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EX-32.1 - EXHIBIT 32.1 - Sleep Number Corpex321_2015xq2.htm
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EX-32.2 - EXHIBIT 32.2 - Sleep Number Corpex322_2015xq2.htm
EX-31.2 - EXHIBIT 31.2 - Sleep Number Corpex312_2015xq2.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 July 4, 2015

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 ý 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 ý 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
ý
 
 
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 ý

As of July 4, 2015, 51,414,000 shares of the Registrant’s Common Stock were outstanding.
 
 



SELECT COMFORT CORPORATION
AND SUBSIDIARIES
INDEX

 
Page
 
 
 
 
 
 
Item 1.
 
 
 
 
 
 
 
Item 2.
Item 3.
Item 4.
 
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.




ii


PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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

July 4,
2015

January 3,
2015
Assets
 

 
Current assets:
 

 
Cash and cash equivalents
$
26,074


$
51,995

Marketable debt securities – current
62,379


69,609

Accounts receivable, net of allowance for doubtful accounts of $701 and $739, respectively
20,464


19,693

Inventories
68,377


53,535

Prepaid expenses
20,584


17,792

Deferred income taxes
8,757


8,786

Other current assets
10,836


11,185

Total current assets
217,471


232,595






Non-current assets:
 


 
Marketable debt securities – non-current
28,751


44,441

Property and equipment, net
186,696


165,453

Goodwill and intangible assets, net
15,570


15,986

Deferred income taxes
7,944


3,433

Other assets
19,139


12,279

Total assets
$
475,571


$
474,187






Liabilities and Shareholders’ Equity
 


 
Current liabilities:
 


 
Accounts payable
$
87,985


$
84,197

Customer prepayments
25,660


28,726

Accrued sales returns
12,679

 
15,262

Compensation and benefits
24,395


33,066

Taxes and withholding
9,867


10,207

Other current liabilities
18,684


15,594

Total current liabilities
179,270


187,052






Non-current liabilities:
 


 
Warranty liabilities
3,425


2,722

Other long-term liabilities
37,484


27,506

Total liabilities
220,179


217,280






Shareholders’ equity:
 


 
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding



Common stock, $0.01 par value; 142,500 shares authorized, 51,414 and 52,798 shares issued and outstanding, respectively
514


528

Additional paid-in capital



Retained earnings
254,860


256,413

Accumulated other comprehensive income (loss)
18


(34
)
Total shareholders’ equity
255,392


256,907

Total liabilities and shareholders’ equity
$
475,571


$
474,187



See accompanying notes to condensed consolidated financial statements.

2


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

 
Three Months Ended
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Net sales
$
275,289

 
$
234,763

 
$
625,098

 
$
511,175

Cost of sales
104,750

 
92,366

 
238,726

 
197,395

Gross profit
170,539

 
142,397

 
386,372

 
313,780

 
 
 
 

 
 

 
 

Operating expenses:
 

 
 
 
 
 
 
Sales and marketing
126,627

 
106,712

 
267,130

 
231,734

General and administrative
23,880

 
21,265

 
52,134

 
40,161

Research and development
3,403

 
1,709

 
6,754

 
3,372

Total operating expenses
153,910

 
129,686

 
326,018

 
275,267

Operating income
16,629

 
12,711

 
60,354

 
38,513

Other income, net
133

 
78

 
286

 
180

Income before income taxes
16,762

 
12,789

 
60,640

 
38,693

Income tax expense
5,724

 
4,308

 
20,803

 
13,220

Net income
$
11,038

 
$
8,481

 
$
39,837

 
$
25,473

 
 
 
 
 
 
 
 
Basic net income per share:
 

 
 

 
 
 
 
Net income per share – basic
$
0.21

 
$
0.16

 
$
0.77

 
$
0.47

Weighted-average shares – basic
51,672

 
53,648

 
52,009

 
53,880

Diluted net income per share:
 

 
 

 
 
 
 
Net income per share – diluted
$
0.21

 
$
0.16

 
$
0.75

 
$
0.47

Weighted-average shares – diluted
52,544

 
54,324

 
52,935

 
54,570


 























See accompanying notes to condensed consolidated financial statements.

3


SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Comprehensive Income
(unaudited - in thousands)

 
Three Months Ended
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Net income
$
11,038

 
$
8,481

 
$
39,837

 
$
25,473

Other comprehensive (loss) income– unrealized (loss) gain on available-for-sale marketable debt securities, net of income tax
(20
)
 
20

 
52

 
30

Comprehensive income
$
11,018

 
$
8,501

 
$
39,889

 
$
25,503












































See accompanying notes to condensed consolidated financial statements.

4


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

 
Common Stock
 
Additional
Paid-in
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income/(Loss)
 
Total
 
Shares
 
Amount
 
 
 
 
Balance at January 3, 2015
52,798

 
$
528

 
$

 
$
256,413

 
$
(34
)
 
$
256,907

Net income

 

 

 
39,837

 

 
39,837

Other comprehensive income:
 

 
 

 
 

 
 

 
 

 
 
Unrealized gain on available-for-sale marketable debt securities, net of tax

 

 

 

 
52

 
52

Exercise of common stock options
198

 
2

 
2,456

 

 

 
2,458

Tax effect from stock-based compensation

 

 
1,939

 

 

 
1,939

Stock-based compensation
52

 
1

 
5,827

 

 

 
5,828

Repurchases of common stock
(1,634
)
 
(17
)
 
(10,222
)
 
(41,390
)
 

 
(51,629
)
Balance at July 4, 2015
51,414

 
$
514

 
$

 
$
254,860

 
$
18

 
$
255,392

 





































See accompanying notes to condensed consolidated financial statements.

