form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the Quarterly Period Ended June 30, 2012

Commission File Number: 0-25121
 


Logo 
 
SELECT COMFORT CORPORATION
(Exact name of registrant as specified in its charter)

Minnesota
 
41-1597886
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
9800 59th Avenue North
 
 
Minneapolis, Minnesota
 
55442
(Address of principal executive offices)
 
(Zip Code)

Registrant’s telephone number, including area code: (763) 551-7000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).YES x NO o

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer
x
 
 
Accelerated filer o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
 
Smaller reporting company o

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO x

As of June 30, 2012, 56,263,000 shares of the Registrant’s Common Stock were outstanding.
 


 
 

 
 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
INDEX

 
Page
 
 
PART I: FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
7
 
 
 
 
8
 
 
 
Item 2.
14
 
 
 
Item 3.
23
 
 
 
Item 4.
23
 
 
 
23
 
 
 
Item 1.
23
 
 
 
Item 1A.
24
 
 
 
Item 2.
24
 
 
 
Item 3.
24
 
 
 
Item 4.
24
 
 
 
Item 5.
24
 
 
 
Item 6.
25
 
 
 
26

 
2

 
PART I: FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)

 
 
(unaudited)
   
 
 
 
 
June 30,
2012
   
December 31,
2011
 
Assets
 
 
   
 
 
Current assets:
 
 
   
 
 
Cash and cash equivalents
  $ 90,324     $ 116,255  
Marketable debt securities – current
    32,772       20,020  
Accounts receivable, net of allowance for doubtful accounts of $391 and $397, respectively
    10,908       13,844  
Inventories
    27,301       24,851  
Prepaid expenses
    6,905       5,778  
Deferred income taxes
    4,489       4,443  
Other current assets
    7,008       6,004  
Total current assets
    179,707       191,195  
                 
Noncurrent assets:
               
Marketable debt securities – non-current
    32,367       10,042  
Property and equipment, net
    60,311       43,850  
Deferred income taxes
    15,373       12,964  
Other assets
    4,583       4,606  
Total assets
  $ 292,341     $ 262,657  
                 
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Accounts payable
  $ 49,644     $ 50,141  
Customer prepayments
    11,637       13,529  
Compensation and benefits
    20,470       29,806  
Taxes and withholding
    8,596       9,883  
Other current liabilities
    18,315       15,691  
Total current liabilities
    108,662       119,050  
                 
Non-current liabilities:
               
Warranty liabilities
    2,343       2,714  
Other long-term liabilities
    12,328       11,502  
Total liabilities
    123,333       133,266  
                 
Shareholders’ equity:
               
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding
           
Common stock, $0.01 par value; 142,500 shares authorized, 56,263 and 56,397 shares issued and outstanding, respectively
    563       564  
Additional paid-in capital
    47,967       47,701  
Retained earnings
    120,491       81,101  
Accumulated other comprehensive (loss) income
    (13 )     25  
Total shareholders’ equity
    169,008       129,391  
Total liabilities and shareholders’ equity
  $ 292,341     $ 262,657  
 
See accompanying notes to condensed consolidated financial statements.
 
 
3

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited – in thousands, except per share amounts)

   
Three Months Ended
   
Six Months Ended
 
   
June 30,
2012
   
July 2,
2011
   
June 30,
2012
   
July 2,
2011
 
Net sales
  $ 205,219     $ 161,462     $ 467,602     $ 354,530  
Cost of sales
    73,648       58,958       171,732       128,925  
Gross profit
    131,571       102,504       295,870       225,605  
                                 
Operating expenses:
                               
Sales and marketing
    88,240       70,517       194,425       150,788  
General and administrative
    16,220       13,120       33,149       28,743  
Research and development
    1,256       1,223       2,546       1,954  
Asset impairment charges
    3       18       7       96  
CEO transition costs
                5,595        
Total operating expenses
    105,719       84,878       235,722       181,581  
Operating income
    25,852       17,626       60,148       44,024  
Other income (expense), net
    48       (30 )     55       (60 )
Income before income taxes
    25,900       17,596       60,203       43,964  
Income tax expense
    8,927       6,307       20,813       16,092  
                                 
Net income
  $ 16,973     $ 11,289     $ 39,390     $ 27,872  
                                 
Basic net income per share:
                               
Net income per share – basic
  $ 0.30     $ 0.21     $ 0.71     $ 0.51  
Weighted-average shares – basic
    55,719       54,958       55,680       54,842  
Diluted net income per share:
                               
Net income per share – diluted
  $ 0.30     $ 0.20     $ 0.69     $ 0.50  
Weighted-average shares – diluted
    57,394       56,407       57,367       56,157  
 
See accompanying notes to condensed consolidated financial statements.
 
