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

Show all filings for SELECT COMFORT CORP

Form 10-Q for SELECT COMFORT CORP


25-Jul-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;

• 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 are leading the industry in delivering unparalleled sleep experiences by offering consumers high-quality and individualized sleep solutions and services, which include a complete line of Sleep Numberฎ beds and bedding. We are the exclusive designer, manufacturer, marketer, retailer and servicer of the revolutionary Sleep Number bed. We offer further individualization through our new sleep tracking technology, SleepIQTM, and a solutions-focused line of Sleep Number pillows, sheets, FlexFitTM adjustable bases, and other bedding products, including the innovative DualTempTM temperature-balancing layer.

We generate revenue by selling products through two distribution channels. Our vertical, direct to consumer business model is our primary source of revenue with exclusive distribution through our Company-Controlled channel, which includes Retail, Direct Marketing and E-Commerce. In addition, we operate a small wholesale business in the United States and Australia.

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 expect our customer-focused strategies and goals will build our competitive advantages and deliver sustainable, profitable growth.

Our long-term goals are:

• Everyone will know Sleep Numberฎ;

• Innovative Sleep Number 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, 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 June 28, 2014 were as follows:

• Net sales increased 13% to $234.8 million, compared with $207.4 million for the same period one year ago. Strong sales of our innovative new products contributed to the 13% net sales increase. The 13% net sales increase was driven by sales from 38 net new stores opened in the past 12 months and a 7% comparable sales increase in our Company-Controlled channel.

• Retail sales-per-store (for stores open at least one year), on a trailing twelve-month basis, of $2.1 million increased 2% compared with the prior-year trailing twelve-month period.

• Operating income decreased to $12.7 million, or 5.4% of net sales, compared with $15.1 million, or 7.3% of net sales, for the same period one year ago. The decline in operating income was primarily due to a 2.7 percentage point
(ppt.) decrease in our gross profit rate, partially offset by the additional operating income generated by the 13% increase in net sales. See page 19 for additional details on our gross profit rate.

• Net income decreased 15% to $8.5 million, or $0.16 per diluted share, compared with net income of $9.9 million, or $0.18 per diluted share, for the same period one year ago.


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• Cash provided by operating activities totaled $49.6 million for the six months ended June 28, 2014, compared with $36.1 million for the same period one year ago.

• At June 28, 2014, cash, cash equivalents and marketable debt securities totaled $120.8 million and we had no borrowings under our revolving credit facility. In the second quarter of 2014, we repurchased 531,943 shares of our common stock under our Board-approved share repurchase program at a cost of $10.0 million (an average of $18.82 per share). As of June 28, 2014, the remaining authorization under our Board-approved share repurchase program was $116.7 million.

The following table sets forth 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                           Six Months Ended
                                    June 28,              June 29,                                    June 29,
                                      2014                  2013              June 28, 2014             2013
Net sales                      $ 234.8     100.0 %   $ 207.4     100.0 %   $ 511.2     100.0 %   $ 465.6     100.0 %
Cost of sales                     92.4      39.3 %      76.0      36.6 %     197.4      38.6 %     170.8      36.7 %
Gross profit                     142.4      60.7 %     131.4      63.4 %     313.8      61.4 %     294.8      63.3 %

Operating expenses:
Sales and marketing              106.7      45.5 %      98.4      47.4 %     231.7      45.3 %     208.2      44.7 %
General and administrative        21.3       9.1 %      15.4       7.4 %      40.2       7.9 %      31.2       6.7 %
Research and development           1.7       0.7 %       2.6       1.2 %       3.4       0.7 %       5.1       1.1 %
Total operating expenses         129.7      55.2 %     116.3      56.1 %     275.3      53.8 %     244.5      52.5 %
Operating income                  12.7       5.4 %      15.1       7.3 %      38.5       7.5 %      50.3      10.8 %
Operating income - as
adjusted (1)                      12.7       5.4 %      15.1       7.3 %      38.5       7.5 %      49.9      10.7 %
Other income, net                  0.1       0.0 %       0.1       0.0 %       0.2       0.0 %       0.2       0.0 %
Income before income taxes        12.8       5.4 %      15.2       7.3 %      38.7       7.6 %      50.5      10.8 %
Income tax expense                 4.3       1.8 %       5.3       2.5 %      13.2       2.6 %      17.1       3.7 %
Net income                     $   8.5       3.6 %   $   9.9       4.8 %   $  25.5       5.0 %   $  33.4       7.2 %
Net income - as adjusted (1)   $   8.5       3.6 %   $   9.9       4.8 %   $  25.5       5.0 %   $  33.1       7.1 %