5


SELECT COMFORT CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited - in thousands)
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
Cash flows from operating activities:
 
 
 
Net income
$
39,837

 
$
25,473

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 

Depreciation and amortization
21,903

 
19,213

Stock-based compensation
5,828

 
2,035

Net loss on disposals and impairments of assets
184

 
87

Excess tax benefits from stock-based compensation
(1,945
)
 
(720
)
Deferred income taxes
(4,515
)
 
(2,003
)
Changes in operating assets and liabilities:
 
 
 

Accounts receivable
(825
)
 
651

Inventories
(14,842
)
 
(3,004
)
Income taxes
4,221

 
(394
)
Prepaid expenses and other assets
(944
)
 
(4,355
)
Accounts payable
7,879

 
(1,042
)
Customer prepayments
(3,066
)
 
2,695

Accrued compensation and benefits
(8,121
)
 
9,724

Other taxes and withholding
(2,622
)
 
(529
)
Warranty liabilities
1,113

 
281

Other accruals and liabilities
969

 
1,466

Net cash provided by operating activities
45,054

 
49,578

 
 
 
 
Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(38,938
)
 
(39,766
)
Investments in marketable debt securities
(19,306
)
 
(28,405
)
Proceeds from maturities of marketable debt securities
41,932

 
23,548

Proceeds from sales of property and equipment
41

 
5

Increase in restricted cash

 
(500
)
Net cash used in investing activities
(16,271
)
 
(45,118
)
 
 
 
 
Cash flows from financing activities:
 

 
 

Repurchases of common stock
(51,629
)
 
(21,470
)
Net decrease in short-term borrowings
(7,478
)
 
(6,192
)
Proceeds from issuance of common stock
2,458

 
1,366

Excess tax benefits from stock-based compensation
1,945

 
720

Net cash used in financing activities
(54,704
)
 
(25,576
)
 
 
 
 
Net decrease in cash and cash equivalents
(25,921
)
 
(21,116
)
Cash and cash equivalents, at beginning of period
51,995

 
58,223

Cash and cash equivalents, at end of period
$
26,074

 
$
37,107












See accompanying notes to condensed consolidated financial statements.

6


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 July 4, 2015 of Select Comfort Corporation and 100%-owned 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 July 4, 2015, and January 3, 2015, and the consolidated results of operations and cash flows for the periods presented. Our historical and quarterly consolidated 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 January 3, 2015 and other recent filings with the SEC.

The preparation of condensed 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 stock-based compensation, goodwill and indefinite-lived intangible assets, warranty liabilities and revenue recognition.

The condensed consolidated financial statements include the accounts of Select Comfort Corporation and our 100%-owned subsidiaries. All significant intra-entity balances and transactions have been eliminated in consolidation.

New Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This new guidance was originally effective for annual reporting periods beginning after December 15, 2016 and early adoption was not permitted. In July 2015, the FASB deferred the effective date from annual reporting periods beginning after December 15, 2016 to annual reporting periods beginning after December 15, 2017 (including interim reporting periods within those periods). Early adoption is permitted to the original effective date of annual reporting periods beginning after December 15, 2016 (including interim reporting periods within those periods). Companies may use either a full retrospective or a modified retrospective approach to adopt this new guidance. We are evaluating the effect of the new standard on our consolidated financial statements and related disclosures, and have not yet selected a transition method.




7



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



2. Fair Value Measurements

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, according to the valuation techniques we used to determine their fair value (in thousands):
 
 
July 4, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Marketable debt securities – current
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
15,012

 
$

 
$

 
$
15,012

Corporate bonds
 

 
15,059

 

 
15,059

U.S. Agency bonds
 

 
15,011

 

 
15,011

Municipal bonds
 

 
9,804

 

 
9,804

Commercial paper
 

 
7,493

 

 
7,493

 
 
15,012

 
47,367

 

 
62,379

Marketable debt securities – non-current
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
7,515

 

 

 
7,515

Corporate bonds
 

 
12,627

 

 
12,627

U.S. Agency bonds
 

 
7,530

 

 
7,530

Municipal bonds
 

 
1,079

 

 
1,079

 
 
7,515

 
21,236

 

 
28,751

 
 
$
22,527

 
$
68,603

 
$

 
$
91,130


 
 
January 3, 2015
 
 
Level 1
 
Level 2
 
Level 3
 
Total
Marketable debt securities – current
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
$
17,506

 
$

 
$

 
$
17,506

Corporate bonds
 

 
20,139

 

 
20,139

U.S. Agency bonds
 

 
12,525

 

 
12,525

Commercial paper
 

 
12,486

 

 
12,486

Municipal bonds
 

 
6,953

 

 
6,953

 
 
17,506

 
52,103

 

 
69,609

Marketable debt securities – non-current
 
 
 
 
 
 
 
 
U.S. Treasury securities
 
14,990

 

 

 
14,990

Corporate bonds
 

 
15,236

 

 
15,236

U.S. Agency bonds
 

 
10,014

 

 
10,014

Municipal bonds
 

 
4,201

 

 
4,201

 
 
14,990

 
29,451

 

 
44,441

 
 
$
32,496

 
$
81,554

 
$

 
$
114,050


At July 4, 2015 and January 3, 2015, we had $1.3 million and $1.0 million, respectively, of debt and equity securities that fund our deferred compensation plan and are classified in other assets in our condensed consolidated balance sheets. We also had corresponding deferred compensation plan liabilities of $1.3 million and $1.0 million at July 4, 2015 and January 3, 2015, respectively, which are included in other long-term liabilities in our condensed consolidated balance sheets. The majority of the debt and equity 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 debt and equity securities offset those associated with the corresponding deferred compensation plan liabilities.


