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SCSS > SEC Filings for SCSS > Form 10-Q on 25-Oct-2013All Recent SEC Filings

Show all filings for SELECT COMFORT CORP

Form 10-Q for SELECT COMFORT CORP


25-Oct-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 and volume of QVC shows, consumer confidence and general economic conditions. Therefore, 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 September 28, 2013 were as follows:

• Net income decreased 23% to $20.3 million, or $0.36 per diluted share, compared with net income of $26.2 million, or $0.46 per diluted share, for the same period one year ago.

• Net sales increased 7% to $263.7 million, compared with $246.8 million for the same period one year ago. The net sales increase was primarily driven by sales from 29 net new stores opened in the past 12 months.

• Operating income decreased to $30.7 million, or 11.6% of net sales, compared with $40.2 million, or 16.3% of net sales, for the same period one year ago. The decline in operating income was primarily due to an increase in marketing expenses driven by higher media spending, an increase in fixed costs associated with new, repositioned and remodeled stores, and a 2.0 percentage point decrease in our gross profit rate.

• Retail sales-per-store (for stores open at least one year), on a trailing twelve-month basis, of $2.1 million were in line with sales-per-store in the comparable period one year ago.


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• Cash provided by operating activities totaled $90.1 million for the nine months ended September 28, 2013, compared with $97.6 million for the same period one year ago.

• At September 28, 2013, cash, cash equivalents and marketable debt securities totaled $164.4 million and we had no borrowings under our revolving credit facility. In the third quarter of 2013, we repurchased 417,210 shares of our common stock under our Board approved share repurchase program at a cost of $10.0 million ($23.99 per share).

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                               Nine Months Ended
                                                            September 29,                                   September 29,
                                 September 28, 2013             2012             September 28, 2013             2012
Net sales                      $   263.7      100.0  %   $ 246.8     100.0 %   $   729.3      100.0  %   $ 714.4     100.0 %
Cost of sales                       97.3       36.9  %      86.1      34.9 %       268.1       36.8  %     257.8      36.1 %
Gross profit                       166.4       63.1  %     160.7      65.1 %       461.2       63.2  %     456.6      63.9 %

Operating expenses:
Sales and marketing                118.3       44.9  %     101.7      41.2 %       326.5       44.8  %     296.1      41.5 %
General and administrative          15.2        5.7  %      16.9       6.9 %        46.7        6.4  %      50.1       7.0 %
Research and development             2.4        0.9  %       1.7       0.7 %         7.5        1.0  %       4.3       0.6 %
CEO transition (benefit)
costs                               (0.1 )     (0.1 )%         -       0.0 %        (0.5 )     (0.1 )%       5.6       0.8 %
Asset impairment charges               -        0.0  %       0.1       0.0 %         0.1        0.0  %       0.1       0.0 %
Total operating expenses           135.7       51.5  %     120.5      48.8 %       380.2       52.1  %     356.2      49.9 %
Operating income                    30.7       11.6  %      40.2      16.3 %        81.0       11.1  %     100.4      14.0 %
Operating income - as
adjusted (1)                        30.6       11.6  %      40.2      16.3 %        80.5       11.0  %     106.0      14.8 %
Other income, net                    0.1        0.0  %       0.1       0.0 %         0.2        0.0  %       0.1       0.0 %
Income before income taxes          30.8       11.7  %      40.3      16.3 %        81.3       11.1  %     100.5      14.1 %
Income tax expense                  10.5        4.0  %      14.1       5.7 %        27.6        3.8  %      34.9       4.9 %
Net income                     $    20.3        7.7  %   $  26.2      10.6 %   $    53.7        7.4  %   $  65.6       9.2 %
Net income - as adjusted (1)   $    20.2        7.6  %   $  26.2      10.6 %   $    53.3        7.3  %   $  69.3       9.7 %

Net income per share:
Basic                          $    0.37                 $  0.47               $    0.98                 $  1.18
Diluted                        $    0.36                 $  0.46               $    0.96                 $  1.15
Diluted - as adjusted (1)      $    0.36                 $  0.46               $    0.95                 $  1.21

Weighted-average number of common shares:
Basic 54.9 55.4 55.0 55.6 Diluted 55.7 57.0 56.0 57.2

(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 23 for a reconciliation of this non-GAAP measure to the appropriate GAAP measure.

