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SCSS > SEC Filings for SCSS > Form 10-Q on 25-Apr-2014All Recent SEC Filings

Show all filings for SELECT COMFORT CORP

Form 10-Q for SELECT COMFORT CORP


25-Apr-2014

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 primary 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, including the digital platform supporting our website;

• 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.


Index

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 individualization through our new sleep tracking technology, SleepIQTM, and a solutions-focused line of Sleep Number pillows, sheets, adjustable bases, and other bedding products, including the innovative DualTempTM temperature-balancing layer.

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 Goals

Our mission is to improve lives by Individualizing Sleep Experiences.

Our vision is to become one of the world's most beloved brands by delivering an Unparalleled Sleep Experience. We plan to achieve this by executing our consumer brand strategy to advance our long-term goals and strengthen our competitive advantages.

Our long-term goals are:

• Everyone will know Sleep Numberฎ;

• Innovative Sleep Numberฎ products will deliver meaningful benefits;

• Customers will easily find and interact with Sleep Number;

• Customers will enthusiastically recommend Sleep Number; and

• We will leverage our business model to fund innovation and growth.

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 March 29, 2014 were as follows:

• Net sales increased 7% to $276.4 million, compared with $258.2 million for the same period one year ago. Company-Controlled comparable sales increased 2%. The net sales increase was primarily driven by sales from 32 net new stores opened in the past 12 months.

• 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.

• Operating income decreased to $25.8 million, or 9.3% of net sales, compared with $35.2 million, or 13.6% of net sales, for the same period one year ago. The decline in operating income was primarily driven by a 1.3 percentage point (ppt.) decrease in our gross profit rate and a 2.7 ppt. increase in our sales and marketing expense rate. See page 18 for additional details.


Index

• Net income decreased 28% to $17.0 million, or $0.31 per diluted share, compared with net income of $23.5 million, or $0.42 per diluted share, for the same period one year ago.

• Cash provided by operating activities totaled $38.9 million for the three months ended March 29, 2014, compared with $45.0 million for the same period one year ago.

• At March 29, 2014, cash, cash equivalents and marketable debt securities totaled $143.0 million and we had no borrowings under our revolving credit facility. In the first quarter of 2014, we repurchased 566,543 shares of our common stock under our Board-approved share repurchase program at a cost of $10.0 million ($17.67 per share). As of March 29, 2014, the remaining authorization under our Board-approved share repurchase program was $126.7 million.

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 29,            March 30,
                                            2014                 2013
Net sales                            $ 276.4    100.0 %   $ 258.2    100.0 %
Cost of sales                          105.0     38.0 %      94.8     36.7 %
Gross profit                           171.4     62.0 %     163.4     63.3 %

Operating expenses:
Sales and marketing                    125.0     45.2 %     109.8     42.5 %
General and administrative              18.9      6.8 %      15.8      6.1 %
Research and development                 1.7      0.6 %       2.6      1.0 %
Total operating expenses               145.6     52.7 %     128.2     49.6 %
Operating income                        25.8      9.3 %      35.2     13.6 %
Operating income - as adjusted (1)      25.8      9.3 %      34.8     13.5 %
Other income, net                        0.1      0.0 %       0.1      0.0 %
Income before income taxes              25.9      9.4 %      35.3     13.7 %
Income tax expense                       8.9      3.2 %      11.8      4.6 %
Net income                           $  17.0      6.1 %   $  23.5      9.1 %
Net income - as adjusted (1)         $  17.0      6.1 %   $  23.2      9.0 %

Net income per share:
Basic                                $  0.31              $  0.43
Diluted                              $  0.31              $  0.42
Diluted - as adjusted (1)            $  0.31              $  0.41

Weighted-average number of common shares:
Basic 54.1 55.1 Diluted 54.8 56.3

(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 20 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
                             March 29,     March 30,
                                2014          2013
Company-Controlled channel      96.1 %         94.8 %
Wholesale/Other channel          3.9 %          5.2 %
Total                          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
                                             March 29,     March 30,
                                                2014          2013
Sales change rates:
Retail comparable-store sales(1)                 2 %            (8 %)
Direct and E-Commerce                            2 %           (18 %)
Company-Controlled comparable sales change       2 %            (9 %)
Net store openings/closings                      7 %             6 %
Total Company-Controlled channel                 9 %            (3 %)
Wholesale/Other channel                        (21 %)           35 %
Total net sales change                           7 %            (2 %)

(1) Stores are included in the comparable-store calculations in the 13th full month of operations. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base.

Other sales metrics were as follows:

                                                                  Three Months Ended
                                                              March 29,        March 30,
                                                                 2014            2013
Average sales per store(1) ($ in thousands)                 $     2,120      $     2,118
Average sales per square foot(1)                            $     1,042      $     1,256
Stores > $1 million in net sales(1)                                  97 %             98 %
Stores > $2 million in net sales(1)                                  47 %             46 %
 Average net sales per mattress unit - Company-Controlled
channel(2)                                                  $     3,373      $     3,132

(1) Trailing twelve months for stores included in our comparable-store calculations.
(2) Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.