8



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



3. Investments

Marketable Debt Securities

Investments in marketable debt securities were comprised of the following (in thousands):
 
July 4, 2015
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate bonds
$
27,700

 
$
3

 
$
(17
)
 
$
27,686

U.S. Agency bonds
22,517

 
24

 

 
22,541

U.S. Treasury securities
22,503

 
24

 

 
22,527

Municipal bonds
10,887

 
1

 
(5
)
 
10,883

Commercial paper
7,494

 

 
(1
)
 
7,493

 
$
91,101

 
$
52

 
$
(23
)
 
$
91,130

 
January 3, 2015
 
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
Corporate bonds
35,409

 
2

 
(36
)
 
35,375

U.S. Treasury securities
$
32,507

 
$
12

 
$
(23
)
 
$
32,496

U.S. Agency bonds
22,545

 
4

 
(10
)
 
22,539

Commercial paper
12,487

 

 
(1
)
 
12,486

Municipal bonds
11,157

 
2

 
(5
)
 
11,154

 
$
114,105

 
$
20

 
$
(75
)
 
$
114,050

 
Maturities of marketable debt securities were as follows (in thousands):
 
July 4, 2015
 
January 3, 2015
 
Amortized
Cost
 
Fair
Value
 
Amortized
Cost
 
Fair
Value
Marketable debt securities – current (due in less than one year)
$
62,359

 
$
62,379

 
$
69,607

 
$
69,609

Marketable debt securities – non-current (due in one to two years)
28,742

 
28,751

 
44,498

 
44,441

 
$
91,101

 
$
91,130

 
$
114,105

 
$
114,050


During the three months ended July 4, 2015 and June 28, 2014, $25.6 million and $13.5 million, respectively, of marketable debt securities matured and were redeemed at face value. During the six months ended July 4, 2015 and June 28, 2014, $41.8 million and $23.5 million, respectively, of marketable debt securities matured and were redeemed at face value.
 
Other Investments

We have a minority equity investment in one of our strategic product-development partners. The carrying value of this investment at July 4, 2015 and January 3, 2015 using the cost method is $6.0 million and is included in other assets on our condensed consolidated balance sheets.


9



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



4. Inventories

Inventories consisted of the following (in thousands):
 
July 4,
2015
 
January 3,
2015
Raw materials
$
9,499

 
$
10,220

Work in progress
333

 
411

Finished goods
58,545

 
42,904

 
$
68,377

 
$
53,535


5. Goodwill and Intangible Assets

Goodwill and Indefinite-Lived Intangible Assets

At both July 4, 2015 and January 3, 2015, our condensed consolidated balance sheets included goodwill of $9.0 million and indefinite-lived trade name/trademarks of $1.4 million.

Definite-Lived Intangible Assets

The following table provides the gross carrying amount and related accumulated amortization of our definite-lived intangible assets (in thousands):
 
July 4, 2015
 
January 3, 2015
 
Gross Carrying
Amount
 
Accumulated
Amortization
 
Gross Carrying
Amount
 
Accumulated
Amortization
Developed technologies
$
5,231

 
$
1,586

 
$
5,231

 
$
1,342

Customer relationships
2,413

 
847

 
2,413

 
675

Trade names/trademarks
101

 
101

 
101

 
101

 
$
7,745

 
$
2,534

 
$
7,745

 
$
2,118


6. Credit Agreement
  
Our $20.0 million Credit Agreement (Credit Agreement) with Wells Fargo Bank, National Association, as amended, is an unsecured revolving credit facility that matures on August 31, 2016. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20 million to up to $50 million in total availability, subject to lender approval.
  
Any borrowings under the Credit Agreement 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 Credit Agreement, including minimum tangible net worth, a requirement to maintain a minimum amount of cash, cash equivalents and marketable debt securities, and to maintain at the administrative agent cash, cash equivalents and marketable debt securities equal to the amount the lenders are committed to lend under the Credit Agreement.
  
At both July 4, 2015 and January 3, 2015, we had no borrowings and $20 million was available under the Credit Agreement. We had no outstanding letters of credit as of July 4, 2015 or January 3, 2015.


10



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



7. Repurchase of Common Stock
   
Repurchases of our common stock were as follows (in thousands): 
 
 
Three Months Ended
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Amount repurchased under Board-approved share repurchase program
 
$
30,019

 
$
10,011

 
$
50,026

 
$
20,022

Amount repurchased in connection with the vesting of employee restricted stock grants
 
1,135

 
1,223

 
1,603

 
1,448

Total amount repurchased
 
$
31,154

 
$
11,234

 
$
51,629

 
$
21,470

  
As of July 4, 2015, the remaining share repurchase authorization under our Board-approved share repurchase plan was $185 million. There is no expiration date governing the period over which we can repurchase shares. Any repurchased shares are constructively retired and returned to an unissued status. The cost of stock repurchases is first charged to additional paid-in capital. Once additional paid-in capital is reduced to zero, any additional amounts are charged to retained earnings.

