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MFRM > SEC Filings for MFRM > Form 10-Q on 6-Dec-2013All Recent SEC Filings

Show all filings for MATTRESS FIRM HOLDING CORP.

Form 10-Q for MATTRESS FIRM HOLDING CORP.


6-Dec-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our unaudited condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q. The discussion in this section contains forward-looking statements that involve risks and uncertainties. See "Cautionary Note Regarding Forward-Looking Statements" included elsewhere in this report for a discussion of important factors that could cause actual results to differ materially from those described or implied by the forward-looking statements contained herein.

Unless the context otherwise requires, the terms "Mattress Firm®," "our company," "the Company," "we," "us," "our" and the like refer to Mattress Firm Holding Corp. and its consolidated subsidiaries. Unless otherwise indicated,
(i) the term "our stores" refers to our company-operated stores and our franchised stores and (ii) when used in relation to our company, the terms "market" and "markets" refer to the metropolitan statistical area or an aggregation of the metropolitan statistical areas in which we or our franchisees operate.

In this report, we refer to earnings before interest, taxes, depreciation and amortization and other adjustments (such as goodwill impairment charges, loss on store closings and acquisition expenses), or "Adjusted EBITDA." Adjusted EBITDA is not a performance measure under accounting principles generally accepted in the United States, or "U.S. GAAP." See "Adjusted EBITDA to Net Income Reconciliation" below for a definition of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income.

We report on the basis of a 52- or 53-week fiscal year, which ends on the Tuesday closest to January 31. Each fiscal year is described by the period of the calendar year that comprises the majority of the fiscal year period. For example, the fiscal year ending January 28, 2014 is described as "fiscal 2013." Fiscal 2013 contains 52 weeks.

Executive Summary

Net sales during the thirteen weeks ended October 29, 2013 improved $48.9 million from the comparable prior year levels as a result of the addition of new and acquired store units and an increase in comparable-store sales. Net sales during the thirty-nine weeks ended October 29, 2013 improved $155.6 million from the comparable prior year levels as a result of the addition of new and acquired store units, less a slight decrease in comparable store sales. We believe that our net sales growth is outpacing our competitors in most of the markets in which we operate and is resulting in increased market share. Net income and other profitability measures improved during both the thirteen and thirty-nine weeks ended October 29, 2013, as a result of the net sales growth and a higher amount of costs incurred in the prior year related to acquisitions and a secondary offering. Key results for the thirteen and thirty-nine weeks ended October 29, 2013 include:

† Net income increased $5.6 million to $18.1 million for the thirteen weeks ended October 29, 2013, compared to $12.5 million for the comparable prior year period. Net income increased $12.0 million to $44.3 million for the thirty-nine weeks ended October 29, 2013, compared to $32.3 million for the comparable prior year period.

† Income from operations for the thirteen weeks ended October 29, 2013 was $31.8 million. Excluding $1.0 million of enterprise resource planning ("ERP") system implementation costs, adjusted income from operations was $32.8 million, and adjusted operating margin during the thirteen weeks ended October 29, 2013 decreased 10 basis-points from 10.1% during the thirteen weeks ended October 30, 2012 to 10.0% during the thirteen weeks ended October 29, 2013. This operating margin decrease on an adjusted basis (excluding acquisition-related, secondary offering costs and ERP system implementation costs) is comprised of a 150 basis-point improvement in sales and marketing expense leverage, offset by a 130 basis-point decline in gross margin and a 30 basis-point decrease from general and administrative expense deleverage. Income from operations for the thirty-nine weeks ended October 29, 2013 was $80.2 million. Excluding $3.3 million of acquisition-related and ERP system implementation costs, adjusted income from operations was $83.5 million, and adjusted operating margin during the thirty-nine weeks ended October 29, 2013 decreased 20 basis-points from 9.4% during the thirty-nine weeks ended October 30, 2012 to 9.2% during the thirty-nine weeks ended October 29, 2013. This operating margin decrease on an adjusted basis (excluding acquisition-related, secondary offering and ERP system implementation costs) is comprised of an 80 basis-point decline in gross margin, a 10 basis-point decrease from general and administrative expense deleverage, offset by an 80 basis-point improvement in sales and marketing expense leverage, and a 10 basis-point decline in other categories. Acquisition-related costs for purposes of management's discussion and analysis, which are included in the results of operations, consist of the acquisition-related costs as defined under U.S. GAAP, including advisory, legal, accounting, valuation, and other professional or consulting fees and, in addition, costs of integrating store and warehouse operations and corporate functions that are not expected to recur in future periods. Secondary offering costs, which are included in the results of operations, consist of costs borne by us in connection with a secondary offering of shares of common stock by certain of our selling stockholders which was completed in October 2012. ERP system implementation costs, which are included in the results of operations, consist