GAAP - generally accepted accounting principles

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

                                              Three Months Ended                    Nine Months Ended
                                       September 28,      September 29,      September 28,      September 29,
                                           2013                2012              2013               2012
Company-Controlled channel                   96.8 %              97.8 %            95.9 %             96.8 %
Wholesale/Other channel                       3.2 %               2.2 %             4.1 %              3.2 %
Total                                       100.0 %             100.0 %           100.0 %            100.0 %


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

                                                Three Months Ended                        Nine Months Ended
                                        September 28,        September 29,       September 28,         September 29,
                                            2013                 2012                2013                  2012
Sales change rates:
Retail comparable-store sales                (1 %)                 21 %               (5 %)                   28 %
Direct and E-Commerce                        (6 %)                 14 %               (8 %)                   13 %
Company-Controlled comparable sales
change                                       (1 %)                 21 %               (5 %)                   27 %
Net store openings/closings                   7 %                   4 %                6 %                     3 %
Total Company-Controlled channel              6 %                  25 %                1 %                    30 %
Wholesale/Other channel                      55 %                 (15 %)              31 %                     9 %
Total net sales change                        7 %                  24 %                2 %                    29 %

Other sales metrics were as follows:

                                              Three Months Ended                       Nine Months Ended
                                        September 28,      September 29,       September 28,         September 29,
                                            2013               2012                 2013                 2012
Average sales per store(1) ($ in
thousands)                            $        2,102      $       2,108
Average sales per square foot(1)      $        1,131      $       1,314
Stores > $1 million in net sales(1)               97 %               98 %
Stores > $2 million in net sales(1)               47 %               48 %
 Average net sales per mattress
unit -
  Company-Controlled channel(2)       $        3,304      $       3,208     $         3,207        $         2,993

(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 was as follows:

                                              Three Months Ended                    Nine Months Ended
                                       September 28,      September 29,     September 28,       September 29,
                                           2013               2012              2013                2012
Beginning of period                          413                381               410                  381
Opened                                        16                 15                43                   37
Closed                                        (6 )               (2 )             (30 )                (24 )
End of period                                423                394               423                  394

Comparison of Three Months Ended September 28, 2013 with Three Months Ended September 29, 2012

Net sales
Net sales increased 7% to $263.7 million for the three months ended September 28, 2013, compared with $246.8 million for the same period one year ago. The net sales increase was primarily driven by sales from 29 net new stores opened in the past 12 months, partially offset by a 1% decrease in comparable sales in our Company-Controlled channel. We believe a progressively more challenged macro-economic environment during the three months ended September 28, 2013 negatively impacted customer traffic and sales.

The $16.9 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $16.6 million sales increase resulting from net new store openings, partially offset by a $1.5 million decrease in sales from our Company-Controlled comparable retail stores; (ii) a $3.0 million increase in Wholesale/Other channel sales; and (iii) a $1.2 million decrease in Direct and E-Commerce sales. Company-Controlled mattress units increased 3% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 3%.


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Gross profit
The gross profit rate decreased to 63.1% of net sales for the three months ended September 28, 2013, compared with 65.1% for the prior-year period. A sales mix shift to lower-margin products, including this year's Labor Day limited-edition mattress and the introduction of the DualTempฎ layer, reduced the gross profit rate by 1.5 percentage points ("ppt.") compared to the same period one year ago. In addition, an increase in our 30-night trial policy to 100 nights reduced the gross profit rate by 0.4 ppt. The gross profit rate was favorably impacted by supply chain efficiencies and was also impacted by a variety of other factors that can fluctuate from quarter to quarter, including other sales return and exchange costs not related to the trial policy change, performance-based incentive compensation and warranty expenses.

Sales and marketing expenses
Sales and marketing expenses for the three months ended September 28, 2013 increased 16% to $118.3 million, or 44.9% of net sales, compared with $101.7 million, or 41.2% of net sales, for the same period one year ago. The $16.6 million expense increase resulted from (i) an $8.5 million, or 27%, increase in media spending; (ii) $6.4 million of incremental fixed costs primarily due to new, repositioned and remodeled stores; (iii) a $1.7 million increase in financing costs, as a greater percentage of our customers utilized promotional financing to purchase our products; and (iv) a $0.7 million increase in other marketing and promotional expenses. These increases were partially offset by lower percentage rent. The sales and marketing expense rate increased 3.7 ppt. compared with the same period one year ago due to the factors noted above and the deleveraging impact of the 1% comparable sales decrease.

General and administrative expenses
General and administrative ("G&A") expenses decreased $1.8 million to $15.2 million for the three months ended September 28, 2013, compared with $16.9 million in the same period one year ago, and decreased to 5.7% of net sales, compared with 6.9% of net sales last year. The $1.8 million decrease in G&A expenses was primarily due to (i) a $2.1 million decrease in performance-based incentive compensation; and (ii) a $0.9 million net decrease in miscellaneous other expenses, including professional services, partially offset by (i) a $0.8 million increase in employee compensation resulting from headcount increases to support business growth initiatives, and salary and wage rate increases that were in line with inflation; and (ii) $0.4 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business. The G&A expense rate decreased by 1.2 ppt. in the current period compared with the same period one year ago due to the net reduction in expenses and the leveraging impact from the 7% net sales increase.