8. Stock-Based Compensation

Stock-based compensation expense consisted of the following (in thousands):
 
 
Three Months Ended
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Options
 
$
672

 
$
694

 
$
1,316

 
$
929

Restricted shares
 
2,374

 
1,449

 
4,512

 
1,106

Total stock-based compensation expense(1)
 
3,046

 
2,143

 
5,828

 
2,035

Income tax benefit
 
1,038

 
722

 
2,005

 
696

Total stock-based compensation expense, net of tax
 
$
2,008

 
$
1,421

 
$
3,823

 
$
1,339

 
(1) The six months ended June 28, 2014 includes a $1.2 million benefit related to a change in estimated forfeitures due to employee turnover during the three months ended March 29, 2014.
 
9. 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 calendar quarter, we may make a discretionary contribution equal to a percentage of the employee’s contribution. During the three months ended July 4, 2015 and June 28, 2014, our contributions, net of forfeitures, were $0.9 million and $0.9 million, respectively. During the six months ended July 4, 2015 and June 28, 2014, our contributions, net of forfeitures, were $2.1 million and $1.8 million, respectively.

10. Other Income, Net

Other income, net, consisted of the following (in thousands):
 
Three Months Ended
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Interest income
$
143

 
$
88

 
$
306

 
$
200

Interest expense
(10
)
 
(10
)
 
(20
)
 
(20
)
Other income, net
$
133

 
$
78

 
$
286

 
$
180



11



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



11. Net Income per Common Share

The components of basic and diluted net income per share are as follows (in thousands, except per share amounts):
 
Three Months Ended
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Net income
$
11,038

 
$
8,481

 
$
39,837

 
$
25,473

 
 
 
 
 
 
 
 
Reconciliation of weighted-average shares outstanding:
 
 

 
 
 
 
Basic weighted-average shares outstanding
51,672

 
53,648

 
52,009

 
53,880

Dilutive effect of stock-based awards
872

 
676

 
926

 
690

Diluted weighted-average shares outstanding
52,544

 
54,324

 
52,935

 
54,570

 
 
 
 
 
 
 
 
Net income per share – basic
$
0.21

 
$
0.16

 
$
0.77

 
$
0.47

Net income per share – diluted
$
0.21

 
$
0.16

 
$
0.75

 
$
0.47

Anti-dilutive stock-based awards excluded from the calculations of diluted net income per share calculations were immaterial for the periods presented.

12. Commitments and Contingencies

Sales Returns
   
The activity in the sales returns liability account was as follows (in thousands):
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
Balance at beginning of year
$
15,262

 
$
9,433

Additions that reduce net sales
40,076

 
32,923

Deductions from reserves
(42,659
)
 
(33,162
)
Balance at end of period
$
12,679

 
$
9,194



Warranty Liabilities
   
The activity in the accrued warranty liabilities account was as follows (in thousands): 
 
Six Months Ended
 
July 4,
2015
 
June 28,
2014
Balance at beginning of year
$
5,824

 
$
4,153

Additions charged to costs and expenses for current-year sales
4,869

 
3,237

Deductions from reserves
(4,177
)
 
(3,231
)
Changes in liability for pre-existing warranties during the current year, including expirations
421

 
274

Balance at end of period
$
6,937

 
$
4,433



12



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



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 consolidated 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

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
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 to protect sensitive data from potential cyber threats;
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.
  
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

We offer consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of SLEEP NUMBER® beds and bedding accessories. Our vertically integrated business model has three significant competitive advantages: proprietary sleep innovations, ongoing customer relationships and exclusive distribution.

We are the exclusive designer, manufacturer, marketer, retailer and servicer of a complete line of Sleep Number® beds. Only the Sleep Number bed offers SleepIQ® technology - proprietary sensors that works directly with the bed’s DualAir™ technology to monitor each individual’s sleep. Select Comfort also offers a full line of exclusive sleep products, including FlextFit™ adjustable base technology and Sleep Number® pillows, sheets and other bedding products.
 
We are committed to delivering superior shareholder value through three primary EPS drivers: increasing demand, leveraging our business model, and deploying our capital efficiently. We are the sleep innovation leader and drive growth through effective brand marketing and a differentiated retail experience.

Our mission is to Improve Lives by Individualizing Sleep Experiences.

Our vision is To Become One of the World's Most Beloved Brands By Delivering An Unparalleled Sleep Experience. We plan to achieve this through our consumer-driven innovation strategy with technology as our differentiator.

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 new product introductions, 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, 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 period ended July 4, 2015 were as follows:

Net sales for the quarter increased 17% to $275 million, compared with $235 million for the same period one year ago. The sales increase was driven by a 13% comparable sales increase in our Company-Controlled channel and 5 percentage points of growth from sales generated by 16 net new stores opened in the past 12 months.
Sales per store (for stores open at least one year), on a trailing twelve-month basis, increased 16% to $2.5 million, compared with $2.1 million for the prior-year trailing twelve-month period.
Operating income for the quarter increased 31% to $17 million, or 6.0% of net sales, compared with $13 million, or 5.4% of net sales, for the same period one year ago. The increase in operating income was primarily due to the additional operating income generated by the 17% increase in net sales and the 120 basis point improvement in the gross profit rate.
Net income for the quarter increased 30% to $11 million, or $0.21 per diluted share, compared with net income of $8 million, or $0.16 per diluted share, for the same period one year ago.
We achieved a return on invested capital (ROIC) of 16.4% during the trailing-twelve month period ended July 4, 2015, well above our 10% cost of capital.
Cash provided by operating activities totaled $45 million for the six months ended July 4, 2015, compared with $50 million for the same period one year ago.
At July 4, 2015, cash, cash equivalents and marketable debt securities, less customer prepayments, totaled $92 million and there were no borrowings under our revolving credit facility.
In the second quarter of 2015, we repurchased 948,745 shares of our common stock under our Board-approved share repurchase program at a cost of $30 million (an average of $31.64 per share). As of July 4, 2015, the remaining authorization under our Board-approved share repurchase program was $185 million.