 
4

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(unaudited – in thousands, except per share amounts)

 
Three Months Ended
 
Six Months Ended
 
 
June 30,
2012
 
July 2,
2011
 
June 30,
2012
 
July 2,
2011
 
Net income
  $ 16,973     $ 11,289     $ 39,390     $ 27,872  
Other comprehensive loss – unrealized loss on available-for-sale marketable debt securities, net of tax
    (26 )     (27 )     (38 )     (27 )
Comprehensive income
  $ 16,947     $ 11,262     $ 39,352     $ 27,845  

See accompanying notes to condensed consolidated financial statements.
 
 
5

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statement of Shareholders’ Equity
(unaudited – in thousands)

 
 
Common Stock
 
 
Additional
Paid-in
 
 
Retained
 
 
Accumulated
Other
Comprehensive
Income
 
 
 
 
 
 
Shares
 
 
Amount
 
 
Capital
 
 
Earnings
 
 
(Loss)
 
 
Total
 
Balance at December 31, 2011
 
 
56,397
 
 
$
564
 
 
$
47,701
 
 
$
81,101
 
 
$
25
 
 
$
129,391
 
Comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income
 
 
 
 
 
 
 
 
 
 
 
39,390
 
 
 
 
 
 
39,390
 
Unrealized loss on available-for-sale marketable debt securities
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(38
)
 
 
(38
)
Total comprehensive income
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
39,352
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exercise of common stock options
 
 
257
 
   
3
 
 
 
1,934
 
 
 
 
 
 
 
 
 
1,937
 
Tax effect from stock-based compensation
 
 
 
 
 
 
 
 
3,981
 
 
 
 
 
 
 
 
 
3,981
 
Stock-based compensation
 
 
166
 
 
 
2
 
 
 
8,368
 
 
 
 
 
 
 
 
 
8,370
 
Repurchases of common stock
 
 
(557
)
 
 
(6
)
 
 
(14,017
)
 
 
 
 
 
 
 
 
(14,023
)
Balance at June 30, 2012
 
 
56,263
 
 
$
563
 
 
$
47,967
 
 
$
120,491
 
 
$
(13
)
 
$
169,008
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
6

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited – in thousands)

 
 
Six Months Ended
 
 
 
June 30,
2012
 
 
July 2,
2011
 
Cash flows from operating activities:
 
 
 
 
 
 
Net income
 
$
39,390
 
 
$
27,872
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
 
 
 
 
Depreciation and amortization
 
 
9,049
 
 
 
6,386
 
Stock-based compensation
 
 
8,370
 
 
 
2,256
 
Net loss on disposals and impairments of assets
 
 
(12
)
 
 
89
 
Excess tax benefits from stock-based compensation
 
 
(4,120
)
 
 
(1,132
)
Deferred income taxes
 
 
(2,431
)
 
 
2,819
 
Changes in operating assets and liabilities:
 
 
 
 
 
 
 
 
Accounts receivable
 
 
3,055
 
 
 
2,775
 
Inventories
 
 
(2,450
)
 
 
(932
)
Income taxes
 
 
3,614
 
 
 
1,181
 
Prepaid expenses and other assets
 
 
(2,474
)
 
 
(3,212
)
Accounts payable
 
 
202
 
 
 
(682
)
Customer prepayments
 
 
(1,892
)
 
 
(2,451
)
Accrued compensation and benefits
 
 
(9,085
)
 
 
(2,716
)
Other taxes and withholding
 
 
(920
)
 
 
(320
)
Warranty liabilities
 
 
(453
)
 
 
(314
)
Other accruals and liabilities
 
 
3,390
 
 
 
2,066
 
Net cash provided by operating activities
 
 
43,233
 
 
 
33,685
 
 
 
 
 
 
 
 
 
 
Cash flows from investing activities:
 
 
 
 
 
 
 
 
Purchases of property and equipment
 
 
(22,499
)
 
 
(9,585
)
Investments in marketable debt securities
   
(45,351
)
   
(40,021
)
Proceeds from maturities of marketable debt securities
   
10,018
     
 
Proceeds from sales of property and equipment
 
 
30
 
 
 
7
 
Increase in restricted cash
 
 
 
 
 
(2,650
)
Net cash used in investing activities
 
 
(57,802
)
 
 
(52,249
)
 
 
 
 
 
 
 
 
 
Cash flows from financing activities:
 
 
 
 
 
 
 
