillow sales decreased $8.2 million, or 16.9%. Many of our pillow products are sold with mattress purchases. As a result, when mattress sales decline, pillow sales are also traditionally impacted.

International. International Net sales for the nine months ended September 30, 2008 increased to $276.3 million from $271.2 million for the same period in 2007, an increase of $5.2 million, or 1.9%. The increase was driven by favorable foreign exchange rates in 2008. On a constant currency basis, our International sales declined by approximately 8.2%. Our International segment was primarily impacted by macroeconomic factors in certain key European markets, primarily late in the second quarter and in the third quarter. The International Retail channel increased $7.3 million, or 3.5%, for the nine months ended September 30, 2008. Our Direct channel Net sales decreased 20.6%. Our Third party sales decreased 1.0%. Additionally, our Healthcare channel Net sales decreased $0.2 million, or 0.8%. International mattress sales increased $4.7 million, or 2.8%, as compared to 2007. Pillow sales for the nine months ended September 30, 2008 decreased $1.0 million, or 1.9% as compared to the same period in 2007.

Gross profit. Gross profit for the nine months ended September 30, 2008 decreased to $319.6 million from $393.8 million for the same period in 2007, a decrease of $74.3 million, or 18.9%. Several factors impacted our Gross profit margin during the quarter. These factors are identified and discussed below in the respective segment discussions.

Domestic. Domestic Gross profit for the nine months ended September 30, 2008 decreased to $170.0 million from $237.5 million for the same period in 2007, a decrease of $67.6 million, or 28.4%. The Gross profit margin in our Domestic segment was 36.8% and 43.5% for the nine months ended September 30, 2008 and September 30, 2007, respectively. The decrease in our Gross profit margin for the Domestic segment was impacted by declines in the Direct channel, an inflationary raw material cost environment and reduced production levels resulting from lower sales and our efforts to reduce inventories. Our Domestic Cost of sales decreased to $292.3 million for the nine months ended September 30, 2008 as compared to $309.1 million for the nine months ended September 30, 2007, a decrease of $16.7 million, or 5.4%.

International. International Gross profit for the nine months ended September 30, 2008 decreased to $149.6 million from $156.3 million for the same period in 2007, a decrease of $6.7 million, or 4.3%. The Gross profit margin in our International segment was 54.1% and 57.6% for the nine months ended September 30, 2008 and September 30, 2007, respectively. For the nine months ended September 30, 2008, the Gross profit margin for our International segment was primarily impacted by an inflationary raw material cost environment and by decreased production levels related to lower sales and our efforts to reduce inventories. Our International Cost of sales for the nine months ended September 30, 2008 increased to $126.8 million from $114.9 million for the same period in 2007, an increase of $11.9 million, or 10.3%.

Selling and marketing expenses. Selling and marketing expenses decreased to $137.8 million for the nine months ended September 30, 2008 as compared to $144.6 million for the nine months ended September 30, 2007. Selling and marketing expenses as a percentage of Net sales increased to 18.7% for the nine months ended September 30, 2008 from 17.7% for the same period for 2007. For the first quarter of 2008, much of our cost structure was in place and we were limited in our ability to take actions to reduce our selling and marketing costs to match our reduced sales levels. In the second and third quarters we were able to better align Selling and marketing expenses with our revised sales expectations through leveraging advertising and cost control initiatives put in place earlier in the year.

General, administrative and other expenses. General, administrative and other expenses remained relatively even, at $73.2 million for the nine months ended . . .