15


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
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Net sales
 
$
275.3

 
100.0
%
 
$
234.8

 
100.0
%
 
$
625.1

 
100.0
%
 
$
511.2

 
100.0
%
Cost of sales
 
104.8

 
38.1
%
 
92.4

 
39.3
%
 
238.7

 
38.2
%
 
197.4

 
38.6
%
Gross profit
 
170.5

 
61.9
%
 
142.4

 
60.7
%
 
386.4

 
61.8
%
 
313.8

 
61.4
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Sales and marketing
 
126.6

 
46.0
%
 
106.7

 
45.5
%
 
267.1

 
42.7
%
 
231.7

 
45.3
%
General and administrative
 
23.9

 
8.7
%
 
21.3

 
9.1
%
 
52.1

 
8.3
%
 
40.2

 
7.9
%
Research and development
 
3.4

 
1.2
%
 
1.7

 
0.7
%
 
6.8

 
1.1
%
 
3.4

 
0.7
%
Total operating expenses
 
153.9

 
55.9
%
 
129.7

 
55.2
%
 
326.0

 
52.2
%
 
275.3

 
53.8
%
Operating income
 
16.6

 
6.0
%
 
12.7

 
5.4
%
 
60.4

 
9.7
%
 
38.5

 
7.5
%
Other income, net
 
0.1

 
0.0
%
 
0.1

 
0.0
%
 
0.3

 
0.0
%
 
0.2

 
0.0
%
Income before income taxes
 
16.8

 
6.1
%
 
12.8

 
5.4
%
 
60.6

 
9.7
%
 
38.7

 
7.6
%
Income tax expense
 
5.7

 
2.1
%
 
4.3

 
1.8
%
 
20.8

 
3.3
%
 
13.2

 
2.6
%
Net income
 
$
11.0

 
4.0
%
 
$
8.5

 
3.6
%
 
$
39.8

 
6.4
%
 
$
25.5

 
5.0
%
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per share:
 
 

 
 

 
 

 
 

 
 

 
 

 
 

 
 

Basic
 
$
0.21

 
 

 
$
0.16

 
 
 
$
0.77

 
 
 
$
0.47

 
 

Diluted
 
$
0.21

 
 

 
$
0.16

 
 
 
$
0.75

 
 
 
$
0.47

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average number of common shares:
 
 

 
 
 
 
 
 
 
 
 
 
 
 

Basic
 
51.7

 
 

 
53.6

 
 
 
52.0

 
 
 
53.9

 
 

Diluted
 
52.5

 
 

 
54.3

 
 
 
52.9

 
 
 
54.6

 
 


The percentage of our total net sales, by dollar volume, from each of our channels was as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Company-Controlled channel
 
97.2
%
 
96.4
%
 
97.4
%
 
96.3
%
Wholesale/Other channel
 
2.8
%
 
3.6
%
 
2.6
%
 
3.7
%
Total
 
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%

The components of total net sales growth, including comparable net sales changes, were as follows: 
 
 
Three Months Ended
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Sales change rates:
 
 
 
 
 
 

 
 

Retail comparable-store sales(1)
 
13
%
 
8
%
 
18
%
 
5
%
E-Commerce and Direct
 
14
%
 
(5
%)
 
15
%
 
(2
%)
Company-Controlled comparable sales change
 
13
%
 
7
%
 
18
%
 
4
%
Net store openings/closings
 
5
%
 
6
%
 
6
%
 
7
%
Total Company-Controlled channel
 
18
%
 
13
%
 
24
%
 
11
%
Wholesale/Other channel
 
(9
%)
 
6
%
 
(15
%)
 
(11
%)
Total net sales change
 
17
%
 
13
%
 
22
%
 
10
%
 
(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.

16


Other sales metrics were as follows: 
 
 
Three Months Ended
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Average sales per store ($ in thousands)(1) (3)
 
$
2,480

 
$
2,144

 
 
 
 
Average sales per square foot(1) (3)
 
$
1,048

 
$
1,009

 
 
 
 
Stores > $1 million in net sales(1) (3)
 
100
%
 
97
%
 
 
 
 
Stores > $2 million in net sales(1) (3)
 
67
%
 
46
%
 
 
 
 
Average revenue per mattress unit – Company-Controlled channel(2)
 
$
4,081

 
$
3,709

 
$
3,991

 
$
3,520

 
(1) Trailing twelve months for stores included in our comparable store sales calculation.
(2) Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.
(3) Fiscal 2014 included 53 weeks, as compared to 52 weeks in fiscal 2015 and 2013. The additional week in 2014 was in the fiscal fourth quarter. Company-Controlled comparable sales metrics have been adjusted to remove the estimated impact of the additional week on those metrics.

The number of retail stores operating was as follows:
 
 
Three Months Ended
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Beginning of period
 
463

 
443

 
463

 
440

Opened
 
5

 
16

 
13

 
33

Closed
 
(1
)
 
(8
)
 
(9
)
 
(22
)
End of period
 
467

 
451

 
467

 
451


Comparison of Three Months Ended July 4, 2015 with Three Months Ended June 28, 2014

Net sales
Net sales increased 17% to $275 million for the three months ended July 4, 2015, compared with $235 million for the same period one year ago. Demand for our product innovations, effective marketing and our differentiated retail experience all contributed to the strong sales increase. The sales increase was driven by a 13% comparable sales increase in our Company-Controlled channel and 5 percentage points of growth from sales generated by 16 net new stores opened in the past 12 months.
 