 
Repurchases of common stock
 
 
(14,023
)
 
 
(309
)
Excess tax benefits from stock-based compensation
 
 
4,120
 
 
 
1,132
 
Net decrease in short-term borrowings
 
 
(3,349
)
 
 
(1,500
)
Proceeds from issuance of common stock
 
 
1,937
 
 
 
870
 
Debt issuance costs
   
(47
)
   
 
Net cash (used in) provided by financing activities
 
 
(11,362
)
 
 
193
 
 
 
 
 
 
 
 
 
 
Net decrease in cash and cash equivalents
 
 
(25,931
)
 
 
(18,371
)
Cash and cash equivalents, at beginning of period
 
 
116,255
 
 
 
76,016
 
Cash and cash equivalents, at end of period
 
$
90,324
 
 
$
57,645
 
 
See accompanying notes to condensed consolidated financial statements.
 
 
7


SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

1. Basis of Presentation

We prepared the condensed consolidated financial statements as of and for the three and six months ended June 30, 2012 of Select Comfort Corporation and subsidiaries (“Select Comfort” or the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and they reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly our financial position as of June 30, 2012, and December 31, 2011 and the results of operations and cash flows for the periods presented. Our historical and quarterly results of operations may not be indicative of the results that may be achieved for the full year or any future period.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with our most recent audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2011 and other recent filings with the SEC.

The preparation of consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of sales, expenses and income taxes during the reporting period. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates will be reflected in the financial statements in future periods. Our critical accounting policies consist of asset impairment charges, stock-based compensation, self-insured liabilities, warranty liabilities and revenue recognition.

The consolidated financial statements include the accounts of Select Comfort Corporation and our subsidiaries. All significant intra-entity balances and transactions have been eliminated in consolidation.

Subsequent Events

Events that have occurred subsequent to June 30, 2012 have been evaluated through the date the consolidated financial statements were issued. There have been no subsequent events that occurred during such period that would require recognition or disclosure in the condensed consolidated financial statements as of or for the period ended June 30, 2012.

2. Fair Value Measurements

The guidance for fair value measurements establishes the authoritative definition of fair value, sets out a framework for measuring fair value and outlines the required disclosures regarding fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-tier fair value hierarchy based upon observable and unobservable inputs as follows:

Level 1 – observable inputs such as quoted prices in active markets;
Level 2 – inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
Level 3 – unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

 
8

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis

The fair value hierarchy requires the use of observable market data when available. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability.

The following tables set forth by level within the fair value hierarchy, our financial assets that were accounted for at fair value on a recurring basis at June 30, 2012, and December 31, 2011, according to the valuation techniques we used to determine their fair value (in thousands):

 
June 30, 2012
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Marketable debt securities – current
                               
U.S. Treasury securities
 
$
20,031
 
 
$
 
 
$
 
 
$
20,031
 
Corporate bonds
 
 
 
 
 
7,711
 
 
 
 
 
 
7,711
 
U.S. Agency bonds
 
 
 
 
 
5,030
 
 
 
 
 
 
5,030
 
     
20,031
     
12,741
     
     
32,772
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketable debt securities – non-current
                               
U.S. Treasury securities
   
14,997
     
     
     
14,997
 
Corporate bonds
   
     
10,250
     
     
10,250
 
U.S. Agency bonds
 
 
 
 
 
5,006
 
 
 
 
 
 
5,006
 
Municipal bonds
 
 
 
 
 
2,114
 
 
 
 
 
 
2,114
 
     
14,997
     
17,370
     
     
32,367
 
 
 
$
35,028
 
 
$
30,111
 
 
$
 
 
$
65,139
 

 
December 31, 2011
 
Level 1
 
Level 2
 
Level 3
 
Total
 
Marketable Debt Securities – current
                               
U.S. Treasury securities
 
$
20,020
 
 
$
 
 
$
 
 
$
20,020
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Marketable Debt Securities – non-current
                               
U.S. Treasury securities
   
10,042
     
     
     
10,042
 
 
 
$
30,062
 
 
$
 
 
$
 
 
$
30,062
 

At June 30, 2012, and December 31, 2011, we had $1.3 million and $1.3 million, respectively, of marketable securities that fund our deferred compensation plan. We also had corresponding deferred compensation plan liabilities of $1.3 million and $1.3 million at June 30, 2012, and December 31, 2011, respectively, which are included in other long-term liabilities. Substantially all of the marketable securities are Level 1 as they trade with sufficient frequency and volume to enable us to obtain pricing information on an ongoing basis. Unrealized gains/(losses) on the marketable securities offset those associated with the corresponding deferred compensation liabilities.

