Sleep Number Corp - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - Sleep Number Corp	Financial_Report.xls
EX-31.2 - EXHIBIT 31.2 - Sleep Number Corp	ex31_2.htm
EX-32.1 - EXHIBIT 32.1 - Sleep Number Corp	ex32_1.htm
EX-32.2 - EXHIBIT 32.2 - Sleep Number Corp	ex32_2.htm
EX-31.1 - EXHIBIT 31.1 - Sleep Number Corp	ex31_1.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

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

	Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011	3

	Condensed Consolidated Statements of Operations for the Three and Six Months ended June 30, 2012 and July 2, 2011	4

	Condensed Consolidated Statements of Comprehensive Income for the Three and Six Months ended June 30, 2012 and July 2, 2011	5

	Condensed Consolidated Statement of Shareholders’ Equity for the Six Months ended June 30, 2012	6

	Condensed Consolidated Statements of Cash Flows for the Six Months ended June 30, 2012 and July 2, 2011	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	23

Item 4.	Controls and Procedures	23

PART II: OTHER INFORMATION		23

Item 1.	Legal Proceedings	23

Item 1A.	Risk Factors	24

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24

Item 3.	Defaults Upon Senior Securities	24

Item 4.	Mine Safety Disclosures	24

Item 5.	Other Information	24

Item 6.	Exhibits	25

SIGNATURES		26

Index

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.

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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.

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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.

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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.

Index

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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.

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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.

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SELECT COMFORT CORPORATION

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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

Index

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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.

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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	)

Index

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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.

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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.

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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:

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Risk Factors

●

Overview

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Results of Operations

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Liquidity and Capital Resources

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Non-GAAP Data Reconciliations

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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.

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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:

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Everyone will know Sleep Number and how it will improve their life;

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Innovative Sleep Number products will move society forward with meaningful consumer benefits;

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Sleep Number will be easy to find and customers will interact with us when and how they want;

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Customers will love their Sleep Number experience and enthusiastically recommend Sleep Number to their family and friends; and

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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:

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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.

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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.

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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.

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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).

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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	%

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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

Sleep Number Corp - FORM 10-Q - July 27, 2012

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