The $41 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $26 million increase in sales from our Company-Controlled comparable retail stores; (ii) a $13 million increase resulting from net store openings; and (iii) a $2 million increase in E-Commerce and Direct sales. Company-Controlled mattress unit sales increased 7% compared to the prior-year period. Average revenue per mattress unit in our Company-Controlled channel increased by 10% to $4,081 driven by sales of product innovations, including our new FlexFit™ adjustable bases.

Gross profit
Gross profit of $171 million increased by $28 million, or 20%, compared with the same period one year ago. The gross profit rate was 61.9% of net sales for the three months ended July 4, 2015, compared with 60.7% for the prior-year period. The 120 basis point increase in the gross profit rate was primarily due to: (i) favorable product mix changes resulting from advancements in our selling process and product innovations over the last 12 months; and (ii) reductions in promotional discounts. In addition, our gross profit rate can fluctuate from quarter to quarter due to a variety of other factors, including raw material price fluctuations, return and exchange costs, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses
Sales and marketing expenses for the three months ended July 4, 2015 increased to $127 million, or 46.0% of net sales, compared with $107 million, or 45.5% of net sales, for the same period one year ago. The 50 basis point increase in the sales and marketing expense rate in the current period was mainly due to the timing of media expenses incurred (fiscal calendar year shift); partially offset by the leveraging impact of the 17% net sales increase.


17


General and administrative expenses
General and administrative (G&A) expenses increased $2.6 million to $24 million for the three months ended July 4, 2015, compared with $21 million in the same period one year ago, but decreased to 8.7% of net sales, compared with 9.1% of net sales last year. The increase in G&A expenses was mainly due to a $2.0 million increase in employee compensation, including incremental compensation costs to enhance our IT infrastructure. The G&A expense rate decreased by 40 basis points in the current period compared with the same period one year ago due to the leveraging impact of the 17% net sales increase.

Research and development expenses
Research and development expenses for the three months ended July 4, 2015 were $3.4 million, or 1.2% of net sales, compared with $1.7 million, or 0.7% of net sales, for the same period one year ago. The $1.7 million increase in R&D expenses was due to increased investments to support product innovations, consistent with our long-term consumer innovation strategy.

Comparison of Six Months Ended July 4, 2015 with Six Months Ended June 28, 2014

Net sales
Net sales in 2015 increased 22% to $625 million, compared with $511 million for the same period one year ago. Demand for our product innovations, effective marketing and our differentiated retail experience all contributed to the strong sales increase. The sales increase was driven by an 18% comparable sales increase in our Company-Controlled channel and 6 percentage points of growth from sales generated by 16 net new retail stores opened in the past 12 months.
 
The $114 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $77 million increase from our Company-Controlled comparable retail stores; (ii) a $35 million increase resulting from net store openings; and (iii) a $5 million increase in E-Commerce and Direct sales; partially offset by (iv) a $3 million decrease in Wholesale/Other channel sales. Company-Controlled mattress units increased 9% compared to the prior-year period. Average revenue per mattress unit in our Company-Controlled channel increased by 13%.

Gross profit
Gross profit of $386 million increased by $73 million, or 23%, compared with the same period one year ago. The gross profit rate increased to 61.8% of net sales for the first six months of 2015, compared with 61.4% for the prior-year period. The 40 basis point increase in the gross profit rate was primarily due to: (i) favorable product mix changes resulting from advancements in our selling process and product innovations over the last 12 months; and (ii) reductions in promotional discounts. In addition, our gross profit rate can fluctuate from quarter to quarter due to a variety of other factors, including raw material price fluctuations, return and exchange costs, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses
Sales and marketing expenses in 2015 increased to $267 million, or 42.7% of net sales, compared with $232 million, or 45.3% of net sales, for the same period one year ago. The 260 basis point decrease in the sales and marketing expense rate in the current period was mainly due to the leveraging impact of the 22% net sales increase, which more than offset higher marketing, selling and occupancy costs as we continue to invest in our exclusive distribution strategy.
 
General and administrative expenses
General and administrative (G&A) expenses increased to $52 million in 2015, compared with $40 million in the prior year and increased to 8.3% of net sales, compared with 7.9% of net sales one year ago. The increase in G&A expenses was mainly due to: (i) a $6.7 million increase in employee compensation, including increased stock-based compensation (the six months ended June 28, 2014 included a $1.2 million benefit related to a change in estimated forfeitures due to employee turnover during the three months ended March 29, 2014) and incremental compensation costs to enhance our IT infrastructure; (ii) $2.0 million of additional legal expenses, including costs associated with proxy preparation, filing and consulting services; (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 $2.2 million increase in miscellaneous other expenses. The G&A expense rate increased by 40 basis points in the current period compared with the same period one year ago due to the increase in expenses discussed above, partially offset by the leveraging impact of the 22% net sales increase.

Research and development expenses
Research and development expenses for the six months ended July 4, 2015 were $6.8 million, or 1.1% of net sales, compared with $3.4 million, or 0.7% of net sales, for the same period one year ago. The $3.4 million increase in R&D expenses was due to increased investments to support product innovations, consistent with our long-term consumer innovation strategy.