3. Inventories

Inventories consisted of the following (in thousands):

 
 
June 30,
2012
 
 
December 31,
2011
 
Raw materials
 
$
3,453
 
 
$
4,834
 
Work in progress
 
 
158
 
 
 
96
 
Finished goods
 
 
23,690
 
 
 
19,921
 
 
 
$
27,301
 
 
$
24,851
 

 
9

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

4. Marketable Debt Securities

Investments of marketable debt securities were comprised of the following (in thousands):

   
June 30, 2012
 
   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value(1)
 
U.S. Treasury securities
  $ 35,024     $ 15     $ (11 )   $ 35,028  
Corporate bonds
    17,986             (25 )     17,961  
U.S. Agency bonds
    10,035       3       (2 )     10,036  
Municipal bonds
    2,114                   2,114  
    $ 65,159     $ 18     $ (38 )   $ 65,139  

   
December 31, 2011
 
   
Amortized
Cost
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Value(1)
 
U.S. Treasury securities
  $ 30,021     $ 41     $     $ 30,062  
 
Maturities of marketable debt securities were as follows (in thousands):
 
   
June 30, 2012
   
December 31, 2011
 
   
Amortized
Cost
   
Fair
Value(1)
   
Amortized
Cost
   
Fair
Value(1)
 
Marketable debt securities – current (due in less than one year)
  $ 32,764     $ 32,772       20,004     $ 20,020  
Marketable debt securities – non-current (due in one to two years)
    32,395       32,367       10,017       10,042  
    $ 65,159     $ 65,139     $ 30,021     $ 30,062  
 

(1) See Note 2 for discussion of fair value measurements.

During the three and six months ended June 30, 2012, $10.0 million of U.S. Treasury securities matured and were redeemed at face value. During the three and six months ended June 30, 2012, there were no other-than-temporary declines in market value.
 
5. Debt

Credit Agreement

On April 23, 2012, we entered into an Amendment to our $20.0 million Credit Agreement (the “Amendment”) with Wells Fargo Bank, National Association. The Amendment changes the Credit Agreement from a secured revolving credit facility to an unsecured revolving credit facility and extends the maturity date of the credit facility from July 1, 2012 to April 23, 2015. The amended credit facility 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. The Amendment also decreases the amount of commitment fees, lowers the rate at which interest accrues and increases the financial flexibility with regard to our financial covenants.

Any borrowings under the Amendment will, at our request, be classified as either LIBOR Loans or Adjusted Base Rate (“ABR”) Loans (both as defined in the Credit Agreement). The rate of interest payable by us in respect of loans outstanding under the revolving credit facility is (i) with respect to LIBOR Loans, the Adjusted LIBO Rate (as defined in the Credit Agreement) for the interest period then in effect plus 1.25%, or (ii) with respect to ABR Loans, the ABR (as defined in the Credit Agreement) then in effect for the Daily One-Month LIBO Rate (as defined in the Credit Agreement), plus 1.50% or the prime rate. We are subject to certain financial covenants under the Amendment, including minimum tangible net worth, a requirement to maintain a minimum amount of cash and cash equivalents, and to maintain at the administrative agent cash and cash equivalents equal to the amount the lenders are committed to lend under the Amendment.

At both June 30, 2012, and December 31, 2011, $20.0 million was available under the Credit Agreement, we had no borrowings and we were in compliance with all financial covenants. We had no outstanding letters of credit as of June 30, 2012 or December 31, 2011.
 
 
10

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

Capital Lease Obligations

We had outstanding capital lease obligations of $0.2 million and $0.3 million at June 30, 2012, and December 31, 2011, respectively. At June 30, 2012, and December 31, 2011, $0.1 million and $0.2 million, respectively, were included in other current liabilities and $0.1 million and $0.1 million, respectively, were included in other long-term liabilities in our condensed consolidated balance sheets.

6. Repurchases of Common Stock
 
During the second quarter of 2012, we reinitiated repurchasing our stock with the objective to maintain common shares outstanding at current levels. Under the current Board approved $290.0 million share repurchase program, we repurchased and retired 0.4 million shares at a cost of $10.0 million (based on trade dates), during the three months ended June 30, 2012. We did not repurchase any shares during the three or six months ended July 2, 2011. As of June 30, 2012, the remaining authorization under our Board approved share repurchase program was $196.8 million. There is no expiration date governing the period over which we can repurchase shares.

