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SCSS > SEC Filings for SCSS > Form 10-Q on 26-Apr-2013All Recent SEC Filings

Show all filings for SELECT COMFORT CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SELECT COMFORT CORP


26-Apr-2013

Quarterly Report


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

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in seven sections:

• Risk Factors

• Overview

• Results of Operations

• Liquidity and Capital Resources

• Non-GAAP Data Reconciliations

• Off-Balance-Sheet Arrangements and Contractual Obligations

• Critical Accounting Policies

Risk Factors

The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included herein. This quarterly report on Form 10-Q contains certain forward-looking statements that relate to future plans, events, financial results or performance. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as "may," "will," "should," "could," "expect," "anticipate," "believe," "estimate," "plan," "project," "predict," "intend," "potential," "continue" or the negative of these or similar terms. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections.

These risks and uncertainties include, among others:

• Current and future general and industry economic trends and consumer confidence;

• The effectiveness of our marketing messages;

• The efficiency of our advertising and promotional efforts;

• Our ability to execute our Company-Controlled distribution strategy;

• Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;

• Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;

• Industry competition, the emergence of additional competitive products, and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;

• Availability of attractive and cost-effective consumer credit options;

• Pending and unforeseen litigation and the potential for adverse publicity associated with litigation;

• Our "just-in-time" manufacturing processes with minimal levels of inventory, which may leave us vulnerable to shortages in supply;

• Our dependence on significant suppliers and our ability to maintain relationships with key suppliers, including several sole-source suppliers;

• Rising commodity costs and other inflationary pressures;

• Risks inherent in global sourcing activities;

• Risks of disruption in the operation of either of our two manufacturing facilities;

• Increasing government regulation;

• The adequacy of our management information systems to meet the evolving needs of our business and existing and evolving regulatory standards applicable to data privacy and security;

• The costs and potential disruptions to our business related to upgrading our management information systems;

• Our ability to attract, retain and motivate qualified management, executive and other key employees, including qualified retail sales professionals and managers; and

• Uncertainties arising from global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events.

Additional information concerning these and other risks and uncertainties is contained under the caption "Risk Factors" in our Annual Report on Form 10-K.


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We have no obligation to publicly update or revise any of the forward-looking statements contained in this quarterly report on Form 10-Q.

Overview

Business Overview

We believe we are leading the industry in delivering an unparalleled sleep experience by offering consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of Sleep Numberฎ beds and bedding. We are the exclusive manufacturer, marketer, retailer and servicer of the revolutionary Sleep Number bed, which allows individuals to adjust the firmness and support of each side at the touch of a button. We offer further personalization through our solutions-focused line of Sleep Number pillows, sheets and other bedding products.

As the only national specialty-mattress retailer, we generate revenue by selling products through two distribution channels. Our Company-Controlled channel, which includes Retail, Direct Marketing and E-Commerce, sells directly to consumers. Our Wholesale/Other channel sells to and through selected retail and wholesale customers in the United States and Australia, and the QVC shopping channel.

Mission, Vision and Strategy

Our mission is to improve lives by individualizing sleep experiences. Our vision is to become the world's most beloved brand by delivering an Unparalleled Sleep Experience.

We are executing against a defined strategy which focuses on the following key components:
• Everyone will know Sleep Number and how it will improve their life;

• Innovative Sleep Number products will move society forward with meaningful consumer benefits;

• Sleep Number will be easy to find and customers will interact with us when and how they want;

• Customers will love their Sleep Number experience and enthusiastically recommend Sleep Number to their family and friends; and

• Leveraging our unique business model to fund innovation and growth will benefit our customers, employees and shareholders.

Results of Operations

Quarterly and Annual Results

Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including increases or decreases in sales, the timing, amount and effectiveness of advertising expenditures, changes in sales return rates or warranty experience, the timing of store openings/closings and related expenses, changes in net sales resulting from changes in our store base, the timing of promotional offerings, competitive factors, changes in commodity costs, any disruptions in supplies or third-party service providers, seasonality of retail and bedding industry sales, timing of QVC shows, consumer confidence and general economic conditions. As a result, our historical results of operations may not be indicative of the results that may be achieved for any future period.

Highlights

Financial highlights for the three months ended March 30, 2013 were as follows:

• Net income increased 5% to $23.5 million, or $0.42 per diluted share, compared with net income of $22.4 million, or $0.39 per diluted share, for the same period one year ago. Financial results for 2012 included a $5.6 million ($3.7 million, net of income tax), or $0.06 per diluted share, non-recurring, non-cash charge associated with the June 1, 2012 chief executive officer transition.

• Net sales decreased 2% to $258.2 million, compared with $262.4 million for the same period one year ago, primarily due to changes to our media buying, which negatively impacted customer traffic and sales. The changes to media buying were a key contributing factor to the 9% comparable sales decline in our Company-Controlled channel, against the backdrop of soft industry performance. Management took decisive action to correct the media buying issue and adjust discretionary expenses during the quarter.