Research and development expenses
Research and development (R&D) expenses for the three months ended September 28, 2013 were $2.4 million, or 0.9% of net sales, compared with $1.7 million, or 0.7% of net sales, for the same period one year ago. The $0.6 million change in R&D expenses was due to increased investments to support product innovations during the current year and the Company's long-term product innovation roadmap.

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 September 28, 2013, we recorded a non-cash compensation benefit of $0.1 million ($0.1 million, net of income tax) resulting from performance-based stock award adjustments. There were no performance-based stock award adjustments recorded during the three months ended September 29, 2012.

Asset impairment charges
During the three months ended September 28, 2013 and September 29, 2012, we recognized asset impairment charges of $48 thousand and $0.1 million, respectively, related to certain store assets and computer software.

Other income, net
Other income, net was $0.1 million for the three months ended September 28, 2013, consistent with the comparable period one year ago.

Income tax expense
Income tax expense was $10.5 million for the three months ended September 28, 2013 compared with $14.1 million for the same period one year ago. The effective tax rate for the three months ended September 28, 2013 was 34.2%, compared with the prior-year period rate of 35.0%. The 2012 effective tax rate was negatively impacted by a variety of factors, including a modest change in our annual effective tax rate estimate.


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Comparison of Nine Months Ended September 28, 2013 with Nine Months Ended September 29, 2012

Net sales
Net sales increased 2.1% to $729.3 million for the nine months ended September 28, 2013, compared with $714.4 million for the same period one year ago. The sales increase was primarily driven by sales from 29 net new stores opened in the past 12 months, partially offset by a 5% comparable sales decrease in our Company-Controlled channel. We believe changes to our media buying in the first quarter of 2013 and a more challenging macro-economic environment as the year progressed, both negatively impacted customer traffic and sales, and were key contributing factors to the 5% comparable sales decline. Management took decisive action to correct the media buying issue with 2013 quarterly sales trends improving on a sequential basis.

The $14.9 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $42.2 million sales increase resulting from net new store openings, partially offset by a $30.0 million decrease in sales from our Company-Controlled comparable retail stores; (ii) a $7.0 million increase in Wholesale/Other channel sales; and (iii) a $4.3 million decrease in Direct and E-Commerce sales. Company-Controlled mattress units decreased 6% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 7%.

Gross profit
The gross profit rate decreased to 63.2% of net sales for the nine months ended September 28, 2013, compared with 63.9% for the prior-year period. A sales mix shift to lower-margin products, including this year's Memorial Day and Labor Day limited-edition mattresses and the introduction of the DualTemp layer, reduced the gross profit rate by 0.8 percentage points ("ppt.") compared to the same period one year ago. In addition, an increase in our 30-night trial policy to 100 nights reduced the gross profit rate by 0.2 ppt. The gross profit rate was favorably impacted by supply chain efficiencies and was also impacted by a variety of factors that can fluctuate from quarter to quarter, including other sales return and exchange costs not related to the trial policy change, performance-based incentive compensation and warranty expenses.

Sales and marketing expenses
Sales and marketing expenses for the nine months ended September 28, 2013 increased 10.2% to $326.5 million, or 44.8% of net sales, compared with $296.1 million, or 41.5% of net sales, for the same period one year ago. The $30.3 million increase resulted from (i) a $17.5 million increase in fixed selling expenses primarily due to new, repositioned and remodeled stores; (ii) a $13.2 million, or 14%, increase in media spending; and (iii) a $3.9 million increase in customer financing expenses, as a larger percentage of our customers took advantage of promotional financing offers. These increases were partially offset by lower percentage rent ($3.4 million) and a net decrease in miscellaneous other expenses. The sales and marketing expense rate increased 3.3 ppt. compared with the same period one year ago due to the increase in expenses noted above and the deleveraging impact of the 5% comparable sales decrease in our Company-Controlled channel.

General and administrative expenses
General and administrative ("G&A") expenses decreased $3.4 million to $46.7 million for the nine months ended September 28, 2013, compared with $50.1 million in the prior year, and decreased to 6.4% of net sales, compared with 7.0% of net sales one year ago. The $3.4 million decrease in G&A expenses was primarily due to an $8.0 million decrease in performance-based incentive compensation and stock-based compensation, partially offset by (i) a $3.7 million increase in employee compensation resulting from headcount increases to support business growth initiatives, and salary and wage rate increases that were in line with inflation; (ii) $1.6 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 decrease in miscellaneous other expenses. The G&A expense rate decreased by 0.6 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 (R&D) expenses for the nine months ended September 28, 2013 were $7.5 million, or 1.0% of net sales, compared with $4.3 million, or 0.6% of net sales, for the same period one year ago. The $3.2 million change in R&D expenses was due to increased investments to support product innovations during the current year and the Company's long-term product innovation roadmap.

Asset impairment charges
During the nine months ended September 28, 2013 and September 29, 2012, we recognized asset impairment charges of $0.1 million in both periods related to certain store assets and computer software.


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