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primarily of training-related costs related to the roll-out of the Microsoft Dynamics AX for Retail ERP system. (Adjusted income from operations is not a performance measure under U.S. GAAP. See "Reconciliation of Reported (U.S. GAAP) to Adjusted Statements of Operations Data" below for a reconciliation of net income as reported to adjusted net income.)

† Net sales increased $48.9 million, or 17.7%, to $326.2 million for the thirteen weeks ended October 29, 2013, compared to $277.3 million for the comparable prior year period primarily as the result of an increase in the number of stores we operated and an increase in comparable-store sales. Comparable-store sales increased 2.9% during the thirteen weeks ended October 29, 2013. Net sales increased $155.6 million, or 20.8%, to $904.7 million for the thirty-nine weeks ended October 29, 2013, compared to $749.1 million for the comparable prior year period primarily as the result of an increase in the number of stores we operated, less a slight decrease in comparable store sales. Comparable-store sales decreased 0.5% during the thirty-nine weeks ended October 29, 2013.

The components of the net sales increase for the thirteen and thirty-nine weeks ended October 29, 2013 as compared to the thirteen and thirty-nine weeks ended October 30, 2012 were as follows (in millions):

                              Increase (Decrease) in Net
                                        Sales
                          Thirteen Weeks        Thirty-Nine
                              Ended             Weeks Ended
                           October 29,          October 29,
                               2013                2013
Comparable-store sales   $            7.9     $          (3.6 )
New stores                           35.0                97.4
Acquired stores                      10.1                71.8
Closed stores                        (4.1 )             (10.0 )
                         $           48.9     $         155.6

The components of net sales by major category of product and services were as follows (in millions):

                              Thirteen Weeks Ended                             Thirty-Nine Weeks Ended
                  October 30,     % of     October 29,     % of     October 30,     % of     October 29,     % of
                     2012        Total        2013        Total        2012        Total        2013        Total
Conventional
mattresses       $       109.3     39.4 % $       151.7     46.5 % $       307.2     41.0 % $       421.8     46.6 %
Specialty
mattresses               144.8     52.2 %         144.5     44.3 %         378.7     50.6 %         403.5     44.6 %
Furniture and
accessories               17.9      6.5 %          24.3      7.5 %          49.2      6.6 %          62.6      6.9 %
Total product
sales                    272.0     98.1 %         320.5     98.3 %         735.1     98.1 %         887.9     98.1 %
Delivery
service
revenues                   5.3      1.9 %           5.7      1.7 %          14.0      1.9 %          16.8      1.9 %
Total net
sales            $       277.3    100.0 % $       326.2    100.0 % $       749.1    100.0 % $       904.7    100.0 %

† Adjusted EBITDA increased $7.3 million to $42.4 million for the thirteen weeks ended October 29, 2013, compared with $35.1 million for the comparable prior year period. Adjusted EBITDA as a percentage of net sales increased to 13.0% during the thirteen weeks ended October 29, 2013, compared with 12.6% for the comparable prior year period. Adjusted EBITDA increased $20.6 million to $110.6 million for the thirty-nine weeks ended October 29, 2013, compared with $90.1 million for the comparable prior year period. Adjusted EBITDA as a percentage of net sales increased to 12.2% during the thirty-nine weeks ended October 29, 2013, compared with 12.0% for the comparable prior year period. See "Adjusted EBITDA to Net Income Reconciliation" below for a definition of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income.


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The activity with respect to the number of company-operated store units was as follows:

                                   Thirteen Weeks   Thirty-Nine
                                       Ended        Weeks Ended
                                    October 29,     October 29,
                                        2013           2013
Store units, beginning of period            1,121         1,057
New stores                                     40           121
Closed stores                                  (6 )         (23 )
Store units, end of period                  1,155         1,155

† Operating cash flows were $30.3 million and $70.9 million during the thirteen and thirty-nine weeks ended October 29, 2013, respectively, which were a primary funding source for capital expenditures and debt principal payments.