• Operating income increased to $35.2 million, or 13.6% of net sales, for the three months ended March 30, 2013 compared with $34.3 million, or 13.1% of net sales, for the same period one year ago. Adjusted operating income (operating income excluding CEO transition (benefit) costs) decreased to $34.8 million, or 13.5% of net sales, for the three months ended March 30, 2013


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compared with $39.9 million, or 15.2% of net sales, for the same period one year ago. The decline in adjusted operating income was primarily due to the 2% net sales decrease and increased sales and marketing expenses.
• Retail sales-per-store (for stores open at least one year), on a trailing twelve-month basis, increased by 12% from one year ago to $2.1 million.

• Cash provided by operating activities totaled $45.0 million for the three months ended March 30, 2013, compared with $44.5 million for the same period one year ago.

• At March 30, 2013, cash, cash equivalents and marketable debt securities totaled $181.4 million compared with $177.8 million at December 29, 2012, and we had no borrowings under our revolving credit facility. In the first quarter of 2013, we repurchased 458,637 shares of our common stock under our Board approved share repurchase program at a cost of $10.0 million ($21.82 per share).

• On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems, for $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. We purchased Comfortaire to progress our role as the leader in delivering innovative products as part of an individualized sleep experience, while also strengthening our competitive advantages.

The following table sets forth, for the periods indicated, our results of operations expressed as dollars and percentages of net sales. Figures are in millions, except percentages and per share amounts. Amounts may not add due to rounding differences.

                                                Three Months Ended
                                                                March 31,
                                        March 30, 2013             2012
Net sales                            $ 258.2     100.0  %   $ 262.4    100.0 %
Cost of sales                           94.8      36.7  %      98.1     37.4 %
Gross profit                           163.4      63.3  %     164.3     62.6 %

Operating expenses:
Sales and marketing                    109.8      42.5  %     106.2     40.5 %
General and administrative              16.2       6.3  %      16.9      6.5 %
Research and development                 2.6       1.0  %       1.3      0.5 %
CEO transition (benefit) costs          (0.4 )    (0.2 )%       5.6      2.1 %
Asset impairment charges                   -       0.0  %         -      0.0 %
Total operating expenses               128.2      49.6  %     130.0     49.5 %
Operating income                        35.2      13.6  %      34.3     13.1 %
Operating income - as adjusted (1)      34.8      13.5  %      39.9     15.2 %
Other income, net                        0.1       0.0  %         -      0.0 %
Income before income taxes              35.3      13.7  %      34.3     13.1 %
Income tax expense                      11.8       4.6  %      11.9      4.5 %
Net income                           $  23.5       9.1  %   $  22.4      8.5 %
Net income - as adjusted (1)         $  23.2       9.0  %   $  26.1      9.9 %

Net income per share:
Basic                                $  0.43                $  0.40
Diluted                              $  0.42                $  0.39
Diluted - as adjusted (1)            $  0.41                $  0.45

Weighted-average number of common shares:
Basic 55.1 55.6 Diluted 56.3 57.4

(1) This non-GAAP measure is not in accordance with, or preferable to, GAAP financial data. However, we are providing this information as we believe it facilitates annual and year-over-year comparisons for investors and financial analysts. See page 22 for a reconciliation of this non-GAAP measure to the appropriate GAAP measure.

GAAP - generally accepted accounting principles


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The percentage of our total net sales, by dollar volume, from each of our channels was as follows:

                                Three Months Ended
                             March 30,     March 31,
                                2013          2012
Company-Controlled channel      94.8 %         96.2 %
Wholesale/Other channel          5.2 %          3.8 %
Total                          100.0 %        100.0 %

The components of total net sales change, including comparable net sales changes, were as follows:

                                                Three Months Ended
                                              March 30,     March 31,
                                                2013           2012
Sales change rates:
Retail comparable-store sales                    (8 %)          36 %
Direct and E-Commerce                           (18 %)          17 %
Company-Controlled comparable sales change       (9 %)          34 %
Net store openings/closings                       6 %            2 %
Total Company-Controlled channel                 (3 %)          36 %
Wholesale/Other channel                          35 %           26 %
Total net sales change                           (2 %)          36 %

Other sales metrics were as follows:

                                                                  Three Months Ended
                                                              March 30,        March 31,
                                                                 2013            2012
Average sales per store(1) ($ in thousands)                 $     2,118      $     1,897
Average sales per square foot(1)                            $     1,256      $     1,229
Stores > $1 million in net sales(1)                                  98 %             97 %
Stores > $2 million in net sales(1)                                  46 %             36 %
Average net sales per mattress unit - Company-Controlled
channel(2)                                                  $     3,132      $     2,751

(1) Trailing twelve months for stores open at least one year.
(2) Represents Company-Controlled Channel total net sales divided by Company-Controlled Channel mattress units.