7. Stock-Based Compensation

We compensate officers, directors and key employees with stock-based compensation under three stock plans approved by our shareholders in 1997, 2004 and 2010 and administered under the supervision of our Board of Directors. Compensation expense, net of estimated forfeitures, is recognized ratably over the vesting period. Stock-based compensation expense for the three months ended June 30, 2012, and July 2, 2011, was $1.4 million and $1.1 million, respectively. Stock-based compensation expense for the six months ended June 30, 2012, and July 2, 2011, was $8.4 million and $2.3 million, respectively.

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, 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 based on free cash flows and actual market share growth versus performance targets. During the three and six months ended June 30, 2012, we incurred $0.0 million and $5.6 million, respectively, of non-recurring, non-cash expenses associated with these stock award modifications.
 
8. Employee Benefits

Under our profit sharing and 401(k) plan, eligible employees may defer up to 50% of their compensation on a pre-tax basis, subject to Internal Revenue Service limitations. Each year, we may make a discretionary contribution equal to a percentage of the employee’s contribution. During the three months ended June 30, 2012, and July 2, 2011, our contributions, net of forfeitures, were $0.5 million and $0.5 million, respectively. During the six months ended June 30, 2012, and July 2, 2011, our contributions, net of forfeitures, were $1.1 million and $0.9 million, respectively.

9. Other Income (Expense), Net

Other income (expense), net, consisted of the following (in thousands):
 
 
 
Three Months Ended
 
 
Six Months Ended
 
 
 
June 30,
2012
 
 
July 2,
2011
 
 
June 30,
2012
 
 
July 2,
2011
 
Interest expense
 
$
(20
)
 
$
(64
)
 
$
(62
)
 
$
(121
)
Interest income
 
 
68
 
 
 
34
 
 
 
117
 
 
 
61
 
Other income (expense), net
 
$
48
 
 
$
(30
)
 
$
55
 
 
$
(60
)
 
 
11

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

10. Net Income per Common Share

The following computations reconcile net income per share – basic with net income per share – diluted (in thousands, except per share amounts):
 
 
 
Three Months Ended
 
 
Six Months Ended
 
 
 
June 30,
2012
 
 
July 2,
2011
 
 
June 30,
2012
 
 
July 2,
2011
 
Net income
 
$
16,973
 
 
$
11,289
 
 
$
39,390
 
 
$
27,872
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Reconciliation of weighted-average shares outstanding:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic weighted-average shares outstanding
 
 
55,719
 
 
 
54,958
 
 
 
55,680
 
 
 
54,842
 
Effect of dilutive securities:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Options
 
 
1,129
 
 
 
911
 
 
 
1,099
 
 
 
762
 
Restricted shares
 
 
546
 
 
 
538
 
 
 
588
 
 
 
553
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted weighted-average shares outstanding
 
 
57,394
 
 
 
56,407
 
 
 
57,367
 
 
 
56,157
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per share – basic
 
$
0.30
 
 
$
0.21
 
 
$
0.71
 
 
$
0.51
 
Net income per share – diluted
 
$
0.30
 
 
$
0.20
 
 
$
0.69
 
 
$
0.50
 

We excluded potentially dilutive stock options totaling 0.3 million and 0.3 million for the three and six months ended June 30, 2012, respectively, and 1.5 million and 2.4 million for the three and six months ended July 2, 2011, respectively, from our diluted net income per share calculations because these securities’ exercise prices were greater than the average market price of our common stock.

11. Commitments and Contingencies

Sales Returns

The accrued sales returns estimate is based on historical return rates, which are reasonably consistent from period to period, and is adjusted for any current trends as appropriate. If actual returns vary from expected rates, sales in future periods are adjusted.

The activity in the sales returns liability account was as follows (in thousands):
 
 
 
Six Months Ended
 
 
 
June 30,
2012
 
 
July 2,
2011
 
Balance at beginning of year
 
$
4,402
 
 
$
2,944
 
Additions that reduce net sales
 
 
22,480
 
 
 
19,015
 
Deductions from reserves
 
 
(21,765
)
 
 
(18,395
)
Balance at end of period
 
$
5,117
 
 
$
3,564
 

Warranty Liabilities

We provide a 20-year limited warranty on our beds. The customer participates over the last 18 years of the warranty period by paying a portion of the retail value of replacement parts. The estimated warranty costs, which are expensed at the time of sale and included in cost of sales, are based on historical claims rates incurred by us and are adjusted for any current trends as appropriate. Actual warranty claim costs could differ from these estimates. We regularly assess and adjust the estimate of accrued warranty claims by updating claims rates for actual trends and projected claim costs.
 