Net income per share:
Basic                          $  0.16               $  0.18               $  0.47               $  0.61
Diluted                        $  0.16               $  0.18               $  0.47               $  0.60
Diluted - as adjusted (1)      $  0.16               $  0.18               $  0.47               $  0.59

Weighted-average number of common
shares:
Basic                             53.6                  55.0                  53.9                  55.1
Diluted                           54.3                  56.0                  54.6                  56.1

(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

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

                               Three Months Ended         Six Months Ended
                              June 28,     June 29,     June 28,    June 29,
                                2014         2013         2014        2013
Company-Controlled channel      96.4 %        96.1 %      96.3 %       95.4 %
Wholesale/Other channel          3.6 %         3.9 %       3.7 %        4.6 %
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                  Six Months Ended
                                         June 28,          June 29,         June 28,          June 29,
                                           2014              2013             2014              2013
Sales change rates:
Retail comparable-store sales(1)              8 %              (7 %)             5 %              (7 %)
Direct and E-Commerce                        (5 %)              4 %             (2 %)             (9 %)
Company-Controlled comparable sales
change                                        7 %              (6 %)             4 %              (8 %)
Net store openings/closings                   6 %               7 %              7 %               7 %
Total Company-Controlled channel             13 %               1 %             11 %              (1 %)
Wholesale/Other channel                       6 %               7 %            (11 %)             23 %
Total net sales change                       13 %               1 %             10 %               0 %

(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               Six Months Ended
                                         June 28,        June 29,        June 28,        June 29,
                                           2014            2013            2014            2013
Average sales per store(1) ($ in
thousands)                            $     2,144      $     2,094
Average sales per square foot(1)      $     1,009      $     1,197
Stores > $1 million in net sales(1)            97 %             98 %
Stores > $2 million in net sales(1)            46 %             46 %
 Average revenue per mattress
unit(2)                               $     3,709      $     3,182     $     3,520     $     3,154

(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        Six Months Ended
                      June 28,     June 29,    June 28,     June 29,
                        2014         2013        2014         2013
Beginning of period      443          411         440           410
Opened                    16           17          33            27
Closed                    (8 )        (15 )       (22 )         (24 )
End of period            451          413         451           413

Comparison of Three Months Ended June 28, 2014 with Three Months Ended June 29, 2013

Net sales
Net sales increased 13% to $234.8 million for the three months ended June 28, 2014, compared with $207.4 million for the same period one year ago. Strong sales of our innovative new products contributed to the 13% net sales increase. The net sales increase was primarily driven by sales from 38 net stores opened in the past 12 months and a 7% comparable sales increase in our Company-Controlled channel.

The $27.4 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $14.7 million sales increase resulting from net store openings; (ii) a $13.0 million increase in sales from our Company-Controlled comparable retail stores; and (iii) a $0.5 million increase in Wholesale/Other channel sales, partially offset by (iv) a $0.8 million decrease in Direct and E-Commerce sales. Company-Controlled mattress units decreased 3% compared to the prior-year period. Average revenue per mattress unit in our Company-Controlled channel increased by 17%. The 17% increase reflects our highly effective selling process and the strong sales of our innovative new products, including our new FlexFit adjustable bases.