The number of retail stores operating during the first three months of 2013 and 2012 was as follows:

                         Three Months Ended
                      March 30,     March 31,
                         2013          2012
Beginning of period       410           381
Opened                     10            10
Closed                     (9 )         (11 )
End of period             411           380


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Comparison of Three Months Ended March 30, 2013 with Three Months Ended March 31, 2012

Net sales
Net sales decreased 2% to $258.2 million for the three months ended March 30, 2013, compared with $262.4 million for the same period one year ago. The sales decrease was primarily driven by a 9% comparable sales decrease in our Company-Controlled channel partially offset by the sales from 31 net new stores opened in the past 12 months. Changes to our media buying, which negatively impacted customer traffic and sales, were a key contributing factor to the 9% comparable sales decline. Management took decisive action to correct the media buying issue and is making steady progress against a backdrop of soft industry performance. Company-Controlled mattress units decreased 15% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 14%.

The $4.1 million net sales decrease compared with the same period one year ago was comprised of the following: (i) a $17.1 million decrease in sales from our Company-Controlled comparable retail stores, partially offset by a $13.1 million sales increase resulting from net new store openings; (ii) a $3.7 million decrease in Direct and E-Commerce sales; and (iii) a $3.6 million increase in Wholesale/Other channel sales.

Gross profit
The gross profit rate improved to 63.3% of net sales for the three months ended March 30, 2013, compared with 62.6% for the prior year period. Approximately 0.5 percentage points ("ppt.") of the gross profit rate improvement was due to price increases associated with product innovations over the last 12 months. In addition, the prior-year period included higher promotional costs (approximately 0.4 ppt.) resulting mainly from the close-out and re-launch of our classic-series beds. The remaining change is due to a variety of factors that can fluctuate from quarter-to-quarter, including manufacturing efficiencies and logistics costs.

Sales and marketing expenses
Sales and marketing expenses for the three months ended March 30, 2013 increased 3% to $109.8 million, or 42.5% of net sales, compared with $106.2 million, or 40.5% of net sales, for the same period one year ago. The $3.6 million expense increase was primarily due to a $2.9 million, or 8%, increase in media spending, and $5.0 million of incremental fixed costs associated with new, relocated and remodeled stores. These increases were offset by a decrease in variable selling expenses resulting from the lower sales volume. The sales and marketing expense rate increased 2.0 ppt. compared with the same period one year ago due to the increase in media spending, fixed store costs and the deleveraging impact of the 2% net sales decline.

General and administrative expenses
General and administrative ("G&A") expenses decreased $0.7 million to $16.2 million for the three months ended March 30, 2013, compared with $16.9 million in the same period one year ago, and decreased to 6.3% of net sales, compared with 6.5% of net sales last year. The $0.7 million decrease in G&A expenses was primarily due to a $3.6 million decrease in performance-based incentive compensation and stock-based compensation, partially offset by (i) a $1.5 million increase in employee compensation resulting from headcount increases to support growth initiatives of the business, and salary and wage rate increases that were in line with inflation; (ii) $0.7 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business; and (iii) a $0.7 million net increase in miscellaneous other expenses, including outside consulting expenses. The G&A expense rate decreased by 0.2 ppt. in the current period compared with the same period one year ago due to the net reduction in expenses.

Research and development expenses
Research and development expenses for the three months ended March 30, 2013 were $2.6 million, or 1.0% of net sales, compared with $1.3 million, or 0.5% of net sales, for the same period one year ago. The $1.3 million change in R&D expenses was due to increased investments in product innovations during the current year.

CEO transition costs
In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin's contributions to the Company, the Company's Compensation Committee approved the modification of Mr. McLaughlin's unvested stock awards, including performance stock awards. The performance stock awards are subject to applicable performance adjustments (through 2014) based on free cash flow and actual market share growth versus performance targets. During the three months ended March 31, 2012, we incurred $5.6 million ($3.7 million, net of income tax) of non-recurring, non-cash expenses associated with these stock award modifications. During the three months ended March 30, 2013, we recorded a non-cash compensation benefit of $0.4 million ($0.3 million, net of income tax) resulting from performance-based stock award adjustments.


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Asset impairment charges
During the three months ended March 30, 2013 we recognized asset impairment charges of $30 thousand related to certain store assets. During the three months ended March 31, 2012 we recognized asset impairment charges of $4 thousand related to certain store assets.