 
12

 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

We classify as noncurrent those estimated warranty costs expected to be paid out in greater than one year. The activity in the accrued warranty liabilities account was as follows (in thousands):
 
 
 
Six Months Ended
 
 
 
June 30,
2012
 
 
July 2,
2011
 
Balance at beginning of year
 
$
6,310
 
 
$
5,744
 
Additions charged to costs and expenses for current-year sales
 
 
1,832
 
 
 
2,137
 
Deductions from reserves
 
 
(2,435
)
 
 
(2,217
)
Changes in liability for pre-existing warranties during the current year, including expirations
 
 
151
 
 
 
(233
)
Balance at end of period
 
$
5,858
 
 
$
5,431
 

Legal Proceedings

We are involved from time to time in various legal proceedings arising in the ordinary course of our business, including primarily commercial, product liability, employment and intellectual property claims. In accordance with generally accepted accounting principles in the United States, we record a liability in our consolidated financial statements with respect to any of these matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. With respect to currently pending legal proceedings, we have not established an estimated range of reasonably possible additional losses either because we believe that we have valid defenses to claims asserted against us or the proceeding has not advanced to a stage of discovery that would enable us to establish an estimate. We currently do not expect the outcome of these matters to have a material effect on our consolidated results of operations, financial position or cash flows. Litigation, however, is inherently unpredictable, and it is possible that the ultimate outcome of one or more claims asserted against us could adversely impact our results of operations, financial position or cash flows. We expense legal costs as incurred.
 
 
13

 
ITEM 2.

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;
Availability of attractive and cost-effective consumer credit options, including the impact of recent changes in federal law that restricts various forms of consumer credit promotional offerings;
Our ability to execute our retail distribution strategy;
Our ability to continue to improve our product line and service levels, and consumer acceptance of our products, product quality, innovation and brand image;
Our ability to achieve and maintain acceptable levels of product quality and acceptable product return and warranty claims rates;
Pending and unforeseen litigation and the potential for adverse publicity associated with litigation;
Industry competition and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;
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;
Our ability to attract and retain senior leadership and other key employees, including qualified sales professionals; 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.

We have no obligation to publicly update or revise any of the forward-looking statements contained in this quarterly report on Form 10-Q.
 
 
14


 Overview

Business Overview

Select Comfort designs, manufactures, markets and supports a line of adjustable-firmness mattresses featuring air-chamber technology. The air-chamber technology of our proprietary Sleep Number® bed allows adjustable firmness on each side of the mattress and provides a sleep surface that is clinically proven to provide better sleep quality and greater relief of back pain compared to traditional mattress products. In addition, we market and sell bedding and other sleep-related products which focus on providing personalized comfort to complement the Sleep Number bed and provide a better night’s sleep for consumers.

We generate revenue by selling our products through two distribution channels. Our Company-Controlled channel, which includes Retail, Direct Marketing and E-Commerce, sells directly to consumers. Our Wholesale channel sells to and through the QVC shopping channel and wholesale customers in Alaska, Hawaii and Australia.

Mission, Vision and Strategy

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

We are executing against a defined strategy which focuses on the following key components:

 
Everyone will know Sleep Number and how it will improve their life;
 
 
Innovative Sleep Number products will move society forward with meaningful consumer benefits;
 
 
Sleep Number will be easy to find and customers will interact with us when and how they want;
 
 
Customers will love their Sleep Number experience and enthusiastically recommend Sleep Number to their family and friends; and
 
 
Leveraging our unique business model to fund innovation and growth will benefit our customers, employees and shareholders.
 
Results of Operations

Quarterly and Annual Results

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

Highlights

Financial highlights for the three months ended June 30, 2012 were as follows:

 
Net income increased 50% to $17.0 million, or $0.30 per diluted share, compared with net income of $11.3 million, or $0.20 per diluted share, for the same period one year ago.
 
Net sales increased 27% to $205.2 million, compared with $161.5 million for the same period one year ago, primarily due to a 25% comparable sales increase in our Company-Controlled channel.
 
Operating income improved to $25.9 million, or 12.6% of net sales, for the three months ended June 30, 2012, compared with $17.6 million, or 10.9% of net sales, for the same period one year ago. The operating income improvement was driven by strong comparable sales growth and continued efficiency enhancements. Retail sales-per-store (for stores open at least one year), on a trailing twelve-month basis, increased by 35% from one year ago to $2.0 million.
 
Cash provided by operating activities totaled $43.2 million for the six months ended June 30, 2012, compared with $33.7 million for the same period one year ago.
 