The number of retail stores operating was as follows:

                         Three Months Ended
                      March 29,     March 30,
                         2014          2013
Beginning of period       440           410
Opened                     17            10
Closed                    (14 )          (9 )
End of period             443           411

Comparison of Three Months Ended March 29, 2014 with Three Months Ended March 30, 2013

Net sales
Net sales increased 7% to $276.4 million for the three months ended March 29, 2014, compared with $258.2 million for the same period one year ago. The net sales increase was primarily driven by sales from 32 net stores opened in the past 12 months and a 2% increase in comparable sales in our Company-Controlled channel.

The $18.2 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $16.4 million sales increase resulting from net store openings; (ii) a $4.3 million increase in sales from our Company-Controlled comparable retail stores; and (iii) a $0.3 million increase in Direct and E-Commerce sales; partially offset by (iv) a $2.8 million decrease in Wholesale/Other channel sales. Company-Controlled mattress units increased 1% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 8%.


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Gross profit
The gross profit rate decreased to 62.0% of net sales for the three months ended March 29, 2014, compared with 63.3% for the prior-year period. Increased sales return and exchange costs, including the impact of the second quarter 2013 change in our 30-night trial policy to 100 nights, reduced the gross profit rate by 1.0 ppt. An increase in logistic costs resulting from the severe winter weather reduced the gross profit rate by 0.2 ppt. The remaining change was due to a variety of other factors that can fluctuate from quarter to quarter, including performance-based incentive compensation and warranty expenses.

Sales and marketing expenses
Sales and marketing expenses for the three months ended March 29, 2014 increased 14% to $125.0 million, or 45.2% of net sales, compared with $109.8 million, or 42.5% of net sales, for the same period one year ago. The $15.2 million increase mainly resulted from (i) $6.6 million of incremental fixed costs resulting from new, repositioned and remodeled stores; (ii) a $3.5 million increase in variable store compensation; (iii) a $2.1 million increase in financing costs, as a greater percentage of our customers utilized promotional financing to purchase our products; (iv) a $1.5 million increase in production expenses related to our new marketing campaign; and (v) a $1.3 million, or 3%, increase in media spending. The sales and marketing expense rate increased 2.7 ppt. compared with the same period one year ago due to the factors noted above.

General and administrative expenses
General and administrative ("G&A") expenses increased $3.1 million to $18.9 million for the three months ended March 29, 2014, compared with $15.8 million in the same period one year ago, and increased to 6.8% of net sales, compared with 6.1% of net sales last year. The $3.1 million increase in G&A expenses was primarily due to (i) a $2.5 million increase in performance-based incentive compensation; (ii) a $0.5 million increase in employee compensation to support business growth initiatives, and salary and wage rate increases that were in line with inflation; and (iii) $0.3 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business. These increases were partially offset by a $0.2 million net decrease in miscellaneous other expenses, including a reduction in stock-based compensation. The G&A expense rate increased by 0.7 ppt. in the current period compared with the same period one year ago due to the net increase in expenses.

Research and development expenses
Research and development ("R&D") expenses for the three months ended March 29, 2014 were $1.7 million, or 0.6% of net sales, compared with $2.6 million, or 1.0% of net sales, for the same period one year ago.

Other income, net
Other income, net was $0.1 million for the three months ended March 29, 2014, consistent with the comparable period one year ago.

Income tax expense
Income tax expense was $8.9 million for the three months ended March 29, 2014 compared with $11.8 million for the same period one year ago. The effective tax rate for the three months ended March 29, 2014 was 34.4%, compared with the prior-year period rate of 33.5%. The 2013 effective tax rate was positively impacted by the retroactive reinstatement of the 2012 R&D tax credit in the first quarter of 2013. In addition, the R&D tax credit expired at the end of 2013 and has not yet been extended by Congress. As a result, our 2014 effective tax rate does not include any benefit from the R&D tax credit.