† On June 14, 2013, we acquired substantially all of the assets and operations of Olejo, Inc., an online retailer primarily focused on mattresses and bedding-related products, for a total purchase price of approximately $3.2 million.

† On September 4, 2013, the compensation committee of our Board of Directors granted equity awards to employees consisting of options to purchase shares of our common stock and restricted common stock under the Mattress Firm Holding Corp. 2011 Omnibus Incentive Plan covering 219,504 shares of common stock, which vest over four years, subject to specified criteria.

† At October 29, 2013, there were no outstanding revolver borrowings, $1.4 million outstanding standby letters of credit, and additional borrowing capacity of $98.6 million under the 2012 Senior Credit Facility.

General Definitions for Operating Results

Net sales are recognized upon delivery and acceptance of mattresses and bedding products by our customers and include fees collected for delivery services, and are recorded net of estimated returns. Customer deposits collected prior to the delivery of merchandise are recorded as a liability. Net sales are recognized net of sales tax collected from customers and remitted to various taxing jurisdictions.

Cost of sales consist of the following:

† Costs associated with purchasing and delivering our products to our stores and customers, net of vendor incentives earned on the purchase of products subsequently sold;

† Physical inventory losses;

† Store and warehouse occupancy and depreciation expense of related facilities and equipment;

† Store and warehouse operating costs, including warehouse (i) labor costs, (ii) utilities, (iii) repairs and maintenance, (iv) supplies and
(v) store facilities; and

† Estimated costs to provide for customer returns and exchanges and to service customer warranty claims.

Gross profit from retail operations is net sales minus cost of sales.

Franchise fees and royalty income represents initial franchise fees earned upon the opening of new franchisee stores and ongoing royalties based on a percentage of gross franchisee sales.


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Sales and marketing expenses consist of the following:

† Advertising and media production;

† Payroll and benefits for sales associates; and

† Merchant service fees for customer credit and debit card payments, check guarantee fees and promotional financing expense.

General and administrative expenses consist of the following:

† Payroll and benefit costs for corporate office and regional management employees;

† Stock-based compensation costs;

† Occupancy costs of corporate facility;

† Information systems hardware, software and maintenance;

† Depreciation related to corporate assets;

† Management fees;

† Insurance; and

† Other overhead costs.

Loss (gain) on store closings and impairment of store assets consists of the following:

† Estimated future costs to close locations at the time of closing including, as applicable, the difference between future lease obligations and anticipated sublease rentals;

† The write off of unamortized fixed assets related to store leasehold costs on closed stores; and

† Non-cash charges recognized for long-lived assets generally consisting of leasehold costs and related equipment resulting in a reduction of the carrying value to estimated fair value, based on our periodic assessment of whether projected future cash flows of individual stores are sufficient to recover the carrying value of the related assets.

Income from operations consists of gross profit from retail operations plus franchise fees and royalty income, minus (i) sales and marketing expenses,
(ii) general and administrative expenses, (iii) goodwill and intangible asset impairment charges, and (iv) loss (gain) on store closings and impairment of store assets.

Other expense, net includes interest income, interest expense, and gain (loss) on early debt extinguishments. Interest expense includes interest on outstanding debt, amortization of debt discounts, and amortization of financing costs.


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Results of Operations

The following table presents the consolidated historical financial operating data for our business for each period indicated (amounts in thousands). The historical results are not necessarily indicative of results to be expected for any future period.

                                  Thirteen Weeks Ended                               Thirty-Nine Weeks Ended
                     October 30,     % of      October 29,     % of      October 30,     % of      October 29,     % of
                        2012         Sales        2013         Sales        2012         Sales        2013         Sales
Net sales           $     277,259     100.0 % $     326,233     100.0 % $     749,091     100.0 % $     904,731     100.0 %
Costs of sales            167,173      60.3 %       200,267      61.4 %       454,299      60.6 %       553,878      61.2 %
Gross profit from
retail operations         110,086      39.7 %       125,966      38.6 %       294,792      39.4 %       350,853      38.8 %
Franchise fees
and royalty
income                      1,490       0.5 %         1,655       0.5 %         4,022       0.5 %         4,342       0.5 %
                          111,576      40.2 %       127,621      39.1 %       298,814      39.9 %       355,195      39.3 %
Sales and
marketing
expenses                   67,475      24.3 %        74,605      22.9 %       183,167      24.5 %       214,104      23.7 %
General and
administrative
expenses                   20,868       7.5 %        21,225       6.5 %        56,746       7.6 %        60,143       6.6 %
Loss on store
closings and
impairment of
store assets                  196       0.1 %            (5 )     0.0 %           267       0.0 %           739       0.1 %
Income from
operations                 23,037       8.3 %        31,796       9.7 %        58,634       7.8 %        80,209       8.9 %
Other expense,
net                         2,097       0.8 %         2,543       0.7 %         6,385       0.9 %         8,185       0.9 %
Income before
income taxes               20,940       7.6 %        29,253       9.0 %        52,249       7.0 %        72,024       8.0 %
Income tax
expense                     8,484       3.1 %        11,117       3.4 %        19,972       2.7 %        27,756       3.1 %
Net income          $      12,456       4.5 % $      18,136       5.6 % $      32,277       4.3 % $      44,268       4.9 %