As of June 30, 2012, cash, cash equivalents and marketable debt securities totaled $155.5 million compared with $146.3 million at December 31, 2011, and we had no borrowings under our revolving credit facility. In the second quarter of 2012, we repurchased 409,770 shares of our common stock under our Board approved share repurchase program at a cost of $10.0 million ($24.42 per share).

 
15

 
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
 
 
Six Months Ended
 
 
 
June 30, 2012
 
 
July 2, 2011
 
 
June 30, 2012
 
 
July 2, 2011
 
Net sales
 
$
205.2
 
 
 
100.0
%
 
$
161.5
 
 
 
100.0
%
 
$
467.6
 
 
 
100.0
%
 
$
354.5
 
 
 
100.0
%
Cost of sales
 
 
73.6
 
 
 
35.9
%
 
 
59.0
 
 
 
36.5
%
 
 
171.7
 
 
 
36.7
%
 
 
128.9
 
 
 
36.4
%
Gross profit
 
 
131.6
 
 
 
64.1
%
 
 
102.5
 
 
 
63.5
%
 
 
295.9
 
 
 
63.3
%
 
 
225.6
 
 
 
63.6
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
 
 
88.2
 
 
 
43.0
%
 
 
70.5
 
 
 
43.7
%
 
 
194.4
 
 
 
41.6
%
 
 
150.8
 
 
 
42.5
%
General and administrative
 
 
16.2
 
 
 
7.9
%
 
 
13.1
 
 
 
8.1
%
 
 
33.1
 
 
 
7.1
%
 
 
28.7
 
 
 
8.1
%
Research and development
 
 
1.3
 
 
 
0.6
%
 
 
1.2
 
 
 
0.8
%
 
 
2.5
 
 
 
0.5
%
 
 
2.0
 
 
 
0.6
%
Asset impairment charges
 
 
 
 
 
0.0
%
 
 
 
 
 
0.0
%
 
 
 
 
 
0.0
%
 
 
0.1
 
 
 
0.0
%
CEO transition costs
   
     
0.0
%
   
     
0.0
%
   
5.6
     
1.2
%
   
     
0.0
%
Total operating expenses
 
 
105.7
 
 
 
51.5
%
 
 
84.9
 
 
 
52.6
%
 
 
235.7
 
 
 
50.4
%
 
 
181.6
 
 
 
51.2
%
Operating income
 
 
25.9
 
 
 
12.6
%
 
 
17.6
 
 
 
10.9
%
 
 
60.1
 
 
 
12.9
%
 
 
44.0
 
 
 
12.4
%
Operating income – as adjusted(1)
   
25.9
     
12.6
%
   
17.6
     
10.9
%
   
65.8
     
14.1
%
   
44.0
     
12.4
%
Other income (expense), net
 
 
 
 
 
0.0
%
 
 
 
 
 
0.0
%
 
 
0.1
 
 
 
0.0
%
 
 
(0.1
)
 
 
0.0
%
Income before income taxes
 
 
25.9
 
 
 
12.6
%
 
 
17.6
 
 
 
10.9
%
 
 
60.2
 
 
 
12.9
%
 
 
44.0
 
 
 
12.4
%
Income tax expense
 
 
8.9
 
 
 
4.3
%
 
 
6.3
 
 
 
3.9
%
 
 
20.8
 
 
 
4.5
%
 
 
16.1
 
 
 
4.5
%
Net income
 
$
17.0
 
 
 
8.3
%
 
$
11.3
 
 
 
7.0
%
 
$
39.4
 
 
 
8.4
%
 
$
27.9
 
 
 
7.9
%
Net income – as adjusted(1)
 
$
17.0
     
8.3
%
 
$
11.3
     
7.0
%
 
$
43.1
     
9.2
%
 
$
27.9
     
7.9
%
 
 
   
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
$
0.30
 
 
 
 
 
 
$
0.21
 
 
 
 
 
 
$
0.71
 
 
 
 
 
 
$
0.51
 
 
 
 
 
Diluted
 
$
0.30
 
 
 
 
 
 
$
0.20
 
 
 
 
 
 
$
0.69
 
 
 
 
 
 
$
0.50
 
 
 
 
 
Diluted – as adjusted(1)
 
$
0.30
           
$
0.20
           
$
0.75
           
$
0.50
         
Weighted-average number of common shares:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Basic
 
 
55.7
 
 
 
 
 
 
 
55.0
 
 
 
 
 
 
 
55.7
 
 
 
 
 
 
 
54.8
 
 
 
 
 
Diluted
 
 
57.4
 
 
 
 
 
 
 
56.4
 
 
 
 
 
 
 
57.4
 
 
 
 
 