Index

Liquidity and Capital Resources

As of March 29, 2014, cash, cash equivalents and marketable debt securities totaled $143.0 million compared with $145.0 million as of December 28, 2013. The $2.0 million decrease was primarily due to $38.9 million of cash provided by operating activities offset by $16.7 million of cash used to purchase property and equipment, $10.2 million of cash used to repurchase our common stock and a $6.1 million decrease in short-term borrowings. The $82.6 million of marketable debt securities held as of March 29, 2014 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 29, 2014, and March 30, 2013 (dollars in millions). Amounts may not add due to rounding differences:

                                                           Three Months Ended
                                                        March 29,       March 30,
                                                           2014           2013
Total cash provided by (used in):
Operating activities                                   $    38.9       $    45.0
Investing activities                                       (20.8 )         (38.3 )
Financing activities                                       (15.9 )          (9.8 )
Net increase (decrease) in cash and cash equivalents   $     2.2       $    (3.1 )

Cash provided by operating activities for the three months ended March 29, 2014 was $38.9 million compared with $45.0 million for the three months ended March 30, 2013. The $6.2 million year-over-year decrease in cash from operating activities was comprised of a $6.5 million decrease in net income for the three months ended March 29, 2014 compared with the same period one year ago and a $2.0 million decrease in cash from changes in operating assets and liabilities, partially offset by a $2.3 million increase in adjustments to reconcile net income to net cash provided by operating activities.

Net cash used in investing activities was $20.8 million for the three months ended March 29, 2014, compared with $38.3 million for the same period one year ago. Investing activities for the current-year period included $16.7 million of property and equipment purchases, compared with $14.3 million for the same period one year ago. On a net basis, we increased our investment in marketable debt securities by $3.6 million during the three months ended March 29, 2014 compared with a net investment of $7.0 million during the comparable period one year ago.

Net cash used in financing activities was $15.9 million for the three months ended March 29, 2014, compared with $9.8 million for the same period one year ago. During the three months ended March 29, 2014, we repurchased $10.2 million of our stock ($10.0 million under our Board-approved share repurchase program and $0.2 million in connection with the vesting of employee restricted stock grants) compared with $10.1 million ($10.0 million under our Board-approved share repurchase program and $0.1 million in connection with the vesting of employee restricted stock grants) during the same period one year ago. Changes in book overdrafts 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.

Under the Board-approved $290 million share repurchase program, we repurchased 566,543 shares at a cost of $10.0 million ($17.67 per share) during the three months ended March 29, 2014. During the three months ended March 30, 2013, we repurchased 458,637 shares at a cost of $10.0 million ($21.82 per share). As of March 29, 2014, the remaining authorization under our Board-approved share repurchase program was $126.7 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, as amended, is an unsecured revolving credit facility that matures August 31, 2016. 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 29, 2014 we were in compliance with all financial covenants.

Our business model, which can operate with minimal working capital, does not require additional capital from external sources to fund operations or organic growth. The $143.0 million of cash, cash equivalents and marketable debt securities, cash generated from ongoing operations, and cash available under our revolving credit facility are expected to be adequate to maintain operations and fund anticipated expansion and strategic initiatives for the foreseeable future.

We have an agreement with GE Capital Retail Bank to offer qualified customers revolving credit arrangements to finance purchases from us ("GE Agreement"). The GE Agreement contains certain financial covenants, including a minimum tangible net worth requirement and a minimum cash requirement. As of March 29, 2014 we were in compliance with all financial covenants.


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Under the terms of the GE Agreement, GE Capital Retail Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts.

Non-GAAP Data Reconciliations

Reported to Adjusted Statements of Operations Data (in thousands, except per share amounts)

In addition to disclosing results that are determined in accordance with U.S. Generally Accepted Accounting Principles ("GAAP"), we also disclose non-GAAP results that exclude certain significant charges or credits. Our "as adjusted" data is considered a non-GAAP financial measure and is not in accordance with, or preferable to, "as reported," or GAAP financial data. However, we believe that the disclosure of results excluding certain significant charges or credits provides additional insights into underlying business performance and facilitates year-over-year comparisons. Below are our reconciliations of our non-GAAP financial measures to the most comparable GAAP financial measures.

                                                  Three Months Ended
                            March 29, 2014                    March 30, 2013
                                                                   CEO
                                                                Transition
                             As Reported       As Reported      Benefit(1)     As Adjusted
Operating income           $        25,802    $      35,227    $     (391 )   $      34,836
Other income, net                      102               91             -                91

Income before income taxes          25,904           35,318          (391 )          34,927
Income tax expense(2)                8,912           11,847          (134 )          11,713
Net income                 $        16,992    $      23,471    $     (257 )   $      23,214

Net income per share -
  Basic                    $          0.31    $        0.43    $     0.00     $        0.42
  Diluted                  $          0.31    $        0.42    $     0.00     $        0.41

  Basic Shares                      54,113           55,095        55,095            55,095
  Diluted Shares                    54,844           56,251        56,251            56,251

(1) 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, the Compensation Committee approved the modification of Mr. McLaughlin's currently unvested stock awards, including performance-based stock awards. The performance-based 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 30, 2013, we incurred $0.4 million ($0.3 million, net of income tax) of non-recurring, non-cash expenses associated with these stock award modifications which is included in general and administrative expenses in the condensed consolidated statement of operations.
(2) Reflects effective income tax rates, before discrete adjustments, of 34.3% for 2013. GAAP - generally accepted accounting principles

. . .

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