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Gross profit
Gross profit of $142.4 million increased by $11.0 million, or 8%, compared with the same period one year ago. The gross profit rate decreased to 60.7% of net sales for the three months ended June 28, 2014, compared with 63.4% for the prior-year period. The 2.7 ppt. decrease in the gross profit rate was primarily due to: (i) a higher sales mix of lower-margin rate products, including FlexFit adjustable bases; (ii) increased sales return and exchange costs resulting from the second quarter 2013 change in our 30-night trial policy to 100 nights; and
(iii) certain supply chain inefficiencies related to the strong demand for our new products. In addition, our gross profit rate can fluctuate from quarter to quarter due to a variety of other factors, including manufacturing and logistics efficiencies, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses
The sales and marketing expense rate for the three months ended June 28, 2014 decreased to 45.5% of net sales, compared with 47.4% of net sales for the same period one year ago. The 1.9 ppt. decrease in the sales and marketing expense rate in the current period was mainly due to leveraging our media spending which was consistent with last year, while net sales increased 13%.

General and administrative expenses
General and administrative ("G&A") expenses increased $5.9 million to $21.3 million for the three months ended June 28, 2014, compared with $15.4 million in the same period one year ago, and increased to 9.1% of net sales, compared with 7.4% of net sales last year. The $5.9 million increase in G&A expenses was primarily due to: (i) a $2.1 million increase in performance-based incentive compensation; (ii) a $1.3 million increase in employee compensation to support business growth initiatives; (iii) $0.8 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business, including our new digital website which was launched in the second quarter of 2014; and (iv) a $1.7 million increase in miscellaneous other expenses. The G&A expense rate increased by 1.7 ppt. in the current period compared with the same period one year ago due to the increase in expenses, partially offset by the 13% increase in net sales.

Research and development expenses
Research and development expenses for the three months ended June 28, 2014 were $1.7 million, or 0.7% of net sales, compared with $2.6 million, or 1.2% 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 June 28, 2014, consistent with the comparable period one year ago.

Income tax expense
Income tax expense was $4.3 million for the three months ended June 28, 2014 compared with $5.3 million for the same period one year ago. The effective tax rate for the three months ended June 28, 2014 was 33.7%, compared with the prior-year period rate of 34.6%.

Comparison of Six Months Ended June 28, 2014 with Six Months Ended June 29, 2013

Net sales
Net sales increased 10% to $511.2 million for the six months ended June 28, 2014, compared with $465.6 million for the same period one year ago. The net sales increase was primarily driven by sales from 38 net new stores opened in the past 12 months and a 4% comparable sales increase in our Company-Controlled channel.

The $45.5 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $31.1 million sales increase resulting from net new store openings; and (ii) a $17.3 million increase in sales from our Company-Controlled comparable retail stores; partially offset by (iii) a $2.3 million decrease in Wholesale/Other channel sales; and (iv) a $0.6 million decrease in Direct and E-Commerce sales. Company-Controlled mattress units decreased 1% compared to the prior-year period. Average revenue per mattress unit in our Company-Controlled channel increased by 12%. The 12% increase reflects our highly effective selling process and the strong sales of our innovative new products, including our new FlexFit adjustable bases.


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Gross profit
Gross profit of $313.8 million increased by $19.0 million, or 6%, compared with the same period one year ago.The gross profit rate decreased to 61.4% of net sales for the six months ended June 28, 2014, compared with 63.3% for the prior-year period. The 1.9 ppt. decrease in the gross profit rate was primarily due to: (i) a higher sales mix of lower-margin rate products, including FlexFit adjustable bases; (ii) increased sales return and exchange costs resulting from the second quarter 2013 change in our 30-night trial policy to 100 nights; and
(iii) certain supply chain inefficiencies related to the strong demand for our new products. In addition, our gross profit rate can fluctuate from quarter to quarter due to a variety of other factors, including manufacturing and logistics efficiencies, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses
The sales and marketing expense rate for the six months ended June 28, 2014 increased to 45.3% of net sales, compared with 44.7% of net sales, for the same period one year ago. The 0.6 ppt. increase in the sales and marketing expense rate in the current period was primarily due to an increase in fixed selling expenses related to new, repositioned and remodeled stores, partially offset by leveraging our media spending which increased 2% compared with the prior year period, while net sales increased 10%.