 
 
56.2
 
 
 
 
 
 

(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 21 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 30,
2012
 
 
July 2,
2011
 
 
June 30,
2012
 
 
July 2,
2011
 
Percent of net sales:
 
 
 
 
 
 
 
 
 
 
 
 
Company-Controlled
 
 
96.4
%
 
 
95.8
%
 
 
96.3
%
 
 
95.9
%
Wholesale
 
 
3.6
%
 
 
4.2
%
 
 
3.7
%
 
 
4.1
%
Total
 
 
100.0
%
 
 
100.0
%
 
 
100.0
%
 
 
100.0
%
 
 
16

 
The components of total sales growth, including comparable net sales changes, were as follows:
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
2012
 
 
July 2,
2011
 
 
June 30,
2012
 
 
July 2,
2011
 
Sales growth rates:
 
 
 
 
 
 
 
 
 
 
 
 
Retail comparable-store sales
 
 
27
%
 
 
25
%
 
 
32
%
 
 
28
%
Direct and E-Commerce
 
 
8
%
 
 
(13
%)
 
 
13
%
 
 
(8
%)
Company-Controlled comparable sales growth
 
 
25
%
 
 
20
%
 
 
30
%
 
 
23
%
Net store openings/closings
 
 
3
%
 
 
(2
%)
 
 
2
%
 
 
(2
%)
Total Company-Controlled channel
 
 
28
%
 
 
18
%
 
 
32
%
 
 
21
%
Wholesale
 
 
11
%
 
 
(19
%)
 
 
19
%
 
 
(8
%)
Total sales growth
 
 
27
%
 
 
16
%
 
 
32
%
 
 
19
%

Other sales metrics were as follows:
 
 
 
Three Months Ended
 
Six Months Ended
 
 
June 30,
2012
 
 
July 2,
2011
 
 
June 30,
2012
 
 
July 2,
2011
 
Company-Controlled retail stores:
 
 
 
 
 
 
 
 
 
 
 
 
Average sales per store(1) ($ in thousands)
 
$
2,012
   
$
1,492
                 
Average sales per square foot(1)
 
$
1,281
   
$
998
                 
Stores > $1 million in net sales(1)
 
 
98
%
   
85
%
               
Stores > $2 million in net sales(1)
 
 
42
%
   
13
%
               
Average mattress sales per mattress unit – Company-Controlled channel
 
 $
2,540
 
 
 $
2,223
 
 
 $
2,397
 
 
 $
2,157
 
 

(1)
Trailing twelve months for stores open at least one year.

The number of Company-Controlled retail stores was as follows:
 
 
 
Three Months Ended
 
 
Six Months Ended
 
 
 
June 30,
2012
 
 
July 2,
2011
 
 
June 30,
2012
 
 
July 2,
2011
 
Company-Controlled retail stores:
 
 
 
 
 
 
 
 
 
 
 
 
Beginning of period
 
 
380
 
 
 
375
 
 
 
381
 
 
 
386
 
Opened
 
 
12
 
 
 
5
 
 
 
22
 
 
 
6
 
Closed
 
 
(11
)
 
 
(5
)
 
 
(22
)
 
 
(17
)
End of period
 
 
381
 
 
 
375
 
 
 
381
 
 
 
375
 

Comparison of Three Months Ended June 30, 2012 with Three Months Ended July 2, 2011

Net sales
Net sales increased 27% to $205.2 million for the three months ended June 30, 2012, compared with $161.5 million for the same period one year ago. The sales increase was primarily driven by a 25% comparable sales increase in our Company-Controlled channel. Company-Controlled sales of mattress units increased 13% compared to the prior-year period. Average mattress sales per mattress unit in our Company-Controlled channel increased by 14%. Sales of other products and services increased by 22%.
 
The $43.8 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $35.4 million increase in sales from our Company-Controlled comparable retail stores and a $6.6 million sales increase resulting from net new store openings; (ii) a $1.1 million increase in Direct and E-Commerce sales; and (iii) a $0.7 million increase in Wholesale channel sales.

Gross profit
The gross profit rate increased to 64.1% of net sales for the three months ended June 30, 2012, compared with 63.5% for the prior year period. Approximately 1.0 percentage points (“ppt.”) of the gross profit rate increase was due to product price increases over the last year. An additional 0.3 ppt. of the gross profit rate improvement was due to a decrease in warranty expenses. These increases were partially offset by a variety of factors that can fluctuate from quarter-to-quarter, including promotional costs, sales return and exchange costs, and year-over-year changes in QVC programming.
 
 
17

 
Sales and marketing expenses