Other income, net
Other income, net was $0.1 million for the three months ended March 30, 2013, compared with other income, net of $7 thousand for the comparable period one year ago. The current-year improvement in other income, net was primarily due to a higher average yield on our portfolio in the current-year period, an increase in our average cash, cash equivalents and marketable debt securities balance for the three months ended March 30, 2013 compared with the same period one year ago, and a reduction of fees associated with our line of credit.

Income tax expense
Income tax expense was $11.8 million for the three months ended March 30, 2013 compared with $11.9 million for the same period one year ago. The effective tax rate for the three months ended March 30, 2013 was 33.5%, a decrease from the prior-year period rate of 34.7%. The 2013 effective tax rate was positively impacted by the retroactive reinstatement of the research and development tax credit.

Liquidity and Capital Resources

As of March 30, 2013, cash, cash equivalents and marketable debt securities totaled $181.4 million compared with $177.8 million as of December 29, 2012. The $3.6 million increase was primarily due to $45.0 million of cash provided by operating activities offset by $14.3 million of cash used to purchase property and equipment, $17.0 million of strategic investments, including the purchase of Comfortaire (see discussion below), and $10.1 million of cash used to repurchase our common stock. Our $96.6 million of marketable debt securities held as of March 30, 2013 are all highly liquid and include U.S. government and agency securities, corporate debt securities and municipal bonds.

The following table summarizes our cash flows for the three months ended March 30, 2013, and March 31, 2012 (dollars in millions). Amounts may not add due to rounding differences:

                                                           Three Months Ended
                                                        March 30,       March 31,
                                                           2013           2012
Total cash provided by (used in):
Operating activities                                   $    45.0       $    44.5
Investing activities                                       (38.3 )          (9.3 )
Financing activities                                        (9.8 )          (0.6 )
Net (decrease) increase in cash and cash equivalents   $    (3.1 )     $    34.7

Cash provided by operating activities for the three months ended March 30, 2013 was $45.0 million compared with $44.5 million for the three months ended March 31, 2012. The $0.5 million year-over-year increase in cash from operating activities was comprised of a $1.1 million increase in our net income for the three months ended March 30, 2013 compared with the same period one year ago and a $0.4 million increase in cash from changes in operating assets and liabilities, partially offset by a $0.9 million decrease in adjustments to reconcile net income to net cash provided by operating activities.

Net cash used in investing activities was $38.3 million for the three months ended March 30, 2013, compared with net cash used in investing activities of $9.3 million for the same period one year ago. Investing activities for the current-year period included $14.3 million of property and equipment purchases, compared with $9.3 million for the same period one year ago. Capital expenditures - primarily for new stores, repositioned and remodeled stores, and continued investment in customer-management systems and other information technology that supports the growth of the business - are projected to be approximately $70 - $80 million in 2013 compared with $51.6 million in 2012. On a net basis, we invested $7.0 million in marketable debt securities during the three months ended March 30, 2013 compared with none during the comparable period one year ago. On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems, for $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. We purchased Comfortaire to progress our role as the leader in delivering innovative products as part of an individualized sleep experience, while also strengthening our competitive advantages.


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See Note 3, Purchase of Comfortaire, of the Notes to Condensed Consolidated Financial Statements for additional details. In addition, we made a $1.5 million minority equity investment in one of our strategic product-development partners and committed to invest an additional $3.0 million during the remainder of 2013.

Net cash used in financing activities was $9.8 million for the three months ended March 30, 2013, compared with net cash used in financing activities of $0.6 million for the same period one year ago. During the three months ended March 30, 2013, we repurchased $10.1 million of our stock ($10.0 million under our Board approved share repurchase program and $0.1 million in connection with the vesting of employee restricted stock grants) compared with $1.2 million during the same period one year ago. Changes in book overdrafts and payments on capital lease obligations are included in the net change in short-term borrowings. Financing activities for both periods reflect the vesting of employee restricted stock awards and exercise of employee stock options along with the associated excess tax benefits.

During the second quarter of 2012, we reinitiated repurchasing our common stock with the current objective to maintain common shares outstanding at or slightly below existing levels. Under the Board approved $290 million share repurchase program, we repurchased 458,637 shares at a cost of $10.0 million ($21.82 per share) during the three months ended March 30, 2013. We did not repurchase any shares under our share repurchase program during the three months ended March 31, 2012. As of March 30, 2013, the remaining authorization under our Board approved share repurchase program was $166.7 million. There is no expiration date governing the period over which we can repurchase shares.

Our $20.0 million Credit Agreement (the "Credit Agreement") with Wells Fargo Bank, National Association is an unsecured revolving credit facility that matures April 23, 2015. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20.0 million to up to $50.0 million in total availability, subject to lender approval. As of March 30, 2013 we were in compliance with all financial covenants.

Any borrowings under the Credit Agreement will, at our request, be classified as either LIBOR Loans or Adjusted Base Rate ("ABR") Loans (both as defined in the . . .

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