Due to rounding, totals may not equal the sum of the line items in the table above.

Thirteen Weeks Ended October 29, 2013 Compared to Thirteen Weeks Ended October 30, 2012

Net sales. Net sales increased $48.9 million, or 17.7%, to $326.2 million during the thirteen weeks ended October 29, 2013, compared to $277.3 million during the thirteen weeks ended October 30, 2012 primarily as a result of an increase in the number of stores we operated and an increase in comparable-store sales. The components of the net sales increase for the thirteen weeks ended October 29, 2013 as compared to the thirteen weeks ended October 30, 2012 were as follows (in millions):

                            Increase
                          (Decrease) in
                            Net Sales
                         Thirteen Weeks
                              Ended
                           October 29,
                              2013
Comparable-store sales   $           7.9
New stores                          35.0
Acquired stores                     10.1
Closed stores                       (4.1 )
                         $          48.9

The increase in comparable-store net sales noted above represents a 2.9% comparable-store sales increase which was primarily the result of an increase in unit sales driven by sales initiatives implemented during the current quarter that encouraged our sales associates to improve sales productivity, partially offset by a decrease in average unit price. The increase in our net sales from new stores was the result of 151 new stores opened at various times during the twelve fiscal periods ended October 29, 2013, including 40 stores opened during the thirteen-week period ended October 29, 2013, prior to their inclusion in the comparable-store sales calculation which begins with the thirteenth full fiscal period of operations. The increase in net sales from acquired stores was the result of the acquisitions of 34 Mattress XPress, Inc. and Mattress Xpress of Georgia, Inc. (collectively, "Mattress X-Press") stores in September 2012 and 27 Factory Mattress & Water Bed Outlet of Charlotte, Inc. ("Mattress Source") stores in December 2012. The reduction in net sales from closed stores was the result of 34 stores we closed during the twelve fiscal periods ended October 29, 2013, including six stores during the thirteen-week period ended October 29, 2013. We operated 1,155 stores at October 29, 2013, compared with 1,011 stores at October 30, 2012.

Cost of sales. Cost of sales increased $33.1 million, or 19.8%, to $200.3 million during the thirteen weeks ended October 29, 2013, compared to $167.2 million during the thirteen weeks ended October 30, 2012. The major components of the increase in cost of sales are discussed below. Cost of sales as a percentage of net sales increased to 61.4% during the thirteen weeks ended October 29, 2013, as compared to 60.3% for the comparable prior year period.


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Product costs increased by $22.0 million, or 21.1%, to $126.0 million during the thirteen weeks ended October 29, 2013, compared with $104.0 million during the thirteen weeks ended October 30, 2012. The increase in the amount of product costs was the result of the corresponding increase in net sales. Product costs as a percentage of net sales increased to 38.6% during the thirteen weeks ended October 29, 2013 from 37.5% during the thirteen weeks ended October 30, 2012. The increase of product costs as a percentage of net sales is primarily attributable to the implementation of sales initiatives noted above, which resulted in an increase in unit sales at lower product margins.

Store and warehouse occupancy costs, consisting primarily of lease related costs of rented facilities, increased $6.8 million, or 18.8%, to $43.0 million during the thirteen weeks ended October 29, 2013, compared to $36.2 million for the corresponding prior year period. The increase in the amount of store and warehouse occupancy costs during the thirteen weeks ended October 29, 2013 was mainly attributable to the increase in the number of stores we operated and the warehouse operations in a number of new markets opened during the last 12 months. Store and warehouse occupancy costs as a percentage of net sales increased to 13.2% during the thirteen weeks ended October 29, 2013, compared to 13.1% during the thirteen weeks ended October 30, 2012. The increase in store and warehouse occupancy costs as a percentage of net sales during the thirteen weeks ended October 29, 2013 was mostly attributable to our entrance into new markets that resulted in less scale and cost leverage relative to established markets, partially offset by leverage generated from comparable-store sales growth in our established markets.