General and administrative expenses
General and administrative ("G&A") expenses increased $9.0 million to $40.2 million for the six months ended June 28, 2014, compared with $31.2 million in the prior year, and increased to 7.9% of net sales, compared with 6.7% of net sales one year ago. The $9.0 million increase in G&A expenses was primarily due to: (i) a $4.6 million increase in performance-based incentive compensation;
(ii) a $1.5 million increase in employee compensation resulting from headcount increases to support business growth initiatives; (iii) $1.1 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business, including our new digital website which was launched in the second quarter of 2014; and (iv) a $1.8 million net increase in miscellaneous other expenses. The G&A expense rate increased by 1.2 ppt. in the current period compared with the same period one year ago due to the increase in expenses.

Research and development expenses
Research and development ("R&D") expenses for the six months ended June 28, 2014 were $3.4 million, or 0.7% of net sales, compared with $5.1 million, or 1.1% of net sales, for the same period one year ago.

Other income, net
Other income, net was $0.2 million for the six months ended June 28, 2014, consistent with the comparable period one year ago.

Income tax expense
Income tax expense was $13.2 million for the six months ended June 28, 2014, compared with $17.1 million for the same period one year ago. The effective tax rate for the six months ended June 28, 2014 increased to 34.2% compared with 33.9% for the prior-year period. The 2013 effective tax rate was favorably 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.

Liquidity and Capital Resources

As of June 28, 2014, cash, cash equivalents and marketable debt securities totaled $120.8 million compared with $145.0 million as of December 28, 2013. The $24.3 million decrease was primarily due to $49.6 million of cash provided by operating activities which was more than offset by $39.8 million of cash used to purchase property and equipment, $21.5 million of cash used to repurchase our common stock ($20.0 million under our Board-approved share repurchase program and $1.4 million in connection with the vesting of employee restricted stock grants), and a $6.2 million decrease in short-term borrowings. The $83.7 million of marketable debt securities held as of June 28, 2014 are all highly liquid and include U.S. government and agency securities, corporate debt securities and municipal bonds.


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The following table summarizes our cash flows (dollars in millions). Amounts may not add due to rounding differences:

                                               Six Months Ended
                                             June 28,     June 29,
                                               2014         2013
Total cash provided by (used in):
Operating activities                        $   49.6     $   36.1
Investing activities                           (45.1 )      (48.5 )
Financing activities                           (25.6 )      (17.3 )
Net decrease in cash and cash equivalents   $  (21.1 )   $  (29.7 )

Cash provided by operating activities for the six months ended June 28, 2014 was $49.6 million compared with $36.1 million for the six months ended June 29, 2013. The $13.4 million year-over-year increase in cash from operating activities was comprised of a $20.1 million increase in cash from changes in operating assets and liabilities and a $1.3 million increase in adjustments to reconcile net income to net cash provided by operating activities, partially offset by a $7.9 million decrease in net income for the six months ended June 28, 2014 compared with the same period one year ago.

Net cash used in investing activities was $45.1 million for the six months ended June 28, 2014, compared with $48.5 million for the same period one year ago. Investing activities for the current-year period included $39.8 million of property and equipment purchases, compared with $37.1 million for the same period one year ago. On a net basis, we increased our investments in marketable debt securities by $4.9 million during the six months ended June 28, 2014 compared with a net reduction of $7.0 million during the comparable period one year ago.

Net cash used in financing activities was $25.6 million for the six months ended June 28, 2014, compared with $17.3 million for the same period one year ago. During the six months ended June 28, 2014, we repurchased $21.5 million of our stock ($20.0 million under our Board-approved share repurchase program and $1.4 million in connection with the vesting of employee restricted stock grants) . . .

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