18


Liquidity and Capital Resources

As of July 4, 2015, cash, cash equivalents and marketable debt securities totaled $117 million compared with $166 million as of January 3, 2015. The $49 million decrease was primarily due to $45 million of cash provided by operating activities, which was more than offset by $39 million of cash used to purchase property and equipment, $51.6 million of cash used to repurchase our common stock ($50.0 million under our Board-approved share repurchase program and $1.6 million in connection with the vesting of employee restricted stock grants). Our $91 million of marketable debt securities held as of July 4, 2015 are all highly liquid and include U.S. government and agency securities, corporate debt securities, municipal bonds and commercial paper.

The following table summarizes our cash flows (dollars in millions). Amounts may not add due to rounding differences:
 
 
Six Months Ended
 
 
July 4,
2015
 
June 28,
2014
Total cash provided by (used in):
 
 
 
 
Operating activities
 
$
45.1

 
$
49.6

Investing activities
 
(16.3
)
 
(45.1
)
Financing activities
 
(54.7
)
 
(25.6
)
Net decrease in cash and cash equivalents
 
$
(25.9
)
 
$
(21.1
)
 
Cash provided by operating activities for the six months ended July 4, 2015 was $45 million compared with $50 million for the six months ended June 28, 2014. Significant components of the $5 million year-over-year decrease in cash from operating activities included: (i) an $18 million fluctuation in accrued compensation and benefits which primarily resulted from year-over-year changes in company-wide performance-based incentive compensation that was earned in 2014 and paid in the first quarter of 2015, but was not earned in 2013; partially offset by (ii) a $14 million increase in our 2015 net income. In addition, inventories increased by $15 million to support the Fourth of July event (fiscal year calendar shift), preparation ahead of the Labor Day event and our planned fourth quarter 2015 Enterprise Resource Planning (ERP) systems launch, with $8 million of the increase funded by an increase in accounts payable.
 
Net cash used in investing activities was $16 million for the six months ended July 4, 2015, compared with $45 million for the same period one year ago. Investing activities for the current-year period included $39 million of property and equipment purchases, compared with $40 million for the same period one year ago. On a net basis, we decreased our investments in marketable debt securities by $23 million during the six months ended July 4, 2015, compared with a net increase of $5 million during the comparable period one year ago.

Net cash used in financing activities was $55 million for the six months ended July 4, 2015, compared with $26 million for the same period one year ago. During the six months ended July 4, 2015, we repurchased $51.6 million of our stock ($50.0 million under our Board-approved share repurchase program and $1.6 million in connection with the vesting of employee restricted stock grants) compared with $21.5 million ($20.0 million under our Board-approved share repurchase program and $1.4 million in connection with the vesting of employee restricted stock grants) during the same period one year ago. Changes in book overdrafts are included in the net change in short-term borrowings. Financing activities for both periods reflect the vesting of employee restricted stock awards and exercise of employee stock options along with the associated excess tax benefits.

Under the Board-approved share repurchase program, we repurchased 1,584,397 shares at a cost of $50 million (an average of $31.57 per share) during the six months ended July 4, 2015. During the six months ended June 28, 2014, we repurchased 1,098,486 shares at a cost of $20 million (an average of $18.23 per share). As of July 4, 2015, the remaining share repurchase authorization under our Board-approved share repurchase plan was $185 million. There is no expiration date governing the period over which we can repurchase shares.

Our $20.0 million Credit Agreement (Credit Agreement) with Wells Fargo Bank, National Association, as amended, is an unsecured revolving credit facility that matures August 31, 2016. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20 million to up to $50 million in total availability, subject to lender approval. As of July 4, 2015 we were in compliance with all financial covenants.

Our business model, which can operate with minimal working capital, does not require additional capital from external sources to fund operations or organic growth. The $117 million of cash, cash equivalents and marketable debt securities, cash generated from ongoing operations, and cash available under our revolving credit facility are expected to be adequate to maintain operations and fund anticipated expansion and strategic initiatives for the foreseeable future.

19



We have an agreement with Synchrony Bank to offer qualified customers revolving credit arrangements to finance purchases from us (Synchrony Agreement). The Synchrony Agreement contains certain financial covenants, including a minimum tangible net worth requirement and a minimum working capital requirement. As of July 4, 2015 we were in compliance with all financial covenants.

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

Non-GAAP Data

Return on Invested Capital (ROIC)
(dollars in thousands)
  
ROIC is a financial measure we use to determine how efficiently we deploy our capital. It quantifies the return we earn on our invested capital. Management believes ROIC is also a useful metric for investors and financial analysts. We compute ROIC as outlined below. Our definition and calculation of ROIC may not be comparable to similarly titled definitions and calculations used by other companies. The tables below reconcile net operating profit after taxes (NOPAT) and total invested capital, which are non-GAAP financial measures, to the comparable GAAP financial measures:
 
 
Trailing-Twelve
Months Ended
 
 
July 4,
2015
 
June 28,
2014
Net operating profit after taxes (NOPAT)
 
 
 
 
Operating income
 
$
123,587

 
$
78,866

Add: Rent expense(1)
 
61,157

 
53,165

Add: Interest income
 
521

 
380

Less: Depreciation on capitalized operating leases(2)
 
(15,280
)
 
(13,500
)
Less: Income taxes(3)
 
(57,496
)
 
(40,451
)
NOPAT
 
$
112,489

 
$
78,460

 
 
 
 
 
Average invested capital
 
 
 
 
Total equity
 
$
255,392

 
$
232,967

Less: Cash greater than target(4)
 

 
(2,673
)
Add: Long-term debt(5)
 

 

Add: Capitalized operating lease obligations(6)
 
489,256

 
425,320

Total invested capital at end of period
 
$
744,648

 
$
655,614

Average invested capital(7)
 
$
686,514

 
$
604,661

Return on invested capital (ROIC)(8)
 
16.4
%
 
13.0
%
___________________
(1) Rent expense is added back to operating income to show the impact of owning versus leasing the related assets.