Depreciation expense related to leasehold improvements and other fixed assets used in stores and warehouse operations increased $1.0 million, or16.7%, to $6.7 million, during the thirteen weeks ended October 29, 2013, compared to $5.7 million during the thirteen weeks ended October 30, 2012. The increase in expense was primarily attributable to the increase in the number of stores we operated during the thirteen weeks ended October 29, 2013, as compared to the comparable prior year period.

Other cost of sales, consisting of store and warehouse operating and delivery costs, increased $3.3 million, or 15.8%, to $24.6 million during the thirteen weeks ended October 29, 2013, compared to $21.3 million during the thirteen weeks ended October 30, 2012, primarily as a result of the increase in net sales and in the increase in the number of stores we operated during the thirteen weeks ended October 29, 2013, as compared to the corresponding prior year period. Other cost of sales for the thirteen weeks ended October 30, 2012 included $0.5 million of acquisition-related costs related to the Mattress Giant and Mattress X-Press acquisitions, consisting of temporary storage facilities during the integration periods and duplicate costs attributable to certain warehouse facilities that have since been consolidated.

Gross profit from retail operations. As a result of the above, gross profit from retail operations increased $15.9 million, or 14.4%, to $126.0 million during the thirteen weeks ended October 29, 2013, compared with $110.1 million during the thirteen weeks ended October 30, 2012. Gross profit from retail operations as a percentage of net sales decreased to 38.6% during the thirteen weeks ended October 29, 2013, as compared to 39.7% during the thirteen weeks ended October 30, 2012, for the reasons discussed above.

Franchise fees and royalty income. Franchise fees and royalty income increased $0.2 million, or 11.1%, to $1.7 million for the thirteen weeks ended October 29, 2013, compared to $1.5 million during the corresponding prior year period. The increase in income was attributable to an increase in royalty income, which was primarily due to increases in sales for franchised stores as compared with the prior year period mainly due to new stores. Our franchisees operated 171 stores at October 29, 2013, compared with 160 stores at October 30, 2012.

Sales and marketing expenses. Sales and marketing expenses increased $7.1 million, or 10.6%, to $74.6 million during the thirteen weeks ended October 29, 2013, compared to $67.5 million during the thirteen weeks ended October 30, 2012. Sales and marketing expenses as a percentage of net sales decreased to 22.9% during the thirteen weeks ended October 29, 2013, compared to 24.3% during the thirteen weeks ended October 30, 2012. The components of sales and marketing expenses are explained below.

Advertising expense increased $3.8 million, or 16.6%, to $26.8 million during the thirteen weeks ended October 29, 2013, from $23.0 million during the thirteen weeks ended October 30, 2012. The increase in the amount of advertising spend was mainly attributable to increased spending to enhance our market share in many of our established markets and, to a lesser extent, our expansion into new markets. Advertising expense as a percentage of net sales decreased to 8.2% during the thirteen weeks ended October 29, 2013, compared to 8.3% during the thirteen weeks ended October 30, 2012. We receive funds from time to time from certain vendors for the advertisement of their products, and we recognize these funds as a direct reduction of advertising expense. The amount of vendor advertising funds that were recognized as a reduction of advertising expense totaled $3.8 million during the thirteen weeks ended October 29, 2013, compared with $2.1 million during the thirteen weeks ended October 30, 2012.

Other sales and marketing expenses, consisting mainly of salesman compensation costs, but also including costs incurred to accept payments from our customers, such as credit card and third party finance fees, increased $3.3 million, or 7.5%, to $47.8 million during the thirteen weeks ended October 29, 2013, compared to $44.5 million during the thirteen weeks ended October 30, 2012, primarily as a result of the increase in net sales during the period. Other sales and marketing expenses as a percentage of net sales


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decreased to 14.7% during the thirteen weeks ended October 29, 2013, compared to 16.1% during the thirteen weeks ended October 30, 2012. The decrease in expense as a percentage of net sales is primarily the result of the increase in net sales during the period and the normalization of per store staffing levels that had temporarily increased above normal levels in the prior year period as a result of acquisitions completed during Fiscal 2012.

General and administrative expenses. General and administrative expenses . . .

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