(2) Depreciation is based on the average of the last five fiscal quarters' ending capitalized operating lease obligations (see note 6) for the respective reporting periods with an assumed thirty-year useful life. This is subtracted from operating income to illustrate the impact of owning versus leasing the related assets.

(3) Reflects annual effective income tax rates, before discrete adjustments, of 33.8% and 34.0% for 2015 and 2014, respectively.

(4) Cash greater than target is defined as cash, cash equivalents and marketable debt securities less customer prepayments in excess of $100 million.

(5) Long-term debt includes existing capital lease obligations.

(6) A multiple of eight times annual rent expense is used as an estimate for capitalizing our operating lease obligations. The methodology utilized aligns with the methodology of a nationally recognized credit rating agency.

(7) Average invested capital represents the average of the last five fiscal quarters' ending invested capital balances.

(8) ROIC equals NOPAT divided by average invested capital.
  
Note - Our ROIC calculation and data are considered non-GAAP financial measures and are not in accordance with, or preferable to, GAAP financial data. However, we are providing this information as we believe it facilitates analysis of the Company's financial performance by investors and financial analysts.
  
GAAP - generally accepted accounting principles in the U.S.

20


Non-GAAP Data (continued)

Earnings before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA)
 
We define earnings before interest, taxes, depreciation and amortization (Adjusted EBITDA) as net income plus: income tax expense, interest expense, depreciation and amortization, stock-based compensation and asset impairments. Management believes Adjusted EBITDA is a useful indicator of our financial performance and our ability to generate cash from operating activities. Our definition of Adjusted EBITDA may not be comparable to similarly titled definitions used by other companies. The table below reconciles Adjusted EBITDA, which is a non-GAAP financial measure, to the comparable GAAP financial measure.

Our Adjusted EBITDA calculations are as follows (dollars in thousands):
 
 
Three Months Ended
 
Trailing-Twelve
Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Net income
 
$
11,038

 
$
8,481

 
$
82,338

 
$
52,157

Income tax expense
 
5,724

 
4,308

 
41,717

 
27,044

Interest expense
 
10

 
10

 
53

 
44

Depreciation and amortization
 
10,921

 
9,765

 
41,582

 
34,744

Stock-based compensation
 
3,046

 
2,143

 
10,591

 
4,275

Asset impairments
 
15

 
88

 
630

 
173

Adjusted EBITDA
 
$
30,754

 
$
24,795

 
$
176,911

 
$
118,437


Free Cash Flow
 
Our “free cash flow” data is considered a non-GAAP financial measure and is not in accordance with, or preferable to, “net cash provided by operating activities,” or GAAP financial data. However, we are providing this information as we believe it facilitates analysis for investors and financial analysts.
 
The following table summarizes our free cash flow calculations (dollars in thousands): 
 
 
Six Months Ended
 
Trailing-Twelve
Months Ended
 
 
July 4,
2015
 
June 28,
2014
 
July 4,
2015
 
June 28,
2014
Net cash provided by operating activities
 
$
45,054

 
$
49,578

 
$
139,944

 
$
101,540

Subtract: Purchases of property and equipment
 
38,938

 
39,766

 
75,766

 
79,481

Free cash flow
 
$
6,116

 
$
9,812

 
$
64,178

 
$
22,059


Off-Balance-Sheet Arrangements and Contractual Obligations

As of July 4, 2015, we were not involved in any unconsolidated special purpose entity transactions. Other than our operating leases, we do not have any off-balance-sheet financing. There were no outstanding letters of credit at July 4, 2015.

There has been no material change in our contractual obligations since the end of fiscal 2014. See Note 6, Credit Agreement, of the Notes to our Condensed Consolidated Financial Statements for information regarding our credit agreement. See our Annual Report on Form 10-K for the fiscal year ended January 3, 2015 for additional information regarding our other contractual obligations.

Critical Accounting Policies

We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended January 3, 2015. There were no significant changes in our critical accounting policies since the end of fiscal 2014.


21


ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Changes in the overall level of interest rates affect interest income generated from our short-term and long-term investments in marketable debt securities. If overall interest rates were one percentage point lower than current rates, our annual interest income would not change by a significant amount based on our investments in marketable debt securities as of July 4, 2015 and the current low interest-rate environment. We do not manage our investment interest-rate volatility risk through the use of derivative instruments.

As of July 4, 2015, we had no borrowings under our revolving credit facility.
 
ITEM 4. CONTROLS AND PROCEDURES

Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Controls

There were no changes in our internal control over financial reporting during the fiscal quarter ended July 4, 2015, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. 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 consolidated results of operations, financial position or cash flows. We expense legal costs as incurred.



22


ITEM 1A. RISK FACTORS

Our business, financial condition and operating results are subject to a number of risks and uncertainties, including both those that are specific to our business and others that affect all businesses operating in a global environment. Investors should carefully consider the information in this report under the heading, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and also the information under the heading, “Risk Factors” in our most recent Annual Report on Form 10-K. The risk factors discussed in the Annual Report on Form 10-K and in this Quarterly Report on Form 10-Q do not identify all risks that we face because our business operations could also be affected by additional risk factors that are not presently known to us or that we currently consider to be immaterial to our operations.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) – (b)
Not applicable.
(c)
Issuer Purchases of Equity Securities
Fiscal Period
 
Total
Number
of Shares
   Purchased(1)(2)
 
Average
Price
Paid
per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1)
 
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(3)